-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, D48uQgEQJIN/DyVUuZOAxBip1DaPzYSN6CaNlSk4iBGYp7gu2rSJ7ONMK1zEMGI1 L5kYfRnk0iayR7xYuzoCdw== 0000950134-03-004822.txt : 20030328 0000950134-03-004822.hdr.sgml : 20030328 20030328144112 ACCESSION NUMBER: 0000950134-03-004822 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FULLNET COMMUNICATIONS INC CENTRAL INDEX KEY: 0001092570 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROCESSING & DATA PREPARATION [7374] IRS NUMBER: 731473361 STATE OF INCORPORATION: OK FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-27031 FILM NUMBER: 03624569 BUSINESS ADDRESS: STREET 1: 201 ROBERT S KERR AVENUE STREET 2: SUITE 210 CITY: OKLAHOMA CITY STATE: OK ZIP: 73102 BUSINESS PHONE: 4052320958 MAIL ADDRESS: STREET 1: 200 N HARVEY STREET 2: SUITE 1704 CITY: OKLAHOMA CITY STATE: OK ZIP: 73102 10KSB 1 d04287e10ksb.txt FORM 10KSB UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR FISCAL YEAR ENDED DECEMBER 31, 2002 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________________ TO ___________________ COMMISSION FILE NUMBER: 000-27031 FULLNET COMMUNICATIONS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) OKLAHOMA 73-1473361 ------------------------------- ------------------- (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 201 ROBERT S. KERR AVENUE, SUITE 210 OKLAHOMA CITY, OKLAHOMA 73102 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (405) 236-8200 (REGISTRANT'S TELEPHONE NUMBER) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT: Title of each class ------------------- Common Stock, $0.00001 Par Value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if there is no disclosure contained herein of delinquent filers in response to Item 405 of Regulation S-B, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes No X --- --- The Registrant's revenues for its most recent fiscal year were $2,425,016 The aggregate market value of the registrant's common stock, $0.00001 par value, held by non-affiliates of the Registrant as of June 28, 2002 was $551,396 based on the closing price of $.10 per share on that date as reported by the NASD Electronic Bulletin Board. As of March 25, 2003, 6,663,135 shares of the registrant's common stock, $0.00001 par value, were outstanding. Transitional Small Business Disclosure Format (check one): Yes [ ] No [X] FULLNET COMMUNICATIONS, INC. FORM 10-KSB For the Fiscal Year Ended December 31, 2002 TABLE OF CONTENTS PART I. ITEM 1. DESCRIPTION OF BUSINESS..................................................................................................4 ITEM 2. DESCRIPTION OF PROPERTY.................................................................................................13 ITEM 3. LEGAL PROCEEDINGS.......................................................................................................14 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.....................................................................14 PART II. ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS................................................................15 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION...............................................................17 ITEM 7. FINANCIAL STATEMENTS....................................................................................................20 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE....................................21 PART III. ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS, COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.........21 ITEM 10. EXECUTIVE COMPENSATION..................................................................................................23 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..........................................................24 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..........................................................................26 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K........................................................................................26 ITEM 14. CONTROLS AND PROCEDURES.................................................................................................30 SIGNATURES.......................................................................................................................31
2 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This Annual Report on Form 10-KSB and the information incorporated by reference may include "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). In particular, we direct your attention to Item 1. Description of Business, Item 2. Description of Property, Item 3. Legal Proceedings, Item 6. Management's Discussion and Analysis or Plan of Operation, and Item 7. Financial Statements and Supplementary Data. We intend the forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in these sections. All statements regarding our expected financial position and operating results, our business strategy, our financing plans and the outcome of any contingencies are forward-looking statements. These statements can sometimes be identified by our use of forward-looking words such as "may," "believe," "plan," "will," "anticipate," "estimate," "expect," "intend" and other phrases of similar meaning. Known and unknown risks, uncertainties and other factors could cause the actual results to differ materially from those contemplated by the statements. The forward-looking information is based on various factors and was derived using numerous assumptions. Although we believe that our expectations that are expressed in these forward-looking statements are reasonable, we cannot promise that our expectations will turn out to be correct. Our actual results could be materially different from our expectations, including the following: - - We may lose subscribers or fail to grow our subscriber base; - - We may not successfully integrate new subscribers or assets obtained through acquisitions; - - We may fail to compete with existing and new competitors; - - We may not be able to sustain our current growth; - - We may not adequately respond to technological developments impacting the Internet; - - We may experience a major system failure; - - We may not be able to find needed financing. This list is intended to identify some of the principal factors that could cause actual results to differ materially from those described in the forward-looking statements included elsewhere in this report. These factors are not intended to represent a complete list of all risks and uncertainties inherent in our business, and should be read in conjunction with the more detailed cautionary statements included in this Report under the caption "Item 1. Description of Business- Additional Factors to Consider," our other Securities and Exchange Commission filings and our press releases. 3 PART I ITEM 1. DESCRIPTION OF BUSINESS General We are an integrated communications provider offering integrated communications and Internet connectivity to individuals, businesses, organizations, educational institutions and government agencies. Through our subsidiaries, we provide high quality, reliable and scalable Internet access, web hosting, and equipment co-location. Our overall strategy is to become the dominant integrated communications provider for residents and small to medium-sized businesses in Oklahoma. References to us in this Report include our subsidiaries: FullNet, Inc. ("FullNet"), FullTel, Inc. ("FullTel"), and FullWeb, Inc. ("FullWeb"). Our principal executive offices are located at 201 Robert S. Kerr Avenue, Suite 210, Oklahoma City, Oklahoma 73102, and our telephone number is (405) 236-8200. We also maintain an Internet site on the World Wide Web ("WWW") at www.fullnet.net. Information contained on our Web site is not, and should not be deemed to be, a part of this Report. Company History We were founded in 1995 as CEN-COM of Oklahoma, Inc., an Oklahoma corporation, to bring dial-up Internet access and education to rural locations in Oklahoma that did not have dial-up Internet access. We changed our name to FullNet Communications, Inc. in December 1995, and shifted our focus from offering dial-up services to providing wholesale and private label network connectivity and related services to other Internet service providers. During 1995 and 1996, we furnished wholesale and private label network connectivity services to Internet service providers in Bartlesville, Cushing, Durant, Perry, Tahlequah, and Tulsa. During 1996, we sold our Internet service provider operations in Enid, Oklahoma and began Internet service provider operations in Ponca City, Oklahoma. In 1997 we continued our focus on being a backbone provider by upgrading and acquiring more equipment. We also started offering our own Internet service provider brand access and services to our wholesale customers. As of December 31, 2002, there was one Internet service provider in Oklahoma that used the FullNet brand name for whom we provide the backbone to the Internet. There was also one Internet service provider that used a private label brand name, for whom we are its access backbone and provide on an outsource basis technical support, systems management and operations. Additionally, we provide high-speed broadband connectivity, website hosting, network management and consulting solutions to over 100 businesses in Oklahoma. In 1998 our gross revenues exceeded $1,000,000 and we made the Metro Oklahoma City Top 50 Fastest Growing Companies list. In 1998 we commenced the process of organizing a competitive local exchange carrier ("CLEC") through FullTel, and acquired Animus Communications, Inc. ("Animus"), a wholesale Web-service company, which enabled us to become a total solutions provider to individuals and companies seeking a "one-stop shop" in Oklahoma. Animus was renamed FullWeb in January 2000. With the incorporation of FullTel and the acquisition of FullWeb, our current business strategy is to become the dominant integrated communications provider in Oklahoma, focusing on rural areas. We expect to grow through the acquisition of additional customers for our carrier-neutral co-location space, the acquisition of Internet service providers, as well as through a FullNet brand marketing campaign. During the years ended 2000 and 2001, we completed eight separate acquisitions of Internet service provider companies, with customers in the Oklahoma cities of Tahlequah, Bartlesville, Enid, Nowata, Lawton, Oklahoma City, Adair, Jay, Pryor, Wyandotte, Leach, Colcord and Moseley. During the month of February 2000, our common stock began trading on the NASD Electronic Bulletin Board under the symbol FULO. While our common stock trades on the NASD Electronic Bulletin Board, it is very thinly traded, and there can be no assurance that shareholders will be able to sell their shares should they desire. Any market for the common stock that may develop, in all likelihood, will be a limited one, and if such a market does develop, the market price may be volatile. On June 20, 2000, we began providing co-location services to KMC Telecom V, Inc. ("KMC"), a facilities-based competitive local exchange carrier pursuant to an agreement that ends on December 31, 2005. Under the terms of this agreement, we receive $42,275 per month to provide co-location and support services for KMC's telecommunications equipment at our network operations center in Oklahoma City, Oklahoma. We completed our network operations center during the first quarter of 2001. KMC moved into our network operations center and began making payments during the third quarter of 2000. We plan to market additional carrier neutral co-location solutions in our network operations center to other competitive local exchange carriers, Internet service providers and web-hosting companies. 4 Our co-location facility is carrier neutral, allowing customers to choose among competitive offerings rather than being restricted to one carrier. Our network operations center is Telco-grade and provides customers a high level of operative reliability and security. We offer flexible space arrangements for customers, 24-hour onsite support with both battery and generator backup. Mergers and Acquisitions Our acquisition strategy is designed to leverage our existing network backbone and internal operations to enable us to enter new markets in Oklahoma, as well as to expand our presence in existing markets, and to benefit from economies of scale. We acquired four Internet service provider businesses in Oklahoma during 2001. On February 28, 2001, we purchased substantially all of the assets of LawtonNet Communications (LAWTONNET), a sole proprietorship, including approximately 700 individual and business Internet access customer accounts. Pursuant to the purchase, we issued LAWTONNET 35,000 shares of our common stock. In addition, we agreed to pay LAWTONNET an amount based upon the future collected revenues received from all active LAWTONNET customers transferred at the time of closing of the purchase until the customers become inactive. During the 30 days following the closing of this purchase, advance payments of $30,000 were made on future collected revenues received. Total amounts due to the seller pursuant to this provision of the purchase agreement were $27,182 and $4,611 for 2001 and 2002, respectively. On February 28, 2001, we purchased substantially all of the assets of Computer Concepts & Research, Inc., doing business as SONET Communications (SONET), including approximately 900 individual and business Internet access customer accounts. Pursuant to this purchase, we agreed to issue 30,000 shares of our common stock to SONET. In addition, we agreed to pay SONET an amount based upon the future collected revenues received from all active SONET customers transferred at the time of closing until the customers become inactive. Total amounts due to the seller pursuant to this provision of the purchase agreement were $38,404 and $10,995 for 2001 and 2002, respectively. On June 15, 2001, we purchased substantially all of the assets of IPDatacom, a division of Higganbotham.com, LLC (IPDatacom), including approximately 400 individual and business Internet access customer accounts. Pursuant to this purchase, we issued IPDatacom 135,000 shares of our common stock, notes payable in the aggregate principal amount of $58,500 and paid $1,500. On November 19, 2001, we purchased from Northeast Rural Services, a subsidiary of Northeast Oklahoma Electric Cooperative, Inc. (RECTEC) its Internet access customers, including approximately 1,400 individual and business Internet access accounts, and the associated equipment in the Oklahoma cities of Adair, Jay, Pryor, Wyandotte, Leach, Colcord and Moseley. We paid RECTEC an aggregate amount of $92,394, comprised of $37,394 in cash and two notes payable in the aggregate principal amount of $55,000. These acquisitions were accounted for as purchases. The aggregate purchase price has been allocated to the underlying net assets purchased or net liabilities assumed, including intangible assets which consist primarily of acquired customer bases and covenants not to compete, based on their estimated fair values at the respective acquisition dates. Intangible assets acquired totaled approximately $245,397, which are being amortized based on decreases of acquired customer base Our Business Strategy As an integrated communications provider, we intend to increase shareholder value by continuing to build scale through both acquisitions and internal growth and then leveraging increased revenues over our fixed costs base. Our strategy is to meet the customer service requirements of retail, business, educational and government Internet users in our target markets, while benefiting from the scale advantages obtained through being a fully integrated backbone and broadband provider. The key elements of our overall strategy with respect to our principal business operations are as follows: Target Strategic Acquisitions The goal of our acquisition strategy is to accelerate market penetration by acquiring Internet service providers in Oklahoma communities with populations of 5,000 or more and to acquire strategic Internet service providers in Oklahoma City and Tulsa. Additionally, we will continue to build upon our core competencies and expand our technical, customer service staff and sales force in Oklahoma communities. We evaluate acquisition candidates based on their compatibility with our overall business plan of penetrating rural and outlying markets as well as Oklahoma City and Tulsa. When a candidate is acquired, we will integrate our existing Internet, network connectivity and value-added services with the services offered by the acquired company and use either the local sales force or install our own dealer sales force to continue to increase market share. The types of acquisitions targeted by us include Internet service providers located in markets into which we want to expand or to which we may already provide "private-label" Internet connectivity. Other types of targeted acquisitions include local business-only Internet service providers in markets where we have established points of presence and would benefit from the acquired company's local 5 sale and network solutions sales and technical staff and installed customer base through the potential increase in our network utilization. When assessing an acquisition candidate, we focus on the following criteria: o Potential revenue and subscriber growth; o Low subscriber turnover or churn rates; o Density in the market as defined by a high ratio of subscribers to points of presence ("POPs"); o Favorable competitive environment; o Low density network platforms that can be integrated readily into our backbone network; and o Favorable consolidation savings. Generate Internal Sales Growth We intend to expand our customer base by increasing our independent re-seller network as well as our marketing efforts. At December 31, 2002, our direct sales force consisted of one individual in our Oklahoma City office coordinating all our business-to-business solutions sales. We currently have one individual responsible statewide to manage the consumer Internet service provider market, with independent re-sellers responsible for their individual markets. Our sales force is supported in its efforts by technical engineers and, in some instances, our senior management. We intend to increase the size of our independent re-seller network to establish an effective selling presence in all major communities in Oklahoma. In addition, we are exploring other strategies to increase our sales, including developing an inside sales center and other marketing partners such as electric cooperatives. We currently have one of the 20 local Oklahoma electric cooperatives as a marketing partner. Develop the Dominant Regional Brand We seek to support internal growth by converting each local acquired Internet service provider to its regional FullNet brand supported by community based marketing programs. This strategy includes two components: o Regional branding. Change strong local brands to a regional FullNet brand. We intend to change these brands on a market-by-market basis as we implement enhancements to improve customer satisfaction. o Community based marketing. We intend to continue to build goodwill through community involvement, such as providing free services to libraries and educational institutions, sponsoring local sports teams and other community organizations and furthering relationships with local retailers to promote our products and services in their stores. Develop Strategic Relationships We intend to develop strategic relationships with advertisers and content providers, capitalizing on opportunities to sell value-added products and services to our local subscribers. Grow Subscriber Base We intend to grow our subscriber base through a combination of internal and acquisition driven growth. We anticipate that this growth will increase the density of our subscriber base within a service area utilizing our available network operations, customer support, back office functions and management overhead without further cost increase or with minimal cost increase. We expect our local markets to generate internal subscriber growth primarily by enhancing subscribers' online experience, providing a sense of a national presence while maintaining local community content and developing a consumer recognized regional FullNet brand. Increase Rural Area Market Share We believe that the rural areas of Oklahoma are underserved by Internet service providers, and that significant profitable growth can be achieved in serving these markets by providing reliable Internet connectivity at a reasonable cost to the residents and businesses located in these areas. We believe we can obtain a significant Internet service provider and business-to-business market share in Oklahoma. To that end, we, through our wholly-owned subsidiary, FullTel, became a licensed competitive local exchange carrier in Oklahoma. As a competitive local exchange carrier, FullTel is now able to provide local telephone numbers for Internet access since the purchase and installation of a telephone switch in March 2003. Cross-Sell Value Added Services We intend to capitalize on our existing customer base and future customers by aggressively cross selling our value-added services through a referral system that has every local retail Internet service provider sales representative referring business-to-business customers. We are committed to offering our customers reliable value-added network services necessary to address their 6 Internet, communications and network management requirements. Based on our existing network infrastructure and expertise, we are able to offer these services continuously, reliably and on a cost-effective basis. Enhance Subscribers' Online Experience We intend to maximize our subscriber retention and add new subscribers by enhancing our services in the following ways: o Ease of Use - During the first quarter of 2001, we implemented a common, easy to use CD ROM based software package that automatically configures all of the individual Internet access programs after a one time entry by the user of a few required fields of information such as, name, user name and password. o Local Content - During the first quarter of 2001, we began sourcing local, customized, community specific content, such as weather, traffic, crop reports, business club meetings and high school and college sports information, through national providers of local content or partnerships with businesses and organizations in the subscribers' local communities. o New Products and Services - Offer subscribers new products and services, such as audio and visual streaming, as the technologies supporting these products and services become standardized, stable and profitable. o Co-marketing Opportunities - Develop affinity based marketing programs to offer products and services, such as calling cards and long distance telephone service, to our subscribers in exchange for fee based revenues. Internet Access Services Our core business is the sale of Internet access services to individual and small business subscribers located in Oklahoma. Through FullNet, we provide our customers with a variety of dial-up and dedicated connectivity, as well as direct access to a wide range of Internet applications and resources, including electronic mail. FullNet's full range of services include: o Private label retail and business direct dial-up connectivity to the Internet and o Secure private networks through our backbone network Our branded and private label Internet access services are provided through a statewide network with points-of -presence in 18 communities throughout Oklahoma. Points-of-presence are local telephone numbers through which subscribers can access the Internet. Our business services consist of high-speed Internet access services and other services that enable wholesale customers to outsource their Internet and electronic commerce activities. We had approximately 3,600 subscribers at December 31, 2002. Additionally, FullNet sells Internet access to other Internet service providers, who then resell Internet access to their own customers under their private label or under the "FullNet" brand name. We intend to expand our subscriber base through a marketing campaign and through acquisitions. We are focusing our acquisition efforts on companies with forward-looking sales and marketing, high-quality customer service and a solid local market dominance. See "Item 1. Description of Business - Mergers and Acquisitions." Additionally, we are expanding our independent re-seller network in an effort to increase our subscriber base in the markets in which we currently operate. Currently, we offer the following two types of Internet connections: o Dial-Up Connections The simplest connection to the Internet is the dial-up account. This method of service connects the user to the Internet through the use of a modem and standard telephone line. Currently, FullNet users can connect via dial-up at speeds up to 56 Kbps. We support these users through the use of sophisticated modem banks at the point-of-presence that send data through a router and out to the Internet. We support the higher speed 56K, V.92 and Integrated Services Digital Network connections with state-of-the-art digital modems. With a dial-up connection, a user can gain access to the Internet for e-mail, the World Wide Web, file transfer protocol, news groups, and a variety of other useful applications. o Leased Line Connections Many businesses and some individuals have a need for more bandwidth to the Internet to support a network of users or a busy Web site. We have the capacity to sell a leased line connection to users. This method of connection gives the user a full-time high-speed (up to 1.5 mbps) connection to the Internet through our point-of-presence. The leased line solution comes at greater expense to the user, who must lease a dedicated line from its location to our point-of-presence. These lines are leased through the telephone companies at a high installation and monthly fee. 7 We believe that our Internet access services provide customers with the following benefits: Fast and Reliable Internet Access-We have implemented a network architecture providing exceptional quality and consistency in Internet services, making us the recognized backbone leader in the Oklahoma Internet service provider industry. We offer unlimited, unrestricted and reliable Internet access at a low monthly price. A user-to-modem ratio of approximately 7:1 assures access with minimal busy signals. Dial-up access is available for the following modem speeds: 14.4K, 28.8K, 33.6K, K56Flex, 56K V.90, ISDN 64K and ISDN 128K. Our dial-up access supports all major platforms and operating systems, including MS Windows, UNIX(R), Mac OS, OS/2 and LINUX. This allows simplified access to all Internet applications, including the World Wide Web, email, news and file transfer protocol. Cost-Effective Access-We offer high quality Internet connectivity and enhanced business services at price points that are generally lower than those charged by other Internet service providers with national coverage. Additionally, we offer pre-bundled access services packages under monthly or prepaid plans. Superior Customer Support-We provide superior customer service and support, with customer care and technical personnel available by telephone and on-line. CLEC Operations Through FullTel, our wholly owned subsidiary, we are a fully licensed competitive local exchange carrier or CLEC in Oklahoma. CLECs are new phone companies born out of the Telecommunications Act of 1996 (Telecommunications Act), which requires the incumbent local exchange carriers or ILECs, such as the regional Bell companies, to provide CLECs access to their local facilities, and to compensate CLECs for traffic originated by ILECs and terminated on the CLECs network. By adding our own telephone switch and infrastructure to the existing telephone network in March 2003, we are now able to offer local services in most of Oklahoma, including local dial-up and digital subscriber line for the Internet access services provided by us. As a CLEC, we may subscribe to and resell all forms of local telephone service in Oklahoma. We intend to build our own network infrastructure, which we believe will reduce our current reliance upon the infrastructures of the ILECs. We believe that our CLEC status, combined with the efficiencies inherent in operating our own network, should result in lower overhead costs and a more predictable infrastructure, both of which should be to the benefit of our customers. While Internet access is the core focus of growth for us, we plan to also provide traditional telephone service throughout Oklahoma. A core piece of our marketing strategy is the "cross pollination" between our Internet activities and FullTel's local dial-up service. By organizing and funding FullTel, we expect to gain local dial-up Internet access to approximately 80% of Oklahoma. In return, FullTel will gain immediate access to our entire Internet service provider customer base. The FullTel data center telephone switching equipment was installed in March 2003. Therefore, FullTel will begin extending local access telephone numbers to every city in which we will market, sell and operate our retail FullNet Internet service provider brand and our business-to-business network design, connectivity, domain and Web hosting businesses. It is anticipated that initially, FullTel will provide us with local telephone access in 35-40 targeted cities where we will either already have Internet service customers or have commenced sales and marketing. However, our ability to fully take advantage of these opportunities will be dependent upon the availability of additional capital. Sales and Marketing Although we expect that the bulk of our new subscribers will come through acquisition of Internet service providers, our expanded local sales system is also an integral part of our growth plan. We believe local sales and marketing will develop further recognition of our name brand that will lead to increased subscriber revenues. The 15 largest metropolitan areas in the United States comprise only 38% of the U.S. population, leaving the majority of the country's population in hundreds of smaller markets as potential subscribers. More specifically, predominantly smaller metropolitan and rural markets may have penetration rates of 22% and lower, versus larger markets with penetration rates of around 40%. In addition, in many cases national providers are a long distance phone call in our markets. Finally, since there is not as much competition in the smaller metropolitan and rural markets, monthly churn rates are lower and word-of-mouth referrals are a significant generator of new subscribers. We believe that we have significant opportunities for acquisition and internal sales growth in these market areas. We focus on marketing our services to two distinct market segments: enterprises (primarily small and medium size businesses) and consumers. By attracting enterprise customers who use the network primarily during the daytime, and consumer customers who use the network primarily at night, we are able to utilize our network infrastructure more cost effectively. 8 Competition The market for Internet connectivity and related services is extremely competitive. We anticipate that competition will continue to intensify as the use of the Internet grows. The tremendous growth and potential market size of the Internet access market has attracted many new start-ups as well as existing businesses from a variety of industries. We believe that a reliable network, knowledgeable salespeople and the quality of technical support currently are the primary competitive factors in our targeted market and that price is usually secondary to these factors. Our current and prospective competitors include, in addition to other national, regional and local Internet service providers, long distance and local exchange telecommunications companies, cable television, direct broadcast satellite, wireless communications providers and online service providers. While we believe that our network, products and customer service distinguish us from these competitors, most of these competitors have significantly greater market presence, brand recognition, financial, technical and personnel resources than us. Internet Service Providers Our current primary competitors include other Internet service providers with a significant national presence that focus on business customers, such as MCI WorldCom, Cox Communications and SBC. These competitors have greater market share, brand recognition, financial, technical and personnel resources than us. We also compete with regional and local Internet service providers in our targeted markets. Telecommunications Carriers The major long distance companies, also known as interexchange carriers, including AT&T, MCI WorldCom, Cable & Wireless/IMCI and Sprint, offer Internet access services and compete with us. Reforms in the federal regulation of the telecommunications industry have created greater opportunities for ILECs, including the Regional Bell Operating Companies or RBOCs, and other competitive local exchange carriers, to enter the Internet connectivity market. In order to address the Internet connectivity requirements of the business customers of long distance and local carriers, we believe that there is a move toward horizontal integration by ILECs and CLECs through acquisitions or joint ventures with, and the wholesale purchase of, connectivity from Internet service providers. The MCI/WorldCom merger (and the prior WorldCom/MFS/UUNet consolidation), GTE's acquisition of BBN, the acquisition by ICG Communications, Inc. of Netcom, Global Crossing's acquisition of Frontier Corp. (and Frontier's prior acquisition of Global Center) and AT&T's recent purchase of IBM's global communications network are indicative of this trend. Accordingly, we expect that we will experience increased competition from the traditional telecommunications carriers. These telecommunication carriers, in addition to their greater network coverage, market presence, financial, technical and personnel resources also have large existing commercial customer bases. Cable Companies, Direct Broadcast Satellite and Wireless Communications Companies Many of the major cable companies are offering Internet connectivity, relying on the viability of cable modems and economical upgrades to their networks, including Media One and Time Warner Cablevision, Inc., Cox Communications and Tele-Communications, Inc. ("TCI"). The companies that own these broadband networks could prevent us from delivering Internet access through the wire and cable connections that they own. Cable television companies are not currently required to allow Internet service providers to access their broadband facilities and the availability and terms of Internet service provider access to broadband local telephone company networks are under regulatory review. Our ability to compete with telephone and cable television companies that are able to support broadband transmissions, and to provide better Internet services and products, may depend on future regulation to guarantee open access to the broadband networks. However, in January 1999, the Federal Communications Commission declined to take any action to mandate or otherwise regulate access by Internet service providers to broadband cable facilities at this time. It is unclear whether and to what extent local and state regulatory agencies will take any initiatives to implement this type of regulation, and whether they will be successful in establishing their authority to do so. Similarly, the Federal Communications Commission is considering proposals that could limit the right of Internet service providers to connect with their customers over broadband local telephone lines. In addition to competing directly in the Internet service provider market, both cable and television facilities operators are also aligning themselves with certain Internet service providers who would receive preferential or exclusive use of broadband local connections to end users. If high-speed, broadband facilities increasingly become the preferred mode by which customers access the Internet and we are unable to gain access to these facilities on reasonable terms, our business, financial condition and results of operations could be materially adversely affected. 9 Online Service Providers The dominant online service providers, including Microsoft Network, America Online, Incorporated and Prodigy, Inc., have all entered the Internet access business by engineering their current proprietary networks to include Internet access capabilities. We compete to a lesser extent with these service providers, which currently are primarily focused on the consumer marketplace and offer their own content, including chat rooms, news updates, searchable reference databases, special interest groups and shopping. However, America Online's merger with Time-Warner, its acquisition of Netscape Communications Corporation and related strategic alliance with Sun Microsystems enable it to offer a broader array of Internet -based services and products that could significantly enhance its ability to appeal to the business marketplace and, as a result, compete more directly with Internet service providers like us. CompuServe has also announced that it will target Internet connectivity for the small to medium sized business market. We believe that our ability to attract business customers and to market value-added services is a key to our future success. However, there can be no assurance that our competitors will not introduce comparable services or products at similar or more attractive prices in the future or that we will not be required to reduce our prices to match competition. Recently, many competitive ISPs have shifted their focus from individual customers to business customers. Moreover, there can be no assurance that more of our competitors will not shift their focus to attracting business customers, resulting in even more competition for us. There can be no assurance that we will be able to offset the effects of any such competition or resulting price reductions. Increased competition could result in erosion of our market share and could have a material adverse effect on our business, financial condition and results of operations. Government Regulations The following summary of regulatory developments and legislation is not complete. It does not describe all present and proposed federal, state, and local regulation and legislation affecting the Internet service provider and telecommunications industries. Existing federal and state regulations are currently subject to judicial proceedings, legislative hearings, and administrative proposals that could change, in varying degrees, the manner in which our businesses operate. We cannot predict the outcome of these proceedings or their impact upon the Internet service provider and telecommunications industries or upon our business. Both the provision of Internet access service and the provision of underlying telecommunications services are affected by federal, state, local and foreign regulation. The Federal Communications Commission or FCC exercises jurisdiction over all facilities of, and services offered by, telecommunications carriers to the extent that they involve the provision, origination or termination of jurisdictionally interstate or international communications. The state regulatory commissions retain jurisdiction over the same facilities and services to the extent they involve origination or termination of jurisdictionally intrastate communications. In addition, as a result of the passage of the Telecommunications Act, state and federal regulators share responsibility for implementing and enforcing the domestic pro-competitive policies of the Telecommunications Act. In particular, state regulatory commissions have substantial oversight over the provision of interconnection and non-discriminatory network access by ILECs. Municipal authorities generally have some jurisdiction over access to rights of way, franchises, zoning and other matters of local concern. Our Internet operations are not currently subject to direct regulation by the FCC or any other U.S. governmental agency, other than regulations applicable to businesses generally. However, the FCC continues to review its regulatory position on the usage of the basic network and communications facilities by Internet service providers. Although in an April 1998 Report, the FCC determined that Internet service providers should not be treated as telecommunications carriers and therefore should not be regulated, it is expected that future Internet service provider regulatory status will continue to be uncertain. Indeed, in that report, the FCC concluded that certain services offered over the Internet, such as phone-to-phone Internet telephony, may be functionally indistinguishable from traditional telecommunications service offerings, and their non-regulated status may have to be re-examined. Changes in the regulatory structure and environment affecting the Internet access market, including regulatory changes that directly or indirectly affect telecommunications costs or increase the likelihood of competition from RBOCs or other telecommunications companies, could have an adverse effect on our business. Although the FCC has decided not to allow local telephone companies to impose per-minute access charges on Internet service providers, and the reviewing court has upheld that decision, further regulatory and legislative consideration of this issue is likely. In addition, some telephone companies are seeking relief through state regulatory agencies. The imposition of access charges would affect our costs of serving dial-up customers and could have a material adverse effect on our business, financial condition and results of operations. 10 In addition to our Internet service provider operations, we have recently focused attention on acquiring telecommunications assets and facilities, which is a regulated activity. Fulltel, our wholly owned subsidiary, has received competitive local exchange carrier or CLEC certification in Oklahoma, and an important part of our growth strategy is obtaining CLEC certification in certain other states. The Telecommunications Act requires CLECs not to prohibit or unduly restrict resale of their services; to provide dialing parity, number portability, and nondiscriminatory access to telephone numbers, operator services, directory assistance, and directory listings; to afford access to poles, ducts, conduits, and rights-of-way; and to establish reciprocal compensation arrangements for the transport and termination of telecommunications traffic. In addition to federal regulation of CLECs, the states also impose regulatory obligations upon CLECs. While these obligations vary from state to state, most states require CLECs to file a tariff for their services and charges; require CLECs to charge just and reasonable rates for their services, and not to discriminate among similarly-situated customers; to file periodic reports and pay certain fees; and to comply with certain services standards and consumer protection laws. As a provider of domestic basic telecommunications services, particularly competitive local exchange services, we could become subject to further regulation by the FCC and/or another regulatory agency, including state and local entities. The Telecommunications Act has caused fundamental changes in the markets for local exchange services. In particular, the Telecommunications Act and the FCC rules issued pursuant to it mandate competition in local markets and require that ILECs interconnect with CLECs. Under the provisions of the Telecommunications Act, the FCC and state public utility commissions share jurisdiction over the implementation of local competition: the FCC was required to promulgate general rules and the state commissions were required to arbitrate and approve individual interconnection agreements. The courts have generally upheld the FCC in its promulgation of rules, including a January 25, 1999 U.S. Supreme Court ruling which determined that the FCC has jurisdiction to promulgate national rules in pricing for interconnection. An important issue for CLECs is the right to receive reciprocal compensation for the transport and termination of Internet traffic. We believe that, under the Telecommunications Act, CLECs are entitled to receive reciprocal compensation from ILECs. However, some ILECs have disputed payment of reciprocal compensation for Internet traffic, arguing that Internet service provider traffic is not local traffic. Most states have required ILECs to pay CLECs reciprocal compensation. However, in October 1998, the FCC determined that dedicated digital subscriber line service is an interstate service and properly tariffed at the interstate level. In February 1999, the FCC concluded that at least a substantial portion of dial-up Internet service provider traffic is jurisdictionally interstate. The FCC also concluded that its jurisdictional decision does not alter the exemption from access charges currently enjoyed by Internet service providers. The FCC established a proceeding to consider an appropriate compensation mechanism for interstate Internet traffic. Pending the adoption of that mechanism, the FCC saw no reason to interfere with existing interconnection agreements and reciprocal compensation arrangements. The FCC order has been appealed. In addition, there is a risk that state public utility commissions that have previously considered this issue and ordered the payment of reciprocal compensation by the ILECs to the CLECs may be asked by the ILECs to revisit their determinations, or may revisit their determinations on their own motion. To date, at least one ILEC has filed suit seeking a refund from a carrier of reciprocal compensation that the ILEC had paid to that carrier. There can be no assurance that any future court, state regulatory or FCC decision on this matter will favor our position. An unfavorable result may have an adverse impact on our potential future revenues as a CLEC. As we become a competitor in local exchange markets, we will become subject to state requirements regarding provision of intrastate services. This may include the filing of tariffs containing rates and conditions. As a new entrant, without market power, we expect to face a relatively flexible regulatory environment. Nevertheless, it is possible that some states could require us to obtain the approval of the public utilities commission for the issuance of debt or equity or other transactions which would result in a lien on our property used to provide intrastate services. Additional Factors to Consider This Report includes "forward looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Although we believe that our plans, intentions and expectations reflected in such forward looking statements are reasonable, we can give no assurance that such plans, intentions or expectations will be achieved. Important factors that could cause actual results to differ materially from our forward looking statements are set forth below and elsewhere in this Annual Report. All forward looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth below. Limited Operating History. We have a relatively limited operating history upon which an evaluation of our prospects can be made. Consequently, the likelihood of our success must be considered in view of all of the risks, expenses and delays inherent in the establishment and growth of a new business including, but not limited to, expenses, complications and delays which cannot be foreseen when a business is commenced, initiation of marketing activities, the uncertainty of market acceptance of new services, intense competition from larger more established competitors and other factors. Our ability to achieve profitability and growth will depend on successful development and commercialization of our current and proposed services. No assurance can be given that we will be able to introduce our proposed services or market our services on a commercially successful basis. 11 Necessity of Additional Financing. In order for us to have any opportunity for significant commercial success and profitability, we must successfully obtain additional financing, either through borrowings, additional private placements or an initial public offering, or some combination thereof. Although we are actively pursuing a variety of funding sources, there can be no assurance that we will be successful in such pursuit. Limited Marketing Experience. We have limited experience in developing and commercializing new services based on innovative technologies, and there is limited information available concerning the potential performance of our hardware or market acceptance of our proposed services. There can be no assurance that unanticipated expenses, problems or technical difficulties will not occur which would result in material delays in product commercialization or that our efforts will result in successful product commercialization. Uncertainty of Products/Services Development. Although considerable time and financial resources were expended in the development of our services and products, there can be absolutely no assurance that problems will not develop which would have a material adverse effect on us. We will be required to commit considerable time, effort and resources to finalize such development and adapt our products/services to satisfy specific requirements of potential customers. Continued system refinement, enhancement and development efforts are subject to all of the risks inherent in the development of new products/services and technologies, including unanticipated delays, expenses, technical problems or difficulties, as well as the possible insufficiency of funds to satisfactorily complete development, which could result in abandonment or substantial change in commercialization. There can be no assurance that development efforts will be successfully completed on a timely basis, or at all, that we will be able to successfully adapt our hardware and/or software to satisfy specific requirements of potential customers, or that unanticipated events will not occur which would result in increased costs or material delays in development or commercialization. In addition, technologies as complex as those planned to be incorporated into our products/services may contain errors which become apparent subsequent to commercial use. Remedying such errors could delay our plans and cause us to incur substantial additional costs. New Concept; Uncertainty of Market Acceptance and Commercialization Strategy. As is typical in the case of a new business concept, demand and market acceptance for a newly introduced product/service is subject to a high level of uncertainty. Achieving market acceptance for this new concept will require significant efforts and expenditures by us to create awareness and demand by consumers. Our marketing strategy and preliminary and future marketing plans may be unsuccessful and are subject to change as a result of a number of factors, including progress or delays in our marketing efforts, changes in market conditions (including the emergence of potentially significant related market segments for applications of our technology), the nature of possible license and distribution arrangements which may or may not become available to us in the future and economic, regulatory and competitive factors. There can be no assurance that our strategy will result in successful product commercialization or that our efforts will result in initial or continued market acceptance for our proposed products. Competition; Technological Obsolescence. The markets that we intend to enter are characterized by intense competition and an increasing number of potential new market entrants who have developed or are developing potentially competitive products and/or services. We will face competition from numerous sources, certain of which may have substantially greater financial, technical, marketing, distribution, personnel and other resources than us, permitting such companies to implement extensive marketing campaigns, both generally and in response to efforts by additional competitors to enter into new markets and market new products and services. In addition, the markets for our proposed products/services are characterized by rapidly changing technology and evolving industry standards that could result in product obsolescence or short product life cycles. Accordingly, our ability to compete will be dependent upon our ability to complete the development of our products and to introduce our products and/or services into the marketplace in a timely manner, to continually enhance and improve our software and to successfully develop and market new products. There can be no assurance that we will be able to compete successfully, that competitors will not develop technologies or products that render our products and/or services obsolete or less marketable or that we will be able to successfully enhance our products or develop new products and/or services. Risks Relating to the Internet. Businesses reliant on the Internet may be at risk due to inadequate development of the necessary infrastructure, such as reliable network backbones, or complementary services, such as high-speed modems and security procedures. The Internet has experienced, and is expected to continue to experience, significant growth in the number of users and amount of traffic. There can be no assurance that the Internet infrastructure will continue to be able to support the demands placed on it by sustained growth. In addition, there may be delays in the development and adoption of new standards and protocols, the inability to handle increased levels of Internet activity or due to increased government regulation. If the necessary Internet infrastructure or complementary services are not developed to effectively support growth that may occur, our business, results of operations and financial condition would be materially adversely affected. Potential Government Regulations. We are subject to state commission, Federal Communications Commission and court decisions as they relate to the interpretation and implementation of the Telecommunications Act, the interpretation of Competitive Local Exchange Carrier interconnection agreements in general and our interconnection agreements in particular. In some cases, we may become bound by the results of ongoing proceedings of these bodies or the legal outcomes of other contested 12 interconnection agreements that are similar to agreements to which we are a party. The results of any of these proceedings could have a material adverse effect on our business, prospects, financial condition and results of operations. Dependence on Key Personnel. Our success depends in large part upon the continued successful performance of our current executive officers and key employees, Messrs. Timothy J. Kilkenny, Roger P. Baresel and Jason Ayers, for our continued research, development, marketing and operation. Although we have employed, and will employ in the future, additional qualified employees as well as retaining consultants having significant experience, if Messrs. Kilkenny, Baresel or Ayers fail to perform any of their duties for any reason whatsoever, our ability to market, operate and support our products/services will be adversely affected. While we are located in areas where the available pool of people is substantial, there is also significant competition for qualified personnel. Limited Public Market. During February 2000, our common stock began trading on the NASD Electronic Bulletin Board under the symbol FULO. While our common stock continues to trade on the Electronic Bulletin Board, there can be no assurance that stockholders will be able to sell their shares should they desire to do so. Any market for the common stock that may develop, in all likelihood, will be a limited one, and if such a market does develop, the price may be volatile. No Payment of Dividends on Common Stock. We have not paid any dividends on our common stock. For the foreseeable future, we anticipate that all earnings, if any, which may be generated from our operations will be used to finance our growth and that cash dividends will not be paid to holders of the common stock. Penny Stock Regulation. Broker-dealer practices in connection with transactions in "penny stocks" are regulated by certain penny stock rules adopted by the SEC. Penny stocks generally are equity securities with a price of less than $5.00 (other than securities registered on certain national securities exchanges or quoted on the NASDAQ system). The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, and, if the broker dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market, and monthly account statements showing the market value of each penny stock held in the customer's account. In addition, broker-dealers who sell such securities to persons other than established customers and accredited investors (generally, those persons with assets in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together with their spouse), must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. Consequently, these requirements may have the effect of reducing the level of trading activity, if any, in the secondary market for a security that is or becomes subject to the penny stock rules. Our common stock is subject to the penny stock rules at the present time, and consequently our stockholders will find it more difficult to sell their shares. Customers In 2002 and 2001, we had one customer that represented 27% and 26%, respectively, of our gross revenues. In June 2000, pursuant to an agreement that ends on December 31,2005, we began providing co-location services to KMC Telecom V, Inc. ("KMC"), a facilities-based competitive local exchange carrier. Under the terms of this agreement, we receive $42,275 per month to provide co-location and support services for KMC's telecommunications equipment at our network operations center in Oklahoma City, Oklahoma. KMC moved into our network operations center and began making payments during the third quarter of 2000. Employees As of December 31, 2002, we had 19 employees employed in engineering, sales, marketing, customer support and related activities and general and administrative functions. None of our employees are represented by a labor union, and we consider our relations with our employees to be good. We also engage consultants from time to time with respect to various aspects of our business. ITEM 2. DESCRIPTION OF PROPERTY We maintain our executive office in approximately 13,000 square feet at 201 Robert S. Kerr Avenue, suite 210 in Oklahoma City, at an effective annual rental rate of $10.20 per square foot. These premises are occupied pursuant to a ten-year lease that expires December 31, 2009. We also lease space in a number of private facilities in which our equipment is housed. The monthly lease payments for such private facilities are approximately $1,300. 13 ITEM 3. LEGAL PROCEEDINGS We are not currently engaged in any material legal proceedings. We are, however, subject to state commission, FCC and court decisions as they relate to the interpretation and implementation of the Telecommunications Act, the interpretation of CLEC interconnection agreements in general and our interconnection agreements in particular. In some cases, we may be bound by the results of ongoing proceedings of these bodies or the legal outcomes of other contested interconnection agreements that are similar to agreements to which we are a party. The results of any of these proceedings could have a material adverse effect on our business, prospects, financial condition and results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this Report. 14 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock is traded in the over-the-counter market and is quoted on the NASD Electronic Bulletin Board under the symbol FULO. Prior to February 9, 2000, there was no public trading market for our common stock. The closing sale prices reflect inter-dealer prices without adjustment for retail markups, markdowns or commissions and may not reflect actual transactions. The following table sets forth the high and low closing sale prices of our common stock during the calendar quarters presented as reported by the NASD Electronic Bulletin Board.
Common Stock Closing Sale Prices ------------------- High Low ------ ----- 2002 -Calendar Quarter Ended: March 31 $ .06 $ .05 June 30 .10 .10 September 30 .06 .06 December 31 .05 .05 2001 -Calendar Quarter Ended: March 31 $ 1.03 $ .69 June 30 1.01 .60 September 30 .70 .43 December 31 .45 .11
Number of stockholders The number of beneficial holders of record of our common stock as of the close of business on March 25, 2003 was approximately 112. Dividend Policy To date, we have declared no cash dividends on our common stock, and do not expect to pay cash dividends in the near term. We intend to retain future earnings, if any, to provide funds for operations and the continued expansion of our business. Recent Sales of Unregistered Securities In February, March, June and September 2000, we obtained interim loans totaling $505,000 through the issuance of promissory notes bearing interest at 14% per annum to 14 accredited investors. This offering was pursuant to Rule 506 of Regulation D of the Securities Act. Net proceeds were approximately $478,500, after payment of placement fees and commissions totaling $26,500 and other offering expenses. The terms of the financing additionally provided for the issuance of five-year warrants exercisable for the purchase of 250,000 shares of our common stock at $0.01 per share and provided for certain registration rights. The promissory notes required monthly interest payments, matured in six months and were extendible for two 90-day periods upon issuance of additional warrants exercisable for the purchase of 250,000 shares at $0.01 per share for each extension. In August 2000, we extended the terms of ten of the interim loans for an additional 90 days and in connection therewith, issued warrants exercisable for the purchase of 137,500 shares of common stock. As of December 31, 2002, we had issued 287,500 shares of common stock pursuant to exercise of these warrant for proceeds of $2,875. In March 2000, we obtained interim loans totaling $500,000 through the issuance of promissory notes bearing interest at 14% per annum to two accredited investors. This offering was pursuant to Rule 506 of Regulation D of the Securities Act. Net proceeds were approximately $460,000, after payment of placement fees and commissions totaling $40,000 and other offering expenses. The terms of the financing additionally provided for the issuance of five-year warrants to purchase 100,000 shares of our common stock at $0.01 per share, and provided for certain registration rights. The promissory notes required quarterly interest payments, matured in six months and initially were extendible for two 90-day periods upon issuance of additional warrants exercisable for the purchase of 10,000 shares of common stock at $0.01 per share for each extension. In October 2000, the terms of the two interim loans were amended to provide that, in the event of a second 90-day extension, we would issue warrants 15 exercisable for the purchase of 160,000 shares of common stock. On March 8, 2000, the interim loan investors exercised their warrants and we issued 100,000 shares of our common stock for net proceeds of $1,000. In August 2000, we extended the terms of the two interim loans for an additional 90 days, and, in connection therewith, issued warrants exercisable for the purchase of 10,000 shares, and as of December 31, 2002, we had issued 5,000 shares of common stock pursuant to exercise for net proceeds of $50. In August 2000, we obtained a short-term loan of $100,000 from Timothy J. Kilkenny, Chairman of the Board and Chief Executive Officer bearing interest at 9% per annum. In connection with this loan, we issued to Mr. Kilkenny five-year warrants exercisable for the purchase of 50,000 shares of our common stock at $0.01 per share, and provided for certain registration rights. This offering was pursuant to Rule 506 of Regulation D of the Securities Act. This loan requires monthly interest payments, matures on the earlier of (i) the date that is within five days of receipt of funds by us of any offering raising gross proceeds to us of at least $1,000,000 or (ii) May 2, 2001. These warrants were exercised on April 2, 2001. On September 29, 2000, we began offering through a private placement a minimum of $700,000 and a maximum of $2.0 million in the form of three-year term convertible promissory notes bearing interest at 11% per annum (the "Notes"), which can be increased to $2.5 million at the election of the placement agent. The initial closing of $700,000 occurred on November 9, 2000. The second closing of $62,500 occurred on December 1, 2000. Net proceeds were approximately $667,500, after payment of placement fees and commissions totaling $95,000 and other offering expenses. Each of the Notes is convertible into our common stock at the election of the holder thereof, at a conversion rate of $1.00 per share of our common stock, subject to adjustment under certain circumstances. The Notes are accompanied by warrants exercisable for the purchase of the number of shares of our common stock equal to the number obtained by dividing 25% of the face amount of the Notes purchased by $1.00 and provide for certain registration rights. These warrants may be exercised at any time after the date of grant for five years at a price of $0.01 per share. Additionally, $1,005,000 of interim loans, as discussed above, was converted to the Notes on November 9, 2000. As of December 31, 2000, 267,500 shares of our common stock have been issued pursuant to warrant exercise for net proceeds of $2,675. Because we failed to timely file a registration statement covering the common stock underlying the Notes and the warrants the interest rate of the Notes increased to 12.5% per annum and at December 31, 2002, the conversion price was reduced to $.63 per share in accordance with the terms of the Notes. This offering was pursuant to Rule 506 of Regulation D of the Securities Act. On January 5, 2001, we obtained an interim loan for $250,000 from an unrelated third party. In connection with this loan, we issued warrants exercisable for the purchase of 125,000 shares of our common stock at $.01 per share. This loan bears interest at 10% per annum and requires payments equal to 50% of the net proceeds received from our private placement of convertible notes payable. On March 31, 2001, this loan was increased to $320,000 and the due date for the unpaid principal and interest was extended to July 31, 2001, which was subsequently extended to December 31, 2001. Through December 31, 2002, we had made payments of principal and interest aggregating $35,834 and the past due principal and accrued interest was $376,110 at December 31, 2002. These warrants were exercised on January 22, 2001. This offering was pursuant to Rule 506 of Regulation D of the Securities Act. Pursuant to two separate acquisitions of assets on February 28, 2001, we agreed to issue 30,000 shares of our common stock to Sonet Communications and issued 35,000 shares of our common stock to LawtonNet Communications. These offerings were pursuant to Rule 506 of Regulation D of the Securities Act. On May 31, 2001, we exchanged 2,064,528 shares of our common stock and warrants (exercisable for the purchase of 436,748 shares of common stock at $2.00 per share) for convertible notes in the principal amount of $1,746,988 (recorded at $1,283,893) plus accrued interest of $123,414. These warrants expire on May 31, 2006. At December 31, 2002, the remaining outstanding principal and interest of the convertible notes payable was $541,922. On April 23, 2001 we issued 1,500 shares of our common stock in exchange for professional services performed. This offering was pursuant to Rule 506 of Regulation D of the Securities Act. Pursuant to the acquisition of certain assets on June 15, 2001, we issued 135,000 shares of our common stock to IPDatacom. This offering was pursuant to Rule 506 of Regulation D of the Securities Act. On July 1, 2001 and October 1, 2001, we agreed to issue 3,853 and 11,815 shares of common stock, respectively, in payment of $15,668 accrued interest on a portion of our convertible debt. This offering was pursuant to Rule 506 of Regulation D of the Securities Act. Pursuant to the provisions of the private placement of our convertible notes payable, as of December 31, 2002, warrants to purchase an aggregate 506,575 shares of common stock have been exercised at an aggregate exercise price of $5,066. On January 1, 2002, we agreed to issue 11,815 shares of common stock in payment of $11,815 accrued interest on a portion of our convertible debt. This offering was pursuant to Rule 506 of Regulation D of the Securities Act. 16 During September 2002, we received $5,000 from the issuance of a five-year 8% convertible note payable. This note is convertible into our common stock at the election of the holder, at a conversion rate of $.15 per share, subject to adjustment under certain circumstances. This offering was pursuant to Rule 506 of Regulation D of the Securities Act. During December 2002, we agreed to issue 1,500 shares of common stock in settlement of a note payable. This offering was pursuant to Rule 506 of Regulation D of the Securities Act. With respect to each of the foregoing common stock and warrant sale transactions, we relied on Sections 4(2) and 3(b) of the Securities Act of 1933 and applicable registration exemptions of Rules 504 and 506 of Regulation D and applicable state securities laws. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION The following discussion should be read in conjunction with our Consolidated Financial Statements and notes thereto included in Part II, Item 7 of this Report. The results shown herein are not necessarily indicative of the results to be expected in any future periods. This discussion contains forward-looking statements based on current expectations that involve risks and uncertainties. Actual results and the timing of events could differ materially from the forward-looking statements as a result of a number of factors. For a discussion of the factors that could cause actual results to differ materially from the forward-looking statements, see "Item 1. Description of Business -- Additional Factors to Consider" and our other periodic reports and documents filed with the Securities and Exchange Commission. The following table sets forth certain statement of operations data as a percentage of revenues for the years ended December 31, 2002 and 2001:
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------------------- 2002 2001 ----------------------- ----------------------- AMOUNT PERCENT AMOUNT PERCENT ------------ ------- ------------ ------- Revenues: Access service revenues $ 1,421,699 58.6% $ 1,392,711 60.5% Co-location and other revenues 1,003,317 41.4 908,301 39.5 ------------ ------- ------------ ------- Total revenues 2,425,016 100.0 2,301,012 100.0 Cost of access service revenues 834,338 34.4 833,766 36.2 Cost of co-location and other revenues 98,371 4.1 112,876 4.9 Selling, general and administrative expenses 1,315,827 54.3 2,136,295 92.8 Loss (gain) on sale of assets (33,827) (1.4) 8,166 .4 Depreciation and amortization 660,870 27.2 855,973 37.2 Impairment expense -- -- 741,295 32.2 ------------ ------- ------------ ------- Total operating costs and expenses 2,875,579 118.6 4,688,371 203.7 ------------ ------- ------------ ------- Loss from operations (450,563) (18.6) (2,387,359) (103.7) Interest expense (372,417) (15.3) (558,998) (24.3) Debt conversion expense -- -- (370,308) (16.1) Other expense -- -- (8,165) (.4) ------------ ------- ------------ ------- Net loss $ (822,980) (33.9)% $ (3,324,830) (144.5)% ============ ======= ============ =======
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 Revenues Access service revenues increased $28,988 or 2.1% to $1,421,699 for the year ended December 31, 2002 from $1,392,711 for the year 2001. This increase was the result of the acquisition of two Internet service providers during 2001 resulting in a full year of revenue in 2002 compared to a partial year in 2001. Co-location and other revenues increased $95,016 or 10.5% to $1,003,317 for the year ended December 31, 2002 from $908,301 for the year 2001. This increase was primarily attributable to selling additional services to existing customers. 17 Operating Costs and Expenses Cost of access service revenues remained essentially unchanged at $834,338 for the year ended December 31, 2002 compared to $833,766 for the year 2001. Cost of co-location other revenues decreased $14,505 or 12.9% to $98,371 for the year ended December 31, 2002 from $112,876 for the year 2001, as a result of a reduction in certain non-recurring services that we provided to certain co-location customers. Selling, general and administrative expenses decreased $820,468 or 38.4% to $1,315,827 for the year ended December 31,2002 from $2,136,295 for the year 2001. This decrease was primarily due to decreases in professional fees and employee costs. Professional fees decreased $540,765 during the year ended December 31, 2002 compared to the year 2001 primarily due to non-recurring fees associated with the private placement offering of convertible notes payable in 2001. Professional fees include legal, accounting, investment banking and consulting fees. Approximately $3,937 and $408,338 of the $47,827 and $588,598 professional fees for the years ended December 31, 2002 and 2001, respectively, were attributable to noncash expenses relating to the fair value of common stock, options and warrants issued in payment of professional services. Employee costs decreased $224,317 for the year ended December 31, 2002 from the prior year primarily due to a decrease in the number of employees to 23 during the first quarter of 2002, 17 during the second quarter of 2002, 17 during the third quarter of 2002 and an increase to 19 during the fourth quarter of 2002 as compared to 28, 26, 23 and 18, respectively during the same periods of 2001. Advertising, rent and bad debt expense decreased $20,384, $23,940 and $26,736, respectively, for the year ended December 31, 2002 from the prior year. These decreases were offset primarily by an increase in insurance expense of $14,673 for the year ended December 31, 2002 over the prior year. Selling, general and administrative expenses as a percentage of total revenues decreased to 54.3% during 2002 from 92.8% during 2001. During the year ended December 31, 2002, we recorded a gain on sale of assets of $33,827. This gain was primarily attributable to the sale of customer bases in certain cities based upon our determination that it was no longer cost effective for us to provide access services. Depreciation and amortization expense decreased $195,103or 22.8% to $660,870 for the year ended December 31, 2002 from $855,973 for the prior year. In January 2002, upon initially applying SFAS 142 we reassessed useful lives of our acquired customer bases and we began amortizing these intangible assets over their estimated useful lives and in direct relation to any decreases in the acquired customer bases. Amortization expense for the years ended December 31, 2002 and 2001 relating to intangible assets was $448,579 and $706,249, respectively. During December 2001, due to a decline in customer base we assessed recoverability of intangible assets relating to the Harvest merger. The effect of this assessment for the year ended December 31, 2001 was to record impairment expense of $741,295. The impairment expense increased basic and diluted loss per share by $.13. Interest Expense Interest expense decreased $186,581 or 33.4% to $372,417 for the year ended December 31, 2002 from $558,998 for the year 2001. This decrease was primarily attributable to the elimination of $463,095 of the loan discount associated with our interim financing issued with warrants and the future amortization of this discount. The elimination of the loan discount occurred in May 2001 as a result of the exchange of our common stock and warrants for our interim financing debt in the recorded amount of $1,283,893 (face amount of $1,746,988). Debt Conversion Expense In the second quarter of 2001, we exchanged 2,064,528 shares of common stock and 436,748 common stock purchase warrants for convertible notes payable with a face value of $1,746,988 and a carrying value of $1,283,893 plus accrued interest of $123,414. This exchange was accounted for as an induced debt conversion and we recorded a debt conversion expense of $370,308. Liquidity and Capital Resources At December 31, 2002, we had a deficit working capital of $1,929,308, while at December 31, 2001 we had a deficit working capital of $1,521,090. We do not have a line of credit or credit facility to serve as an additional source of liquidity. Historically we have relied on shareholder loans as an additional source of funds. Cash provided by operations was $57,761 for the year ended December 31, 2002. This was an increase from cash used in operations of $12,889 during the prior year. As of December 31, 2002, we had $26,955 in cash and $2,114,969 in current liabilities, including $401,552 of deferred revenues that will not require settlement in cash. 18 Net cash provided by investing activities was $84,726 for the year ended December 31, 2002. The cash provided during 2002 was primarily related to the sale of excess equipment and the sale of customer bases in certain cities based upon our determination that it was no longer cost effective for us to provide access services. Cash used in investing activities was $307,790 for the year ended December 31, 2001. The cash used during 2001 was primarily related to leasehold improvements for our new office space and construction on our network operations center, which was completed during the first quarter 2001 and capital expenditures related to business acquisitions. Net cash used by financing activities consisting primarily of principal payments on notes payable and capital lease obligations was $172,107 for the year ended December 31, 2002. Net cash provided by financing activities was $364,104 for the year ended December 31, 2001. The cash provided in 2001 was due primarily to the issuance of interim notes payable and the sale of convertible promissory notes payable. The planned expansion of our business will require significant capital to fund capital expenditures, working capital needs, debt service and the cash flow deficits generated by operating losses. In June 2002, the Company issued a purchase order for the purchase and installation of a telephone switch that will enable the Company to broaden its product line. This switch was delivered in February 2003. A down payment of $14,950 was paid upon delivery of the switch and the supplier financed the remaining balance of $202,000 at 10% interest to be paid in 18 monthly payments beginning in March 2003. As additional consideration we issued the supplier a warrant exercisable for the purchase 50,000 shares of our common stock for $.01 per share on or before February 7, 2008. Our additional principal capital expenditure requirements will include: o mergers and acquisitions and o further development of operations support systems and other automated back office systems. As our cost of developing new networks and services, funding other strategic initiatives and operating our business will depend on a variety of factors (including, among other things, the number of subscribers and the service for which they subscribe, the nature and penetration of services that may be offered by us, regulatory changes, and actions taken by competitors in response to our strategic initiatives), it is almost certain that actual costs and revenues will materially vary from expected amounts and these variations are likely to increase our future capital requirements. Our cash balances as of March 28, 2003 will not be sufficient to fund our current business plan beyond a few months. As a consequence, we are currently focusing on revenue enhancement and cost cutting opportunities as well as working to sell non core assets and to extend vendor payment terms. We continue to seek additional convertible debt or equity financing as well as the placement of a credit facility to fund our liquidity needs. There is no assurance that we will be able to obtain additional capital on satisfactory terms or at all. In the event that we are unable to obtain additional capital or to obtain it on acceptable terms or in sufficient amounts, we will be required to delay the development of our network or take other actions. This could have a material adverse effect on our business, operating results and financial condition and our ability to achieve sufficient cash flow to service debt requirements. Our ability to fund the capital expenditures and other costs contemplated by our business plan and to make scheduled payments with respect to bank borrowings will depend upon, among other things, our ability to seek and obtain additional financing during 2003. Capital will be needed in order to implement our business plan, deploy our network, expand our operations and obtain and retain a significant number of customers in our target markets. Each of these factors is, to a large extent, subject to economic, financial, competitive, political, and regulatory and other factors, many of which are beyond our control. There is no assurance that we will be successful in developing and maintaining a level of cash flows from operations sufficient to permit payment of our outstanding indebtedness. If we are unable to generate sufficient cash flows from operations to service our indebtedness, we will be required to modify our growth plans, limit our capital expenditures, restructure or refinance our indebtedness or seek additional capital or liquidate our assets. There is no assurance that (i) any of these strategies could be effectuated on satisfactory terms, if at all, or on a timely basis or (ii) any of these strategies will yield sufficient proceeds to service our debt or otherwise adequately fund operations. Critical Accounting Policies and Estimates The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect certain reported amounts and disclosures. In applying our accounting principles, we must often make individual estimates and assumptions regarding expected outcomes or uncertainties. As you might expect, the actual results or outcomes are generally different than the estimated or assumed amounts. These differences are usually minor and are included in our consolidated financial statements as soon as they are known. Our 19 estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates. We periodically review the carrying value of our intangible assets when events and circumstances warrant such a review. One of the methods used for this review is performed using estimates of future cash flows. If the carrying value of our intangible assets is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the intangible assets exceeds its fair value. We believe that the estimates of future cash flows and fair value are reasonable. Changes in estimates of such cash flows and fair value, however, could affect the calculation and result in additional impairment charges in future periods. Certain Accounting Matters In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. Subsequently, the asset retirement cost should be allocated to expense using a systematic and rational method. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. We do not expect SFAS No. 143 to have a material effect on our financial position or results of operations. In June 2002, FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issues No. 94-3 Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The Statement is effective for exit or disposal activities initiated after December 31, 2002 with early application encouraged. We estimate that the new standard will not have a material effect on our financial statements. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS No. 123 (SFAS 148). This statement amends Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition and annual disclosure provisions of SFAS 148 will be effective for us in the first quarter of 2003. We estimate that the new standard will not have a material effect on our financial statements but are still in the evaluation process. In November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 requires certain guarantees to be recorded at fair value, which is different from current practice, which is generally to record a liability only when a loss is probable and reasonably estimable. Fin 45 also requires a guarantor to make significant new disclosures, even when the likelihood of making any payments under the guarantee is remote. The disclosure provisions of FIN 45 were effective immediately in 2002. We are required to adopt the recognition and measurement provisions of FIN 45 on a prospective basis with respect to guarantees issued or modified after December 31, 2002. We do not believe the adoption of the recognition and measurement provisions of FIN 45 will have a material effect on our consolidated financial statements. In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). Subject to certain criteria defined in the Interpretation, FIN 46 will require consolidation by business enterprises of variable interest entities if the enterprise has a variable interest that will absorb the majority of the entity's expected residual losses on returns if they occur, or both. The Interpretation will be effective for us in the third quarter of 2003. Management has not yet determined the effect, if any, of FIN 46, on our financial position or results of operations. Certain disclosures concerning variable interest entities are required in financial statements initially issued after January 31, 2003. We are evaluating the effect of FIN 46 on our financial statements. ITEM 7. FINANCIAL STATEMENTS Our financial statements, prepared in accordance with Regulation S-B, are set forth in this Report beginning on page F-1. 20 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On January 30, 2003, we engaged BUXTON & CLOUD, P.C. as our new independent accountants, commencing with the audit for the fiscal year ended December 31, 2002, and thereby dismissed Grant Thornton LLP. The decision to change independent accountants was approved by our Board of Directors. The reports of Grant Thornton LLP on our financial statements for the past two years ended December 31, 2001 and December 31, 2000 contained no adverse opinion or disclaimer of opinion and were not qualified or modified as to audit scope or accounting principle. The reports of Grant Thornton LLP on our financial statements for the past two years ended December 31,2001 and December 31, 2000 did however contain explanatory paragraphs describing an uncertainty about our ability to continue as a going concern. In connection with the audits for the fiscal years ended December 31, 2001 and December 31, 2000 and all interim periods preceding the dismissal, there have been no disagreements with Grant Thornton LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Grant Thornton LLP, would have caused them to make reference thereto in their report on the financial statements for such years. During the fiscal years ended December 31, 2001 and December 31, 2000 and all subsequent interim periods and to January 30, 2003, the date of dismissal, there have been no reportable events (as defined in Regulation S-B Item 304(a)(1)(v)). During the fiscal years ended December 31, 2001 and December 31, 2000 and to January 30, 2003, we did not consult with BUXTON & CLOUD, P.C. on any items concerning the application of accounting principles to a specified transaction, the type of audit opinion that might be rendered on our financial statements, or the subject matter of a disagreement or reportable event with the former auditor (as described in Regulation S-B Item 304(a)(2)). PART III. ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS, COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT The following information is furnished as of March 25, 2003 for each person who serves on our Board of Directors or serves as one of our executive officers. Our Board of Directors currently consists of two members, although we intend to increase the size of the Board in the future. The directors serve one-year terms until their successors are elected. Our executive officers are elected annually by our Board. The executive officers serve terms of one year or until their death, resignation or removal by our Board. There are no family relationships between our directors and executive officers. In addition, there was no arrangement or understanding between any executive officer and any other person pursuant to which any person was selected as an executive officer.
Name Age Position ---- --- -------- Timothy J. Kilkenny 44 Chairman of the Board of Directors, President and CEO Roger P. Baresel 47 Director, Chief Financial Officer and Secretary Jason C. Ayers 28 Vice President of Operations Patricia R. Shurley 46 Vice President of Finance
Timothy J. Kilkenny has served as our Chief Executive Officer, President and Chairman of the Board of Directors since our inception in May 1995. Prior to that time, he spent 14 years in the financial planning business as a manager for both MetLife and Prudential. Mr. Kilkenny is a graduate of Central Bible College in Springfield, Missouri. Roger P. Baresel became one of our directors and our Chief Financial Officer on November 9, 2000. Mr. Baresel is an accomplished senior executive and consultant who has served at a variety of companies. While serving as President and CFO of Advantage Marketing Systems, Inc., a publicly-held company engaged in the multi-level marketing of healthcare and dietary supplements, from June 1995 to May 2000, annual sales increased from $2.5 million to in excess of $22.4 million and annual earnings increased from $80,000 to more than $l.2 million. Also, during this period Advantage successfully completed two public offerings, four major acquisitions and its stock moved from the over the counter bulletin board to the American Stock Exchange. Mr. Baresel has the following degrees from Central State University in Edmond, Oklahoma: BA Psychology, BS Accounting and MBA Finance, in which he graduated Summa Cum Laude. Mr. Baresel is also a certified public accountant. Jason C. Ayers has been our Vice President of Operations since December 8, 2000 and prior to that served as President of Animus, a privately-held web hosting company. Mr. Ayers received a BS degree from Southern Nazarene University in Bethany, Oklahoma in May 1996 with a triple major in Computer Science, Math and Physics. Upon graduating, he was a co-founder of Animus. On April 1, 1998, we acquired Animus and Mr. Ayers assumed the role of President of our wholly owned subsidiary, renamed FullWeb. 21 Patricia R. Shurley has been our Vice President of Finance since May 2001. Prior to that she served for three years as the Controller for Advantage Marketing Systems, Inc., a publicly-held company engaged in the multi-level marketing of healthcare and dietary supplements. And prior to that she was self-employed and had an accounting practice. She graduated from the University of Central Oklahoma in Edmond, Oklahoma with a BS degree in Accounting and is a certified public accountant. Key Employees Michael D Tomas, 30, has been Information Systems Manager since June 1999 and our employee since July 1996. Mr. Tomas currently is completing his studies at the University of Oklahoma for a degree in Management Information Systems. Mr. Tomas has formal training with Cisco, Win 3.1, Win95/98, and Windows NT 4.0 as well as LAN/WAN setup, including experience with wireless networking and is Lucent certified. Audit Committee Financial Expert Because our board of directors only consists of two directors, each of whom does not qualify as an independent director, our board performs the functions of an audit committee. Our board of directors has determined that Roger P. Baresel, our Chief Financial Officer qualifies as a "financial expert." This determination was based upon Mr. Baresel's o understanding of generally accepted accounting principles and financial statements; o ability to assess the general application of generally accepted accounting principles in connection with the accounting for estimates, accruals and reserves; o experience preparing, auditing, analyzing or evaluating financial statements that present the breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by our financial statements, or experience actively supervising one or more persons engaged in such activities; o understanding of internal controls and procedures for financial reporting; and o understanding of audit committee functions. Mr. Baresel's experience and qualification as a financial expert were acquired through the active supervision of a principal financial officer, principal accounting officer, controller, public accountant, auditor or person performing similar functions and overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements. Mr. Baresel is not an independent director. We have been unable to attract a person to serve as one of our directors and that would qualify both as an independent director and as a financial expert because of inability to compensate our directors and provide liability insurance protection. Compliance with Section 16(a) of the Exchange Act, Beneficial Ownership Reporting Requirements Section 16(a) of the Securities and Exchange Act of 1934, as amended, requires our directors and executive officers and any persons who own more than 10% of a registered class of our equity securities to file with the Securities and Exchange Commission ("SEC") and each exchange on which our securities are listed, reports of ownership and subsequent changes in ownership of our common stock and our other securities. Officers, directors and greater than 10% stockholders are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file. Based solely on review of the copies of such reports furnished to us or written representations that no other reports were required, we believe that during 2002 all filing requirements applicable to our officers, directors and greater than 10% beneficial owners were met, except for the late filing of Form 4 for Jason C. Ayers and Patricia R. Shurley. Code of Ethics On March 25, 2003, our board of directors adopted our code of ethics that applies to all of our employees and directors, including our principal executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions. A copy of the portion of this code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions may be obtained by written request addressed to Mr. Roger P. Baresel, Corporate Secretary, Fullnet Communications, Inc., 201 Robert S. Kerr, Suite 210, Oklahoma City, Oklahoma 73102. 22 ITEM 10. EXECUTIVE COMPENSATION The following table sets forth, for the last three fiscal years, the cash compensation paid by us to our Chairman and Chief Executive Officer (the "Named Executive Officer"). None of our executive officers earned annual compensation in excess of $100,000 during fiscal 2002.
Long-Term Annual Compensation Compensation ----------------------------- ------------ Securities Underlying Options and Fiscal Other Warrants Name and Principal Position Year Salary Compensation (#)(1) - --------------------------- ------ ---------- ------------ ----------- Timothy J. Kilkenny 2002 $75,000(2) $ 12,614(3) 80,000 Chairman, President and CEO 2001 75,000(2) 7,748(4) 132,000 2000 75,000(2) 12,480(5) 100,000
(1) Options are granted with an exercise price equal to the fair market value of our common stock on the date of the grant. (2) Includes $25,000 of deferred compensation. (3) Represents $6,331 of expense reimbursement for business use of Mr. Kilkenny's automobile and $6,283 of insurance premiums paid by us for the benefit of Mr. Kilkenny. We also provide use of an automobile to Mr. Kilkenny, the value of which is not greater than $5,000 annually. (4) Represents $360 of expense reimbursement for business use of Mr. Kilkenny's automobile and $7,388 of insurance premiums paid by us for the benefit of Mr. Kilkenny. We also provide use of an automobile to Mr. Kilkenny, the value of which is not greater than $5,000 annually. (5) Represents $1,200 of expense reimbursement for business use of Mr. Kilkenny's automobile and $11,280 of insurance premiums paid by us for the benefit of Mr. Kilkenny. We also provide use of an automobile to Mr. Kilkenny, the value of which is not greater than $5,000 annually. Stock Options Granted We do not have a written stock option plan. However, the Board of Directors granted to our employees stock options exercisable for the purchase of 488,830 shares of our common stock during 2002. The following table shows stock options granted to Mr. Kilkenny during 2002.
Individual Grants ----------------------------------------------------------------------------- Number of % of Total Securities Options Granted Exercise or Underlying To Employees in Base price Expiration Name Options Granted Fiscal Year ($/sh) Date - ---- --------------- --------------- ----------- ---------- Timothy J. Kilkenny 80,000(1) 16.4%(2) $.05 03/18/12 Chairman, President and CEO
(1) Options were granted pursuant to an individual stock option agreement. These options are subject to a three year vesting schedule, subject to certain exceptions, with one-third became or will become exercisable on March 18 of each of 2002, 2003 and 2004. The options expire on March 18, 2012 and have an exercise price of $.05 per share, which was the fair value per share price of our common stock on the grant date. (2) All options granted during 2002 are nonqualified stock options. During 2002, an aggregate of 488,830 options were granted outside of a formal plan to employees. Options granted generally become exercisable in part after one year from the date of grant and generally have a term of ten years following the date of grant, unless sooner terminated in accordance with the terms of the stock option agreement. 2002 Year End Option Values The following table sets forth information related to the exercise of stock options during 2002 and the number and value of options held by the following Named Executive Officer at December 31, 2002. During 2002, the Named Executive Officer did not exercise any options, nor did we reprice any outstanding options. For the purposes of this table, the "value" of an option is the difference between the estimated fair market value at December 31, 2002 of the shares of common stock subject to the option and the aggregate exercise price of such option. 23
Number of Unexercised Value of Unexercised In-the- Options at Money Options at December 31, 2002 December 31, 2002(1) --------------------------------- --------------------------------- Name Exercisable Unexercisable Exercisable Unexercisable ---- ----------- ------------- ----------- ------------- Timothy J. Kilkenny 180,667 81,333 $ -- $ -- Chairman, President and CEO
(1) Based on the December 31, 2002 estimated fair value of our common stock of $.05 per share. Director Compensation During the fiscal year ended December 31, 2002, our directors did not receive any compensation for serving in such capacities. Employment Agreements and Lack of Keyman Insurance On July 31, 2002, we entered into employment agreements with Timothy J. Kilkenny and Roger P. Baresel. Each agreement is effective January 1, 2002, and has a term of two years; however, the term is automatically extended for additional one-year terms, unless we or the employee gives six-month advance notice of termination. These agreements provide, among other things, (i) an annual base salary of at least $75,000 for Mr. Kilkenny (of which he has voluntarily agreed to defer $25,000) and $65,000 for Mr. Baresel (of which he has voluntarily agreed to defer $15,000), (ii) bonuses at the discretion of the Board of Directors, (iii) entitlement to fringe benefits including medical and insurance benefits as may be provided to our other senior officers; and (iv) eligibility to participate in our incentive, bonus, benefit or similar plans. These agreements require the employee to devote the required time and attention to our business and affairs necessary to carry out his responsibilities and duties. These agreements may be terminated under certain circumstances and upon termination provide for (i) the employee to be released from personal liability for our debts and obligations, and (ii) the payment of any amounts we owe the employee. We do not maintain any keyman insurance covering the death or disability of our executive officers. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Security Ownership The following table sets forth information as of March 25, 2003, concerning the beneficial ownership of our Common Stock by each person (other than our directors and executive officers) who is known by us to own more than 5% of the outstanding shares of our Common Stock. The information is based on Schedules 13D or 13G filed by the applicable beneficial owner with the Securities and Exchange Commission or other information provided to us by the beneficial owner or our stock transfer agent.
Common Stock ------------------------------ Number of Percent of Beneficial Owner(1) Shares Class(1) - --------------------- --------- ---------- Generation Capital Associates(2) 695,007 9.9% Rupinder Sidu(3) 628,685 9.1% Alexander M. Eaton Trust(4) 610,851 9.1% Peter Rettman(5) 490,296 7.1% Laura L. Kilkenny(6) 465,000 7.0%
(1) Percent of class for any stockholder listed is calculated without regard to shares of common stock issuable to others upon exercise of outstanding stock options. Any shares a stockholder is deemed to own by having the right to acquire by exercise of an option or warrant are considered to be outstanding solely for the purpose of calculating that stockholder's ownership percentage. We computed the percentage ownership amounts in accordance with the provisions of Rule 13d-3(d), which includes as beneficially owned all shares of common stock which the person or group has the right to acquire within the next 60 days, based upon 6,663,135 outstanding shares of common stock as of March 25, 2003. (2) Generation Capital Associates' address is 333 Sandy Springs Circle, Suite 230 Atlanta, GA 30328. Generation Capital Associates holds 267,608 shares of our common stock. The number of shares includes 427,399 shares of our common stock that are subject to currently exercisable common stock purchase warrants. Amounts shown do not include 162,601 shares of our common stock that are subject to common stock purchase warrants that are not currently exercisable because they contain a provision prohibiting their exercise to the extent that they would increase Generation Capital Associates' percentage ownership beyond 9.9% of our outstanding shares of common stock. 24 (3) Rupinder Sidu's address is 10229 Tavistock Road, Orlando, FL 32827. Mr. Sidu holds 344,018 shares of our common stock. The number of shares includes 284,667 shares of our common stock that are subject to currently exercisable common stock purchase warrants. (4) The Alexander M. Eaton Trust's address is 4102 Evans Avenue, Fort Meyers, FL 33901. The Trust holds 503,018 shares of our common stock. The number of shares includes 107,833 shares of our common stock that are subject to currently exercisable common stock purchase warrants. (5) Peter Rettman's address is 1001 Fourth Avenue, Seattle, WA 98154. Mr. Rettman holds 163,078 shares of our common stock. The number of shares includes 206,250 shares of our common stock that are subject to currently exercisable common stock purchase warrants and 120,968 shares of our common stock that are subject to a currently convertible promissory note. (6) Laura L. Kilkenny's address is 12720 Southwest 58th Street, Mustang, OK 73064. Ms. Kilkenny is the ex-wife of Timothy J. Kilkenny, our Chairman of the Board and Chief Executive Officer. Ms. Kilkenny holds 415,000 shares of our common stock. The number of shares includes 50,000 shares of our common stock that are subject to currently exercisable common stock purchase options. The following table sets forth information as of March 25, 2003, concerning the beneficial ownership of our Common Stock by each of our directors, each executive officer named in the table under the heading "Item 9. Directors and Executive Officers, Promoters and Control Persons" and all of our directors and executive officers as a group. There are no family relationships amongst our executive officers and directors. Unless otherwise indicated, the beneficial owner has sole voting and investment power with respect to such stock.
Common Stock Beneficially Owned ----------------------- Number of Percent of Beneficial Owner(1) Shares Class(1) - ------------------- ---------- ---------- Timothy J. Kilkenny*(2)(3) 1,195,667 17.5% Roger P. Baresel*(2)(4) 281,184 4.2% Jason C. Ayers(2)(5) 112,529 1.7% Patricia R. Shurley(2)(6) 93,834 1.4% ---------- ---------- All executive officers and directors as a group (6 persons) 1,683,214 23.4%
* Director (1) Percent of class for any stockholder listed is calculated without regard to shares of common stock issuable to others upon exercise of outstanding stock options. Any shares a stockholder is deemed to own by having the right to acquire by exercise of an option or warrant are considered to be outstanding solely for the purpose of calculating that stockholder's ownership percentage. We computed the percentage ownership amounts in accordance with the provisions of Rule 13d-3(d), which includes as beneficially owned all shares of common stock which the person or group has the right to acquire within the next 60 days, based upon 6,663,135 shares being outstanding at March 25, 2003. (2) Address is c/o 201 Robert S. Kerr Avenue, Suite 210, Oklahoma City, Oklahoma 73102. (3) Timothy J. Kilkenny holds 1,015,000 shares of our common stock. The number of shares includes 180,667 shares of our common stock that are subject to currently exercisable stock options held by Mr. Kilkenny. Amounts shown do not include options, held by Mr. Kilkenny, to purchase 33,334 shares of our common stock exercisable at $1.00 per share beginning December 8, 2003, 21,333 shares of our common stock exercisable at $.11 per share beginning November 16, 2003, and 26,666 shares of our common stock exercisable at $.05 per share beginning March 18, 2004. (4) Roger P. Baresel and Judith A. Baresel, husband and wife, each hold 34,408 and 42,659 shares of our common stock, respectively. They hold 31,250 shares of our common stock as joint tenants. The number of shares includes 107,915 shares of our common stock subject to currently exercisable stock options held by Mr. Baresel, 52,452 shares of our common stock subject to currently exercisable stock options held by Mrs. Baresel, and 12,500 currently exercisable common stock purchase warrants held jointly. Amounts shown do not include options, held by Mr. Baresel, to purchase 15,830 shares of our common stock exercisable at $.11 per share beginning November 16, 2003, and options held by Mrs. Baresel, to purchase 40,000 shares of our common stock exercisable at $.05 per share beginning June 3, 2003. (5) Jason C. Ayers holds 25,865 shares of our common stock. The number of shares includes 86,664 shares of our common stock that are subject to currently exercisable common stock options held by Mr. Ayers. Amounts shown do not include options, held by Mr. Ayers, to purchase 9,000 shares exercisable at $.08 per share beginning June 4, 2003, 5,000 shares of our common stock exercisable at $.11 per share beginning November 16, 2003, 15,000 shares exercisable at $1.00 per share beginning December 8, 2003 and 6,666 shares exercisable at $.05 per share beginning March 18, 2004. (6) The number of shares includes 93,834 shares of our common stock that are subject to currently exercisable common stock purchase options held by Ms. Shurley. Amounts shown do not include options to purchase 5,000 shares of our common stock exercisable at $.11 per share beginning November 16, 2003, 6,666 shares exercisable at $.05 per share beginning March 18, 2004 and 25,000 shares exercisable at $1.00 per share beginning May 16, 2004. 25 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On August 2, 2000, we obtained a short-term loan of $100,000 from Timothy J. Kilkenny, our Chairman of the Board and Chief Executive Officer, through the issuance of a 14% promissory note. The terms of the financing additionally provided for the issuance of five-year warrants to purchase 50,000 shares of our common stock at $.01 per share, and provided for certain registration rights. The promissory note required monthly interest payments, matured on the earlier of (i) the date which is within five days of receipt of funds by us of any offering raising gross proceeds to us of at least $1,000,000 or (ii) in three months, and was extendible for two 90-day periods upon issuance of additional warrants exercisable for the purchase of 50,000 shares of our common stock for $.01 per share for each extension. In the fourth quarter of 2000, our founder and CEO agreed to reduce the interest rate on the promissory note to 9% and waive the warrant provisions relating to extensions of the loan. We repaid $50,000 on this note and the note was due in May 2001. In May 2001 Mr. Kilkenny agreed to a replacement note with an interest rate of 8.5% with monthly principal and interest payments and the note will become due in May 2006. In connection with his employment, during March 2002, we granted stock options exercisable for the purchase of 80,000 shares of our common stock to Timothy J. Kilkenny, our Chairman of the Board and Chief Executive Officer, which were one-third vested and exercisable immediately and will vest and become exercisable one-third on each annual anniversary of the issue. The options have an exercise price of $.05 per share and expire during March 2012. In April 2001, Timothy J. Kilkenny, our Chairman of the Board and Chief Executive Officer, exercised warrants for the purchase of 50,000 shares of our common stock for an aggregate purchase price of $500. In connection with his employment, during July 2001, we granted stock options exercisable for the purchase of 100,000 shares of our common stock to Timothy J. Kilkenny, our Chairman of the Board and Chief Executive Officer, which were fully vested and exercisable. The options have an exercise price of $.70 per share and expire during July 2011. In connection with his employment, during November 2001, we granted stock options exercisable for the purchase of 32,000 shares of our common stock to Timothy J. Kilkenny, our Chairman of the Board and Chief Executive Officer, which will vest and become exercisable one-third on each annual anniversary of the issue. The options have an exercise price of $.11 per share and expire during November 2011. In connection with the employment of Roger P. Baresel, during March 2002, we granted stock options exercisable for the purchase of 60,000 shares of our common stock to Mr. Baresel that were one-third vested and exercisable immediately and will vest and become exercisable one-third on each annual anniversary of the issue. These options have an exercise price of $.05 per share and expire during March 2012. During April 2001, Roger P. Baresel and his wife purchased $25,000 of the 11% convertible promissory notes and related warrants sold in our private placement. In addition, Mr. Baresel exercised 56,250 stock purchase warrants for the purchase of 56,250 shares of common stock at an aggregate exercise price of $563. During May 2001, Roger P. Baresel exchanged convertible notes in the principal amount of $50,000 plus interest for 57,617 shares of common stock and 12,500 warrants (exercisable for the purchase of 12,500 shares of common stock at $2.00 per share). These warrants expire May 31, 2006. During August 2001, Roger P. Baresel purchased 5,000 shares of our common stock at $.55 per share. In connection with the employment of Roger P. Baresel, during October 2001, we granted stock options for exercisable for the purchase of 137,452 shares of our common stock to Mr. Baresel that will vest and become exercisable on a quarterly basis over a one-year period. These options have an exercise price of $.50 per share and expire during October 2011. In connection with the employment of Roger P. Baresel, during November 2001, we granted stock options exercisable for the purchase of 23,745 shares of our common stock to Mr. Baresel that will vest and become exercisable one-third on each annual anniversary of the issue. The options have an exercise price of $.11 per share and expire during November 2011. In March 2001, the former shareholders of Harvest exchanged a note and the accrued interest thereon approximating $188,000 for a three-year convertible promissory note bearing interest at 11% and a five-year warrant exercisable for the purchase of 46,963 shares of our common stock for $.01 per share (the same instrument we offered in our private placement on September 29,2000). ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed as part of this Report: 26
Exhibit Number Exhibit ------- ------- 3.1 Certificate of Incorporation, as amended (filed as Exhibit 2.1 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference). # 3.2 Bylaws (filed as Exhibit 2.2 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference). # 4.1 Specimen Certificate of Registrant's Common Stock (filed as Exhibit 4.1 to the Company's Form 10-KSB for the fiscal year ended December 31, 1999, and incorporated herein by reference). # 4.2 Certificate of Correction to the Amended Certificate of Incorporation and the Ninth Section of the Certificate of Incorporation (filed as Exhibit 2.1 to Registrant's Registration Statement on form 10-SB, file number 000-27031 and incorporated by reference). # 4.3 Certificate of Correction to Articles II and V of Registrant's Bylaws (filed as Exhibit 2.1 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference). # 4.4 Form of Warrant Agreement for Interim Financing in the amount of $505,000 (filed as Exhibit 4.1 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.5 Form of Warrant Certificate for Florida Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.2 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.6 Form of Promissory Note for Florida Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.3 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.7 Form of Warrant Certificate for Georgia Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.4 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.8 Form of Promissory Note for Georgia Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.5 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.9 Form of Warrant Certificate for Illinois Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.6 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.10 Form of Promissory Note for Illinois Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.7 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.11 Form of Warrant Agreement for Interim Financing in the amount of $500,000 (filed as Exhibit 4.8 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.12 Form of Warrant Certificate for Interim Financing in the amount of $500,000 (filed as Exhibit 4.9 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.13 Form of Promissory Note for Interim Financing in the amount of $500,000 (filed as Exhibit 4.10 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). #
27 4.14 Form of Convertible Promissory Note for September 29, 2000, private placement (filed as Exhibit 4.13 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000 and incorporated herein by reference). # 4.15 Form of Warrant Agreement for September 29, 2000, private placement (filed as Exhibit 4.13 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000 and incorporated herein by reference). # 4.16 Form of 2001 Exchange Warrant Agreement (filed as Exhibit 4.16 to Registrant's Form 10-QSB for the quarter ended June 30, 2001 and incorporated herein by reference) # 4.17 Form of 2001 Exchange Warrant Certificate (filed as Exhibit 4.17 to Registrant's Form 10-QSB for the quarter ended June 30, 2001 and incorporated herein by reference) # 10.1 Financial Advisory Services Agreement between the Company and National Securities Corporation, dated September 17, 1999 (filed as Exhibit 10.1 to Registrant's Form 10-KSB for the fiscal year ended December 31, 1999, and incorporated herein by reference). # 10.2 Lease Agreement between the Company and BOK Plaza Associates, LLC, dated December 2, 1999 (filed as Exhibit 10.2 to Registrant's Form 10-KSB for the fiscal year ended December 31, 1999, and incorporated herein by reference). # 10.3 Interconnection agreement between Registrant and Southwestern Bell dated March 19, 1999 (filed as Exhibit 6.1 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference). # 10.4 Stock Purchase Agreement between the Company and Animus Communications, Inc. (filed as Exhibit 6.2 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference). # 10.5 Registrar Accreditation Agreement effective February 8, 2000, by and between Internet Corporation for Assigned Names and Numbers and FullWeb, Inc. d/b/a FullNic f/k/a Animus Communications, Inc. (filed as Exhibit 10.1 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 10.6 Master License Agreement For KMC Telecom V, Inc., dated June 20, 2000, by and between FullNet Communications, Inc. and KMC Telecom V, Inc. (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-QSB for the Quarter ended June 30, 2000 and incorporated herein by reference). # 10.7 Domain Registrar Project Completion Agreement, dated May 10, 2000, by and between FullNet Communications, Inc., FullWeb, Inc. d/b/a FullNic and Think Capital (filed as Exhibit 10.2 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended June 30, 2000 and incorporated herein by reference). # 10.8 Amendment to Financial Advisory Services Agreement between Registrant and National Securities Corporation, dated April 21, 2000 (filed as Exhibit 10.3 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended June 30, 2000 and incorporated herein by reference). # 10.9 Asset Purchase Agreement dated June 2, 2000, by and between FullNet of Nowata and FullNet Communications, Inc. (filed as Exhibit 99.1 to Registrant's Form 8-K filed on June 20, 2000 and incorporated herein by reference). # 10.10 Asset Purchase Agreement dated February 4, 2000, by and between FullNet of Bartlesville and FullNet Communications, Inc. (filed as Exhibit 2.1 to Registrant's Form 8-K filed on February 18, 2000 and incorporated herein by reference). # 10.11 Agreement and Plan of Merger Among FullNet Communications, Inc., FullNet, Inc. and Harvest Communications, Inc. dated February 29, 2000 (filed as Exhibit 2.1 to Registrant's Form 8-K filed on March 10, 2000 and incorporated herein by reference). # 10.12 Asset Purchase Agreement dated January 25, 2000, by and between FullNet of Tahlequah, and FullNet Communications, Inc. (filed as Exhibit 2.1 to Registrant's Form 8-K filed on February 9, 2000 and incorporated herein by reference). #
28 10.13 Promissory Note dated August 2, 2000, issued to Timothy J. Kilkenny (filed as Exhibit 10.13 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.14 Warrant Agreement dated August 2, 2000, issued to Timothy J. Kilkenny (filed as Exhibit 10.14 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.15 Warrant Certificate dated August 2, 2000 issued to Timothy J. Kilkenny (filed as Exhibit 10.15 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.16 Stock Option Agreement dated December 8, 2000, issued to Timothy J. Kilkenny (filed as Exhibit 10.16 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.17 Warrant Agreement dated November 9, 2000, issued to Roger P. Baresel (filed as Exhibit 10.17 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.18 Warrant Agreement dated December 29, 2000, issued to Roger P. Baresel (filed as Exhibit 10.18 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.19 Stock Option Agreement dated February 29, 2000, issued to Wallace L Walcher (filed as Exhibit 10.19 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.20 Stock Option Agreement dated February 17, 1999, issued to Timothy J. Kilkenny (filed as Exhibit 3.1 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference). # 10.21 Stock Option Agreement dated October 19, 1999, issued to Wesdon C. Peacock (filed as Exhibit 10.21 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.22 Stock Option Agreement dated April 14, 2000, issued to Jason C. Ayers (filed as Exhibit 10.22 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.23 Stock Option Agreement dated May 1, 2000, issued to B. Don Turner (filed as Exhibit 10.23 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.24 Form of Stock Option Agreement dated December 8, 2000, issued to Jason C. Ayers, Wesdon C. Peacock, B. Don Turner and Wallace L. Walcher (filed as Exhibit 10.24 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.25 Warrant Certificate Dated November 9, 2000, issued to Roger P. Baresel (filed as Exhibit 10.25 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.26 Warrant Certificate Dated November 9, 2000, issued to Roger P. Baresel (filed as Exhibit 10.26 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.27 Warrant Certificate Dated December 29, 2000, issued to Roger P. Baresel (filed as Exhibit 10.27 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.28 Stock Option Agreement dated October 13, 2000, issued to Roger P. Baresel (filed as Exhibit 10.28 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.29 Stock Option Agreement dated October 12, 1999, issued to Travis Lane (filed as Exhibit 10.29 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.30 Promissory Note dated January 5, 2001, issued to Generation Capital Associates (filed as Exhibit 10.30 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.31 Placement Agency Agreement dated November 8, 2000 between FullNet Communications, Inc. and National Securities Corporation (filed as Exhibit 10.31 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.32 Promissory Note dated January 25, 2000, issued to Fullnet of Tahlequah, Inc. #
29 10.33 Promissory Note dated February 7, 2000, issued to David Looper # 10.34 Promissory Note dated February 29, 2000, issued to Wallace L. Walcher # 10.35 Promissory Note dated June 2, 2000, issued to Lary Smith # 10.36 Promissory Note dated June 15, 2001, issued to higganbotham.com L.L.C. # 10.37 Promissory Note dated November 19, 2001, issued to Northeast Rural Services # 10.38 Promissory Note dated November 19, 2001, issued to Northeast Rural Services # 10.39 Form of Convertible Promissory Note dated September 6, 2002 # 10.40 Employment Agreement with Timothy J. Kilkenny dated July 31, 2002 * 10.41 Employment Agreement with Roger P. Baresel dated July 31, 2002 * 10.42 Letter from Grant Thornton LLP to the Securities and Exchange Commission dated January 30, 2003 # 22.1 Subsidiaries of the Registrant # 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Timothy J. Kilkenny * 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Roger P. Baresel *
- ---------- # Incorporated by reference. * Filed herewith. (b) Reports on Form 8-K Form 8-K dated January 30, 2003 reporting change in certifying accountant to Buxton & Cloud, P.C. commencing with the audit for the fiscal year ended December 31, 2002. ITEM 14. CONTROLS AND PROCEDURES Our Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining disclosure controls and procedures and have designed these controls and procedures to ensure that material information, financial or otherwise, relating to us and our consolidated subsidiaries are made known to them in their capacity as executive officers, particularly during the period that this Report was prepared. These executive officers have evaluated the effectiveness of our disclosure controls and procedures within the preceding 90 days of this Report, having concluded that our disclosure controls and procedures were fully effective as of the date of this report and have reported this conclusion to our auditors and board of directors. There have been significant changes in internal controls and in other factors that could significantly affect our internal controls subsequent to the date of their evaluation. 30 SIGNATURES Pursuant to the requirements of the Exchange Act, the Registrant caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. REGISTRANT: FULLNET COMMUNICATIONS, INC. Date: March 28, 2003 By: /s/ TIMOTHY J. KILKENNY ----------------------- Timothy J. Kilkenny President and Chief Executive Officer Date: March 28, 2003 By: /s/ ROGER P. BARESEL -------------------- Roger P. Baresel Chief Financial and Accounting Officer Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 28, 2003 By: /s/ TIMOTHY J. KILKENNY ----------------------- Timothy J. Kilkenny, Chairman of the Board and Director Date: March 28, 2003 By: /s/ ROGER P. BARESEL -------------------- Roger P. Baresel, Director 31 CERTIFICATIONS I, Timothy J. Kilkenny, President and Chief Executive Officer, certify that: 1. I have reviewed this annual report on Form 10-KSB of FullNet Communications, Inc. (the "registrant"); 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the year covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the years presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the year in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. FULLNET COMMUNICATIONS, INC. Date: March 28, 2003 By: /s/ TIMOTHY J. KILKENNY ----------------------- Timothy J. Kilkenny President and Chief Executive Officer 32 I, Roger P. Baresel, Chief Financial and Accounting Officer, certify that: 1. I have reviewed this annual report on Form 10-KSB of FullNet Communications, Inc. (the "registrant"); 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the year covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the years presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the year in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. FULLNET COMMUNICATIONS, INC. Date: March 28, 2003 By: /s/ ROGER P. BARESEL -------------------- Roger P. Baresel Chief Financial and Accounting Officer 33 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors FullNet Communications, Inc. We have audited the accompanying consolidated balance sheet of FullNet Communications, Inc. (an Oklahoma corporation) and Subsidiaries, as of December 31, 2002 and the related consolidated statements of operations, stockholders' (deficit) equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above presents fairly, in all material respects, the financial position of FullNet Communications, Inc. and Subsidiaries, as of December 31, 2002 and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying 2002 financial statements have been prepared assuming that the Company will continue as a going concern. As shown in the financial statements, the Company incurred a net loss of $822,980 for the year ended December 31, 2002 and, as of that date, the Company's current liabilities exceeded its current assets by $1,929,308. These factors, among others, as discussed in Note A to the financial statements, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note A. The 2002 financial statements do not include any adjustments that might result from the outcome of this uncertainty. BUXTON & CLOUD, P.C. Oklahoma City, Oklahoma March 14, 2003 F-1 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors FullNet Communications, Inc. We have audited the accompanying consolidated balance sheet of FullNet Communications, Inc. (an Oklahoma corporation) and Subsidiaries, as of December 31, 2001, and the related consolidated statements of operations, stockholders' (deficit) equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FullNet Communications, Inc. and Subsidiaries, as of December 31, 2001, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying 2001 financial statements have been prepared assuming that the Company will continue as a going concern. As shown in the financial statements, the Company incurred a net loss of $3,324,830 for the year ended December 31, 2001 and, as of that date, the Company's current liabilities exceeded its current assets by $1,521,090. These factors, among others, as discussed in Note A to the financial statements, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note A. The 2001 financial statements do not include any adjustments that might result from the outcome of this uncertainty. GRANT THORNTON LLP Oklahoma City, Oklahoma February 9, 2002 F-2 FULLNET COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31,
ASSETS 2002 2001 ------------ ------------ CURRENT ASSETS Cash $ 26,955 $ 56,575 Accounts receivable, net 122,569 189,369 Prepaid expenses and other current assets 36,137 90,286 ------------ ------------ Total current assets 185,661 336,230 PROPERTY AND EQUIPMENT, net 978,249 1,152,565 INTANGIBLE ASSETS, net 506,273 954,852 OTHER ASSETS 28,323 42,875 ------------ ------------ TOTAL $ 1,698,506 $ 2,486,522 ============ ============ LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES Accounts payable - trade $ 413,037 $ 518,306 Accrued and other current liabilities 382,677 265,613 Notes payable, current portion 865,057 549,219 Capital lease obligations, current portion 52,646 55,537 Deferred revenue 401,552 468,645 ------------ ------------ Total current liabilities 2,114,969 1,857,320 NOTES PAYABLE, less current portion 435,386 866,366 CAPITAL LEASE OBLIGATIONS, less current portion 47,949 30,693 OTHER 142,808 126,786 STOCKHOLDERS' DEFICIT Commonstock - $.00001 par value; authorized, 10,000,000 shares; issued and outstanding, 6,592,878 shares in 2002 and 2001 66 66 Common stock issuable, 70,257 shares in 2002 and 56,942 shares in 2001 57,596 45,781 Additional paid-in capital 8,127,293 7,964,091 Accumulated deficit (9,227,561) (8,404,581) ------------ ------------ Total stockholders' deficit (1,042,606) (394,643) ------------ ------------ TOTAL $ 1,698,506 $ 2,486,522 ============ ============
See accompanying notes to financial statements. F-3 FULLNET COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Year ended December 31,
2002 2001 ------------ ------------ REVENUES Access service revenues $ 1,421,699 $ 1,392,711 Co-location and other revenues 1,003,317 908,301 ------------ ------------ Total revenues 2,425,016 2,301,012 OPERATING COSTS AND EXPENSES Cost of access service revenues 834,338 833,766 Cost of co-location and other revenues 98,371 112,876 Selling, general and administrative expenses 1,315,827 2,136,295 Loss (gain) on sale of assets (33,827) 8,166 Depreciation and amortization 660,870 855,973 Impairment expense -- 741,295 ------------ ------------ Total operating costs and expenses 2,875,579 4,688,371 ------------ ------------ LOSS FROM OPERATIONS (450,563) (2,387,359) INTEREST EXPENSE (372,417) (558,998) DEBT CONVERSION EXPENSE -- (370,308) OTHER EXPENSE -- (8,165) ------------ ------------ NET LOSS $ (822,980) $ (3,324,830) ============ ============ Net loss per common share Basic and diluted $ (.12) $ (.59) ============ ============ Weighted average number of common shares outstanding Basic and diluted 6,661,205 5,680,424 ============ ============
See accompanying notes to financial statements. F-4 FULLNET COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' (DEFICIT) EQUITY Years ended December 31, 2002 and 2001
Common stock Common Additional --------------------- stock paid-in Accumulated Shares Amount issuable capital deficit Total ---------- -------- -------- ---------- ----------- ----------- Balance at January 1, 2001 3,942,775 39 -- 5,250,026 (5,079,751) 170,314 Issuance of common stock in conjunction with Acquisitions 170,000 2 30,000 129,498 -- 159,500 Warrant exercise 414,075 4 113 4,137 -- 4,254 Intrinsic value of beneficial conversion feature on debt -- -- -- 363,386 -- 363,386 Warrants issued related to financing -- -- -- 188,336 -- 188,336 Common stock and warrants issued in exchange for services 1,500 -- -- 396,538 -- 396,538 Common stock issuable in payment of accrued interest -- -- 15,668 -- -- 15,668 Conversion of debt to equity 2,064,528 21 -- 1,632,170 -- 1,632,191 Net loss -- -- -- -- (3,324,830) (3,324,830) ---------- -------- -------- ---------- ----------- ----------- Balance at December 31, 2001 6,592,878 $ 66 $ 45,781 $7,964,091 $(8,404,581) $ (394,643) ========== ======== ======== ========== =========== =========== Intrinsic value of beneficial conversion feature on debt -- -- -- 157,564 -- 157,564 Common stock issuable in exchange for debt -- -- -- 105 -- 105 Common stock issuable in payment of accrued interest -- -- 11,815 -- -- 11,815 Options and warrants issued in exchange for compensation and services -- -- -- 5,533 -- 5,533 Net loss -- -- -- -- (822,980) (822,980) ---------- -------- -------- ---------- ----------- ----------- Balance at December 31, 2002 6,592,878 $ 66 $ 57,596 $8,127,293 $(9,227,561) $(1,042,606) ========== ======== ======== ========== =========== ===========
See accompanying notes to financial statements. F-5 FULLNET COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended December 31,
2002 2001 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (822,980) $ (3,324,830) Adjustments to reconcile net loss to net cash provided by (used in) operating activities Depreciation and amortization 660,870 855,973 Stock issued for services -- 1,125 Options and warrants issued for compensation and services 5,533 385,720 Amortization of discount and costs relating to financing 178,568 261,170 Debt conversion expense -- 370,308 Impairment expense -- 741,295 Accrued interest converted to equity 11,815 172,851 Loss (gain) on sale of assets (33,827) 8,166 Provision for uncollectible accounts receivable (812) (19,130) Net (increase) decrease in Accounts receivable 67,612 (28,527) Prepaid expenses and other current assets 51,839 (55,071) Other assets (2,645) 25,828 Net increase (decrease) in Accounts payable - trade (105,269) 82,498 Accrued and other liabilities 128,690 194,588 Deposits (14,540) 25,000 Deferred revenue (67,093) 290,147 ------------ ------------ Net cash provided by (used in) operating activities 57,761 (12,889) CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment (8,288) (244,709) Proceeds from sale of assets, net of closing costs 93,014 4,944 Acquisitions of businesses, net of cash acquired -- (68,025) ------------ ------------ Net cash provided by (used in) investing activities 84,726 (307,790) CASH FLOWS FROM FINANCING ACTIVITIES Principal payments on borrowings under notes payable (94,579) (133,739) Principal payments on note payable to related party (8,888) (4,684) Principal payments on capital lease obligations (73,640) (39,501) Proceeds from issuance of interim financing and warrants, net of offering costs -- 350,000 Proceeds from exercise of warrants -- 4,254 Proceeds from issuance of notes payable -- 54,235 Proceeds from issuance of convertible notes payable 5,000 162,500 Convertible debt issue costs -- (28,961) ------------ ------------ Net cash (used in) provided by financing activities (172,107) 364,104 ------------ ------------ NET (DECREASE) INCREASE IN CASH (29,620) 43,425 Cash at beginning of year 56,575 13,150 ------------ ------------ Cash at end of year $ 26,955 $ 56,575 ============ ============
(continued) F-6 FULLNET COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED Year ended December 31,
2002 2001 ------------ ------------ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid for interest $ 67,574 $ 102,814 NONCASH INVESTING AND FINANCING ACTIVITIES Conversion of notes payable to equity -- 1,138,468 Assets acquired through issuance of capital lease 88,005 81,491 LawtonNet Asset Purchase Fair value of common stock issued $ -- $ 35,000 Fair value of intangible assets -- (65,000) ------------ ------------ Cash paid to purchase LawtonNet assets $ -- $ (30,000) ============ ============ Sonet Asset Purchase Fair value of assets acquired $ (23,978) Fair value of common stock issuable -- 30,000 Fair value of intangible assets -- (42,547) ------------ ------------ Cash paid to purchase Sonet assets $ -- $ (36,525) ============ ============ IPDatacom Asset Purchase Fair value of net assets acquired $ -- $ (11,650) Fair value of common stock issued -- 94,500 Fair value of intangible assets -- (142,850) Note payable issued -- 58,500 ------------ ------------ Cash paid to purchase IPDatacom assets $ -- $ (1,500) ============ ============
(concluded) See accompanying notes to financial statements. F-7 FULLNET COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002 and 2001 NOTE A - ORGANIZATION AND NATURE OF OPERATIONS FullNet Communications, Inc. and Subsidiaries (the Company) is an integrated communications provider (ICP) offering communications, connectivity and data storage to individuals, businesses, organizations and educational institutions, as well as governmental agencies. Through its subsidiaries, FullNet, Inc., FullTel, Inc. and FullWeb, Inc., the Company provides Internet solutions designed to meet customer needs. Services offered include: o Dial-up and direct high-speed connectivity to the Internet through the FullNet brand name; o Backbone services to private label Internet services providers (ISPs) and businesses; o Carrier-neutral telecommunications premise co-location; and o Web page hosting and server co-location. The Company operates and grants credit, on an uncollateralized basis, to customers in Oklahoma and surrounding states. Concentrations of credit risk with respect to accounts receivable are limited due to the large number of customers comprising the Company's customer base and their dispersion across different industries. However, the Company has one primary customer for its carrier-neutral telecommunications premise co-location services. The accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of the Company as a going concern. However, the Company has sustained substantial net losses in 2002 and 2001. In addition, at December 31, 2002 current liabilities exceed current assets by $1,929,308. In view of the matters described in the preceding paragraph, the ability of the Company to continue as a going concern is dependent upon continued operations of the Company that in turn is dependent upon the Company's ability to meet its financing requirements on a continuing basis, to maintain present financing, to achieve the objectives of its business plan and to succeed in its future operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence. The Company's business plan includes, among other things, expansion of its Internet access services through mergers and acquisitions and the development of its web hosting and co-location services. Execution of the Company's business plan will require significant capital to fund capital expenditures, working capital needs, debt service and the cash flow deficits generated by operating losses. Current cash balances will not be sufficient to fund the Company's current business plan beyond the next few months. As a consequence, the Company is currently seeking additional convertible debt and/or equity financing as well as the placement of a credit facility to fund the Company's liquidity. There can be no assurance that the Company will be able to raise additional capital on satisfactory terms or at all. NOTE B - SUMMARY OF ACCOUNTING POLICIES A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows. F-8 1. Consolidation The consolidated financial statements include the accounts of FullNet Communications, Inc. and its wholly owned subsidiaries. All material intercompany accounts and transactions have been eliminated. 2. Revenue Recognition Access service revenues are recognized on a monthly basis over the life of each contract as services are provided. Contract periods range from monthly to yearly. Deferred revenues are calculated for those contracts that require prepayment and continue subsequent to the current year-end. Carrier-neutral telecommunications co-location revenues are recognized on a monthly basis over the life of the contract as services are provided. 3. Accounts Receivable Accounts receivable consist of the following as of December 31:
2002 2001 ---------- ---------- Accounts receivable $ 131,630 $ 199,240 Less allowance for doubtful accounts (9,069) (9,871) ---------- ---------- $ 122,569 $ 189,369 ========== ==========
4. Property and Equipment Property and equipment are stated at cost. Depreciation is computed primarily using the straight-line method over the estimated useful lives of the related assets as follows: Software 3 years Computers and equipment 5 years Furniture and fixtures 7 years Leasehold improvements Shorter of estimated life of improvement or the lease term
5. Intangible Assets Intangible assets consist primarily of acquired customer bases and covenants not to compete and are carried net of accumulated amortization. Upon initial application of SFAS 142 as of January 1, 2002, the Company reassessed useful lives and began amortizing these intangible assets over their estimated useful lives and in direct relation to any decreases in the acquired customer bases to which they relate. Management believes that such amortization reflects the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up. 6. Long-Lived Assets The Company follows the provisions of Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-lived Assets in determining impairment losses on long-term assets. All long-lived assets held and used by the Company, including intangible assets, are reviewed to determine whether any events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The Company bases its evaluation on such impairment indicators as the nature of the assets, the future economic benefit of the assets, any historical or future profitability measurements, as well as other external market conditions or factors that may be present. If such impairment indicators are present or other factors exist that indicate that the carrying amount of the asset may not be recoverable the Company determines whether an impairment has occurred through the use of an F-9 undiscounted cash flows analysis of the asset. If an impairment has occurred, the Company recognizes a loss for the difference between the carrying amount and the estimated value of the asset. 7. Income Taxes The Company follows the liability method of accounting for income taxes. Under the liability method, deferred income taxes are provided on temporary differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements and carryforwards that will result in taxable or deductible amounts in future years. Deferred income tax assets or liabilities are determined by applying the presently enacted tax rates and laws. Additionally, the Company provides a valuation allowance on deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. 8. Loss Per Common Share Loss per common share is calculated based on the weighted average number of shares outstanding during the year, including common shares issuable without additional consideration. Basic and diluted loss per share were the same for the years ended December 31, 2002 and 2001 because the following were not dilutive:
2002 2001 ---------- ---------- Common shares attributable to convertible notes payable 810,535 654,662 Employee common stock options 1,589,252 1,437,196 Other common stock options and warrants 2,151,681 2,099,681 ---------- ---------- 4,551,468 4,191,539 ========== ==========
9. Stock Options and Warrants The Company's employee stock options are accounted for under APB Opinion No. 25 and related interpretations. Had compensation cost for the Company's stock options been determined based on the fair value at the grant dates consistent with the method of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, the Company's net loss and loss per share in 2002 and 2001 would have been increased to the pro forma amounts indicated below:
2002 2001 ------------ ------------ Net loss As reported $ (822,980) $ (3,324,830) Pro forma $ (1,074,967) $ (4,006,240) Basic and diluted loss per share As reported $ (.12) $ (.59) Pro forma $ (.16) $ (.71)
The fair value of each option grant prior to February 2000 was estimated on the date of grant using the minimum value method because there was no public trading market for the Company's securities. During February 2000, the Company's common stock began trading on the NASD Electronic Bulletin Board under the symbol FULO. The fair value of the options granted subsequent to February 2000 have been estimated at the date of grant using the Black-Scholes option pricing model. The following weighted average assumptions were used: F-10
2002 2001 ------ ------ Risk free interest rate 5.1% 5.3% Expected lives (in years) 5 5 Expected volatility 143.2% 134% Dividend yield 0% 0%
For warrants issued with debt, a portion of the proceeds received is allocated to the warrants based on the relative fair values of the warrants, determined using the Black-Scholes valuation model, and the debt. The resulting discount on the debt is amortized to interest expense over the life of the debt. Other issuances of stock options and warrants are valued using the Black-Scholes valuation model and accounted for based on the consideration received. 10. Advertising The Company expenses advertising production costs as they are incurred and advertising communication costs the first time the advertising takes place. Advertising expense for the years ended December 31, 2002 and 2001 was $9,224 and $29,608, respectively. 11. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures; accordingly, actual results could differ from those estimates. 12. Recently Issued Accounting Standards In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. Subsequently, the asset retirement cost should be allocated to expense using a systematic and rational method. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The Company does not expect SFAS No. 143 to have a material effect on its financial position or results of operations. In June 2002, FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issues No. 94-3 Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The Statement is effective for exit or disposal activities initiated after December 31, 2002 with early application encouraged. The Company estimates that the new standard will not have a material effect on its financial statements. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS No. 123 (SFAS 148). This statement amends Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition and annual disclosure provisions of SFAS 148 will be effective for the Company in the first quarter of 2003. The Company estimates that the new standard will not have a material effect on its financial statements but is still in the evaluation process. F-11 In November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 requires certain guarantees to be recorded at fair value, which is different from current practice, which is generally to record a liability only when a loss is probable and reasonably estimable. Fin 45 also requires a guarantor to make significant new disclosures, even when the likelihood of making any payments under the guarantee is remote. The disclosure provisions of FIN 45 were effective immediately in 2002. The Company is required to adopt the recognition and measurement provisions of FIN 45 on a prospective basis with respect to guarantees issued or modified after December 31, 2002. The Company does not believe the adoption of the recognition and measurement provisions of FIN 45 will have a material effect on its consolidated financial statements. In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). Subject to certain criteria defined in the Interpretation, FIN 46 will require consolidation by business enterprises of variable interest entities if the enterprise has a variable interest that will absorb the majority of the entity's expected residual losses on returns if they occur, or both. The Interpretation will be effective for the Company in the third quarter of 2003. Management has not yet determined the effect, if any, of FIN 46, on the Company's financial position or results of operations. Certain disclosures concerning variable interest entities are required in financial statements initially issued after January 31, 2003. The Company estimates that FIN 46 will have no material effect on its financial statements. 13. Reclassifications Certain reclassifications have been made to the 2001 financial statements to conform to the 2002 presentation. NOTE C - PROPERTY AND EQUIPMENT Property and equipment consist of the following at December 31:
2002 2001 ------------ ------------ Computers and equipment $ 752,584 $ 752,966 Leasehold improvements 921,827 921,827 Software 50,187 75,427 Furniture and fixtures 19,153 17,506 ------------ ------------ 1,743,751 1,767,726 Less accumulated depreciation (765,502) (615,161) ------------ ------------ $ 978,249 $ 1,152,565 ============ ============
Depreciation expense for the years ended December 31, 2002 and 2001 was $212,291 and $149,724, respectively. NOTE D - INTANGIBLE ASSETS Intangible assets consist primarily of acquired customer bases and covenants not to compete and relate to the 2001 purchases of certain business operations in Lawton, Oklahoma (the LawtonNet Communications (LAWTONNET) acquisition), Lawton, Oklahoma (the SONET Communications (SONET) acquisition) and Oklahoma City, Oklahoma (the IPDatacom acquisition), the 2000 purchases of certain business operations in Tahlequah, Oklahoma (the FullNet of Tahlequah, Inc. (FOT) acquisition), Bartlesville, Oklahoma (the FullNet of Bartlesville (FOB) acquisition), Nowata, Oklahoma (the FullNet of Nowata (FON) acquisition), the 2000 merger with Harvest Communications, Inc. (the Harvest merger), the 1998 purchase of Animus (the Animus acquisition) and the 1997 purchase of certain business operations in Tulsa, Oklahoma (the Tulsa acquisition) as follows: F-12
December 31, ---------------------------- 2002 2001 ------------ ------------ LAWTONNET acquisition $ 65,000 $ 65,000 SONET acquisition 42,547 42,547 IPDatacom acquisition 137,849 137,849 FOT acquisition 93,649 93,649 FOB acquisition 194,780 194,780 FON acquisition 139,650 139,650 Harvest merger 2,009,858 2,009,858 Animus acquisition 318,597 318,597 Tulsa acquisition 70,000 70,000 ------------ ------------ 3,071,930 3,071,930 Less accumulated amortization (2,565,657) (2,117,078) ------------ ------------ $ 506,273 $ 954,852 ============ ============
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 141, Business Combinations, and SFAS 142, Goodwill and Intangible Assets. SFAS 141 is effective for all business combinations completed after June 30, 2001. SFAS 142 is effective for fiscal years beginning after December 15, 2001; however, certain provisions of this Statement apply to goodwill and other intangible assets acquired between July 1, 2001 and the effective date of SFAS 142. The provisions of 142 provide that goodwill, as well as intangible assets with indefinite lives, acquired after June 30, 2001, not be amortized and, effective January 1, 2002, all previously recognized goodwill and intangible assets with indefinite lives will no longer be subject to amortization. The statement also provides that upon initial application the useful lives of previously recognized intangible assets be reassessed and remaining amortization periods adjusted accordingly. The Company's previously recognized intangible assets consist primarily of customer bases and covenants not to compete relating to those customer bases. Upon initial application of SFAS 142 as of January 1, 2002, the Company reassessed useful lives and began amortizing these intangible assets over their estimated useful lives and in direct relation to any decreases in the acquired customer bases to which they relate. Management believes that such amortization reflects the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up. The following information presents net loss as adjusted to reflect adjustments for changes in amortization periods for the Company's intangible assets pursuant to SFAS 142 for the years ended December 31, 2002 and 2001:
2002 2001 ------------ ------------ Reported net loss $ (822,980) $ (3,324,830) Adjust: intangible amortization -- (201,503) ------------ ------------ Adjusted net loss $ (822,980) $ (3,526,333) ============ ============ Basic and diluted loss per common share Reported net loss $ (.12) $ (.59) Intangible amortization -- (.03) ------------ ------------ Adjusted net loss $ (.12) $ (.62) ============ ============
Amortization expense for the years ended December 31, 2002 and 2001 relating to intangible assets was $448,579 and $706,249, respectively. F-13 During December 2001, due to a decline in customer base the Company assessed recoverability of intangible assets relating to the Harvest merger. The effect of this assessment for the year ended December 31, 2001 was to record impairment expense of $741,295. NOTE E - NOTES PAYABLE On January 5, 2001, the Company obtained a $250,000 interim loan. This loan bears interest at 10% per annum and requires payments equal to 50% of the net proceeds received by the Company from its private placement of convertible notes payable. On March 31, 2001, the principal balance of the note was increased to $320,000 and the due date was extended to July 31, 2001. Subsequently, the due date was extended until December 31, 2001. Through December 31, 2002, the Company had made aggregate payments of principal and interest of $35,834 on this loan. At December 31, 2002, the past due principal and accrued interest totaled $376,110. Pursuant to the terms of this loan the balance was due on December 31, 2001 and the Company has not made payment or negotiated an extension of the note and the lender has not made any demands. During February and April 2001, the Company received $100,000 and $62,500, respectively, of subscriptions to the Company's private placement offering of convertible notes payable. These notes bear interest at an annual rate of 12.5%, as adjusted, and become due three years following issuance. These notes are convertible into the Company's common stock at the rate of one share of common stock for each $1.00, subject to adjustment under certain circumstances, of principal and accrued unpaid interest at the option of the holders. Subsequently, these notes were exchanged for common stock on May 31, 2001,which is discussed below. During February 2001, the Company converted accounts payable of $94,680 to a note with terms substantially equivalent to the terms of the Company's convertible notes payable. Subsequently, this note was exchanged for common stock on May 31, 2001,which is discussed below. Effective February 1, 2001, the holders exchanged their non-interest bearing acquisition note payable for a note bearing interest at 10% per annum commencing January 1, 2001, and a six-month deferral of payments of principal and interest from April 2001 to September 2001. Payments of principal and interest resumed in October 2001, and this note matures in June 2002. During March 2001, the Company converted acquisition notes payable of $232,944 to notes with terms substantially equivalent to the Company's convertible notes payable. Subsequently, these notes were exchanged for common stock on May 31, 2001,which is discussed below. On May 31, 2001, the Company exchanged 2,064,528 shares of its common stock and warrants (exercisable for the purchase of 436,748 shares of common stock at $2.00 per share) for convertible notes in the principal amount of $1,746,988 (recorded at $1,283,893) plus accrued interest of $123,414. The warrants expire on May 31, 2006. This exchange was accounted for as an induced debt conversion and a debt conversion expense of $370,308 was recorded. Pursuant to the provisions of the November and December 2000 convertible notes payable, the conversion price was reduced from $1.00 per share on January 15, 2001 to $.63 per share on December 15, 2002 for failure to register under the Securities Act of 1933, as amended, the common stock underlying the convertible notes payable and underlying warrants on December 15, 2001. Reductions in conversion price are recognized at the date of reduction by an increase to additional paid-in capital and an increase in the discount on the convertible notes payable. Furthermore, the interest rate was increased to 12.5% per annum from 11% per annum because the registration statement was not filed before March 1, 2001. At December 31, 2002, the outstanding principal and interest of the convertible notes payable was $577,367. On July 1 and October 1, 2001, the Company recorded 3,853 and 11,815 shares of common stock issuable, respectively, in payment of $15,668 accrued interest on a portion of the Company's convertible notes payable. F-14 Notes payable consist of the following at December 31:
2002 2001 Three notes payable to a bank, payable in monthly installments aggregating $10,010, including interest ranging from 9.5% to 11.5%, maturing September 2008; collateralized by property and equipment, accounts receivable and Company common stock owned by the founder and CEO of the Company; guaranteed by the founder and CEO of the Company; partially guaranteed by the Small Business Administration $ 474,523 $ 526,886 Interim loan, interest at 10%, requires payments equal to 50% of the net proceeds received by the Company from its private placement of convertible notes payable, matured December 2001; unsecured 320,000 320,000 Convertible notes payable; interest at 12.5% of face amount, payable quarterly; these notes are unsecured and $505,000 and $5,636 mature in 2003 and 2004, respectively; $510,636 face amount less unamortized discount of $196,271 ($199,799 for 2001); effective rate of 20% (convertible into approximately 810,535 and 654,662 shares at December 31, 2002 and 2001, respectively) 314,365 310,837 Note payable to a bank, payable in monthly installments of $1,277 until paid in full, including interest at a variable rate (prime plus 2.25%; 7.0% at December 31, 2002), matures September 2014; collateralized by substantially all assets acquired in conjunction with the acquisition of Harvest Communications, Inc. A former officer of the Company who was the sole stockholder of Harvest Communications, Inc. is a co-maker on this note and it is partially guaranteed by the Small Business Administration 37,060 49,278 Note payable to the Company's founder and CEO, payable in monthly installments of $1,034 including interest at 8.5%, maturing May 2006; unsecured 36,492 45,380 Other notes payable(1) 118,003 163,204 ---------- ---------- 1,300,443 1,415,585 Less current portion 865,057 549,219 ---------- ---------- $ 435,386 $ 866,366 ========== ==========
(1) Includes three notes with past due principal and accrued interest totaling $51,229 at December 31, 2002. The Company has not made payment or negotiated an extension of the notes and the lenders have not made any demands. F-15 Aggregate future maturities of notes payable at December 31, 2002 are as follows:
Year ending December 31 2003 $ 1,059,147 2004 106,823 2005 105,774 2006 106,486 2007 109,117 Thereafter 9,367 ----------- 1,496,714 Less unamortized discount (196,271) ----------- $ 1,300,443 ===========
NOTE F - LEASE AGREEMENTS Capital Leases The Company has various capital leases for equipment. The lease terms range from 24 to 36 months. Additionally, annual lease rental payments for each lease range from $1,387 to $23,236 per year. The property and equipment accounts include $186,436 and $98,431 for leases that have been capitalized at December 31, 2002 and 2001, respectively. Related accumulated amortization amounted to $46,550 and $16,353 at December 31, 2002 and 2001, respectively. The schedule of future minimum lease payments below reflects all payments under capital leases in effect at December 31, 2002.
Year ending December 31 2003 $ 66,089 2004 36,431 2005 17,313 -------- Total minimum lease payments $119,833 Less amount representing interest 19,238 -------- Present value of net minimum lease payments $100,595 Less current portion 52,646 -------- Long-term capital lease obligations $ 47,949 ========
Operating Leases The Company leases certain office facilities used in its operations under noncancellable operating leases expiring at various dates through 2009. Future minimum lease payments required at December 31,2002 under noncancellable operating leases that have initial lease terms exceeding one year are presented in the following table:
Year ending December 31 2003 $ 163,749 2004 163,761 2005 170,284 2006 176,807 2007 183,330 Thereafter 386,229 ---------- $1,244,160 ==========
F-16 Rental expense for all operating leases for the years ended December 31, 2002 and 2001 was approximately $306,759 and $408,000, respectively. Certain of the Company's long-term noncancellable operating leases include scheduled base rental increases over the term of the lease. The total amount of the base rental payments is charged to expense on the straight-line method over the term of the lease. The Company has recorded a deferred credit of $72,956 and $57,286 at December 31, 2002 and 2001, respectively, which is reflected in Other Long-term Liabilities on the Balance Sheet to reflect the net excess of rental expense over cash payments since inception of the leases. NOTE G - INCOME TAXES Due to net losses, no provision for income taxes was necessary for 2002 or 2001. The Company's effective income tax rate on net loss differed from the federal statutory rate of 34% as follows at December 31:
2002 2001 ------------ ------------ Income taxes at federal statutory rate $ (280,000) $ (1,130,000) Change in valuation allowance 159,000 443,000 Nondeductible expenses 169,000 733,000 State income taxes, net of federal benefit (46,000) (125,000) Other (2,000) 79,000 ------------ ------------ Total tax expense $ -- $ -- ============ ============
The components of deferred income tax assets were as follows at December 31:
2002 2001 ------------ ------------ Deferred income tax assets Basis difference in intangible assets $ 165,000 $ 107,500 Deferred revenue 157,000 177,000 Net operating loss 1,014,000 939,000 Other 94,000 65,000 Valuation allowance (1,430,000) (1,271,000) ------------ ------------ Net deferred income tax asset $ -- $ 17,500 ============ ============ Increase in valuation allowance $ 159,000 $ 474,000 ============ ============
A valuation allowance is provided for deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be realized. At December 31, 2002, the Company has a net operating loss carryforward of approximately $2,700,000 that will expire at various dates through 2021. As such carryforward can only be used to offset future taxable income of the Company, management has provided a valuation allowance until it is more likely than not that taxable income will be generated. NOTE H - STOCKHOLDERS' (DEFICIT) EQUITY COMMON STOCK - During January 2002, the Company agreed to issue 11,815 shares valued at $11,815 in payment of accrued interest on a portion of the Company's convertible debt. At December 31, 2002 these shares are shown as Common Stock Issuable. F-17 During December 2002, the Company agreed to issue 1,500 shares valued at $105 in settlement of a note payable. At December 31, 2002 these shares are shown as Common Stock Issuable. During 2001, the Company issued 170,000 shares valued at $129,500 in conjunction with the completion of two acquisitions and has an obligation to issue 30,000 shares valued at $30,000 in conjunction with a third acquisition. Warrants exercisable for the purchase of 425,349 shares of stock were exercised during 2001 for an aggregate price of $4,254. Of these shares, 414,075 of these shares were issued and 11,274 shares are issuable at December 31, 2002. During April 2001, 1,500 shares were issued as partial compensation for consulting services performed. Consulting services expense of $1,125 was recorded based on an estimated fair value of $.75 per share. COMMON STOCK OPTIONS - The following table summarizes the Company's employee stock option activity for the years ended December 31, 2002 and 2001:
Weighted Weighted Average Average 2002 Exercise Price 2001 Exercise Price ---------- -------------- ---------- -------------- Options outstanding, beginning of year 1,437,196 $ 1.08 1,041,034 $ 1.40 Options granted during the year 488,830 .07 800,063 .79 Options exercised during the year -- -- -- -- Options cancelled during the year (336,774) .81 (403,901) 1.33 ---------- -------------- ---------- -------------- Options outstanding, end of year 1,589,252 $ .80 1,437,196 $ 1.08 ========== ============== ========== ============== Options exercisable at end of year 1,106,090 $ .97 871,368 $ 1.06 ========== ============== ========== ============== Weighted average fair value of options granted during the year $ .06 $ .45 ============== ==============
The following table summarizes information about employee stock options outstanding at December 31, 2002:
Options outstanding Options exercisable -------------------------------------------------- ------------------------------------ Weighted- average Number remaining Weighted- Number Weighted- Range of exercise outstanding contractual average exercise exercisable at average exercise prices at 12/31/02 life price 12/31/02 price - ----------------- ----------- ----------- ---------------- -------------- ---------------- $0.01 - $0.70 790,829 9.04 years $0.27 450,001 $0.41 $1.00 - $1.50 674,290 7.86 years $1.07 543,956 $1.09 $1.81 - $3.00 124,133 7.32 years $2.62 112,133 $2.66 --------- --------- 1,589,252 8.32 years $1.08 1,106,090 $ .97 ========= =========
The Company's employee stock options are accounted for under APB Opinion No. 25 and related interpretations. Had compensation cost for the Company's stock options been determined based on the fair value at the grant dates consistent with the method of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, the Company's net loss and loss per share in 2002 and 2001 would have been increased to the pro forma amounts indicated below: F-18
2002 2001 ------------ ------------ Net loss As reported $ (822,980) $ (3,324,830) Pro forma $ (1,074,967) $ (4,006,240) Basic and diluted loss per share As reported $ (.12) $ (.59) Pro forma $ (.16) $ (.71)
The fair value of each option grant prior to February 2000 was estimated on the date of grant using the minimum value method because there was no public trading market for the Company's securities. During February 2000, the Company's common stock began trading on the NASD Electronic Bulletin Board under the symbol FULO. The fair value of the options granted subsequent to February 2000 have been estimated at the date of grant using the Black-Scholes option pricing model. The following weighted average assumptions were used:
2002 2001 ------ ------ Risk free interest rate 5.1% 5.3% Expected lives (in years) 5 5 Expected volatility 143.2% 134% Dividend yield 0% 0%
COMMON STOCK WARRANTS AND CERTAIN STOCK OPTIONS - A summary of common stock purchase warrant and certain stock option activity for the years ended December 31, 2002 and 2001 follows:
Number of shares --------- Issued during 2002 For professional services (weighted average exercise price $.08 per share) 52,000 --------- Total issued during 2002 52,000 ========= Issued during 2001 In connection with interim financing (weighted average exercise price $.51 per share) 250,000 For professional services (weighted average exercise price $.28 per share) 739,000 In connection with the issuance of convertible notes payable (exercise price $.01 per share) 122,532 In connection with the exchange of convertible notes (exercise price $2.00 per share) 436,748 --------- Total issued during 2001 1,548,280 =========
Outstanding common stock purchase warrants and certain stock options outstanding at December 31, 2002 are as follows: F-19
Number Exercise Expiration of shares price year --------- -------- ---------- 57,375 $ 1.25 2002 25,000 2.77 2003 10,000 2.55 2005 70,000 1.00 2005 560,000 .01 2005 436,748 2.00 2006 311,000 1.00 2006 73,500 .13 2006 100,000 .11 2006 456,058 .01 2006 6,000 .12 2007 14,000 .10 2007 12,000 .08 2007 20,000 .05 2007 --------- 2,151,681 =========
The following table summarizes the Company's common stock purchase warrant and certain stock option activity for the years ended December 31, 2002 and 2001:
Weighted Weighted Average Average Exercise Exercise 2002 Price 2001 Price ---------- ---------- ---------- ---------- Warrants and certain stock options outstanding, beginning of year 2,099,681 $ .69 1,076,750 $ .32 Warrants and certain stock options issued during the year 52,000 .08 1,548,280 1.46 Warrants and certain stock options exercised during the year -- -- (425,349) .01 Warrants and certain stock options cancelled during the year -- -- (100,000) 1.00 ---------- ---------- ---------- ---------- Warrants and certain stock options outstanding, end of year 2,151,681 $ .68 2,099,681 $ .69 ========== ========== ========== ==========
NOTE I - RELATED PARTY TRANSACTIONS In connection with his employment, during March 2002, the Company issued stock options exercisable for the purchase of 80,000 shares of common stock to the founder and CEO of the Company that were one-third vested and exercisable immediately and will vest and become exercisable one-third on each annual anniversary of the issue. These options have an exercise price of $.05 per share and expire during March 2012. In April 2001, the Company's founder and CEO purchased 50,000 shares of common stock pursuant to exercise of warrants for an aggregate exercise price of $500. In connection with his employment, during July 2001, the Company issued stock options exercisable for the purchase of 100,000 shares of the Company's common stock to the founder and CEO of the Company that were fully vested and exercisable. These options have an exercise price of $.70 per share and expire during July 2011. In connection with his employment, during November 2001, the Company issued stock options exercisable for the purchase of 32,000 shares of common stock to the founder and CEO of the Company that will vest and become exercisable one-third on each annual anniversary of the issue. These options have an exercise price of $.11 per share and expire during November 2011. F-20 In connection with his employment, during March 2002, the Company issued stock options exercisable for the purchase of 60,000 shares of common stock to one of its officers and directors that were one-third vested and exercisable immediately and will vest and become exercisable one-third on each annual anniversary of the issue. These options have an exercise price of $.05 per share and expire during March 2012. During April 2001, this officer and his wife purchased $25,000 of the 11% convertible promissory notes and attached warrants sold in the Company's private placement. In addition, this officer exercised warrants for the purchase of 56,250 shares of common stock for an aggregate purchase price of $563. During May 2001, this officer exchanged convertible notes in the principal amount of $50,000 plus interest for 57,617 shares of common stock and 12,500 warrants (exercisable for the purchase of 12,500 shares of common stock at $2.00 per share). These warrants expire May 31, 2006. During August 2001, this officer purchased 5,000 shares of the Company's common stock at $.55 per share. In connection with his employment, during October 2001, the Company granted stock options exercisable for the purchase of 137,452 shares of common stock to this officer that will vest and become exercisable on a quarterly basis over a one-year period. These options have an exercise price of $.50 per share and expire during October 2011. In connection with his employment, during November 2001, the Company granted stock options exercisable for the purchase of 23,745 shares of common stock to this officer that will vest and become exercisable one-third on each annual anniversary of the grant date. These options have an exercise price of $.11 per share and expire during November 2011. On August 2, 2000, the Company obtained a short-term loan of $100,000 from its founder and CEO through the issuance of a 14% promissory note. The terms of the financing additionally provided for the issuance of five-year warrants exercisable for the purchase of 50,000 shares of the Company's common stock at $.01 per share, and provided for certain registration rights. The promissory note required monthly interest payments, matured on the earlier of (i) the date which is within five days of receipt of funds by the Company of any offering raising gross proceeds to the Company of at least $1,000,000 or (ii) in three months, and was extendible for two 90-day periods upon issuance of additional warrants exercisable for the purchase of 50,000 shares of the Company's common stock exercisable at $.01 per share for each extension. In the fourth quarter of 2000, the Company's founder and CEO agreed to reduce the interest rate on the promissory note to 9% and waive the warrant provisions relating to extensions of the loan. The Company repaid $50,000 on this note during 2000 and the note was due in May 2001. In May 2001 the Company's founder and CEO agreed to a replacement note with an interest rate of 8.5% with monthly principal and interest payments and the note is due in May 2006. NOTE J - ACQUISITIONS On February 28, 2001, the Company purchased substantially all of the assets of LawtonNet Communications (LAWTONNET), a sole proprietorship, including approximately 700 individual and business Internet access customer accounts. Pursuant to the purchase, the Company issued LAWTONNET 35,000 shares of its common stock. In addition, the Company agreed to pay LAWTONNET an amount based upon the future collected revenues received from all active LAWTONNET customers transferred at the time of closing of the purchase until the customers become inactive. During the 30 days following the closing of this purchase, advance payments of $30,000 were made on the future collected revenues received. Total amounts due to the seller pursuant to this provision of the purchase agreement were $27,182 and $4,611 for the years ended December 31, 2001 and 2002, respectively. On February 28, 2001, the Company purchased substantially all of the assets of Computer Concepts & Research, Inc., doing business as SONET Communications (SONET), including approximately 900 individual and business Internet access customer accounts. Pursuant to this purchase, the Company agreed to issue 30,000 shares of its common stock to SONET. In addition, the Company agreed to pay SONET an amount based upon the future collected revenues F-21 received from all active SONET customers transferred at the time of closing of this purchase until the customers become inactive. Total amounts due to the seller pursuant to this provision of the purchase agreement were $38,404 and $10,995 for the years ended December 31, 2001 and 2002, respectively. On June 15, 2001, the Company purchased substantially all of the assets of IPDatacom, a division of Higanbotham.com, LLC (IPDatacom), including approximately 400 individual and business Internet access customer accounts. Pursuant to this purchase, the Company issued IPDatacom 135,000 shares of the Company's common stock, notes payable in the aggregate principal amount of $58,500 and paid $1,500. On November 19, 2001, the Company purchased the assets of Northeast Rural Services, a subsidiary of Northeast Oklahoma Electric Cooperative, Inc. (Rectec), a cooperative corporation, including the Internet access customers consisting approximately of 1,400 individual and business Internet access accounts, and the associated equipment in the Oklahoma cities of Adair, Jay, Pryor, Wyandotte, Leach, Colcord and Moseley. The Company paid RECTEC an aggregate amount of $92,394 of which $37,394 was paid in cash and the balance by delivery of two notes in the aggregate principal amount of $55,000. These acquisitions were accounted for as purchases. The aggregate purchase price has been allocated to the underlying net assets purchased or net liabilities assumed, including intangible assets, which consist primarily of acquired customer bases and covenants not to compete, based on their estimated fair values at the respective acquisition dates. Intangible assets acquired totaled approximately $245,397, which are being amortized based on decreases of acquired customer base. The unaudited pro forma combined historical results, as if the entities listed above had been acquired at the beginning of the period presented, are included in the table below.
2001 ------------ Revenue $ 2,511,000 Net loss $ (3,323,000) Basic and diluted loss per share $ (.58)
The pro forma results above include amortization of intangible assets acquired and interest expense on debt assumed or issued to finance the acquisitions. The pro forma results are not necessarily indicative of what actually would have occurred if the acquisitions had been completed as of the beginning of the period presented, nor are they necessarily indicative of future consolidated results. NOTE K - COMMITMENTS AND CONTINGENCIES In June 2002, the Company issued a purchase order for the purchase and installation of a telephone switch that will enable the Company to broaden its product line. This switch was delivered in February 2003. A down payment of $14,950 was paid upon delivery of the switch and the remaining balance of $202,200 was financed by the supplier at 10% interest to be paid in 18 monthly payments beginning in March 2003. As additional consideration the Company issued the supplier a warrant on February 7, 2003 to purchase 50,000 shares of its common stock for $.01 per share for a period of five years from the date of issuance. NOTE L - FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments are held for purposes other than trading. The estimated fair value of notes payable is the discounted amount of future cash flows using the estimated current rate for similar borrowings. F-22
2002 2001 ----------------------- ----------------------- Carrying Fair Carrying Fair amount value amount value ---------- ---------- ---------- ---------- Financial liabilities Notes payable $1,300,000 $ 811,000 $1,416,000 $1,246,000
NOTE M - SIGNIFICANT CUSTOMER During the years ended December 31, 2002 and 2001, the Company had one customer that comprised approximately 27% and 26%, respectively, of total revenues. F-23 Index of Exhibits 3.1 Certificate of Incorporation, as amended (filed as Exhibit 2.1 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference). # 3.2 Bylaws (filed as Exhibit 2.2 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference) # 4.1 Specimen Certificate of Registrant's Common Stock (filed as Exhibit 4.1 to the Company's Form 10-KSB for the fiscal year ended December 31, 1999, and incorporated herein by reference). # 4.2 Certificate of Correction to the Amended Certificate of Incorporation and the Ninth Section of the Certificate of Incorporation (filed as Exhibit 2.1 to Registrant's Registration Statement on form 10-SB, file number 000-27031 and incorporated by reference). # 4.3 Certificate of Correction to Articles II and V of Registrant's Bylaws (filed as Exhibit 2.1 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference). # 4.4 Form of Warrant Agreement for Interim Financing in the amount of $505,000 (filed as Exhibit 4.1 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.5 Form of Warrant Certificate for Florida Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.2 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.6 Form of Promissory Note for Florida Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.3 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.7 Form of Warrant Certificate for Georgia Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.4 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.8 Form of Promissory Note for Georgia Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.5 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.9 Form of Warrant Certificate for Illinois Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.6 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.10 Form of Promissory Note for Illinois Investors for Interim Financing in the amount of $505,000 (filed as Exhibit 4.7 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.11 Form of Warrant Agreement for Interim Financing in the amount of $500,000 (filed as Exhibit 4.8 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.12 Form of Warrant Certificate for Interim Financing in the amount of $500,000 (filed as Exhibit 4.9 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.13 Form of Promissory Note for Interim Financing in the amount of $500,000 (filed as Exhibit 4.10 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 4.14 Form of Convertible Promissory Note for September 29, 2000, private placement (filed as Exhibit 4.13 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000 and incorporated herein by reference). #
34 4.15 Form of Warrant Agreement for September 29, 2000, private placement (filed as Exhibit 4.13 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000 and incorporated herein by reference). # 4.16 Form of 2001 Exchange Warrant Agreement (filed as Exhibit 4.16 to Registrant's Form 10-QSB for the quarter ended June 30, 2001 and incorporated herein by reference). # 4.17 Form of 2001 Exchange Warrant Certificate (filed as Exhibit 4.17 to Registrant's Form 10-QSB for the quarter ended June 30, 2001 and incorporated herein by reference). # 10.1 Financial Advisory Services Agreement between the Company and National Securities Corporation, dated September 17, 1999 (filed as Exhibit 10.1 to Registrant's Form 10-KSB for the fiscal year ended December 31, 1999, and incorporated herein by reference). # 10.2 Lease Agreement between the Company and BOK Plaza Associates, LLC, dated December 2, 1999 (filed as Exhibit 10.2 to Registrant's Form 10-KSB for the fiscal year ended December 31, 1999, and incorporated herein by reference). # 10.3 Interconnection agreement between Registrant and Southwestern Bell dated March 19, 1999 (filed as Exhibit 6.1 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference). # 10.4 Stock Purchase Agreement between the Company and Animus Communications, Inc. (filed as Exhibit 6.2 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference). # 10.5 Registrar Accreditation Agreement effective February 8, 2000, by and between Internet Corporation for Assigned Names and Numbers and FullWeb, Inc. d/b/a FullNic f/k/a Animus Communications, Inc. (filed as Exhibit 10.1 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended March 31, 2000 and incorporated herein by reference). # 10.6 Master License Agreement For KMC Telecom V, Inc., dated June 20, 2000, by and between FullNet Communications, Inc. and KMC Telecom V, Inc. (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-QSB for the Quarter ended June 30, 2000 and incorporated herein by reference). # 10.7 Domain Registrar Project Completion Agreement dated May 10, 2000, by and between FullNet Communications, Inc., FullWeb, Inc. d/b/a FullNic and Think Capital (filed as Exhibit 10.2 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended June 30, 2000 and incorporated herein by reference). # 10.8 Amendment to Financial Advisory Services Agreement between Registrant and National Securities Corporation, dated April 21, 2000 (filed as Exhibit 10.3 to Registrant's Quarterly Report on Form 10-QSB for the Quarter ended June 30, 2000 and incorporated herein by reference). # 10.9 Asset Purchase Agreement dated June 2, 2000, by and between FullNet of Nowata and FullNet Communications, Inc. (filed as Exhibit 99.1 to Registrant's Form 8-K filed on June 20, 2000 and incorporated herein by reference). # 10.10 Asset Purchase Agreement dated February 4, 2000, by and between FullNet of Bartlesville and FullNet Communications, Inc. (filed as Exhibit 2.1 to Registrant's Form 8-K filed on February 18, 2000 and incorporated herein by reference). # 10.11 Agreement and Plan of Merger Among FullNet Communications, Inc., FullNet, Inc. and Harvest Communications, Inc. dated February 29, 2000 (filed as Exhibit 2.1 to Registrant's Form 8-K filed on March 10, 2000 and incorporated herein by reference). # 10.12 Asset Purchase Agreement dated January 25, 2000, by and between FullNet of Tahlequah, and FullNet Communications, Inc. (filed as Exhibit 2.1 to Registrant's Form 8-K filed on February 9, 2000 and incorporated herein by reference). # 10.13 Promissory Note dated August 2, 2000, issued to Timothy J. Kilkenny (filed as Exhibit 10.13 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). #
35 10.14 Warrant Agreement dated August 2, 2000, issued to Timothy J. Kilkenny (filed as Exhibit 10.14 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.15 Warrant Certificate dated August 2, 2000 issued to Timothy J. Kilkenny (filed as Exhibit 10.15 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.16 Stock Option Agreement dated December 8, 2000, issued to Timothy J. Kilkenny (filed as Exhibit 10.16 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.17 Warrant Agreement dated November 9, 2000, issued to Roger P. Baresel (filed as Exhibit 10.17 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.18 Warrant Agreement dated December 29, 2000, issued to Roger P. Baresel (filed as Exhibit 10.18 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.19 Stock Option Agreement dated February 29, 2000, issued to Wallace L Walcher (filed as Exhibit 10.19 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.20 Stock Option Agreement dated February 17, 1999, issued to Timothy J. Kilkenny (filed as Exhibit 3.1 to Registrant's Registration Statement on Form 10-SB, file number 000-27031 and incorporated herein by reference). # 10.21 Stock Option Agreement dated October 19, 1999, issued to Wesdon C. Peacock (filed as Exhibit 10.21 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.22 Stock Option Agreement dated April 14, 2000, issued to Jason C. Ayers (filed as Exhibit 10.22 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.23 Stock Option Agreement dated May 1, 2000, issued to B. Don Turner (filed as Exhibit 10.23 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.24 Form of Stock Option Agreement dated December 8, 2000, issued to Jason C. Ayers, Wesdon C. Peacock, B. Don Turner and Wallace L. Walcher (filed as Exhibit 10.24 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.25 Warrant Certificate Dated November 9, 2000, issued to Roger P. Baresel (filed as Exhibit 10.25 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.26 Warrant Certificate Dated November 9, 2000, issued to Roger P. Baresel (filed as Exhibit 10.26 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.27 Warrant Certificate Dated December 29, 2000, issued to Roger P. Baresel (filed as Exhibit 10.27 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.28 Stock Option Agreement dated October 13, 2000, issued to Roger P. Baresel (filed as Exhibit 10.28 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.29 Stock Option Agreement dated October 12, 1999, issued to Travis Lane (filed as Exhibit 10.29 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.30 Promissory Note dated January 5, 2001, issued to Generation Capital Associates (filed as Exhibit 10.30 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.31 Placement Agency Agreement dated November 8, 2000 between FullNet Communications, Inc. and National Securities Corporation (filed as Exhibit 10.31 to Registrant's Form 10-KSB for the fiscal year ended December 31, 2000). # 10.32 Promissory Note dated January 25, 2000, issued to Fullnet of Tahlequah, Inc. # 10.33 Promissory Note dated February 7, 2000, issued to David Looper # 10.34 Promissory Note dated February 29, 2000, issued to Wallace L. Walcher #
36 10.35 Promissory Note dated June 2, 2000, issued to Lary Smith # 10.36 Promissory Note dated June 15, 2001, issued to higganbotham.com L.L.C. # 10.37 Promissory Note dated November 19, 2001, issued to Northeast Rural Services # 10.38 Promissory Note dated November 19, 2001, issued to Northeast Rural Services # 10.39 Form of Convertible Promissory Note dated September 6, 2002 # 10.40 Employment Agreement with Timothy J. Kilkenny dated July 31, 2002 * 10.41 Employment Agreement with Roger P. Baresel dated July 31, 2002 * 10.42 Letter from Grant Thornton LLP to the Securities and Exchange Commission dated January 30, 2003 # 22.1 Subsidiaries of the Registrant # 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Timothy J. Kilkenny * 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Roger P. Baresel *
- ---------- # Incorporated by reference * Filed herewith 37 EX-10.40 3 d04287exv10w40.txt EMPLOYMENT AGREEMENT WITH TIMOTHY J. KILKENNY EXHIBIT 10.40 EMPLOYMENT AGREEMENT THIS AGREEMENT is made and entered into this 31st day of July 2002, but is effective for all purposes as of the Commencement Date (as hereinafter defined), by and between FullNet Communications, Inc. (the "Company"), an Oklahoma corporation, and Timothy J. Kilkenny ("Kilkenny"), an individual. WITNESSETH: WHEREAS, the Company and Kilkenny desire to enter into a long-term employment agreement on the terms and conditions hereinafter provided; NOW, THEREFORE, for and in consideration of the conditions herein below to be performed on the part of the respective parties hereto, and in consideration of the mutuality thereof, the parties hereto agree as follows: 1. Term of Employment. The Company hereby agrees to employ Kilkenny as Chairman of the Board and Chief Executive Officer of the Company, and Kilkenny hereby accepts such employment and agrees to serve the Company as its Chairman of the Board and Chief Executive Officer. The term of employment under this Agreement shall commence on January 1, 2002 (the "Commencement Date), and shall continue through December 31, 2004; provided, however, the term of this agreement shall automatically be extended for additional one-year terms, unless either party give notice of termination to the other on or before June 30 in the year of termination, commencing June 30, 2004 ("Period of Employment"). 2. Duties. Substantially all of the duties and responsibilities of Kilkenny, subject to such travel as the duties of Kilkenny hereunder may reasonably require, shall be performed by Kilkenny at and from the corporate offices of the Company in Oklahoma City, Oklahoma. 2.1 Time and Best Efforts. During the term of employment hereunder, Kilkenny shall be a full-time employee and shall devote his time, attention, skill, energy and best efforts as a full-time employee to the duties assigned to him from time to time as Chairman of the Board and Chief Executive Officer by the Board of Directors of the Company, which duties shall be of the general character referred to in Section 2.2, and shall, but without obligation hereunder, serve the Company in the other executive officer positions to which he may be elected or appointed by the Board of Directors of the Company, subject to acceptance by Kilkenny of such other executive officer position or positions. Notwithstanding the foregoing, Kilkenny may (i) engage in other business pursuits or other endeavors which do not conflict with his ability to perform his duties on a best efforts basis to the business interests of the Company and (ii) become a director of other corporations and engage in charitable, civic and other similar pursuits; provided, however, that such other business pursuits or other endeavors do not interfere with his devoting his best efforts to his duties to the Company or violate the duty of loyalty and care which Kilkenny has to the Company by reason of this Agreement or in his capacity as an executive officer of the Company. 2.2 Supervision. As an employee and Chairman of the Board and Chief Executive Officer of the Company (and other executive officer positions held by Kilkenny), Kilkenny shall be responsible for the general management of the business operations of the Company which shall be subject to the overall supervision and instructions of the Board of Directors of the Company. EMPLOYMENT AGREEMENT PAGE 1 3. Compensation and Other Benefits. During the Period of Employment, the Company shall pay or provide to Kilkenny, and Kilkenny shall be entitled to receive or have maintained for his benefit, for his services such compensation as the Board of Directors shall fix from time to time, but not less than the following amounts and benefits: 3.1 Regular Compensation. The salary paid by the Company to Kilkenny under this Section 3.1 shall be not less than $6,250 per month, such monthly salary shall be subject to not less than a five percent (5%) increase, on each January 1 during the Period of Employment, based upon the monthly compensation paid Kilkenny during the month of December immediately preceding the applicable January 1. Payment of such salary shall be made in installments in accordance with the Company's compensation payments to its other employees. Salary paid in accordance with this Section 3.1 shall be considered Kilkenny's "regular compensation." 3.2 Bonus Compensation. In addition to regular compensation, Kilkenny shall be eligible for annual bonuses that are not guaranteed and are to be determined by the Company's Board of Directors. 3.3 Grant of Stock Options. From time to time the Company may grant stock options to its executive officers as determined by the Board of Directors (or the Compensation Committee and/or Stock Option Committee established by the Board of Directors). To the extent that stock options are granted by the Board of Directors (or the Compensation Committee and/or Stock Option Committee established by the Board of Directors) to its executive officers, Kilkenny shall be deemed to be a member of the group to which stock options are granted, and his stock option grants shall be determined in the same manner as are the stock option grants of other executives in the group. In no event shall this Agreement have any effect upon the stock options granted to Kilkenny prior to the date of execution of this Agreement. 3.4 Entertainment, Travel and Similar Expense Reimbursement. Kilkenny is hereby authorized to incur reasonable expenses for the promotion of the Company's business, including entertainment, travel, lodging, meals, and similar expenses, and he shall be reimbursed therefore, by the Company upon his presentation of itemized accounts of such expenditures. 3.5 Health, Dental, and Disability Insurance Arrangements and Programs. The Company shall provide to Kilkenny (including coverage of the dependents of Kilkenny) health, medical, dental, and disability insurance benefits comparable to those provided to the executive officers of the Company either as a group or individually. 3.6 Vacation and Leave; Holidays. Kilkenny shall be entitled to (i) vacation leave with pay (at his regular compensation rate at the time such vacation leave is taken) during each calendar year of the Period of Employment, and (ii) reasonable periods of sick leave with pay (at his regular compensation rate at the time such sick leave is taken) commensurate with his position, in accordance with Company policy as established by the Board of Directors. Any annual vacation leave not taken by Kilkenny during a calendar year shall accumulate, and, at the option of Kilkenny, he may elect to receive his vacation compensation (at his regular compensation rate at the time of such election) in lieu of taking vacation leave. Kilkenny shall be entitled to all paid holidays observed by the Company. 3.7 Automobile and Cellular Phone. At Kilkenny's sole option, the Company shall (i) pay to Kilkenny an automobile allowance of seven hundred dollars ($700) per month, payable on the first day of each month, or (ii) the use of a Company owned or leased automobile, the make and model to be selected and determined in Kilkenny's sole discretion and pay all costs and expenses EMPLOYMENT AGREEMENT PAGE 2 of operation, including without limitation insurance (in such amounts as mutually agreed upon by Kilkenny and the Company), gasoline, repairs, maintenance. Furthermore, and the Company shall provide to Kilkenny, at the sole cost and expense of the Company, a cellular phone to assist Kilkenny in the performance of his duties and responsibilities as an executive officer and employee of the Company. 3.8 Life Insurance. The Company shall provide to Kilkenny and maintain term insurance, at the Company's sole cost and expense, covering the life of Kilkenny in the face amount of $500,000 (the "Life Insurance Policy"), the proceeds of which shall be payable to such beneficiary that Kilkenny shall designate or, in the event of failure to designate a named beneficiary, shall be payable to the estate of Kilkenny. Upon expiration of the Period of Employment, the Company shall assign and transfer to Kilkenny, without any payment therefore by Kilkenny, the Life Insurance Policy in the event ownership thereof is not maintained in the name of Kilkenny. 3.9 No Limitation on Other Obligations of Company. No regular compensation or bonus compensation payment or the providing of any other compensation benefits to Kilkenny pursuant to this Agreement shall in any way limit or reduce any other obligation of the Company to Kilkenny as an employee of the Company. Kilkenny shall be entitled to participate in and receive benefits under any employee benefit plan or arrangement made available by the Company (both as of the effective date of this Agreement as well as in the future) to its employees or to any executive officer of the Company. 3.10 Employment Termination. In the event of (i) a termination (as defined below) of Kilkenny's employment with the Company prior to the end of the Period of Employment, or (ii) termination of Kilkenny's employment at the end of the Period of Employment, the Company shall pay or provide the following: 3.10.1 Lump Sum Payment of Regular Compensation and Bonus Compensation. The Company shall pay to Kilkenny (i) in a lump sum an amount equal to the regular compensation payments for the remainder of the Period of Employment at the salary rate of regular compensation as provided in Section 3.1 to which Kilkenny would have been entitled if Kilkenny had remained in the employ of the Company for the remainder of the Period of Employment, (ii) the automobile allowance, in such amount and payable in accordance with and as provided by Section 3.7 during the remainder of the Period of Employment, and (iii) payment of the insurance premiums on the policies of insurance required to be maintained by the Company in accordance with and as provided by Sections 3.8 and 4.1 during the remained of the Period of Employment. The lump sum payment pursuant to (i) of this Section 3.10.1 shall be paid to Kilkenny on or before the date of termination of Kilkenny's employment pursuant to Section 3.10. 3.10.2 Incentive Compensation and Stock Options. The Company shall provide Kilkenny with the following (or the value thereof): (i) incentive compensation (including, but not limited to, the right to receive and exercise stock options and stock appreciation rights and to receive restricted stock and grants thereof and similar incentive compensation benefits) to which Kilkenny would have been entitled under all incentive compensation plans maintained by the Company if Kilkenny had remained in the employ of the Company for the remainder of the Period of Employment; and EMPLOYMENT AGREEMENT PAGE 3 (ii) the employee benefits (including, but not limited to, coverage under medical, dental, disability and life insurance arrangements or programs) to which Kilkenny would have been entitled under all employee benefit plans, programs and arrangements maintained by the Company in the event Kilkenny had remained employed by the Company for the remainder of the Period of Employment. 3.10.3 Release of Personal Liability for the Company's Liabilities. The Company shall obtain the complete release of Kilkenny from all personal liability for any and all of the Company's debts, including but not limited to leases and promissory notes, and provide Kilkenny with acceptable proof (as determined in Kilkenny's sole discretion) of said release no later than ten business days prior to the last day of Kilkenny's employment by the Company. 3.10.4 Lump Sum Payment of Other Amounts Due Kilkenny. The Company shall pay to Kilkenny in a lump sum an amount equal to the sum of (i) all accrued but unpaid compensation that has been previously deferred due to the Company's financial difficulties, (ii) all amounts advanced and/or loaned by Kilkenny to the Company, and (iii) any and all other amounts due Kilkenny. The Company shall pay the lump sum payment pursuant to this Section 3.10.4 to Kilkenny on or before the last day of Kilkenny's employment. 3.11 Termination and Cause Defined. The term "termination" shall mean termination by the Company, upon 60 days' prior written notice to Kilkenny, of the employment of Kilkenny with the Company for any reason other than cause (as defined below), or resignation of Kilkenny upon the occurrence of either (i) a significant change in the nature or scope of Kilkenny's authorities or duties from those described in Section 2, a reduction in his compensation or breach by the Company of any other provision of this Agreement, (ii) a reasonable determination by Kilkenny that, as a result of a change in circumstances regarding his duties, he is unable to exercise his authorities, powers, functions or duties attached to his executive officer position or positions with the Company as contemplated in Section 2, or (iii) a change in control within the meaning of Section 3.12. The term "cause" means gross misconduct materially injurious to the Company or willful and material breach of this Agreement by Kilkenny that results in material injury to the Company. 3.12 Change of Control Defined. For purposes of this Agreement, each of the following specified events shall be deemed a "change of control": (i) any third person, including a "group" as defined in Sections 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended, becomes the beneficial owner of shares of the Company or of proxies or other rights pertaining to the Company which carry 25 percent or more of the total number of votes for the election of the Board of Directors of the Company or with respect to a merger, consolidation or sale; (ii) as result of, or in connection with, any cash tender offer, merger, or other business combination of the foregoing, the persons who were directors of the Company immediately prior to such event cease to constitute a majority of the Board of Directors of the Company; (iii) the approval of an agreement providing either for a transaction or series of transactions by which the Company will cease to be an independent publicly-owned company or for a sale, lease or other disposition of all or substantially all of the assets of the Company; (iv) the determination by Kilkenny, in his sole discretion, that a Change of Control has occurred; or following any public offering of securities of the Company during any period of 24 consecutive months the persons who were members of the Company's Board of Directors at the commencement of the period cease for any reason to constitute a majority of the Company's Board of Directors. EMPLOYMENT AGREEMENT PAGE 4 4. Disability or Death. 4.1 Disability. The Company shall provide and maintain, at its sole cost and expense, a policy of disability insurance covering the sickness, disability or incapacity of Kilkenny (the "Disability Policy"), the terms, extent of coverage (including the nature of disabilities cover thereby) and the issuer thereof shall be within the sole discretion of Kilkenny. In no event shall the Disability Policy provide for a monthly disability payment to Kilkenny of less than $5,000 per month in the event of his disability within the meaning of the Disability Policy. During any period from the date of the commencement of period that Kilkenny's is absent from work due to sickness, disability or incapacity and until commencement of his receipt of payments of the monthly disability benefits under the Disability Policy, Kilkenny shall continue to be entitled to receive and the Company shall pay and provide his regular compensation, bonus compensation and the other compensation and benefits, in accordance with and as provided in Sections 3.1 through 3.8 during the remaining Period of Employment. The Company hereby agrees and acknowledges that the Company undertakes and assumes the risk of all such disability, incapacity or inability of Kilkenny during the Period of Employment (except to the extent such risk is insured against pursuant to the Disability Policy) to perform the services contemplated by Section 2 by reason of sickness, disability, incapacity or other inability. Upon expiration of the Period of Employment, the Company shall assign and transfer to Kilkenny, without any payment therefore by Kilkenny, the Disability Policy in the event ownership thereof is not maintained in the name of Kilkenny. 4.2 Death. In the event Kilkenny shall die during the period Kilkenny is employed by the Company pursuant to this Agreement, this Agreement shall terminate effective on the last day of the month following the date of death, and the Company shall pay to the wife of Kilkenny, or if unmarried at the time of his death, to the estate of Kilkenny, the regular compensation and bonus compensation payable to Kilkenny pursuant to Sections 3.1 and 3.2 and for a period of three (3) months following the effective date of such employment termination pursuant to this Section 4.2, payable on the dates provided for such compensation payment there under. 4.3 Accrued Compensation; Benefits; Reimbursement. In the event of termination of this Agreement pursuant to Section 4.1 and/or Section 4.2 of this Agreement, Kilkenny (or his wife or if unmarried on the date of his death his estate) shall be entitled to receive accrued and unpaid expense reimbursements, automobile allowance and any unpaid bonus amounts awarded to Kilkenny prior to such termination and stock option grants awarded to Kilkenny prior to such termination exercisable in accordance with the terms of such stock option grants, as well as the benefits set forth Sections 3.10.3 and 3.10.4. 5. Termination for Cause. In the event the Board of Directors of the Company determines in good faith that Kilkenny is guilty of willful misconduct or gross negligence materially injurious to the Company in the performance of the services contemplated by this Agreement, the Company shall have the right, by resolution unanimously adopted by all members (other than Kilkenny) of the Board of Directors of the Company, to terminate this Agreement at the end of any month by giving not less than 60 days' prior written notice to Kilkenny of its election to so terminate this Agreement, and all obligations hereunder shall thereupon terminate thereafter, except for those obligations set forth in Sections 3.10.3 and 3.10.4. 6. Non-Competition. During the period Kilkenny is employed by the Company pursuant to this Agreement, Kilkenny may engage in any other employment or pursuit of other endeavors which does not conflict with his ability to perform his duties to the business interests of the Company, provided that such other employment or pursuit of other endeavors does not violate the duty of loyalty and care which EMPLOYMENT AGREEMENT PAGE 5 Kilkenny has to the Company by reason of this Agreement or in his capacity as an executive officer of the Company. 7. Confidentiality. During the period that Kilkenny is employed by the Company, and for a period of one year thereafter, Kilkenny will not divulge to anyone, other than the Company or persons designated by the Company in writing, any confidential material information directly or indirectly useful in any aspect of the business of the Company or any of its subsidiaries or affiliates, as conducted from time to time, as to which Kilkenny is now, or at any time during employment shall become, informed and which is not then generally known to the public or recognized as standard practice. 8. Certain Provisions to Survive Termination; Etc. Notwithstanding any termination of his employment under this Agreement, Kilkenny, in consideration of his employment hereunder to the date of such termination, shall remain bound by the provisions of Section 7, and consequently, in addition to all other remedies that may be available to it, the Company shall be entitled to injunctive relief for any actual or threatened violation of such Sections. 9. Non-Assignability. Neither party hereto shall have the right to assign this Agreement or any rights or obligations hereunder without the written consent of the other party. 10. Arbitration. Any controversy or claim arising out of or relating to this Agreement, or the breach thereof, shall be settled by arbitration in the City of Oklahoma City in accordance with the laws of the State of Oklahoma by three arbitrators, one of whom shall be appointed by the Company, one by Kilkenny and the third by the two arbitrators appointed by the Company and Kilkenny. If the arbitrators appointed by the Company and Kilkenny cannot agree on the appointment of a third arbitrator, then the third arbitrator shall be appointed by the Chief Judge of the United States District Court of the Western District of Oklahoma. The arbitration shall be conducted in accordance with the rules of the American Arbitration Association, except with respect to the selection of arbitrators which shall be as provided in this Section 10. Judgment upon the award rendered by the arbitrators may be entered in any court having jurisdiction thereof. In the event that is shall be necessary or desirable for Kilkenny to retain legal counsel and/or incur other costs and expenses in connection with the enforcement of any and all of his rights under this Agreement, he shall be entitled to recover from the Company reasonable attorneys' fees and costs and expenses incurred by him in connection with the enforcement of said rights, regardless of the final outcome. 11. Notice. All notices required or permitted to be given hereunder shall be in writing and shall be deemed to have been given forty-eight (48) hours after depositing in the United States mail, certified mail, postage prepaid, addressed to the party to receive such notice at the address set forth herein below or such other address as either party may give to the other in writing pursuant to written notice pursuant to this Section: If to Kilkenny: Mr. Timothy J. Kilkenny 3131 SW 89th Street, Apt 15102 Oklahoma City, OK 73159 If to the Company: FullNet Communications, Inc. 201 Robert S. Kerr Avenue, Suite 210 Oklahoma City, OK 73102 12. General. The terms and provisions herein contained (i) may be amended or modified only by a written instrument executed by the parties hereto, and (ii) shall be construed and enforced in accordance EMPLOYMENT AGREEMENT PAGE 6 with the laws in effect in the State of Oklahoma without regard to its conflicts of law provisions. Failure by a party hereto to require performance of any provision of this Agreement shall not affect, impair or waive such party's right to require full performance at any time thereafter. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the 31st day of July, 2002. "Company" FULLNET COMMUNICATIONS, INC. By: ------------------------------------------- Roger P. Baresel, Chief Financial Officer "Kilkenny" ---------------------------------------------- Timothy J. Kilkenny EMPLOYMENT AGREEMENT PAGE 7 EX-10.41 4 d04287exv10w41.txt EMPLOYMENT AGREEMENT WITH ROGER P. BARESEL EXHIBIT 10.41 EMPLOYMENT AGREEMENT THIS AGREEMENT is made and entered into this 31st day of July 2002, but is effective for all purposes as of the Commencement Date (as hereinafter defined), by and between FullNet Communications, Inc. (the "Company"), an Oklahoma corporation, and Roger P. Baresel ("Baresel"), an individual. WITNESSETH: WHEREAS, the Company and Baresel desire to enter into a long-term employment agreement on the terms and conditions hereinafter provided; NOW, THEREFORE, for and in consideration of the conditions herein below to be performed on the part of the respective parties hereto, and in consideration of the mutuality thereof, the parties hereto agree as follows: 1. Term of Employment. The Company hereby agrees to employ Baresel as Chief Financial Officer of the Company, and Baresel hereby accepts such employment and agrees to serve the Company as its Chief Financial Officer. The term of employment under this Agreement shall commence on January 1, 2002 (the "Commencement Date), and shall continue through December 31, 2004; provided, however, the term of this agreement shall automatically be extended for additional one-year terms, unless either party give notice of termination to the other on or before June 30 in the year of termination, commencing June 30, 2004 ("Period of Employment"). 2. Duties. Substantially all of the duties and responsibilities of Baresel, subject to such travel as the duties of Baresel hereunder may reasonably require, shall be performed by Baresel at and from the corporate offices of the Company in Oklahoma City, Oklahoma. 2.1 Time and Best Efforts. During the term of employment hereunder, Baresel shall be a full-time employee and shall devote his time, attention, skill, energy and best efforts as a full-time employee to the duties assigned to him from time to time as Chief Financial Officer by the Board of Directors of the Company, which duties shall be of the general character referred to in Section 2.2, and shall, but without obligation hereunder, serve the Company in the other executive officer positions to which he may be elected or appointed by the Board of Directors of the Company, subject to acceptance by Baresel of such other executive officer position or positions. Notwithstanding the foregoing, Baresel may (i) engage in other business pursuits or other endeavors which do not conflict with his ability to perform his duties on a best efforts basis to the business interests of the Company and (ii) become a director of other corporations and engage in charitable, civic and other similar pursuits; provided, however, that such other business pursuits or other endeavors do not interfere with his devoting his best efforts to his duties to the Company or violate the duty of loyalty and care which Baresel has to the Company by reason of this Agreement or in his capacity as an executive officer of the Company. 2.2 Supervision. As an employee and Chief Financial Officer of the Company (and other executive officer positions held by Baresel), Baresel shall be responsible for overseeing and managing the financial activities of the Company which shall be subject to the overall supervision and instructions of the Board of Directors of the Company. EMPLOYMENT AGREEMENT PAGE 1 3. Compensation and Other Benefits. During the Period of Employment, the Company shall pay or provide to Baresel, and Baresel shall be entitled to receive or have maintained for his benefit, for his services such compensation as the Board of Directors shall fix from time to time, but not less than the following amounts and benefits: 3.1 Regular Compensation. The salary paid by the Company to Baresel under this Section 3.1 shall be not less than $5,417 per month, such monthly salary shall be subject to not less than a five percent (5%) increase, on each January 1 during the Period of Employment, based upon the monthly compensation paid Baresel during the month of December immediately preceding the applicable January 1. Payment of such salary shall be made in installments in accordance with the Company's compensation payments to its other employees. Salary paid in accordance with this Section 3.1 shall be considered Baresel's "regular compensation." 3.2 Bonus Compensation. In addition to regular compensation, Baresel shall be eligible for annual bonuses that are not guaranteed and are to be determined by the Company's Board of Directors. 3.3 Grant of Stock Options. From time to time the Company may grant stock options to its executive officers as determined by the Board of Directors (or the Compensation Committee and/or Stock Option Committee established by the Board of Directors). To the extent that stock options are granted by the Board of Directors (or the Compensation Committee and/or Stock Option Committee established by the Board of Directors) to its executive officers, Baresel shall be deemed to be a member of the group to which stock options are granted, and his stock option grants shall be determined in the same manner as are the stock option grants of other executives in the group. In no event shall this Agreement have any effect upon the stock options granted to Baresel prior to the date of execution of this Agreement. 3.4 Entertainment, Travel and Similar Expense Reimbursement. Baresel is hereby authorized to incur reasonable expenses for the promotion of the Company's business, including entertainment, travel, lodging, meals, and similar expenses, and he shall be reimbursed therefore, by the Company upon his presentation of itemized accounts of such expenditures. 3.5 Health, Dental, and Disability Insurance Arrangements and Programs. The Company shall provide to Baresel (including coverage of the dependents of Baresel) health, medical, dental, and disability insurance benefits comparable to those provided to the executive officers of the Company either as a group or individually. 3.6 Vacation and Leave; Holidays. Baresel shall be entitled to (i) vacation leave with pay (at his regular compensation rate at the time such vacation leave is taken) during each calendar year of the Period of Employment, and (ii) reasonable periods of sick leave with pay (at his regular compensation rate at the time such sick leave is taken) commensurate with his position, in accordance with Company policy as established by the Board of Directors. Any annual vacation leave not taken by Baresel during a calendar year shall accumulate, and, at the option of Baresel, he may elect to receive his vacation compensation (at his regular compensation rate at the time of such election) in lieu of taking vacation leave. Baresel shall be entitled to all paid holidays observed by the Company. 3.7 Automobile and Cellular Phone. At Baresel's sole option, the Company shall (i) pay to Baresel an automobile allowance of five hundred dollars ($500) per month, payable on the first day of each month, or (ii) the use of a Company owned or leased automobile, the make and model to be selected and determined in Baresel's sole discretion and pay all costs and expenses of EMPLOYMENT AGREEMENT PAGE 2 operation, including without limitation insurance (in such amounts as mutually agreed upon by Baresel and the Company), gasoline, repairs, maintenance. Furthermore, and the Company shall provide to Baresel, at the sole cost and expense of the Company, a cellular phone to assist Baresel in the performance of his duties and responsibilities as an executive officer and employee of the Company. 3.8 Life Insurance. The Company shall provide to Baresel and maintain term insurance, at the Company's sole cost and expense, covering the life of Baresel in the face amount of $250,000 (the "Life Insurance Policy"), the proceeds of which shall be payable to such beneficiary that Baresel shall designate or, in the event of failure to designate a named beneficiary, shall be payable to the estate of Baresel. Upon expiration of the Period of Employment, the Company shall assign and transfer to Baresel, without any payment therefore by Baresel, the Life Insurance Policy in the event ownership thereof is not maintained in the name of Baresel. 3.9 No Limitation on Other Obligations of Company. No regular compensation or bonus compensation payment or the providing of any other compensation benefits to Baresel pursuant to this Agreement shall in any way limit or reduce any other obligation of the Company to Baresel as an employee of the Company. Baresel shall be entitled to participate in and receive benefits under any employee benefit plan or arrangement made available by the Company (both as of the effective date of this Agreement as well as in the future) to its employees or to any executive officer of the Company. 3.10 Employment Termination. In the event of (i) a termination (as defined below) of Baresel's employment with the Company prior to the end of the Period of Employment, or (ii) termination of Baresel's employment at the end of the Period of Employment, the Company shall pay or provide the following: 3.10.1 Lump Sum Payment of Regular Compensation and Bonus Compensation. The Company shall pay to Baresel (i) in a lump sum an amount equal to the regular compensation payments for the remainder of the Period of Employment at the salary rate of regular compensation as provided in Section 3.1 to which Baresel would have been entitled if Baresel had remained in the employ of the Company for the remainder of the Period of Employment, (ii) the automobile allowance, in such amount and payable in accordance with and as provided by Section 3.7 during the remainder of the Period of Employment, and (iii) payment of the insurance premiums on the policies of insurance required to be maintained by the Company in accordance with and as provided by Sections 3.8 and 4.1 during the remained of the Period of Employment. The lump sum payment pursuant to (i) of this Section 3.10.1 shall be paid to Baresel on or before the date of termination of Baresel's employment pursuant to Section 3.10. 3.10.2 Incentive Compensation and Stock Options. The Company shall provide Baresel with the following (or the value thereof): (i) incentive compensation (including, but not limited to, the right to receive and exercise stock options and stock appreciation rights and to receive restricted stock and grants thereof and similar incentive compensation benefits) to which Baresel would have been entitled under all incentive compensation plans maintained by the Company if Baresel had remained in the employ of the Company for the remainder of the Period of Employment; and EMPLOYMENT AGREEMENT PAGE 3 (ii) the employee benefits (including, but not limited to, coverage under medical, dental, disability and life insurance arrangements or programs) to which Baresel would have been entitled under all employee benefit plans, programs and arrangements maintained by the Company in the event Baresel had remained employed by the Company for the remainder of the Period of Employment. 3.10.3 Release of Personal Liability for the Company's Liabilities. The Company shall obtain the complete release of Baresel from all personal liability for any and all of the Company's debts, including but not limited to leases and promissory notes, and provide Baresel with acceptable proof (as determined in Baresel's sole discretion) of said release no later than ten business days prior to the last day of Baresel's employment by the Company. 3.10.4 Lump Sum Payment of Other Amounts Due Baresel. The Company shall pay to Baresel in a lump sum an amount equal to the sum of (i) all accrued but unpaid compensation that has been previously deferred due to the Company's financial difficulties, (ii) all amounts advanced and/or loaned by Baresel to the Company, and (iii) any and all other amounts due Baresel. The Company shall pay the lump sum payment pursuant to this Section 3.10.4 to Baresel on or before the last day of Baresel's employment. 3.11 Termination and Cause Defined. The term "termination" shall mean termination by the Company, upon 60 days' prior written notice to Baresel, of the employment of Baresel with the Company for any reason other than cause (as defined below), or resignation of Baresel upon the occurrence of either (i) a significant change in the nature or scope of Baresel's authorities or duties from those described in Section 2, a reduction in his compensation or breach by the Company of any other provision of this Agreement, (ii) a reasonable determination by Baresel that, as a result of a change in circumstances regarding his duties, he is unable to exercise his authorities, powers, functions or duties attached to his executive officer position or positions with the Company as contemplated in Section 2, or (iii) a change in control within the meaning of Section 3.12. The term "cause" means gross misconduct materially injurious to the Company or willful and material breach of this Agreement by Baresel that results in material injury to the Company. 3.12 Change of Control Defined. For purposes of this Agreement, each of the following specified events shall be deemed a "change of control": (i) any third person, including a "group" as defined in Sections 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended, becomes the beneficial owner of shares of the Company or of proxies or other rights pertaining to the Company which carry 25 percent or more of the total number of votes for the election of the Board of Directors of the Company or with respect to a merger, consolidation or sale; (ii) as result of, or in connection with, any cash tender offer, merger, or other business combination of the foregoing, the persons who were directors of the Company immediately prior to such event cease to constitute a majority of the Board of Directors of the Company; (iii) the approval of an agreement providing either for a transaction or series of transactions by which the Company will cease to be an independent publicly-owned company or for a sale, lease or other disposition of all or substantially all of the assets of the Company; (iv) the determination by Baresel, in his sole discretion, that a Change of Control has occurred; or following any public offering of securities of the Company during any period of 24 consecutive months the persons who were members of the Company's Board of Directors at the commencement of the period cease for any reason to constitute a majority of the Company's Board of Directors. EMPLOYMENT AGREEMENT PAGE 4 4. Disability or Death. 4.1 Disability. The Company shall provide and maintain, at its sole cost and expense, a policy of disability insurance covering the sickness, disability or incapacity of Baresel (the "Disability Policy"), the terms, extent of coverage (including the nature of disabilities cover thereby) and the issuer thereof shall be within the sole discretion of Baresel. In no event shall the Disability Policy provide for a monthly disability payment to Baresel of less than $3,334 per month in the event of his disability within the meaning of the Disability Policy. During any period from the date of the commencement of period that Baresel's is absent from work due to sickness, disability or incapacity and until commencement of his receipt of payments of the monthly disability benefits under the Disability Policy, Baresel shall continue to be entitled to receive and the Company shall pay and provide his regular compensation, bonus compensation and the other compensation and benefits, in accordance with and as provided in Sections 3.1 through 3.8 during the remaining Period of Employment. The Company hereby agrees and acknowledges that the Company undertakes and assumes the risk of all such disability, incapacity or inability of Baresel during the Period of Employment (except to the extent such risk is insured against pursuant to the Disability Policy) to perform the services contemplated by Section 2 by reason of sickness, disability, incapacity or other inability. Upon expiration of the Period of Employment, the Company shall assign and transfer to Baresel, without any payment therefore by Baresel, the Disability Policy in the event ownership thereof is not maintained in the name of Baresel. 4.2 Death. In the event Baresel shall die during the period Baresel is employed by the Company pursuant to this Agreement, this Agreement shall terminate effective on the last day of the month following the date of death, and the Company shall pay to the wife of Baresel, or if unmarried at the time of his death, to the estate of Baresel, the regular compensation and bonus compensation payable to Baresel pursuant to Sections 3.1 and 3.2 and for a period of three (3) months following the effective date of such employment termination pursuant to this Section 4.2, payable on the dates provided for such compensation payment there under. 4.3 Accrued Compensation; Benefits; Reimbursement. In the event of termination of this Agreement pursuant to Section 4.1 and/or Section 4.2 of this Agreement, Baresel (or his wife or if unmarried on the date of his death his estate) shall be entitled to receive accrued and unpaid expense reimbursements, automobile allowance and any unpaid bonus amounts awarded to Baresel prior to such termination and stock option grants awarded to Baresel prior to such termination exercisable in accordance with the terms of such stock option grants, as well as the benefits set forth Sections 3.10.3 and 3.10.4. 5. Termination for Cause. In the event the Board of Directors of the Company determines in good faith that Baresel is guilty of willful misconduct or gross negligence materially injurious to the Company in the performance of the services contemplated by this Agreement, the Company shall have the right, by resolution unanimously adopted by all members (other than Baresel) of the Board of Directors of the Company, to terminate this Agreement at the end of any month by giving not less than 60 days' prior written notice to Baresel of its election to so terminate this Agreement, and all obligations hereunder shall thereupon terminate thereafter, except for those obligations set forth in Sections 3.10.3 and 3.10.4. 6. Non-Competition. During the period Baresel is employed by the Company pursuant to this Agreement, Baresel may engage in any other employment or pursuit of other endeavors which does not conflict with his ability to perform his duties to the business interests of the Company, provided that such other employment or pursuit of other endeavors does not violate the duty of loyalty and care which EMPLOYMENT AGREEMENT PAGE 5 Baresel has to the Company by reason of this Agreement or in his capacity as an executive officer of the Company. 7. Confidentiality. During the period that Baresel is employed by the Company, and for a period of one year thereafter, Baresel will not divulge to anyone, other than the Company or persons designated by the Company in writing, any confidential material information directly or indirectly useful in any aspect of the business of the Company or any of its subsidiaries or affiliates, as conducted from time to time, as to which Baresel is now, or at any time during employment shall become, informed and which is not then generally known to the public or recognized as standard practice. 8. Certain Provisions to Survive Termination; Etc. Notwithstanding any termination of his employment under this Agreement, Baresel, in consideration of his employment hereunder to the date of such termination, shall remain bound by the provisions of Section 7, and consequently, in addition to all other remedies that may be available to it, the Company shall be entitled to injunctive relief for any actual or threatened violation of such Sections. 9. Non-Assignability. Neither party hereto shall have the right to assign this Agreement or any rights or obligations hereunder without the written consent of the other party. 10. Arbitration. Any controversy or claim arising out of or relating to this Agreement, or the breach thereof, shall be settled by arbitration in the City of Oklahoma City in accordance with the laws of the State of Oklahoma by three arbitrators, one of whom shall be appointed by the Company, one by Baresel and the third by the two arbitrators appointed by the Company and Baresel. If the arbitrators appointed by the Company and Baresel cannot agree on the appointment of a third arbitrator, then the third arbitrator shall be appointed by the Chief Judge of the United States District Court of the Western District of Oklahoma. The arbitration shall be conducted in accordance with the rules of the American Arbitration Association, except with respect to the selection of arbitrators which shall be as provided in this Section 10. Judgment upon the award rendered by the arbitrators may be entered in any court having jurisdiction thereof. In the event that is shall be necessary or desirable for Baresel to retain legal counsel and/or incur other costs and expenses in connection with the enforcement of any and all of his rights under this Agreement, he shall be entitled to recover from the Company reasonable attorneys' fees and costs and expenses incurred by him in connection with the enforcement of said rights, regardless of the final outcome. 11. Notice. All notices required or permitted to be given hereunder shall be in writing and shall be deemed to have been given forty-eight (48) hours after depositing in the United States mail, certified mail, postage prepaid, addressed to the party to receive such notice at the address set forth herein below or such other address as either party may give to the other in writing pursuant to written notice pursuant to this Section: If to Baresel: Mr. Roger P. Baresel 3509 Banner Court Edmond, OK 73013 If to the Company: FullNet Communications, Inc. 201 Robert S. Kerr Avenue, Suite 210 Oklahoma City, OK 73102 12. General. The terms and provisions herein contained (i) may be amended or modified only by a written instrument executed by the parties hereto, and (ii) shall be construed and enforced in accordance EMPLOYMENT AGREEMENT PAGE 6 with the laws in effect in the State of Oklahoma without regard to its conflicts of law provisions. Failure by a party hereto to require performance of any provision of this Agreement shall not affect, impair or waive such party's right to require full performance at any time thereafter. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the 31st day of July, 2002. "Company" FULLNET COMMUNICATIONS, INC. By: ------------------------------------------- Timothy J. Kilkenny, Chief Executive Officer "Baresel" ---------------------------------------------- Roger P. Baresel EMPLOYMENT AGREEMENT PAGE 7 EX-99.1 5 d04287exv99w1.txt CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to 18 U.S.C. Section 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002), I, the undersigned President and Chief Executive Officer of FullNet Communications, Inc. (the "Company"), hereby certify that, to the best of my knowledge, the Annual Report on Form 10-KSB of the Company for the year ended December 31, 2002 (the "Report") fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 28, 2003 /s/ Timothy J. Kilkenny, ----------------------- President and Chief Executive Officer EX-99.2 6 d04287exv99w2.txt CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to 18 U.S.C. Section 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002), I, the undersigned Chief Financial and Accounting Officer of FullNet Communications, Inc. (the "Company"), hereby certify that, to the best of my knowledge, the Annual Report on Form 10-KSB of the Company for the year ended December 31, 2002 (the "Report") fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 28, 2003 /s/ Roger P. Baresel, -------------------- Chief Financial and Accounting Officer -----END PRIVACY-ENHANCED MESSAGE-----