<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K/A
_X_ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
Commission File Number 000-26668
HITSGALORE.COM, INC.
- ------------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
FLORIDA 65-0036344
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
10134 6th STREET, SUITE J., RANCHO CUCAMONGA, CA 91730
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(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code (417) 335-2297
SYSTEMS COMMUNICATIONS, INC.
- ------------------------------------------------------------------------------
(Former Name)
4707 140th AVENUE NORTH, CLEARWATER, FL (727) 530-4800
- ------------------------------------------------------------------------------
(Former address and telephone number)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
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 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.
Yes _X_ No __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants' knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. _X__
(Continued on next page)
<PAGE> 2
The aggregate market value of the voting stock held by non-affiliates of the
registrant on March 31, 1998, (based on the average of the high and low bid
prices of such stock on the over-the-counter securities market) was
$3,023,000.
The number of shares of the registrant's common stock, $.001 par value,
outstanding as of March 31, 1998 was 14,174,052.
[REMAINDER OF PAGE LEFT BLANK]
<PAGE> 3
ITEM 1. BUSINESS.
Hitsgalore.com, Inc. (the "Company"), formerly Systems Communications, Inc.,
is a Florida corporation. The Company was incorporated as Florida One Capital
Corporation in 1987 and made an initial public offering of its common stock in
1988 as a "blank check" company for the purpose of acquiring other companies.
The Company underwent several corporate name changes from its inception until
1991 when it changed its name to Systems Communications, Inc. During 1990 and
1991, the Company acquired companies engaged in merchandising optical products
and developing residential properties. These acquisitions were rescinded and
Company was inactive from 1991 until August 1994. Beginning in August 1994,
the Company acquired a number of companies engaged in various
telecommunications businesses and businesses engaged in the healthcare cost
containment industry. On March 19, 1999, the Company and Hitsgalore.com, a
Nevada corporation, completed a reorganization and merger agreement (the
"Merger and Reorganization Agreement"). Pursuant to the Merger and
Reorganization Agreement, (a) the Company transferred its existing business,
properties and assets to International Healthcare Solutions, Inc. ("IHSI"), a
newly formed wholly owned subsidiary, and caused IHSI to assume the
obligations, debts and liabilities of the Company and, then, (b)
Hitsgalore.com was merged into the Company and the Company changed its name to
Hitsgalore.com, Inc. The Company also transferred the outstanding shares of
common stock of IHSI into a constructive trust for the benefit of and
distribution to the Company's stockholders.
All of the disclosures contained herein are for periods prior to the
completion of the Reorganization and Merger Agreement.
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<PAGE> 4
The following table sets forth the name of each acquired company, beginning
in 1994, the year of its acquisition by the Company, the general nature of
its business and, if applicable, year of its disposition by the Company.
<TABLE>
Year Year of
Name Acquired Business Disposition (5)
- ---- --------- ------------------ ---------------
<S> <C> <C> <C>
Ameristar 1994 Pay-per-view 1997 (1)
Telecommunications, Inc. television
("ATI") services and products
Coast Communications, 1994 Installation of 1996 (1)
Inc.("CCI" or pay-per-view
"Coast") television equipment
LCI Communications, 1995 Switch-less reseller 1997 (2)
Inc. ("LCI") of long-distance
telephone services
Comstar Network 1995 Switch-less reseller 1997 (2)
Services, Inc. of long-distance
("Comstar") telephone services
Affiliated Communications 1995 Switch-less reseller 1997 (4)
Integrators Corp. of long-distance
telephone services
Telcom Network, 1995 Switch-less reseller 1997 (3)
Inc. ("TNI") of long-distance
telephone services
National Solutions 1995 Healthcare cost N\A
Corporation ("NSC") containment services
and products
Health Management 1996 Developer of medical 1997 (1)
Technologies, Inc. management computer
("HMT") software
</TABLE>
____________
(1) Transaction rescinded or business abandoned.
(2) Business and assets transferred to TNI. The Company is now a dormant
wholly owned subsidiary.
(3) Business sold. The Company is now a dormant wholly owned subsidiary.
(4) This Company was inactive at the date of its acquisition and is a
dormant wholly owned subsidiary of the Company.
(5) For a description of the effect of the rescissions and sales identified
in this table, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial
statements and the notes thereto appearing elsewhere herein.
____________
The principal executive offices of the Company are located at Suite 107, 4707
140th Avenue North, Clearwater, Florida 33762 and the telephone number at
that office is (727) 530-4800.
<PAGE> 5
Business Development and Suspended Operations-
With the acquisition of NSC in 1995, the Company entered the healthcare cost
containment field. The Company pursued development for commercial use of
healthcare management information systems technology designed to manage
healthcare benefit costs. The Company licensed the systems technology
("Champus Software") and statistical databases under a Cooperative Research
and Development Agreement ("CRDA") with the U.S. Army. The Champus Software
and statistical data bases are part of the Civilian Health and Medical Program
for the Uniformed Services ("Champus") program developed by the U.S. Armed
Services. The CRDA expired in June 1998. As a result, the Company's license
agreement to use the Champus systems and databases is non-exclusive. As
discussed below, the Company suspended further development of its systems
technology in June 1997 and has not determined if it will initiate any further
development efforts or if the existing license will be of any future benefit
to the Company. Accordingly, the Company wrote off its investment in the
acquired software and technology as of December 31, 1996.
The Company initially enhanced the Champus Software, which it has copyrighted
under the name "Continuum", to improve the management and administration of
healthcare benefits by intelligent application of data analysis with
strategies to identify misapplied expenditures and overpayments. The
proprietary enhancements included in Continuum significantly expanded its
capabilities as a healthcare claims case management, treatment analysis and
data mining tool for use by commercial users in controlling their healthcare
costs. The Company planned to operate a data center using Continuum and sell
the benefits of the Continuum operating system to the U.S. automotive
industry, other large, self-insured companies, healthcare insurers, PPO's,
HMO's, healthcare benefit plan administrators and large pharmaceutical
companies who the Company believes have a need to analyze the outcomes of
medical treatment regimes and drug therapies. The Company suspended further
development of Continuum in June 1997, prior to completion of a fully working
and marketable management information operating system.
In 1993 and 1995, respectively, NSC entered into service agreements with
Chrysler Corporation and Ford Motor Company to audit healthcare claims which
had been previously paid. Both companies have self-insured health programs for
its employees administered by third party administrators. The purpose of the
audits was to recover payments of claims which were not covered under their
self-insured health benefit programs. In 1993, the Company entered into a
subcontract agreement with Health Management Services ("HMS"), a healthcare
claims management company located in New York, NY, under which HMS used its
own analytical software to audit these healthcare claims. The Company
received ten to thirty percent of recovered payments and generally shared half
of its receipts from recovered claims with HMS. Due to a dispute between the
Company and HMS, the subcontract with HMS was terminated in May 1997; and, due
to performance issues between Chrysler Corporation and HMS, the Company's 1993
service agreement with Chrysler Corporation was terminated in September 1997.
The Company's 1995 service agreement with Ford Motor Company expired by its
terms in March 1997.
Continuing Operations-
In September 1997, the Company entered into an alliance agreement with HMG
Health Care Claims Auditing, Inc. located in Pittsburg, PA ("HMG") to replace
HMS as the Company's subcontractor for healthcare cost containment contracts
the Company might obtain in the future. The Company believes HMG's proprietary
computer software programs provide a greater range of healthcare cost
containment features and services than those offered by HMS. These features
and services include, among others, electronic review and reporting of health
care claims paid and on an ongoing basis to identify duplicate, erroneous or
medically inconsistent charges, payments for ineligible patients and other
responsible party liabilities from other group benefit programs, workers'
<PAGE> 6
compensation coverage, motor vehicle or third party liability coverage,
payments for non-covered services, misapplied deductibles and co-payments and
provider agreement compliance.
The Company was able to negotiate a service agreement with Chrysler
Corporation beginning January 1998 to perform pharmaceutical retrospective
analysis and recovery services. As a result of the Company's uncertain
financial condition, however, Chrysler Corporation and HMG entered into the
agreement directly. Pursuant to the services agreement between HMG and
Chrysler Corporation and the alliance agreement between the Company and HMG,
the Company and HMG are to receive a monthly fee of $4,000 and $12,000,
respectively, from Chrysler Corporation and will share on a 50%-50% basis
twenty percent (20%) of the claim recoveries, up to a maximum of $5,000,000
in claim recoveries, under the services agreement between HMG and Chrysler
Corporation. HMG began performance under the services agreement with Chrysler
Corporation in May 1998.
Following suspension of development of Continuum, the Company redirected its
business to focus on the development of a network of healthcare cost
containment companies, providers of healthcare products and services and
third-party healthcare plan administrators, beginning with HMG, with an
objective of obtaining the right to market a wide array of non-competing
healthcare cost containment services and products to large, self-insured
companies on a fee or revenue sharing basis. Subsequent to December 31, 1997,
the Company also entered into an alliance agreement with Haddon National
Companies, Inc. located in Maple Shade, NJ ("HNCI") and was negotiating an
agreement with a major pharmaceutical manufacturer. The alliance agreement
with HNCI gives the Company the ability to sell and market HNCI's claims
administration and processing services, medical and surgical cost containment
services and Medicare A and B validation services to large self-insured
corporations, third party administrators, commercial health insures and other
managed healthcare companies. The agreement under negotiation with a major
pharmaceutical manufacturer, if consummated, would allow the Company to sell
and market the healthcare cost containment products of its other alliance
partners to the customers of the pharmaceutical manufacturer.
Market and Marketing-
The market for the products and services offered and expected to be offered
by the Company include large corporations that self-insure and rely on third-
party administrators to manage their healthcare benefit programs, the third-
party administrators themselves, HMO's, PPO's and healthcare insurers.
Healthcare programs administered by state and municipal governments also
represent potential customers for the products and services the Company
expects to market. The Company believes that interest in healthcare cost
containment, including recovering payments of healthcare claims which should
not have been made and prepayment screening of claims, will become
increasingly more important to large corporations, third-party
administrators, HMO's, PPO's and healthcare insurers.
Competition-
The Company is not aware of any other organizations that market the services
of multiple providers of healthcare cost containment and case management
products and services. The Company believes its primary competition is the
providers of such services with whom the Company does not have a marketing
agreement or affiliation. The Company believes that this field is
fragmented, with many companies providing healthcare claims auditing and
prepayment claims screening services.
Licenses and Copyrights-
The Company has a non-exclusive license to use the Champus Software and
databases to perform evaluation, analysis and recovery of benefit payments
<PAGE> 7
involving the healthcare benefit programs of the U.S. automotive industry and
their down-line vendors, including indemnity claims, coordinated benefits and
workers compensation claims, and to perform in-depth studies of the U.S.
automobile industry's healthcare benefit programs ("field of use"). The
Company also has the ability, with prior approval of the U.S. Army, to use
the Champus Software and databases to analyze the healthcare benefits of
companies outside of the U.S. automotive industry. As mentioned above, the
Company has not determined if this license has any future benefit to the
Company in light of its decision to suspend development and commercialization
of the Champus software technology.
NSC is not required to turn over to the U.S. Army the enhancements which it
has made to the CHAMPUS Software in the development of Continuum and is
entitled to patent any inventions made and copyright any works created under
the CRDA.
Facilities and Employees-
The Company does not own any facilities. All office space, consisting of a
corporate office with approximately 1,450 sq. ft., is leased. The monthly
rental is approximately $1,600. The Company believes the leased facilities
are adequate for its current needs and that additional suitable space will
be available as needed. The Company has three executive employees and one
administrative assistant. The Company makes extensive use of independent
contractors for accounting, administration and sales and marketing and
currently has approximately 10 persons under contract providing such
services. The Company also has commission-based marketing representatives who
serve over 20 major metropolitan areas.
Segment Information-
For the past three fiscal years the Company has operated in two industry
segments: healthcare management information products and services ("Healthcare
Management"); and, telecommunications products and services
("Telecommunications"). The healthcare segment includes the operations of NSC
and HMT from their respective dates of acquisition; and, the
telecommunications segment includes the operations of TNI, Comstar and LCI
from their respective dates of acquisition and the operations of ATI and CCI
for all periods presented. In 1996 and 1997, the Company disposed of
substantially all of the assets of its telecommunications businesses.
Consequently, the healthcare segment is the only segment in which the Company
has continuing operations. The operations of the Company's telecommunications
segment are classified as discontinued operations in the consolidated
statements of operations for all periods presented.
Following is a summary of segment information for each of the three years in
the period ended December 31, 1997:
<TABLE>
1997 1996 1995
----------- ------------ ----------
<S> <C> <C> <C>
Healthcare:
Net revenues $ 1,498,353 $ 2,832,123 $ 91,106
Operating loss(1) (1,502,336) (17,104,177) (363,857)
Telecommunications:
Net revenues 405,617 2,177,858 2,893,778
Operating loss(2) (91,768) (2,232,649) (4,036,371)
</TABLE>
(1) Includes impairment and other losses of $1,898,953 in 1997 and $14,233,953
in 1996. See Note 5 to the consolidated financial statements.
(2) Includes impairment and other losses of $494,901 and $2,758,779 in 1996
and 1995, respectively. See Note 5 to the consolidated financial statements.
<PAGE> 8
ITEM 2. PROPERTIES.
The Company and its subsidiaries do not own any properties. All office space
is leased and the Company believes the leased facilities are adequate for its
current needs and that additional suitable space will be available as
required.
The following table sets forth information with respect to the office space
leased by the Company and its subsidiaries as of December 31, 1997.
<TABLE>
Square Annual Lease
Entity Location Footage Rental Expiration Date
- ----------- ------------------- ------- -------- ---------------
<S> <C> <C> <C> <C>
The Company 4707 140th Avenue N.
Suite 107
Clearwater, Florida 1,450 $19,478 05-31-98
NSC 4241 Piedras
San Antonio, TX (1) 4,429 47,832 11-30-00
</TABLE>
(1) As of December 31, 1997, the Company is in default of the lease agreement
due to non-payment. The total amount of past due lease payments is
approximately $40,000.
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<PAGE> 9
ITEM 3. LEGAL PROCEEDINGS.
The Company is subject to various legal and administrative proceedings. These
proceedings include (i) a consent order executed between the Company and the
State of Michigan requiring the Company to use its best efforts to satisfy
the prerequisites of the Securities and Exchange Commission and the Michigan
Securities Bureau for registering the common stock sold by the Company to
purchasers of its securities in the State of Michigan, (ii) actions brought
against the Company by certain former employees and persons formerly under
contract with the Company for payments allegedly due them, (iii) an action by
a shareholder seeking the rescission of the sale by the Company of its common
stock to the shareholder, (iv) an action by an equipment lessor seeking
approximately $500,000 in lease payments and other charges due under a lease
agreement and (v) an action by the former stockholders of CCI. These legal
proceedings are more fully described in Note 14 to the consolidated financial
statements included elsewhere herein.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of security holders during the
fourth quarter of 1997.
[REMAINDER OF PAGE LEFT BLANK]
<PAGE> 10
PART II
ITEM 5. MARKET FOR THE REGISTRANTS' COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
The Company's common stock is quoted under the stock symbol "SCMI" on the OTC
Bulletin Board and the over-the-counter market. The following table sets forth
the approximate high and low bid quotations for the Company's Common Stock for
each quarter during the last two years. These bid quotations are inter-dealer
prices without retail markup, mark-down or commission, and may not represent
actual transactions.
Quarter ended High bid Low bid
- ------------- -------- -------
March 31, 1996 $ 17.75 $ 9.375
June 30, 1996 $ 12.375 $ 8.50
September 30, 1996 $ 9.00 $ 6.125
December 31, 1996 $ 5.875 $ 4.25
March 31, 1997 $ 1.50 $ 1.4375
June 30, 1997 $ 0.3125 $ 0.28125
September 30, 1997 $ 0.40625 $ 0.1875
December 31, 1997 $ 0.34375 $ 0.1875
The high and low bid quotations for the Company's common stock on March 31,
1998 were $0.24 and $0.23 per share, respectively. As of the date hereof,
there is no market for the Company's outstanding warrants, options or
debentures and a market is not expected to develop.
The Company has not paid any dividends on its common stock from the date of
its incorporation. There are no restrictions on the declaration or payment of
dividends or any provisions which restrict dividends. The payment by the
Company of dividends in the future rests within the discretion of the
Company's Board of Directors and will depend, among other things, upon the
Company's earnings, its capital requirements, its financial condition and
other relevant factors.
As of March 31, 1998, the Company had 558 registered owners of its common
stock.
<PAGE> 11
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected financial data of the Company for each
of the five years in the period ending December 31, 1997. The selected
financial data for the years ended December 31, 1997 and 1996 has been
restated to (i) reflect the operations, assets and liabilities of CCI, and
related acquisition indebtedness, in the consolidated financial statements and
(ii) to value the shares of common stock returned to the Company's in
connection with rescinded business acquisitions at their fair market value on
the dates of the respective rescission transactions (see note 20 to the
consolidated financial statements). This table should be reviewed in
conjunction with the consolidated financial statements of the Company and the
notes thereto appearing elsewhere herein.
<TABLE>
INCOME STATEMENT DATA:
Year Ended December 31,
---------------------------------------------------------
1997 1996 1995 1994 1993
--------- ---------- --------- ------- -------
<S> <C> <C> <C> <C> <C>
Net revenues $1,498,533 $ 2,832,123 $ 91,106 $ -- $ --
Loss from
continuing operations
before income
taxes(1)(2) (3,644,074) (20,488,639) (2,004,228) (78,233) --
Loss from continuing
Operations (3,038,574) (18,048,489) (1,989,104) (78,233) --
Income(loss) from
operations of
discontinued
telecommunications
businesses (1) 391,752 (1,508,179) (3,818,921) (50,769) 338,909
Gain from disposition
of discontinued
telecommunication
businesses 596,648 -- -- -- --
--------- ---------- --------- ------- -------
Net income (loss) $(2,050,174) $(19,556,668) $(5,808,025) $(129,002) $338,909
========= ========== ========= ======= =======
Basic and diluted
earnings per share:
Loss from continuing
operations $ (.28) $ (2.16) $ (0.58) $ (0.06) $ --
Income(loss) from
operations of
discontinued
telecommunications
businesses .04 (0.18) (1.23) (0.04) 0.41
Gain from
disposition of
telecommunication
discontinued businesses .05 -- -- -- --
--------- ---------- -------- ------- -------
Net income (loss) $ (.19) $ (2.34) $ (1.81) $ (0.10) $ 0.41
========= ========== ========= ======= =======
Weighted average number
of common shares
outstanding 10,802,103 8,349,459 3,201,991 1,306,493 825,765
========== =========== ========= ========= =======
<PAGE> 12
BALANCE SHEET DATA (3):
December 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
--------- ---------- ---------- -------- -------
Current assets $ 256,883 $ 1,403,881 $ 4,156,868 $ 442,069 $492,216
Current liabilities 7,028,193 8,208,138 5,417,864 652,107 13,335
Total assets 388,194 5,847,300 21,545,654 780,222 578,549
Long-term liabilities(4) 310,794 1,207,488 4,597,671 77,750 553,750
Common stock subject
to rescission(5) 674,124 709,124 789,624 -- --
Common stock to be
issued(6) -- 2,000,000 2,000,000 -- --
Stockholders' equity
(deficiency in assets) (7,624,917) (6,277,450) 8,740,495 50,365 11,464
</TABLE>
(1) Includes impairment and other losses of $1,898,953 and $14,233,953 in
1997 and 1996, respectively, applicable to continuing operations and $494,901
and $2,758,779 in 1996 and 1995, respectively, applicable to operations of
discontinued telecommunications businesses. See Note 5 to the consolidated
financial statements appearing elsewhere herein.
(2) Includes a loss of $1,595,412 from the disposition of HMT in 1997. This
loss was principally due to a decrease in the Company's stock price from the
date of the acquisition to the date of the rescission transaction.
(3) Includes the assets and liabilities of discontinued telecommunications
businesses. See Note 4 to the consolidated financial statements appearing
elsewhere herein.
(4) Includes long-term portion of notes and debentures payable; obligations
under capital leases, deferred compensation and other long-term liabilities.
(5) See Note 14 to the consolidated financial statements appearing elsewhere
herein for a description of common stock subject to rescission.
(6) Consists of shares issuable in connection with business acquisitions. See
Note 4 to the consolidated financial statements appearing elsewhere herein.
<PAGE> 13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
The following table sets forth certain information derived from the
consolidated financial statements of the Company for each of the three years
in the period ended December 31, 1997. The results from continuing operations
include the operations of NSC, acquired in October 1995,and HMT, acquired in
March 1996 and disposed of by a rescission of the acquisition agreement in
June 1997. The results from discontinued telecommunications businesses include
the operations of TNI (including the operations of LCI and Comstar), ATI and
CCI. These businesses were sold or otherwise disposed of in 1996 and 1997. The
following discussion should be read in conjunction with the consolidated
financial statements and notes thereto appearing elsewhere herein.
<TABLE>
Year Ended December 31,
-------------------------------------
1997 1996 1995
----------- ---------- ---------
<S> <C> <C> <C>
Operations of continuing businesses:
Net revenues $ 1,498,533 $ 2,832,123 $ 91,106
Cost of revenues 109,563 827,063 --
Selling and administrative
expenses 3,027,384 6,322,627 1,887,275
Impairment and other losses 1,898,953 14,233,953 --
Depreciation and amortization 497,377 1,459,436 148,192
Loss from disposition of subsidiary 1,595,412 -- --
Gain from sale of license agreement 2,695,214 -- --
Interest income 4,070 8,183 3,777
Interest expense 587,884 381,975 63,644
Other income (expense), net (125,318) (103,891) --
Loss from continuing operations before
income taxes (3,644,074) (20,488,639) (2,004,228)
Operations of discontinued
telecommunications businesses:
Net revenues 405,617 2,177,858 2,893,778
Cost of revenues -- 1,320,256 2,014,460
Selling and administrative expenses 449,925 2,304,059 1,845,775
Impairment and other losses -- 494,901 2,758,779
Depreciation and amortization 47,460 291,291 311,135
Interest income -- 971 627
Interest expense 32,393 38,713 20,466
Other income (expense), net 755,913 832 4,288
Income (loss) from operations of
discontinued businesses
before income taxes 631,752 (2,271,223) (4,060,498)
</TABLE>
The operating results of acquired businesses are well below those which were
anticipated at the time of the respective acquisitions. As more fully
discussed below, the business of TNI was severely damaged by the actions of GE
Capital Communications Services, Inc, ("GECCS") and New Enterprises Wholesale
Services, Limited Partnership ("News"); and, the revenues and results of
operations of the Company's healthcare businesses are less than anticipated at
the time of their respective acquisitions, principally due to higher levels of
spending on software and systems development and on sales and marketing than
originally
<PAGE> 14
anticipated (and limitations on the part of the Company to continue to fund
those collective efforts). These factors, combined, have strained the
financial resources of the Company and required the Company to undertake
restructuring measures, which included, among other things, the sale of the
operating assets of TNI in January 1997 and the rescission of the ATI and HMT
acquisition agreements in May and June 1997, respectively. For further
discussion of the impact of these events and uncertainties on future
operations and the Company's financial condition, see "Liquidity and Capital
Resources"
OPERATIONS OF BUSINESS ACQUIRED AND DISPOSED OF
The Company acquired various businesses in 1996 and 1995 and disposed of
various businesses in 1996 and 1997. The more significant acquisitions were:
TNI acquired in July 1995; NSC acquired in October 1995; and, HMT acquired in
March 1996. Disposals of businesses included (i) the sale, in January 1997, of
the operating assets of TNI, (ii) the rescission, in May 1997, of the ATI
acquisition agreement and (iii) the rescission, in June 1997, of the HMT
acquisition agreement (see Note 4 to the consolidated financial statements
appearing elsewhere herein). As a result of the disposition of all businesses
included in the Company's telecommunications segment, the operations of the
Company's telecommunications segment are shown as discontinued operations in
the accompanying consolidated statements of operations for all periods
presented.
For purposes of the following discussion, the operations of TNI include the
operations of TNI, LCI and Comstar. TNI, LCI and Comstar all operate as
switch-less re-sellers of long-distance telephone services and products and
were combined into one operating division after the acquisition of TNI.
In 1997, TNI had no revenues and its loss from operations was $52,307. The net
revenues and loss from operations of TNI were $1,481,317 and $1,792,795,
respectively, in 1996 and $2,373,491 and $3,122,621 (including impairment
losses of $2,758,779), respectively, for the period from the date of its
acquisition by the Company (July 7, 1995) to December 31, 1995. TNI's
operating results for the periods subsequent to the date of acquisition were
adversely affected by (i) the failure of GECCS and News to, among other
things, provision customer accounts for telecommunications products offered by
GECCS/News and sold by TNI pursuant to a contractual agreement among TNI,
GECCS and News (the "GECCS Agreement"), (ii) the cancellation of TNI customers
by GECCS and News, (iii)the failure of GECCS/News to properly bill and collect
revenues due to TNI and (iv) a diminution of TNI's marketing and distribution
organization as a result of such failures and other actions taken by GECCS and
News. TNI, as claimant in a binding arbitration proceeding against GECCS and
News, was awarded damages under the GECCS Agreement in the amount of
approximately $1,250,000. The award, which was entered on October 10, 1996,
was appealed by GECCS to the U.S. District Court for the Northern District of
Georgia on the grounds that the arbitrators exceeded their powers by awarding
TNI damages under the GECCS Agreement. On September 30, 1997, the U.S.
District Court confirmed the award; and, a motion for summary judgment was
entered on October 1, 1997. On December 24, 1997, the Company, GECCS and News
entered into a Confidential Settlement Agreement and Mutual Full and Final
Releases (the "Settlement Agreement"). Pursuant to the Settlement Agreement,
GECCS\News paid $1,250,000 in full satisfaction of the arbitration award. Of
that amount, the Company received approximately $750,000, which is net of
legal fees. The net proceeds from the Settlement Agreement were used to pay
trade and other obligations. The net proceeds from the Settlement Agreement
are reflected in income (loss) from discontinued operations in the
accompanying consolidated statement of operations for the year ended December
31, 1997.
<PAGE> 15
The diminution in TNI's marketing and distribution organization that occurred
as a result of such failures and other actions taken by GECCS and News,
together with limitations on the ability of the Company to provide additional
working capital to TNI, also adversely affected TNI's operations. As a result
thereof, in January 1997, the Company disposed of substantially all of TNI's
operating assets.
The revenues of TNI declined from $2,373,491 in 1995 to $1,481,317 in 1996.
This decrease is principally the result of reduced revenues from the GECCS
Agreement. The operating loss of TNI was $343,842 in 1995 (before $2,758,779
of impairment losses) compared to $1,792,795 in 1996. The increase in TNI's
operating loss (before impairment losses) is due to the reduction in revenues
from the GECCS Agreement and valuation adjustments recorded at year-end 1996
to reduce assets sold in January 1997 to their net realizable value and the
write-off of the Company's remaining investment in Comstar, including
goodwill, the effects of which were not fully offset by reduced operating
expenses. Asset valuation adjustments recorded at year-end 1996 totaled
approximately $370,000 and the write-off of the Company's investment in
Comstar totaled approximately $194,000.
In 1997 NSC had net revenues of $187,478 and an operating loss of $1,348,679.
NSC's operating loss for the year ended December 31, 1997 reflects impairment
and other losses of approximately $892,000. Excluding these items, NSC's 1997
operating loss would have been approximately $457,000. The net revenues and
operating loss of NSC were $1,574,825 and $16,275,288 , respectively, in 1996
and $91,106 and $363,857 respectively, for the period from the date of its
acquisition by the Company (October 27, 1995) to December 31, 1995. The loss
from operations of NSC in 1996 includes one-time charges of $14,233,953, to
write-off, as of December 31, 1996, the unamortized cost of intangibles and
goodwill recorded by the Company in connection with its acquisition of NSC.
The write-off of the unamortized cost of goodwill and intangibles recorded in
connection with the acquisition of NSC is due to the failure of NSC to
successfully market its healthcare management information systems technology,
the likelihood that NSC may not be able to market such technology in the
future without further significant capital investment and the likelihood of
the Company being able to provide NSC with additional capital investment (see
"Liquidity and Capital Resources"). The decrease in NSC net revenues from 1996
to 1997 is the result of the termination of the Chrysler service agreement,
effective in September 1997, due to performance issues between Chrysler and
HMS, NSC's subcontractor, the expiration of the Ford Motor Company services
agreement by its terms, effective March 31, 1997, and lower healthcare claim
recoveries under the service agreements from period to period. NSC's operating
loss decreased from 1996 to 1997 due principally to the elimination of NSC'
corporate offices, lower management compensation as a result of the retirement
of founding management and the suspension of software development activities
due to cash flow constraints.
The net revenues and loss from operations of HMT were $1,311,055 and $153,656,
respectively, for the period from January 1, 1997 to the date of the
rescission of the HMT acquisition agreement and $1,257,298 and $828,895,
respectively, for the period from the date of its acquisition by the Company
to December 31, 1996. HMT's 1997 net revenues reflect sales to one customer
totaling approximately $800,000. HMT's operating losses during the periods
principally reflect amortization of intangibles and goodwill recorded in
connection with the acquisition and spending for new product development.
The revenues and operating losses of ATI were $405,617 and $39,461,
respectively, for the period from January 1, 1997 to the date of disposition,
$673,995 and $116,460, respectively, in 1996, and $427,445 and $289,791,
respectively, in 1995. The increasing trend in revenues reflects the
introduction of ATI's OSP and PPV services, beginning in 1996, into the
Mexican hospitality market. Similarly, operating losses have decreased from
period to period due to higher OSP and PPV revenues from Mexico which carry
higher profit margins when compared to margins from domestic sales.
<PAGE> 16
NET REVENUES
Net revenues for each of the three years in the period ending December 31,
1997 are summarized as follows:
<TABLE>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Net revenues from operations of
continuing businesses $ 1,498,533 $ 2,832,123 $ 91,106
Net revenues from discontinued
telecommunications businesses 405,617 2,177,858 2,893,778
---------- ---------- ----------
$ 1,904,150 $ 5,009,981 $ 2,984,884
========== ========== ==========
</TABLE>
The decrease in net revenues from operations of continuing businesses from
1996 to 1997 is the result of lower NSC revenues, offset by higher HMT
revenues. See "Operations of Businesses Acquired and Disposed Of." The
decrease in net revenues from discontinued telecommunications businesses is
the result of the sale of the operating assets of TNI in January 1997 and the
disposition of ATI in May 1997.
The increase in net revenues from operations of continuing businesses from
1995 to 1996 is the result of the acquisitions of HMT and NSC. HMT
contributed $1,257,298 to this increase and NSC contributed $1,483,719. HMT
was acquired in March 1996 and NSC was acquired in October 1995. The decrease
in net revenues from discontinued telecommunications businesses from 1995 to
1996 is due to lower revenues from the GECCS Agreement, offset by an increase
in net revenues of approximately $177,000 from the Company's PPV business,
principally in Mexico.
COST OF REVENUES
Cost of revenues applicable to continuing operations in 1997 declined
substantially as compared to 1996. This decrease is attributable to lower
healthcare claim recoveries under the Chrysler and Ford Motor Company service
agreements and final revenue adjustments recorded in connection with the
Chrysler and Ford Motor Company service agreements. See "Operations of
Businesses Acquired and Disposed Of."
Cost of telecommunications revenues generally consists of the cost of long-
distance services sold by TNI under the GECCS Agreement. In 1997, no revenues
were generated under that agreement. In addition, the operating assets of TNI
were sold in January 1997. See "Operations of Businesses Acquired and
Disposed Of."
The cost of revenues from discontinued telecommunications businesses in 1996
was 61% of net revenues from discontinued telecommunications businesses
compared to 70% in 1995. This decrease is the result of product mix changes,
which included lower revenues from the resale of domestic telecommunication
services under the GECCS Agreement and higher revenues from the sale of pay-
per-view and related telecommunication products to the hospitality industry,
principally in Mexico.
Cost of revenues from discontinued telecommunications businesses was
$2,014,460 in 1995 compared to $134,607 in 1994. This increase was
principally due to the acquisition of TNI and the inclusion of the cost of
long distance services sold by TNI in the cost of telecommunications
revenues. In 1995, the Company also made a provision of $145,776 to reduce
the value of obsolete PPV equipment to net realizable value. Prior to 1995,
the cost of telecommunication revenues principally reflected the cost of PPV
installation, only.
<PAGE> 17
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses applicable to operations of continuing
businesses decreased from $6,322,627 in 1996 to $3,027,384 in 1997. This
decrease principally reflects cost reduction measures undertaken as a result
of continued operating losses and the effect from period to period of the
disposition of HMT (see "Operations of Businesses Acquired and Disposed Of").
The disposition of HMT had the effect of reducing selling and administrative
expenses by approximately $ 443,000 in 1997 versus 1996. Significant cost
reduction measures included the retirement of NSC management in January 1997
and the elimination of all related salaries, wages, benefits, travel and
other administrative expenses of NSC, closure of NSC's corporate offices,
consolidation of the Company's remaining operations, reductions in corporate
staff and termination of certain consulting agreements. As a result of these
cost reduction measures, the selling and administrative expenses of NSC
declined by approximately $1.4 million and corporate expenses declined by
approximately $900,000.
Selling and administration expenses applicable to operations of continuing
businesses increased by $4,093,749 in 1996 over 1995. This increase reflected
the operations of businesses acquired and higher corporate expenses.
Corporate expenses increased primarily due to costs associated with the
registration of the Company's securities under the Securities Exchange Act of
1934, costs related to a failed attempt by the Company to file a registration
statement under the Securities Act of 1933 and costs associated with the
development, sale and marketing of NSC's healthcare management information
products. Offsetting this increase was a reduction in stock compensation
expense and the effect of stock purchase warrants.
Selling and administrative expenses applicable to operations of continuing
businesses increased by $2,150,645 in 1995 over 1994. This increase included
the selling and administrative expenses of acquired businesses and higher
corporate expenses for personnel, office space and information systems for
expanded operations, legal, professional and consulting costs incurred in
connection with the Company's acquisition activities and $793,373 from the
issuance of stock and common stock purchase warrants for services rendered
and in consideration for extension of related party indebtedness.
Selling and administrative expenses applicable to discontinued
telecommunications businesses were $449,925 in 1997, $2,304,059 in 1996,
$1,845,775 in 1995 and $649,036 in 1994. The decrease in 1997 as compared to
1996 was due to the discontinuance of TNI's operations and the rescission of
the ATI acquisition agreement and the increases in 1996 over 1995 and in 1995
over 1994 are due to the acquisition of TNI. See "Operations of Businesses
Acquired and Disposed Of".
IMPAIRMENT AND OTHER LOSSES
Impairment and other losses recognized in 1997 include (i) the write-off
equipment under capital lease and certain other assets related to equipment
under lease from Boston Financial Corporation totaling $768,545, (ii)
provisions for loss contingencies totaling $437,335 related to office space,
which has been vacated, leased equipment that the Company is no longer using
and settlement of actions brought against the Company by Timboon, LTD and
(iii) the write-off of $625,728 of deferred compensation assets. See Note 5 to
the consolidated financial statements appearing elsewhere herein.
<PAGE> 18
In 1996, the Company recognized impairment losses applicable to operations
from continuing businesses of $13,806,557, net of a tax benefit of $427,396,
to write off the unamortized cost, as of December 31, 1996, of intangibles and
goodwill recorded in connection with the acquisition of NSC. The write-off of
the unamortized cost of goodwill and intangibles recorded in connection with
the acquisition of NSC is due to the failure of NSC to successfully market its
healthcare management information systems technology, the likelihood that NSC
may not be able to market such technology in the future without further
significant capital investment and the likelihood of the Company being able to
provide NSC with additional capital investment (see "Liquidity and Capital
Resources").
Impairment losses applicable to discontinued telecommunications businesses
recognized in 1996 consist of the write-off the Company's remaining
investments in Comstar and CCI due to the Company's decision to dispose or
otherwise discontinue the operations of its telecommunications businesses.
As of December 31, 1995, the Company recognized a charge to income of
$2,758,779 to write off, with no associated income tax benefit, all of the
goodwill related to its acquisition of TNI. This write-off, which is included
in the operations of discontinued telecommunications businesses in the
consolidated statement of operations for the year ended 1995, reflects the
Company's belief that the business of TNI was severely damaged as a result of
actions taken by GECCS and News which actions included, among other things,
(i)the failure of GECCS/News to provision customer accounts for
telecommunications products and services offered by GECCS/News and sold by TNI
pursuant to a contractual agreement among TNI, GECCS and News, (ii) the
cancellation of TNI customers by GECCS/News and (iii) the failure of
GECCS/News to properly bill and collect revenues due to TNI. As more fully
discussed herein and in the Notes to the consolidated financial statements,
the Company was awarded approximately $1,250,000 in a binding arbitration
proceeding with GECCS/News. The arbitration award was confirmed by the United
States District Court, Northern District of Georgia on September 30, 1997 and
the Company's motion for summary judgment was entered October 1, 1997. On
December 24, 1997, the Company, GECCS and NEWS entered into a Confidential
Settlement Agreement and Mutual Full and Final Releases (the "Settlement
Agreement"). Pursuant to the Settlement Agreement, GECCS\NEWS paid $1,250,000
in full satisfaction of the arbitration award granted to the Company. Of that
amount, the Company received approximately $750,000, which is net of legal
fees. The proceeds from the Settlement Agreement were used to pay trade and
other obligations of the Company, including $468,000 of notes and debentures
payable.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization applicable to continuing operations decreased by
$962,059 in 1997 as compared to 1996. The decrease principally reflects the
write-off, effective as of December 31, 1996, of the goodwill and intangibles
recorded in connection with the acquisition of NSC.
Depreciation and amortization applicable to both operations of continuing
businesses and operations of discontinued telecommunications businesses
increased in 1996 over 1995 and in 1995 over 1994. These increases are
principally due to the amortization of intangibles and goodwill arising from
business acquisitions and a higher investment in furniture and equipment.
INTEREST EXPENSE
Interest expense applicable to both operations of continuing businesses and
operations of discontinued telecommunications businesses totaled $620,277,
$420,688 and $84,110 in 1997, 1996 and 1995, respectively. The increases from
period-to-period in interest expense are principally due to higher levels of
average borrowings outstanding during the periods and an increase in the
average effective rate on borrowings outstanding during 1997 as compared to
1996.
<PAGE> 19
OTHER ITEMS
In 1997, the Company recognized a loss from the disposition of HMT of
$1,595,412 and a gain of approximately $2,695,000 from the sale of a license
agreement to the founding management of NSC (see Note 4 to the consolidated
financial statements). The Company also incurred $120,000 of financing fees in
connection with the issuance of its 4% convertible debentures. The loss from
the disposition of HMT was principally due to a decrease in the Company's
stock price from the date of its acquisition to the date of the rescission
transaction.
INCOME TAXES
Income tax benefits applicable to continuing operations were 16.6%, 11.9% and
0.75% of pre-tax loss from continuing operations in 1997, 1996 and 1995,
respectively. The principal reasons for the differences between the effective
income tax rates during the periods and the Federal statutory rate of 34% were
the changes during each year in the net deferred income tax valuation
allowance, the tax effects from the rescission of business acquisitions and
impairment losses recognized in 1996. No provisions for taxes currently
payable were made in 1997, 1996 or 1995. As of December 31, 1997, the
Company's deferred income tax assets exceeded its deferred tax liabilities by
$4,509,700, for which the Company has provided a valuation allowance.
LIQUIDITY AND CAPITAL RESOURCES
Over the past three fiscal years, the principal sources of liquidity have
been derived from financing activities. In fiscal 1997, 1996 and 1995, the
Company received cash of approximately $232,000, $2.2 million and $4.1
million, respectively, from the issuance of 205,556 shares, 413,668 shares
and 1,477,874 shares, respectively, of its common stock in reliance upon
exemptions under Regulation D of the Securities Act of 1933 and approximately
$1.6 million, $2.4 million and $475,000, respectively, from the issuance of
notes and debentures payable. In 1997, the Company also received cash of
approximately $371,000 from the disposition of businesses, net of cash of
businesses disposed of. Payments on notes, debentures and capital leases
during the respective periods were approximately $687,000, $638,000 and
$263,000. In 1997, the Company also used approximately $75,000 and $35,000 in
cash, respectively, to repay borrowings outstanding under lines of credit and
for the repurchase of common stock subject to rescission; and, in 1995 used
cash of approximately $1.4 million to acquire NSC. Capital expenditures
ranged from a low of approximately $7,700 in 1997 to a high of approximately
$553,000 in 1996.
The Company has incurred substantial operating losses; and, at December 31,
1997, the Company has an excess of total liabilities over total assets of
approximately $7.6 million and an excess of current liabilities over current
assets of approximately $6.8 million. These factors, among others, have
diminished the Company's ability to attract equity or debt capital, have
required the Company to cease further development of its healthcare
management software technology and redirect its business and have made it
increasingly difficult for the Company to carry on normal operating
activities. As of December 31, 1997, the Company does not have any used or
unused lines of credit or any other committed and unused financing
facilities. Consequently, it is uncertain whether or not the Company will
have available sufficient cash resources to continue operations, in which
case the Company would be required to seek other alternatives, including
sale, merger or discontinuance of operations.
The proceeds from financing activities were used principally to fund
operating losses. In fiscal 1997, 1996 and 1995, the Company used cash of
approximately $1.4 million, $4.2 million and $1.8 million, respectively, in
operating activities. See the consolidated statements of cash flows.
<PAGE> 20
Significant debt financing transactions during 1997, 1996 and 1995 were the
issuance in February 1997 of $1,120,000 4% convertible debentures due October
1, 1998 to Timboon, LTD ("Timboon", a non U.S. person) in reliance upon
exemptions under Regulation S of the Securities Act of 1933 and the issuance
in 1996 of (i) a series of 10% cumulative convertible debentures, due on
various dates through November 1997, issued in reliance upon exemptions under
Regulation D of the Securities Act of 1933 and (ii) $500,000 10% cumulative
convertible debentures, due in November 1997, issued to RANA Investment
Company ("RANA") and an affiliate of RANA (non U.S. persons) in reliance upon
exemptions under Regulation S of the Securities Act of 1993. During 1997,
1996 and 1995, the Company also received proceeds of $286,743, $562,735 and
$475,349 from the issuance of notes and debentures payable to officers,
directors and shareholders of the Company.
The Company realized $1 million in net proceeds after financing costs of
$120,000 from the sale of its $1,200,000 4% convertible debentures to
Timboon. These debentures were convertible at the election of the holder into
the Company's common stock beginning forty-five days after issuance until
maturity on October 1, 1997. The number of shares issuable in conversion to
common stock was determinable as a percentage of the average bid for the
Company's common stock on the OTC Bulletin Board during one of two five day
periods, whichever computation resulted in the issuance of a greater number
of shares to the holder. The Company converted $120,000 principal amount of
these debentures into 256,361 shares of common stock through December 31,
1997. Based on a belief that short sales were driving the Company's stock
price downward, the Company refused to convert any more of the 4% convertible
debentures. Timboon filed suit to force either conversion or repayment. The
Company entered into a Settlement Agreement and Release ("Settlement") with
Timboon, effective March 2, 1998 covering this litigation. The Settlement
provides for the Company's payment of $1,200,000 in full satisfaction of
outstanding principal of and accrued interest on these debentures or the
Company's issuance to Timboon of such number of shares of its common stock as
can be sold by Timboon with net proceeds of $1,200,000. The Settlement
Agreement also provided that the Company designate 4,000,000 shares of its
common stock, to be held in escrow, for liquidation by Timboon pursuant to
the terms of an escrow agreement. As a result of the Settlement, if Timboon
is unable to realize net proceeds of $1,200,000 from the resale of the
4,000,000 shares placed in escrow, then the Company would be required to
either liquidate the remaining balance by the payment of cash or by the
issuance of additional shares, with the number of additional shares to be
determined based on the remaining amount of the debt still owing to Timboon
by the Company and the then market price of the Company's common stock.
The 10% cumulative convertible debentures, due on various dates through
November 1997, were issued to Nidan Corporation. These debentures were
convertible into shares of the Company's common stock on their respective
maturity dates or on the effective date of a registration statement under the
Securities Act of 1993, if earlier. The number of shares of common stock
issuable upon conversion of these debentures, in either case, was generally
to be determined by dividing the principal amount of the debentures, plus
accrued and unpaid interest, by the lesser of (a) the fixed conversion prices
set forth in the debentures, which range from $1.50 to $5.00 per share, or
(b) a conversion price equal to 50% of the average closing bid and ask prices
of the Company's common stock at the close of trading on the next day
following the maturity date as set forth in the respective debenture. Nidan
transferred a significant portion of these debentures to residents of the
State of Michigan without the consent of the Company. The Company believes
that the conversion of these debentures may constitute a violation of
Michigan securities law as a result of the Company being subject to a consent
order; accordingly, the Company refused to convert these debentures at
maturity pending a determination of the conversion rights available to
residents of the State of Michigan.
<PAGE> 21
The 10% cumulative convertible debentures, due in November 1997, were issued
to a non-U.S. person other than Timboon. These debentures were convertible
into shares of the Company's common stock at any time after 45 days from the
date of their issuance and prior to their scheduled one-year maturity dates.
The conversion price of these debentures, plus accrued and unpaid interest,
is equal to the lesser of (a) 70% of the average closing bid price of the
Company's common stock for the five days preceding the conversion date or (b)
80% of the average closing bid price of the Company's common stock for the
five days prior to issuance of the debentures. In connection with the
issuance of these debentures, the Company incurred placement fees and other
costs of approximately $50,000 and received net proceeds of approximately
$450,000. As of December 31, 1997, the Company has converted $330,000 of
these debentures into 93,301 shares of the Company's common stock and has
outstanding unconverted debentures totaling $170,000. At the time the Company
determined not to convert any more of the Timboon debentures for the reasons
described above, it decided not to convert any more of these debentures for
the same reasons.
The terms of notes and debentures outstanding at December 31, 1997, are more
fully described in Note 7 to the consolidated financial statements appearing
elsewhere herein.
The Company and its subsidiaries are subject to various legal and
administrative proceedings arising from the sale of its securities, disputes
with certain persons formerly associated with the Company and its subsidiary
companies as employees or who were under contract in a consulting capacity,
from cancellation or defaults under certain non-cancelable lease agreements
and from non-payment of certain of its debts. As of December 31, 1997, the
Company has accrued loss reserves totaling approximately $1.9 million for
claims, assessments and losses related to pending legal and administrative
actions, including approximately $800,000 for the potential rescission offer
the Company may be required to make to the purchasers of the Company's
securities who reside in the State of Michigan. The loss reserves accrued for
these legal and administrative actions are generally equal to the amounts
claimed by the plaintiffs' in such actions, with the exception of the actions
brought by Mr. Ken Lame and Mr. Jeff Good, both of whom were formerly
associated with the Company or its subsidiaries as an employee or consultant.
The amounts claimed by these two persons are in excess of $450,000 and the
Company has recorded loss reserves for these actions totaling approximately
$120,000. In the event of an adverse outcome in either of these actions, the
Company may be required to make additional loss provisions. However, the
Company believes that it has made adequate provisions, in the aggregate, for
loss contingencies that existed as of December 31, 1997 (see "Legal
Proceedings"). In the event of unfavorable outcomes in one or more of the
proceedings pending against the Company, it is unlikely the Company would
have a sufficient amount of cash to sustain operations.
The amount of financing necessary to continue to support the operations and
capital needs of businesses acquired, the continuing operating losses of
businesses acquired, the lack of equity and debt financing available to the
Company (together with the inability of the Company to meet its funding
obligations under the HMT acquisition agreement and its payment obligations
to trade and other creditors), and the desire of the former shareholders of
ATI and HMT to rescind the original purchases transactions, among other
factors, led to management's decision to dispose of ATI and HMT and sell
substantially all of the operating assets of TNI. After the rescission of the
ATI and HMT acquisitions and the sale of the operating assets of TNI, the
remaining operations of the Company consist of NSC. NSC has incurred
substantial operating losses since its acquisition by the Company in October
1995 and there is no assurance that NSC will be able to reverse this trend in
the future.
<PAGE> 22
The Company's present business strategy is to grow its healthcare cost
containment revenue base, of which there is no assurance, through joint
venture alliances or other partnership arrangements that will not require
significant future outlays of capital resources (see "Item 1. Business"). The
ability of the Company to implement this strategy is dependent on the
Company's ability to raise additional equity or debt financing, of which
there is no assurance.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
NO. 130"), which is effective for fiscal years beginning after December 15,
1997. SFAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. Although SFAS No. 130 only impacts display as opposed to
actual amounts recorded, it represents a change in financial reporting.
Management has not completed its review of SFAS No. 130, but does not
anticipate that the adoption of this statement will have a significant impact
on the Company's reported earnings.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information ("SFAS No. 131"), which is effective for
years beginning after December 15, 1997. SFAS No. 131 establishes standards
for the way public enterprises report information about operating segments in
annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports. It
also establishes standards for related disclosures about products and
services, geographic areas and major customers. Management has not completed
its review of this statement, but does not anticipate that the adoption of the
statement will have a significant effect on the Company's reported segments.
IMPACT OF INFLATION
The impact of inflation on the costs of the Company and its business units,
and the ability to pass on cost increases to its customers over time is
dependent upon market conditions. The Company is not aware of any
inflationary pressures that have had any significant impact on the Company's
operations over the past three years and, the Company does not anticipate that
inflationary factors will have a significant impact on future operations.
<PAGE> 23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Independent Auditors' Report on the Consolidated Financial
Statements for the year ended December 31, 1997 24
Statement of Management on the Consolidated Financial
Statements for the years ended December 31, 1996 and 1995 25
Consolidated Balance Sheets as of December 31, 1997 and 1996 27
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 1997 29
Consolidated Statements of Changes in Stockholders' Deficit for
each of the three years ended in the period
December 31, 1997 30
Consolidated Statements of Cash Flows for each of the three
years ended in the period December 31, 1997 32
Notes to Consolidated Financial Statements 33
<PAGE> 24
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Systems Communications, Inc.
Clearwater, Florida
We have audited the consolidated balance sheet of Systems Communications,
Inc. and Subsidiaries as of December 31, 1997, and the related consolidated
statement of operations, changes in stockholders' deficit and cash flows for
the year 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 audit.
We conducted our audit 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 audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Systems Communications, Inc. and Subsidiaries at December 31, 1997, and
the consolidated results of their operations and their cash flows for the
year ended December 31, 1997, in conformity with generally accepted
accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that Systems Communications, Inc. and Subsidiaries will continue as
a going concern. As more fully described in Note 3, the Company has incurred
operating losses during each of the years in the three-year period ended
December 31, 1997, and has a working capital deficiency and stockholders'
equity deficiency at December 31, 1997. In addition, the Company has not
complied with certain repayment terms of loan agreements and currently has no
source of operating revenues. These conditions raise substantial doubt about
the Company's ability to continue as a going concern. The consolidated
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the
amounts and classification of liabilities that may result from the outcome of
this uncertainty.
/s/ Moore Stephens Lovelace, P.A.
Orlando, Florida
April 8, 1998
<PAGE> 25
STATEMENT OF MANAGEMENT
The accompanying consolidated balance sheet of Systems Communications, Inc. as
of December 31, 1996 and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the two years in the period
ended December 31, 1996 are unaudited.
The consolidated balance sheet as of December 31, 1996 and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the two years in the period ended December 31, 1996, referred to above,
were previously audited by Ernst & Young LLP. The audit report of Ernst & Young
LLP on such financial statements, dated December 24, 1997, was included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1996.
Ernst & Young LLP advised the Company that it would not permit its audit
report, dated December 24, 1997, to be associated with any Exchange Act or
Securities Act filings by the Company. Ernst & Young LLP stated that its
position was based upon the association of Mr. Dorian Reed with the Company.
Mr. Reed's association with the Company arose from the merger of Hitsgalore.com
(a Nevada corporation) into the Company effective March 19, 1999.
On March 19, 1999, the Company and Hitsgalore.com completed a merger
pursuant to a Merger and Reorganization Agreement. In the merger, the
Company changed its name to Hitsgalore.com, Inc.
The Company considers Mr. Dorian Reed, a principal stockholder after the
merger, to be a key person who provides services to the Company. In 1994
Mr. Reed was engaged in internet consulting and research, primarily
studying internet market trends for not-for-profit entities. The
business Mr. Reed was involved in was incorporated in January 1995 as
Angel Industries, Inc. Mr. Reed became an employee of Angel Industries
until a new business, incorporated in 1995 by the President of Angel
Industries, Inc., called Internet Business Broadcasting ("IBB"), became
his employer. The original concept of IBB was to build web sites for
small businesses and create an internet business mall for third party on-
line retailers.
In late 1996, IBB started selling billboard space in IBB's internet
business mall, and elsewhere on the IBB site, to companies wishing to
advertise on the then new and growing internet. IBB signed contracts
with individuals who leased the on-line billboards and IBB would then
seek advertisers to purchase the space on the leased billboards. The
proceeds generated by selling the advertising were to be split between
IBB and the lessee of the billboard. In mid-1997, after failing to
adequately collect revenues from a sufficient number of customers, IBB
shut down its business and dissolved.
In early 1998, the Federal Trade Commission ("FTC") filed a lawsuit
against Tom Maher, former President of IBB, Audrey Reed, and Mr. Reed for
failure to refund money to customers and allegedly misleading investors
about the potential return on their investment. In April, 1998, Mr. Reed
filed an answer to the FTC complaint, pro se, denying all the
allegations, and did not receive any subsequent correspondence from the
government.
Mr. Reed says he was unaware any case was pending against him until
stories appeared in the press and he was served with a default judgment
at the Hitsgalore.com office in Rancho Cucamonga, CA on May 11, 1999.
The judgement served on Mr. Reed informed him that a federal judge in
Baltimore issued an order in April 1999 for he and his co-defendants to
pay $613,110 to 100 customers of IBB.
<PAGE> 26
STATEMENT OF MANAGEMENT, CONTINUED
After being served on May 11, 1999, Mr. Reed immediately and pro-actively
contacted the FTC through counsel regarding the matter. As of May 20,
1999, Mr. Reed is exploring his legal options for resolving the dispute,
including the possibility of appealing or vacating the judgment.
In addition, the following incident involving Mr. Reed took place more than 5
years ago, and the Company is under no obligation to include it in this
filing. In 1992, Mr. Reed was convicted at trial of wire fraud and unlawful
use of access device and served a 10 month sentence in a federal prison camp
and successfully completed the rest of his term on supervised release. There
were several counts amounting to approximately $2,800.00 in losses, plus court
and other costs, which all have been paid. This case did not involve the
purchase or sale of any security.
The Securities and Exchange Commission has advised the Company that its
Annual Report on Form 10-K for the year ended December 31, 1997 does not
comply with the requirements of the Exchange Act. The event of noncompliance
is the inclusion of unaudited, and not audited, consolidated financial
statements in its Annual Report on Form 10-K.
The Securities and Exchange Commission has requested that the Company
subsequently amend this Annual Report on Form 10-K to include audited
financial statements for the year ended December 31, 1996. On June 16,
1999 the Company engaged Moore Stephens Lovelace, P.A. to audit and
report on such financial statements.
<PAGE> 27
<TABLE>
SYSTEMS COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-------------------------
1997 1996
--------- ---------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 65,556 $ 61,039
Accounts receivable, less allowance for
doubtful accounts of $28,074 in 1996 -- 802,079
Notes and accounts receivable from officers
and employees 60,908 102,000
Other current assets 130,419 438,763
--------- ---------
Total current assets 256,883 1,403,881
--------- ---------
Furniture and equipment 130,162 1,812,867
Less accumulated depreciation (56,774) (587,598)
--------- ---------
Net furniture and equipment 73,388 1,225,269
Note receivable from the sale of assets, less
allowance of $500,000 in 1997 -- --
Deferred compensation 52,941 662,199
Intangible assets, net of accumulated amortization
of $566,666 in 1996 -- 1,083,334
Excess of cost over fair value of net assets
acquired, net of accumulated amortization of
$75,034 in 1996 -- 1,298,950
Other non-current assets 4,982 173,667
--------- ---------
Total assets $ 388,194 $ 5,847,300
========= =========
See Notes to Consolidated Financial Statements
<PAGE> 28
SYSTEMS COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Continued)
DECEMBER 31,
----------------------
1997 1996
---------- ----------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Borrowings under lines of credit $ -- $ 182,651
Current portion of notes and debentures payable 3,661,700 3,480,758
Current portion of obligations under capital lease -- 242,477
Accounts payable 535,516 1,452,192
Accrued compensation and employee benefits 1,176,578 1,528,153
Accrued interest 497,514 286,312
Liabilities and accruals for claims, assessments
and other losses 1,129,823 --
Other current liabilities 27,062 595,363
Deferred revenue -- 440,232
---------- ----------
Total current liabilities 7,028,193 8,208,138
---------- ----------
Obligations under capital lease, less current portion -- 458,654
Deferred liabilities under employment agreements 310,794 676,261
Other liabilities -- 72,573
---------- ----------
Total liabilities 7,338,987 9,415,626
---------- ----------
Common stock subject to rescission 674,124 709,124
---------- ----------
Common stock to be issued -- 2,000,000
---------- ----------
Commitments and Contingencies
Stockholders' deficit:
Class A convertible preferred stock, stated value
and liquidation preference - $1.00 per share;
authorized 5,000,000 shares, issued and
outstanding 200,000 shares in 1997 and 392,000
shares in 1996 -- 630
Class B convertible preferred stock, stated value
and liquidation preference - $1.00 per share;
authorized 10,000,000 shares, issued and
outstanding 2,953,125 shares in 1997 and
4,550,000 shares in 1996 1,617,260 2,491,745
Common stock - $.001 par value; authorized
50,000,000 shares, issued and outstanding
12,083,646 shares in 1997 and 10,626,874
shares in 1996 12,084 10,627
Additional paid in capital 18,399,891 16,823,526
Accumulated deficit (27,654,152) (25,603,978)
---------- ----------
Total stockholders' deficit (7,624,917) (6,277,450)
---------- ----------
Total liabilities and stockholders' deficit $ 388,194 $ 5,847,300
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE> 29
<TABLE>
SYSTEMS COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
---------------------------------------
1997 1996 1995
---------- ---------- -----------
<S> <C> <C> <C>
Net revenues $ 1,498,533 $ 2,832,123 $ 91,106
---------- ---------- -----------
Costs and expenses:
Cost of revenues 109,563 827,063 --
Selling and administrative expenses 3,027,384 6,322,627 1,887,275
Impairment and other losses 1,898,953 14,233,953 --
Depreciation and amortization 497,377 1,459,436 148,192
---------- ---------- ---------
Total operating costs and expenses 5,533,277 22,843,079 2,035,467
---------- ---------- ---------
(4,034,744) (20,010,956) (1,944,361)
Loss from disposition of subsidiary (1,595,412) -- --
Gain from sale of license agreement 2,695,214 -- --
Interest income 4,070 8,183 3,777
Interest expense (587,884) (381,975) (63,644)
Other income (expense), net (125,318) (103,891) --
---------- ---------- ---------
Loss from continuing operations before
income taxes (3,644,074) (20,488,639) (2,004,228)
Income tax benefit (605,500) (2,440,150) ( 15,124)
---------- ---------- ---------
Loss from continuing operations (3,038,574) (18,048,489) (1,989,104)
Discontinued operations:
Income (loss) from operations of
discontinued telecommunications
businesses, less income tax expense
(benefit) of $240,000, ($763,044)
and ($241,577) in 1997, 1996 and
1995, respectively 391,752 ( 1,508,179) (3,818,921)
Gain from disposition of
telecommunication businesses, less
income tax expense of $365,500 in 1997 596,648 -- --
---------- ----------- ----------
Net loss $(2,050,174) $(19,556,668) $(5,808,025)
========== ========== =========
Basic and diluted earnings per share:
Loss from continuing operations $ (.28) $ (2.16) $ (0.58)
Income (loss) from operations of
discontinued telecommunications
businesses .04 (0.18) (1.23)
Gain from disposition of
telecommunications businesses .05 -- --
---------- ----------- ----------
Net loss $ (.19) $ (2.34) $ (1.81)
========== ========== ==========
Weighted average number of
common shares outstanding 10,802,103 8,349,459 3,201,991
========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE> 30
<TABLE>
SYSTEMS COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT
CLASS A CLASS B
PREFERRED PREFERRED COMMON STOCK
------------------ -------------------- ------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- ------- --------- --------- ---------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 1,700,000 $ -- -- $ -- 2,797,485 $ 2,798
Issuance of common stock and warrants
for cash -- -- -- -- 1,477,874 1,478
Issuance of stock as compensation 1,525,000 20,625 -- -- 1,053,090 1,053
Issuance of stock and warrants in
consideration for extension of
related party indebtedness -- -- 140,000 236,600 -- --
Issuance of stock and warrants in
connection with business acquisitions 1,575,000 157,500 4,550,000 2,491,745 2,339,765 2,339
Reclassification of common stock
subject to rescission -- -- -- -- (242,416) (242)
Net loss -- -- -- -- -- --
--------- ------- --------- --------- ---------- ------
Balance at December 31, 1995 4,800,000 178,125 4,690,000 2,728,345 7,425,798 7,426
Issuance of common stock and warrants
for cash -- -- -- -- 413,688 414
Conversion of preferred stock (4,408,000)(177,495) (140,000) (236,600) 2,254,910 2,255
Issuance of common stock as
compensation -- -- -- -- 41,754 42
Issuance of common stock in connection
with business acquisitions -- -- -- -- 283,172 283
Issuance of stock for debt -- -- -- -- 207,552 207
Net loss -- -- -- -- -- --
--------- ------- --------- --------- ---------- ------
Balance at December 31, 1996 392,000 630 4,550,000 2,491,745 10,626,874 10,627
Issuance of common stock and warrants
for cash -- -- -- -- 205,556 206
Conversion of preferred stock (192,000) (630)(1,596,875) (874,485) 676,682 677
Issuance of common stock as
compensation -- -- -- -- 1,000,857 1,001
Issuance of stock for debt -- -- -- -- 577,421 577
Rescission of business acquisitions -- -- -- -- (994,247) (994)
Repayment of loan to officer -- -- -- -- (9,497) (10)
Net loss -- -- -- -- -- --
--------- ------- --------- --------- ---------- -----
Balance at December 31, 1997 200,000 $ -- 2,953,125 $1,617,260 12,083,646 $12,084
========= ======= ========= ========= ========== -=====
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE> 31
<TABLE>
SYSTEMS COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT (Continued)
Additional
Paid-In Accumulated
Capital Deficit Total
---------- ---------- ----------
<S> <C> <C> <C>
Balance at December 31, 1994 $ 286,852 $ (239,285) $ 50,365
Issuance of common stock and warrants
for cash 4,109,409 -- 4,110,887
Issuance of stock as compensation 430,095 -- 451,773
Issuance of stock and warrants in
consideration for extension of
related party indebtedness 105,000 -- 341,600
Issuance of stock and warrants in
connection with business acquisitions 7,731,935 -- 10,383,519
Reclassification of common stock
subject to rescission (789,382) -- (789,624)
Net loss -- (5,808,025) (5,808,025)
---------- ---------- ----------
Balance at December 31, 1995 11,873,909 (6,047,310) 8,740,495
Issuance of common stock and warrants
for cash 2,186,859 -- 2,187,273
Conversion of preferred stock 411,840 -- --
Issuance of common stock as
compensation 260,151 -- 260,193
Issuance of common stock in connection
with business acquisitions 1,891,824 -- 1,892,107
Issuance of stock for debt 198,943 -- 199,150
Net loss -- (19,556,668) (19,256,668)
---------- ---------- ----------
Balance at December 31, 1996 16,823,526 (25,603,978) ( 6,277,450)
Issuance of common stock and warrants
for cash 231,294 -- 231,500
Conversion of preferred stock 874,438 -- --
Issuance of common stock as
compensation 383,234 -- 384,235
Issuance of stock for debt 715,741 -- 716,318
Rescission of business acquisitions (571,997) -- (572,991)
Repayment of loan to officer (56,345) -- (56,355)
Net loss -- (2,050,174) (2,050,174)
---------- ---------- ----------
Balance at December 31, 1997 $18,399,891 $ (27,654,152) $ (7,624,917)
========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE> 32
<TABLE>
SYSTEMS COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
----------------------------------
1997 1996 1995
---------- ---------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (2,050,174) $(19,556,668) $(5,808,025)
Adjustments to reconcile net loss to
net cash used in operations:
Depreciation and amortization 544,839 1,750,727 459,327
Amortization of deferred compensation, net (125,503) (16,552) 61,819
Provision for bad debts 39,816 522,687 181,753
Provision for inventory obsolescence -- -- 145,776
Stock and warrants issued for compensation
and as consideration for extension of debt 384,235 260,193 793,373
Deferred income taxes -- (3,203,194) (256,699)
Impairment losses 1,898,953 14,728,854 2,758,779
Gain from sale of license agreement (2,695,214) -- --
Loss from disposition of subsidiary 1,595,412 -- --
Gain from disposition of telecommunications
businesses (962,148) -- --
Increase (decrease) in cash from change
in operating assets and liabilities:
Accounts receivable 148,912 214,330 317,161
Equipment inventories -- 73,211 (80,091)
Deferred expenses -- 498,697 (92,130)
Other assets 52,252 67,037 (42,702)
Accounts payable (484,304) (39,308) (430,448)
Accrued expenses and other liabilities 401,162 1,060,019 224,948
Deferred revenue (109,957) (553,982) 5,937
---------- ---------- ---------
Net cash used in operating activities (1,361,719) (4,193,949) (1,761,222)
---------- ---------- ---------
Cash flows from investing activities:
Acquisition of businesses, net of cash acquired -- (46,854) (1,428,312)
Disposition of businesses, net of cash disposed of 370,844 -- --
Expenditures for furniture and equipment (7,693) (552,718) (131,744)
Notes receivable from officers and employees -- (50,000) (52,000)
Acquisition of other assets -- -- (64,852)
---------- ---------- -----------
Net cash provided by (used in) investing activities 363,151 (649,572) (1,676,908)
---------- ----------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock 231,500 2,187,273 4,110,887
Proceeds from notes and debentures payable 1,568,443 2,422,752 475,349
Payments on notes payable and capital leases (686,858) (637,596) (262,814)
Payments on shares subject to rescission (35,000) (80,500) --
Proceeds from (payments on) borrowings under line of
credit (75,000) 47,917 (2,100)
---------- ---------- ---------
Net cash provided by financing activities 1,003,085 3,939,846 4,321,322
---------- ---------- ---------
Net increase (decrease) in cash 4,517 (903,675) 883,192
Cash and cash equivalents at beginning of the year 61,039 964,714 81,522
---------- ---------- ---------
Cash and cash equivalents at end of the year $ 65,556 $ 61,039 $ 964,714
========== ========== =========
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE> 33
SYSTEMS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 FORMATION OF THE COMPANY AND DESCRIPTION OF BUSINESS
Systems Communications, Inc. (the "Company") was organized as Florida One
Capital Corporation in 1987 and in 1988 made an initial public offering of
its common stock as a blank check company for the purpose of acquiring other
companies. During 1990 and 1991, the Company acquired and divested companies
engaged in the eye glass distribution and residential building industries and
for a brief period of time, operating under the name of Highland Healthcare
Corporation, was under the control of another publicly-owned blank check
company formed for the purpose of acquiring healthcare related businesses.
During the period from the fall of 1991 to the date of the first acquisition
described below, the Company had no operations or assets and was dormant.
During the period 1994 through 1997, the Company acquired and disposed of
various businesses and currently has one operating subsidiary ( "National
Solutions Corporation"). The acquisition and disposition of businesses during
this period are more fully described herein.
In 1994, the Company changed its name from Highland Healthcare Corporation
to Systems Communications, Inc. and, effective August 29, 1994, acquired all
of the outstanding stock of (i) Ameristar Telecommunications, Inc. ("ATI"), a
re-seller of long-distance and pay-per-view services and products,
principally to the hospitality industry, and (ii) Coast Communications, Inc.
("CCI"), whose principal business is the installation and servicing of pay-
per-view equipment. The Company identified ATI as the accounting acquirer and
accounted for the transaction as a purchase business combination.
Effective June 1, 1995, the Company completed the acquisition of all of the
outstanding stock of LCI Communications, Inc. ("LCI"), a re-seller of
telecommunication services, from a Director and executive officer of the
Company (a person designated as a "promoter/shareholder" of the Company). The
net assets acquired were recorded at the promoter/shareholder's historical
cost basis.
Effective June 12, 1995, the Company acquired all of the outstanding stock of
Comstar Network Services, Inc. ("Comstar"), a re-seller of long-distance
telephone services.
Effective July 7, 1995, the Company acquired all of the outstanding stock of
Telcom Network, Inc. ("TNI"), a re-seller of telecommunications services and
products, principally to residential and small business customers. TNI also
audits utility and telecommunications payments and provides cost recovery
services to its customers (large and small businesses and governmental
entities) for a percentage of recovered savings.
Effective October 27, 1995, the Company acquired all of the outstanding stock
of National Solutions, Inc. ("NSC"). The principal business of NSC is to (i)
develop, for commercial use, healthcare management information systems
technology acquired from the U.S. Government pursuant to the Federal
Technology Transfer Act of 1986, as amended, and (ii) sell the benefits from
the use of such technology to large, self-insured companies, insurers, third
party administrators ("TPA's"), health maintenance organizations ("HMO's")
and healthcare plan administrators. To date, the Company's revenues have been
derived primarily from retroactive analysis of claims paid using the services
of subcontractors, with respect to which the Company has received a
percentage of the recovered savings.
Effective March 12, 1996, the Company acquired all of the outstanding stock
of Healthcare Management Technologies ("HMT"). The principal business of HMT
is the development, sale and maintenance of medical management "Windows"
based computer software.
<PAGE> 34
In May 1996, the Company gave notice to the principals of CCI that it was
canceling all of the related acquisition agreements and abandoning the
business of CCI. The abandonment of CCI is subject to an arbitration
proceeding initiated by the former shareholders of CCI (see Notes 4 and 14).
In January 1997, the Company sold substantially all of the operating assets
of TNI. As of that date, the only remaining significant asset of TNI
consisted of the arbitration award in the amount of $1,250,000 granted to TNI
in a binding arbitration proceeding between and among TNI, GE Capital
Communications Services Corporation ("GECCS") and New Enterprise Wholesale
Services, Limited Partnership ("NEWS"). On December 24, 1997, the Company,
GECCS and NEWS entered into a Confidential Settlement Agreement and Mutual
Full and Final Releases (the "Settlement Agreement") regarding the
arbitration award in favor of the Company. Pursuant to the Settlement
Agreement, GECCS\NEWS paid $1,250,000 in full satisfaction of the arbitration
award. Of that amount, the Company received approximately $750,000, which is
net of legal fees. The proceeds from the Settlement Agreement were used to
pay trade and other obligations.
In May 1997, the Company and the former shareholders of ATI entered into a
rescission agreement which provides for the rescission of the Company's
August 1994 acquisition of ATI; and, in June 1997, the Company entered into
an agreement with the former shareholders of HMT to rescind the Company's
March 1996 acquisition of HMT (See Note 4).
The dispositions of CCI, TNI (which includes the operations of Comstar and
LCI subsequent to the dates of their respective acquisitions) and ATI, all of
which comprised the Company's telecommunications segment, and the operations
of those businesses for all periods presented are reflected as components of
discontinued operations in the accompanying consolidated statements of
operations (See Note 4).
NOTE 2 SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant inter-company
transactions and balances have been eliminated in consolidation.
CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost. Depreciation is provided using
the straight-line method over periods that approximate the assets' useful
lives.
Capitalized lease assets are recorded at the lower of present value of
minimum future lease payments at inception of the lease or the fair value of
the asset and are amortized straight-line over the shorter of the lease term
or estimated useful life of the asset.
INTANGIBLE ASSETS
Intangible assets as of December 31, 1996 consist of the cost of acquired
medical management computer software ($1,500,000) and acquired customer
lists. The useful life assigned to medical computer software was 3 years. As
of December 31, 1996, the unamortized cost of medical computer software was
approximately $1,083,000 and amortization for the year 1996 was approximately
$416,700. In 1997, the cost of medical computer software and related
<PAGE> 35
accumulated amortization were removed from the Company's consolidated balance
sheet as a result of the rescission of the HMT acquisition agreement.
Amortization in 1997 for the period prior to the rescission of the HMT
acquisition agreement was approximately $208,000. The cost of acquired
customer lists ($150,000) was fully amortized at December 31, 1995.
In 1995, the Company recorded $12,400,000 of intangible assets (healthcare
management decision software technology) acquired in connection with its
acquisition of NSC. The estimated useful life of the acquired software
technology was 20 years. The Company wrote-off the unamortized cost of the
software technology acquired in connection with the NSC acquisition, as of
December 31, 1996, due to continued operating losses and the failure of NSC
to successfully market the acquired technology (See Note 5).
EXCESS OF COST OVER FAIR VALUE OF NET ASSETS ACQUIRED
The Company assesses the recoverability of intangible assets, including
goodwill, if facts and circumstances suggest that the carrying amount of
intangible assets may have been impaired. In making its assessment, the
Company gives consideration to the undiscounted cash flows from the use of
such assets, the estimated fair value of such assets and other factors which
may affect the recoverability of such assets. If such an assessment indicates
that the carrying value of intangible assets may not be recoverable, the
carrying value of intangible assets is reduced.
Excess of cost over the fair value of net assets acquired as of December 31,
1996 consists of goodwill recorded in connection with the acquisition of HMT
and was assigned a useful life of 15 years. In 1997, the excess of cost over
the fair value of net assets acquired associated with the HMT acquisition and
related accumulated amortization were removed from the Company's consolidated
balance sheet as a result of the rescission of the HMT acquisition agreement
(See Note 4).
In 1995, the Company recorded approximately $2,718,000 in goodwill in
connection with its acquisition of NSC. As of December 31, 1996, the Company
wrote-off the unamortized cost of goodwill recorded in connection with the
NSC acquisition, as an impairment loss, due to the failure of NSC to
successfully market the acquired technology (See Note 5).
REVENUE RECOGNITION
The Company recognizes revenue in the period in which the service is provided
or, in the case of software sales, at the time the software is delivered.
Revenues related to audit or retroactive claims review services, which are
based on a percentage of the savings, are recognized at the time of third
party approval of the reimbursable amounts.
INCOME TAXES
The Company has applied, for all years presented, the provisions of Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes,"
which requires an asset and liability approach in accounting for income
taxes.
EARNINGS PER SHARE
In 1997, the Company adopted Statement of Financial Accounting Standards No.
128 "Earnings Per Share" ("SFAS No. 128"), which requires the presentation of
both basic and diluted earning per share. Basic earnings per share is
computed based on the weighted average number of common shares outstanding
during each year. Diluted earnings per share is to be computed based on the
sum of the weighted average number of common shares outstanding plus the
additional number of shares that would have been outstanding if all
potentially dilutive common shares, pursuant to stock purchase warrants and
<PAGE> 36
options, convertible preferred stock and convertible notes and debentures,
had been issued. The Company has not presented diluted earnings per share
because the inclusion of potential common shares, pursuant to stock purchase
warrants and options, convertible preferred stock and convertible notes and
debentures, would be antidilutive due to the Company having operating losses
for all periods presented. The adoption of SFAS No. 128 did not have any
impact on previously reported earnings per share.
STATEMENT OF CASH FLOWS
The operating, investing and financing activities included in the
consolidated statements of cash flows are presented net of the assets and
liabilities acquired in connection with business combinations and the assets
and liabilities disposed of in connection with the rescission of the ATI and
HMT acquisition agreements. As permitted by Statement of Financial Accounting
Standards No. 95, cash flows from operations of discontinued
telecommunications businesses are not separately presented.
LONG-LIVED ASSETS
The Company has applied, for all periods presented , the provisions of
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of",
which requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted
cash flows estimated to be generated by those assets are less than the
assets' carrying amount. Statement No. 121 also addresses the accounting for
long-lived assets that are expected to be disposed of (see Note 5).
IMPACT OF OTHER RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
NO. 130"), which is effective for fiscal years beginning after December 15,
1997. SFAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. Although SFAS No. 130 only impacts display as opposed
to actual amounts recorded, it represents a change in financial reporting.
The adoption of this statement will not have an impact on the Company's
reported earnings.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information ("SFAS No. 131"), which is effective for
years beginning after December 15, 1997. SFAS No. 131 establishes standards
for the way public enterprises report information about operating segments in
annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports.
It also establishes standards for related disclosures about products and
services, geographic areas and major customers. The adoption of this
statement will not have a significant effect on the Company's reported
segments and related disclosures.
USE OF ESTIMATES
The process of preparing financial statements requires the use of estimates
and assumptions regarding certain types of assets, liabilities, revenues and
expenses. Such estimates primarily relate to unsettled transactions and
events as of the date of the financial statements. Accordingly, upon
settlement, actual results may differ from estimated amounts.
RECLASSIFICATIONS
Certain amounts in the 1996 and 1995 consolidated financial statements have
been reclassified to conform to the 1997 presentation.
<PAGE> 37
NOTE 3 GOING CONCERN
The accompanying financial statements have been prepared on a going concern
basis which contemplates the realization of assets and liquidation of
liabilities in the ordinary course of business. The Company incurred net
losses (including losses from operations of discontinued businesses) of
$2,050,174, $19,556,668 and $5,808,025 in 1997, 1996 and 1995, respectively,
and used approximately $1,362,000, $4,194,000 and $1,761,000, respectively,
of cash in operations. The Company has a net working capital deficiency of
approximately $6.8 million and a deficiency in assets of approximately $7.6
million at December 31, 1997 and is currently in default of certain of its
obligations to trade and other creditors (see Notes 7 and 14). Additionally,
as discussed in Note 14, the Company is required to offer purchasers of the
Company's common stock in certain jurisdictions the right to rescind their
stock purchase transactions. Pursuant to a consent order from the State of
Michigan, the Company is required to make a rescission offer to Michigan
purchasers of the Company's common stock, unless such purchasers are afforded
an opportunity to resell their shares in the public market pursuant to an
effective registration statement at prices higher than the cost of such
shares to the Michigan purchasers. The Company has not been be able to
satisfy the requirements of the consent order. It is uncertain whether or not
the failure by the Company to satisfy the requirements of the consent order
will have a material adverse impact on the accompanying consolidated
financial statements (See Note 14).
The Company is attempting to raise additional equity and debt financing to
support its business operations but, there is no assurance that sufficient
amounts of equity or debt financing will be available to the Company. As of
December 31, 1997, the Company had no financing facilities available for
working capital or for other purposes.
Based on the foregoing factors, it is uncertain whether or not the Company
can generate adequate cash flows from operations, or from financing
transactions, to meet its obligations as they become due. In that event, the
Company would be required to seek other alternatives, including sale, merger
or discontinuance of operations. The consolidated financial statements do
not included any adjustments that might result from the outcome of this
uncertainty.
NOTE 4 ACQUISITIONS AND DISPOSITIONS OF BUSINESSES
On August 29, 1994, the Company acquired, in two separate transactions, all
of the outstanding stock of ATI and CCI in exchange for an aggregate of
1,700,000 shares of the Company's Class A convertible preferred stock and an
aggregate of $550,000 principal amount of notes payable. Of the preferred
stock issued in connection with these acquisitions, 1,500,000 shares were
issued to the former shareholders of ATI and 200,000 shares were issued to
the former shareholders of CCI. Of the notes issued in connection with these
acquisitions, $300,000 were issued to the former shareholders of CCI and
$250,000 were issued to the former shareholders of ATI. Each share of
preferred stock issued in connection with these acquisitions is convertible
into one-half share of the Company's common stock at the election of the
holder at any time prior to a public offering of the Company's common stock
and are automatically converted at the time of such public offering. The
shares of Class A convertible preferred stock issued to the former
shareholders of ATI were converted into 750,000 shares of common stock in
August 1996. The shares of Class A preferred stock issued to the former
shareholders of CCI are subject to an arbitration proceeding between the
Company and the former shareholders of CCI (See Note 14). The $550,000 of
acquisition notes payable bear interest at the rate of 6% per annum and were
originally due within 90 days of the date of such acquisitions. Such notes
have been extended from time to time and are now due upon completion of a
public offering of the Company's common stock. The $300,000 of acquisition
notes payable to the former shareholders of CCI are also subject to an
<PAGE> 38
arbitration proceeding between the Company and the former shareholders of CCI
(See Note 14). The Company identified ATI as the accounting acquirer and
accounted for the acquisition of ATI and CCI as a purchase business
combination. No goodwill was recorded in connection with these business
acquisitions.
In June 1995, the Company completed the acquisition of all of the outstanding
stock of LCI from a Director and executive officer of the Company (a person
designated as a promoter/shareholder of the Company) in exchange for
1,075,000 shares of the Company's Class A preferred stock. The net assets
acquired were recorded at the promoter/shareholder's historical cost. The
cost basis of the promoter/shareholder was de minimis.
In June 1995, the Company acquired all of the outstanding stock of Comstar in
exchange for 200,000 shares of the Company's common stock, valued at
$126,000,and 500,000 shares of its Class A convertible preferred stock,
valued at $157,500. The total purchase price was $283,500. Each share of
preferred stock issued in connection with this acquisition is convertible
into one-half share of the Company's common stock at the election of the
holder at any time prior to a public offering of the Company's common stock
and are automatically converted at the time of such public offering. The
shares of Class A preferred stock issued to the former shareholder(s) of
Comstar were converted into 250,000 shares of common stock in October 1996.
The excess of the purchase price over the fair value of net assets acquired
($273,250) was allocated to goodwill and assigned a useful life of 5 years.
The unamortized cost of goodwill recorded in connection with the acquisition
of Comstar was written off as an impairment loss in 1996 with no associated
income tax benefit (see Note 5). This impairment loss is included in the loss
from operations of discontinued telecommunications businesses for the year
ended December 31, 1996.
In July 1995, the Company acquired all of the outstanding stock of TNI in
exchange for 4,550,000 shares of the Company's Class B convertible preferred
stock, valued at $2,492,000, $450,000 of 10% convertible debentures and
$50,000 in cash. Holders of the convertible debentures are also entitled to
receive an aggregate of 225,000 stock purchase warrants, valued and recorded
at $141,750, exercisable at any time prior to a public offering of the
Company's common stock for an exercise price of $1.50 per share. Each share
of preferred stock issued in connection with this acquisition is convertible
into approximately .36 shares of the Company's common stock at the election
of the holder at any time prior to a public offering of the Company's common
stock and are automatically converted at the time of such public offering.
The 10% convertible debentures issued in connection with the acquisition,
plus accrued interest, are due at the time of a public offering of the
Company's common stock and are convertible, at the election of the holder,
into the Company's common stock at the public offering price in such public
offering. The total purchase price for TNI was $3,138,195. The excess of the
purchase price over the fair value of the net assets acquired was $2,943,401.
The unamortized cost of goodwill recorded in connection with the TNI
acquisition was written off as an impairment loss in 1995 with no associated
income tax benefit (see Note 5). This impairment loss is included in the loss
from operations of discontinued telecommunications businesses for the year
ended December 31, 1995. As of December 31, 1997, the Company has converted
1,596,875 shares of Class B convertible preferred stock issued in connection
with the acquisition into 580,682 shares of common stock. There have been no
conversions of the notes issued in connection with the acquisition.
Subsequent to December 31, 1997, the Company made a redemption offer to the
holders of the $450,000 10% convertible debentures issued in connection with
the acquisition (see Notes 7 and 18).
In October 1995, the Company acquired all of the outstanding stock of NSC in
exchange for 2,000,000 shares of the Company's common stock valued at
$6,916,000, cash of $1,000,000 and $250,000 in notes payable. The purchase
<PAGE> 39
price also included shares of the Company's common stock, valued at
$2,000,000, which were to have been issued to the founders and management of
NSC no later than November 30, 1996. The dollar amount of the shares to be
issued ($2,000,000) is shown as common stock to be issued in the accompanying
consolidated balance sheet as of December 31, 1996. The number of additional
shares to be issued was to be determined at the date of issuance based upon a
formula and upon issuance valued at $2,000,000 in the aggregate. The formula
to determine the number of additional shares which were to have been issued
is $5,000,000 minus outstanding advances made to NSC by the Company divided
by the quoted market value of the Company's common stock. The $250,000 in
notes payable are non-interest bearing and are due in equal monthly
installments of $20,000 (see Note 7). The total purchase price for NSC was
$14.4 million, including the $2,000,000 in additional shares which were to
have been issued in November 1996 pursuant to the acquisition agreement and
approximately $1.7 million of liabilities assumed in excess of assets
acquired and deferred income taxes of approximately $1.0 million. The excess
of the purchase price over the fair value of the assets acquired
(approximately $2,718,000) was assigned a useful life of 20 years. The net
assets acquired also included $12,400,000 for healthcare management decision
software technology that was assigned a useful life of 20 years. The Company
wrote off the unamortized cost of goodwill and intangibles recorded in
connection with the acquisition of NSC as of December 31, 1996, as an
impairment loss (See Note 5).
As of December 31,1996, the Company had not issued any of the shares of
common stock which were to be issued to the founders and management of NSC
pursuant to the NSC acquisition agreement. In January 1997, the founders and
management of NSC (the "Retiring Management") resigned in a negotiated
agreement between the Company and Retiring Management. The material features
of the agreement included the waiver by Retiring Management of (a) all
accrued and unpaid bonuses ($695,214) and (b) $2,000,000 of the Company's
common stock which was to be issued to Retiring Management pursuant to the
NSC acquisition agreement in exchange for a license agreement for the
exclusive use by Retiring Management of NSC's software and technology to
service state governments west of the Mississippi River (excluding Utah),
Mexico and Central and South America. The license agreement, subject to
minimum performance standards, is to provide for a royalty fee of one-half of
one percent of all revenues derived by Retiring Management from such license
agreement and for (i) the sharing on a 50-50 basis, of the net profits (to be
defined) earned by NSC from the States of New York and New Jersey and by
Retiring Management from Mexico and (ii) a requirement that Retiring
Management use NSC, for a reasonable fee, as its sole supplier of data
processing services to process work derived from the license agreement for a
period of two years. As a result of the waiver by Retiring Management of
accrued and unpaid bonuses and common stock to be issued, the Company removed
the common stock to be issued and the accrued and unpaid bonuses from its
consolidated balance sheet and recognized a gain from the sale of the license
agreement totaling approximately $2,695,000.
Effective March 12, 1996, the Company acquired all of the outstanding stock
of Health Management Technologies, Inc. ("HMT"), whose principal business is
the development, sale and maintenance of medical management computer
software, for 309,837 shares of its common stock valued at $2,000,000. The
total purchase price was $2,140,000, including costs of $140,000. The excess
of the purchase price over the fair value of the net assets acquired
($1,373,984) was assigned a useful life of 15 years. The net assets acquired
included $1,500,000 of medical computer software, which was assigned a useful
life of 3 years.
<PAGE> 40
The following unaudited pro forma summary operating results for the year
ended December 31, 1996, include the results of operations of companies
acquired in 1995 for the full year and the operating results of HMT (with pro
forma adjustments for amortization of goodwill and intangible assets
acquired) as if HMT was acquired as of January 1, 1996. The pro forma
operating results for the year ended December 31, 1995 reflect the operating
results of companies acquired in 1995 and, HMT acquired in 1996, with pro
forma adjustments (primarily goodwill and intangible amortization) as if the
acquisitions were consummated on January 1, 1995. The pro forma summary is
provided for information purposes only. It is based on historical information
and does not necessarily reflect the actual results that would have occurred
nor is it necessarily indicative of future operating results of the combined
companies.
Year Ended December 31,
--------------------------------
1996 1995
----------- -----------
Net revenues from continuing
operations $ 3,035,195 $ 2,384,874
------------ -----------
Loss from continuing operations $(18,161,862) $(4,085,486)
------------ -----------
Loss from operations of discontinued
telecommunications businesses $( 1,508,179) $(3,794,890)
------------ -----------
Basic earnings per share:
Loss from continuing operations $( 2.18) $( 1.28)
Loss from operations of
discontinued telecommunications
businesses ( 0.18) ( 1.19)
------------ -----------
Net loss $( 2.36) $( 2.47)
============ ===========
All of the acquisitions described above have been accounted for using the
purchase method of accounting. The results of operations of these acquired
businesses have been included in the consolidated financial statements since
their respective dates of acquisition.
As more fully discussed below, the Company has sold or otherwise disposed of
the businesses included in the Company's telecommunications segment. The
operations of those businesses are shown as operations of discontinued
telecommunications businesses in the above pro forma summary.
In May 1996, the Company informed the principals of Coast Communications,
Inc. ("CCI") that the Company was canceling the acquisition of CCI,
terminating all of the related acquisition documents and abandoning the
business of CCI. In connection with the abandonment of CCI's business, the
Company wrote off its remaining investment in CCI and recognized a loss of
approximately $300,000. The principals of CCI filed suit to enforce the
acquisition notes issued by the Company in connection with the CCI
acquisition (see Note 7) and the issuance of 200,000 shares of the Company's
Class A preferred stock they allege are due them under the acquisition
agreement. This matter was referred by court order to mandatory arbitration
in the State of Florida. On February 3, 1998, the Arbitrators' awarded in
favor of the former shareholders of CCI. The award requires, among other
things, that the Company (i) convert 200,000 shares of its Class A Preferred
Stock, held by the former shareholders of CCI, into 100,000 shares of its
common stock and (ii) issue another 200,000 shares of Class A Preferred Stock
to the former CCI stockholders, which is also convertible into 100,000 shares
of the Company's common stock, and that the Company give the former
shareholders of CCI the ability to seek a summary judgment against the
Company for $500,000, without opposition, or accept 500,000 shares of the
<PAGE> 41
Company's Class A Preferred Stock in lieu of a summary judgment (See Note
14). The arbitration award granted to the former stockholders of CCI had the
effect of extinguishing the acquisition notes in exchange for the
consideration awarded to the former stockholders of CCI. Assuming that the
former stockholders of CCI elect stock in lieu of a summary judgement, the
fair value of the consideration awarded, consisting of 700,000 shares of
Class A Preferred Stock, was approximately $83,000 based on the quoted market
price of the Company's common stock in the OTC Bulletin Board on the date of
the award. Assuming the former stockholders elect a summary judgement in
lieu of the 500,000 shares of Class A Preferred Stock, the fair value of the
consideration awarded was approximately $528,000, which includes 200,000
shares of Class A Preferred Stock which are to be issued to the former
stockholders in either case. As of December 31, 1997, the Company has
$300,000 of acquisition notes outstanding, which were extinguished as a
result of the arbitration proceeding, in addition to a loss contingency
reserve of approximately $111,000 related to this action. In the event the
former stockholders of CCI elect a summary judgment in lieu of stock, the
Company would be required to recognize an additional loss of approximately
$145,000.
As more fully discussed below, in January 1997 and May 1997, the Company
disposed of substantially all of the remaining assets of its
telecommunications segment, consisting of TNI (which include the operations
of Comstar and LCI) and ATI and, entered into an agreement to rescind the
March 1996 acquisition of HMT.
In January 1997, the Company sold, in two separate transactions (i) TNI's
long-distance customer base and existing customer receivables for $76,000 in
cash and (ii) TNI's utility audit division customer base, agreements and
work-in-process for $25,000 in cash and a $500,000 convertible debenture
issued by International Teledata Corporation ("ITD"). No value was assigned
to the $500,000 convertible debenture (the "ITD Note") received by the
Company. By its terms, the ITD Note is due on January 31, 1999 and bears
interest at 8% per annum beginning on April 2, 1997 and through the date of
conversion. Such conversion is at the average bid and ask prices of the
acquiring company's common stock on the effective date of a registration (See
Note 18).
In May 1997, the Company and ATI entered into an agreement to rescind the
August 1994 acquisition of ATI. The ATI rescission agreement provides for the
return of all of the ATI stock acquired by the Company to the former ATI
shareholders in exchange for 684,410 shares of the Company's common stock,
the 6% acquisition notes payable issued to the former shareholders of ATI and
unexercised warrants to purchase 168,668 shares of the Company's common
stock. On the date of the rescission agreement, ATI had future minimum
rentals of approximately $180,000 due under non-cancelable leases, guaranteed
by the Company. In connection with the rescission of the ATI acquisition, ATI
issued a promissory note to the Company in the amount of $180,000, payable in
the event of default by ATI in payments due under the leases. Payments due
the Company under the promissory note are to be equal to the amount, if any,
the Company may be required to pay under the lease guaranty agreements
entered into between the Company and ATI's equipment lessor(s). No amounts
are currently due under the promissory note issued to the Company by ATI as a
result of the Company not having made any payments pursuant to such lease
guarantee agreements. In the event the Company is required to make payments
under the lease guarantee agreements, there is no assurance that ATI would
have sufficient funds to make the payments due to the Company under the
promissory note.
Included in the gain from disposition of telecommunications businesses in the
accompanying consolidated statement of operations for the year ended December
31, 1997 are pre-tax gains of approximately $25,000 and $937,148 from the
sale of TNI assets and from the rescission of the ATI acquisition agreement,
respectively. The gain from the disposition of ATI was based on the fair
value of the Company's common stock returned to the Company by the former
<PAGE> 42
stockholders of ATI in exchange for the return of the stock of ATI to the
former stockholders of ATI. On the effective date of the rescission
agreement, ATI had net liabilities, including acquisition indebtedness, of
approximately $509,392 and the fair value of the 684,410 shares of the
Company's common stock that were returned to the Company by the former
stockholders of ATI totaled approximately $427,756, based on the quoted
market price of the Company's common stock on the OTC Bulletin Board as of
the date of the rescission transaction. The return of the shares was recorded
as a reduction in common stock and additional paid in capital in the amounts
of $684 and $427,072, respectively.
In June 1997, the Company entered into an agreement with the former
shareholders of HMT to rescind the Company's March 1996 acquisition of HMT.
The HMT rescission agreement provided for the return of all of the HMT stock
acquired by the Company to the former shareholders of HMT in exchange for
$450,000 in cash (in payment of inter-company loans to HMT from the Company)
and the 309,837 shares of the Company's common stock issued in connection
with the acquisition. In connection with the rescission agreement, the
Company and HMT entered into a separate Cooperative Marketing and Option
Agreement. The Cooperative Marketing and Option Agreement provides both the
Company and HMT the non-exclusive right, for a five (5) year period, to
market each other's products, on a fee basis, and granted the Company a non-
transferable option, exercisable at any time for eighteen months after the
date of grant (June 9, 1997), to acquire approximately 10% of HMT, adjusted
for stock splits, stock dividends, reclassifications, reorganizations,
consolidations or mergers, for approximately $45,000 in cash. The HMT
rescission agreement also had the effect of relieving the Company of its
obligation to provide financing to HMT under the terms of the acquisition
agreement.
In connection with the disposition of HMT, the Company recognized a pre-tax
loss of approximately $1,595,412, which is included as a component of loss
from continuing operations in the accompanying consolidated statement of
operations for the year ended December 31, 1997. The loss was based on the
fair value of the Company's common stock returned to the Company by the
former stockholders of HMT in exchange for the return of the stock of HMT to
the former stockholders of HMT. On the effective date of the rescission
agreement, HMT had net assets of approximately $1,740,648, net of cash
received, and the fair value of the 309,837 shares of the Company's common
stock that were returned to the Company by the former shareholders of HMT
totaled approximately $145,236, based on the quoted market price of the
Company's common stock on the OTC Bulletin Board as of the date of the
rescission transaction. The return of the shares was recorded as a reduction
in common stock and additional paid in capital in the amounts of $310 and
$144,925, respectively.
The consolidated operating results of the Company for all years presented
have been restated to segregate, as discontinued operations, the results of
operations of the Company's discontinued telecommunications businesses. The
assets and liabilities of the telecommunications segment, included in the
accompanying consolidated balance sheets as of December 31, 1997 and 1996,
are summarized as follows:
1997 1996
--------- ---------
Current assets $ 539 $ 332,856
Total assets 539 660,094
Current liabilities 494,133 1,186,206
Total liabilities 494,133 1,378,026
<PAGE> 43
The revenues, costs and expenses of the Company's telecommunications
businesses, included in income(loss) from operations of discontinued
telecommunications businesses in the accompanying consolidated statements of
operations for each of the three years in the period ended December 31, 1997,
are summarized as follows:
1997 1996 1995
-------- --------- ---------
Net revenues $405,617 $2,177,858 $2,893,778
Cost of revenues -- 1,320,256 2,014,460
Selling and administrative expenses 449,925 2,304,059 1,845,775
Impairment and other losses -- 494,901 2,758,779
Depreciation and amortization 47,460 291,291 311,135
Interest income -- (971) (627)
Interest expense 32,393 38,713 20,466
Other income(expense), net 755,913 832 4,288
Income (loss) from operations of
discontinued businesses, before
income taxes 631,752 (2,271,223) (4,060,498)
Income tax expense (benefit) 240,000 (763,044) (241,577)
Income (loss) from operations of
discontinued businesses 391,752 (1,508,179) (3,818,921)
NOTE 5 IMPAIRMENT AND OTHER LOSSES
Impairment and other losses included in the accompanying consolidated
statements of operations are summarized as follows:
<TABLE>
Year Ended December 31,
-----------------------------------
1997 1996 1995
--------- ---------- ---------
<S> <C> <C> <C>
Impairment and other losses included
in loss from continuing operations:
Write-off of capital lease and related
assets $ 768,545 $ -- $ --
Provision for loss contingencies 437,335 -- --
Write- off of deferred compensation
assets 625,728 -- --
Write-down of other assets 67,345 -- --
Write-off of NSC intangibles and goodwill -- 14,233,953 --
--------- ---------- ---------
1,898,953 14,233,953 --
--------- ---------- ---------
Impairment and other losses included
in loss from discontinued operations:
Write-off of TNI goodwill -- -- 2,758,779
Write-off of investment in Comstar 194,901 --
Write-off of investment in CCI -- 300,000 --
--------- ---------- ---------
-- 494,901 2,758,779
--------- ---------- ---------
$1,898,953 $14,728,854 $2,758,779
========= ========== =========
</TABLE>
In 1997, the Company removed, from its consolidated balance sheet, the
capital lease and other assets related to equipment under lease from Boston
Financial & Equity Corporation ("BFC") due to BFC having taken possession of
certain computer equipment leased by NSC from BFC and the initiation by BFC
of an action filed in the State of Texas against the Company seeking
approximately $500,000, due under the lease agreement. The removal of the
capital lease and other assets related to equipment under lease resulted in a
loss of $768,545. The Company also recorded a loss contingency of
approximately $500,000 and removed the related capital lease obligation from
<PAGE> 44
the Company's consolidated balance sheet, which resulted in an additional
loss provision of $122,986, which is included in the provision for loss
contingencies in the above table.
In 1997, the Company also made various other provisions for loss contingencies
related to leased office space, which has been vacated, leased equipment that
the Company is not presently using and for the loss from the settlement of
claims brought against the Company by Timboon, LTD. The total amount of these
loss provisions was $437,335, including $122,986 related to the BFC lease. Also
included in this amount is $162,053 related to the Timboon Settlement Agreement
(see Notes 7 and 14).
The write-off of deferred compensation assets in 1997 is the result of the
resignation of certain employees subject to employment agreements (see Note
13).
Impairment and other losses in 1996 reflect the write-off of the Company's
investments in Comstar and CCI, including goodwill recorded in connection with
the acquisitions, and the write-off of the unamortized cost of goodwill and
intangibles recorded in connection with the Company's 1995 acquisition of NSC.
The write-off of the Company's investmens in Comstar and CCI is the result of
the Company's decision to sell substantially all of the assets of TNI and
abandon its remaining Telecommunications businesses; and, the write-off of the
unamortized cost of goodwill and intangibles recorded in connection with the
acquisition of NSC is the result of continued operating losses and the failure
of NSC to successfully market the software technology acquired by the Company
in connection with the acquisition. The write-off of the Company's investments
in Comstar and CCI is included in loss from operations of discontinued
telecommunications businesses for the year ended December 31, 1996; and, the
write-off of the unamortized cost of goodwill and intangibles recorded in
connection with the acquisition of NSC is reflected in loss from continuing
operations for the year ended December 31, 1996.
At December 31, 1995, the Company recognized a charge to income of $2,758,779,
which is reflected as a component of discontinued operations in the
accompanying consolidated statement of operations for the year ended December
31, 1995, to write off, with no associated income tax benefit, all of the
goodwill related to its acquisition of TNI. This write-off reflects the damages
caused to the business of TNI as a result of actions taken by GE Capital
Communications Services Corporation ("GECCS") and New Enterprise Wholesale
Services, Ltd. ("News"), which actions included, among other things, (i) the
failure of GECCS and News to provision customer accounts for telecommunications
products and services offered by GECCS and News and sold by TNI pursuant to a
contractual agreement among TNI, GECCS and News, (ii) the cancellation of TNI
customers by GECCS and News and (iii) the failure of GECCS and News to properly
bill and collect revenues due to TNI. TNI, as claimant in a binding arbitration
proceeding against GECCS and News, was awarded damages under the GECCS
Agreement in the amount of approximately $1,250,000. The award, which was
entered on October 10, 1996, was appealed by GECCS to the U.S. District Court
for the Northern District of Georgia on the grounds that the arbitrators
exceeded their powers by awarding TNI damages under the GECCS Agreement. On
September 30, 1997, the U.S. District Court confirmed the award; and, a motion
for summary judgment was entered on October 1, 1997. On December 24, 1997, the
Company, GECCS and News entered into a Confidential Settlement Agreement and
Mutual Full and Final Releases (the "Settlement Agreement"). Pursuant to the
Settlement Agreement, GECCS\News paid $1,250,000 in full satisfaction of the
arbitration award. Of that amount, the Company received approximately $750,000,
which is net of legal fees. The net proceeds from the Settlement Agreement are
reflected in income(loss) from discontinued operations in the accompanying
consolidated statement of operations for the year ended December 31, 1997.
<PAGE> 45
NOTE 6 FURNITURE AND EQUIPMENT
Furniture and equipment consists of the following:
DECEMBER 31,
----------------------
1997 1996
------- ---------
Furniture and equipment $130,162 $ 917,869
Equipment held under capital lease -- 880,163
Leasehold improvements -- 14,835
------- ---------
130,162 1,812,867
Less: accumulated depreciation (56,744) (587,598)
------- ---------
Net furniture and equipment $ 73,388 $1,225,269
======= =========
Depreciation expense was $174,545, $330,973 and $122,471 in 1997, 1996 and
1995 respectively.
In 1997, the Company removed, from its consolidated balance sheet, capital
lease assets with a net carrying amount of $579,681 related to equipment
under lease from Boston Financial & Equity Corporation. See Notes 5 and 14.
Included in furniture and equipment, net, as of December 31, 1996 is
$327,237, applicable to discontinued telecommunications businesses.
<PAGE> 46
NOTE 7 NOTES AND DEBENTURES PAYABLE
Notes and debentures payable consist of the following:
DECEMBER 31,
------------------------
1997 1996
--------- ---------
4% Cumulative convertible debentures
due October 1, 1998 $ 1,200,000 $ --
10% Cumulative convertible debentures
due on various dates through
November 1997 1,195,000 1,279,000
10% Cumulative convertible debentures
due on November 21, 1997 -- 300,000
10% Cumulative convertible debentures
due on November 26, 1997 170,000 200,000
10% Convertible debentures payable to
former shareholders of TNI 450,000 450,000
Notes payable to former shareholders of
NSC in equal monthly installments of
$20,000, non-interest bearing 150,000 150,000
6% Acquisition notes payable to former
shareholders of ATI, secured by the
stock of ATI -- 250,000
6% Acquisition notes payable to former
shareholders of CCI (see Notes 4 and 14) 300,000 300,000
18% Cumulative Convertible Debenture
Note due January 15, 1999 80,000 --
12% Cumulative Convertible Debenture
Notes due on various dates through
November 1998 50,000 --
12% Convertible Promissory Note
due March 28, 1997, in default 30,000 --
10% Cumulative Convertible Debenture
Note due September 1998 30,000 --
8%-10% Notes payable to stockholders 1,700 162,741
Promissory note in default -- 200,000
10.75% demand note payable, secured by
certain accounts receivable -- 100,000
5% Note to former shareholder of CCI, due
on demand, secured by certain equipment -- 75,000
Other 5,000 14,017
--------- ----------
3,661,700 3,480,758
Less: current portion (3,661,700) (3,480,758)
--------- ---------
Long-term portion $ -- $ --
========= =========
On February 24, 1997, the Company issued $1,120,000 of 4% cumulative
convertible debentures due October 1, 1998 (the "4% Debentures") to Timboon,
LTD ("Timboon", a non U.S. person) in reliance upon exemptions under
Regulation S of the Securities Act of 1933. The 4% Debentures are convertible
at any time after 45 days from the date of their issuance, until maturity,
into the Company's common stock at a conversion price equal to the lesser of
(a) 80% of the average closing bid price of the Company's common stock for
the five days preceding the issuance of the debentures or (b) 70% of the
average closing bid price of the Company's common stock for the five days
preceding the conversion date. The Company incurred costs in connection with
this financing of $120,000 and received net proceeds of $1,000,000. The
Company, through December 31, 1997, converted $120,000 of the 4% Debentures
issued to
<PAGE> 47
Timboon into 256,361 shares of the Company's common stock. On June 6, 1997,
as a result of the Company's refusal to convert additional 4% Debentures,
Timboon, as Plaintiff, filed an action in the United District Court, Southern
District of New York, against the Company, as Defendant, seeking the delivery
of 163,438 shares of the Company's common stock to Plaintiff as a result of
the conversion of an additional $150,000 of 4% Debentures and the payment of
$970,000 (the principal amount of the 4% Debentures that had not been
converted by Timboon) to Timboon, plus damages. The Company filed a
counterclaim against Timboon alleging that Timboon breached the
representations and covenants it made in the Off-Shore Securities
Subscription Agreement. These representations and covenants related to, among
other things, Timboon's investment intent in acquiring the Company's
securities and its possible "shorting" of the Company's common stock in
contemplation of conversion. In addition, the Company alleged that Timboon
participated in manipulative market activity with the intent to artificially
depress the market price of the Company's common stock. Effective March 2,
1998, the Company and Timboon entered into a Settlement Agreement and Release
(the "Settlement Agreement") in settlement of all claims brought against each
other in connection with the 4% Debentures. Pursuant to the Settlement
Agreement, the Company is required to pay Timboon $1,200,000, in cash, or by
the liquidation by Timboon of shares of the Company's common stock into which
the 4% Debentures are convertible. The Company has designated 4,000,000
shares of its common stock, to be held in escrow, for liquidation by Timboon
pursuant to the terms of an escrow agreement (the "Escrow Agreement"). The
terms of the Escrow Agreement generally provide that Timboon may liquidate
during each four-week period ("Trading Period")(i)up to 50% of the aggregate
trading volume of the Company's common stock on the NASDAQ Bulletin Board, or
such other trading market on which the Company's may be publicly traded, for
the prior four-week period at no less than the "bid" price, or for the first
eight weeks of trading, up to 37.5% of the trading volume for the previous
four-week period at no less than the "bid" price, provided a minimum "bid"
price of $0.31 per share, or greater, is maintained or (ii) up to 200,000
shares of the Company's common stock during any Trading Period at or above
the average of the "bid" and "ask" price. In either case, the liquidation of
shares of the Company's common stock by Timboon is not to exceed $200,000 of
net proceeds, in the aggregate, during any Trading Period. The Escrow
Agreement also provides that when Timboon receives cumulative net proceeds of
$1,200,000, the escrow agent is to return all remaining shares held in
escrow, if any, to the Company or, in the event Timboon receives cumulative
net proceeds of $1,200,000 from the liquidation of 600,000 shares, or less,
then the escrow agent is to return all remaining shares, less 100,000 shares
which are to be retained by Timboon. In connection with the Settlement
Agreement the Company increased the principal balance of the 4% Debentures to
equal $1,200,000 and recognized a loss of approximately $162,000 (See Note
5).
During 1996, the Company privately placed, in reliance upon exemptions under
Regulation D of the Securities Act of 1933, a series of one-year 10%
cumulative convertible debentures in the aggregate principal amount of
$1,279,000. These debentures are convertible into shares of the Company's
common stock on various dates through November 1997 or on the effective date
of a registration statement under the Securities Act of 1993, if earlier. The
number of shares of common stock issuable upon conversion of these
debentures, in either case, is generally to be determined by dividing the
principal amount of the debentures, plus accrued and unpaid interest, by the
lesser of (a) the fixed conversion prices set forth in the debentures, which
range from $1.50 to $5.00 per share, or (b) a conversion price equal to 50%
of the average closing bid and ask prices of the Company's common stock at
the close of trading on the next day following the maturity date as set forth
in the respective debenture. The Company has been informed that $845,000 of
these convertible debentures have been assigned to persons residing in the
State of Michigan. On September 24, 1997 the persons to whom these
convertible debentures were assigned filed a Schedule 13D under the
Securities and Exchange Act of 1934. The Schedule 13D filed by those persons
<PAGE> 48
discloses that the persons to whom the debentures were assigned beneficially
own 5,045,102 shares of the Company's common stock, including 4,801,640
shares of the Company's common stock which are to be issued upon conversion
of the debentures. All of these persons share voting power in the shares
beneficially owned by them. The Company believes the shares issuable to the
assignees of the Company's 10% cumulative convertible debentures upon
conversion may violate the terms and conditions of the consent order entered
into between the Company and the State of Michigan (see Note 14). The Company
has not made a final determination as to the
conversion rights of such assignees. During 1997, the Company issued 19,033
shares upon conversion of $84,000 in principal amount of such debentures,
plus accrued interest. As a result of the Company not having converted these
debentures on their respective maturity dates, the Company is in default of
the terms of the debentures.
On November 21, 1996 and November 26, 1996, the Company privately placed, in
reliance upon exemptions under Regulation S of the Securities Act of 1933,
$300,000 and $200,000, respectively, of 10% one-year cumulative convertible
debentures. These debentures are convertible into shares of the Company's
common stock at any time after 45 days from the date of their issuance and
prior to their scheduled one-year maturity dates. The conversion price of
these debentures, plus accrued and unpaid interest, is equal to the lesser of
(a) 70% of the average closing bid price of the Company's common stock for
the five days preceding the conversion date or (b)80% of the average closing
bid price of the Company's common stock for the five days prior to issuance
of the debentures. In connection with the issuance of these debentures, the
Company incurred placement fees and other costs of approximately $50,000 and
received net proceeds of approximately $450,000. As of December 31, 1997, the
Company has converted $330,000 of these debentures into 122,000 shares of the
Company's common stock and has outstanding unconverted debentures totaling
$170,000. The Company is in default of the terms of the debenture outstanding
at December 31, 1997 by virtue of not having converted the debenture on its
maturity date.
The 10% convertible debentures payable to the former shareholders of TNI,
plus accrued and unpaid interest, are due at the time of a public offering of
the Company's common stock and the filing of a registration statement. These
debentures are convertible at a conversion price equal to the public offering
price in such registration statement at the election of the holder. In March
1997, the Company made an offer to each of the holders of these convertible
debentures to redeem the debentures in return for 1.5 shares of the Company's
common stock for each dollar of principal, plus accrued interest, due to each
of the debenture holders, plus common stock purchase warrants exercisable at
any time over a five year period at an exercise price of $0.20 per share. The
number of common stock purchase warrants to be issued upon acceptance of the
offer to redeem the debentures is to be determined by dividing the principal
amount of each debenture by two(2). As of March 31, 1998 (the expiration date
of the offer), the Company received the acceptance of all of the holders of
the debentures. Pursuant to the redemption offer, the Company is to issue
893,278 shares of its common stock and 450,000 stock purchase warrants
(225,000 of which are exercisable at $1.50 per share by the terms of the
respective debenture note and 225,000 of which are exercisable at $0.20 per
share pursuant to the redemption offer).
The notes payable to the former shareholders of NSC, due in equal monthly
installments of $20,000, are currently in default. The Company has not made
any payments on these notes since April 1996. The holders of these notes
have not initiated collection efforts for the amounts due to them under the
notes. The Company is currently accruing interest on these notes at 18% per
annum, the default rate of interest as called for by the notes.
The 6% acquisition notes payable to the former shareholders of ATI were
originally due within 90 days of the date of acquisition of ATI. These notes
were subsequently modified to delay their due date to the date of a public
offering of the Company's common stock or upon placement of a bridge
financing
<PAGE> 49
facility to refinance the debt. These notes were also extended from time to
time. In consideration of these extensions, the Company issued 140,000 shares
of its Class B preferred stock and 166,668 stock purchase warrants
exercisable at $1.50 per share to the note holders. The 140,000 shares of
Class B preferred stock were converted into 50,910 shares of the Company's
common stock in September 1996. The acquisition notes payable, the stock
purchase warrants and 684,410 shares of the Company's common stock issued to
the former shareholders of ATI in connection with the acquisition and as
consideration for extension of indebtedness are to be
returned to the Company in connection with the May 1997 rescission of the ATI
acquisition agreement(see Note 4).
The notes payable and debentures associated with the acquisitions of
subsidiaries, described above, are collateralized by the stock of the
respective subsidiaries.
The 18% Cumulative Convertible Debenture Note due January 15, 1999 is
convertible into the Company's common stock, at the election of the holder,
at a conversion price of $2.50 per share, is guaranteed by the Company's
Chairman of the Board and is collateralized by 500,000 shares of the
Company's common stock, which is held in escrow pursuant to an escrow
agreement.
The 12% Cumulative Debenture Notes consist of two notes in the principal
amount of $25,000, each, and are due in October and November 1998,
respectively. These notes are convertible, at the election of the holder,
into shares of the Company's common stock at an exercise price of $.10 per
share. Interest accrued may also be converted into shares of the Company's
common stock at a price equal to the average of the bid and ask prices of the
Company's common stock on the next day following conversion. Upon conversion,
the holders of the notes are also entitled to receive common stock purchase
warrants. The number of warrants to be issued upon conversion of these notes
is equal to the principal amount of the notes divided by 0.1 and are
exercisable at $0.10 per share.
The 12% Convertible Promissory Note due March 28, 1997 is in default. The
Note is convertible, at the election of the holder, into the Company's common
stock at $2.00 per share, plus 3,000 common stock purchase warrants,
exercisable at $2.00 per share for a two year period. The common stock
purchase warrants are to be issued either upon conversion or payment of the
Note.
The 10% Convertible Debenture Note due September 1998 is payable, at the
election of the holder, from the proceeds of the GECCS\News arbitration
award, from the proceeds of the $500,000 note received by the Company from
the sale of certain of TNI assets (the "ITD Note") or by the issuance of the
Company's common stock at the average of the bid and ask prices of the
Company's common stock as of the date of the note. This note was not paid
from the proceeds of the GECCS\News arbitration award and, in March 1998, the
Company canceled the ITD Note pursuant to an agreement between and among the
Company, ITD and certain former employees of the Company and TNI (see Note
18). After these events, the note is either payable in cash or by the
issuance of the Company's common stock at the election of the holder.
As of December 31, 1996, the Company had $162,741 of 8-10% notes payable to
stockholders due on various dates through December 1997. These notes are
generally due one year after the date of issuance and provide the holder with
the right to convert the principal amount of the note, plus accrued and
unpaid interest, into shares of the Company's common stock at predetermined
conversion prices at any time prior to maturity. During 1997, these
stockholders loaned the Company an additional $91,443, the Company made
payments of $84,484 and $168,000 of such notes, plus accrued interest, were
converted into shares of the Company's common stock at a negotiated
conversion prices ranging from $0.90 to $1.00 per share.
<PAGE> 50
The $200,000 promissory note in default outstanding as of December 31, 1996
was paid in December 1997 from the proceeds of the Settlement Agreement with
GECCS and News (see Note 4).
The 10.75% demand note payable in the amount of $100,000 outstanding at
December 31, 1996 was paid in December 1997 from the proceeds of the
Settlement Agreement with GECCS and News (see Note 4).
The 5% note payable to a former shareholder of CCI in the amount of $75,000
at December 31, 1996 was relieved, in full, as a result of the rescission in
May 1997 of the ATI acquisition (see Note 4).
As of December 31, 1997 and 1996, all of the Company's notes and debentures
outstanding are classified as current in the accompanying balance sheet.
NOTE 8 BORROWINGS UNDER LINES OF CREDIT
As of December 31, 1997, the Company had no used or unused lines of credit.
The Company, through two of its subsidiaries, had lines of credit which were
fully utilized at December 31, 1996.
NOTE 9 FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 "Disclosures about Fair
Value of Financial Instruments" requires disclosure of the estimated fair
value of financial instruments. It is not practicable to estimate the fair
value of the Company's debt instruments because most of the debt instruments
that have been issued by the Company are unique due to their terms being
negotiated as a part of the acquisition of companies or in connection with
private placements and, in many cases, comparable instruments do not exist.
The carrying amount of the Company's other financial instruments, cash and
cash equivalents and accounts receivable, are a reasonable estimate of their
fair value.
NOTE 10 INCOME TAXES
Income tax expense (benefit) for each of the three years in the period ended
December 31, 1997 consists of deferred income taxes and is allocated among
(i) continuing operations and (ii) the components of discontinued operations
in proportion to their individual effects on income tax expense (benefit) for
the year after the allocation of income tax expense (benefit) applicable to
continuing operations. No provisions for income taxes currently payable were
made in 1997, 1996 or 1995.
The allocation of income tax expense (benefit) for each of the three years in
the period ended December 31, 1997 among continuing operations and the
components of discontinued operations is summarized as follows:
<TABLE>
YEAR ENDED DECEMBER 31
------------------------------------
1997 1996 1995
-------- ---------- --------
<S> <C> <C>
Loss from continuing operations $(605,500) $(2,440,150) $( 15,124)
Discontinued operations:
Income(loss) from operations of
discontinued telecommunications
businesses 240,000 ( 763,044) (241,577)
Gain from disposition of
telecommunications businesses 365,500 -- --
------- --------- -------
Income tax expense (benefit) $ -- $(3,203,194) $(256,701)
======= ========= =======
</TABLE>
<PAGE> 51
Income tax expense (benefit) applicable to continuing operations differs from
the amounts computed by applying the U.S. Federal income tax rate of 34
percent to loss before income taxes as a result of the following:
<TABLE>
YEAR ENDED DECEMBER 31
----------------------------------
1997 1996 1995
------- --------- --------
<S> <C> <C> <C>
Amount computed at statutory rate $(1,239,000) $(6,966,137) $(681,438)
Increase (reduction) in taxes
resulting from:
State income taxes (120,400) (819,546) (80,169)
Amortization of goodwill 38,900 80,158 9,490
Rescission of business acquisitions 176,900 -- --
Impairment losses -- 971,769 --
Change in valuation allowance 538,190 4,125,702 732,893
Other (90) 167,904 4,100
------- --------- -------
$(605,500) $(2,440,150) $( 15,124)
======= ========= =======
</TABLE>
The principal reasons for the difference between the amounts of income tax
benefit allocated to loss from discontinued operations in 1996 and 1995 and
the amounts computed by applying the U.S. federal income tax rate of 34
percent to loss from discontinued operations before income taxes, is due
primarily to amortization of goodwill, impairment losses and adjustments to
the valuation allowance recorded as a reduction of goodwill in conjunction
with the Company's 1995 acquisition of NSC.
In the first ten months of 1995, the Company recorded net deferred tax assets
of approximately $930,000 with an addition to the valuation allowance in the
same amount. As part of the acquisition of NSC, the Company recorded
approximately $3.8 million of deferred tax liabilities. Because the deferred
tax liabilities after the NSC acquisition exceeded the previously recorded
gross deferred tax assets, the Company reversed the valuation allowance
(approximately $980,000 as of October 31, 1995, $248,000 of which is
applicable to operations of discontinued businesses). Because this occurred
as part of a business combination rather than through operations, the
adjustment was recorded as a reduction in goodwill associated with the NSC
acquisition rather than as an adjustment to operations.
<PAGE> 52
The Company has temporary differences between the amounts of assets and
liabilities for financial reporting purposes and the amounts of such assets
and liabilities as measured by enacted tax laws. The Company also has net
operating loss carryforwards available to reduce future taxable income. The
significant components of the Company's deferred tax assets and liabilities
as of December 31, 1997 and 1996 are as follows:
1997 1996
--------- ---------
Deferred tax assets:
Net operating loss carryforwards $4,034,296 $4,113,122
Allowance for doubtful accounts 190,000 10,668
Accrued compensation and liabilities under
employment agreements 257,000 777,922
Accrued expenses and other current liabilities 250,800 --
--------- ---------
Total deferred tax assets 4,732,096 4,901,712
Less-valuation allowance (4,663,996) (4,125,806)
--------- ---------
Net deferred tax assets 68,100 776,007
--------- ---------
Deferred tax liabilities:
Intangible assets -- 371,029
Deferred compensation 68,100 389,401
Other -- 15,577
--------- ---------
Total deferred tax liabilities 68,100 776,007
--------- ---------
Net deferred income taxes $ -- $ --
========= =========
At December 31, 1997, the Company and its subsidiaries had unused net
operating loss carryforwards of approximately $10 million, expiring on
various dates through 2011. Of this amount, approximately $9 million is not
restricted as to use. The balance of the carryforwards amounting to
approximately $1 million is restricted to offsetting future taxable income,
if any, of the respective companies which generated the carryforwards and may
be further limited as to utilization in any one year by existing tax laws.
Prior to the acquisition of HMT (See Note 4), it was taxed under Subchapter S
of the Internal Revenue Code and consequently, was not subject to Federal
income tax.
NOTE 11 - STOCKHOLDERS' EQUITY
CLASS A PREFERRED STOCK
The Company's Class A preferred stock is non-voting, has a stated value and
liquidation preference of $1.00 per share, is convertible into one-half share
of the Company's common stock at the election of the holder at any time prior
to a public offering of the Company's common stock and automatically converts
into common stock at the time of such public offering.
CLASS B PREFERRED STOCK
The Company's Class B preferred stock is non-voting, has a stated value and
liquidation preference of $1.00 per share, is convertible into shares of the
Company's common stock (with such number of shares to be determined as of the
date of issuance, based on the stated value divided by the 10-day average
closing bid price of the Company's common stock) at the election of the
holder at any time prior to a public offering of the Company's common stock
and automatically converts into common stock at the time of such public
offering. As of December 31, 1997, the Company had 2,953,125 shares of Class
B preferred stock outstanding.
<PAGE> 53
STOCK PURCHASE OPTIONS AND WARRANTS
The Company has issued common stock purchase warrants in conjunction with the
sale and issuance of common stock, preferred stock and convertible
debentures. The exercise prices of warrants issued were determined based upon
prices related to the issuance of the Company's other securities. Such
warrants are generally exercisable at any time within two years from the date
of issuance and entitle the holder to receive one share of common stock for
each warrant. In August 1997, the Company, by written consent of the Board of
Directors, extended the exercise date of all warrants with expiration dates
in 1997 and 1998 to December 31, 1998.
The Company has also issued stock options to certain officers, employees and
directors. Options granted in 1996 totaled 1,000,000 and are exercisable at
$6.00 per share. These options were canceled effective as of December 31,
1997. Options granted in 1997 totaled 1,417,500. Of the total number of
options granted in 1997, 117,500 are exercisable at any time over a two year
period at an exercise price of $1.50 per share and 1,300,000 are exercisable
at any time over a five year period at an exercise price of $0.10 per share.
<PAGE> 61
Options and warrants outstanding are summarized as follows:
<TABLE>
Exercise Weighted
Price Range Average
Shares per Share Exercise Price
--------- ------------ --------------
<S> <C> <C> <C>
Warrants outstanding
at December 31, 1995 1,680,936 $1.50-$8.00 $2.73
Warrants issued 1,822,098 $1.50-$10.00 $4.00
Options issued 1,000,000 $6.00 $6.00
---------
Warrants and options
outstanding at December 31, 1996 4,503,700 $1.50-$10.00 $3.78
Warrants issued 697,805 $0.10-$4.50 $1.06
Warrants canceled (166,668) $1.50 $1.50
Options issued 1,417,500 $.010-$1.50 $0.22
Option canceled (1,000,000) $6.00 $6.00
---------
Warrants and options
outstanding at December 31, 1997 5,452,337 $0.10-$10.00 $1.93
=========
</TABLE>
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25) and related Interpretations
in accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
"Accounting for Stock-Based Compensation," requires use of option valuation
models that were not developed for use in valuing employee stock options. Under
APB 25, because the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
Pro forma information regarding net income and earnings per share is required
by Statement No. 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method of that Statement.
The fair value for the options granted in 1997 was estimated at the date of
grant using a Black-Scholes option pricing model with the following assumptions:
risk-free interest rate of 6.50%; no dividend yield; a volatility factor of the
expected market price of the Company's common stock of 173%; and a weighted-
average expected life of 4.75 years. The assumptions used in 1996 to estimate
the fair value of options granted in that year were: risk-free interest rate of
6.66%; no dividend yield; a volatility factor of the expected market price of
the Company's common stock of 40.77%; and a weighted-average expected life of
two years.
<PAGE> 54
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no restrictions and are fully
transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, the existing models, in management's opinion, do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
For purposes of the following pro forma disclosure, the estimated fair value
of options granted to employees have been expensed. The Company's pro forma
net loss and basic earnings per share data after giving effect to the charges
to income, as if the Company accounted for stock options under the provisions
of Statement No. 123, for the years ended December 31, 1997 and 1996 are
summarized as follows:
1997 1996
--------- ----------
Loss from continuing operations $(3,319,331) $(19,728,489)
--------- ----------
Income (loss) from operations of discontinued
telecommunications businesses 391,863 ( 1,508,179)
Gain from disposition of discontinued
telecommunications businesses 596,648 --
--------- ---------
Net loss $(2,330,820) $(21,236,668)
========= ==========
Basic earnings per share:
Loss from continuing operations $ (.31) $ (2.36)
Income (loss) from operations of discontinued
telecommunications businesses .04 (0.18)
Gain from disposition of discontinued
telecommunications businesses .05 --
--------- ---------
Net loss $ (.22) $ (2.54)
========= =========
NOTE 12 LEASES
The capital lease obligations outstanding as of December 31, 1996 were
removed from the Company's consolidated balance sheet in 1997 as a result of
the rescission of the ATI acquisition agreement (see Note 4) and the taking
of possession by the lessor of certain computer equipment leased by NSC (see
Notes 5 and 14).
The Company leases office space and equipment under operating leases expiring
on various dates through November 31, 2000. Total minimum future rental
payments under non-cancelable operating leases having remaining terms in
excess of one year as of December 31, 1997 are as follows:
1998 $ 55,949
1999 47,833
2000 43,847
2001 --
2002 --
-------
Total minimum future rental payments $ 147,629
=======
<PAGE> 55
Rental expense under all operating leases was $167,354, $359,474, and $94,961
in 1997, 1996, and 1995, respectively. During 1997, the Company vacated
certain leased premises and is subject to certain additional lease payments
and other charges under the leases, all which have been recorded as of
December 31, 1997. In addition, the Company is in default of the lease
agreement on its San Antonio, TX location as a result of the abandonment of
that facility and non-payment of payments due under the lease.
NOTE 13 - EMPLOYMENT AGREEMENTS
Employment agreements with certain key employees provide for, among other
things, the payment of compensation over 5 years from the date of employment
regardless of whether or not the employee remains in the employ of the
Company. The present value of future obligations under such agreements was
$675,966 at December 31, 1997. The Company also has deferred compensation
assets related to these agreements. Deferred compensation has been reported
on the basis that the related employee(s) continue to provide meaningful
service to the Company. In the event the employee(s) cease to provide such
service, deferred compensation is reduced accordingly. Following is a summary
of amounts included in the accompanying consolidated balance sheets for such
agreements as of December 31, 1997 and 1996:
<TABLE>
1997 1996
--------- ---------
<S> <C> <C>
Deferred compensation assets included in:
Other current assets $ 126,627 $ 355,415
Deferred compensation (non-current) 52,941 647,355
--------- ---------
$ 179,568 $1,002,770
========= =========
Deferred compensation liabilities included in:
Accrued expenses and other current liabilities $ 365,172 $ 344,652
Deferred liabilities under employment agreements 310,794 676,261
--------- ---------
$ 675,966 $1,020,913
========= =========
</TABLE>
During 1997, certain employees subject to the above described employee
agreements resigned resulting in charges to income, in the aggregate, of
approximately $626,000, to write-off the unamortized portion of the related
deferred compensation asset (see Note 5).
Effective in May 1994, the Company entered into a letter agreement to employ
its then current Chief Executive Officer. In connection with that letter
agreement, the Company reserved 500,000 shares of its common stock, valued at
$15,000, and 1,375,000 shares of its Class A preferred stock, valued at
$20,625, to be issued as additional compensation upon satisfaction of certain
conditions as set forth in the letter agreement. Such conditions were met
during 1995 and the shares of common stock and Class A preferred stock
previously reserved for issuance were issued. In connection with the issuance
of such shares, the Company recorded deferred compensation of $35,625 which
is being amortized over the life of the related employment agreement(5
years). The unamortized deferred compensation asset recorded in 1995 was
written-off in 1997 due to the resignation of that Chief Executive Officer.
<PAGE> 56
NOTE 14 COMMITMENTS AND CONTINGENCIES
The Company is subject to various legal and administrative proceedings. These
proceedings include (i) a consent order executed between the Company and the
State of Michigan requiring the Company to use its best efforts to satisfy
the prerequisites of the Securities and Exchange Commission and the Michigan
Securities Bureau for registering the common stock sold by the Company to
purchasers of its securities in the State of Michigan, (ii) actions brought
against the Company by certain former employees and persons formerly under
contract with the Company for payments allegedly due them, (iii) an action by
a shareholder seeking the rescission of the sale by the Company of its common
stock to the shareholder, (iv) an action by an equipment lessor seeking
approximately $500,000 in lease payments and other charges due under a lease
agreement and (v) an action by the former stockholders of CCI.
These legal and administrative actions are more fully described below.
The consent order executed by the Company and the State of Michigan in
December 1996, requires the Company to use its best efforts to satisfy the
prerequisites of the Security and Exchange Commission and the Michigan
Securities Bureau for registering the common stock sold to Michigan
purchasers of its common stock for resale by them in the public market. This
action is the result of the sale by the Company of its securities in the
State of Michigan without an exemption from registration under the Michigan
Uniform Securities Act. In the event the Company is unable to effect a
registration statement or such purchasers are unable to resell their shares
pursuant to such registration statement at a higher price than their cost,
then the Company is required to use its best efforts to satisfy the
prerequisites of the Securities and Exchange Commission and the State of
Michigan for making a rescission offer to all such purchasers. Also, pursuant
to the consent order, the Company must cease the unregistered sale of
securities in Michigan, has been censured and has paid costs to the state of
$2,500. Upon satisfaction of the consent order, all sanctions are terminated.
As of December 31, 1997, the Company estimates its maximum potential exposure
as a result of any rescission offer which may be required to be made in the
State of Michigan to be approximately $795,739, including accrued interest of
approximately $121,615, which is included as a component of accrued interest
in the accompanying consolidated balance sheet. The number of shares the
Company believes may be subject to a rescission offer in the State of
Michigan, if such an offer were to be made, is approximately 219,000 shares;
and, the weighted average purchase price of such shares is approximately
$3.25 per share. The Company has not satisfied the requirements of the
consent order. Due to the "best efforts" nature of the Company's compliance
obligation, the Company believes that its performance of the terms of the
consent order is deferred until such time it is able to both financially and
functionally comply with the consent order.
On April 15, 1997, Mr. Ken Lame, as Plaintiff, filed an action in the United
States District Court, District Court of Utah, Central Division (Case No.
2:97CV0292W) against the Company and NSC, as Defendants. This action arises
from a consulting agreement between Mr. Lame and the Company. The action
seeks approximately $250,000, plus interest, for payments Mr. Lame alleges
are due under the consulting agreement. The Company has accrued a loss
reserve of approximately $118,500 related to this action. Resolution of this
matter is not expected to result in a cash outlay in excess of the amount
provided.
On May 21, 1997, Mr. Jeff Good, as Plaintiff, filed an action in the United
States District Court, Southern District of Iowa, Davenport Division (Case
No. 3-97-CV-80085) against the Company, as Defendant, for amounts Mr. Good
alleges are due under an employment agreement between Mr. Good and one of the
Company's subsidiaries (which subsidiary is no longer conducting business).
This action seeks compensation and benefits under the employment agreement in
excess of $200,000. The Company believes this action to be without merit and
<PAGE> 57
intends to vigorously defend it. However, it is not possible to predict the
likely outcome of this matter.
On May 1, 1997, Mr. John Jassy, as Plaintiff, filed an action in the Circuit
Court of the Sixth Judicial Circuit in and for Pinellas County, Fl., Civil
Division (Case No. 97-3103-CI-20) against the Company, Mr. Stephen E.
Williams and Mr. Edwin B. Salmon, Jr., as Defendants. This action alleges
that numerous misrepresentations and deceptive statements were made to Mr.
Jassy and certain family members of Mr. Jassy to induce them to purchase the
Company's securities. The action seeks rescission of those security
purchases, payment of compensation Mr. Jassy alleges is due to him from his
employ by the Company as an executive officer and repayment of a loan made to
Mr. Williams by Mr. Jassy. This action seeks approximately $500,000, plus
interest and attorney's fees. Included in the amounts claimed by plaintiff,
are approximately $450,000, including interest, to repurchase approximately
100,000 shares of the Company's common stock purchased by plaintiff and his
family members, approximately $60,000, plus interest, Mr. Jassy alleges is
payable to him in unpaid salary and benefits and $2,500, plus interest, Mr.
Jassy claims is owed to him by Mr. Williams, a former President and Chief
Executive Officer of the Company. The Company believes this action to be
without merit and intends to vigorously defend it. In the event of an
unfavorable outcome, it is unlikely that the Company would be able to
repurchase the shares of common stock or pay other amounts subject to the
action.
In May 1996, the Company informed the principals of CCI that it was canceling
the acquisition of CCI and terminating all of the related acquisition
documents. The principals of CCI filed suit to enforce promissory notes in
the aggregate principal amount of $300,000, which were issued by the Company
in connection with the acquisition and the issuance of 200,000 shares of the
Company's Class A preferred stock they allege are due them under the
acquisition agreement. This matter was referred by court order to mandatory
arbitration in the State of Florida. On February 3, 1998, the Arbitrators'
awarded in favor the former stockholders of CCI. The award requires, among
other things, that the Company (i) convert 200,000 shares of its Class A
preferred stock held by the former stockholders of CCI into 100,000 shares of
its common stock and (ii) issue another 200,000 shares of its Class A
preferred stock to the former CCI stockholders, which are also convertible
into 100,000 shares of the Company's common stock, and gave the former
stockholders of CCI the ability to seek a summary judgement against the
Company for $500,000, without opposition, or accept 500,000 shares of the
Company's Class A preferred stock in lieu of a summary judgement. As of
December 31, 1997, the Company has recorded a loss contingency of $111,000 in
excess of the $300,000 of promissory notes issued in connection with the
acquisition and which were extinguished as a part of the arbitration award.
In the event the former stockholders elect to seek a summary judgement in
lieu of the issuance by the Company of 500,000 shares of its Class A
Preferred Stock, the Company would be required to record an additional loss
provision of approximately $145,000. If the formal stockholders elect a
summary judgement, it is unlikely that the Company would have sufficient cash
to satisfy it (see Note 4).
In October 1997, Boston Financial Corporation ("BFC") took possession of
certain computer equipment leased by NSC from BFC as a result of the default
by NSC of payments due under the lease. On December 11, 1997, BFC filed an
amended suit in District Court, 45th Judicial District, Bexar County, Texas
(Case No. 97CI-14567) against NSC and, as guarantors of the lease agreement,
the Company, ATI and TNI. This action seeks approximately $500,000 in lease
payments and other charges due under the lease agreement. The Company is
attempting to negotiate a settlement of this matter and may have several
counterclaims against BFC should the Company and BFC fail to settle. However,
it is not possible to predict the likely outcome of such negotiations or any
counterclaims the Company may have against BFC. As of December 31, 1997, the
Company has recorded a loss contingency reserve of approximately $500,000
related to this action.
<PAGE> 58
On June 6, 1997, Timboon, LTD ("Timboon"), as Plaintiff, filed an action in
the United States District Court, Southern District of New York (Case No. 97
Civ. 4464 (JSR), against the Company, as Defendant, seeking the delivery of
163,438 shares of the Company's common stock to Plaintiff as a result of the
conversion of $150,000 of the Company's 4% Convertible Debentures, issued to
Timboon in February 1997 in reliance upon exemptions under Regulation S of
the Securities Act of 1933, and the payment of $970,000 (the principal amount
of the Company's $4% Convertible Debentures that have not been converted by
Timboon) to Timboon, plus damages. The Company filed a counterclaim against
Timboon alleging that Timboon breached the representations and covenants it
made in the Off-Shore Securities Subscription Agreement. These
representations and covenants related to, among other things, Timboon's
investment intent in acquiring the Company's securities and its possible
"shorting" of the Company's common stock in contemplation of conversion. In
addition, the Company alleged that Timboon participated in manipulative
market activity with the intent to artificially depress the market price of
the Company's common stock. Effective March 2, 1998, the Company and Timboon
Ltd. entered into a Settlement Agreement and Release (the "Settlement
Agreement") in settlement of all claims brought against each other in
connection with the debentures issued to Timboon. See Note 7.
Prior to the rescission of the ATI acquisition agreement, the Company
obtained and guaranteed an equipment lease financing facility for ATI's use.
The
financing facility was subsequently terminated by the lessor due to non-
payment by ATI of payments due under the related lease agreements. In
connection with the rescission of the ATI acquisition agreement, ATI issued a
promissory note to the Company in the amount of $180,000, payable upon the
default by ATI of payments due under the lease financing facility. Payments
due to the Company under the promissory note are to be equal to the amount,
if any, the Company may be required to pay under the lease guaranty
agreement. In the event of a default by ATI under the lease financing
facility, it is uncertain whether or not the Company would be able to satisfy
the terms of the guaranty agreement or whether or not ATI would be able to
satisfy the terms of the promissory note.
As of December 31, 1997, the Company and its subsidiaries have pending
outstanding judgments totaling approximately $170,000, exclusive of the CCI
judgment referred to above. These judgments arose from cancellation of office
and equipment leases and from non-payment of obligations due to trade
creditors.
The Company is also involved in numerous other legal and administrative
actions incurred in the ordinary course of business, none of which are
expected to have a material impact on the Company's financial condition or
results of operations.
NOTE 15 SEGMENT INFORMATION
The Company's operations are classified into two industry segments:
healthcare management and cost containment products and services
("Healthcare") and telecommunications products and services, including pay-
per-view related services ("Telecommunications"). In 1996 and 1997, the
Company disposed of substantially all of the assets of its telecommunications
businesses. Consequently, the healthcare segment is the only segment in which
the Company has continuing operations. The operations of the Company's
telecommunications segment are classified as discontinued operations in the
accompanying consolidated statements of operations for all periods presented.
For summary operating results of the Company's discontinued
telecommunications segment, see Note 4.
Capital expenditures of the Company's discontinued telecommunications segment
were $-0-, $12,561 and $208,503 in 1997, 1996 and 1995, respectively; and,
the identifiable assets of the Company's discontinued telecommunications
<PAGE> 59
segment included in the consolidated balance sheets as of December 31, 1997
and 1996 are $539 and $660,094, respectively.
In 1997, HMT had one customer that counted for approximately 50% of the
Company's consolidated net revenues from continuing operations. In 1996 and
1995, the NSC had one customer that accounted for approximately 47% and
100.0% of the Company's consolidated net revenues from continuing operations.
The Company has no inter-segment revenues.
NOTE 16 STATEMENTS OF CASH FLOWS SUPPLEMENTAL INFORMATION
<TABLE>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
-------- -------- ---------
<S> <C> <C> <C>
Non-cash investing and financing activities:
Equipment capital leases $ 73,184 $ 703,215 $ 112,308
======== ======== ========
Notes payable issued in
connection with
business acquisitions $ -- $ -- $ 700,000
======== ======== =========
Issuance of stock for debt $ 716,318 $ 199,150 $ --
======== ======== =========
Cash paid during the period for:
Interest $ 131,635 $ -- $ 23,055
======== ======== =========
Income taxes $ -- $ -- $ --
======== ======== =========
</TABLE>
NOTE 17 EVENTS SUBSEQUENT TO DECEMBER 31, 1997
In March 1998, the Company made an offer to each of the holders of its 10%
convertible debentures payable to the former shareholders of TNI to redeem
the debentures in return for 1.5 shares of the Company's common stock for
each dollar of principal, plus accrued interest, due to each of the debenture
holders, plus common stock purchase warrants exercisable at any time over a
five year period at an exercise price of $0.20 per share. The number of
common stock purchase warrants to be issued upon acceptance of the offer to
redeem the debentures is to be determined by dividing the principal amount of
each debenture by two(2). As of March 31, 1998 (the expiration date of the
offer), the Company received the acceptance of all of the holders of the
debentures. Pursuant to the redemption offer, the Company is to issue 893,278
shares of its common stock and 450,000 stock purchase warrants (225,000 of
which are exercisable at $1.50 per share by the terms of the respective
debenture note and 225,000 of which are exercisable at $0.20 per share
pursuant to the redemption offer).
In March 1998, the Company, TNI, International Teledata Corporation ("ITD")
and certain former employees of the Company (the "Employees") entered into an
agreement (the "Agreement") which provided for the transfer of certain ITD
assets to the Employees. The assets transferred pursuant to the Agreement
were sold to ITD by TNI pursuant to the Purchase and Sale Agreement, dated as
of January 31, 1997, between TNI and ITD. In connection with the transfer of
assets pursuant to the Agreement, the Company canceled the $500,000
convertible debenture note issued by ITD (the "ITD Note") in conjunction with
the Purchase and Sale Agreement in exchange for 496,902 shares of the
Company's common stock beneficially owned by the Employees and the waiver by
the Employees of accrued and unpaid compensation due to them and cancellation
of their employment agreements with the Company.
<PAGE> 60
NOTE 18 - Valuation and Qualifying Accounts
Valuation and qualifying accounts (which are deducted from the assets to which
they apply) consist of an allowance for doubtful accounts.
Following is a summary of the allowance for doubtful accounts:
Balance, December 31, 1995 $510,000
Additions:
Provision for bad debts charged
to operations 522,687
Deductions:
Write-offs (985,254)
CCI Elimination (19,359)
-------
Balance, December 31, 1996 28,074
Additions:
Provision for bad debts charged
to operations 39,816
Deductions:
Write-offs (63,214)
Discontinued operations (4,676)
-------
Balance, December 31, 1997 $ --
=======
The provision for bad debts charged to operations applicable to discontinued
operations was $475,711 in 1996.
NOTE 19 PROPOSED ACQUISITION
On November 14, 1997, the Company and the stockholders of HMG Health Care
Claims Auditing, Inc. ("HMG") entered into an agreement to exchange stock (
the "Agreement to Exchange Stock"). Pursuant to the Agreement to Exchange
Stock, the Company is to acquire all of the outstanding stock of HMG in
exchange for shares of the Company's common stock (the "HMG Acquisition
Shares"). The number of HMG Acquisition Shares is to be determined at closing
and are to be equal to 30% of the then outstanding common stock of the
Company after giving effect to the issuance of the HMG Acquisition Shares.
The acquisition of HMG is subject to, among other things, the Company
obtaining equity or debt financing to refinance the existing indebtedness of
HMG ($850,000) and pay other costs and expenses related to the acquisition.
The Agreement to Exchange Stock contemplated a December 31, 1997 closing.
Subsequent thereto, the Agreement to Exchange Stock was terminated by the
mutual consent of the parties.
NOTE 20 RESTATEMENT OF FINANCIAL RESULTS
The Company has restated its consolidated financial results for the years
ended December 31, 1997 and 1996. The 1996 financial statements have been
restated to reflect the business, assets and liabilities of CCI. The assets
and liabilities of CCI had previously been removed from the Company's balance
sheet, effective May 1996, as a result of the Company having abandoned the
business of CCI. As of the date the Company abandoned the business of CCI,
CCI had ceased operations. Accordingly, the inclusion of the business of CCI
in the consolidated financial statements had no effect on the Company's
operations or cash flows for periods after May 1996. As a result of the
reinstatement of the assets and liabilities of CCI, the Company retroactively
recorded, as a charge to income, $300,000 to fully reserve the carrying value
of CCI's assets. This had the effect of increasing the Company's loss from
continuing operations and net loss for the year ended December 31, 1996, as
previously reported, by $114,000 and $300,000, respectively.
<PAGE> 61
The 1997 financial statements have been restated to retroactively record the
shares of the Company's common stock returned to the Company in connection
with the rescission of business acquisitions at fair value (see note 4). The
shares of common stock returned to the Company in connection with the
rescission of business acquisitions were previously valued and recorded at
their original issue prices at the time of the respective business
acquisitions. The effect of adjusting the value assigned to the shares of the
Company's common stock returned to the Company in connection with the
rescission of business acquisitions was to increase the Company's loss from
continuing operations and net loss, for the year ended December 31, 1997, as
previously reported, by $1,732,264 and $1,533,008, respectively, and increase
the gain from disposition of telecommunication businesses, as previously
reported, by $199,256. The per share effects were to increase the loss from
continuing operations and net loss by $0.16 and $0.14, respectively, and
increase the gain from disposition of telecommunications businesses by $0.02.
The adjustments to the statement of operations for the year ended December
31, 1997 were offset by a corresponding increase in the Company's previously
reported amount of additional paid in capital. As a result, the Company's net
assets as of December 31, 1997 were unchanged by the restatement.
[REMAINDER OF PAGE LEFT BLANK]
<PAGE> 62
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON FINANCIAL
DISCLOSURE.
Effective February 20, 1998, Ernst & Young LLP resigned as independent
auditor of the Registrant. The reports of Ernst & Young LLP on the
Registrant's consolidated financial statements for the past two fiscal years
did not contain an adverse opinion or a disclaimer of opinion and were not
qualified or modified as to audit scope or accounting principles. The reports
of Ernst & Young LLP included an explanatory paragraph expressing substantial
doubt about the Registrant's ability to continue as a going concern.
In connection with the audits of the Registrant's consolidated financial
statements for each of the two years ended December 31, 1996, and in the
subsequent interim periods, there were no disagreements with Ernst & Young
LLP on any matters of accounting principles or practices, financial statement
disclosure, or auditing scope and procedures which, if not resolved to the
satisfaction of Ernst & Young LLP, would have caused Ernst & Young LLP to
make reference to the matter in their report.
Ernst & Young LLP has furnished a letter addressed to the Commission stating
that it agrees with the statements contained herein. A copy of that letter,
dated February 25, 1998, is filed as an exhibit to the Company's Form 8-K
dated February 25, 1998.
Effective March 4, 1998, the Registrant engaged Moore Stephens Lovelace, P.A.
to audit its 1997 consolidated financial statements. The decision to cease
the registrant-auditor relationship between Registrant and Ernst & Young LLP
and the engagement of Moore Stephens Lovelace, P.A. was not recommended or
approved by the Registrant's Board of Directors.
<PAGE> 63
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The names and ages of directors(including the year in which each became a
director) and executive officers of the Company as of the date hereof are set
forth in the following table:
<TABLE>
Director
Name Age Positions With Co. and Subsidiaries Since
- ---------------------- --- ----------------------------------- --------
<S> <C> <C> <C>
Edwin B. Salmon, Jr. 60 Chairman of the Board of Directors 1991
and Chief Financial Officer
James T. Kowalczyk 57 Director and President 1997
Richard A. Sweet 64 Director 1997
Larry R. Snapp 52 Director 1997
Hugh M. Gibbons 57 Executive Vice President N/A
</TABLE>
N/A means the named executive officer is not a director.
Each director is elected by holders of a majority of the Common Stock to
serve for a term of one year ending on the next following annual meeting of
stockholders and until his successor is elected and qualified. Officers serve
at the will of the board. Directors are not compensated for their services
apart from their executive officer salaries, if the Director is also an
executive officer, and stock options that may be granted from time-to-time
for their services as Directors (see Item 11 "Executive Compensation" and
Item 12 "Security Ownership of Certain Beneficial Owners and Management"). In
the event the Company has directors who are not also officers, the Company
may reimburse such directors for travel expenses related to Company business.
The directors and officers of the Company are indemnified against liabilities
which they incur by virtue of being directors and officers under the
corporate laws of the State of Florida. The articles of incorporation and
bylaws of the Company do not contain any provisions with respect to
indemnification of directors and officers. The Company has been advised that
in the opinion of the Securities and Exchange Commission, indemnification for
liabilities arising under the federal securities laws is against public
policy and may be unenforceable. The Company would seek approval of any such
indemnification by a court of competent jurisdiction.
Messrs. Kowalczyk, Sweet and Snapp were elected to the Board of Directors at
various times during 1997 by remaining Directors to fill vacancies. The
Company did not hold an annual meeting of shareholders in 1997 due its
inability to comply with the information requirements of Rule 14a-3, as
promulgated by the Securities and Exchange Commission for the solicitation of
proxies. Rule 14a-3 requires registrants to furnish security holders with an
annual report which includes audited balance sheets as of the end of the two
most recent fiscal years and audited statements of operations and cash flows
for each of the three most recent fiscal years. The Company was unable to
comply with such requirements due the Company not having timely filed its
Annual Report on Form 10-K for the year ended December 31,1996. The Company
did not timely file its Annual Report on Form 10-K for the year ended
December 31, 1996 due to its inability to timely pay for the services of its
independent auditors and the time required by management to complete its
assessment of the carrying value of intangible assets and goodwill recorded
in connection with the acquisition of NSC. The Company contemplates holding
an annual meeting of shareholders in 1998 after the filing of this Annual
Report on Form 10-K for the year ended December 31, 1997. It is uncertain,
however, whether or not the Company will be able to prepare and mail proxy
solicitation materials to its shareholders due to limitations on the part of
<PAGE> 64
the Company to fund those collective efforts. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations".
Mr. Edwin B. Salmon, Jr. has been associated with the Company in various
capacities since its formation. Mr. Salmon is currently Chairman of the Board
of Directors and the Company's Chief Financial Officer and previously held
the position of the Company's Executive Vice President. In 1991, Mr. Salmon
became President and a controlling stockholder of Associated Healthcare
Industries, Inc. ("Associated"), a publicly owned shell corporation, which
changed its name to Contour Medical, Inc. in connection with the acquisition
of a disposable medical products manufacturing business. In 1993, Mr. Salmon
left Associated to resume his efforts in the Company's acquisition of
operating businesses. Mr. Salmon was also the founder of LCI Communications,
Inc., which was acquired by the Company in June of 1995.
Mr. James T. Kowalczyk became a Director and was appointed President of the
Company in July 1997. For the past 30 years, Mr. Kowalczyk was a co-founder,
director and franchiser in Pittsburgh, Pennsylvania with Budget Marketing,
Inc. and was a co-founder and senior officer of 2001/VIP Clubs of America.
Mr. Richard A. Sweet became a Director of the Company in April 1997. For the
past five years, Mr. Sweet has been a Branch Manager for Insurance Adjustors
and Services Corporation of Tampa, Florida and from 1960 to 1986 was Branch
Manager and Supervisor of Claims for Indiana Insurance Co.
Mr. Larry R. Snapp became a Director of the Company in May 1997. Mr. Snapp
has over 30 years of banking industry experience and, for the last five years
was Vice President of National City Bank of Indiana, a position he recently
retired from.
Mr. Hugh M. Gibbons was appointed as the Company's Executive Vice President
in July 1977. For the past five years Mr. Gibbons has served as President of
Gibbons' Health Plan Recoveries, Inc., President of and Principal of Health
Plan Audit Services, Inc., President of H.M. Gibbons & Associates, Inc. and
Executive Vice President of HMG Health Care Auditing, Inc. Mr. Gibbons has
over 34 years of healthcare cost containment experience and has a Doctor of
Jurisprudence Degree from the University of Baltimore School of Law.
[REMAINDER OF PAGE LEFT BLANK]
<PAGE> 65
ITEM 11. EXECUTIVE COMPENSATION.
The following table sets forth the compensation paid or accrued to the chief
executive officer of the Registrant or person discharging comparable duties
and to the executive officers of the registrant whose compensation exceeded
$100,000 for the year ending December 31, 1997.
<TABLE>
Annual Compensation
----------------------------------------------------
Name & Principal Positions Long-Term
- -------------------------- Year Salary Bonus Other Compensation
---- ------ ----- ----- ------------
<S> <C> <C> <C> <C> <C>
Stephen E. Williams 1997 $150,000 $ -- $ -- $ --
Chief Executive 1996 177,500 -- 7,500 --
Officer (1)(2)(3) 1995 190,625 -- 7,500 --
James T. Kowalczyk 1997 32,500 -- -- --
President and Director (4) 1996 N\A N\A N\A N\A
1995 N\A N\A N\A N\A
Edwin B. Salmon, Jr. 1997 150,000 -- -- --
Chief Financial Officer, 1996 177,000 -- 7,500 --
Treasurer and Chairman of 1995 99,630 -- 9,000 --
the Board(1)(4)
</TABLE>
(1) The named executive officers have entered into employment agreements with
the Company. These agreements provide, among other things, for the payment of
compensation over 5 years from the date of employment, regardless of whether
or not these executive officers remain in the employ of the Company. See Note
13 to the consolidated financial statements. Effective December 1, 1996, the
annual salaries of Messrs. Salmon and Williams were reduced to $150,000,
each.
(2) In 1995, the Company issued, as additional compensation to Mr. Williams,
500,000 shares of Common Stock, valued at $15,000, and 1,375,000 shares of
Class A preferred stock, valued at $20,625, in connection with the
performance of certain conditions set forth in a 1994 letter agreement. See
Note 13 to the Consolidated Financial Statements.
(3)In April and June 1997, Mr. Willliams resigned as the Company's President
and CEO and Director, respectively.
(4)In August 1997, each of Messrs. Kowalczyk and Salmon were granted options
to purchase 500,000 shares of the Registrant's common stock, exercisable at
$0.10 per share at any time over five years.
N/A means the respective officer was not employed by the Company during that
period.
<PAGE> 66
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding beneficial
ownership of the Company's common stock as of February 28, 1998 by each
shareholder known by the Company to be a beneficial owner of more than five
percent of the Company's common stock, by each of the registrant's named
directors and executive officers, and by all directors and executive officers
of the registrant as a group. Except as indicated in the footnotes to this
table, the Company believes that the persons named in the table have sole
voting and investment power with respect to all shares of common stock shown
as beneficially owned by them.
Name of Amount and Nature Percent
Beneficial Owner of Beneficial Interest(1) of Class(1)
- ---------------------- ------------------------- -----------
Edwin B. Salmon, Jr. (2g) 625,762 (2a) 1.89
200,000 (2b) 0.60
261,533 (2c) 0.79
224,418 (2d) 0.68
40,000 (2e) 0.12
40,000 (2f) 0.12
James T. Kowalczyk 571,709 (3) 1.72
Richard A. Sweet 226,410 (4) 0.68
Larry R. Snapp 127,250 (4) 0.38
Hugh M. Gibbons 400,000 1.21
All Directors and Executive Officers
as a Group(5 persons) 2,717,082 (5) 8.19
4,000,000 (6) 12.06
NIDAN Corporation 7,746,389 (7)(8) 23.35
NIDAN Corporation 7,042,172 (9) 21.23
(1)Based on information available to the Company, unless otherwise indicated
such shares are owned of record by the named beneficial owner or the named
beneficial owner and spouse, and represent sole voting and investment power.
Such person's percentage ownership has been calculated assuming that all
warrants, options and convertible debentures held by such person that are
exercisable within 6 months have been exercised, but that no other
outstanding warrants, options or convertible debentures have been exercised.
(2a) Includes options for 500,000 shares exercisable at an exercise price of
$0.10 per share at any time through August 15, 2002. Mr. Salmon has sole
voting and investment power over these shares. The address of Mr. Salmon is
the address of the Company.
(2b) These shares are owned by the SBE Trust. Mr. Salmon is the grantor and
beneficiary of this revocable trust; but, his two adult daughters who do not
reside with him are the co-trustees. The address of the trust is the address
of the Company.
(2c) These shares are owned by Brittany Leigh, Inc. Mr. Edwin B. Salmon
disclaims beneficial ownership of these shares. Mr. David Salmon, Mr. Edwin
B. Salmon's adult son, is a Director and the President and Mr. Winfred
Russell is a former President of this corporation. Mr. Edwin B. Salmon was
reported to be one of two directors on the annual report for the corporation
filed with the State of Florida; but, Mr. David Salmon and Mr. Edwin B.
Salmon maintain that the annual report was filed in error and Mr. Edwin B.
Salmon neither is nor in the past two years has been a director or officer of
this corporation. Mr. Edwin B. Salmon is a creditor of this corporation and
has received repayment of his loans to the corporation from proceeds realized
by the corporation from the sale of the registrant's common stock. Mr.
Russell, in his capacity as the former President of this corporation, also
authorized Mr. Edwin B. Salmon, in Mr. Russell's absence, to approve
purchases and sales of the registrant's common stock by the corporation when
<PAGE> 67
unsolicited offers are received from brokers. Mr. Edwin B. Salmon currently
has no such authority. No purchases or sales of the registrant's common stock
by this corporation have been initiated by the registrant. The address of
Brittany Leigh, Inc. is 1520 San Charles Drive, Dunedin, Florida 34698.
(2d) These shares are owned by American First Equipment Leasing, Inc. Mr.
Edwin B.Salmon disclaims beneficial ownership of these shares. Mr. David
Salmon, Mr. Edwin B. Salmon's adult son is a Director and President and Mr.
Winfred Russell is a former President of this corporation. Mr. Edwin B.
Salmon was reported to be one of two directors on the annual report for the
corporation filed with the State of Florida; but, Mr. David Salmon and Mr.
Edwin B. Salmon maintain that the annual report was filed in error and Mr.
Edwin B. Salmon neither is nor in the past two years has been a director or
officer of the corporation. Mr. Salmon is a creditor of this corporation and
has received repayment of his loans to the corporation from proceeds realized
by the corporation from the sale of the registrant's common stock. Mr.
Russell, in his capacity as the former President of this corporation, also
authorized Mr. Edwin B. Salmon, in Mr. Russell's absence, to approve
purchases and sales of the registrant's common stock by the corporation when
unsolicited offers are received from brokers. Mr. Edwin B. Salmon currently
has no such authority. No purchases or sales of the registrant's common stock
by this corporation have been initiated by the registrant. The address of
American First Equipment Leasing, Inc. is 1520 San Charles Drive, Dunedin,
Florida 34698.
(2e) These shares are owned by the Paige Irrevocable Trust. Mr. Edwin B.
Salmon is the grantor of this irrevocable trust; but, his three adult
children, including Mr. David Salmon, none of whom reside with him, are the
co-trustees and one of Mr. Edwin B. Salmon's daughters is the sole
beneficiary. Mr. Edwin B. Salmon disclaims any beneficial interest in this
trust. The address of the trust is the address of the Company.
(2f) These shares are owned by the Jennifer Irrevocable Trust. Mr. Edwin B.
Salmon is the grantor of this irrevocable trust; but, his three adult
children, including Mr. David Salmon, none of whom reside with him, are the
co-trustees and one of Mr. Edwin B. Salmon's daughters is the sole
beneficiary. Mr. Edwin B. Salmon disclaims any beneficial interest in this
trust. The address of the trust is 700 S.W. 66 nd Blvd. ,Gainesville, Fla.
32607.
(2g) The number and percentage of shares that would be attributable to Mr.
Salmon if all shares held by the referenced persons were attributed to Mr.
Salmon are 1,391,913 and 4.2%, respectively.
(3) Includes options for 500,000 shares exercisable at an exercise price of
$0.10 per share at any time through August 15, 2002. The address of Mr.
Kowalczyk is the address of the Company.
(4) Includes options for 100,000 shares exercisable at an exercise price of
$0.10 per share at any time through August 15, 2002. The address of Mr. Sweet
and Mr. Snapp is the addresses of the Company.
(5) Includes the shares and options referred to in (2a)-(2g) above, plus the
options referred to in (3) and (4). Mr. Edwin B. Salmon disclaims beneficial
ownership of the shares referred to in (2c)-(2g) above. The address of each
director and executive officer of the Company is the address of the Company.
(6) Includes 4,000,000 shares issued in escrow pursuant to the terms of a
Settlement Agreement and Release dated as of March 2, 1998 between the
Company and Timboon LTD. These shares are to be liquidated by Timboon LTD in
payment of $1,200,000 of 4% cumulative convertible debentures. Timboon LTD
has appointed the Board of Directors ex-officio as proxy of Timboon with full
power of substitution to vote the number of shares Timboon LTD would be
entitled to cast if personally present at any annual meeting or special
<PAGE> 68
meeting of stockholders of the Company at any time prior to January 31, 1999.
The address of Timboon LTD is 28 Hagvura Street, Karni Shomron, Israel.
(7)Includes 7,746,389 of shares issuable upon the conversion of $1,195,000 of
outstanding 10% cumulative convertible debentures issued by the Company to
NIDAN Corporation ("NIDAN") , assuming such convertible debentures were
converted as of February 28, 1998, and 243,462 shares of common stock owned
by the persons referred to in (5) below. NIDAN is a Florida corporation whose
address is 13015 S.W. 89 Place, Suite 212, Miami, FL 33176.
(8) The Company has been informed that NIDAN has assigned to other persons
$845,000 of the Company's $1,195,000 of outstanding 10% cumulative
convertible debentures. To the best of the Company's knowledge, these persons
are not stockholders of NIDAN. On September 24, 1997, those persons filed a
Schedule 13D under the Securities and Exchange Act of 1934. The Schedule 13D
filed by those persons discloses that the persons to whom the debentures were
assigned beneficially own 5,045,102 shares of the Company's common stock,
including 4,801,640 shares of the Company's common stock which are to be
issued upon conversion of the debentures. All of these persons share voting
power in the shares beneficially owned by them.
Following are the names and addresses of these persons:
Name Address
- ------------------- ----------------------
Harold Meyering 235 S. Pine St.
McBain, Michigan 49657
Kenneth Edward Gilde 1630 W. Blue Road
McBain, Michigan 49657
Kenneth Earl Gilde 570 W. Blue Road
Falmouth, Michigan 49632
David E. Gilde 4565 Forward Road
Falmouth, Michigan 49632
Phillip S. Gilde 8200 S.McGee Road
McBain, Michigan 49657
Dale Meyering 9525 W. Watergate Road
McBain, Michigan 49657
Charles O. Helsel 9321 N. Burkett Road
Lake City, Michigan 49651
Edwin L. Helsel 5981 N. Edwards Rd.
Lake City, Michigan 49651
The Company believes the issuance of shares to the above named persons upon
conversion of the 10% cumulative convertible debentures, which debentures
were originally issued to NIDAN and subsequently assigned to the above named
persons by NIDAN, may violate the terms and conditions of the consent order
entered into between the Company and the State of Michigan. The Company has
not yet made a final determination as to conversion of the debentures without
a violation of Michigan law and the consent order.
(9) Includes 7,042,172 shares issuable upon exercise of warrants to be issued
to NIDAN at the time of the conversion of convertible debentures issued to
NIDAN, assuming (i) such convertible debentures were converted as of February
28, 1998 and (ii) exercise of warrants issuable upon conversion.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
At December 31, 1996, the Company had an outstanding $25,000 note payable to
Mr. Edwin B. Salmon bearing interest at 8%. This note, plus accrued interest,
was converted into 25,762 shares of the Company's common stock in February
1997. During 1997, Mr. Salmon loaned the Company $40,243 without interest and
the Company repaid Mr. Salmon $40,243.
At December 31, 1996, the Company had notes outstanding to American First
Equipment Leasing totaling $62,741. During 1997, the Company borrowed $39,500
<PAGE> 69
from American First Equipment Leasing, repaid $44,241 of such notes, plus
accrued interest, and converted $58,000 of such notes, plus accrued interest,
into shares of the Company's common stock at a conversion price of $1.00 per
share. See Note 2(d) to Item 12 "Security Ownership of Certain Beneficial
Owners and Management."
During 1997, the Company borrowed $65,000 from Brittany Leigh, Inc. and
repaid $65,000, plus accrued interest. See Note 2(c) to Item 12 "Security
Ownership of Certain Beneficial Owners and Management."
At December 31, 1996, the Company had outstanding notes payable to Mr.
Richard A. Sweet, a Director and shareholder of the Company, totaling
$40,000. During 1997, the Company converted the notes payable outstanding to
Mr. Sweet, plus accrued interest, into 41,565 shares of the Company's common
stock.
As of December 31, 1996, the Company had outstanding notes payable to the
former shareholders of TNI totaling $450,000, bearing interest at 10% per
annum, and $250,000 outstanding to the former shareholders of ATI, bearing
interest at 6% per annum. Subsequent to December 31, 1997, the Company issued
893,278 shares of its common stock and 450,000 stock purchase warrants
(225,000 of which are exercisable at $1.50 per share by the terms of the
respective debenture note and 225,000 of which are exercisable at $0.20 per
share pursuant to a redemption offer) in satisfaction of the notes payable to
the former shareholders of TNI. The notes payable to the former shareholders
of ATI were removed from the consolidated balance sheet in 1997 in connection
with the rescission of the ATI acquisition.
At December 31, 1996, the Company had outstanding notes to certain
shareholders (other than to Mr. Salmon, Brittany Leigh, Inc., American First
Equipment Leasing, Inc. and Mr. Sweet) totaling $235,000 bearing interest at
8% to 10% per annum. During 1997, certain shareholders of the Company (other
than Mr. Salmon, Brittany Leigh, Inc., American First Equipment Leasing, Inc.
and Mr. Sweet) loaned the Company an aggregate amount of $135,000 at 10%
interest. Of these notes, $170,000, plus accrued interest, was converted
during the year into shares of the Company's common stock at prices ranging
from $0.90 to $1.00 per share and $200,000, plus accrued interest, was paid
in cash.
During 1996, the Company issued $1,195,000 of 10% convertible debentures to
NIDAN. Subsequent to the issuance of these debentures, the Company and NIDAN
entered into addendum agreements to revise the terms of such convertible
debentures to provide for (i) the conversion of such debentures into shares
of the Company's common stock at the lesser of 50% the bid-ask price of the
Company's common stock at the close of trading on the first day next
following the conversion date, defined as the earlier of either the maturity
date of the respective debenture or the date of an effective registration
statement covering the shares issuable upon conversion, or at the per share
conversion price as set forth in the respective debenture and (ii) reset the
exercise price of warrants which are to be issued upon conversion of the
debentures to the lesser of 50% the bid-ask price of the Company's common
stock at the close of trading on the first day next following the conversion
date, defined as the earlier of either the maturity date or the date of an
effective registration statement covering the shares issuable upon
conversion, or the per share exercise price as set forth in the respective
warrant agreement. During 1997, the Company converted $84,000 of these
convertible debentures, plus accrued interest, into 19,033 shares of the
Company's common stock.
During 1997, the Company issued an aggregate of 142,857 shares of its common
stock to American First Equipment Leasing and Brittany Leigh, valued at
$61,829, for services rendered to the Company.
<PAGE> 70
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements
PAGE
----
Independent Auditors' Report on the Consolidated Financial
Statements for the year ended December 31, 1997 24
Statement of Management on the Consolidated Financial
Statements for the years ended December 31, 1996 and 1995 25
Consolidated Balance Sheets as of December 31, 1997 and 1996 27
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 1997 29
Consolidated Statements of Stockholders' Equity for each of
the three years ended in the period December 31, 1997 30
Consolidated Statements of Cash Flows for each of the three
years ended in the period December 31, 1997 32
Notes to Consolidated Financial Statements 33
(a) 2. Financial Statement Schedules
No schedules are being filed as a part of this registration statement as such
schedules are not applicable, are not required or the required information is
included in the consolidated financial statements or notes thereto.
(a) 3. Exhibits
(3)i. *Articles of Incorporation, as amended
(3)ii.*By-laws, as amended
(4)Convertible Debentures
P 1.* Convertible Debenture Note, dated December 5, 1995,
between the Company and Telcom United North, Inc.
P 2.* Convertible Debenture Note, dated December 5, 1995,
between the Company and Donald T. McAllister, M.D
P 3.* Convertible Debenture Note, dated December 5, 1995,
between the Company and David Fisk.
P 4.* Convertible Debenture Note, dated December 5, 1995,
between the Company and Leonard F. D'Innocenzo
P 5.* Convertible Debenture Note, dated December 5, 1995,
between the Company and Dean Charles Colantino
P 6.* Convertible Debenture Note, dated December 5, 1995,
between the Company and Donald P. Dugan.
P 7.* Convertible Debenture Note, dated December 5, 1995,
between the Company and Comgi Retirement Trust,
John R. Lang, M.D./Sharon B. Lang: Trustees
P 8.* Convertible Debenture Note, dated December 5, 1995,
between the Company and John R. Lang, M.D./Sharon B. Lang.
P 9.* Convertible Debenture Note, dated December 5, 1995,
between the Company and Dale D. Higgins
P 10.* Convertible Debenture Note dated December 5, 1995,
between the Company and R. Thomas Jannarone.
<PAGE> 71
11.# Form of Offshore Offering Distribution agreement by and
between Systems Communications, Inc. and Victory
Investments, LLC.
12.# Form of 10% cumulative Convertible Debentures due November
21, 1997 in the aggregate amount of $500,000.
13.# Form of Offshore Securities Subscription Agreement for
$500,000 10% Cumulative Convertible Debentures.
14.# Form of Offshore Securities Subscription Agreement for
$1,120,000 4% Convertible Debentures.
15.#### Form of 10% Cumulative Convertible Debenture Note.
16.++ Form of Settlement Agreement dated as of March 2, 1998
between
the Company and Timboon LTD, including Joint Escrow
Instructions and Revocable Proxy.
(10) Material Contracts
P 1.* Ameristar Stock Acquisition Agreement
P 2.* HMT Stock Purchase Agreement (March 12, 1996)
P 3.* NSC Agreement to Exchange Stock (August 24, 1995)
P 4.* NSC Restated Agreement to Exchange Stock (October 13, 1995)
P 5.* NSC Assignment and Amendment of Restated Agreement to
Exchange Stock (October 20, 1995)
P 6.* Telcom Restated Stock Purchase Agreement (June 16, 1995)
7. Employment Contracts
P (a)* Robert L. Alexander
P (b)* Russell H. Armstrong
P (c)* Edwin B. Salmon
P (d)* Stephen E. Williams
P (e)* Mark Woodward
P (f)* John D. Looney
P (g)* John A. Paolicelli
P (h)* James L. Tolley
P (i)* David J. Olivet
(j)## Karen Wolfe
(k)## James W. Wolfe
(l)## Eric R. Wolfe
P 8.* HMT Trademark Registration for "RETURN" Software Program
(December 8, 1992)
P 9.* HMT - Medicode Value-Added Reseller Software Development,
Marketing, and Maintenance Agreement (March 9, 1995)
P 10.* NSC Cooperative Research and Development Agreement Between
NSC and the U.S. Army (June 2, 1994)
P 11.* Services and Marketing Agreement By and Among GE Capital
Communication Services Corporation and Telcom
(March 31,1995)
P 12.* Joint Venture Agreement Between Universal Network
Services, Inc. and Telcom (February 13, 1995).
P 13.* Comstar Acquisition Agreement
P 14.* Coast Communications Acquisition Agreement
P 15.* Teaming Agreement with Health Management Systems, Inc.
P 16.** Authorized sales agent agreement between MCI
Telecommunications Corporation and Ameristar, dated June 12,
1995
P 17.** Zero Plus-Zero Minus billing and information management
agreement between Zero Plus Dialing, Inc. and Ameristar,
dated May 16, 1996
P 18.** Telecommunications Agreement between U.S. Long Distance,
Inc. and Ameristar
P 19.** Tri-Party Agreement among Ameristar, U.S. Long Distance,
Inc. and Zero Plus Dialing, Inc.
<PAGE> 72
P 20.** Telephone Agreement between Ameristar and U.S. Long
Distance, Inc., dated July 10, 1996
P 21.** License Agreement between Ameristar and VCA Pictures, dated
February 13, 1996
P 22.** Agreement between Ameristar and United International
Pictures, dated April 1, 1996
P 23.** Marketing Agreement, dated October 2, 1995, between
Ameristar and U.S. Osiris Corporation
P 24.** Operator Service Agreement dated April 15, 1995, between
Opticom and Ameristar
P 25.** Mitel OSS Servicing Agreement, dated September 1, 1993
between MasterCorp, Inc. and Ameristar
P 26.** Telecommunications Agreement, dated January 15, 1996
between Long Distance Exchange Corp. and Ameristar
P 27.** Agreement, dated January 1995, between LDOS
Communications, Inc. and Ameristar
P 28.** Agreement, dated February 28, 1994, between L.D.
Communications, Inc. and Ameristar
P 29.** Contract Operator Services Agreement for Public Pay Phones
and Letters of Agency, dated January 7, 1992, between Fone
America, Inc. and Ameristar
P 30.** Payphone Aggregator Agreement, dated July 22, 1993,
between Communication TeleSystems International and
Ameristar
P 31.** Operator Service Agreements between Capital Network
System, Inc. and Ameristar
P 32.** Agreements between Ameristar Network Exchange, Inc. and
Ameristar
P 33.** Agreement dated November 11, 1991 between Ameristar and
Access Telecommunications, Inc.
P 34.** Agreement dated September 16, 1991 between Conquest
Operator Services Corporation and Ameristar
35.## Heads of Agreement for change in Management of National
Solutions Corporation.
36.## Rescission Agreement, dated May 21, 1997 by and between the
Company, Ameristar Telecommunications, Inc., Mark Woodward
and Russell Armstrong.
37.## Promissory note dated May 21, 1997 between ATI and the
Company.
38.## Agreement dated as of June 9,1997 by and among the Company,
Karen Wolfe and Eric Wolfe, Eric Wolfe, on behalf of his
infant son, Tyler Wolfe, and Lori Wolfe, wife of Eric
Wolfe, on behalf of herself and her infant son Tyler Wolfe.
39.## Cooperative Marketing and Option Agreement dated June 9, 1997
between HMT and the Company.
40.## Purchase and Sale Agreement between TNI and International
TeleData Corporation dated January 31, 1997.
41.## Form of Convertible Debenture in the amount of $500,000
between International TeleData Corporation and TNI.
42.## Memorandum dated June 16, 1997 from the Department of the Army
regarding renewal of the Cooperative Research and Development
Agreement between the Company and the Department of the Army.
43.### Agreement to Exchange Stock, dated November 14, 1997, by and
between Grant Kolb and Patrick Loeprich (as "Sellers") and the
Company
(16) * Letter re change in certifying accountant
(16) 1.+ Letter re change in certifying accountant
<PAGE> 73
(17) 1.## Resignation Letter of Stephen Williams.
(17) 2.## Resignation Letter of David J. Olivet
P(21) * List of Subsidiaries of Registrant
(27.1) * Financial Data Schedule (Year ended December 31, 1995)
(27.2) **** Financial Data Schedule (Nine months ended September 30, 1996)
(27.3)#### Financial Data Schedule (Year ended December 31, 1996)
(27.4)**** Financial Data Schedule (Three months ended March 31, 1997)
(27.5)**** Financial Data Schedule (Six months ended June 30, 1997)
(27.6)**** Financial Data Schedule (Nine months ended September 30, 1997)
(27.7)+++ Financial Data Schedule (Year ended December 31, 1997)
(99) Additional Exhibits
1.*** Arbitration award in the matter of the Arbitration between
Telcom Network, Inc. and GE Capital Communication Services
("GECCS") and New Enterprise Wholesale Services, Ltd.
(News")
* Incorporated by reference to the Company's Registration Statement on
Form 10 as filed with the Commission on July 23, 1996
** Incorporated by reference to the Company's Registration Statement on
Form 10/A as filed with the Commission on September 17, 1996
*** Incorporated by reference to the Company's Current Report on Form 8-K
dated October 29, 1996
**** Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the respective quarterly period.
# Incorporated by reference to the Company's Current Report on Form 8-K
as filed on March 27, 1997.
## Incorporated by reference to the Company's Current Report on Form 8-K,
as filed on July 28,1997.
### Incorporated by reference to the Company's Current Report on Form 8-K,
as filed on November 21,1997.
#### Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 31, 1996.
+ Incorporated by reference to the Company's Current Report on Form 8-K, as
filed on November 25, 1998.
++ Incorporated by reference to the Company's Current Report on Form 8-K, as
filed on March 10, 1998.
+++ Filed herewith.
<PAGE> 74
(b) Reports on Form 8-K
The following reports were filed on Form 8-K for the three months ended
December 31, 1997 and prior to the filing date hereof:
1. The Company filed a Form 8-K on November 21, 1997. The date of the
earliest event reported was November 14, 1997. On November 14, 1997, the
Company and the stockholders of HMG Health Care Claims Auditing, Inc.("HMG")
entered into an agreement to exchange stock ( the "Agreement to Exchange
Stock"). Pursuant to the Agreement to Exchange Stock, the Company is to
acquire all of the outstanding stock of HMG in exchange for shares of the
Company's common stock ( the "HMG Acquisition Shares). The number of HMG
Acquisition Shares is to be determined at closing and are to be equal to 30%
of the then outstanding common stock of the Company after giving effect to
the issuance of the HMG Acuisition Shares. The acquisition of HMG is subject
to, among other things, the Company obtaining debt financing to refinance the
existing indebtedness of HMG ($850,000) and pay other costs and expenses
related to the acquisition. The Agreement to Exchange Stock contemplates a
December 31, 1997 closing.
2. On November 25, 1997, the Company filed a Form 8-K. The date of the event
reported was November 20, 1997. The event reported was the resignation of
Ernst & Young LLP as independent auditor of the Registrant.
3. On March 10, 1998, the Company filed a Form 8-K. The date of the event
reported was March 2, 1998. The event reported was the agreement between the
Company and Timboon LTD (the "Settlement Agreement and Release") in
settlement of all claims brought against each other in connection with the
Company's $1,120,000 4% cumulative convertible debentures.
<PAGE> 75
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. The undersigned
persons were not officers and directors of the registrant for the period
covered by this report.
HITSGALORE.COM, INC. Date: July 1, 1999
\s\ Steve Bradford
- ---------------------------------
STEVE BRADFORD
President, Principal Executive Officer,
Principal Accounting Officer and Director
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTIANS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENES OF SYSTEMS COMMUNICATIONS, INC. FOR THE YEAR ENDED
DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERNCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 65,556
<SECURITIES> 0
<RECEIVABLES> 60,908
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 256,883
<PP&E> 130,162
<DEPRECIATION> (56,774)
<TOTAL-ASSETS> 388,194
<CURRENT-LIABILITIES> 7,028,193
<BONDS> 0
0
1,617,260
<COMMON> 12084
<OTHER-SE> (9,254,261)
<TOTAL-LIABILITY-AND-EQUITY> 388,194
<SALES> 1,498,533
<TOTAL-REVENUES> 1,498,533
<CGS> 109,563
<TOTAL-COSTS> 5,533,277
<OTHER-EXPENSES> 125,318
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 587,884
<INCOME-PRETAX> (3,644,074)
<INCOME-TAX> (605,500)
<INCOME-CONTINUING> 3,038,574
<DISCONTINUED> 988,400
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,050,174)
<EPS-BASIC> (.19)
<EPS-DILUTED> (.19)
</TABLE>
