EXHIBIT 99.2
GTI TELECOM, INC.
Financial Statements
December 31, 1996, 1995 and 1994
With Independent Auditors' Report Thereon
INDEPENDENT AUDITORS' REPORT
----------------------------
To the Stockholder of
GTI Telecom, Inc.:
We have audited the accompanying balance sheet of GTI Telecom, Inc. as of
December 31, 1996 and the related statements of operations, changes in
stockholder's deficit and cash flows for the year ended December 31, 1996.
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 financial statements referred to above present fairly, in
all material respects, the financial position of GTI Telecom, Inc. as of
December 31, 1996, and the results of its operations and cash flows for the year
then ended, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in note 3, the Company
has suffered recurring losses from operations and has working capital and
stockholder's deficits which raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in note 3. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ KPMG PEAT MARWICK LLP
April 4, 1997, except as to note 15 which
is as of May 16, 1997
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
July 18, 1996
To the Stockholder of
GTI Telecom, Inc.
In our opinion, the accompanying balance sheets and the related statements of
operations, of changes in stockholder's deficit and of cash flows present
fairly, in all material respects, the financial position of GTI Telecom, Inc.
(the "Company") at December 31, 1995 and 1994, and the results of its operations
and its cash flows for the years then ended in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 3, the Company
has suffered recurring losses from operations and has a working capital deficit
which raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 3. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ Price Waterhouse LLP
GTI TELECOM, INC.
Balance Sheets
December 31, 1996 and 1995
ASSETS 1996 1995
------ ------------- ------------
Current assets:
Cash $ 600,614 $ 1,814,568
Accounts receivable, net (note 4) 1,602,180 851,959
Inventories (note 5) 733,838 690,648
Note receivable from stockholder (note 12) 1,279,483 209,991
Other current assets (note 6) 1,619,773 1,451,675
Prepaid expenses 16,033 --
------------ -----------
Total current assets 5,851,921 5,018,841
Property and equipment, net (note 7) 1,829,159 1,533,203
Intangible assets (net of accumulated amortization of $318,000 and
$147,000 for 1996 and 1995, respectively) 202,423 203,981
Deposits 27,360 14,181
------------ -----------
$ 7,910,863 $ 6,770,206
============ ===========
LIABILITIES AND STOCKHOLDER'S DEFICIT
- -------------------------------------
Current liabilities:
Accounts payable $ 6,940,820 $ 2,223,509
Accrued expenses 1,061,329 675,854
Customer deposits 2,180,075 1,140,535
Excise and sales taxes payable (note 8) 2,302,226 837,993
Current portion of treasury stock repurchase debt and notes payable (note 9) 1,319,688 1,291,719
Current portion of capital leases payable (note 10) 187,481 65,443
Deferred revenue - telecards 5,671,907 6,633,790
------------ -----------
Total current liabilities 19,663,526 12,868,843
Treasury stock repurchase debt and notes payable (note 9) 244,203 1,114,895
Capital leases payable (note 10) 417,866 368,477
------------ -----------
Total liabilities 20,325,595 14,352,215
------------ -----------
Stockholder's deficit:
Preferred stock, $.001 par value, 5,000,000 shares authorized, no shares issued
and outstanding (note 14) -- --
Common stock, $.001 par value, 10,000,000 shares authorized, 1,000 issued 1 1
Additional paid-in capital 83,707 83,707
Accumulated deficit (9,888,128) (5,055,405)
Treasury stock - 500 common shares in treasury, at cost (2,610,312) (2,610,312)
------------ -----------
Total stockholder's deficit (12,414,732) (7,582,009)
Commitments, contingencies and subsequent events (notes 8, 13, 14 and 15)
------------ -----------
$ 7,910,863 $ 6,770,206
============ ===========
See accompanying notes to financial statements.
GTI TELECOM, INC.
Statements of Operations
Years ended December 31, 1996, 1995 and 1994
1996 1995 1994
------------ ------------ ------------
Net revenues $21,168,508 $ 8,771,398 $ 2,627,107
----------- ----------- -----------
Operating expenses:
Cost of revenues 18,226,789 6,320,806 2,148,781
Selling, general and administrative expenses 6,575,261 4,904,562 2,090,322
Depreciation and amortization expense 773,727 278,735 72,874
----------- ----------- -----------
Total operating expenses 25,575,777 11,504,103 4,311,977
----------- ----------- -----------
Loss from operations (4,407,269) (2,732,705) (1,684,870)
----------- ----------- -----------
Other income (expenses):
Other income 133,908 1,870
Interest expense, net (559,362) (143,057) (34,031)
----------- ----------- -----------
(425,454) (141,187) (34,031)
----------- ----------- -----------
Net loss before income taxes (4,832,723) (2,873,892) (1,718,901)
Income taxes -- -- --
----------- ----------- -----------
Net loss $(4,832,723) $(2,873,892) $(1,718,901)
=========== =========== ===========
Net Loss per common share $ (9,665.45) $ (3,179.08) $ (1,718.90)
=========== =========== ===========
Weighted average number of shares outstanding 500 904 1,000
=========== =========== ===========
See accompanying notes to financial statements.
GTI TELECOM, INC.
Statements of Stockholder's Deficit
Years ended December 31, 1996, 1995 and 1994
SERIES A PREFERRED
STOCK (NOTE 14) ADDITIONAL TOTAL
---------------- COMMON PAID-IN ACCUMULATED TREASURY STOCKHOLDER'S
SHARES AMOUNT STOCK CAPITAL DEFICIT STOCK DEFICIT
------ ------ ------ ---------- ----------- ----------- -------------
Balance at December 31, 1993 - $ - $ 10 $ 83,698 $ (462,612) $ - $ (378,904)
Adjustment of par value of
common stock from
$.01 to $.001 - - (9) 9 - - -
Net loss - - - - (1,718,901) - (1,718,901)
------ ------ ------ ---------- ----------- ----------- -------------
Balance at December 31, 1994 - - 1 83,707 (2,181,513) - (2,097,805)
Purchase of treasury stock - - - - - (2,610,312) (2,610,312)
Net loss - - - - (2,873,892) - (2,873,892)
------ ------ ------ ---------- ----------- ----------- -------------
Balance at December 31, 1995 - - 1 83,707 (5,055,405) (2,610,312) (7,582,009)
Net loss - - - - (4,832,723) - (4,832,723)
------ ------ ------ ---------- ----------- ----------- -------------
Balance at December 31, 1996 - $ - $ 1 $ 83,707 $(9,888,128) $(2,610,312) $ (12,414,732)
====== ====== ====== ========== =========== =========== =============
See accompanying notes to financial statements.
5
GTI TELECOM, INC.
Statements of Cash Flows
Years ended December 31, 1996, 1995 and 1994
1996 1995 1994
------------ ------------ ------------
Cash flows from operating activities:
Net loss $(4,832,723) $(2,873,892) $(1,718,901)
Adjustments to reconcile net loss to cash
provided by operating activities:
Depreciation and amortization 773,727 278,735 72,874
Increase (decrease) in cash caused by
changes in operating assets and
liabilities:
Accounts receivable (750,221) (508,047) (202,775)
Inventories (43,190) (342,862) (303,588)
Other current assets (168,098) (1,219,497) (189,798)
Prepaid expenses (16,033) 26,199 (23,272)
Intangible assets (169,298) (100,387) (103,594)
Deposits (13,179) 9,176 (23,357)
Accounts payable 4,717,311 1,597,565 426,786
Accrued expenses 385,475 55,438 573,318
Customer deposits 1,039,540 1,110,342 30,193
Excise and sales taxes payable 1,464,233 607,390 213,536
Deferred distribution agreement -- -- (200,000)
Deferred revenue - telecards (961,883) 4,417,940 1,961,195
----------- ----------- -----------
Cash provided by operating activities 1,425,661 3,058,100 512,617
----------- ----------- -----------
Cash flows used in investing activities:
Acquisition of property and equipment (595,682) (1,371,406) (256,152)
Proceeds from equipment sale leaseback -- 414,744 --
----------- ----------- -----------
Cash used in investing activities (595,682) (956,662) (256,152)
----------- ----------- -----------
(Continued)
GTI TELECOM, INC.
Statements of Cash Flows, Continued
1996 1995 1994
------------ ---------- ---------
Cash used in financing activities:
Principal payments for treasury stock repurchase debt (831,342) (403,698) --
Principal payments on notes payable (28,381) -- --
Proceeds from notes payable -- 50,000 50,000
Collection of stockholder notes receivable 220,000 20,000 --
Advances to stockholder under notes receivable (1,289,492) (202,949) (64,396)
Principal payments for capital leases (114,718) (8,166) --
----------- ---------- ---------
Cash used in financing activities (2,043,933) (544,813) (14,396)
----------- ---------- ---------
(Decrease) increase in cash (1,213,954) 1,556,625 242,069
Cash at beginning of year 1,814,568 257,943 15,874
----------- ---------- ---------
Cash at end of year $ 600,614 $1,814,568 $ 257,943
=========== ========== =========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 287,756 $ 143,100 $ 32,500
=========== ========== =========
Supplemental disclosures of noncash financing activities:
Capital lease obligations of $286,145 were incurred
when the Company entered into leases for computer
equipment during the year ended December 31,
1996.
A note payable of $17,000 was incurred when the
Company entered into a financing arrangement
for an automobile during the year ended
December 31, 1996.
See accompanying notes to financial statements.
2
GTI TELECOM, INC.
Notes to Financial Statements
December 31, 1996, 1995 and 1994
(1) NATURE OF BUSINESS
GTI Telecom, Inc. ("GTI" or the "Company") was incorporated on February 15,
1993 in the state of Florida. GTI is a fully integrated telecommunications
company that develops, implements and supports specialized communication
applications for business and individual use.
GTI provides domestic and switch service for intrastate, interstate and
international telephone calls and is an international carrier licensed by
the Federal Communications Commission ("F.C.C."). The primary product line
of GTI is telecards; which are prepaid calling cards that can be used for
either domestic or international telephone calls.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) ACCOUNTS RECEIVABLE AND REVENUE RECOGNITION
The Company sells its product in two distinct markets, retail and
promotional. Retail card sales are ultimately sold to the end user,
while promotional cards are given to the end user to promote the
buyer's product or service. Accounts receivable relate to the sale of
telecards to retail and promotional customers. Deferred revenues are
established at the time the telecards are sold. Revenue is then
recognized upon the utilization of minutes by the end user.
Management estimates that only a portion of the calling time available
on these cards will be utilized by the end user. As most of the
telecards issued by the Company prior to 1996 do not have printed
expiration dates, management estimates, based on usage patterns of
customers, the telecard minutes associated with certain telecard sales
programs which will not be used ("breakage"). As such, the Company
recognizes additional revenue based upon both the expiration of cards
and usage patterns for both its retail and promotional sales programs.
Additional revenue from these sales is accounted for as follows.
Revenue of approximately $258,000, $824,000 and $283,000 was
recognized in 1996, 1995 and 1994, respectively, for telecard minutes
which were not used prior to expiration of the telecards. Revenue of
approximately $1,432,000, $602,000 and $383,000 was recognized in
1996, 1995 and 1994, respectively, for breakage. Approximately
$648,000 of the amount recognized in 1996 for breakage represents
revenue related to telecards which will expire over the next six
months.
(Continued)
GTI TELECOM, INC.
Notes to Financial Statements
(b) INVENTORIES
Inventories consist of telecards and supplies held primarily for sale
and are stated at the lower of cost or market on a first-in, first-out
basis. Cost has been determined using the average cost method.
(c) OTHER CURRENT ASSETS
Other current assets consist primarily of prepaid telecard and
commission expense and prepaid royalties.
GTI defers the recognition of production costs of telecards and
commission expense for telecards sold and recognizes the expense as
the related revenue is recognized.
Royalty costs relate to agreements entered into by GTI to reproduce
images on GTI telecards for a one, two or three year period. The costs
are deferred and recognized as expense in conjunction with the
recognition of revenues.
(d) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Additions, improvements and
expenditures that significantly extend the useful life of an asset are
capitalized. Expenditures for repair and maintenance are charged to
operations as incurred.
The Company provides for depreciation and amortization of property,
equipment and leasehold improvements over their estimated useful lives
as follows:
DESCRIPTION USEFUL LIVES
----------- ------------
Communications and distribution equipment 5 years
Office equipment 5 years
Furniture and fixtures 1-5 years
Automobiles 5 years
Leasehold improvements expenses are amortized over the shorter of the
useful life of the asset on the term of the lease.
(Continued)
-2-
GTI TELECOM, INC.
Notes to Financial Statements
(e) INTANGIBLE ASSETS
GTI capitalizes expenditures for state licenses and registrations,
trademarks and telecard design artwork. The costs are amortized over
the estimated useful lives of the assets which range from one to five
years for the state licenses, registrations and trademarks. Telecard
design artwork is amortized over two years which approximates the
telecard production and distribution period.
(f) INCOME TAXES
GTI follows Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes", which requires an asset and liability
approach for financial accounting and reporting on income taxes. The
asset and liability approach requires the recognition of deferred tax
assets and liabilities for the expected future tax consequences of
temporary differences between the carrying amounts and the tax basis
of assets and liabilities. Recognition of a deferred tax asset is
allowed if future realization is more likely than not. As discussed
more fully in note 6, GTI has established a full valuation allowance
against its deferred tax asset associated with its tax carryforward
benefits.
(g) ADVERTISING
The Company expenses costs of advertising as incurred. Advertising
costs for the years ended December 31, 1996, 1995 and 1994 amounted to
approximately $1,190,000, $61,000 and $95,000, respectively.
(h) USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
In particular, in preparing the Company's financial statements,
management has been required to use estimates in determining revenue
and cost of revenues.
(Continued)
-3-
GTI TELECOM, INC.
Notes to Financial Statements
The Company has recognized revenues as described in note 2(a) based
upon historic customer usage patterns. To the extent that estimated
usage patterns are greater or less than these estimates, revenue
associated with breakage and recorded in the accompanying statement of
operations could vary from the estimates used.
The Company's financial statements reflect the Company earning certain
volume discounts with their sole supplier of long distance phone
service due to their level of purchases. However, as further described
in note 14, the Company has financed these purchases with the supplier
and in the event that the Company does not meet its payment
commitments under the terms of the financing agreement, the supplier
can retroactively revoke the volume discount. Management believes it
can meet its commitments under the financing agreement.
(i) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash, accounts and notes receivable, accounts
and notes payable approximates fair value because of the short
maturity of those instruments.
(j) RECLASSIFICATIONS
Certain amounts in the 1995 and 1994 financial statements and notes
have been reclassified to conform with the 1996 presentation.
(3) OPERATING PLANS
GTI has incurred significant operating losses since inception resulting in
working capital and stockholder's deficits as of December 31, 1996, 1995
and 1994, which raise substantial doubt about its ability to continue as a
going concern. The financial statements do not include any adjustments that
may result from the outcome of this uncertainty. Management believes that
expansion of the distribution of telecards and the introduction of new
products will result in increased revenues, both domestic and
international, which, when coupled with the Company seeking and obtaining
additional financing will provide sufficient liquidity for GTI to continue
as a going concern.
(Continued)
-4-
GTI TELECOM, INC.
Notes to Financial Statements
(4) ACCOUNTS RECEIVABLE AND CONCENTRATION OF RISK
Receivables at December 31, 1996 and 1995 consisted of the following:
1996 1995
---------- ---------
Trade $1,227,098 $ 833,208
Other 465,082 162,751
Allowance for doubtful accounts (90,000) (144,000)
---------- ---------
$1,602,180 $ 851,959
========== =========
The Company grants credit for sales to customers located throughout the
United States. Two retail companies have been extended credit at December
31, 1996 amounting to 81% of total trade receivables. These two retail
companies accounted for approximately 46% of the Company's sales during the
year ended December 31, 1996. Two retail companies and one automobile
rental company had been extended credit at December 31, 1995 amounting to
69% of total trade receivables. These two retail companies and one
automobile rental company accounted for approximately 33% of the Company's
sales during the year ended December 31, 1995.
Currently the Company utilizes one supplier of long distance telephone
service. While the Company believes that there are alternate suppliers,
there is no guarantee that the Company will be able to secure the same
rates as currently contracted in the event the relationship with the
supplier is terminated. Recorded amounts due to this supplier totaled
approximately $7,481,000 at December 31, 1996. The Company has granted this
supplier a security interest in all assets of the Company. As further
described in note 14, the Company financed certain amounts due to this
supplier subsequent to December 31, 1996.
(5) INVENTORIES
Inventories consist of the following components as of December 31:
1996 1995
-------- --------
Raw materials $194,465 $ 14,040
Work-in-process 344,732 390,684
Finished goods 194,641 285,924
-------- --------
Total inventories $733,838 $690,648
======== ========
(Continued)
-5-
GTI TELECOM, INC.
Notes to Financial Statements
(6) OTHER CURRENT ASSETS
Other current assets consist of the following at December 31:
1996 1995
---------- ----------
Telecards distributed $ 860,622 $ 680,033
Sales commissions 610,638 592,660
Royalties 148,513 178,982
---------- ----------
$1,619,773 $1,451,675
========== ==========
(7) PROPERTY AND EQUIPMENT, NET
Property and equipment, net consists of the following at December 31:
1996 1995
---------- ---------
Communications and distribution equipment $1,414,134 $ 969,548
Office equipment 819,441 578,748
Furniture and fixtures 287,799 155,005
Leasehold improvements 117,102 102,306
Automobile 65,958 -
---------- ----------
2,704,434 1,805,607
Less: accumulated depreciation (875,275) (272,404)
---------- ----------
$1,829,159 $1,533,203
========== ==========
(Continued)
-6-
GTI TELECOM, INC.
Notes to Financial Statements
(8) EXCISE AND SALES TAXES PAYABLE
GTI has recorded excise and sales taxes payable and accrued interest
totaling $2,302,226 and $837,993 as of December 31, 1996 and 1995,
respectively, for state, local and federal excise taxes. State and local
jurisdictions in which GTI operates have not been contacted to determine
amounts owed based on GTI's calculations for those jurisdictions. Federal
excise taxes were first remitted in February 1997 as part of a voluntary
disclosure. The Company has not yet been advised as to whether penalties
and additional interest, if any, will be assessed relating to these taxes.
Management is in the process of reviewing GTI's tax collection, remittance
and compliance policies and procedures. Depending on the ultimate
resolution of these matters, it is reasonably possible that the amount of
this reserve could require adjustment in the near term.
(9) LONG-TERM DEBT
Long-term debt consists of the following at December 31:
1996 1995
----------- -----------
Promissory note for treasury stock repurchase,
including imputed interest of 10.75% $ 1,375,272 $ 2,206,614
Promissory note payable; interest at 13.5% per annum,
payable quarterly, commencing March 31, 1996;
principal balance due March 31, 1997 175,000 200,000
Promissory note payable; interest rate of 9.25%, payable
in monthly installments of $542 including principal
and interest, maturing in April 1999; collateralized by
a vehicle 13,619 -
----------- -----------
1,563,891 2,406,614
Less current portion (1,319,688) (1,291,719)
----------- -----------
$ 244,203 $ 1,114,895
=========== ===========
(Continued)
-7-
GTI TELECOM, INC.
Notes to Financial Statements
In October 1995, an agreement was entered into between GTI and a
stockholder of GTI to repurchase all of the stockholder's stock for $3
million. GTI paid $250,000 upon the execution of the agreement and issued a
noninterest bearing note payable for $2,750,000. Interest has been imputed
at 10.75%. The note payments are payable in the following installments
commencing in December 1995: $250,000 quarterly through June 30, 1996;
$500,000 semi-annually from September 30, 1996 through June 30, 1997; and
$500,000 on December 31, 1997. The note is secured by the redeemed shares
of stock. In 1995 and 1994, this former stockholder served as a GTI officer
and received compensation totaling approximately $135,000 and $68,000,
respectively. The compensation expense is included in selling, general and
administrative expenses.
GTI obtained a $100,000 loan for working capital in 1993 and an additional
$50,000 in 1995 and 1994. The loans bear interest at 13.5%, requires
quarterly interest payments and the principal balance is due on March 31,
1997. The working capital loans were obtained from an individual who was a
stockholder in a related entity which was dissolved.
Aggregate future annual principal payments on long-term debt for years
ending subsequent to December 31, 1996 are summarized as follows:
YEAR ENDING DECEMBER 31,
-----------------------
1997 $1,319,688
1998 242,065
1999 2,138
----------
$1,563,891
==========
(Continued)
-8-
GTI TELECOM, INC.
Notes to Financial Statements
(10) LEASES
The Company is obligated under various capital leases for certain
communications computer and office equipment which expire over the next
four years. At December 31, 1996, the gross amount of property and
equipment and related accumulated amortization recorded under capital
leases was $701,915 and $135,384, respectively.
During 1995, GTI entered into an agreement for the sale and leaseback of
certain communications and distribution equipment under a capital lease.
The book value and accumulated depreciation of approximately $430,000 and
$54,000 were removed from the accounts and the equipment was recorded at
the sale price of approximately $404,000. The deferred gain approximating
$28,000 is netted against capital leases payable and will be recognized
over the lease term as other income. Payments under the lease approximate
$155,000 annually, commencing January 1996.
The Company also has several noncancelable operating leases, primarily for
office and warehouse space that expire over the next two years. Rental
expense for operating leases during 1996, 1995 and 1994 was approximately
$405,000, $163,000 and $94,000, respectively.
Future minimum lease payments under noncancelable operating leases (with
initial or remaining lease terms in excess of one year) and future minimum
capital lease payments as of December 31, 1996 are:
CAPITAL OPERATING
YEAR ENDING DECEMBER 31: LEASES LEASES
----------------------- -------- -------
1997 $252,952 $293,340
1998 240,807 52,873
1999 216,975 --
2000 23,621 --
-------- --------
Total minimum lease payments 734,355 $346,213
========
Less amount representing interest 129,008
--------
Present value of net minimum capital lease payments 605,347
Less current installments of obligations under capital leases 187,481
--------
Obligations under capital leases, excluding
current installments $417,866
========
-9-
(Continued)
GTI TELECOM, INC.
Notes to Financial Statements
(11) INCOME TAXES
As of December 31, 1996 and 1995, GTI had a net operating loss
carryforwards available to reduce future income of approximately $7,000,000
and $4,000,000, respectively. The tax net operating loss carryforwards
begin expiring in the year 2008.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and amounts used for income tax purposes.
Significant components of the Company's deferred income tax assets and
liability are as follows:
DECEMBER 31,
-------------------------
1996 1995
----------- ----------
Gross deferred tax assets:
Net operating loss carryforward $ 2,753,541 $ 1,425,514
Excise and sales tax provision 885,143 315,337
Bad debt provision 33,867 54,311
Other 23,304 33,897
----------- -----------
3,695,855 1,829,059
----------- -----------
Gross deferred tax liability:
Depreciation (77,495) (81,303)
----------- -----------
Net deferred tax assets before valuation allowance 3,618,360 1,747,756
Valuation allowance (3,618,360) (1,747,756)
----------- -----------
Net deferred tax asset $ - $ -
=========== ===========
As of December 31, 1996 and 1995, a valuation allowance was recorded to
fully offset the net deferred tax asset.
(Continued)
-10-
GTI TELECOM, INC.
Notes to Financial Statements
The valuation allowance for deferred tax assets was increased $1,871,104
during the year ended December 31, 1996, relating primarily to continued
operating losses.
The difference between the "expected" tax benefit (computed by applying the
federal corporate income tax rate of 34% to the net loss before income
taxes) and the actual tax benefit is due to limitations on the benefit for
the net operating losses recognized and the effect of the valuation
allowance.
(12) RELATED PARTY TRANSACTIONS
During 1996 and 1995, GTI entered into note receivable agreements with the
remaining stockholder of GTI. At December 31, 1996 and 1995, the notes
receivable balances were $1,279,483 and $209,991, respectively. The 1996
note is due upon demand and the 1995 note was repaid during 1996. The notes
earn interest at 7% per annum for 1996 and 1995, respectively. The balances
are recorded as notes receivable from stockholder in the accompanying
balance sheets.
In January 1996, the remaining stockholder formed Tuscany, Inc., a Delaware
Corporation. Tuscany, Inc. owns and operates charter aircraft. At December
31, 1996 and 1995, GTI advanced approximately $259,000 and $50,000,
respectively to Tuscany, Inc. These advances are recorded as accounts
receivable. During 1996, Tuscany, Inc. provided the Company with
approximately $159,900 of charter aircraft services.
In January 1996, the remaining stockholder purchased Wicks Printing. As of
December 31, 1996, the Company advanced approximately $8,200 to Wicks
Printing. During 1996, Wicks Printing provided printing services of
approximately $703,000 for the production of prepaid telecards for the
Company.
(Continued)
-11-
GTI TELECOM, INC.
Notes to Financial Statements
(13) COMMITMENTS AND CONTINGENCIES
COMMISSION AGREEMENTS
GTI entered into several agreements to produce telecards with selected
designs or logos. GTI provides the company, which owns the design and logo
rights, a commission based on the quantity of telecards sold. Certain
agreements include commitments to provide a guaranteed minimum commission
or cooperative advertising costs. In accordance with the contract terms,
GTI records the greater of the liability for cards sold or the guaranteed
minimum. As of December 31, 1996, commitments through December 31, 1998
total approximately $220,000.
DISTRIBUTION AGREEMENT
On October 22, 1993, the Company entered into a three-year exclusive
agreement for the distribution of telecards in Brazil. The Company sold
telecards to the distributor at suggested retail prices less a stated
discount percentage. The agreement terminated in 1994 and in conjunction
with settlement of the agreement, the Company recognized revenue of
$200,000.
LITIGATION
GTI is involved in litigation for which counsel has been retained. In the
opinion of management, the pending matters will not result in a material
adverse effect upon the financial condition or results of operations of
GTI.
(14) SUBSEQUENT EVENTS
SERIES A CONVERTIBLE EXCHANGEABLE PREFERRED STOCK
In February 1997, the Company issued 3,500 shares of Series A convertible
preferred stock for $3.5 million. The preferred stock is convertible into
common stock based upon a conversion price, as defined (initial conversion
price is $43,000 per share), and has a liquidation preference of $1,000 per
share and certain voting rights. On or after July 20, 1997 and before
August 20, 1997, the holder of the preferred stock may exchange all
preferred stock for telecard inventory having an aggregate card value equal
to the liquidation preference plus an amount equal to any accrued interest
and unpaid dividends, if any.
(Continued)
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GTI TELECOM, INC.
Notes to Financial Statements
WORLDCOM FINANCING AGREEMENT
On January 30, 1997, the Company entered into an agreement with its sole
long distance supplier, Worldcom Network Services, Inc. ("Worldcom"), to
finance a portion of its indebtedness to Worldcom totaling approximately
$6.0 million which is included in accounts payable and accrued expenses in
the accompanying December 31, 1996 balance sheet. As part of the agreement,
the Company agreed to pay monthly installments of $500,000 commencing
February 25, 1997 with the final balance due on January 25, 1998. The note
bears interest at 16% per annum and includes certain restrictive debt
covenants as well as a lock box arrangement for cash collections of the
Company. As of the date of this report, the Company was in violation of
certain debt covenants. The agreement also reinstates certain volume
discounts and forgives related finance charges related to these amounts
contingent upon the Company's payment of all amounts due in accordance with
the note agreement.
SALES COMMITMENT
Subsequent to December 31, 1996, the Company entered into an agreement to
be the exclusive supplier of prepaid phone cards to a major retailer. As
part of the supply agreement, the Company is required to support the
retailer's marketing and promotion expense with payments totaling
approximately 16% of the retailer's phone card purchase commitment over the
two year term of the contract.
(15) SALE OF COMPANY TO SMARTALK TELESERVICES, INC.
On May 31, 1997, the Company entered into a merger agreement (the Merger)
with SmarTalk Teleservices, Inc. (SmarTalk) in which SmarTalk acquired all
outstanding common stock of the Company in a tax-free, stock-for-stock
merger transaction. Under the terms of the Merger, the GTI Telecom common
stockholder received 2,580,000 shares of SmarTalk common stock, which,
using a SmarTalk per share value of $13.50, had an approximate value of
$35,000,000.
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