1
EXHIBIT 99.2
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 (all
as restated, see note 2(a)). 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 Company restated its 1996 financial statements as discussed in note
2(a).
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
Orlando, Florida
April 4, 1997, except as to note 15 which
is as of May 16, 1997 and note 2(a)
which is as of November 24, 1997
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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders 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 Company restated its 1995 and 1994 financial statements as discussed in
Note 2(a).
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
Orlando, Florida
July 18, 1996, except as to Note 2(a)
which is as of November 24, 1997.
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3
GTI TELECOM, INC.
BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
ASSETS
1996 1995
(RESTATED) (RESTATED)
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 (notes 2 and 6)........................ 1,773,928 1,587,922
Prepaid expenses............................................ 16,033 --
------------ -----------
Total current assets..................................... 6,006,076 5,155,088
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
------------ -----------
$ 8,065,018 $ 6,906,453
============ ===========
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
Accounts payable............................................ 6,323,882 1,518,626
Accrued expenses............................................ 1,678,267 1,380,737
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 (note 2)...................... 7,151,141 8,122,931
------------ -----------
Total current liabilities................................ 21,142,760 14,357,984
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........................................ 21,804,829 15,841,356
------------ -----------
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 (note 2)................................ (11,213,207) (6,408,299)
Treasury stock -- 500 common shares in treasury, at cost.... (2,610,312) (2,610,312)
------------ -----------
Total stockholder's deficit.............................. (13,739,811) (8,934,903)
Commitments, contingencies and subsequent events (notes 8, 13,
14 and 15).................................................. -- --
------------ -----------
$ 8,065,018 $ 6,906,453
============ ===========
See accompanying notes to financial statements.
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GTI TELECOM, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994
(RESTATED) (RESTATED) (RESTATED)
Net revenues...................................... $21,264,323 $ 8,064,864 $ 1,988,974
----------- ----------- ----------
Operating expenses:
Cost of revenues................................ 18,294,789 6,218,159 2,115,181
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..................... 25,643,777 11,401,456 4,278,377
----------- ----------- ----------
Loss from operations......................... (4,379,454) (3,336,592) (2,289,403)
----------- ----------- ----------
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................. (4,804,908) (3,477,779) (2,323,434)
Income taxes...................................... -- -- --
----------- ----------- ----------
Net loss..................................... $(4,804,908) $(3,477,779) $(2,323,434)
=========== =========== ==========
Net Loss per common share (unaudited)............. $ (9,609.82) $ (3,847.10) $ (2,323.43)
=========== =========== ==========
Weighted average number of shares outstanding
(unaudited)..................................... 500 904 1,000
=========== =========== ==========
See accompanying notes to financial statements.
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GTI TELECOM, INC.
STATEMENTS OF STOCKHOLDER'S DEFICIT
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(ALL AS RESTATED, NOTE 2)
SERIES A
PREFERRED TOTAL
STOCK (NOTE 14) ADDITIONAL ACCUMULATED STOCKHOLDER'S
--------------- COMMON PAID-IN DEFICIT TREASURY DEFICIT
SHARES AMOUNT STOCK CAPITAL (RESTATED) STOCK (RESTATED)
Balance at December 31, 1993...... -- $ -- $ 10 $83,698 $ (607,086) $ -- $ (523,378)
Adjustment of par value of common
stock from $.01 to $.001........ -- -- (9) 9 -- -- --
Net loss.......................... -- -- -- -- (2,323,434) -- (2,323,434)
--- ---- ---- ------- ----------- ----------- ------------
Balance at December 31, 1994...... -- -- 1 83,707 (2,930,520) -- (2,846,812)
Purchase of treasury stock........ -- -- -- -- -- (2,610,312) (2,610,312)
Net loss.......................... -- -- -- -- (3,477,779) -- (3,477,779)
--- ---- ---- ------- ----------- ----------- ------------
Balance at December 31, 1995...... -- -- 1 83,707 (6,408,299) (2,610,312) (8,934,903)
Net loss.......................... -- -- -- -- (4,804,908) -- (4,804,908)
--- ---- ---- ------- ----------- ----------- ------------
Balance at December 31, 1996...... -- $ -- $ 1 $83,707 $(11,213,207) $(2,610,312) $(13,739,811)
=== ==== ==== ======= =========== =========== ============
See accompanying notes to financial statements.
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GTI TELECOM, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994
(RESTATED) (RESTATED) (RESTATED)
Cash flows from operating activities:
Net loss (note 2), as restated.............................. $(4,804,908) $(3,477,779) $(2,323,434)
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 (note 2), as restated................ (186,006) (1,322,144) (223,398)
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.......................................... 4,805,256 892,682 426,786
Accrued expenses.......................................... 297,530 760,321 573,318
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 (note 2), as restated....... (971,790) 5,124,474 2,599,328
----------- ----------- ----------
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)
----------- ----------- ----------
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.
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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, REVENUE RECOGNITION AND RESTATEMENT
The Company sells its product in two distinct markets, retail and
promotional. Retail telecard sales are ultimately sold to the end user, while
promotional telecards 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 or upon expiration. For telecards which had no printed
expiration date, revenue for unused minutes is recognized when telecards have
been in circulation for greater than twelve months.
From inception, the Company's management estimated the portion of calling
time which would not be used by the customer ("breakage") and recognized this
breakage as revenue for both retail (in 1995 and 1994) and promotional programs
(in 1996, 1995 and 1994). In November 1997, in consultation with the Securities
and Exchange Commission staff, the Company modified its revenue recognition
policy such that revenue is recognized as described in the preceding paragraph.
As a result, the Company has restated its financial statements and the
impact on the Company's previously issued financial results for each of the
years ended December 31, 1996, 1995 and 1994 is summarized below:
1996 1996 1995 1995 1994 1994
AS REPORTED AS RESTATED AS REPORTED AS RESTATED AS REPORTED AS RESTATED
----------- ----------- ----------- ----------- ----------- -----------
Net revenues........... $21,168,508 21,264,323 8,771,398 8,064,864 2,627,107 1,988,974
Cost of revenues....... 18,226,855 18,294,789 6,320,806 6,218,159 2,148,781 2,115,181
Loss from operations... (4,407,269) (4,379,454) (2,732,705) (3,336,592) (1,684,870) (2,289,403)
Net loss............... (4,832,723) (4,804,908) (2,873,892) (3,477,779) (1,718,901) (2,323,434)
Net loss per common
share (unaudited).... (9,665.45) (9,609.82) (3,179.08) (3,847.10) (1,718.90) (2,323.43)
The accumulated deficit as of December 31, 1993 was increased by $144,474
to reflect this change in accounting policy.
(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.
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8
GTI TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
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.
(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
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9
GTI TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
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.
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
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10
GTI TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
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
========== ==========
6. OTHER CURRENT ASSETS
Other current assets consist of the following at December 31:
1995
1996 (RESTATED)
(RESTATED)
Telecards distributed............................... $1,014,777 $ 816,280
Sales commissions................................... 610,638 592,660
Royalties........................................... 148,513 178,982
---------- ----------
$1,773,928 $1,587,922
========== ==========
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
========== ==========
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.
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GTI TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
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
========== ==========
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
==========
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
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12
GTI TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
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:
YEAR ENDING CAPITAL OPERATING
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
========
11. INCOME TAXES
As of December 31, 1996, GTI had a net operating loss carryforward
available to reduce future income of approximately $8,000,000. 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
(RESTATED) (RESTATED)
Gross deferred tax assets:
Net operating loss carryforward................. $ 3,253,541 $ 1,925,514
Excise and sales tax provision.................. 885,143 315,337
Bad debt provision.............................. 33,867 54,311
Other........................................... 23,304 33,897
---------- -----------
4,195,855 2,329,059
---------- -----------
Gross deferred tax liability:
Depreciation.................................... (77,495) (81,303)
---------- -----------
Net deferred tax assets before valuation
allowance.................................. 4,118,860 2,247,256
Valuation allowance............................. (4,118,860) (2,247,756)
---------- -----------
Net deferred tax asset....................... $ -- $ --
========== ===========
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GTI TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
As of December 31, 1996 and 1995, a valuation allowance was recorded to
fully offset the net deferred tax asset.
The valuation allowance for deferred tax assets was increased $1,871,104
during the year ended December 31, 1996, relating primarily to the generation of
the 1996 net operating loss carryforward.
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.
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.
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GTI TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
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.
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. MERGER NEGOTIATIONS
As of May 16, 1997, the Company was in the process of negotiating an
agreement to merge into another entity.
16. SALE OF COMPANY TO SMARTALK TELESERVICES, INC. (UNAUDITED)
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 had an approximate
value of $35,000,000.
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