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EXHIBIT 99.3
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
ConQuest Telecommunication Services Corp.
We have audited the accompanying consolidated balance sheets of ConQuest
Telecommunication Services Corp. and subsidiaries as of December 31, 1995 and
1996, and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the three years in the period 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 audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
ConQuest Telecommunication Services Corp. and subsidiaries at December 31, 1995
and 1996 and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Columbus, Ohio
February 7, 1997, except for Note 11
as to which the date is February 19, 1997
and the last paragraph of
Note 9 as to which the
date is November 25, 1997
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CONQUEST TELECOMMUNICATION SERVICES CORP.
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
---------------------------
1995 1996
Current assets:
Cash............................................................ $ -- $ 300,557
Accounts receivable, less allowance for doubtful accounts (1995
-- $123,000; 1996 -- $232,000)............................... 5,513,437 6,796,262
Refundable income taxes......................................... -- 278,431
Agent loans..................................................... 254,783 373,837
Inventory....................................................... 818,904 781,876
Deferred income taxes........................................... 352,000 799,000
Prepaid expenses................................................ 290,153 256,001
----------- -----------
Total current assets......................................... 7,229,277 9,585,964
Property and equipment:
Telecommunications equipment.................................... 5,374,700 7,168,549
Office equipment, furniture and fixtures........................ 551,364 529,799
----------- -----------
5,926,064 7,698,348
Less accumulated depreciation................................... 2,409,145 3,528,917
----------- -----------
3,516,919 4,169,431
Deferred income taxes............................................. -- 31,000
Other assets:
Agent bonuses, net of accumulated amortization.................. 217,503 297,472
Agent loans -- noncurrent....................................... 6,950 --
Goodwill, net of accumulated amortization....................... 1,549,975 2,734,312
Other intangibles, net of accumulated amortization.............. 664,840 544,707
Other........................................................... 66,850 94,983
----------- -----------
2,506,118 3,671,474
----------- -----------
Total assets............................................ $13,252,314 $17,457,869
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................ $ 1,962,493 $ 3,064,861
Deferred revenue................................................ 2,147,156 4,534,319
Borrowings under credit agreements.............................. 58,283 1,033,411
Accrued liabilities............................................. 1,156,662 1,664,017
Income taxes payable............................................ 381,565 --
Current portion of long-term debt and capital lease
obligations.................................................. 531,911 603,343
----------- -----------
Total current liabilities.................................... 6,238,070 10,899,951
Long-term debt.................................................... 1,124,340 2,400,000
Capital lease obligations......................................... 251,147 --
Deferred income taxes............................................. 268,000 --
Contingent liabilities (Note 10).................................. -- --
Shareholders' equity (Note 11):
Preferred stock, $.001 par value:
Authorized shares -- 750
Issued and outstanding -- none............................... -- --
Common stock, $.001 par value:
Authorized shares -- 4,000,000
Issued and outstanding 546,293 and 559,730 shares at December
31, 1995 and 1996........................................... 547 560
Additional paid-in capital...................................... 4,351,014 4,538,036
Retained earnings (deficit)..................................... 1,049,996 (349,878)
----------- -----------
5,401,557 4,188,718
Less treasury stock -- at cost.................................. 30,800 30,800
----------- -----------
5,370,757 4,157,918
----------- -----------
Total liabilities and shareholders' equity.............. $13,252,314 $17,457,869
=========== ===========
See accompanying notes.
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CONQUEST TELECOMMUNICATION SERVICES CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
-------------------------------------------
1994 1995 1996
Revenues:
Call center services.............................. $31,625,716 $28,843,172 $28,020,986
Prepaid calling card.............................. 14,590 761,724 8,592,316
International services............................ 180,514 1,091,508 1,207,759
----------- ----------- -----------
31,820,820 30,696,404 37,821,061
Expenses:
Cost of services.................................. 24,880,174 23,600,604 28,926,051
Sales and marketing expenses...................... 1,596,112 1,387,938 2,856,212
General and administrative expenses............... 3,998,602 4,450,435 6,883,849
Write-down of assets.............................. -- -- 918,445
----------- ----------- -----------
Operating income (loss)............................. 1,345,932 1,257,427 (1,763,496)
Interest expense.................................... 315,339 244,810 402,378
----------- ----------- -----------
Income (loss) before income taxes................... 1,030,593 1,012,617 (2,165,874)
Provision (benefit) for income taxes:
Current........................................... 315,000 529,000 (20,000)
Deferred.......................................... 92,000 (138,000) (746,000)
----------- ----------- -----------
Net income (loss)................................... $ 623,593 $ 621,617 $(1,399,874)
=========== =========== ===========
See accompanying notes.
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CONQUEST TELECOMMUNICATION SERVICES CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ADDITIONAL RETAINED TREASURY
---------------- PAID-IN EARNINGS STOCK
SHARES AMOUNT CAPITAL (DEFICIT) TOTAL TOTAL
Balances at January 1, 1994............ 449,796 $450 $2,646,621 $ (195,214) $ -- $2,451,857
Net income........................... -- -- -- 623,593 -- 623,593
Exercise of B warrants............... 39,719 39 591,491 -- -- 591,530
Shares issued under employment
agreement......................... 520 1 599 -- -- 600
------- ---- ---------- ---------- -------- ----------
Balances at December 31, 1994.......... 490,035 490 3,238,711 428,379 -- 3,667,580
Net income........................... -- -- -- 621,617 -- 621,617
Issuance of stock for acquisition.... 55,298 55 1,105,905 -- -- 1,105,960
Repurchase treasury shares........... (1,400) -- -- -- (30,800) (30,800)
Stock Options Exercised.............. 2,360 2 6,398 -- -- 6,400
------- ---- ---------- ---------- -------- ----------
Balances at December 31, 1995.......... 546,293 547 4,351,014 1,049,996 (30,800) 5,370,757
Net loss............................. -- -- -- (1,399,874) -- (1,399,874)
Issuance of stock for acquisition.... 13,437 13 187,022 -- -- 187,035
------- ---- ---------- ---------- -------- ----------
Balances at December 31, 1996.......... 559,730 $560 $4,538,036 $ (349,878) $(30,800) $4,157,918
======= ==== ========== ========== ======== ==========
See accompanying notes.
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CONQUEST TELECOMMUNICATION SERVICES CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------------------
1994 1995 1996
OPERATING ACTIVITIES
Net income (loss)....................................... $ 623,593 $ 621,617 $(1,399,874)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation.......................................... 730,036 827,156 1,182,997
Amortization.......................................... 292,422 332,470 550,216
Provision (benefit) for deferred taxes................ 92,000 (138,000) (746,000)
Loss on sale of assets................................ -- 120 155
Write-down of assets.................................. -- -- 918,445
Changes in operating assets and liabilities:
Accounts receivable................................ (739,526) (1,018,290) (1,283,004)
Refundable income taxes............................ -- -- (278,431)
Inventory.......................................... (47,103) (224,801) (356,316)
Prepaid expenses and agent loans................... (209,960) 117,059 (208,665)
Other assets....................................... (391,745) (246,376) (327,649)
Accounts payable................................... 116,653 1,259,020 1,102,368
Deferred revenue................................... 263,316 1,883,840 2,387,163
Accrued liabilities................................ 191,171 416,603 (162,454)
Income taxes payable............................... 230,838 94,091 (381,565)
----------- ----------- -----------
Net cash provided by operating activities............... 1,151,695 3,924,509 997,386
INVESTING ACTIVITIES
Acquisition of ACMI..................................... -- (1,820,775) (64,846)
Acquisition of CPC...................................... -- -- (709,360)
Capital expenditures, net of disposals.................. (1,497,533) (1,271,772) (1,993,696)
----------- ----------- -----------
Net cash used in investing activities................... (1,497,533) (3,092,547) (2,767,902)
FINANCING ACTIVITIES
Proceeds from credit agreements and long-term
obligations........................................... 8,082,000 9,538,283 3,975,128
Payments on credit agreements and long-term
obligations........................................... (8,792,037) (10,509,108) (1,904,055)
Proceeds from issuance of common stock.................. 592,130 6,400 --
Repurchase of treasury stock............................ -- (30,800) --
----------- ----------- -----------
Net cash provided by (used in) financing activities..... (117,907) (995,225) 2,071,073
----------- ----------- -----------
Net increase (decrease) in cash......................... (463,745) (163,263) 300,557
Cash, beginning of year................................. 627,008 163,263 --
----------- ----------- -----------
Cash, end of year....................................... $ 163,263 $ -- $ 300,557
=========== =========== ===========
See accompanying notes.
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CONQUEST TELECOMMUNICATION SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
ConQuest Telecommunication Services Corp. (ConQuest), through its
wholly-owned subsidiaries, provides call center services, prepaid calling card
services and international telecommunications services to its customers. The
Company's principal call center services include operator assisted long distance
services and inbound call handling and fulfillment services. Call center
services are provided to consumers mainly through aggregators such as
hotels/motels, hospitals, universities, and public and private pay stations
located primarily in the United States. Prepaid calling card services are
primarily provided to consumers through national and regional convenience and
grocery store chains. International services includes a range of
telecommunication services offered to its customers abroad including call center
services, prepaid calling cards and resale of long distance.
ConQuest has contracted with OAN Services, Inc. (OAN), a clearing house, to
bill and collect a significant portion of its call center services revenues.
Under this arrangement, 46% of ConQuest's accounts receivable are due from OAN.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of ConQuest and
its wholly-owned subsidiaries, collectively referred to herein as the Company.
Significant intercompany accounts and transactions have been eliminated in
consolidation.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
REVENUE RECOGNITION POLICIES
The Company recognizes revenue from its call center services as such
services are performed. Prepaid calling card revenue is recognized based on
actual usage and the unused portion upon 1) expiration of the cards or 2) twelve
months from the date of issuance for promotional and collector cards with no
expiration date.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. Advertising expense was
$138,000, $154,000 and $185,000 for each of the three years ended December 31,
1994, 1995 and 1996, respectively.
INVENTORY
The Company accounts for inventory at cost based upon the specific
identification method. The cost of prepaid calling cards sold is amortized to
cost of services based on actual usage or upon the expiration of the cards.
PROPERTY AND EQUIPMENT
Property and equipment is carried at cost. Depreciation and amortization,
which includes the amortization of assets recorded under capital leases, are
computed principally by the straight-line method over the estimated lives of
assets or, if applicable, the life of lease. Expenditures for maintenance and
repairs are charged to operations as incurred.
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CONQUEST TELECOMMUNICATION SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996
AGENT LOANS AND BONUSES
The Company uses independent agents to obtain new call center services
customers. The Company extends interest-bearing loans to agents typically for
financing the acquisition of telephone equipment. The loans, which are
personally guaranteed by the agents, have repayment terms of one to two years.
Agents also receive one time bonuses for customers who have contracted with the
Company as a result of the agent's efforts. The Company has contractual rights
to recover bonuses from agents for customers who do not meet their predetermined
minimum period of service. These bonuses are deferred and amortized over the
life of the respective agreement. Accumulated amortization totaled $440,000 and
$381,000 at December 31, 1995 and 1996, respectively.
GOODWILL
Goodwill represents the excess of cost over fair value of assets acquired
in acquisitions. Goodwill is amortized on a straight line basis over 10 years.
Accumulated amortization totaled $13,000 and $243,000 at December 31, 1995 and
1996, respectively.
INTANGIBLE ASSETS
Intangible assets are primarily licensing and financing costs, and
installation costs charged by local telephone companies. Licensing costs and
financing costs are amortized using the straight-line method over three years.
Installation costs are being amortized over a maximum of five years. Accumulated
amortization totaled $413,000 and $529,000 at December 31, 1995 and 1996,
respectively.
STOCK COMPENSATION
In 1996, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 123, "Accounting for Stock-Based Compensation." This Statement
encourages, but does not require companies to record compensation cost for
stock-based employee compensation at fair value. In accordance with the
provisions of SFAS No. 123, the Company has elected to continue to account for
stock-based compensation using the intrinsic value method prescribed in APB
Opinion 25, Accounting for Stock Issued to Employees, and related
Interpretations. Accordingly, compensation cost for stock options is measured as
the excess, if any, of the market price of the Company's stock at the date of
the grant over the amount an employee must pay to acquire the stock.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Company's agent loans, borrowings under credit
agreements and long term debt approximated the carrying values at December 31,
1995 and 1996.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1994 and 1995 financial
statements to conform to the 1996 presentation.
2. ACQUISITIONS
On April 19, 1996, the Company acquired substantially all of the assets of
Convenience Products Corporation (CPC), a marketer of prepaid calling cards. The
purchase price was $709,360 in cash (including $209,360 in acquisition expenses)
and 13,437 shares of common stock of the Company (total purchase price of
$896,400). The Company's consolidated financial statements include the results
of operations of CPC since acquisition.
As part of the purchase, additional shares of the Company's common stock
may become issuable to CPC during 1997 if certain financial criteria are met. At
December 31, 1996, the Company determined that these
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CONQUEST TELECOMMUNICATION SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996
criteria will be met. Accordingly, the Company has accrued $403,000 of
additional consideration as additional purchase price at December 31, 1996.
The CPC acquisition has been accounted for under the purchase method, and
accordingly, the acquired assets and assumed liabilities, including goodwill of
$1,205,000, have been recorded at their estimated fair values at acquisition.
On November 30, 1995, the Company acquired Anderton Communications
Marketing, Inc. (ACMI) in exchange for $1,885,621 (including $285,621 in
acquisition expenses) and 55,298 shares of common stock of the Company (total
purchase price of $2,991,582). ACMI is a marketer of telecommunication services
including prepaid calling cards. The Company's consolidated financial statements
include the results of operations of ACMI since acquisition.
In February, 1997, the Company paid an additional $125,000 and issued an
additional 1,547 shares of common stock in settlement of certain provisions of
the purchase agreement. This final payout has been accrued in the consolidated
financial statements at December 31, 1996.
The ACMI acquisition has been accounted for under the purchase method, and
accordingly, the acquired assets and assumed liabilities, including goodwill of
$1,770,427, have been recorded at their estimated fair values at acquisition.
The following pro forma data summarizes the results of operations of the
Company for each of the three years in the period ended December 31, 1996
assuming ACMI was acquired as of January 1, 1994 and CPC was acquired as of
January 1, 1995. In preparing the pro forma data, adjustments have been made to
reflect purchase accounting adjustments, interest expense and amortization.
1994 1995 1996
(Unaudited)
Net sales......................... $35,358,846 $33,806,137 $38,011,143
Net income (loss)................. 578,786 473,047 (1,597,694)
The pro forma information does not purport to be indicative of the results
of operations which would have actually been obtained if the acquisitions had
occurred on the dates indicated or the results of operations which will be
reported in the future.
3. CREDIT ARRANGEMENTS
Long-term debt consists of the following:
DECEMBER 31,
-------------------------
1995 1996
Term loan payable to bank........................... $ -- $3,000,000
Term loan payable to bank........................... 966,666 --
Term loan agreement to vendor....................... 500,819 --
Other notes payable................................. 9,104 3,343
---------- ----------
1,476,589 3,003,343
Less current portion................................ (352,249) (603,343)
---------- ----------
$1,124,340 $2,400,000
========== ==========
In November 1996, the Company refinanced the amounts outstanding under its
existing term loans payable to a bank and a vendor and its capital lease
obligations. The new term loan provided borrowings of $3,000,000 payable in
twenty quarterly principal installments of $150,000 beginning January 31, 1997.
Interest is payable monthly and accrues at a fixed rate of 9.125% per annum for
the first $800,000 and at 7.625% per annum for the remaining $2,200,000. On
November 1, 1997 until maturity, the Company has an option to
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CONQUEST TELECOMMUNICATION SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996
select an interest rate based on the three year treasury rate, one year treasury
rate, or the prime rate plus an additional margin.
In addition to its long term debt, the Company has a $5,000,000 revolving
credit agreement (the Agreement) with a bank which expires May 31, 1997. Under
the terms of the Agreement, interest rates are determined at the time of
borrowing at prime plus 1% at December 31, 1995 and at prime plus 1/2% at
December 31, 1996 (9.500% and 8.750 at December 31, 1995 and 1996,
respectively). Borrowings are restricted based on percentages of eligible
accounts receivable. The Company is required to pay a fee of 1/4% per annum on
the unused portion of the Agreement during the revolving period. At December 31,
1995 and 1996, borrowings outstanding under the Agreement totaled $58,283 and
$1,033,411, respectively. Available borrowings under this Agreement were
approximately $3,821,000 and $3,967,000 at December 31, 1995 and 1996,
respectively.
The Company also has a standby letter of credit facility with the same
bank. This facility provides for the issuance of standby letters of credit in an
aggregate amount not to exceed $500,000. Interest on amounts disbursed under the
standby letter of credit agreement accrues at a rate of prime plus 4.500%. At
December 31, 1995 and 1996, no amounts were borrowed under this facility.
Borrowings under the revolving credit agreement, term loan and standby
letter of credit agreement are secured by substantially all of the Company's
assets.
The credit arrangements discussed above contain various restrictions and
financial ratio maintenance requirements. One of these restrictions limits
payments of dividends to 10% of the Company's net income after taxes.
Interest paid during 1994, 1995 and 1996 was $352,000, $281,000 and
$411,000, respectively.
Maturities of long-term debt for the years subsequent to December 31, 1996
are as follows:
1997................................... $ 603,343
1998................................... 600,000
1999................................... 600,000
2000................................... 600,000
2001................................... 600,000
Thereafter............................. --
----------
$3,003,343
==========
4. LEASES
The Company leases office space under noncancelable operating leases that
expire in various years through 1999.
Future minimum lease payments under noncancelable operating leases consist
of the following at December 31, 1996:
1997................................... $ 438,552
1998................................... 436,148
1999................................... 271,620
2000................................... 131,140
2001................................... 44,148
----------
Total minimum lease payments........... $1,321,608
==========
Rent expense for operating leases was approximately $268,000, $336,000 and
$522,000 for 1994, 1995, and 1996, respectively.
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CONQUEST TELECOMMUNICATION SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996
5. STOCK OPTIONS AND WARRANTS
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, the
alternative fair value accounting provided under Statement of Financial
Accounting Standards No. 123 (FASB 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.
The Company's 1992 Non Qualified Employee Stock Option Plan (the Plan) has
authorized the grant of options to management personnel for up to 20,000 shares
of the Company's common stock. The options granted have 10 year terms and become
exercisable in 20% increments over five years beginning November 6, 1993 and
will be fully vested on November 6, 1998.
Options have also been granted under two executive employment agreements.
Under the first employment agreement, nonqualified stock options were granted to
purchase 3,000 shares of the Company's common stock. The grant was made on
November 6, 1992 and expires on November 6, 2002. At December 31, 1996 all
options under this agreement are fully vested and exercisable.
Under the second employment agreement, nonqualified stock options were
granted to purchase 2,500 shares of the Company's common stock. The grant was
made on August 26, 1996 and expires on August 26, 2006. The options under this
agreement vest as follows: 1,000 on August 26, 1998 and 500 each of the three
years thereafter.
Pro forma information required by FASB No. 123 regarding net income has not
been presented as no significant grants have been made subsequent to December
31, 1994.
A summary of the Company's stock option activity, and related information
for the years ended December 31 follows:
1994 1995 1996
----------------------- ----------------------- -----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
Outstanding -- beginning of
year............................ 21,145 $ 2.50 20,270 $ 2.50 14,325 $ 2.50
Granted........................... -- -- -- -- 2,500 14.45
Exercised......................... (240) 2.50 (2,360) 2.50 -- --
Forfeited......................... (635) 2.50 (3,585) 2.50 (25) 2.50
------ ----- ------ ----- ------ ------
Outstanding -- end of year........ 20,270 14,325 16,800
====== ====== ======
Exercisable at end of year........ 8,740 9,675 11,980
====== ====== ======
Weighted average fair value of
options granted during year..... $ -- $ -- $14.45
====== ====== ======
Exercise prices for options outstanding as of December 31, 1996 ranged from
$2.50 to $14.45. The weighted-average remaining contractual life of those
options is 6.5 years.
In November, 1995, the Company entered into an agreement with a customer
which granted 25,000 common stock warrants to the customer which become
exercisable based upon purchase volume of the Company's products and services.
Each warrant gives the holder the right to purchase one share of common stock.
The warrants expire 48 months from their issue date and are exercisable at
prices ranging from $42 to $50 per share based upon their exercise date. The
excess of fair market value over exercise price, if any, will be reflected as
sales discount as the warrants become exercisable. Total warrants exercisable
under this
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CONQUEST TELECOMMUNICATION SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996
agreement were 2,588 and 14,026 at December 31, 1995 and 1996. As of December
31, 1996, no sales discounts have been recorded since the fair market value of
the warrants was less than the exercise price.
6. INCOME TAXES
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under
Statement No. 109, the liability method is used in accounting for income taxes.
Under this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse. Significant components of the
Company's deferred tax assets and liabilities are as follows:
DECEMBER 31,
-----------------------
1995 1996
Deferred tax assets:
Deferred revenue -- promotional and collector
cards........................................... $ -- $ 460,000
Write down of assets............................... -- 252,000
Net operating loss and AMT carryforward............ 5,000 156,000
Accrued expenses................................... 296,000 92,000
Bad debt allowance................................. 51,000 90,000
Intangible assets.................................. -- 25,000
--------- ---------
Total deferred tax assets............................ 352,000 1,075,000
Deferred tax liabilities:
Tax over book depreciation and amortization........ (175,000) (245,000)
Deferred charges................................... (93,000) --
--------- ---------
Deferred tax liabilities............................. (268,000) (245,000)
--------- ---------
Net deferred tax assets.............................. $ 84,000 $ 830,000
========= =========
Components of net deferred tax assets (liabilities):
Current............................................ $ 352,000 $ 799,000
Long-term.......................................... (268,000) 31,000
--------- ---------
$ 84,000 $ 830,000
========= =========
At December 31, 1996, the Company has alternative minimum tax credit
carryforwards of $156,000.
Significant components of the provision (benefit) for income taxes are as
follows:
YEAR ENDED DECEMBER 31,
------------------------------------
1994 1995 1996
Current:
Federal................................ $251,000 $ 444,000 $ (20,000)
State and local........................ 64,000 85,000 --
-------- --------- ---------
315,000 529,000 (20,000)
Deferred................................. 92,000 (138,000) (746,000)
-------- --------- ---------
$407,000 $ 391,000 $(766,000)
======== ========= =========
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CONQUEST TELECOMMUNICATION SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996
The Company's provision for income taxes differs from the amounts computed
by applying the federal statutory rate due to the following:
YEAR ENDED DECEMBER 31,
-----------------------------------
1994 1995 1996
Expected tax (benefit) at federal
statutory rates......................... $350,000 $344,000 $(736,000)
State and local taxes, net of federal
tax benefit............................. 35,000 47,000 (100,000)
Surtax exemption.......................... -- -- 62,000
Other..................................... 22,000 -- 8,000
-------- -------- ---------
$407,000 $391,000 $(766,000)
======== ======== =========
Taxes paid during 1994, 1995 and 1996 were $83,000, $486,000, and $613,000
respectively.
7. SAVINGS PLAN
Effective January 1, 1995, the Company adopted a 401(k) savings plan which
covers substantially all employees of the Company. Contributions are at the
discretion of the Company at a percentage of voluntary employee contributions
not to exceed 4% of total compensation determined prior to the beginning of each
plan year. Employees may make contributions up to 15% of their compensation and
are limited to the amount deductible for federal income tax purposes. Total
expense under the plan was approximately $6,000 and $27,000 for the years ended
December 31, 1995 and 1996, respectively.
8. WRITE-DOWN OF ASSETS
During 1996, the Company decided to exit the collector prepaid calling card
business. Accordingly, the Company evaluated the recoverability of certain
tangible and intangible assets related to its collector prepaid calling card
operations, and based on the technological obsolescence and non-marketability of
these assets, deemed them to have no fair market value. Accordingly, the Company
wrote off these assets in accordance with Statement of Financial Accounting
Standards No. 121. These assets include certain computer equipment, licensing
agreements and a proportional share of the excess of cost over the fair value of
assets acquired in the ACMI acquisition. The impairment loss of $918,445 is
reflected in the statement of operations as "write-down of assets."
9. ACCOUNTING CHANGES
In anticipation of registering its common stock for public distribution,
the Company has restated its financial statements for the years ended December
31, 1993, 1994 and 1995 to conform the revenue recognition method to that in use
during 1996. During 1996, the Company adopted a more refined method of
recognizing revenue on its prepaid calling cards. The new method provides for
recognition based upon actual decremented minutes of usage. Previously, prepaid
calling card revenue was recognized based upon estimated usage and the passage
of time. The Company also changed its method of accruing for compensated
absences to conform with the provisions of Statement of Financial Accounting
Standards No. 43. The effect of these changes on net income and beginning of the
year shareholders' equity is as follows:
.
1993 1994 1995
----------------------- ----------------------- -----------------------
AS AS AS AS AS AS
REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED
Net income................. $1,026,339 $1,026,339 $ 746,397 $ 623,593 $ 822,507 $ 621,617
Beginning of year
shareholders' equity..... 1,493,613 1,426,613 2,518,857 2,451,857 3,857,384 3,667,580
In November 1997, in consultation with the Securities and Exchange
Commission staff and in conjunction with the use of the Company's financial
statements in a registration statement on Form S-4 by SmarTalk Teleservices,
Inc., the Company adopted a new method of recognizing revenue on promotional and
12
13
CONQUEST TELECOMMUNICATION SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996
collector prepaid calling cards. The new method provides for recognition of
revenue on these cards based upon actual usage or the expiration date of the
card. For cards with no expiration date, revenue from unused minutes is
recognized after 12 months from the date of issuance. Previously, revenue for
promotional and collector cards was recognized at the date of issuance based
upon expected usage which is less than 10%. This change increased the previously
reported net loss for 1996 by $718,966. The adoption of this method had no
effect on the 1994 and 1995 financial statements since sales of promotional and
collector cards were negligible in those years.
10. CONTINGENT LIABILITIES
The Company and certain directors are named defendants among a group of
defendants in a lawsuit brought by a former officer and former directors of the
Company who are also shareholders of the Company. The lawsuit alleges, among
other things, a breach of duties owed to the plaintiffs as shareholders through
unspecified acts of mismanagement, wrongful removal of plaintiffs from their
previous positions as officer and directors of the Company, and tortuous
interference with the plaintiffs alleged right to purchase shares of common
stock of the Company which certain shareholders might desire to sell, and that
the Company failed to comply with its charter documents in the removal of
defendants as directors of the company and in the election of their successors.
The Board of Directors of the Company passed a resolution to indemnify the named
directors for all expenses and liabilities arising from the aforementioned
lawsuit.
Management of the Company, after consulting with legal counsel, believes
that meritorious defenses exist with respect to this lawsuit and is vigorously
defending the lawsuit and disputing all claims relating thereto. Management
further believes that any losses to the Company resulting from resolution of
this matter will not be material to the Company's results of operations or
financial position. However, the ultimate outcome cannot presently be
determined. Accordingly, no accrual for any potential liability that may result
has been made in the financial statements.
The Company has determined that its method of processing prepaid calling
cards may be alleged to infringe a certain U.S. patent held by an unaffiliated
third party. However, there are currently no claims of infringement outstanding
against the Company by the patent holder. The validity of this patent, which
expires November 13, 2005, is at issue in litigation now pending in federal
district court; the Company is not a party to this litigation. The Company has
initiated discussions with the patent holder for a license under the patent and
expects that the terms of the licensing agreement would require the Company to
pay licensing fees to the patent holder until the expiration or invalidation of
the patent. These license fees would be applicable to prepaid calling card
revenues generated subsequent to the date of the license agreement. Although the
validity of the patent has not been determined and license payments under the
potential agreement with the patent holder are based on future use, the ultimate
outcome of the Company's negotiations with the patent holder cannot presently be
determined. Accordingly, no accrual for any potential liability that may result
has been made in the financial statements.
11. SUBSEQUENT EVENTS
On February 19, 1997, the Company restated its certificate of incorporation
increasing the number of shares of all classes of capital stock to 54,000,000
shares which are divided into two classes: 4,000,000 shares of preferred stock
with a par value of $.001 per share and 50,000,000 shares of common stock with a
par value of $.001 per share.
The Company adopted an Incentive Stock Option Plan on February 19, 1997
(Incentive Stock Plan) contingent upon completion of an initial public offering
of the Company's common stock. The purpose of the Incentive Stock Plan is to
attract and retain key personnel, including consultants, advisors and directors
of the Company, and to enhance their interest in the Company's continued
success. The maximum number of shares available to be issued under the Incentive
Stock Plan will be 67,500, subject to adjustment for stock splits and other
similar corporate events. The maximum number of shares of common stock for which
an individual may receive awards is limited to 2,000 shares per year.
13
14
CONQUEST TELECOMMUNICATION SERVICES CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
SEPTEMBER DECEMBER
30, 31,
1997 1996
----------- -----------
(UNAUDITED)
Current assets:
Cash.......................................................... $ -- $ 300,557
Trade accounts receivable, net................................ 9,974,958 6,796,262
Inventories................................................... 349,262 782,210
Prepaid expenses.............................................. 399,076 629,838
Other current assets.......................................... 541,136 1,099,840
----------- -----------
Total current assets....................................... 11,264,432 9,608,707
Non-current assets:
Property and equipment, net................................... 4,886,111 4,178,490
Other non-current assets...................................... 3,807,388 937,360
Goodwill...................................................... 1,046,055 2,733,312
----------- -----------
Total assets.......................................... $21,003,986 $17,457,869
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable.............................................. $ 3,002,385 $ 3,064,861
Deferred revenue.............................................. 5,008,920 4,534,319
Other accrued expenses........................................ 1,239,707 1,664,017
Line of Credit................................................ 1,901,452 1,033,411
Current portion of long-term debt and capital lease
obligations................................................ -- 603,343
----------- -----------
Total current liabilities.................................. 11,152,464 10,899,951
Long-term debt................................................ 5,144,025 2,400,000
----------- -----------
Total liabilities.......................................... 16,296,489 13,299,951
----------- -----------
Shareholders' Equity:
Preferred stock............................................... -- --
Common stock and additional paid-in capital................... 4,941,188 4,538,596
Accumulated deficit........................................... (202,891) (349,878)
Treasury stock, at cost....................................... (30,800) (30,800)
----------- -----------
Total shareholders' equity................................. 4,707,497 4,157,918
----------- -----------
Total liabilities and shareholders' equity............ $21,003,986 $17,457,869
=========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
14
15
CONQUEST TELECOMMUNICATION SERVICES CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1997 1996
----------- -----------
Revenue........................................................... $36,384,544 $28,856,296
Cost of revenue................................................... 26,054,289 22,167,283
----------- -----------
Gross profit.................................................... 10,330,255 6,689,013
Sales and marketing............................................... 3,941,940 2,874,679
General and administrative........................................ 5,959,815 3,948,751
----------- -----------
Operating income (loss)......................................... 428,500 (134,417)
Interest expense, net............................................. 187,541 290,149
----------- -----------
Income (loss) before taxes...................................... 240,959 (424,566)
Provision for income taxes........................................ 93,974 (170,675)
----------- -----------
Net (loss) income............................................... $ 146,985 $ (253,891)
=========== ===========
Net (loss) income per share....................................... $ 0.26 $ (0.46)
=========== ===========
Weighted Average number of shares................................. 565,765 547,693
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
15
16
CONQUEST TELECOMMUNICATION SERVICES CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
1997 1996
----------- -----------
OPERATING ACTIVITIES:
Net income (loss)................................................. $ 146,985 $ (253,891)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization................................... 1,070,728 839,026
Goodwill amortization........................................... 350,052 390,388
Changes in operating assets and liabilities:
Accounts receivable.......................................... (3,171,584) (2,551,499)
Inventory.................................................... 178,699 (657,596)
Prepaid and agent loans...................................... 221,887 446,660
Other current assets......................................... 558,704 (329,821)
Other non-current assets..................................... (1,131,040) (1,131,956)
Accounts payable............................................. (62,307) 1,917,974
Deferred revenue............................................. 474,600 421,131
Other accrued expenses....................................... (18,972) (904,432)
----------- -----------
Net cash used in operating activities............................. (1,382,248) (1,814,016)
INVESTING ACTIVITIES:
Capital expenditures, net of disposals............................ (1,929,694) (1,690,662)
----------- -----------
Net cash used in investing activities............................. (1,929,694) (1,690,662)
FINANCING ACTIVITIES:
Proceeds from credit agreements and long-term obligations......... 3,884,002 4,111,463
Payments on credit agreements and long-term obligations........... (872,617) (606,785)
----------- -----------
Net cash provided by financing activities......................... 3,011,385 3,504,678
----------- -----------
Net (decrease) in cash............................................ (300,557) --
Cash, beginning of period......................................... 300,557 --
----------- -----------
Cash, end of period............................................... $ -- $ --
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
16
17
CONQUEST TELECOMMUNICATION SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF INTERIM PRESENTATION.
The accompanying interim period financial statements are unaudited, pursuant
to certain rules and regulations of the Securities and Exchange Commission,
and include, in the opinion of management, all adjustments (consisting of
only normal recurring accruals) necessary for a fair statement of the
results for the periods indicated; which, however, are not necessarily
indicative of results which may be expected for the full year. Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. The financial statements should be read in conjunction with the
financial statements and the notes thereto for the year ended December 31,
1996.
2. Effective April 1, 1997, the Company sold substantially all of the assets of
its ACMI division, with a net book value of $2,225,000, in exchange for a
promissory note receivable. No gain or loss was recorded on the transaction.
As the disposition of the ACMI Division is a non-cash transaction, the
effects of this transaction have been excluded from the statement of cash
flows.
3. As the settlement of CPC's contingent stock earnout in the amount of
approximately $403,000 is a non-cash transaction, the affects of this
transaction have been excluded from the statement of cash flows.
4. Certain amounts in the 1996 financial statements have been reclassified to
conform to the 1997 presentation.
17