UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [Fee Required] For the fiscal year ended December 31, 1997.
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from ________________to_______________
Commission file number: 0-27704
DIGITAL DATA NETWORKS, INC.
(Name of small business issuer in its charter)
Washington 91-1426372
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3102 Maple Avenue, Suite 230
Dallas, Texas 75201
(Address of principal executive offices) (Zip Code)
(214) 969-7200
(Registrant'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, no par value Common Stock Purchase Warrants
(Title of class) (Title of class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15 (d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B 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 its most recent fiscal year were $889,000.
The aggregate market value of the voting stock held by non-affiliates of the
issuer on April 8, 1998 was approximately $2,828,321.
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: As of April 8, 1998, 2,314,597 shares
of Common Stock and 1,840,000 Common Stock Purchase Warrants were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: 1) The information required by Items 9, 10,
11 and 12, Part III is incorporated by reference from the Registrant's
definitive proxy statement.
<PAGE>
PART I
Item 1. Business.
Company Background
Digital Data Networks, Inc. (the "Registrant" or the "Company"), was
incorporated as Transit Information Systems, Inc. under the laws of the State of
Washington on October 17, 1988. The present name was adopted in July, 1995. The
Company also operates as The Transit Network under an assumed name certificate.
The Company's offices are currently located at 3102 Maple Avenue, Suite 230,
Dallas, Texas 75201, and its telephone number is (214) 969-7200.
In February 1996, the Company completed the sale of 1,322,500 shares of
Common Stock and 1,840,000 Common Stock Purchase Warrants through its initial
public offering (the "Public Offering"), and received net cash proceeds of
approximately $5.8 million. The Company's Common Stock and Common Stock Purchase
Warrants are listed on the Nasdaq SmallCap Market under the trading symbols
"DIDA" and DIDAW", respectively.
General
DDN markets a wireless communications system to the transit industry,
and high-end Internet services targeting business clients. The Company's Transit
Network Division markets a wireless communications system to the transit
industry, while the Company's wholly owned subsidiary, DDN Digital Data Networks
(Canada), Inc. ("DDN Canada"), markets the Internet-related services.
History
The Transit Network
The Company's Transit Network Division markets and operates a digital
information network from which it generates advertising revenue. The digital
information network is a network of computerized electronic displays that
delivers information, both text and graphics, to riders on-board public transit
vehicles, utilizing an FM subcarrier signal to transmit the data. The Transit
Network currently operates its digital information network on the 768-bus fleet
of the DART system. The DART system began operations in 1991. The Company had
been operating its digital information network on approximately 60 buses of the
RIPTA system since 1988, but in December 1997, the Company canceled its contract
with RIPTA and ceased operating in Providence, Rhode Island. The Company helped
fund the development of an automated audio/visual announcement system and had
begun marketing this system, but due to uncertainty surrounding its
manufacturer, as well as the emergence of an increasing number of competitors
with manufacturing and financial resources far greater than those of the
Company, in December 1997, the Company discontinued the marketing of this
system.
DDN Digital Data Networks (Canada), Inc.
DDN Canada, a Vancouver, British Columbia based corporation, was
organized in October 1994, as a provider of Internet services. DDN Canada's
local access service provides customers with a local (i.e. the Greater Vancouver
area) point of presence access to the Internet. This service is comprised of
quality telecommunications hardware, proven software and reliable communications
facilities. DDN Canada intends to continue capitalizing on the demand for
Internet access from corporations and individuals by providing Internet access
via leased and dial-up lines. DDN Canada also provides consulting or training
for clients interested in building an intranet or on-line marketing program. DDN
Canada was acquired by the Company in June 1996.
<PAGE>
In September 1996, the Company acquired hip Communications, Inc.,
another Internet-related company, based in Vancouver, which designs and builds
Web sites, primarily for large corporations and government agencies. hip's
operations have subsequently been merged with DDN Canada's, allowing DDN Canada
to offer Web page design and development in addition to their other Internet
services.
Strategy
The Company's strategy centers around two distinct business plans.
First, to market its digital information network to additional transit
authorities across the United States and Canada; and secondly, to capitalize on
the growing demand for Internet services by building its customer base for these
services through its DDN Canada operation. The Company's strategy to market its
digital information network and build its customer base for Internet services
consists of the following key elements:
Continued availability of funds for transit authorities. Funding
for wireless communications systems, such as The Transit Network's
digital information network, typically originates from federal
programs that pay for approximately 80% of the total cost, with
the remaining difference funded by the local transit authority.
The amount of federal dollars available to transit authorities has
been shrinking the past few years as the United States Congress
has been attempting to reduce the federal budget deficit. The
Company believes that if funding remains near current levels, or
is reduced only slightly in the future, enough federal funding
will exist for some transit authorities to purchase these types of
systems. The Company's strategy is to assist interested transit
authorities in applying for these funds which are available under
certain federal grant programs.
DDN Canada maintaining problem-free access to its service. The
fundamental thrust of DDN Canada's strategy is to attract and
maintain corporate customers and individuals who want access to
the Internet but are unwilling to tolerate the connection and
navigating problems that currently exist with so many other
Internet service providers. DDN Canada intends to continue
addressing these customer concerns by providing unlimited, high
quality set-up assistance, reliable service, state-of-the-art
navigation tools and continual emphasis on customer support.
The Transit Network's Digital Information Network
Background
The Transit Network's digital information network is a network of
computerized electronic displays that delivers transit authority messages, news,
information and may optionally include advertising, to riders on-board public
transit vehicles. The network consists of specialized electronic LED displays,
transmission protocol, and control software. Each system requires an agreement
with a local FM radio station for the use of an FM subcarrier frequency. The
Company does not believe that the cost of these arrangements will be a
significant expense.
The electronic display utilized on the DART buses is approximately six
inches high by twenty-six inches in length, strategically located behind and
slightly above the driver, and is visible from most areas inside the vehicle.
The software for the digital information network is licensed from Sunrise
Systems. See "--Digital Information Network Technology" and "--Software
License."
News briefs, weather, trivia questions, sports reports and transit
authority information are continuously presented, and can be interspersed with
advertising messages as well. The program sequence runs approximately 12-15
minutes, generally assuring that the full program cycle is viewed more than once
during an average commute, which lasts approximately 30 minutes according to
United States Department of Transportation statistics. Programs are usually
updated twice a day, changing content to reflect the demographic profile of
riders at different times, to update the news, and to include new information
from the transit authority. News stories may be changed more frequently if the
<PAGE>
events of the day warrant such updates. The Company subscribes to United Press
International's (UPI) wire service and receives continuous news stories every
few minutes throughout the day via satellite transmission and UPI's software
package. With UPI's service, the Company is able to obtain up-to-the-minute
programming information on news, weather, sports and entertainment. Advertising
copy is usually supplied by the advertiser, while public service and transit
information announcements are provided by the transit authority.
The digital information network has other important capabilities,
including the ability to (i) target specific buses and routes with different
programming, (ii) custom design special programming, and (iii) display in
Spanish and other foreign languages. The network allows certain messages to be
displayed system-wide, on selected vehicles, or on selected routes. In addition
to regular programming, special programming can be custom-tailored for specific
events. For example, in Dallas, the transit authority uses approximately 100
buses to transport fans to Dallas Cowboys football games. Those buses are
targeted with a special program that is filled with football and other
sports-related features, while the other buses in the fleet continue to run the
regular program. This ability to target buses and routes is a feature of the
system that can be sold to advertisers desiring to reach specific riders.
Targeting of individual buses which have been chartered for one-day special
events is also available on the system.
Digital Information Network Technology
The digital information network consists of specialized electronic LED
displays, transmission protocol, and control software. The software allows a
programmer to enter information and entertainment data into a personal computer.
The program is updated via a high-speed modem connected between the programming
site and the transmitting location. It is then broadcast through an FM
subcarrier frequency and received by a small antenna located on each bus. The
digital information is then transferred into buffer memory inside the LED
display. As the program then being displayed completes its cycle, the new data
automatically replaces the old data without any interruption. The entire
broadcast cycle - from in-house computer, to transmitter, to transit vehicle, to
its on-screen appearance, can be completed in just minutes. The Company is
responsible for repairing or replacing its electronic displays that are
defective or damaged after installation. The Company performs monthly
maintenance on all installed message displays.
Software License
The Company licenses the software to operate its digital information
network from Sunrise Systems, pursuant to a License Agreement (the "Software
License") dated November 1, 1995, as amended. The Software License grants the
Company a perpetual, fully paid up license to use the software wherever it
wishes. The Software License is exclusive with regard to each metropolitan area
in the United States and Canada (the "Primary Territory") which has a population
of at least 100,000 people, and is otherwise non-exclusive in the Primary
Territory. In areas other than the United States and Canada (the "Option
Territory"), the Software License is non-exclusive, although the Software
License allows it to become exclusive if certain conditions are met.
Transit Authority Marketing
The Company has contracted with the transit authority in Dallas, and is
continuing to analyze its strategy as it relates to soliciting other public
transit authorities for the purchase of its digital information network, and/or
contracting for the exclusive rights to operate its system inside the transit
vehicles operated by the authorities. In cases where the Company sells its
system to transit agencies, the Company will require initial capital during the
early stages of installation, since transit authorities typically cannot or will
not make payments until certain performance requirements are satisfied. There
can be no assurance that the Company will be awarded contracts in any new
markets.
<PAGE>
Dallas Area Rapid Transit
The Transit Network's Dallas operation serves as a prototype for
operations in a large transit market. Dallas ranks approximately 13th in the
United States bus transit market, with approximately 770 vehicles. The Company
entered into a contract with DART on October 16, 1990, which granted the Company
exclusive rights to install and operate its digital information network on-board
DART's buses for a period of five years. Installation of the DART system was
completed in August 1993. The Company and DART entered into a new contract
effective October 16, 1995 for an additional three years. In November 1997, the
Company and DART modified their contract, whereby the Company was granted the
approval to install its electronic information system on DART's forty (40) light
rail vehicles, subject to the successful completion of a 30-day test which was
concluded in March 1998. Installation of these 40 light rail vehicles is
scheduled to begin in April 1998. Simultaneously, the contract was extended
through October 2001. Under the existing contract, the Company pays DART 4% of
its gross advertising receipts. In addition, DART has reserved a permanent
position on the digital information network program for its exclusive use, as
well as limited access to advertising space for its own printed material. The
Company must reserve up to 30% of available space on interior advertising panels
and one message block on the digital information network during each cycle of
messages for DART'S use and public service announcements. Advertising revenues
from the interior advertising panels account for less than five percent of total
advertising revenues and the reservation of advertising space to DART does not
materially affect the Company's total advertising revenues. Maintenance of the
digital information network is subcontracted to an independent party. Each bus
is inspected at least monthly to ensure that the hardware is functioning
properly and the program is accurately displayed. Defective hardware is returned
to Sunrise Systems for repair or replacement. Programming errors to date have
been minor and are corrected at the Company's office.
Advertiser Participation
In the DART market, where The Transit Network depends on the sale of
advertising to generate revenues, its clients consist primarily of local
consumer products and service companies, as well as regional and local offices
of national companies. The Company will initially focus on local and regional
companies until its system is installed in a sufficient number of transit
markets, at which time large advertisers will consider use of their national
advertising budgets for transit advertising.
Competition for Advertisers
The advertising industry is intensely competitive. The Company competes
for advertising dollars with all advertising and promotional channels, including
television, radio, magazines, newspapers and direct mailings. Management
believes that its primary competition is radio and newspapers, which charge
rates significantly higher than those charged by the Company. The Company
believes that the primary basis for competition in the advertising industry is
price and value, although other factors such as market coverage, audience
demographics, and time and cost of production are also of importance.
Manufacturing, Supply and Installation
The Company does not manufacture its hardware, but contracts with third
parties to produce the equipment. Sunrise Systems assembles The Transit
Network's hardware from components and subassemblies manufactured by others.
While the Company believes that most of such components and subassemblies are
available to Sunrise Systems from multiple sources, there can be no assurance
that Sunrise Systems will be able to obtain commitments from qualified
manufacturers to provide the components and subassemblies within the Company's
time and cost estimates. The Company incorporates both system and application
software, most of which is licensed from Sunrise Systems. See "-Software
License."
<PAGE>
The Company contracts with third party electrical contractors to
install the hardware in participating transit authority vehicles. The Company
has an agreement with a Dallas electrical contractor who has installed The
Transit Network's hardware in DART vehicles, whereby the contractor has the
right of first refusal to install the hardware in other transit systems in the
United States, unless there are union labor or transit authority requirements
which the contractor cannot meet.
DDN Digital Data Networks (Canada), Inc.
Background
DDN Canada is a full service Internet provider that provides local
access to the Internet, consulting and training services for customers
interested in building internal Internet systems or on-line marketing programs,
and Web page design and development. DDN Canada became operational in October
1994, and targets primarily corporate customers and government agencies that
want access to or a presence on the Internet.
The Internet
The Internet is a global web of computer networks, allowing individuals
and companies to transfer and access data worldwide by communicating with other
computers or networks connected to the Internet. All that is required to
successfully communicate via the Internet is a personal computer, a modem and an
Internet access provider, such as DDN Canada.
The World Wide Web
One part of the Internet which has seen significant growth in
popularity over the past few years is the World Wide Web, which links
information of various kinds and allows the user to browse these areas at will.
The Web, based on a client/server model and a set of standards for information
access and navigation, can be accessed using software that allows users to
exploit the capabilities of the Internet. The Web enables users to find,
retrieve and link all types of information available on the Internet.
Services Provided
DDN Canada's primary service is to provide local access to the Internet
for individuals and companies in the Greater Vancouver area. DDN Canada believes
there are a large number of potential customers who want to access the Internet,
but are unwilling to suffer the connection and navigation problems that exist
with many other Internet service providers. To address these concerns, DDN
Canada makes every effort to ensure that customers enjoy simple first-time
access to the Internet when using DDN Canada. This is accomplished by providing
set-up assistance if requested, an adequate number of access lines and quality
communications equipment to ensure rapid and reliable connection to the
Internet, and automated installation of user-friendly software that allows easy
navigation once the customer is connected to the Internet.
DDN Canada believes that there will be substantial growth in internal
Internet systems, called intranets, which allow private corporate networks that
use Internet software to link employees and business partners to share selective
information. Because of the experience and knowledge of DDN Canada's staff, DDN
Canada is able to offer training and consulting services to customers who are
interested in setting up their own intranet. DDN Canada also provides consulting
services for customers who are interested in marketing their products or
services on the Internet.
As a result of the Company's acquisition of hip Communications, Inc.,
DDN Canada currently offers Web page design and development in addition to its
other Internet-related services. Unlike many graphic design firms and
advertising agencies, DDN Canada builds sophisticated Web sites, and will
therefore continue to target large corporations and government agencies which
typically require relatively complex Web sites for their users.
<PAGE>
Customer Support
In choosing an Internet service provider, customers often make their
decision based on the quality of a provider's customer support. Because DDN
Canada believes it is of the utmost importance to provide prompt and effective
assistance to its customers when they request it, it has arranged for a
professionally trained staff to provide quality customer support twenty-four
hours per day, seven days per week.
Competition
The principal competition to DDN Canada's local Internet access comes
from approximately five other Internet access companies in British Columbia,
most of which have larger customer bases than DDN Canada. However, many of these
competitors have experienced difficulties in providing easy access and reliable
service. DDN Canada believes that with its continued commitment to customer
service and quality hardware, it will be able to increase its market share for
these services.
There are several companies in British Columbia that provide Web page
design work. However, many of these competitors do not specialize in complex,
sophisticated Web sites as DDN Canada does. In addition, the Company believes
hip established a favorable reputation for designing quality Web sites from
which the Company expects to benefit.
ACIS Acquisition
In February 1997, the Company entered into a Letter of Intent with
Advanced Communication and Information Services, Inc. ("ACIS") whereby the
Company would acquire all of the capital stock of ACIS through an exchange of
stock. The Letter of Intent was subject to a number of conditions, including the
approval of the transaction by the boards of directors and shareholders of both
companies; ACIS providing audited financial statements of its operations in a
form acceptable for filing with the Commission; and loans from the Company to
ACIS for working capital pending the closing of the transaction. The Company
advanced ACIS approximately $1,048,000 in five different loans which became due
June 1, 1997 and are secured by a subordinated security interest in certain of
ACIS's assets and shares of ACIS stock. Management of ACIS did not deliver its
stock as security for the Company's loans as was initially required, but rather,
ACIS delivered a new certificate for 1,000,000 shares of ACIS common stock.
Because the loans were in default, the Company filed a lawsuit against ACIS for
repayment of these loans, as well as a cancellation fee to the Company, incurred
in connection with the transaction. On April 2, 1998, the Company received a
judgment against ACIS in the principal amount of $1,348,367.34. There can be no
assurance that the Company will be successful in recovering all or part of this
judgment from ACIS. See "Legal Proceedings."
Employees
As of April 1, 1998, the Company had thirteen employees, of which four
were employed by The Transit Network Division, seven by DDN Canada, and two by
the Company.
Item 2. Properties.
The Company leases (i) approximately 1,370 square feet in Dallas for
$1,781 per month pursuant to a 3-year lease which commenced December 1, 1996;
and (ii) approximately 3,800 square feet in Vancouver, British Columbia for
approximately $2,770 per month pursuant to three separate lease agreements which
expire at various times through July 2000.
<PAGE>
Item 3. Legal Proceedings.
In November 1996, Activeware Internet Corp. ("Activeware") and Dick
Hardt ("Hardt"), Plaintiffs, filed a claim against DDN and its subsidiary, hip,
Defendants, in the Supreme Court of British Columbia, in connection with certain
agreements entered into by all parties in September 1996, whereby Hardt agreed
to sell to DDN all of the outstanding capital stock of hip. Hardt alleges that,
among other things, he signed one of the agreements against his will, certain
agreements are not enforceable, DDN failed to provide him with certain payments
and a stock certificate in a timely fashion, DDN and hip breached certain
agreements and obligations, and DDN and hip have failed to pay the Plaintiffs
for work performed. The Plaintiffs are seeking against DDN and/or hip, among
other things, a declaration that certain agreements are unenforceable, specific
performance of certain agreements, damages of $500,000 (Canadian) for breach of
the agreements, monies owing pursuant to certain agreements, general damages,
punitive damages, and costs. The Company denies Plaintiff's claims and intends
to vigorously defend this lawsuit, and further in that regard, in January 1997,
DDN and hip filed a Counterclaim against the Plaintiffs, alleging that, among
other things, the Plaintiffs breached certain terms of the Stock Purchase
Agreement, the Consulting Agreement, and the Intellectual Property Transfer and
Use Agreement. DDN and hip are seeking against the Plaintiffs, among other
things, rescission of certain agreements, an order compelling the Plaintiffs to
transfer ownership of the hip.com domain name to hip forthwith, an order for
possession of the office space, an injunction restraining and enjoining the
Plaintiffs with respect to the design or hosting of Web sites and to return
certain confidential information to hip, damages for misrepresentation, damages
for breach of contract, punitive damages, and costs. The Company believes that
the resolution of this legal proceeding will not have a material adverse impact
on the Company's financial position, results of operations or cash flows. The
suit is in the discovery stage and a trial date is expected for 1999.
In January 1998, the Company filed a lawsuit in King County Superior
Court, Seattle, Washington, against ACIS for repayment of its five promissory
notes owed to the Company which are past due. The Company filed for repayment of
the entire principal amount of these promissory notes (approximately
$1,048,000), plus accumulated interest, plus a cancellation fee in the amount of
approximately $300,000. On April 2, 1998, the Company received a judgment
against ACIS in the principal amount of $1,348,367.34. The Company is now in the
discovery stage and attempting to collect on this judgment.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of security holders during the fourth
quarter of 1997.
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.
(a) The Company's Common Stock (symbol "DIDA") and Warrants (symbol
"DIDAW") have traded on the NASDAQ SmallCap Market since February 13, 1996. The
following table sets forth the high and low sales prices for the Company's
Common Stock and Warrants as reported by the NASDAQ Stock Market for the periods
indicated:
Common Stock
Period High Low
------ ---- ---
1996:
1st Quarter (beginning February 13, 1996) $ 8.75 $ 6.00
2nd Quarter 11.38 6.50
3rd Quarter 8.00 4.88
4th Quarter 6.13 3.75
1997:
1st Quarter 7.00 4.63
2nd Quarter 6.50 2.25
3rd Quarter 3.50 1.38
4th Quarter 3.38 0.63
1998:
1st Quarter 0.88 0.25
Warrants
Period High Low
------ ---- ---
1996:
1st Quarter (beginning February 13, 1996) $ 4.25 $ 2.25
2nd Quarter 6.63 2.63
3rd Quarter 3.50 1.38
4th Quarter 2.00 .88
1997:
1st Quarter 1.97 1.13
2nd Quarter 1.50 0.44
3rd Quarter 0.97 0.25
4th Quarter 1.06 0.19
1998:
1st Quarter 0.25 0.03
The above prices represent inter-dealer prices, without retail mark-up,
mark-down or commissions, and may not represent actual transactions.
(b) As of April 8, 1998, the Company had approximately 161 shareholders
of record and 15 warrantholders of record.
(c) The Company has never paid cash dividends on its Common Stock, and
currently intends to retain earnings, if any, for use in the operation and
expansion of its business and therefore does not anticipate paying any cash
dividends on the Common Stock in the foreseeable future.
<PAGE>
Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Background
From inception in October 1988, through December 1992, the Company
generated insignificant revenues, and as a result of the costs and expenses
associated with funding the development and initial implementation of the
digital information network, the Company incurred significant cumulative net
losses which were financed by the issuance of debt and Common Stock. During
1988, the Company completed the installation of the RIPTA test market. In 1990,
the Company was awarded a contract from DART to install an electronic
advertising system on all of its buses. Installation commenced in 1991, but was
not immediately completed, due to insufficient financial resources to purchase
needed equipment and labor. During 1993, the Company raised approximately
$670,000 from the sale of Common Stock. These funds were used to complete the
installation of the DART digital information network and to hire additional
sales personnel and programmers. The DART system began to generate its
advertising revenues.
The following year and a half was a transitional period for the
Company, as it continued to operate the DART and RIPTA systems, negotiated the
conversion of debt to equity, funded the development of a new product (an
automated audio/visual next-stop announcement system), expanded its sales and
operations departments in Dallas, and implemented changes to its senior
management and Board of Directors.
During the years prior to the Company's public offering, the Company
incurred significant financing, legal and other consulting expenses in
connection with, among other things, extension of credit, modification of
existing contract or agreement terms, debt exchanges, services provided, and the
continued forbearance of its creditors, for which the Company issued shares of
its Common Stock and options to acquire shares of its Common Stock. The
estimated fair value of such securities issued was recorded as financing, legal
and other consulting expense.
In February 1996, the Company closed its initial public offering and
received net cash proceeds of approximately $5.8 million, after deducting for
underwriter's commissions and certain other offering related costs, from the
issuance of 1,322,500 shares of its Common Stock and 1,840,000 of its Common
Stock Purchase Warrants.
Subsequent to the Company's initial public offering, the Company
completed several business acquisitions and an exclusive license agreement. On
June 3, 1996, the Company acquired all of the outstanding common stock of
Pro.Net, a Vancouver, British Columbia, Canada-based Internet service provider,
for 100,000 shares of the Company's Common Stock. On June 14, 1996, the Company
acquired all of the outstanding common stock of Cyber America for 50,000 shares
of the Company's Common Stock. Cyber America, based in Willow Grove,
Pennsylvania, offers high-speed access to the backbone of the Internet. On
September 27, 1996, the Company acquired all of the outstanding common stock of
hip, a Web page design firm located in Vancouver, British Columbia, for 30,000
shares of the Company's Common Stock. Hip's operations have subsequently been
merged with Pro.Net's. On October 4, 1996, the Company entered into an exclusive
license agreement with SSNN to offer SSNN's financial news coverage in Canada.
In consideration of this exclusive license agreement, the Company issued 25,000
shares of its Common Stock to SSNN.
As a result of continuing cash flow losses, the Company closed its
Cyber America operation as well as its Transit Network Division in Providence,
Rhode Island in the 3rd quarter and 4th quarter of 1997, respectively.
<PAGE>
Comparison of the Years Ended December 31, 1996 and December 31, 1997
Revenues for the year ended December 31, 1997 increased $206,000 from
$683,000 to $889,000 from the prior year. This increase is primarily the result
of contributions from DDN Canada, which generated revenues of $365,000, an
increase of $256,000 over 1996, which reflected only approximately 7 months of
revenue. This increase offset a $42,000 decrease in revenue from Cyber America
and a decrease of $8,000 from The Transit Network Division. Total expenses
increased from $2,790,000 for the year ended December 31, 1996 to $3,842,000 for
the year ended December 31, 1997 due primarily to the write-down of assets as
the Company established a reserve against a note receivable from a failed
acquisition target of $1,048,000 and expensed in full the goodwill of $343,000
relative to DDN Canada, as well as an increase of $142,000 in financing, legal
and other consulting, which was the result of legal fees associated with two
different lawsuits, and an increase in marketing, general and administrative
from $722,000 to $783,000. These increases were offset by a reduction in direct
operating costs of $176,000, a decrease in salaries and related from $880,000 to
$740,000, and a decrease in product development costs (associated with the Cyber
America acquisition) and amortization of intangible assets (related to the
acquisition of Pro.Net and hip) from $329,000 to $103,000.
Financial Condition
Cash used by operating activities for the years ended December 31, 1996
and 1997 were $1,456,000 and $984,000 respectively. In 1996 and 1997, cash used
by operating activities was funded by the Company's initial public offering
wherein it received net cash proceeds of approximately $5.8 million, after
deducting for underwriter's commissions and certain other offering related
costs, from the issuance of 1,322,500 shares of its Common Stock and 1,840,000
of its Common Stock Purchase Warrants. The Company's stockholders' equity
decreased from $3,107,000 at December 31, 1996 to $490,000 at December 31, 1997,
due primarily to a net loss in 1997 in the amount of $2,922,000. Total
borrowings approximated $740,000 at December 31, 1997 as compared to $1,170,000
the prior year, the change resulting from certain obligations which matured and
were paid off in 1997.
In June 1996, DART put into service 40 light rail vehicles. The Company
and DART have modified their contract to allow the Company to install its
digital information network on these vehicles. Installation is to begin in April
1998, at which time the Company estimates that it will begin to incur
approximately $175,000 of additional equipment and installation costs. The
Company believes, however, that advertising revenues from these light rail
vehicles will increase in amounts sufficient to offset the initial capital
outlay. See "Business-Digital Information Network."
In August 1996, one of the Company's noteholders exercised his right to
covert the entire amount of principal and accrued but unpaid interest to shares
of the Company's Common Stock. Pursuant to that exercise, the Company issued
30,795 shares of its Common Stock in exchange for approximately $124,000 of
principal and interest. Subsequent to December 31, 1996, two other noteholders
converted promissory notes of principal and accrued interest together
approximating $161,000 to 37,023 shares of the Company's Common Stock.
A valuation allowance has been recorded for the full amount of deferred
taxes as realization of such deferred tax asset is not considered to be more
likely than not.
<PAGE>
Liquidity and Capital Resources
At December 31, 1997, the Company's principal assets consisted of
approximately $540,000 of cash, of which approximately $460,000 was invested in
short-term, interest-bearing investments with banks and other financial
institutions, and approximately $320,000 of short-term notes receivable. The
Company's total obligations of approximately $740,000 consisted primarily of
$352,000 in accounts payable liabilities and accrued payroll and related
expenses, $89,000 in unearned income, and $21,000 as the current portion of
long-term debt. The Company's long-term debt at December 31, 1997 was $278,000.
In February 1997, the Company entered into a Letter of Intent with ACIS
whereby the Company would acquire all of the capital stock of ACIS through an
exchange of stock. The Letter of Intent was subject to a number of conditions,
including the approval of the transaction by the boards of directors and
shareholders of both companies; ACIS providing audited financial statements of
its operations in a form acceptable for filing with the Commission; and loans
from the Company to ACIS for working capital pending the closing of the
transaction. The Company advanced ACIS approximately $1,048,000 in five
different loans which became due June 1, 1997 and are secured by a subordinated
security interest in certain of ACIS's assets and shares of ACIS stock.
Management of ACIS did not deliver its stock as security for the Company's loans
as was initially required, but rather, ACIS delivered a new certificate for
1,000,000 shares of ACIS common stock. Because the loans were in default, the
Company filed a lawsuit against ACIS for repayment of these loans, as well as a
cancellation fee to the Company, incurred in connection with the transaction. On
April 2, 1998, the Company received a judgment against ACIS in the principal
amount of $1,348,367.34. There can be no assurance that the Company will be
successful in recovering all or part of this judgment from ACIS. See "Legal
Proceedings."
The Company closed its Cyber America operation as well as The Transit
Network Division's Providence, Rhode Island operation due to the fact that
neither operation was able to approach profitability.
The Company incurred net losses of $2,922,000 and $1,966,000 for the
years ended December 31, 1997 and 1996 respectively, and continues to experience
negative cash flows from operations. Combined with the Company's establishment
of a reserve against ACIS's note receivable in the amount of $1,048,000, these
conditions raise doubt about the Company's ability to continue as a going
concern. However, management believes that its current operating activities and
sales strategies will, in the near future, provide sufficient cash flows to fund
its ongoing business activities. Management also believes that, due to the
judgment received in favor of DDN in April 1998 in regards to the ACIS note,
substantially all of the $1,348,000 will eventually be recovered.
The Company believes that its future operating results, liquidity and
capital resources will improve, the result of closing the Cyber America and
Providence, Rhode Island operations, as well as anticipated revenue growth by
The Transit Network Division when it has finished installing its electronic
information system on DART's light rail vehicles. The Company believes that with
the cash it has invested in short-term financial instruments, interest earned
from these investments, and anticipated revenue from operations, the Company's
working capital requirements will be sufficient for at least the next six
months.
The Company is subject to various legal proceedings and claims that
arise in the ordinary course of business, including the litigation described in
the following sentence. The former stockholder of a business acquired by the
Company in 1996 has initiated a lawsuit in the Supreme Court of British Columbia
against the Company claiming, among other things, damages for breach of contract
in the amount of approximately $500,000 Canadian (approximately $375,000 U.S.),
plus punitive damages which are unquantified. The Company denies these claims
and intends to vigorously defend this lawsuit and, further, in this regard, the
Company has counterclaimed against the plaintiffs for, among other things,
damages for misrepresentations and breach of contract. Company management
currently believes that resolving these various legal proceedings and claims
will not have a material adverse impact on the Company's financial position,
results of operations or cash flows.
<PAGE>
Effect of Recently Issued Accounting Standards
Recently issued accounting standards having relevant applicability to
the Company consist primarily of Statement of Financial Accounting Standards No.
128 ("SFAS 128"), which establishes standards for computing and presenting
earnings per share ("EPS") and has the effect of simplifying the standards for
computing earnings per share and makes them comparable to international EPS
standards. It replaces presentation of primary EPS with a presentation of basic
EPS. Basic EPS excludes dilution for the effect of common stock equivalents such
as options or warrants. SFAS 128 is effective for financial statements issued
for periods ending after December 15, 1997 (earlier application is not
permitted) and requires restatement of all prior period EPS data presented. It
is not expected that adoption of SFAS 128 will have a significant, if any,
effect on reported EPS data. Other relevant recently issued accounting standards
consist of Statement of Financial Accounting Standards No. 130 ("SFAS 130")
"Reporting Comprehensive Income" and Statement of Financial Accounting Standards
No. 131 ("SFAS 131") "Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 130 requires that an enterprise report, by major
components and as a single total, the change in its net assets during the period
from nonowner sources. SFAS No. 131 establishes annual and interim reporting
standards for an enterprise's operating segments and related disclosures about
its products, services, geographic areas and major customers. Adoption of these
statements will not impact the Company's financial position, results of
operations or cash flows, and any effect will be limited to the form and content
of its disclosures. Both SFAS No.s 130 and 131 are effective for fiscal years
beginning after December 15, 1997.
In December 1997, the Accounting Standard Executive Committee of the
American Institute of CPAs issued Statement of Position 97-2, "Software Revenue
Recognition" ("SOP 97-2"). SOP 97-2 provides guidance on applying generally
accepted accounting principles in recognizing revenue on software transactions.
Adoption of this standard is not expected to have a material impact on the
Company's financial position, results of operations, or cash flows. The standard
is effective for transactions entered into in fiscal years beginning after
December 15, 1997.
<PAGE>
Item 7. Financial Statements.
Index to Financial Statements: Page
Report of Independent Certified Public Accountants F-1
Consolidated Balance Sheets F-2
Consolidated Statements of Operations F-3
Consolidated Statement of Stockholders' Equity F-4
Consolidated Statements of Cash Flows F-5
Notes to Consolidated Financial Statements F-6 to F-16
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
PART III
Items 9, 10, 11 and 12 are incorporated by reference from the Company's
definitive Proxy Statement to be filed by the Company with the Commission.
Item 13. Exhibits and Reports on Form 8-K.
(a) Exhibits - none filed with this report.
(b) The Registrant filed a Form 8-K with the Securities and Exchange
Commission on November 12, 1997, to report the resignation of certain
board members and their named replacements, as well as the closure of
its Cyber America operation. In January 1998, the Company filed a Form
8-K with the Commission to report that The Transit Network was closing
its Providence, Rhode Island operation, and that The Transit Network
Division was ceasing efforts to market its next-stop automated
audio/visual announcement system ("NextStop").
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
DIGITAL DATA NETWORKS, INC.
(Registrant)
By: /s/ Donald B. Scott
--------------------------------------
Donald B. Scott, Chairman of the Board
(Principal Executive Officer)
Date: April 14, 1998
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Signatures Capacity Date
- ---------- -------- ----
/s/ Donald B. Scott Chairman of the Board, April 14, 1998
- ------------------------ President, Director,
Donald B. Scott (Principal Executive Officer)
/s/ James F. Biagi, Jr. Secretary and Director April 14, 1998
- ------------------------
James F. Biagi, Jr.
/s/ Robert F. Hussey Director April 14, 1998
- ------------------------
Robert F. Hussey
/s/ Jerry L. Smith Director April 14, 1998
- ------------------------
Jerry L. Smith
/s/ Richard J. Boeglin Vice President, Finance and April 14, 1998
- ------------------------ Operations (Principal Financial
Richard J. Boeglin and Accounting Officer)
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders of
Digital Data Networks, Inc.
We have audited the accompanying consolidated balance sheets of Digital
Data Networks, Inc. and its subsidiaries ("the Company"), as of December 31,
1996 and 1997 and the related consolidated statements of operations,
stockholders' equity (deficit) and cash flows for each of the years then ended.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly,
in all material respects, the financial position of Digital Data Networks, Inc.
and its subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the years then ended in conformity
with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has suffered recurring losses
from operations, and has experienced negative cash flows from operations. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans concerning these matters are also described in
Note 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
BDO Seidman, LLP
Seattle. Washington
April 2, 1998
F-1
<PAGE>
DIGITAL DATA NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
<TABLE>
<CAPTION>
December 31,
------------------------------
1996 1997
-------- --------
CURRENT ASSETS
<S> <C> <C>
Cash and cash equivalents $ 2,865 $ 540
Trade accounts receivable, net of allowances
for doubtful accounts of $39 and $33 83 58
Prepaid expenses and other current assets 169 92
Notes receivable, net of reserves of $0 and $1,048 325 320
-------- --------
Total Current Assets 3,442 1,010
Equipment, net (Notes 2 and 5) 386 147
Intangible assets, net of accumulated amortization
of $263 (Notes 2 and 3) 362 -
Other assets 87 73
-------- --------
TOTAL ASSETS $ 4,277 $ 1,230
======== ========
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 290 $ 308
Accrued payroll and related 99 44
Current portion of long-term debt (Note 5) 501 21
Unearned income 97 89
Note payable and accrued interest (Note 5) 71 -
Expanded license commitment (Note 6) 78 -
-------- --------
Total current liabilities 1,136 462
-------- --------
LONG-TERM OBLIGATIONS
Long-term debt and accrued interest,
less current portion (Note 5) 34 164
Due to shareholders (Note 8) - 114
-------- --------
Total liabilities 1,170 740
-------- --------
COMMITMENTS AND CONTINGENCIES (Notes 2, 6, 7, 10, 11 and 13)
STOCKHOLDERS' EQUITY
Preferred Stock, no par value, 1 million shares
authorized, no shares issued or outstanding - -
Common Stock, no par value, 10,000,000 shares authorized,
2,297,473 and 2,339,267 shares issued and outstanding 13,099 13,399
Accumulated Deficit (9,992) (12,914)
Cumulative foreign currency translation adjustment - 5
-------- --------
Total Stockholders' Equity 3,107 490
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 4,277 $ 1,230
======== ========
</TABLE>
F-2
<PAGE>
DIGITAL DATA NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands Except Per Share Data)
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------
1996 1997
-------- --------
<S> <C> <C>
REVENUES $ 683 $ 889
-------- --------
EXPENSES:
Direct operating costs 653 477
Salaries and related 880 740
Marketing, general and administrative (Note 7) 722 783
Financing, legal and other consulting (Note 8) 206 348
Product development costs 329 103
Write-off of goodwill (Notes 2, 3 and 14) - 343
Provision for notes receivable reserve (Notes 2, 11 and 14) - 1,048
-------- --------
Total Expenses 2,790 3,842
-------- --------
Loss from operations (2,107) (2,953)
-------- --------
OTHER INCOME (EXPENSE):
Interest expense (51) (104)
Investment income 192 135
-------- --------
Total other income, net 141 31
-------- --------
NET LOSS $ (1,966) $ (2,922)
======== ========
NET LOSS PER SHARE $ (0.98) $ (1.31)
======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING 1,997,321 2,334,942
========= =========
</TABLE>
F-3
<PAGE>
DIGITAL DATA NETWORKS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in Thousands)
<TABLE>
<CAPTION>
Cumulative
Foreign
Common Stock Currency Total
------------ Accumulated Translation Stockholders'
Shares Amount Deficit Adjustment Equity
------ ------ ------- ---------- ------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1996 705 $ 6,359 $ (8,026) $ - $ (1,667)
Shares issued for cash 1,322 6,612 - - 6,612
Warrants issued for cash - 276 - - 276
Stock offering costs - (1,066) - - (1,066)
Shares issued in connection with acquisition of:
Pro.Net Communications, Inc. 100 325 - - 325
Cyber America Corporation 50 163 - - 163
hip Communications, Inc. 30 98 - - 98
Shares issued upon debt exchange 31 124 - - 124
Shares issued for other than cash 59 170 - - 170
Warrants issued for other than cash - 38 - - 38
Net loss - - (1,966) - (1,966)
----------- ----------- ------------ ----------- ------------
Balance, December 31, 1996 2,297 13,099 (9,992) - 3,107
Shares issued upon debt exchange 37 161 - - 161
(Notes 5 and 6)
Shares issued for other than cash 5 27 - - 27
(Note 7)
Options issued to other than employees - 112 - - 112
(Note 7)
Foreign currency translation - - - 5 5
Net loss - - (2,922) - (2,922)
--------- --------- ---------- --------- ---------
Balance, December 31,1997 2,339 $ 13,399 $ (12,914) $ 5 $ 490
========= ========= ========= ========= =========
</TABLE>
F-4
<PAGE>
DIGITAL DATA NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Increase (Decrease) in Cash and Cash Equivalents
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------
1996 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss $ (1,966) $ (2,922)
Adjustments to reconcile net loss to net cash
used by operating activities, exclusive of the
effects of business acquisitions
Depreciation and amortization 427 317
Write-off of goodwill - 343
Reserve for notes receivable - 1,048
Options issued to other than employees - 112
Other non-cash operating expense 538 9
Increase in prepaid and other current assets (149) 122
Decrease in accounts payable and accrued liabilities (252) (45)
Other (54) 32
--------- --------
Net Cash Used by Operating Activities (1,456) (984)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment (15) (75)
Proceeds from equipment sales - 7
Purchases of investments (325) (6)
Advances to shareholder, net - (5)
Advances to acquisition target - (1,048)
Payments on notes receivable - 10
Cash acquired upon acquisition of businesses 99 -
-------- --------
Net Cash Used by Investing Activities (241) (1,117)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock, net of stock issue costs 5,822 -
Repayment of expanded license commitment (225) (78)
Repayment of notes payable (1,047) (71)
Debt principle payments - (189)
Borrowings from shareholder - 114
-------- --------
Net Cash Provided by Financing Activities 4,550 (224)
-------- --------
Net Increase (decrease) in Cash and Cash Equivalents 2,853 (2,325)
CASH AND CASH EQUIVALENTS
Beginning of Year 12 2,865
-------- --------
End of Year $ 2,865 $ 540
======== ========
SUPPLEMENTAL DISCLOSURES OF NON-CASH TRANSACTIONS
Exchange of debt for equity $ 124 $ 161
Common stock and warrants issued for other than cash $ 208 $ 27
Common stock issued in business acquisitions $ 586 $ -
Cash paid during the year for:
Interest $ 51 $ 173
Taxes $ - $ -
</TABLE>
F-5
<PAGE>
DIGITAL DATA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 Description of Business and Summary of Significant Accounting Policies
Digital Data Networks, Inc. ("the Company" or "DDN"), a wireless, passenger
communication and advertising company, is principally engaged in development,
design, installation and operation of the "digital information network", a
network of computerized electronics message displays that deliver current news,
information and advertising to riders on-board public transit vehicles. The
digital information network consists of a series of electronic information
displays utilizing digital radio transmission technology. The Company,
incorporated in 1988, has a digital information network and an operation in
Texas. In July 1995, the Company changed its name from Transit Information
Systems, Inc. to Digital Data Networks, Inc.
As more fully described in Note 3, as a result of acquisitions during the year
ended December 31, 1996, the Company is also engaged in operating and
development of internet related businesses. The Company's Canadian subsidiary,
DDN Canada, provides a range of internet offerings to business customers,
including connectivity services to local subscribers, intranet services to
corporations, the development of on-line working programs for commercial
clients, and web page design and development targeting corporate customers.
Principles of Consolidation - The consolidated financial statements of DDN
include the accounts of its subsidiaries from the date of their acquisition
after the elimination of intercompany balances and transactions.
Cash and Cash Equivalents - For purposes of balance sheet classification and the
statements of cash flows, the Company considers all highly liquid investments
purchased with an original maturity of three months or less to be cash
equivalents.
Equipment - Equipment is stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the respective assets
ranging from five to seven years.
Intangible Assets - Intangible assets includes the cost of an expanded software
license, now fully amortized, and goodwill. Goodwill represents the excess of
the cost of companies acquired over the fair value of their net assets at their
dates of acquisition and was being amortized over 60 months. Cost and
accumulated amortization of fully amortized intangible assets are removed from
the accounts.
Impairment of Long-Lived Assets - In accordance with the provisions of Statement
of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the
Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of",
management of the Company reviews the carrying value of its equipment and
intangible assets on a regular basis. Estimated undiscounted future cash flows
from operations is compared to current carrying value. Reductions or reserves
against assets, if necessary, are recorded to the extent the net book value of
the asset exceeds the estimate of future undiscounted cash flows on an aggregate
basis.
Income Taxes - The Company accounts for income taxes in accordance with the
provisions of SFAS No. 109, "Accounting for Income Taxes". SFAS No. 109 requires
the recognition of deferred income taxes to provide for temporary differences
between the financial reporting and tax basis of assets and liabilities.
Deferred taxes are measured using enacted tax rates expected to be in effect in
the years in which the temporary differences are expected to reverse.
Fair Value of Financial Instruments - The carrying amount reported in the
balance sheet for cash and cash equivalents, trade accounts receivable, notes
receivable, other current assets, accounts payable and other accrued expenses
approximate fair value because of their immediate or short-term nature. The fair
value of long-term debt approximates its carrying value because the stated rates
of the debt either reflect recent market conditions or are variable in nature.
The fair value of amounts due to shareholders cannot be determined.
F-6
<PAGE>
Note 1 Description of Business and Summary of Significant Accounting Policies
(continued)
Revenue Recognition - The Company records revenue as advertising services are
provided. To the extent payment is received for advertising in advance of
providing services, such prepaid amounts are recorded as unearned income until
services are provided.
Stock-Based Compensation - Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation", ("SFAS 123") encourages, but does not
require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to continue to account
for stock-based employee compensation utilizing the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and related interpretations and to furnish the proforma
disclosures required under SFAS 123. Accordingly, compensation cost for stock
options is measured as the excess, if any, of the quoted market price of the
Company's stock at the date of grant over the amount an employee must pay to
acquire the stock.
Net Loss Share - In February 1997, The Financial Accounting Standards Board
("FASB") issued SFAS No. 128, "Earnings Per Share" ("EPS"). SFAS No. 128
requires dual presentation of basic EPS and diluted EPS on the face of all
income statements issued after December 15, 1997 for all entities with complex
capital structures. Adoption of SFAS No. 128 had no effect on the Company's
financial statements. Basic EPS is computed as net income divided by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur from common shares issuable
through stock options, warrants and other convertible securities. As the
Company's stock options and warrants, which cover 2,702,000 shares of the
Company's common stock at December 31, 1997, are antidilutive for all periods
presented only basic EPS is presented. These securities could potentially dilute
future EPS calculations.
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 amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reported period. Actual results could differ from those estimates.
Reclassifications - Certain amounts in the December 31, 1996 financial
statements have been reclassified to conform with the December 31, 1997
presentation.
New Accounting Pronouncements - In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income", and SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information". SFAS No. 130 requires that an
enterprise report, by major components and as a single total, the change in its
net assets during the period from nonowner sources; and SFAS No. 131 establishes
annual and interim reporting standards for an enterprise's operating segments
and related disclosures about its products, services, geographic areas and major
customers. Adoption of these statements will not impact the Company's financial
position, results of operations or cash flows and any effect will be limited to
the form and content of its disclosures. Both statements are effective for
fiscal years beginning after December 15, 1997.
In December 1997, the Accounting Standards Executive Committee of the American
Institute of CPAs issued Statement of Position 97-2, "Software Revenue
Recognition" ("SOP 97-2"). SOP 97-2 provides guidance on applying generally
accepted accounting principles in recognizing revenue on software transactions.
Adoption of this standard is not expected to have a material impact on the
Company's financial position, results of operations, or cash flows. The standard
is effective for transactions entered into in fiscal years beginning after
December 15, 1997.
F-7
<PAGE>
Note 2 Financial Condition, Liquidity and Going Concern
DDN incurred net losses of $2,922,000 and $1,966,000 for the years ended
December 31, 1997 and 1996, and continues to experience negative cash flows from
operations. In addition, the Company established a reserve against a note
receivable from a failed acquisition target of $1,048,000 and expensed in full
the unamortized goodwill relative to the Company's Canadian Subsidiary of
$343,000 under the provisions of SFAS 121. These conditions raise substantial
doubt about the Company's ability to continue as a going concern.
Management believes that its future operating activities and sales strategies
will, in the near term, provide sufficient cash flows to fund ongoing business
activities in Dallas and Canada. Management also believes that, due to a
judgment received in favor of DDN in April 1998 in regards to the
above-mentioned note receivable and the historical financial stability of the
failed acquisition target, all of the $1,048,000 will eventually be recovered.
Lastly, management believes reductions in general and administrative expenses,
possible capital infusions from equity sources, and cut backs in capital
expenditures will bring the Company to profitable operations.
The ability of the Company to achieve its operating goals, and thus generate
positive cash flows from operations and net income, is dependent on market
conditions, the recovery of the reserved note receivable, and the Company's
ability to raise capital under acceptable terms. While the company has been
successful in these endeavors in the past, there can be no assurance that its
efforts in these endeavors will be successful in the future. These financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
Note 3 Business Acquisitions
In June 1996, the Company acquired all of the outstanding common stock of
Pro.Net for 100,000 shares of the Company's common stock valued at approximately
$325,000. Shares of Company common stock issued are subject to a two year resale
restriction, and were recorded at their estimated fair value determined on the
basis of discounting (for, among other things, resale restrictions) the market
price of Company common stock. The total purchase price, including assumed
liabilities at their estimated fair values (which approximated book value), was
allocated to assets acquired based on estimates of fair value. Assets acquired
included tangible assets (which fair values are estimated to approximate book
value) and identifiable intangible assets, being primarily a customer
subscription base. The excess of purchase price over fair value of assets
acquired has been allocated to non-current tangible and identifiable intangible
assets based upon their relative estimated fair values. Intangible assets
recorded in purchase accounting approximated $325,000 and was being amortized
over five years.
In June 1996, the Company acquired all of the outstanding common stock of Cyber
America for 50,000 shares of the Company's common stock valued at approximately
$163,000. Shares of Company common stock issued are subject to a two year resale
restriction, and were recorded at their estimated fair value determined on the
basis of discounting (for, among other things, resale restrictions) the market
price of Company common stock. The total purchase price, including assumed
liabilities at their estimated fair values (which approximate book value), is
allocated to assets acquired based on estimates of fair value. Assets acquired
include tangible assets (which fair values are estimated to approximate book
value) and identifiable intangible assets. being primarily products in
development. The estimated value of products in development which are not deemed
to have attained technological feasibility, as defined by generally accepted
accounting principles, are capitalized in purchase accounting in the amount of
approximately $183,000 and immediately expensed as product development cost
subsequent to recording the business combination. In September 1997 the Company
closed the operations of Cyber America as it was unable to reach profitability.
F-8
<PAGE>
Note 3 Business Acquisitions (continued)
In September 1996, the Company acquired all of the outstanding common stock of
hip for 30,000 shares of the Company's common stock valued at approximately
$98,000. Shares of Company common stock issued are subject to a two year resale
restriction, and were recorded at their estimated fair value determined on the
basis of discounting (for, among other things, resale restrictions) the market
price of Company common stock. The total purchase price, including assumed
liabilities at their estimated fair values (which approximate book value), is
allocated to assets acquired based on estimates of fair value. Assets acquired
include tangible assets (which fair values are estimated to approximate book
value) and identifiable intangible assets, a customer base, and unidentifiable
intangible assets. Intangible assets recorded in purchase accounting approximate
$109,000 and are amortized over their estimated productive lives, which are not
in excess of two years.
Upon review of the Company's undiscounted cash flow estimates, management
determined that the net carrying value of goodwill for both Pro.net and hip at
December 31, 1997 of $342,000 was not recoverable through operations and charged
the entire remaining unamortized balance to expense during the fourth quarter.
The following unaudited pro forma summary presents financial information on the
basis as if the business acquisitions of Pro.Net, Cyber America and hip had
occurred at the beginning 1996. The pro forma information is based on historical
information and is not necessarily indicative of results of operations that
would have occurred had the acquisitions occurred on January 1, 1996, nor is it
necessarily indicative of future results of operations of the combined companies
(in thousands, except per share data):
1996
---------
Revenues $ 1,019
=========
Net loss $ (1,947)
=========
Net loss per share $ (0.94)
=========
The above pro forma financial information does not include non-recurring
expenses of approximately $183,000 recorded in 1996 immediately subsequent to
recording the Cyber America business combination relating to the estimated fair
value of intangible assets acquired associated with products in development
which have not been determined to have yet attained technological feasibility.
Note 4 Equipment
Equipment consists of the following:
($ in thousands)
December 31,
------------------------
1996 1997
------ -------
DDN equipment installed in public transit vehicles $1,390 $ 1,440
Office equipment and other 352 250
------ -------
1,742 1,690
Accumulated depreciation (1,356) (1,543)
------ --------
Equipment, net $ 386 147
====== =======
F-9
<PAGE>
Note 5 Note Payable and Long-Term Debt
Note payable and accrued interest as of December 31, 1996 consisted of a
$54,000, 5% convertible promissory note, unsecured and with accrued interest of
$17,000. The note was paid in full August 1997.
Long-term debt consists of the following:
<TABLE>
<CAPTION>
($ in thousands)
December 31,
1996 1997
------- --------
<S> <C> <C>
5% promissory note due a company, due in full
on October 2001, including accrued interest of
$1,000 and $7,000, secured by equipment. $ 145 $ 151
8.5% note due a bank, payable $1,900 monthly
including interest, due July 1999, secured by
equipment and certificates of deposit 53 34
8% note due a Company, repaid June 1997 195 -
11% note due a Company, converted to DDN
common shares in 1997 111 -
Other notes payable 31 -
Total 535 185
Less current portion 501 21
------- --------
Long-term debt and accrued interest, less current portion $ 34 $ 164
======= ========
</TABLE>
Scheduled long term debt maturities and accrued interest at December 31, 1997
are as follows:
Year ending ($ in thousands)
December 31, Total
------------ -----
1998 $ 21
1999 13
2000 -
2001 151
$ 185
In February 1997, the Company amended the terms of its 11% note due a Company to
include an equity conversion feature, allowing the principal and interest due to
be converted to DDN common stock at a conversion price of $4.50 per share, the
fair market value at the date of amendment. In March 1997, the lender exercised
its options and the outstanding balance of principal and interest of $82,464 was
converted into 18,326 shares of DDN common stock.
F-10
<PAGE>
Note 6 Software License and Supply Agreement
Pursuant to terms of a 1993 agreement, as amended, the Company's Transit Network
Division licenses substantially all of its computer software, which is an
essential element of the digital information network, from Sunrise Systems, Inc.
("Sunrise Systems"), an electronics supplier and software development company.
The license provides the Company with exclusive rights to such software in
metropolitan areas of the United States and Canada with populations over 100,000
and nonexclusive rights elsewhere in the world. The software license was to
terminate immediately if the Company had not completed a major financing, as
defined, by December 1996 and paid Sunrise Systems $250,000 plus 8% of net
financing proceeds over $5 million, up to a maximum total payment of $300,000,
(the "Expanded License Payment"). In 1996, the Company paid Sunrise Systems
$225,000 representing the Expanded License Payment amount then due as a result
of the Company's receipt of its initial stock offering proceeds; the remaining
$75,000, together with accrued interest was due in 1997.
In January 1997, the Company amended the terms of the agreement to include an
equity conversion feature, allowing the principal and interest due to be
converted to DDN common stock at a conversion price of $4.20 per share, the fair
market value at the date of amendment. In January 1997, Sunrise Systems
exercised its option and the outstanding balance of principal and interest of
$78,524 was converted into 18,697 shares of DDN common stock.
Note 7 Common Stock and Stock Options
During the year ended December 31, 1997 the Company granted a total of 5,100
shares of common stock to two consultants, at various dates, in exchange for
services rendered. The aggregate fair value at the date the shares were issued
was $27,375, which amount was expensed in 1997.
In February 1996, the Company closed its initial public stock and warrant
offering and received net cash proceeds of approximately $5.9 million, after
deduction for underwriters commissions and certain other offering related costs.
The Company issued 1,322,500 shares of its common stock and 1,840,000 of its
common stock purchase warrants. The warrants entitle the holder to purchase one
share of the Company's common stock at an exercise price of $6 per share during
the five years commencing upon issuance. The warrants are redeemable after one
year, under certain circumstances. The Company utilized approximately $1.1
million of the proceeds to repay certain notes payable and related accrued
interest.
The Company has granted to certain of its promissory note holders, stockholders,
officers, directors, employees, suppliers, consultants and financial advisors
non-qualified options and warrants to purchase shares of Company common stock.
Options generally expire within 5 to 10 years of grant.
During 1997, the Company granted a total of 200,000 options to purchase common
shares to non-employee directors in exchange for services rendered at an
exercise price of $1.75 expiring in 2002, resulting in a $75,000 charge to
expense for the period.
During 1994, the Company adopted a Combined Incentive and Non-Qualified Stock
Option Plan (the "1994 Plan") which permits the issuance of options to acquire
shares of Company common stock. The plan permits grants of incentive stock
options to employees and of non-qualified stock options to employees, directors,
consultants or independent contractors of the Company. The exercise price of
incentive stock options shall not be less than the fair market value of Company
common stock at the date of grant. The exercise price of non-qualified stock
options may be greater or less than the fair market value of Company common
stock at the date of grant. The duration of options shall be established by the
Board of Directors, and shall not exceed ten years. The 1994 Plan reserves
approximately 112,000 shares of common stock for grant and provides that terms
of each award be determined by the Board of Directors. Prior to 1996, the
Company granted approximately 104,000 1994 Plan options. No 1994 Plan options
have been exercised.
F-11
<PAGE>
Note 7 Common Stock and Stock Options (continued)
During 1996, the Company adopted a Combined Incentive and Non-Qualified Stock
Option Plan (the "1996 Plan") with provisions similar to the 1994 Plan. The 1996
Plan reserves approximately 250,000 shares of common stock for grant and
provides that terms of each award be determined by the Board of Directors.
During 1996, the Company granted approximately 220,000 1996 Plan options. No
1996 Plan options have been exercised.
During 1996, in connection with an agreement pursuant to which the Company
acquired certain financial consulting services, the Company issued options to
acquire 40,000 shares of its common stock at an exercise price of $6.00 per
share, exercisable for two years. The Company recorded the estimated fair value
of such options as expense and an increase in common stock. Further, for a
period of six to twelve months, the Company agreed to issue additional options
(40,000 for each of specified share prices) contingent upon the average closing
bid price per share of Company common stock attaining $7, $8, $9 and $10 for
twenty out of thirty consecutive day time periods. During 1997, these contingent
options were renegotiated and repriced, resulting in 50,000 options issued at an
exercise price of $5.23 and 50,000 options issued at an exercise price of $5.94,
all expiring in November 1998. The resulting charge to expense for the period
was $37,000.
The following summarizes stock option and warrant transactions during the two
years ended December 31, 1997 (thousands of shares):
<TABLE>
<CAPTION>
Exercise Price Weighted Average
Shares Per Share Exercise Price
----------- --------------- ----------------
<S> <C> <C> <C>
Outstanding at January 1, 1996 360 $0.09 to $19.68 $ 5.00
Granted 303 $4.50 to $6.00 $ 5.55
Sold in initial public offering 1,840 $6.00 $ 6.00
Expired (5) $8.94 $ 8.94
----------- ---------------
Outstanding at December 31, 1996 2,498 $0.09 to $19.68 $ 5.79
Granted 300 $1.75 to $5.94 $ 3.03
Expired (96) $0.50 to $5.50 $ 4.74
----------- ---------------
Outstanding at December 31, 1997 2,702 $0.09 to $19.68 $ 5.19
=========== ===============
</TABLE>
Information relating to stock options and warrants at December 31, 1997
summarized by exercise price are as follows (thousands of shares):
<TABLE>
<CAPTION>
Outstanding
-----------------------------------------
Weighted Average Exercisable
---------------------------- ---------------------------
Remaining Life Weighted
Range of Average
Exercise Price Shares in Years Exercise Price Shares Exercise Price
-------------- ------ -------- -------------- ------ --------------
<S> <C> <C> <C> <C> <C>
$ 0.09 to $ 0.89 99 5.0 $ 0.26 99 $ 0.26
$ 1.75 495 3.9 1.75 444 1.75
$ 4.47 to $ 5.00 15 2.8 4.63 15 4.63
$ 5.23 to $ 6.71 1,994 2.9 5.98 1,994 5.98
$ 8.94 to $19.68 99 3.3 9.69 99 9.69
---------- ----------
2,702 3.2 $ 5.13 2,651 $ 5.19
========== ==========
</TABLE>
F-12
<PAGE>
Note 7 Common Stock and Stock Options (continued)
During September 1997 the Company repriced 216,423 of its options to purchase
common shares from various exercise prices to $2.13, the fair market value at
the date of repricing. During December 1997, the Company repriced 335,556 of its
options to purchase common shares from various exercise prices to $1.75 per
share, the fair market value at the date of repricing. The above tables
represent the exercise prices as adjusted for these repricings.
All stock options issued during 1996 and 1997 have an exercise price not less
than the fair market value of the Company's common stock on the date of grant.
For employee options issued in 1996, and in accordance with accounting for such
options utilizing the intrinsic value method, there is no related compensation
expense recorded in the Company's financial statements. Had compensation cost
for stock-based compensation been determined based on the fair value at the
grant dates consistent with the method of SFAS 123, the Company's net loss and
loss per share for the years ended December 31, 1996 and 1997 would have been
increased to the pro forma amounts presented below (in thousands, except per
share data):
1996 1997
---------------- ------------
Net loss
As reported $ (1,966) $ (2,922)
Pro forma $ (2,308) $ (2,922)
Loss per share
As reported $ (0.98) $ (1.31)
Pro forma $ (1.16) $ (1.31)
The fair value of option grants is estimated on the date of grant utilizing the
Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1996: expected life of options of 5 years, expected
volatility of 7.6%, risk-free interest rate of 6.4% and a 0% dividend yield. The
weighted average fair value at date of grant for options granted during 1996
approximated $1.34 per option. No options were issued to employees during 1997.
The above proforma disclosures do not include the effect of options granted
prior to 1995 that vest in subsequent years and accordingly are not necessarily
indicative of the financial impact had the disclosure provisions of SFAS 123
been applicable to all years for previous option grants.
Note 8 Related Party Transactions
Two of the co-owners and executive officers of Sunrise Systems, the provider of
the Company's Expanded License as described in Note 6, are members of the
Company's Board of Advisors. Sunrise Systems owns options to acquire
approximately 60,000 shares of Company common stock (36,000 exercisable at $9.93
per share, 18,400 exercisable at $0.09 per share and 5,600 exercisable at $0.89
per share). During 1997, Sunrise Systems acquired 18,697 shares of Company
common stock in exchange for certain amounts owed.
Amounts due to related parties consist of accounts payable to certain
shareholders for services rendered to Pro.net prior to the purchase date.
F-13
<PAGE>
Note 9 Income Taxes
At December 31, 1997 and 1996, the Company had deferred tax assets of
approximately $2,500,000 and $2,200,000, respectively, principally arising from
net operating loss carryforwards for income tax purposes. As management of the
Company cannot determine that it is more likely than not that the Company will
receive the benefit of these assets, a valuation allowance equal to the deferred
tax asset has been established at both December 31, 1997 and December 31, 1996.
As of December 31, 1997 the Company had net operating loss carryforwards
available to reduce taxable income in future years of $6,400,000, which begin to
expire in 2011. As a result of changes in stockholder ownership, utilization of
net operating loss carryforwards could be subject to annual limitation.
Note 10 Operating Lease Commitments
The Company leases FM side bands for transmission to electronic display signs
located on-board public transit vehicles. One of the FM side band leases is
pursuant to an agreement expiring December 2001, which requires annual payments
of $30,000. The other FM side band lease is on a month-to-month basis. Also, the
Company leases two office facilities under operating leases, with monthly
payments of $1,781 and $2,770, expiring in November 1999 and July 2000,
respectively. Future annual minimum lease payments for all leases are as
follows:
Year ending ($ in thousands)
December 31, Total
------------ -----
1998 $ 85
1999 83
2000 49
2001 30
$ 247
Rental expense for the year ended December 31, 1997 and 1996 under the operating
leases was $89,000 and $54,000.
Note 11 Commitments and Contingencies
The former stockholder of hip has initiated a lawsuit in the Supreme Court of
British Columbia against hip and the Company claiming, among other things,
damages for breach of contract in the amount of approximately $550,000 Canadian
(approximately $400,000 U.S.), plus unqualified punitive damages. The Company
denies these claims and intends to vigorously defend this lawsuit and, further,
in this regard, the Company has counterclaimed against the plaintiffs for, among
other things, damages for misrepresentations and breach of contract. Company
management currently believes that resolving these various legal proceedings and
claims will not have a material adverse impact on the Company's financial
position, results of operations or cash flows. No provision for loss has been
reflected in the financial statements as a result of this contingency.
The Company has a contract to provide services with the Dallas Rapid Transit
authority ("DART") that includes a provision for a 4% royalty paid to DART on
certain gross advertising receipts. The agreement expires in October 2001.
During the year ended December 31, 1997 the Company entered into a letter of
intent with Advanced Communication and Information Services ("ACIS") to acquire
all of the issued and outstanding voting stock of ACIS in exchange for DDN
common shares. Under provisions of the letter of intent, the Company forwarded
ACIS $1,048,000 pursuant to terms of five promissory notes to be used as working
capital pending the completion
F-14
<PAGE>
DIGITAL DATA NETWORKS, INC.
NOTES TO FINANCIAL STATEMENTS
Note 11 Commitments and Contingencies (continued)
of the acquisition. Subsequently, ACIS issued to the Company 1,000,000 shares of
ACIS common stock and withdrew from the letter of intent. In accordance with the
terms of the agreement, the operating cash forwarded to ACIS was to be repaid in
full, however, ACIS has defaulted on that debt. On April 2, 1998, the Company
received a judgment from the King County Superior Court in the State of
Washington against ACIS, ordering them to pay the Company the amount of the
loan, plus interest, plus a $300,000 cancellation fee. As management has been
unable to determine either the financial stability of ACIS, or the amount, if
any, the Company will eventually recover, the entire amount of the receivable
has been reserved at December 31, 1997.
In December 1997, the Company announced its intention to cease a start-up
operation in Providence, Rhode Island as a result of continuing net operating
losses of that venture, and that it would also stop marketing certain related
products. Consequently, the Company has notified the Rhode Island Public Transit
Authority ("RIPTA") that it would not be able to complete the contract that it
had been previously awarded. No provision for loss has been reflected in the
financial statements as a result of this contingency as the fair value of the
ventures assets exceeds the associated net book value.
Note 12 Segment and Geographic Information
The Company operates in two business segments, transit networks and internet
services, which also correspond to the regional segments of the United States
(principally Dallas) and Canada (principally Vancouver). There are no
significant sales between the two segments, and the United States segment
includes the corporate office for DDN. The following table summarizes certain
selected financial information of the Company's balance sheet and operating
results, on a segment basis:
<TABLE>
<CAPTION>
($ in thousands)
United States Canada
(Transit Networks) (Internet Services) Consolidated
------------------ ------------------- ------------
<S> <C> <C> <C>
Year-ended December 31, 1997
Sales $ 524 $ 365 $ 889
Operating Loss $ 2,286 $ 667 $ 2,953
Depreciation and Amortization $ 184 $ 133 $ 317
Capital Expenditures $ 52 $ 23 $ 75
Total Identifiable Assets $ 1,062 $ 168 $ 1,230
Year-ended December 31, 1996
Sales $ 493 $ 190 $ 683
Operating Loss $ 1,255 $ 852 $ 2,107
Depreciation and Amortization $ 257 $ 170 $ 427
Capital Expenditures $ 13 $ 2 $ 15
Total Assets $ 3,618 $ 659 $ 4,277
</TABLE>
Note 13 Significant Customer
Revenues from major customers exceeding 10% of total revenue for the year ended
December 31, 1996 included one customer, Dallas County Community College,
accounting for approximately 10% of the consolidated revenues. There were no
customers exceeding 10% of consolidated revenue during the year ended December
31, 1997.
Note 14 Significant Changes in the Fourth Quarter
In December 1997, the Company recognized the effect of reserving a note
receivable from a failed acquisition target by recording a $1,048,000 charge to
1997 fourth quarter earnings. The Company also recorded a $343,000 loss related
to goodwill acquired through the purchase of a subsidiary in 1996 by recording a
charge to fourth quarter earnings.
F-15
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1997
<CASH> 540
<SECURITIES> 0
<RECEIVABLES> 378
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,010
<PP&E> 1,690
<DEPRECIATION> 1,543
<TOTAL-ASSETS> 1,230
<CURRENT-LIABILITIES> 462
<BONDS> 278
<COMMON> 13,399
0
0
<OTHER-SE> (12,914)
<TOTAL-LIABILITY-AND-EQUITY> 1,230
<SALES> 889
<TOTAL-REVENUES> 889
<CGS> 580
<TOTAL-COSTS> 3,842
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (31)
<INCOME-PRETAX> (2,922)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,922)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,922)
<EPS-PRIMARY> (1.31)
<EPS-DILUTED> 0
</TABLE>
