-----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, MGMfVKSKlkdmTnczzvxQQ3/4sdLhkpfBwANUkHWIVRlosnNVvE8TZNcY+Cw7fLcX bMP2WvTvTNvXjqYcg8pR3Q== 0001029737-98-000325.txt : 19981208 0001029737-98-000325.hdr.sgml : 19981208 ACCESSION NUMBER: 0001029737-98-000325 CONFORMED SUBMISSION TYPE: 10KSB/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970831 FILED AS OF DATE: 19981207 FILER: COMPANY DATA: COMPANY CONFORMED NAME: WAVETECH INTERNATIONAL INC CENTRAL INDEX KEY: 0000799694 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 860916826 STATE OF INCORPORATION: NV FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10KSB/A SEC ACT: SEC FILE NUMBER: 000-15482 FILM NUMBER: 98764732 BUSINESS ADDRESS: STREET 1: 5210 E WILLIAMS CIRCLE STREET 2: STE 200 CITY: TUCSON STATE: AR ZIP: 85711 BUSINESS PHONE: 5207509093 MAIL ADDRESS: STREET 1: 5210 E WILLIAMS CIRCLE CITY: TUCSON STATE: AZ ZIP: 85711 FORMER COMPANY: FORMER CONFORMED NAME: WAVETECH INC DATE OF NAME CHANGE: 19920703 10KSB/A 1 AM #2 TO FORM 10-KSB FOR FYE AUGUST 31, 1997 U. S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB/A Amendment No. 2 (MARK ONE) [X] Annual report under section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee Required) for the fiscal year ended August 31, 1997. [ ] Transition report under section 13 or 15(d) of the Securities Exchange Act of 1934 (No Fee Required) for the transition period from ____________ to ___________. Commission file number: 0-15482 WAVETECH, INC. (Name of small business issuer in its Charter) New Jersey 22-2726569 (State or other jurisdiction (IRS Employer of incorporation) Identification Number) 5210 E. Williams Circle, Suite 200 Tucson, Arizona 85711-4410 (Address of Principal Executive Offices) Registrant's Telephone Number: (520) 750-9093 -------------- Securities to be registered under Section 12(g) of the Act: Name of each exchange Title of Each Class on which registered ------------------- --------------------- None None Securities to be registered under Section 12(b) of the Act: Common Stock $.001 par value (Title of Class) The undersigned Registrant hereby amends, in its entirety, its Annual Report on Form 10-KSB for the Fiscal Year Ended August 31, 1997, as follows: Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 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 [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of 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. [ ] State issuer's revenues for its most recent fiscal year: $719,142. The aggregate market value of the Common Stock of the registrant held by non-affiliates as of November 28, 1997 was approximately $5,187,772 based on the average high and low bid prices for such Common Stock as reported on the Nasdaq SmallCap System. The number of shares of Common Stock outstanding as of November 28, 1997 was 15,141,364. The aggregate number of Redeemable Common Stock Purchase Warrants outstanding as of November 28, 1997 were 3,119,630. Documents Incorporated by Reference - Various like numbered exhibits from the Company's 1987 Registration Statement File No. 33-8353; Post-Effective Amendment No. 1 to Form S-18 Registration Statement, SEC File No. 33-8353 filed September 2, 1988; Form 10-K for the fiscal year ending August 31, 1991. Transitional Small Business Disclosure Format (Check One): Yes [ ] No [X] 2 PART I ITEM 1. DESCRIPTION OF BUSINESS THIS ANNUAL REPORT ON FORM 10-KSB CONTAINS CERTAIN "FORWARD-LOOKING STATEMENTS," INCLUDING STATEMENTS REGARDING, AMONG OTHER ITEMS, THE COMPANY'S GROWTH STRATEGY AND ANTICIPATED TRENDS IN ITS BUSINESS. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE FORWARD-LOOKING STATEMENTS AS A RESULT OF A NUMBER OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THE COMPANY'S NEED FOR ADDITIONAL FINANCING, INTENSE COMPETITION IN VARIOUS ASPECTS OF ITS BUSINESS AND VARIOUS OTHER FACTORS DESCRIBED UNDER "RISK FACTORS" AND ELSEWHERE HEREIN, AS WELL AS THE COMPANY'S PUBLICLY AVAILABLE DOCUMENTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. (A) BUSINESS DEVELOPMENT COMPANY PROFILE Wavetech, Inc. (hereinafter referred to as the "Company" or "Wavetech") was incorporated in the State of New Jersey on July 10, 1986. The Company became subject to the reporting requirements of the Securities Exchange Act of 1934 (the "Exchange Act") by filing and registering with the Securities and Exchange Commission a Form S-18 under the Securities Act of 1933; 400,000 units, each unit consisting of three shares of Common Stock and one Class A and one Class B redeemable Common Stock purchase warrant. Its Registration Statement became effective on February 11, 1987. A total of 400,000 units were sold at the offering price of $6.75 per unit for gross total proceeds of $2,700,000. The Company's Common Stock is listed on the Nasdaq SmallCap Market under the symbol "ITEL." WAVETECH SUBSIDIARIES INTERNATIONAL ENVIRONMENTAL SERVICES CORPORATION. On June 6, 1991, Wavetech acquired all of the outstanding stock of International Environmental Services Corporation (hereinafter referred to as "IES"), a privately held Delaware corporation, in exchange for 8,000,000 shares (400,000 shares after the 1-20 split) of the company and a $5 per cubic yard royalty payment on IES's future operations, if any. IES has not derived any revenue from its operations. IES was incorporated in 1988 and at the time of its acquisition reported as its sole asset approximately 1,000 acres of real property located in Carroll County, Ohio. The property was acquired by IES for the purpose of converting all, or a portion thereof, to a non-hazardous sanitary landfill facility. In November 1995, Wavetech was advised that all of the land was sold to satisfy real estate taxes in arrears by Carroll County, Ohio. This tax sale was consummated in April 1994. The Company intends to pursue legal recourse to recover the value of the land from responsible parties. 3 Following the acquisition of IES, Wavetech was comprised of two divisions: An Environmental Laboratory Testing and Engineering Division through a wholly-owned subsidiary, Applied Environmental Technology, Inc. ("Applied") and a Landfill Development & Management Division ("IES"). During the year ended August 31, 1995, Wavetech, with the then President abstaining, voted to sell the stock of Applied to the father of the then President. This divestiture occurred before March 8, 1995, during the year ended August 31, 1995, resulting in Wavetech having no further liabilities nor assets on its balance sheet associated with Applied. INTERPRETEL, INC. On March 8, 1995, Wavetech, Inc. ("Wavetech") entered into an agreement with Interpretel, Inc. ("Interpretel") pursuant to which Wavetech agreed to issue 6,000,000 shares of its Common Stock in exchange for 100% of the outstanding 1,532,140 shares of Common Stock of Interpretel. The transaction resulted in the former shareholders of Interpretel owning approximately 80% of the outstanding shares of Wavetech. The Acquisition agreement also provides that during the three year period following the March 8, 1995 closing, former shareholders of Interpretel are entitled to receive an additional 7,500,000 Common Shares of Wavetech through an "earn-out" based upon before tax net profit. During the two year period following closing, former shareholders of Interpretel could earn up to 3,750,000 Common Shares of Wavetech for every $0.50 net profit before taxes, and an additional 3,750,000 Common Shares of the Wavetech for every $1.00 of cumulative total net profit before taxes. During the third year following closing, any shares not previously issued pursuant to this agreement can be earned at $1.50 net profit before taxes per share. To date, no additional shares have been issued pursuant to the "earn out." Interpretel is a facilities based telecommunication company using an advanced computer telephony platform to deliver enhanced calling card services. Incorporated in the state of Arizona in September of 1993, the Company was formed to create a simple calling card product featuring direct access to over-the-phone language interpreters with services provided by AT&T Language Line. Employing a digital computer/telephony integrated platform (switch) as a back-bone, the company's products and services have evolved significantly to capitalize on features and capabilities of the system. The Company now focuses on highly customized and branded, enhanced calling cards, virtual office and interactive marketing applications. Since its inception, Interpretel has focused on creating an infrastructure to support product development, administration, sales, marketing, and customer support. Following the acquisition of Interpretel by Wavetech, the former principals of Interpretel were elected to serve as the management for the newly-structured corporation. INTERPRETEL (CANADA) INC. On March 10, 1995, Interpretel (Canada) Inc. was incorporated under the laws of the Province of Ontario as a wholly owned subsidiary of Interpretel, Inc. It was formed to secure a long distance reseller's registration and license in that country through the Canadian Radio 4 and Television Commission (CRTC), which is the equivalent of the FCC in Canada. This reseller's license qualifies Interpretel (Canada) Inc. to operate as a reseller of long distance services and secure contracts with Canadian corporations and organizations as a Canadian entity. Interpretel (Canada) Inc. is essentially a sales and customer service operation. TELPLEX INTERNATIONAL COMMUNICATIONS, INC. On January 1, 1997, the Company acquired certain intangible assets of Telplex, Inc., an Arizona corporation, in exchange for $25,000 in cash. These assets, which consisted primarily of goodwill, an international long distance wholesaler's license, a few customer contracts for the resale of switchless international long distance numbers, as well as a non-compete agreement from the owner of Telplex, Inc., were acquired by the Company through its new wholly-owned subsidiary Telplex International Communications, Inc. ("Telplex"). The Company did not assume any of the liabilities of Telplex, Inc. (B) BUSINESS OF ISSUER AND SUBSIDIARIES The Company conducts most of its operations through its wholly-owned subsidiary, Interpretel. Interpretel is a facilities based telecommunication company using an advanced computer telephony platform to deliver enhanced calling card services. The Company's products are highly customized and branded for specific distributor applications and feature a single point of access, via any touch-tone telephone, to a suite of information and communication services. Sample services include: world-wide direct calling; instant conference calling; over-the-phone language interpretation supporting over 100 languages; fax-based language translation; news, weather and sports headlines; integrated voice and fax mail; integration with customer call centers; and in Canada, Dun & Bradstreet Express business services, and legal consultations and referrals. All services are billed on a post-pay basis directly to the subscriber, usually via a credit card. Positioned as an added-value service, principal benefits to distributors include: cost-effective information distribution and interactive marketing and promotion capability. The product also becomes a customer retention vehicle and new profit center. Since its inception, Interpretel has focused primarily on the development of product specifications, proprietary application software (including call-processing, billing, membership and customer service database software), execution of vendor contracts, development of corporate infrastructure (including customer service, sales and marketing divisions, regional sales staff), design and printing of product and marketing brochures, and strategic planning for international business development. The Company's software packages are tightly integrated into a state-of-the-art communications system creating a platform network that can be duplicated throughout the world as the Company proceeds with its international expansion plans. 5 The Company has issued a tariff, bearing F.C.C. Tariff No. 2, filed in compliance with the requirements of the Communications Act of 1934, as amended, with the Federal Communications Commission. Interpretel has a staff of five employees, of which four were employed on a full-time basis. The Company currently has operations underway in the United States and Canada, and in Australia through a licensing agreement with Switch Telecommunications Pty Ltd. FEATURES AND CAPABILITIES OF THE COMPANY'S INTERACTIVE SYSTEM The Company's call-processing architecture is a UNIX-based multi-tasking digital call-processing system integrated with a Tandem database server, which provides the ability to manage a wide range of diverse applications on a single platform. The Company believes that its systems computer telephony integration technology is "leading edge," is highly robust, modularly designed and can support virtually limitless expansion and capacity. The system offers direct T-1/DS-3 connectivity with the public telephone network and is networked remotely for customer service/database management. The Company's database management system is currently managed and administered from its corporate offices in Tucson, Arizona, with the call processing platforms located in Lincoln, Nebraska. Plans are currently underway to locate call processing platforms in Toronto to support Canadian operations. In Sydney, Australia, a fully operational system is supporting customer traffic for the Company's first international licensing partner, Switch Telecommunications Pty Ltd. From 1994 through 1997, the Company remained focused on the development of the infrastructure for its call-processing and data management systems. Although the Company has signed major distributor agreements over the last three years, results are not expected to be commercially realized until at least early 1998. The Company currently offers the following programs: 1. THE INTERPRETEL TRAVELER CARD. Designed for worldwide business and travel use, this application offers voice and fax mail with pager notification; over-the-phone language interpretation; fax-based document translation; 12-way conference calling; news and sports headlines; and access to domestic and international calling card long distance service. Line charges are billed to the subscriber's credit card of choice. The Company is considering distribution of this program through a direct mail initiative or promotional program. 2. THE AFFINITY CARD PROGRAM. Building on the Interpretel Card, this program allows a company to brand and fully customize services including 6 integration of Interpretel's communication features with their own services. The Company currently has Affinity Card programs with Diners Club International and Delta Hotels and Resorts, among others. The Affinity Card Program constitutes the cornerstone of the Company's current marketing and sales initiatives. 3. THE VIRTUAL OFFICE PROGRAM. Built as a customized "affinity" product and featuring many of the same services as the Interpretel Traveler Card, this product is positioned for the Small Office/Home Office (SOHO) market and uses a private '888' number for access. Unique to this program is a "follow-me" function which dials and searches multiple phone numbers locating the subscriber. As a new initiative, during fiscal 1998, the Company intends to commence marketing this product to multi-level sales organizations. 4. THE INTERACTIVE MARKETING PROGRAM. The Company's advanced call-processing system can be used for non-card based applications, including interactive voice response, fax-backs, surveys/polling and meet-me conferencing systems. The modular call-processing architecture allows easy creation of applications with virtually no limit. As the Company builds its sales and marketing infrastructure, this program will receive greater attention in the future. STRATEGIES FOR THE FUTURE The Company believes it is positioned to significantly expand its customer base and penetrate new markets. The Company's proprietary interactive call-processing software and related systems are designed to address the needs of the international customer and be easily integrated into foreign telecommunication networks. The Company intends to develop additional licensing agreements similar to the agreement signed with Switch Telecommunications Pty Ltd for Southeast Asia. As companies are shifting from mass-marketing initiatives to "one-on-one interactive" marketing, the Company believes it is uniquely and strategically positioned for growth by enabling businesses to customize and personalize their marketing initiatives using the Company's interactive telecommunication systems. The Company intends to aggressively pursue the following growth strategies: SEEK OUT ATTRACTIVE ACQUISITION, MERGER AND JOINT VENTURE OPPORTUNITIES. The Company believes there exist several unaffiliated third parties whose operations or assets would complement the Company's products and services. The Company intends to seek out potential acquisitions, mergers, joint ventures or other partnerships as they arise. However, to date, the Company has no binding agreements for any such opportunities. See "Risk Factors--Uncertainty of Strategic Relations," "--Potential Acquisitions" and "--Need for Additional Financing." 7 FOCUS ON EXPANSION INTO INTERNATIONAL MARKETS. The Company intends to aggressively seek expansion into international markets. To date, the Company has executed a licensing agreement with Switch Telecommunications Pty Ltd for use of the Company's platforms in Southeast Asia. Switch Telecommunications is operational and is currently marketing and distributing products and services from the Interpretel System. The Company expects to receive royalty payments on the sales of these products and services over the next year, however, that amount is not yet readily determinable. The Company believes that its technology can be readily adaptable to a variety of foreign communications networks and that significant demand exists in international markets for the Company's services. See "Risk Factors--Risks Associated with International Expansion." EXPAND SALES AND MARKETING EFFORTS. The Company's operations to date have consisted principally of developing its technology and product offerings. The Company intends to increase revenues by expanding its base of users through direct sales and marketing efforts, as well as through affiliations with other third parties. See "Risk Factors--Competition." ITEM 2. DESCRIPTION OF PROPERTY The Company leases its office and administrative space at 5210 E. Williams Circle, Suite 200, Tucson, Arizona 85711. The lease expires November 30, 2001, and requires the Company to make payments thereunder in an average amount of approximately $8,400 per month over the term of the lease. ITEM 3. LEGAL PROCEEDINGS Applied Environmental Technology, Inc. (Applied') was named as a defendant in a lawsuit filed by Long Beach Memorial Hospital (the "Hospital") on July 30, 1992 and, in December 1994, Wavetech, Inc. was added as a party defendant in the filing of an Amended Complaint. The Hospital alleges to have sustained damages as a result of certain errors and emissions by Applied in performing the engineering of asbestos removal for the Hospital. Litigation counsel for Applied believes that there are adequate defenses to the action and now believe that the action will be dismissed. Litigation counsel has also advised Wavetech, Inc. that the Statute of Limitations has expired on this action. On March 14, 1996, Steven A. Ezell ("Ezell"), a former officer of the Company, sued the Company and two of its current officers and directors in the Superior Court of the State of Arizona in an action titled EZELL VS. WAVETECH, 8 INC., GERALD I. QUINN AND TERENCE E. BELSHAM. The Complaint alleges that the Company breached its employment contract with Ezell and that Messrs. Quinn and Belsham tortiously interfered with Ezell's employment contract with the Company. The complaint seeks unspecified compensatory damages, including costs and attorney's fees. The Company believes Ezell's claims have no merit and intends to vigorously defend this action. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET PRICE FOR THE COMPANY'S SECURITIES The Company's Common Stock is quoted on the Nasdaq SmallCap Market. The high and low bid prices of the Company's Common Stock as reported by Nasdaq from September 1, 1995 through August 31, 1997 by fiscal quarters (i.e. 1st Quarter = September 1 through November 30) were as follows: 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr -------------- -------------- -------------- -------------- High Low High Low High Low High Low ------ ----- ------ ----- ------ ----- ------ ----- 1996 Common Stock 2-1/16 3/4 1-3/8 3/4 2-1/8 3/4 2 3/4 1997 Common Stock 1-1/16 17/32 1-1/32 1/4 15/16 11/32 3/4 5/16 The bid and the asked price of the Company's Common Stock on November 28, 1997 were 15/32 and 7/16, respectively. As of November 28, 1997, the Company had 173 shareholders of record of its Common Stock. As of February 1997, the Company had 1,496 shareholders that beneficially own the stock in the name of various brokers. The Company has never declared a dividend and does not plan to declare a dividend of cash on Wavetech, Inc. Common Stock in the future. 9 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OPERATIONS OVERVIEW The Company's business consists of developing, operating, marketing and selling interactive communication systems through the application of "intelligent" call processing technology and proprietary software to reflect or target the needs of an identified audience. These systems are often used as privatized networks for organizations and special purpose groups. During 1995 and 1994, the Company remained focused on the development of the infrastructure for its call processing and data management systems. Operations in the USA and Canada commenced on a limited basis in 1996. The Company signed an Equipment and Software Turnkey Agreement with Switch Telecommunications Pty Ltd of Australia. On June 30, 1998, an agreement was reached between the Company and Switch which terminated the license agreement and any future obligations thereunder. Consideration of $150,000 was received on July 10, 1998 in connection with this agreement. The Company will recognize income in connection with the termination of $86,906 unamortized deferred revenue and $150,000 of termination fee revenue. On June 30, 1998, an agreement was reached between the Company and Switch which sets forth the terms and conditions of a put option for the shares of common stock of Switch, which are owned by the Company. The sale price is $2,100,000 and the term of the option is one year. On August 25, 1998, the Company exercised the put option thereby selling its entire interest in Switch. On August 31, 1998, the Company received $2,100,000 in satisfaction of the option agreement. The Company will recognize a loss of $216,165 upon disposition of the investment. Wavetech has 300 cardholders on its system. The Company acquired 65 new customers during this period. Wavetech is not currently attempting to implement new solicitation and marketing initiatives in an attempt to conserve capital to complete the Merger. Therefore, the number of active subscribers on the system has remained fairly constant over the periods presented in the financial statements. The Company gains a small percentage of new subscribers each month from previous promotions. However, the Company also loses a small percentage of subscribers each month due to normal attrition. RESULTS OF OPERATIONS TWELVE MONTHS ENDED AUGUST 31, 1997 COMPARED TO TWELVE MONTHS ENDED AUGUST 31, 1996 REVENUES. The Company, after completing the development of its back end systems during the last quarter of 1996 and the first quarter of 1997, commenced operations. Revenues increased to $719,142 in 1997 from $19,895 in 1996. Revenues from the resale of international long distance minutes were $149,155 in 1997 due to the asset purchase of Telplex, Inc. Revenues from the sale of enhanced calling card services, such as long distance, voice and fax mail and news services, increased by $21,511. An increase of $474,106 was due to the sale of the Interpretel System, which consisted of a computer platform and related 10 software, to Switch Telecommunications Pty Ltd in Australia. During 1997 the Company received $200,000 per the terms of the licensing agreement with Switch. A total of $500,000 for a seven-year license is to be paid over a period of three years. An increase of $53,571 in revenue represents the amount recognized pursuant to this licensing agreement with Switch for the period ended August 31, 1997. During the year ended August 31, 1997, Switch did not pay any royalty fees to the Company. The Company was unable to determine the amount due because of disagreements related to the modifications required for compatibility with Australian signaling and the final installation date of the system. These differences precluded Switch from providing the necessary information to compute the royalty fees. In lieu of negotiating a working resolution to these issues, the Company agreed to terminate the licensing agreement with Switch. Effective June 30, 1998, an agreement was reached between the Company and Switch terminating the license agreement. Switch agreed to pay the Company $150,000 in consideration of the termination of the agreement. The payment was received on July 10, 1998. COST OF SALES. Cost of sales increased to $679,930 in 1997 from $179,068 in 1996. $378,009 of the increase was related to the hardware and third party software costs for the sale of the Interpretel System to Switch in 1997. Costs related to the resale of international minutes were $125,766. A direct mail marketing campaign was initiated during 1997 resulted in increased costs for marketing and fulfillment collateral of $69,218. Hardware and software upgrades to the Interpretel System to accommodate the anticipated usage from new contracts increased costs by $15,673. During the twelve months ended August 31, 1997, the positions of National Sales Director and several salaried sales representatives were eliminated thereby reducing costs by $62,062. The positions were eliminated as the Company decided to market its service through direct mail rather than a national sales force. Another existing officer assumed direction of marketing efforts. During 1997, a change was made in the outsourced call center used by the Company to handle customer service calls, resulting in a decrease to costs of $17,336. DEVELOPMENT COSTS. Development costs decreased due to completion of the development of the back end systems during the last quarter of 1996. Fiscal 1996 development costs were $297,935. During fiscal 1997 there were no additional or ongoing development costs as development had been completed. Continued costs of maintaining the system were charged to operations. GENERAL AND ADMINISTRATIVE EXPENSES. Expenses increased to $1,584,747 in 1997 from $1,287,386 in 1996. The total $1,585,747 expenses in 1997 included $634,159 in payroll and related expenses; $232,279 for legal and other professional fees; $141,873 for platform services and fees; $128,725 for investor relation expenses; $88,598 for rent; $57,497 to develop and print general Company marketing collateral; $50,048 for overhead costs associated with the asset purchase of Telplex, Inc.; and $41,935 in travel related expenses. The major increases in expenses for the twelve months ended August 31, 1997 as compared to the twelve months ended August 31, 1996 came in the area of investor relations, which added $128,725 during 1997. Investor relations expenses included fees for consulting services of an investor relations firm, 11 and annual meeting expenses, such as preparation of the proxies and mailing costs. Certain officers of the Company also attended a major investor relations conference during 1997. Other significant expense increases came from overhead costs of $50,048 associated with the asset purchase of Telplex, Inc. Fees for the Company's platforms, space rental and maintenance increased by $48,000. Legal and professional fees rose in 1997 by $37,175. Development of general Company marketing collateral increased general marketing expense by $24,544. DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization costs increased to $211,786 for the twelve months ended August 31, 1997 from $136,902 for the twelve months ended August 31, 1996, due to additional asset purchases. INTEREST EXPENSE. Interest expense increased to $26,893 in 1997 from $11,585 in 1996. The increase was primarily due to notes payable obtained to meet working capital. INCOME TAXES. Wavetech has neither provided for, nor paid any, federal income taxes since its inception because the Company has not generated taxable income in any fiscal year. At August 31, 1997, the Company had net operating loss carryforwards totaling approximately $7,764,000 that may offset future income from 1997 to 2011 with varying expiration dates. No tax benefit has been recorded in the financial statements since realization of net operating loss carryforwards does not appear likely. The potential benefit of the net operating loss carryforwards and the deferred tax benefit of future timing differences under SFAS No. 109 is approximately $2,298.000. The March 8, 1995 acquisition agreement between the Company and Interpretel resulted in a "change of control" as defined by the Internal Revenue Service Regulations. Accordingly, the utilization of the Company's net operating loss carryforwards are deemed more likely than not to expire unutilized. Future financings may cause additional changes in ownership and further limitations on the use of federal net operating loss carryforwards. LIQUIDITY AND CAPITAL RESOURCES At August 31, 1997 the Company had a working capital deficit of $650,761 as compared to working capital of $665,483 at August 31, 1996. The Company borrowed $122,000 from certain Board Members in order to address the working capital needs. As a result of inadequate funds during the last quarter the Company entered into agreements with its employees to compensate such persons' salary with a number of shares of the Company's Common Stock with a fair market value on the last day of a regular pay period equal to each respective employee's salary plus a 10% premium as consideration for entering into such agreements. All of the shares were issued as Deferred Shares pursuant to the Company's 1997 Stock Incentive Plan. As part of this strategy to preserve capital, the Company was aggressively pursuing a number of financing, merger and acquisition opportunities. The Company signed an investment banking agreement with Stern, Agee and Leach to assist in evaluating the opportunities available for re-capitalizing the Company. Short-term debt financing, to be repaid within twelve months, was secured during this period while longer-term solutions, with repayment terms greater than twelve months, were pursued with the investment bankers. 12 If the Company succeeds in acquiring additional financing, such efforts may result in additional dilution to the Company's stockholders; impose restrictions upon the Company's ability to incur additional debt, pay future dividends, enter into future business combinations or other restrictions upon the Company to act in a manner which its Board of Directors may deem advisable; or result in a change in control of the Company. The ability of the Company to continue as a going concern is dependent upon increasing sales and obtaining additional capital and financing. There can be no assurance that the Company will be successful in improving its financial condition, and to the extent it is unsuccessful it may become insolvent, forcing it to suspend or even cease its operations. INFLATION Although the Company's operations are influenced by general economic trends and, specifically, technology advances in the telecommunications industry, the Company does not believe that inflation has had a material impact on its limited operations. (B) RISK FACTORS THIS ANNUAL REPORT ON FORM 10-KSB CONTAINS "FORWARD-LOOKING STATEMENTS," INCLUDING STATEMENTS REGARDING, AMONG OTHER ITEMS, THE COMPANY'S GROWTH STRATEGY, FUTURE PRODUCTS, SALES, ABILITY TO LICENSE FUTURE PRODUCTS AND MARKET PRODUCTS AND ANTICIPATED TRENDS IN THE COMPANY'S BUSINESS. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF A NUMBER OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THE NEED FOR ADDITIONAL FINANCING, INTENSE COMPETITION IN VARIOUS ASPECTS OF ITS BUSINESS, ITS DEPENDENCE ON THIRD PARTY CONSULTANTS AND KEY PERSONNEL, AND OTHER FACTORS DESCRIBED IN THE "RISK FACTORS" SECTION SET FORTH BELOW AND ELSEWHERE HEREIN. LIMITED OPERATING HISTORY; PREVIOUS LOSSES. The Company was incorporated in 1995, however, it did not have any significant business operations until 1997. Accordingly, the Company has only a limited operating history upon which an evaluation of the Company and its prospects can be based. The Company's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stages of development --- particularly companies in new and rapidly evolving markets such as the Company's. To address these risks, the Company must, among other things, respond to competitive developments, attract, retain and motivate qualified personnel and upgrade its technologies and commercialize services utilizing such technologies. There can be no assurance that the Company will be successful in addressing such risks. The Company has incurred net losses of approximately $(1,775,714), $(1,860,204) and $(1,055,099) during each of the three most recent fiscal years. The Company recorded revenues for the quarter ended February 28, 1997, but there can be no assurance that the Company will record a profit or, if so, will be able to sustain growth and profitability. FACTORS AFFECTING OPERATING RESULTS; POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS. The Company's operating results have varied significantly in the past and may vary significantly in the future. Special factors that may cause the Company's future operating results to vary include the unique nature of 13 strategic relationships into which the Company may enter in the future, changes in operating expenses resulting from such strategic relationships and other factors, the continued acceptance of the Company's licensing program, the financial performance of the Company's licenses, the timing of new services, announcements, market acceptance of new and enhanced versions of the Company's services, potential acquisitions and changes in legislation and regulation that may affect the competitive environment for the Company's communications services and general economic and seasonal factors, among others. In the future, revenues from the Company's strategic relationships may become an increasingly significant portion of the Company's total revenues. Due to the unique nature of each strategic relationship, these relationships may change the Company's mix of expenses relative to revenues. In addition, the Company's royalties from Switch Telecommunications Pty Ltd ("Switch") may be adversely affected if Switch experiences equipment failure, cannot secure reasonable long distance rates from an Australian telecommunications company in a highly regulated monopoly market or its equipment becomes redundant or obsolete. Quarterly revenues are difficult to forecast because the market for the Company's information and telecommunications services is rapidly evolving. The Company's expense levels are based, in part, on its expectations as to future revenues. If actual revenue levels are below expectations, the Company may be unable or unwilling to reduce expenses proportionately and operating results would likely be adversely affected. As a result, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Due to all of the foregoing factors, among others, it is likely that in some future quarter the Company's operating results will be below the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock will likely be adversely affected. INTENSE COMPETITION. The information and telecommunications services industries are intensely competitive, rapidly evolving and subject to rapid technological change. The Company expects competition to increase in the future. Many of the Company's current and potential competitors have longer operating histories, greater name recognition, larger customer bases and substantially greater financial, personnel, marketing, engineering, technical and other resources than the Company. There can be no assurance that the Company will be able to successfully compete with such entities. As a result, such competition could materially adversely affect the Company's business, operating results and financial condition. The Company attempts to differentiate itself from its competitors by offering an integrated suite of information and communications services. A number of other providers currently offer each of the individual services and certain combinations of the services offered by the Company. The Company's worldwide long distance services and features, such as conference calling, compete with services provided by companies such as AT&T, MCI and Sprint Corporation ("Sprint"), as well as smaller interexchange long distance providers. The Company's voice mail services compete with voice mail services provided by certain regional bell operating companies ("RBOCs") as well as by independent voice mail vendors such as Octel Communications Corporation. The Company's proposed enhanced travel services, concierge services, new services and electronic mail services are expected to compete with the services of other 14 computer telephony companies such as Premier Technologies (WorldLink), VoiceNet, among others. The Company also expects that other parties will develop and implement information and telecommunications service platforms similar to that of the Company, thereby increasing competition for the Company's services. In addition, the Telecommunications Act of 1996 allows local exchange carriers, including the RBOCs to provide inter-LATA long distance telephone service, which will likely significantly increase competition for long distance services. The new legislation also grants the Federal Communications Commission ("FCC") the authority to deregulate other aspects of the telecommunications industry, which in the future may, if authorized by the FCC, facilitate the offering of an integrated suite of information and telecommunications services by regulated entities, including the RBOCs, in competition with the Company. Such increased competition could have a material adverse effect on the Company's business, operating results and financial position. See "--Regulation." Telecommunication companies often compete for consumers based on price, with major long distance carriers conducting extensive advertising campaigns to capture market share. Many of the Company's competitors can offer lower rates to consumers as a result of higher gross revenues. As a result, the Company may be required to reduce the prices at which it offers services in order to remain competitive. A decrease in the rates charged for communications services by the major long distance carriers or other competitors, whether caused by general competitive pressures or the entry of the RBOCs and other local exchange carriers into the long distance market, could have a material adverse effect on the Company's business, operating results and financial condition. The Company expects that the information and telecommunications services markets will continue to attract new competitors and new technologies, possibly including alternative technologies that are more sophisticated and cost effective than the Company's technology. The Company does not have the contractual right to prevent its subscribers from changing to a competing network, and the Company's subscribers may generally terminate their services with the Company at will. If the Company is unable to compete with emerging technologies or services, it may lose customers and, as a result, its business and operating results may be materially adversely affected. The personal telecommunications products industry is intensely competitive and subject to rapid change. The Company believes that the principal competitive factors affecting the markets for its products include customer service, content, quality, price, marketing, distribution, uninterrupted service and proprietary technology. In addition, consumer demand for particular telecommunications products may be adversely affected by the increasing number of competitive products from which to choose, making it difficult to predict the Company's future success in producing personal telecommunications products for the retail market. TECHNOLOGICAL CHANGE; DEPENDENCE ON NEW SERVICES. The information and telecommunications services markets are characterized by rapid technological change, frequent new product introductions and evolving industry standards. The Company's future success will depend in significant part on its ability to anticipate industry standards, continue to apply advances in technologies, 15 enhance its current services, develop and introduce new services on a timely basis, enhance its software and call processing platform and successfully compete with products and services based on evolving or new technology. The Company expects new products and services, and enhancements to existing products and services, to be developed and introduced which will compete with the services currently offered or planned by the Company. The Company is also aware that products currently exist which allow text-to-voice electronic mail conversion and provide "meet me" services, and that several communications companies are developing or have developed services, that would compete with the Company's proposed devices. The Company currently intends to introduce and market new and enhanced services in 1998, such as a Virtual Office product and an integrated messaging service. The Virtual Office will allow subscribers to enter up to three different telephone numbers into the system including a pager number. A caller will be able to instruct the system to leave a voice or fax message for the subscriber or direct the system to search for the subscriber at one of the designated numbers. If the caller leaves a message for the subscriber, he will then be paged and be notified of a voice or fax message. This type of service is sometimes referred to as a "follow me" service. The Integrated Messaging Service will allow a subscriber to access e-mail and fax messages off the Internet via telephone using text-to-voice conversion. The same application will allow a subscriber to access all the different Wavetech/Interpretel services via a laptop computer. Development of these services will require the implementation of new technologies and the integration of these technologies into the Company's call processing platform. Rapid changes in technology and product obsolescence require the Company to develop or acquire new products and to enhance its existing products on a timely basis. There is no assurance that the Company will be able to predict such changes or have the resources required or otherwise be able to respond to market or technological changes or to compete successfully in the future. There can be no assurance that the Company will be successful in developing and marketing service enhancements or new services that respond to these or other technological changes or evolving industry standards, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of its services, or that its new services, and the enhancements thereto, will adequately meet the requirements of the marketplace and achieve market acceptance. Delays in the introduction of new services, the inability of the Company to develop such new services or the failure of such services to achieve market acceptance could have a material adverse effect on the Company's business, operating results and financial condition. UNCERTAINTY OF STRATEGIC RELATIONSHIPS. A principal element of the Company's growth strategy is the creation and maintenance of strategic relationships that will enable the Company to offer its services to a larger customer base than the Company could otherwise reach through its direct marketing efforts. The Company has entered into or initiated strategic relationships with several companies, including Switch, DonTon Travel, Inc., TeamMark and GroupMark. These relationships were formed recently, and have not produced significant revenues to date. The Company is unable to predict their 16 success or failure due to limited operating experience with these strategic partners. Although the Company intends to continue to expand its direct marketing channels, the Company believes that strategic partner relationships may offer a potentially more effective and efficient marketing channel. Consequently, the Company's success depends in part on the ultimate success of these relationships and on the ability of these strategic partners to effectively market the Company's services. Failure of one or more of the Company's strategic partners to successfully develop and sustain a market for the Company's services, or the termination of one or more of the Company's relationships with a strategic partner, could have a material adverse effect on the Company's overall performance due to the possibility of more costly direct marketing expenditures by the Company and other factors. Although the Company views its strategic relationships as a key factor in its overall business strategy and in the development and commercialization of its services, there can be no assurance that its strategic partners view their relationships with the Company as significant for their own businesses or that they will not reassess their commitment to the Company in the future. The Company's arrangements with its strategic partners do not establish minimum performance requirements for the Company's strategic partners, but instead rely on the voluntary efforts of these partners in pursuing joint goals. Certain of these arrangements prevent the Company from entering into strategic relationships with other companies in the same industry as the Company's strategic partners, either for specified periods of time or while the arrangements remain in force. In addition, even when the Company is without contractual restriction, it may be restrained by business considerations from pursuing alternative arrangements. The ability of the Company's strategic partners to incorporate the Company's services into successful commercial ventures will require the Company, among other things, to continue to successfully enhance its existing services and develop new services. The Company's inability to meet the requirements of its strategic partners or to comply with the terms of its strategic partner arrangements could result in its strategic partners failing to market the Company's services, seeking alternative providers of communication and information services or canceling their contracts with the Company, any of which could have a material adverse impact on the Company. DEPENDENCE ON LICENSING RELATIONSHIPS. The Company has an active licensing relationship with one company, Switch Telecommunications Pty Ltd in Australia. The Company intends to increase its number of licenses and the volume of its licensee transactions volume. However, the telecommunications industry is intensely competitive and rapidly consolidating while the majority of companies that chose to outsource communications card services to the Company are small or medium-sized telecommunications companies that may be unable to withstand the intense competition in the telecommunications industry. The inability of the Company to attract larger or more licensee transactions, the failure of one or more of the Company's licensees to develop and sustain a market for the Company's services, or termination of one or more of the Company's licensing relationships, could have a material adverse effect on the Company's business, operating results and financial condition. ABILITY TO MANAGE GROWTH. The Company expects to experience substantial growth in 1998 and thereafter as it begins to operate its call processing 17 networks. This growth, if any, can be expected to place significant demands on all aspects of the Company's business, including its administrative, technical and financial personnel and systems. In addition, expansion by the Company may strain the Company's management, financial and other resources. There can be no assurance that the Company's systems, procedures, controls and existing resources will be adequate to support expansion of the Company's operations. The Company's future operating results will substantially depend on the ability of its officers and key employees to manage changing business conditions and to implement and improve its technical, administrative, financial control and reporting systems. If the Company is unable to respond to and manage changing business conditions, then the quality in the Company's services, its ability to retain key personnel and its results of operations could be materially adversely affected. At certain stages of growth in network usage, the Company is required to add capacity to the call processing platform, thus requiring the Company continuously to attempt to predict growth in its network usage and add capacity to its system accordingly. Difficulties in managing continued growth, including difficulties in predicting the growth in network usage, could have a material adverse effect on the Company, its business and results of operations. DEPENDENCE ON KEY MANAGEMENT AND PERSONNEL. The Company's success is largely dependent upon its executive officers, the loss of one or more of whom could have a material adverse effect on the Company. The Company believes that its continued success will depend to a significant extent upon the efforts and abilities of Gerald I. Quinn, President and CEO, and Richard P. Freeman, Vice President. The loss of services of any of these individuals could have a material adverse effect upon the Company. Mr. Quinn has entered into an employment agreement with the Company which expires in May, 1998. Mr. Freeman has entered into an employment agreement with the Company which is automatically renewed on an annual basis. The Company does not currently maintain key man life insurance on the lives of any of these persons. The Company also believes that its success depends upon its ability to hire and retain highly qualified engineering and product development personnel. Competition in the recruitment of highly qualified personnel in the information and telecommunications services industry is highly intense. The inability of the Company to identify, attract and retain such personnel may have a material adverse effect on the Company. No assurance can be given that the Company will be able to retain its key employees or that it will be able to attract qualified personnel in the future. DEPENDENCE ON CALL PROCESSING PLATFORM, DAMAGE, FAILURE AND DOWNTIME. The Company currently maintains a single UNIX-based multi-tasking call processing system integrated with a Tandem database server located in Lincoln, Nebraska. The Company's network service operations are dependent upon its ability to protect the equipment and data at its switching facility against damage that may be caused by fire, power loss, technical failures, unauthorized intrusion, natural disasters, sabotage and other similar events. The Company has taken certain precautions to protect itself and its subscribers from events that could 18 interrupt delivery of the Company's services. These precautions include physical security systems, an uninterruptible power supply and an on-site power generator designed to be sufficient to continue operation of the Company's network in the event of a power outage. The Company's network is further designed such that the data on each network server is duplicated on a separate network server. Notwithstanding such precautions, there can be no assurance that a fire, act of sabotage, technical failure, natural disaster or a similar event would not cause the failure of a network server and its backup server, other portions of the Company's network, or the Lincoln facility as a whole, thereby resulting in an outage of the Company's services. Such an outage could have a material adverse effect on the Company. While the Company has not experienced any downtime of its network due to natural disasters or similar events, on occasion the Company has experienced downtime due to various technical failures. When such failures have occurred, the Company has worked to remedy the failure as soon as possible. The Company believes that these technical failures have been infrequent and have not resulted in any material downtime of the call processing platform since the Company's inception. Although the Company maintains business interruption insurance providing for aggregate coverage of approximately $25,000 per occurrence, there can be no assurance that the Company will be able to maintain its business interruption insurance, that such insurance would continue to be available at reasonable prices, that such insurance would cover all such losses or that such insurance would be sufficient to compensate the Company for losses it experiences due to the Company's inability to provide services to its subscribers. LIMITED PROTECTION OF PROPRIETARY TECHNOLOGY: RISKS OF INFRINGEMENT. The Company relies primarily on a combination of copyright and trade secret laws and contractual confidentiality provisions to protect its proprietary rights. These laws and contractual provisions provide only limited protection of the Company's proprietary rights. The Company has no patents or patent applications pending and has no registered trademarks or copyrights. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's software or services or to obtain and use information that the Company regards as proprietary. Although the Company is not aware of any current or previous infringement upon its proprietary rights, there can be no assurance that the Company's means of protecting its proprietary rights will be adequate or that the Company's competitors will not independently develop similar technology. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to as great an extent as the laws of the United States. An inability of the Company to adequately protect its proprietary technology or other assets could have a material adverse effect on its business and results of operations. To date, no actions have been filed against the Company with respect to either alleged patent or trademark infringement claims. However, no assurance can be given that actions or claims alleging trademark, patent or copyright infringement will not be brought against the Company with respect to current of future products or services, or that, if such actions are brought, the Company will ultimately prevail. Any such claiming parties may have significantly 19 greater resources than the Company to pursue litigation of such claims. Any such claims, whether with or without merit, could be time consuming, result in costly litigation, cause delays in introducing new or improved services, require the Company to enter into royalty or licensing agreements or cause the Company to discontinue use of the challenged tradename, service mark or technology at potential significant expense to the Company associated with the marketing of a new name or the development or purchase of replacement technology, any of which results could have a material adverse effect on the Company. DEPENDENCE UPON SOFTWARE. The software developed and utilized by the Company in providing its services may contain undetected errors. Although the Company engages in extensive testing of its software prior to introducing the software onto its network, there can be no assurance that errors will not be found in software after commencement of use of such software. Any such error may result in partial or total failure of the Company's network, additional and unexpected expenses to fund further product development or to add programming personnel to complete a development project, and loss of revenue because of the inability of subscribers to use Wavetech's network or the cancellation by subscribers of their service with Wavetech, any of which could have a material adverse effect on the Company. DEPENDENCE UPON TELECOMMUNICATION PROVIDERS; NO GUARANTEED SUPPLY. The Company does not own a transmission network and, accordingly, depends on MCI for transmission of its subscribers' long distance calls. For the year ended August 31, 1997, MCI was responsible for carrying traffic representing approximately 100% of the minutes of long distance transmissions billed to the Company. Further, the Company is dependent upon local exchange carriers for call origination and termination. If there is an outage affecting the Company's terminating carriers, the Company's call processing platform may not complete a call. The Company has not experienced significant losses in the past because of interruptions of service at terminating carriers, but no assurance can be made in this regard with respect to the future integrity of such carriers. The Company's ability to maintain and expand its business depends, in part, on its ability to continue to obtain telecommunication services on favorable terms from a long distance carrier and the cooperation of both interexchange and local exchange carriers in originating and terminating service for its subscribers in a timely manner. A partial or total failure of the Company's ability to receive or terminate calls would result in a loss of revenues by the Company and could lead to a loss of subscribers, either of which could have a material adverse effect on the Company. The Company obtains long distance telecommunications services pursuant to supply agreements with Interact, Inc. of Lincoln, Nebraska, and MCI. No assurance can be given that the Company will be able to obtain long distance services in the future at favorable prices or at all, and the unavailability of long distance services to the Company, or a material increase in the price at which the Company is able to obtain long distance service, would have a material adverse affect on the Company's business financial condition and results of operations. The Company is not currently a party to a long distance 20 telecommunications services agreement, that requires the Company to purchase a minimum amount of service each month. The Company may determine that it is desirable to enter into agreements containing minimum purchase requirements. No assurance can be given that demand for services in the areas covered by the Company's transmission suppliers will exceed any minimum purchase requirement in the future. REGULATION. Various regulatory factors may have an impact on the Company's ability to compete and on its financial performance. The Company is subject to regulation by the Federal Communications Commission ("FCC") and by various state public service and public utility commissions. Federal and state regulations and regulatory trends have had, and may have in the future, both positive and negative effects on the Company and on the information and telecommunications service industries as a whole. FCC policy currently requires interexchange carriers to provide resale of the use of their transmission facilities. The FCC also requires local exchange carriers to provide all interexchange carriers with equal access to the origination and termination of calls. If either or both of these requirements were removed, the Company would be adversely affected. These carriers may experience disruptions in service due to factors outside the Company's control, which may cause the Company to lose the ability to complete its subscribers' long distance calls. The Company has made all filings with the FCC necessary to allow the Company to provide interstate and international long distance service. In order to provide intrastate long distance service, the Company is required to obtain certification to provide telecommunications services from the public service or public utility commissions of each state, or to register or be found exempt from registration by such commissions. The Company has not yet made any filings or taken any actions to become certified or tariffed to provide intrastate card services to customers throughout the United States. To date, the Company has not been denied any licenses or tariffs. On February 8, 1996, President Clinton signed into law the Telecommunications Act of 1996 which will allow local exchange carriers, including the RBOCs, to provide inter-LATA long distance telephone service and which also grants the FCC authority to deregulate other aspects of the telecommunications industry. The new legislation may result in increased competition for the Company from others, including RBOCs and increased transmission costs in the future. See "--Competition" above. In conducting various aspects of its business, the Company is subject to various laws and regulations relating to commercial transactions generally, such as the Uniform Commercial Code, and is also subject to the electronic funds transfer regulations embodied in Regulation E promulgated by the Board of Governors of the Federal Reserve System ("Federal Reserve"). Given the expansion of the electronic commerce market, the Federal Reserve might revise Regulation E or adopt new rules for electronic funds transfer affecting users other than consumers. Congress has held hearings on whether to regulate providers of services and transactions in the electronic commerce market, and it is possible 21 that Congress or individual states could enact laws regulating the electronic commerce market. If enacted, such laws, rules and regulations could directly regulate the Company's business and industry and could have a material adverse affect on the Company's business, operating results and financial condition. RISKS ASSOCIATED WITH INTERNATIONAL EXPANSION. A key component of the Company's strategy is its planned expansion into international markets. The Company intends to establish call processing platforms in Canada, and potentially other countries in 1998 and beyond. If international revenues are not adjusted to offset the expense of establishing and maintaining these international operations, the Company's business, operating results or financial condition could be materially adversely affected. To date, the Company has only limited experience in marketing and distributing its services internationally. There can be no assurance that the Company will be able to successfully establish the proposed international call processing platforms, or to market, sell and deliver its services in these markets. In addition to the uncertainty as to the Company's ability to expand its international presence, there are certain difficulties and risks inherent in doing business on an international level, such as burdensome regulatory requirements and unexpected changes in these requirements, export restrictions, export controls relating to technology, tariffs and other trade barriers, difficulties in staffing and managing international operations, longer payment cycles, problems in collecting accounts receivable, political instability, fluctuations in currency exchange rates, seasonal reduction in business activity during the summer months in certain parts of the worlds and potentially adverse tax consequences, which could have a material adverse effect on the performance of the Company's international operations. There can be no assurance that one or more of such factors will not have a material adverse affect on the Company's future international operations and, consequently, on the Company's business, operating results and financial condition. RISK OF LOSS FROM RETURNED TRANSACTIONS, FRAUD, BAD DEBT, THEFT OF SERVICES. The Company utilizes Intrust Bank, N.A., principal financial payment clearance systems for electronic fund transfers and ICVerify software for electronic credit card settlement. In its use of these established payment clearance systems, the Company generally bears the same credit risks normally assumed by other users of these systems arising from returned transactions caused by insufficient funds, stop payment orders, closed accounts, frozen accounts, unauthorized use disputes, theft or fraud. From time to time persons may be able to gain unauthorized access to the Company's network and obtain services without rendering payment to the Company by unlawfully utilizing the access numbers and personal identification numbers ("PINs") of authorized users. Although to date the Company has not experienced material losses due to such unauthorized use of access numbers and PINs, no assurance can be given that future losses due to unauthorized use will not be material. The Company currently seeks to manage these risks through its internal controls and proprietary billing system. The Company's call processing platform prohibits a single access number and PIN from establishing multiple simultaneous connections 22 to the network system, and the Company establishes preset spending limits for each subscriber. The Company also maintains a reserve for such risks. Past experience in estimating and establishing reserves and the Company's historical losses are not necessarily accurate indications of the Company's future losses or the adequacy of the reserves established by the Company in the future. Although the Company believes that its risk management and bad debt reserve practices are adequate, there can be no assurance that the Company's risk management practices or reserves will be sufficient to protect the Company from unauthorized or returned transactions or thefts of services which could have a material adverse effect on the Company's business, operating results and financial condition. POTENTIAL ACQUISITIONS. The Company may in the future pursue acquisitions of complementary services, products, technologies or businesses. Future acquisitions may result in potentially dilutive issuances of equity securities, the incurrence of additional debt, the write-off of software development costs, and the amortization of expenses related to goodwill and other intangible assets, all of which could have a material adverse effect on the Company's business, operating results and financial condition. Future acquisitions would involve numerous additional risks, including those related to the assimilation of the operations, services, products and personnel of the acquired company, the diversion of management's attention from other business concerns, entering markets in which the Company has little or no direct prior experience and the potential loss of key employees of the acquired company. The Company currently has no agreements or understandings with regard to any potential acquisitions. NEED FOR ADDITIONAL FINANCING. The Company has significant cash requirements in connection with its business. To date, the Company has been unable to generate sufficient revenues to recover its costs. See "--Limited Operating History; Previous Losses" above. In addition to its working capital requirements, the Company must fund the production and marketing of its products prior to the time the products are made available for sale and generate revenues. The Company's potential receipt of revenues from product sales are subject to substantial contingencies, and there can be no assurances concerning the timing and amount of future revenues from product sales. Additionally, the Company may not receive payment from its customers until a period after products are sold to end-users. The Company may be required to seek additional financing in the event of delays, cost overruns or unanticipated expenses associated with a company in an early stage of development, or in the event the Company does not realize anticipated revenues. In addition, the Company may require additional financing in the future to further expand its product offerings or to make strategic acquisitions. There can be no assurance that such additional financing will be available, or that, if available, such financing will be obtainable on terms favorable to the Company or its stockholders. The Company currently has no commitment for any such financing and in the event such necessary financing is not obtained, the Company's operations will be materially adversely affected and the Company will have to cease or substantially reduce operations. Any 23 additional equity financings may be dilutive to stockholders, and debt financings, if available, may involve restrictive covenants, including limiting the Company's ability to incur additional debt. NASDAQ LISTING AND MAINTENANCE REQUIREMENTS; RISK OF DELISTING. The Company's Common Stock is currently listed on the Nasdaq SmallCap Market. Under the rules for continued listing in the Nasdaq system, the Company must satisfy prior to February 23, 1998 and thereafter will be required to maintain at least $2,000,000 in net tangible assets or $35,000,000 in market capitalization, two market-makers, a public float of at least $500,000 shares and a minimum bid price of $1.00 per share, as well as satisfy certain corporate governance criteria. Upon notice of a deficiency in one or more of the maintenance requirements, the Company would be given 90 days (30 days in the case of the number of market-makers) to comply with the maintenance standards. Failure of the Company to meet the maintenance requirements of Nasdaq prior to February 23, 1998 could result in the Company's securities being delisted from Nasdaq, with the result that the Company's securities would trade on the OTC Bulletin Board or in the "pink sheets" maintained by the National Quotation Bureau Incorporated. As a consequence of such delisting, an investor could find it more difficult to dispose of or to obtain accurate quotations as to the market value of the Company's securities. Among other consequences, delisting from Nasdaq may cause a decline in the stock price, the loss of news coverage about the Company and difficulty in obtaining future financing. RISK OF LOW-PRICED STOCK; PENNY STOCK REGULATIONS. If the Company's securities were delisted from Nasdaq (See "Risk Factors--Nasdaq Listing and Maintenance Requirements; Risk of Delisting"), they could become subject to Rule 15g-9 under the Exchange Act, which imposes additional sales practice requirements on broker-dealers which sell such securities to persons other than established customers and "accredited investors" (generally, individuals with net worth in excess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 together with their spouses). For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transaction prior to sale. Consequently, such rule may adversely affect the ability of broker-dealers to sell the Company's securities and may adversely affect the ability of purchasers in this Offering to sell any of the securities acquired hereby in the secondary market. The Commission adopted regulations which generally define a "penny stock" to be any non-Nasdaq equity security that has a market price (as therein defined) of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the rules require delivery, prior to any transaction in a penny stock of a disclosure schedule prepared by the Commission relating to the penny stock market. Disclosure is also required to be made about commissions payable to both the broker-dealer and the registered representative and current 24 quotations for the securities. Finally, monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. The foregoing required penny stock restrictions will not apply to the Company's securities if such securities are listed on Nasdaq and have certain price and volume information provided on a current and continuing basis or meet certain minimum net tangible assets or average revenue criteria. There can be no assurance that the Company's securities will qualify for exemption from these restrictions. In any event, even if the Company's securities were exempt from such restrictions, it would remain subject to Section 15(b)(6) of the Exchange Act, which gives the Commission the authority to prohibit any person that is engaged in unlawful conduct while participating in a distribution of a penny stock from associating with a broker-dealer or participating in a distribution of a penny stock, if the commission finds that such a restriction would be in the public interest. If the Company's securities were subject to the existing or proposed rules on penny stocks, the market liquidity for the Company's securities could be severely adversely affected. RISKS ASSOCIATED WITH YEAR 2000 Many computer programs were designed to recognize calendar years by their last two digits. As a result, such programs are expected to misidentify dates commencing in calendar year 2000. This problem is referred to as the "Year 2000 Issue." These errors are likely to lead to computer errors, miscalculations, delays and business interruptions if not properly corrected in a timely manner. The Company's main billing program was originally written to accept dates from the year 2000 and beyond. However, the Company plans on having an independent consultant review the billing system for the purpose of thoroughly testing its operation for readiness associated with the Year 2000 Issue. Estimated costs for the consultant and associated testing activities is $700. The Company anticipates that such assessment activities will be completed by March 31, 1999. The Company has completed an assessment of all other internal systems and has determined that no modifications to such systems are necessary. Total costs incurred to date by the Company in connection with its assessment of its internal vulnerability to the Year 2000 Issue equal approximately $5,000. The Company has also contacted its major supplier, which handles the call processing software and supports platform services. The Company's call processing hardware and operating systems are not currently able to address the Year 2000 Issue. Modifications to this system have begun and the host server's operating system is expected to be compliant no later than the end of the first quarter of calendar year 1999. The Company currently estimates that its costs to be incurred with such modification will be approximately $50,000. The Company 25 does not have material relationships with any other third partners upon which its business and operations are substantially dependent. However, it intends to seek assurances from any third parties with which it enters into agreements in the future that the systems are compliant with the Year 2000 Issue. Presently, the Company does not have a contingency plan in the event it is unable to correct any vulnerability to the Year 2000 Issue, but is reviewing alternatives, such as using a service bureau to temporarily process calls and run applications, should any problems arise in system operations. The Company believes there exist multiple alternative suppliers for these services. However, if it is unable to obtain such services and at terms acceptable to it, it may be forced to interrupt or suspend its services. In addition, even if available, the Company may be required to incur substantially higher costs in order to provide such services. The Company has adequate resources to complete its Year 2000 assessment and any necessary modifications. ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA WAVETECH, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Number ----------- REPORT OF INDEPENDENT AUDITORS. . . . . . . . . . . . . . . . . . . 28 CONSOLIDATED BALANCE SHEET - August 31, 1997. . . . . . . . . . . . 29 CONSOLIDATED STATEMENT OF OPERATIONS - Periods ended August 31, 1997 and 1996. . . . . . . . . . . . . . . . . . . . . . 30 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY - Periods ended August 31, 1997 and 1996 . . . . . . . . . . 31 CONSOLIDATED STATEMENTS OF CASH FLOWS - Periods ended August 31, 1997 and 1996. . . . . . . . . . . . . . . . . . . . . . 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. . . . . . . . . . . . . 33 26 WAVETECH, INC. AND SUBSIDIARIES Audited Financial Statements For the years ended August 31, 1997 and 1996 ----------- 27 INDEPENDENT AUDITOR'S REPORT To the Stockholders and Board of Directors Wavetech, Inc. We have audited the accompanying consolidated balance sheet of Wavetech, Inc. and subsidiaries as of August 31, 1997 and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years ended August 31, 1997 and 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Wavetech, Inc. and subsidiaries as of August 31, 1997 and the results of its operations and its cash flows for the years ended August 31, 1997 and 1996, in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 16 to the consolidated financial statements, the Company has incurred a significant loss from operations and has a deficit that raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 16. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. As discussed in Note 17 to the financial statements, certain errors resulting in overstatement of previously reported revenue recognized from the sale of a licensing agreement as of August 31, 1997, were subsequently discovered by management. Accordingly, the August 31, 1997 financial statements have been restated to correct the error. Additionally, Note 11 contains expanded disclosure regarding the fair value of stock options. /s/ Addison, Roberts & Ludwig Tucson, Arizona August 31, 1998 28 WAVETECH, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET August 31, 1997 ----------- ASSETS 1997 Current assets: ------------- Cash and cash equivalents $ 13,329 Accounts receivable, net of allowance of $527 26,273 Prepaid expenses and other assets 9,725 ------------- Total current assets 49,327 Property and equipment, net 410,182 Noncurrent assets: Investment in Switch Telecommunications Pty Ltd 2,316,165 Intangibles, net of amortization of $7,511 29,489 Deposits and other assets 35,633 ------------- Total noncurrent assets 2,381,287 ------------- Total assets $ 2,840,796 ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 395,222 Accrued interest payable, noncurrent portion 5,248 Notes payable, current portion 172,071 Capital leases payable, current portion 56,119 Deferred revenue, current portion 71,428 ------------- Total current liabilities 700,088 Noncurrent liabilities: Capital leases payable 53,892 Deferred revenue 75,001 ------------- Total liabilities 828,981 Commitments (Note 10) Stockholders' equity: Common stock, par value $ .001 per share; 50,000,000 shares authorized, 15,076,807 shares issued and outstanding 15,077 Additional paid-in capital 7,024,823 Accumulated deficit (5,028,085) ------------- Total stockholders' equity 2,011,815 ------------- Total liabilities and stockholders' equity $ 2,840,796 ============= See independent auditor's report. The accompanying notes are an integral part of these consolidated financial statements. 29 WAVETECH, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the years ended August 31, 1997 and 1996 ----------- 1997 1996 ------------ ------------ Revenues $ 719,142 $ 19,895 ------------ ------------ Expenses: Cost of sales (exclusive of depreciation and amortization shown separately below) 679,930 179,068 Development -0- 297,935 General and administrative 1,584,747 1,287,386 Depreciation and amortization expense 211,786 136,902 ------------ ------------ Total expenses 2,476,463 1,901,291 ------------ ------------ Net loss from operations (1,757,321) (1,881,396) Other income and expense: Interest income 8,500 32,777 Interest expense (26,893) (11,585) ------------ ------------ Total other income and expense (18,393) 21,192 ------------ ------------ Net loss $ (1,775,714) $ (1,860,204) ============ ============ Net loss per common share $ (.12) $ (.17) ============ ============ Weighted average number of shares outstanding 14,455,167 11,200,401 ============ ============ See independent auditor's report. The accompanying notes are an integral part of these consolidated financial statements. 30 WAVETECH, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the years ended August 31, 1997 and 1996 -----------
Additional Common Paid-in Accumulated Shares Stock Capital Deficit Total ---------- ----------- ----------- ----------- ----------- Balances, August 31, 1995 9,455,078 $ 9,455 $ 1,540,223 $(1,392,167) $ 157,511 Common stock issued 3,115,253 3,115 2,893,123 2,896,238 Common stock issued in exchange for Switch common stock 1,544,110 1,544 2,314,621 2,316,165 Net loss (1,860,204) (1,860,204) ---------- ----------- ----------- ----------- ----------- Balances, August 31, 1996 14,114,441 14,114 6,747,967 (3,252,371) 3,509,710 Common stock issued 962,366 963 256,856 257,819 Warrants issued 20,000 20,000 Net loss (1,775,714) (1,775,714) ---------- ----------- ----------- ----------- ----------- Balances, August 31, 1997 15,076,807 $ 15,077 $ 7,024,823 $(5,028,085) $ 2,011,815 ========== =========== =========== =========== ===========
See independent auditor's report. The accompanying notes are an integral part of these consolidated financial statements. 31 WAVETECH, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended August 31, 1997 and 1996 ------------ 1997 1996 ----------- ----------- Cash flows from operating activities: Net loss $(1,775,714) $(1,860,204) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 211,876 136,902 Common stock issued for services 204,180 203,125 Changes in assets and liabilities: (Increase) decrease in accounts receivable and other current assets 1,108 (32,758) (Increase) decrease in inventory deposit 241,037 (241,037) Increase (decrease) in accounts payable and accrued expenses 264,507 (104,339) Increase (decrease) in accrued interest payable 5,248 (39,327) Increase (decrease) in unearned revenue (153,556) 299,985 ----------- ----------- Total adjustments 774,400 222,551 ----------- ----------- Net cash used in operating activities (1,001,314) (1,637,653) Cash flows from investing activities: Purchase of property and equipment (25,237) (89,352) Increase in deposits and other assets -0- (2,508) Advance on notes receivable -0- (45,282) Payment of notes receivable 45,282 -0- Purchase of intangibles (25,000) -0- ----------- ----------- Net cash used in investing activities (4,955) (137,142) Cash flows from financing activities: Proceeds from (payments on) notes payable 172,071 (324,600) Payments on capital lease payable (29,961) (22,023) Proceeds from common stock issued -0- 2,693,113 Proceeds from sale of warrants 20,000 -0- ----------- ----------- Net cash provided by financing activities 162,110 2,346,490 ----------- ----------- Net increase (decrease) in cash (844,159) 571,695 Cash and cash equivalents, beginning of year 857,488 285,793 ----------- ----------- Cash and cash equivalents, end of year $ 13,329 $ 857,488 =========== =========== See independent auditor's report. The accompanying notes are an integral part of these consolidated financial statements. 32 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 1. ORGANIZATION The consolidated financial statements include the accounts of Wavetech, Inc. (the Company) and its wholly owned subsidiaries, Interpretel, Inc. (Interpretel), Interpretel (Canada) Inc., Telplex International, Inc. and International Environmental Services Corporation (an inactive corporation). All material intercompany balances and transactions have been eliminated. As of August 31, 1997, and for the previous three years, the Company had no operations other than its investment in Interpretel which was made on March 8, 1995. On March 10, 1995, Interpretel (Canada) Inc. was incorporated in Ontario, Canada as a wholly owned subsidiary of Interpretel. Interpretel (Canada) Inc. had not yet had any activities as of August 31, 1997. Interpretel was incorporated April 15, 1993, under the laws of the state of Arizona to develop, market and provide interactive telecommunication systems and services to business and individual customers. The systems incorporate interactive call processing, computer-telephony integration, card production/fulfillment, bill services, marketing, sales support, and customer service to provide features and services, including but not limited to, long distance dialing, voice/fax messaging, voice/fax broadcast, language interpretation/translation, information retrieval, interface to existing databases, and product promotion services. Each Interpretel system is developed to reflect or target the needs of an identified (target) market, with services provided to individual customers via a calling card product incorporating the use of certain trade secrets, trademarks, service marks, and materials related thereto. In prior years, Interpretel was deemed to be a development stage enterprise. For the year ended August 31, 1997, Interpretel is considered to be an operating company. On January 1, 1997, the Company acquired certain intangible assets of Telplex, Inc., an Arizona corporation, in exchange for $25,000 in cash. These assets were placed in a new wholly-owned subsidiary of Wavetech, Inc. called Telplex International Communications, Inc. ("Telplex"). The Company did not assume any of the liabilities of Telplex. Telplex is a switchless international long distance reseller. The acquisition of Telplex's assets was made pursuant to an Asset Purchase Agreement dated January 22, 1997, by the Company, although it is deemed effective as of January 1, 1997. This acquisition has been accounted for under the purchase method of accounting and the results of Telplex's operations since the acquisition date have been included with those of the Company. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CASH AND CASH EQUIVALENTS For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with a maturity of three 33 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED months or less (money market accounts and certificates of deposit) to be cash equivalents. PROPERTY AND EQUIPMENT All property and equipment is recorded at cost and depreciated over the estimated useful lives of the assets, as follows: Furniture and fixtures 7 years Computer equipment 5 years Software 5 years The costs of maintenance, repairs and minor renewals are charged to expense in the year incurred. Expenditures which increase the useful lives of the asset are capitalized. When items are retired or disposed of, the cost and accumulated depreciation are removed from the accounts and any gain or loss is included in income. INTANGIBLE ASSETS Intangible assets consist of start-up costs. These costs are primarily consulting fees and other costs incurred in connection with the development of the Company. Management believes that these costs will be recovered with future operations. Start-up costs are amortized over five years using the straight-line method. INCOME TAXES The Company uses Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires a liability approach to accounting for deferred income taxes in that the deferred income tax liability or benefit at the end of an accounting period should reflect the estimated deferred tax liability or tax benefit on the temporary book-tax differences at anticipated federal and state income tax rates. CREDIT RISK AND FAIR VALUE OF FINANCIAL INSTRUMENTS At August 31, 1997, the Company maintained a cash balance in a bank account insured by the FDIC. The cash balance did not exceed the FDIC insurable amount. The Company extends credit to customers on an unsecured basis in the ordinary course of business. The Company bills its services directly to authorized customer credit cards as usage is incurred. 34 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED SFAS 107 requires disclosing fair value to the extent practicable for financial instruments which are recognized or unrecognized in the balance sheet. The fair value of the financial instruments disclosed herein is not necessarily representative of the amount that could be realized or settled, nor does the fair value amount consider the tax consequences of realization or settlement. The carrying amounts for cash and cash equivalents, accounts receivable, license fee receivable, accounts payable and notes payable approximate fair value because of the short maturity of these instruments. The fair value of the common stock of Switch Telecommunications Pty Limited is estimated at carrying value as such stock is not traded on the open market and market price is not readily available. The Company does not hold or issue financial instruments for trading purposes. ADVERTISING COSTS The cost of advertising is expensed when incurred or when the first advertising takes place. Wavetech and Interpretel do not participate in direct-response advertising which requires the capitalization and amortization of related costs. The Company incurred $57,637 in advertising costs during the year ended August 31, 1997. INVESTMENTS Investments in companies in which the Company has less than a 20% interest are carried at cost. Dividends received from those companies are included in other income. Dividends received in excess of the Company's proportionate share of accumulated earnings are applied as a reduction of the cost of the investment. REVENUE RECOGNITION Revenue from the sale of the licensing agreement is recognized over the term of the agreement. Revenue from the installation of equipment is recognized when delivered. Revenue from the resale of minutes is recorded when incurred. Cost of sales includes expenses directly related to the operation and maintenance of the telephony platform. Depreciation and amortization expense is separately stated. CONCENTRATION OF REVENUE During the year ended August 31, 1997, the Company recognized revenue from the installment of equipment of $474,160 and $53,571 from the recognition of income from the sale of a licensing agreement all from Switch. This represents 73% of total revenue for the year ended August 31, 1997. 35 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED STOCK-BASED COMPENSATION The Company accounts for its employee stock-based compensation arrangements under the provisions of APB No. 25, Accounting for Stock Issued to Employees. LOSS PER COMMON SHARE Loss per common share is computed using the weighted average number of shares of common stock outstanding. Common equivalent shares from stock options and warrants are excluded from the computation when the effect is antidilutive. 3. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management utilized certain estimates in connection with establishing and maintaining the value of the common stock of Switch (Note 5). It is at least reasonably possible that these estimates may change in the near term due to one or more future events. Such a change would change the value of the common stock of Switch. The effect of the change could be material to the financial statements. 4. BUSINESS COMBINATION - COMMITMENT On March 8, 1995, the Company entered into an agreement with Interpretel pursuant to which the Company agreed to issue 6,000,000 shares of its common stock in exchange for 100% of the outstanding 1,532,140 shares of common stock of Interpretel. The transaction resulted in the former shareholders of Interpretel owning approximately 80% of the outstanding shares of the Company. In accordance with Accounting Principles Board Opinion No. 16 "Business Combinations," the acquisition has been accounted for as a reverse acquisition with Interpretel deemed to be the acquiring entity of the Company. The common shares issued in connection with the acquisition were assigned no value because the Company had no assets or liabilities at the date of the acquisition. The acquisition agreement also provides that during the three year period following the March 8, 1995 closing, former shareholders of Interpretel can 36 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 4. BUSINESS COMBINATION - COMMITMENT, CONTINUED receive an additional 7,500,000 common shares of the Company through an "earn-out" based upon before tax net profit. During the two year period following closing, former shareholders of Interpretel shall earn up to 3,750,000 common shares of the Company for every $0.50 net profit before taxes, and an additional 3,750,000 common shares of the Company for every $1.00 of cumulative total net profit before taxes. During the third year following closing, any shares not previously issued pursuant to this agreement can be earned at $1.50 net profit before taxes per share. These additional shares will not be considered in recording the Acquisition transaction until such time as the earnings targets have been met. 5. INVESTMENT IN SWITCH TELECOMMUNICATIONS PTY LIMITED During August, 1996 the Company entered into an agreement with Switch Telecommunications Pty Limited (Switch) to exchange an equity interest in the Company for an equity interest in Switch. The equity interests consist of outstanding common stock of the respective companies. The Company received five shares of Switch common stock representing 5% of the issued and outstanding common stock, in exchange for 1,544,110 shares of the Company's stock. These shares were pledged as collateral to a note payable to an officer/shareholder and subsequently released as of November 30, 1997. (Note 8) Switch is a wholly owned subsidiary of Tech Pacific Holdings Limited (Tech Pacific). Tech Pacific is an Australian corporation whose stock is not publicly traded. Tech Pacific is a wholly owned subsidiary of First Pacific, a publicly traded company on the Hong Kong stock exchange. Switch conducts business as a telecommunications Fixed Network Service Provider and also validates mobile telephone connections for Telestra Mobilenet in Australia. The Company has entered into a contract appointing Switch as the exclusive provider of Interpretel's telecommunications services in Australia, New Zealand, the subcontinent of India and Asia (excluding Korea and Japan) (Note 6). The value assigned to the Switch shares received was determined by management valuing the whole of the issued capital of Switch on the basis of discounting the anticipated future cash flow. This method determines the net present value of the underlying cash flow of a business. It recognizes that money has a time value by discounting future cash flows at an appropriate discount rate. A valuation using discounted cash flow procedures requires the determination of the nature of timing of future cash inflows and outflows and the discount factor to be applied to the cash flows. Future cash flows may not be achieved and consequently any future variation between the actual cash flow and those utilized by management will affect the valuation. Since Switch is a privately held company, the market value of the shares is not readily ascertainable and is subject to 37 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 5. INVESTMENT IN SWITCH TELECOMMUNICATIONS PTY LIMITED, CONTINUED uncertainty. There have been no events known to the Company which would signify an impairment of the value of the investment. The agreement provides that when Tech Pacific completes an initial public offering of its equity securities, the Company will have the right upon written notice to Tech Pacific to convert its Switch common stock at its current fair market value as determined by an independent third party into equity securities of an equivalent value proposed to be offered by Tech Pacific. If Tech Pacific has not completed an initial public offering within two years from the date of the agreement, then Tech Pacific shall, upon thirty days written notice from the Company, repurchase the Switch common stock held by the Company at its then market value as determined by an independent third party. Switch purchased a three-year warrant to purchase up to 2,000,000 shares of the Company's common stock at a price of $1.50 per share. The warrants expire January 17, 2000. Consideration of $20,000 was received for the warrants. 6. LICENSING AGREEMENT The Company entered into an Equipment and Software Turnkey Agreement with Switch during August, 1996. This agreement sets forth the terms of fees and services between Interpretel and Switch. The agreement provides for the purchase of the Interpretel system and licensing for its use in Australia, New Zealand, the subcontinent of India and Asia (excluding Korea and Japan). The initial term of the license is seven years. In the agreement, Switch contracted to purchase an Interpretel System consisting of a computer platform and related software. The agreement also provides for a licensing fee in the amount of $500,000 to be paid to Interpretel over a three-year period. Switch shall not have an obligation to pay any fees pursuant to termination provisions in the agreement. The Company received $200,000 of the licensing fee during the year ended August 31, 1997. The agreement provides for payments of $150,000 each in year two and three. A payment of $150,000 was due on May 22, 1998. Effective June 30, 1998, an agreement was reached between the Company and Switch terminating the license agreement. Switch agreed to pay the Company $150,000 in consideration of the termination of the agreement. The payment was received on July 10, 1998. Switch agreed to pay an additional fee to Interpretel of 2% of the gross revenues on all sales of products by Switch using the Interpretel System, including without limitation on gross revenues derived from prepaid 38 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 6. LICENSING AGREEMENT, CONTINUED applications, post-paid applications and Interactive Voice Response Systems. The fee of 2% of gross revenues shall be paid monthly on the fifteenth of each month based on prior month payments received by Switch. The fee of 2% of gross revenues shall be reviewed by the parties and increased or decreased by mutual agreement of the parties at least annually, reviewed after the first 15,000 cards are on the Interpretel system in Australia, and reviewed if net revenues for Switch are altered by a change in carrier discounts and/or rates. Net revenues are defined as gross revenues minus carrier costs only. During the year ended August 31, 1997, Switch did not pay any royalty fees to the Company. The Company was unable to determine the amount due because of disagreements related to the installation dates of the system and modifications required for compatibility with Australian signaling. These differences precluded Switch from providing the necessary information to compute the royalty fees. In lieu of negotiating a working resolution to these issues, the Company agreed to terminate the licensing agreement with Switch. The payment of $150,000 received in settlement of the termination of the licensing agreement includes an undetermined amount on satisfaction of potential gross revenue. In consideration of the termination of the licensing agreement, the Company agreed to release Switch from any other obligations including the gross revenue fee. 7. PROPERTY AND EQUIPMENT Property and equipment is composed of the following at August 31, 1997: 1997 --------- Furniture and fixtures $ 170,415 Computer equipment 505,377 Software 112,318 --------- Total property and equipment, at cost 788,110 Less: accumulated depreciation (377,928) --------- Net property and equipment $ 410,182 ========= 39 NOTES TO FINANCIAL STATEMENTS WAVETECH, INC. AND SUBSIDIARIES -------------- 8. NOTES PAYABLE Notes payable is composed of the following at August 31, 1997: Note payable to a shareholder and officer of the Company due on demand with interest payable at 15% annually. Collateralized by five shares of Switch Telecommunications Pty common stock and one share of Interpretel (Canada) common stock. (Note 13) $ 109,071 Note payable to a shareholder and officer of the Company due on demand with interest payable at 15% annually. Uncollateralized. (Note 13) 13,000 Note payable to a shareholder of the Company due and payable on demand no later than January 21, 1998. At the option of the holder, principal and interest can be paid in shares of common stock of Wavetech, Inc. with an aggregate payoff value equal to the aggregate amount of principal plus interest. Collateralized by security interest in accounts receivable, inventory, general intangibles, equipment, investments and personal guarantee of corporate officers. (Note 13) 50,000 --------- Total short-term notes payable $ 172,071 ========= 9. CAPITAL LEASES PAYABLE The Company has entered into capital lease arrangements for office furniture and equipment. The leases require monthly payments of principal and interest. Future lease commitments are as follows: 1998 $ 56,119 1999 35,746 2000 15,662 2001 2,484 --------- $ 110,011 ========= 10. COMMITMENTS The Company has entered into cancelable operating agreements with a telecommunications service provider. The Company has agreed to a $12,555 40 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 10. COMMITMENTS, CONTINUED monthly minimum charge. Although there are a limited number of service providers for the call processing systems used by the Company, management believes that other suppliers could provide similar services on comparable terms. Total rent expense under all operating leases for the years ended August 31, 1997 and 1996 approximated $107,000 and $95,500, respectively. The Company has entered into a lease agreement for office space. Future lease commitments are as follows: 1998 $ 99,453 1999 105,056 2000 110,659 2001 116,262 2002 29,416 -------- Total $460,846 ======== 11. COMMON STOCK During the year ended August 31, 1997, the Company issued 62,342 shares of common stock for consulting services pursuant to various agreements valued at $37,303. The value assigned to the common stock was based on the fair market value of the common stock on the date that the liability was incurred. The value of the consulting services was charged to expense during the period incurred. During the year ended August 31, 1997, the Company issued 361,269 deferred shares of common stock under the 1997 Stock Incentive Plan to meet payroll expenses in the amount of $137,877. The value assigned to the common stock was based on the fair market value on the date of issue. During the year ended August 31, 1997, the Company issued 100,000 shares in satisfaction of a note payable of $53,639. The value assigned to the common stock was based on the fair market value of the common stock on the date of the agreement was negotiated. During the year ended August 31, 1997, the Company issued 438,755 shares of stock in satisfaction for services valued at $203,125 performed in the previous year. The previous values assigned to the common stock and charged to expense in the period the services were performed were based on the fair market values of the common stock. Pursuant to various consulting agreements, the Company has committed to issue 64,578 shares of common stock as payment for services valued at 41 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 11. COMMON STOCK, CONTINUED $29,000. The value of the common stock charged to expense in the period the services were performed were based on the fair market value of the common stock. During the year ended August 31, 1996, the Company issued common stock pursuant to various Securities and Exchange Commission Regulation S stock subscription agreements. The Company issued 3,115,253 shares of common stock and received $2,658,734. On May 21, 1996 the Company entered into an agreement with Switch to exchange an equity interest in the Company for an equity interest in Switch (Note 5). On August 30, 1996 the Company issued 1,544,110 shares common stock in exchange for five shares of Switch common stock. During 1995 and 1994, Interpretel issued warrants for the purchase of its common stock in connection with a note offering. On March 8, 1995, the warrants were converted to warrants to purchase common stock of the Company. The warrants are exercisable at a price of $1.00 per share at any time prior to May 31, 1998. As of August 31, 1997, there were 820,885 warrants outstanding. During 1995 and 1994, Interpretel issued warrants for the purchase of its common stock in connection with a private placement offering of units of common stock. At the date of the acquisition, the warrants were converted to warrants to purchase common stock of the Company. The warrants are exercisable at a price of $3.50 per share. The warrants expire June 30, 1998. As of August 31, 1997, there were 23,745 warrants outstanding. Pursuant to an agreement with Switch (Note 5) the Company issued warrants to purchase up to 2,000,000 shares of common stock at a price of $1.50 per share. Consideration received was $20,000. The value assigned to the warrants was based on an allocation pursuant to the comprehensive agreement (Note 5). In consideration of various consulting and loan agreements, the Company issued warrants to purchase up to 235,000 shares of common stock at an exercise price of between $.44 and $1.75 per share. The exercise price reflects the fair market value of the shares of common stock on the date of the grant of the warrants. The total number of warrants outstanding at August 31, 1997, is 3,079,630. The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25") and related Interpretations in accounting for its stock options because as discussed below, the alternative fair value accounting provided for under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based 42 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 11. COMMON STOCK, CONTINUED Compensation ("SFAS No. 123"), requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB No. 25, because the exercise price of the Company's stock options equals or exceeds the fair market value of the underlying stock on the dates of grant, no compensation expense is recognized. During the year ended August 31, 1997, the Company adopted the Wavetech, Inc. 1997 Stock Incentive Plan. Under this plan, the Company is authorized to issue up to 4,600,000 shares of common stock such options have terms of up to ten years. Shares may be issued as incentive stock options, deferred shares or restricted shares. The options were granted at the fair market value of the common stock on the date of the grant. Pro forma information regarding net loss and net loss per share is required by SFAS No. 123, and such information has been determined as if the Company had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions: risk-free interest rate of 5.64%, dividend yield of 0%, volatility factor of the expected market price of the Company's common stock of .98, and a weighted-average expected life of the options of 2 years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the related vesting period. The Company's pro forma information follows: 43 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 11. COMMON STOCK, CONTINUED Year ended August 31, 1997 --------------- Net loss, as reported $ (1,629,285) Pro forma compensation expense for stock options 1997 grants (414,000) --------------- Pro forma net loss (2,043,285) --------------- Pro forma loss per share $ (.14) =============== A summary of the Company's stock options activity is as follows: Weighted Number of Exercise Price Options Granted Per Share --------------- -------------- Outstanding, August 31, 1995 136,250 $ 1.39 Granted 1,550,000 1.73 Canceled (450,000) 1.94 --------------- -------------- Outstanding, August 31, 1996 1,236,250 1.73 Granted 2,328,935 .68 Canceled (1,236,250) 1.73 --------------- -------------- Outstanding, August 31, 1997 2,328,935 $ .68 =============== ============== Exercise prices for options outstanding as of August 31, 1997 ranged from $0.36 per share to $0.81 per share. The remaining contractual life of such options ranged from two to ten years. Options for the purchase of 1,468,935 shares were immediately exercisable at August 31, 1997. Pro forma compensation expense presented may not be representative of future pro forma expense, when amortization of multiple years of awards may be reflected. The weighted average fair values of stock options granted during 1997 for which the exercise price was equal to the fair market value of the stock were $0.68 per share. 44 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 12. INCOME TAXES At August 31, 1997, the Company has net operating loss carryforwards totaling approximately $7,764,000 that may offset future income from 1997 to 2011 with varying expiration dates. No tax benefit has been recorded in the financial statements since realization of net operating loss carryforwards does not appear likely. The potential benefit of the net operating loss carryforwards and the deferred tax benefit of future timing differences under SFAS No. 109 is approximately $2,988,000. The March 8, 1995 acquisition (Note 4) resulted in a "change in control" as defined by Internal Revenue Service Regulations. Accordingly, the utilization of the Company's net operating loss carryforwards are deemed more likely than not to expire unutilized. The total amount of the net operating loss carryforwards, $7,764,000, consists of pre-acquisition losses of approximately $3,186,000. These losses cannot be applied against income generated in a trade or business significantly different from that which gave rise to the carryforward. The income tax benefit for the years ended August 31 is comprised of the following amounts: 1997 1996 -------------- -------------- Current $ -0- $ -0- Deferred Federal (429,000) (628,000) State (28,000) (67,000) -------------- -------------- (457,000) (695,000) Valuation allowance 457,000 695,000 -------------- -------------- Total tax benefit $ -0- $ -0- ============== =============== The Company's tax benefit differs from the benefit calculated using the federal statutory income tax rate for the following reasons: 1997 1996 -------------- -------------- Statutory tax rate (35.0%) (35.0%) State income taxes (9.0%) (9.0%) Amortization of organization costs 7.0% 7.0% Release of valuation allowance 37.0% 37.0% -------------- -------------- Effective tax rate .0% .0% ============== ============== 45 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 12. INCOME TAXES, CONTINUED The components of the net deferred tax asset are as follows: 1997 -------------- Deferred tax asset: Amortization of organization costs $ (120,000) Net operating loss carryforward (2,868,000) -------------- (2,988,000) Valuation allowance 2,988,000 -------------- $ -0- ============== 13. RELATED PARTY TRANSACTIONS The Company has cancelable operating agreements with a telecommunications service provider who is a shareholder of common stock of the Company. The Company has agreed to a $12,555 monthly minimum charge with the service provider. The current and future contracts with the service provider have been and are anticipated to be at market rates. The Company also purchased computer equipment and software from this provider valued at $378,009. During the year ended August 31, 1997, an officer and shareholder advanced $109,071 to the Company which is reflected in notes payable. The Company pledged as collateral the five shares of Switch common stock and one share of Interpretel (Canada) common stock (Note 8). As of November 30, 1997, the collateral has been released and the note payable is converted to shares of common stock at .35 per share. An officer and shareholder advanced $13,000 to the Company which is reflected in notes payable (Note 8). A shareholder of the Company advanced $50,000 to the Company which is reflected in notes payable (Note 8). The Company pledged as collateral a security interest in accounts receivable, inventory, general intangibles, equipment, instruments and personal guarantees of corporate officers. As of November 30, 1997 the collateral has been released and the shares converted to shares of common stock of the Company. 14. SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES During the year ended August 31, 1997, the Company entered into capital leases in the amount of $53,783 to purchase office equipment. During the year ended August 31, 1997, the Company issued 100,000 shares of common stock in satisfaction of a note payable of $53,639. 46 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 14. SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES, CONTINUED During the year ended August 31, 1996, the Company entered into capital leases in the amount of $108,213 to purchase office equipment. During the year ended August 31, 1996, the Company entered into an agreement with Switch to exchange an equity interest in the Company for an equity interest in Switch (Note 4). The Company issued 1,544,110 shares of its common stock in exchange for 5 shares of the common stock of Switch. Supplemental disclosure of cash flow information: 1997 1996 -------------- -------------- Cash paid during the period for: Income taxes $ 50 $ 50 ============== ============== Interest $ 20,454 $ 39,327 ============== ============== 15. SUBSEQUENT EVENTS On January 6, 1998, the Company entered into a Reorganization Agreement and Plan of Merger with Imagitel, Inc. (Imagitel), a privately owned telecommunication company based in Houston, Texas. The merger would have resulted in Imagitel shareholders receiving approximately 70% of the Company's outstanding common stock an existing shareholders holding the remaining 30%. On August 24, 1998, the Reorganization Agreement was terminated. The Company is currently seeking other potential strategic merger or acquisition candidates. The Company does not have any binding agreements. On February 9, 1998, the Company executed a loan agreement with Imagitel pursuant to which the Company may borrow up to $450,000 for working capital purposes. Outstanding balances under such loan accrue interest at a rate of 12% per annum and all unpaid principal plus interest accrued thereon mature upon completion of the merger. The loan is secured by all of the assets of the Company. On August 31, 1998, the outstanding principal balance of $180,000 and accrued interest was paid in full and the loan agreement was cancelled. In October of 1997, the Company received proceeds of $250,000 from the issuance of convertible notes payable. The notes were issued with attached warrants to purchase an aggregate of 40,000 share of the Company's common stock. Each of the warrants is convertible at any time prior to October 24, 1999 by the holder thereof at an exercise price of $0.46 per share. The warrants were granted at fair market value of the common stock on the date 47 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 15. SUBSEQUENT EVENTS, CONTINUED of the grant. The notes accrue interest at a rate of 12% per annum and principal and accrued interest thereon is payable on or before April 24, 1998. On November 30, 1997, $200,000 in notes payable along with accrued interest of $2,067 was converted into 577,333 shares on common stock. The beneficial conversion feature of $92,894 was charged to expense in the period of the conversion. During the quarter ended May 31, 1998, the Company offered to all warrant holders with warrants expiring May 31, 1998 and an exercise price of $1.00 per share, the following option: for a specific eleven day period, the right to exercise their warrants for $0.585 per common share (the market price on the date of the offer). A total of 380,280 out of 784,781 warrants were exercised under this offer and the balance of 404,501 warrants expired on May 31, 1998. The Company received $222,503 for the warrants. The Company recorded the exercise of the warrants as an increase to additional paid-in-capital. On June 30, 1998, an agreement was reached between the Company and Switch which terminated the license agreement and any future obligations there under. Consideration of $150,000 was received in connection with this agreement. The Company will recognize income in connection with the termination of $86,906 unamortized deferred revenue and $150,000 of termination fee revenue. On June 30, 1998, an agreement was reached between the Company and Switch which sets forth the terms and conditions of a put option for the share of common stock of Switch which are owned by the Company. The sale price is $2,100,000 and the term of the option is one year. On August 25, 1998, the Company exercised the put option thereby selling its entire interest in Switch. On August 31, 1998, the Company received $2,100,000 in satisfaction of the option agreement. The Company will recognize a loss of $216,165 upon disposition of the investment. 16. GOING CONCERN For the year ended August 31, 1997, the Company sustained a loss of $1,775,714. The Company currently lacks adequate funds to finance its ongoing working capital needs. The Company is currently seeking to secure adequate sources of funds to finance its immediate and long-term working capital needs. Such sources may include a private placement of equity by the Company, commercial financing, or a strategic alliance or other business combination. The Company does not currently have any agreements, binding or non-binding, with respect to any such above stated arrangements. Further, there can be no assurance that the Company will be able to secure adequate sources of funds and its inability 48 WAVETECH, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS -------------- 16. GOING CONCERN, CONTINUED to do so would result in a material adverse affect upon the Company's business and results or operations. In addition, if the Company succeeds in acquiring additional financing, such efforts may result in additional dilution to the Company's stockholders; impose restrictions upon the Company's ability to incur additional debt, pay future dividends, enter into future business combinations or other restrictions upon the Company to act in a manner which its Board of Directors may deem advisable; or result in a change in control of the Company. The ability of the Company to continue as a going concern is dependent upon increasing sales and obtaining additional capital and financing. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. 17. RESTATEMENT OF FINANCIAL STATEMENTS Contained in the Company's financial statements for the year ended August 31, 1997, whose report thereon was dated December 4, 1997, was the recognition of revenue related to the receipt of payment of a licensing fee (Note 6). The financial statements have been corrected to recognize revenue from the licensing fee over the seven-year term of the licensing agreement. Revenue previously recognized on the licensing fee was $200,000. Revenue recognized for the licensing fee in the restated financial statements is $53,758. The correction resulted in a decrease in revenue recognized in the amount of $146,242, for the year ended August 31, 1997. Total revenue was $865,384 in the previously issued financial statements and is $719,142 in the restated financial statements. Net loss was $(1,629,472) in the previously issued financial statements and is $(1,775,714) in the restated financial statements. The correction resulted in a change in the net loss per common share from $(0.11) per common share in the previously issued financial statements to $(0.12) per common share in the restated financial statements. 49 ITEM 8. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT All directors hold office until the next annual meeting of stockholders of the Company and thereafter until their successors are chosen and qualified. All officers hold office at the selection and choice of the Board of Directors of the Company. DIRECTORS AND OFFICERS The directors and executive officers of the Company are as follows: Name Age Position Held with Company - ---- --- -------------------------- Terence E. Belsham 61 Chairman of the Company's Board of Directors Gerald I. Quinn 53 President, Chief Executive Officer, and a member of the Company's Board of Directors Lydia M. Montoya 44 Chief Financial Officer Richard P. Freeman 40 Vice President, Investor Relations and Product Development, and a member of the Company's Board of Directors Terrence H. Pocock 65 Director TERENCE E. BELSHAM was a co-founder of Interpretel. Since it was founded in 1992 until May 1996, Mr. Belsham was the President and CEO of Interpretel. Mr. Belsham has also served as the Company's Chairman of the Board since March 1995. From 1989 until 1992, Mr. Belsham was President of Intran Systems, Inc. From 1983 to 1989, Mr. Belsham owned Sinclair Associates, a real estate marketing and management firm. From 1965 to 1983, Mr. Belsham was President and owner of Lackie Manufacturing Company, Ltd., a jewelry manufacturing company in Canada. Mr. Belsham graduated from the business school of the University of Western Ontario. Mr. Belsham has been active in Rotary International, the Canadian Jeweler's Association and the 24 Karat Club. GERALD I. QUINN has been the President of Interpretel (Canada) Inc., a subsidiary of the Company, since 1995. In May 1996, Mr. Quinn became the President, Chief Executive Officer and a Director of the Company. From 1986 to 1994, Mr. Quinn was Vice President of University Affairs and Development at the University of Guelph, which is one of Canada's leading teaching and research universities. While at the University of Guelph, Mr. Quinn's responsibilities included marketing, image development, constituent relations and media relations, including systems development, telemarketing and the development of affinity programs. From 1975 until 1986, Mr. Quinn held many senior administrative positions with Canada's largest college of applied arts and 50 technology, including positions relating to the development and commercialization of technology and multimedia based interactive learning programs. Since 1984, Mr. Quinn has served as a consultant to Cableshare Interactive Technology, Inc., a Canadian TSE listed public company that operates in the interactive television industry. Mr. Quinn has been a director of Cableshare since 1993 and chairs its board committee on mergers and acquisitions. Mr. Quinn is active in numerous civic and professional organizations and has been recognized for his work in marketing, sales, promotion and public relations by various trade organizations. Mr. Quinn has two arts degrees with majors in English, Economics and Political Science. Mr. Quinn's sister is married to Terrence H. Pocock. LYDIA M. MONTOYA joined the Company in September 1996 as its Chief Financial Officer. From May 1994 until September 1996, Ms. Montoya was self-employed as a Certified Public Accountant. Ms. Montoya was Controller of Ugly Duckling Corporation, a publicly traded company ("Ugly Duckling") from November 1992 to May 1994. Ugly Duckling is an operator of nine used car dealerships which also finance and service retail installment contracts generated from the sale of used cars by its dealerships. From July 1987 to October 1992, Ms. Montoya was Director of Partnership Accounting for Verde Investments, Inc., a real estate development company that constructed, operated and sold over 5,000 apartment units. Ms. Montoya began her career with Coopers & Lybrand. Ms. Montoya has a B.S. in Accounting from the University of Arizona and a B.S. in Sociology from Arizona State University. RICHARD P. FREEMAN was a co-founder of Interpretel and has served as Interpretel's Vice President since 1993 and as a Director of the Company since March 1995. Prior to joining Interpretel, Mr. Freeman was a principal in several entrepreneurial companies located in Arizona, which were primarily involved in the tourism and travel industries. Those companies included Desert Divers, a scuba retail and boat charter company, and Vacation, Etc., a tour and travel company which focused on corporate, leisure and adventure travel, wholesale tour operations and escorted senior travel. Mr. Freeman has also served as a consultant to several travel-related organizations, including the Business Radio Network, a national network. Mr. Freeman holds a Bachelor of Arts degree from the University of Arizona and is active in various civic and community organizations. TERRENCE H. POCOCK has been a Director the Company since March 1997. Mr. Pocock is the Vice Chairman of Cableshare Interactive Technology, Inc., a Canadian public company he founded in 1973 that operates in the interactive television industry. Currently, Mr. Pocock is involved in technology oversight for the board of directors at Cableshare. From its inception in 1973 until 1992, Mr. Pocock was the CEO of Cableshare. While at Cableshare, Mr. Pocock was involved in product development and was responsible for obtaining several patents on interactive television technology. Mr. Pocock holds B.A., B Comm. and MBA degrees from various Canadian universities and is a graduate of the Canadian Royal Military College. Mr. Pocock is married to the sister of Gerald I. Quinn. 51 ITEM 10. EXECUTIVE COMPENSATION (A) CASH COMPENSATION The following table summarizes all compensation paid to the Company's Chief Executive Officer (the "Named Executive Officer"), for services rendered in all capacities to the Company during each of the fiscal years ended August 31, 1997, 1996 and 1995. None of the Company's other employees received in excess of $100,000 in compensation during the last completed fiscal year. SUMMARY COMPENSATION TABLE
- ----------------------------------------------------------------------------------------------------------- LONG TERM ANNUAL COMPENSATION COMPENSATION AWARDS - ----------------------------------------------------------------------------------------------------------- RESTRICTED STOCK SECURITIES NAME AND FISCAL BONUS OTHER ANNUAL STOCK AWARDS UNDERLYING PRINCIPAL POSITION YEAR SALARY ($) AWARDS($) COMPENSATION ($) OPTIONS (#) - ----------------------------------------------------------------------------------------------------------- Gerald I. Quinn 1997 $85,000(1) -0- $-0- -0- 800,000(2) President/CEO 1996 $85,000 -0- -0- $203,637 500,000 1995 $58,000 -0- -0- -0- 300,000
(1) Includes the fair market value of 8,853 shares of Common Stock, for which Mr. Quinn elected to receive deferred shares pursuant to the Company's 1997 Stock Option Plan in lieu of a portion of his annual base salary for services rendered. The aggregate fair market value of these shares at the expiration of the applicable deferral periods equalled $34,163. (2) Effective January 31, 1997, the exercise price with respect to an aggregate of 800,000 options to purchase Common Stock previously granted to Mr. Quinn was amended in connection with the cancellation of such previously outstanding options in exchange for a new grant of an equal number of options under the Company's 1997 Stock Incentive Plan. The exercise price of the new options is equal to the fair market value of the Company's common stock on the date of grant. The following table sets forth information concerning individual grants of stock options made to the Named Executive Officer during the last completed fiscal year. 52 OPTION GRANTS IN LAST FISCAL YEAR - -------------------------------------------------------------------------------- NUMBER OF OF SECURITIES PERCENT OF TOTAL UNDERLYING OPTIONS GRANTED OPTIONS TO EMPLOYEES IN EXERCISE EXPIRATION NAME GRANTED (#) FISCAL YEAR PRICE ($/SH) DATE - -------------------------------------------------------------------------------- Gerald I. Quinn 800,000 45% $0.66 May 2006 - --------------- (1) In January of 1997, the Company's stock price had decreased significantly from the date these options were granted. In addition, the Company's Board of Directors approved the Company's 1997 Stock Incentive Plan. The Company's Board of Directors determined that these options were no longer providing appropriate incentives to the officers of the Company due to the significant decrease in market price of the Company's Common Stock. Accordingly, in January of 1997, the Company agreed to cancel these options and issue an equal number of options under the 1997 Stock Incentive Plan to these officers at an exercise price per share equal to the closing bid price of the Company's Common Stock on the date of grant. The following table sets forth certain information concerning each exercise of stock options during the year ended August 31, 1997 by the named Executive Officer and the aggregated fiscal year-end value of the unexercised options of such Named Executive Officer. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
- ------------------------------------------------------------------------------------------------------------------------ NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS AT FISCAL YEAR END (#) AT FISCAL YEAR END ($) - ------------------------------------------------------------------------------------------------------------------------ Shares Acquired Value Name on Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable - ------------------------------------------------------------------------------------------------------------------------ Gerald I. Quinn -0- $0 800,000 -0- $0 $0
(B) COMPENSATION PURSUANT TO PLANS None. 53 (C) COMPENSATION OF DIRECTORS All Directors are reimbursed for their reasonable out-of-pocket expenses incurred in connection with attendance at Board meetings. Directors who are employees of the Company do not receive compensation for service on the Board, other than their compensation as employees. In March 1997, the Company adopted the 1997 Stock Incentive Plan. Under the Plan, members of the Board of Directors of the Company, who are not employees of the Company or its subsidiaries, will receive an option to purchase 10,000 shares of the Company's Common Stock upon their initial election to the Board and thereafter receive an annual grant of an additional 10,000 options. The options vest one year from the respective date of grant and terminate upon the earlier of 10 years from the date of grant or 24 months after the Director ceases to be a member of the Board. The Company lacked sufficient funds to compensate its executives and employees and, therefore, entered into agreements with such executives and employees to compensate them with a number of shares of the Company's Common Stock with a fair market value on the last day of a regular pay period equal to each respective employee's salary plus a ten percent premium as consideration for entering into such agreements. The shares were issued as Deferred Shares pursuant to the Company's 1997 Stock Incentive Plan. (D) EMPLOYMENT CONTRACTS In May 1996, the Board of Directors approved a two-year employment agreement with Gerald I. Quinn for services as President and Chief Executive Officer. The agreement requires Mr. Quinn to devote his full time to the Company and provides for a salary of $85,000 annually. Mr. Quinn is also entitled to receive any fringe benefits generally extended to the employees of the Company, including medical, disability and life insurance. Mr. Quinn also has the right to receive certain sales commissions from the Company under his agreement. In May 1996, the Board of Directors approved a one-year employment agreement with Terence E. Belsham for services as Chairman. In September 1996, the agreement was amended to eliminate Mr. Belsham's responsibilities as Chief Financial Officer because the Company retained Lydia Montoya to serve as its Chief Financial Officer. The agreement requires Mr. Belsham to devote his full time to the Company and provides for a salary of $85,000 annually. Mr. Belsham is also entitled to receive any fringe benefits extended to the employees of the Company, including medical, disability and life insurance. In August 1997, Mr. Belsham's contract was terminated, as per conditions of the agreement, due to illness. In June 1996, the Board of Directors approved a one-year employment agreement with Richard P. Freeman for services as Vice President. The agreement provides for a base salary of $72,000 per year. The agreement requires Richard P. Freeman to devote his full time to the Company. In June 1997, Mr. Freeman's contract was renewed under the same terms. After their initial terms, each of the above-described agreements continue at will, terminable with/on ninety days written notice by either party to the other. The agreements terminate upon the occurrence of any of the following events: (i) if the employee voluntarily terminates; (ii) if the employee dies; 54 (iii) if the employee is unable to properly discharge his obligations under his employment agreement due to illness, disability or accident for three consecutive months or for a period aggregating six months in any continuous twelve months; (iv) if the employee is convicted of a crime of moral turpitude by a court of competent jurisdiction; (v) if the employee is convicted of a felony, except to the extent that the charge arises from an act taken at the board's direction; or (vi) if the employee is grossly negligent or guilty of willful misconduct in connection with the performance of his duties, which negligence or misconduct, if curable, is not cured within fifteen days of a notice of cure by the Board or the Chairman of the Board. Each of the above-described agreements provides that the employee shall not compete with the Company during the term of the agreement and for a period of one year thereafter. In the event of any Corporate Transaction or Change of Control of the Company (each as defined in the Plan), the Common Stock at the time subject to each outstanding option, but not otherwise vested, shall automatically vest in full, so that each such option shall, immediately prior to the effective date of such corporate transaction or change of control, become fully exercisable for all of the Common Shares at the time subject to the option, and may be exercised for all or any portion of those shares as fully vested Common Stock. (E) SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Exchange Act requires the Company's officers and Directors, and persons who beneficially own more than 10% of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the SEC. Officers, Directors and greater than 10% stockholders are required by Exchange Act regulations to furnish the Company with copies of all Section 16(a) forms they file. In 1997, Messrs. Belsham, Freeman and Quinn each failed to make timely one report on Form 4 of a change in the exercise price of certain stock options granted in 1996 and Ms. Montoya failed to timely make one report on Form 4 of the grant of certain stock options. In addition Mr. Pocock failed to timely file an initial statement of beneficial ownership on Form 3 and one report on Form 4 of the grant of certain stock options. (F) COMPENSATION COMMITTEE REPORT ON REPRICING In January 31, 1997, the Board, on the recommendation of the Compensation Committee, canceled the options granted to Gerald I. Quinn, President and CEO, under his Services Agreement of May 21, 1996. Under the May 21, 1996 Services Agreement, Quinn was to receive options on 500,000 Common Shares with an exercise price of $1.75 a share and, from a former Agreement, options on 300,000 Common Shares at an exercise price of $1.3875 per share. On the same date, January 31, 1997, Mr. Quinn was granted a new option plan within the Company's 1997 Stock Incentive Plan of 800,000 Common Shares at an exercise price of $0.66 cents a share. Mr. Quinn's prior options were not within the Stock Incentive Plan of the Company and were at an unrealistic exercise price. It was felt that Mr. Quinn as President and CEO needed to have a reasonable incentive to make Wavetech a financially viable operation for the benefit of the shareholders. Mr. Quinn was not a significant shareholder and was not being paid a large salary. Consequently, the Board felt the change in the option plan for Quinn was appropriate. 55 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth as of November 28, 1997 certain information with regard to the record and beneficial ownership of the Company's Common Stock by (i) each shareholder beneficially owning 5% or more of the Company's outstanding Common Stock, (ii) each Director individually, (iii) the Named Executive Officer and (iv) all Officers and Directors of the Company as a group: Name and Address of Beneficial Owner Shares Owned Percent of Class ------------------- ------------ ---------------- Terence E. Belsham 1,187,876 (1) 7.7% 5210 E. Williams Circle, Suite 200 Tucson, Arizona 85711 Richard P. Freeman 1,195,192 (2) 7.8% 5210 E. Williams Circle, Suite 200 Tucson, Arizona 85711 Gerald I. Quinn 1,346,083 (3) 8.3% 5210 E. Williams Circle, Suite 200 Tucson, Arizona 85711 Terrence H. Pocock 298,096 (4) 1.9% 5210 E. Williams Circle, Suite 200 Tucson, Arizona 85711 Switch Telecommunications Pty Ltd 3,544,110 (5) 20.7% 55 Mentmove Ave. Rosebery, New South Wales 2018 Australia All Officers and Directors as a group (4 in number) 4,027,247 (1)(2)(3)(4) 23.7% - -------------- (1) Includes 200,000 Common Shares issuable in connection with options to purchase Common Stock. The options are exercisable at $0.81 per share and have fully vested. At August 31, 1997, 200,000 of the options are exercisable. (2) Includes 200,000 Common Shares issuable in connection with options to purchase Common Stock. The options are exercisable at $0.81 per share and have fully vested. At August 31, 1997, 200,000 of the options are exercisable. (3) Includes 800,000 Common Shares issuable in connection with options to purchase Common Stock. The options are exercisable at $0.66 per share and have fully vested. At August 31, 1997, 800,000 share options are exercisable. Includes 333,593 Common Shares, issuable upon conversion of convertible note as of November 28, 1997. 56 (4) Includes 10,000 options granted to a non-employee Board member. The options are exercisable at $0.37 and have fully vested. At August 31, 1997, 10,000 of the options are exercisable. Includes 288,096 Common Shares, held by spouse and son of which he expressly disclaims ownership, issuable upon conversion of convertible notes as of November 28, 1997. (5) Includes a warrant of 2,000,000 Common Shares at $1.50 per share. (C) CHANGE IN CONTROL On March 8, 1995, the Company entered into an agreement with Interpretel, Inc. pursuant to which the Company agreed to issue 6,000,000 shares of its Common Stock in exchange for 100% of the outstanding 1,532,140 shares of Common Stock of Interpretel. The transaction resulted in the former shareholders of Interpretel, Inc. owning approximately 80% of the outstanding shares of the Company. In accordance with Accounting Principles Board Opinion No. 16, "Business Combinations," the Acquisition has been accounted for as a reverse acquisition with Interpretel, Inc. deemed to be acquiring entity of the Company. The Common Shares in connection with the Acquisition were valued at $2,000,000, which is based on the fair market value of the Company's only major asset, undeveloped land located in Ohio. The Acquisition agreement also provides that during the three year period following the March 8, 1995 closing, former shareholders of Interpretel can receive an additional 7,500,000 Common Shares of the Company through an "earn-out" based upon before tax net profit. During the two year period following closing, former shareholders of Interpretel can earn up to 3,750,000 Common Shares of the Company for every $0.50 net profit before taxes, and an additional 3,750,000 Common Shares of the Company for every $1.00 of cumulative total net profit before taxes. During the third year following closing, any shares not previously issued pursuant to this agreement can be earned at $1.50 net profit before taxes per share. These additional shares will not be considered in recording the Acquisition transaction until such time as the earnings targets have been met. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On January 21, 1997, the Company granted a warrant to Switch Telecommunications Pty Ltd to purchase up to 2,000,000 shares of the Company's Common Stock at a price of $1.50 per share, in exchange for consideration of $2,000,000. The Company also licensed Switch to use certain Company technology in Australia and various other Asian countries. During the year ended 1997, the Company became indebted to two officers and one shareholder. The Company became indebted to Mr. Gerald I. Quinn, the Chief Executive Officer, for $109,071 plus accrued interest of $3,809; and to Mr. Richard P. Freeman, Vice President, for $13,000 plus accrued interest of $585; and to Mr. Robert Caylor, shareholder, for $50,000 plus accrued interest of $854. The loans were made in the ordinary course of business and were made on substantially the same terms, including rates and collateral, as those prevailing at the time for comparable transactions with other persons. 57 PART IV ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (A)(1) FINANCIAL STATEMENTS. The financial statements listed in the index set forth in Item 7 of this Form 10-KSB are filed as part of this report. (A)(2) EXHIBITS Method of Number Description Filing - ------ ----------- --------- 3.1 Certificate of Incorporation of the Company * 3.2 By-Laws of the Company * 10.30 Employment Contract dated May 21, 1996, between the Company ** and Terence E. Belsham, Chairman and Chief Financial Officer 10.31 Employment Contract dated June 17, 1996 between the Company ** and Richard P. Freeman, Vice President, Product Development & Strategic Planning 10.32 Employment Contract dated May 21, 1996 between the Company ** and Gerald I. Quinn, President and Chief Executive Officer 22 Subsidiaries of the Registrant *** 23 Consent of Addison, Roberts & Ludwig **** 27 Financial Data Schedule **** - ---------- * Incorporated by reference from the like numbered exhibit to the Company's Form 10-QSB for the Quarter ended February 28, 1997. ** Incorporated by reference from the like numbered exhibit to the Company's Form 10-KSB for the Fiscal year ended August 31, 1996. *** Incorporated by reference from the like numbered exhibit to the Company's Form 10-KSB for the Fiscal Year Ended August 31, 1997, filed on December 15, 1997. **** Filed herewith. (B) REPORTS ON FORM 8-K FILED DURING THE LAST QUARTER OF THE PERIOD COVERED BY THIS REPORT ARE AS FOLLOWS: None. 58 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Wavetech, Inc. has duly caused this amended report to be signed on its behalf by the undersigned, thereunto duly authorized. WAVETECH, INC. Dated: December 4, 1998 By: /s/ Gerald I. Quinn ----------------------------------- GERALD I. QUINN, PRESIDENT AND CHIEF EXECUTIVE OFFICER, DIRECTOR (Principal Executive Officer) Dated: December 4, 1998 By: /s/ Lydia M. Montoya ----------------------------------- LYDIA M. MONTOYA, CHIEF FINANCIAL OFFICER (Principal Financial Officer) Dated: December 4, 1998 By: /s/ Terrence E. Belsham ----------------------------------- TERENCE E. BELSHAM, CHAIRMAN OF THE BOARD Dated: December 4, 1998 By: /s/ Richard P. Freeman ----------------------------------- RICHARD P. FREEMAN, DIRECTOR Dated: December 4, 1998 By: /s/ Terrence H. Pocock ----------------------------------- TERRENCE H. POCOCK, DIRECTOR 59 EX-23 2 ACCOUNTANT'S CONSENT EXHIBIT 23 [LETTERHEAD OF ADDISON, ROBERTS & LUDWIG, P.C.] CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANT We hereby consent to the use of our report dated August 31, 1998, related to the consolidated financial statements of Wavetech International, Inc. (formerly Wavetech, Inc. and Subsidiaries), for the year ended August 31, 1997, included in or made a part of this Form 10-KSB/A (Amendment number two). /s/ Addison, Roberts & Ludwig, P.C. Addison, Roberts & Ludwig, P.C. Tucson, Arizona December 4, 1998 EX-27 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF OPERATIONS, FOR THE YEAR ENDED AUGUST 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR AUG-31-1997 SEP-01-1996 AUG-31-1997 13,329 0 26,800 527 0 49,327 788,110 (377,928) 2,840,796 700,018 0 0 0 15,077 1,996,738 2,840,796 719,142 719,142 679,930 679,930 1,796,533 0 26,893 (1,775,714) 0 0 0 0 0 (1,775,714) (0.12) 0
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