ITEM 1. BUSINESS
General
FaxSav Incorporated (the "Company") designs, develops and markets a variety of business-to-business facsimile transmission services, including computer-to-fax, fax-to-fax, enhanced fax and broadcast fax services. The Company has developed proprietary software which enables its customers to specify on a call-by-call basis whether a facsimile transmission will be delivered through FaxSav's real-time, "virtual real-time (Internet fax)" or broadcast services. This software, coupled with FaxSav's fax-only network of three interconnected switching nodes in the United States and Internet-capable facsimile nodes located in twenty-one countries as of December 31, 1998, automatically delivers each outgoing transmission through the route that provides the lowest cost and the highest transmission quality available on the FaxSav network. Pre-negotiated volume-based arrangements with several telephony common carriers, the major carrier being MCI WorldCom, and the cost savings available for transmission through the Internet enable FaxSav to transmit its customers' documents and images to fax machines worldwide at rates that are below the international rates charged by long distance voice carriers. While FaxSav generates cost savings for customers transmitting faxes to international destinations, many FaxSav customers use the Company's services for ease of use and productivity improvements rather than cost savings.
The Company has deployed Internet-capable facsimile nodes in twenty-one key international telecommunications markets to enable it to migrate a portion of its customer traffic off of its telephony-based network and to route it over the Internet. This global Internet backbone, which seamlessly integrates with FaxSav's telephony-based network, enables the Company to bypass long distance common carriers for transmissions originating and terminating in countries where such nodes have been deployed, thereby further reducing its customers' international transmission costs. FaxSav believes that the combination of its telephony-based network and its growing Internet-based network will enable it to emerge as a leading supplier of comprehensive, convenient, low-cost global faxing services.
Industry Background
The Market For Facsimile Services
Technological advances over the past decade have improved the speed and quality of facsimile transmissions and reduced the cost of fax machines to consumers, resulting in a large and increasing worldwide installed base of fax machines. In addition, there recently has been a rapid increase in the installed base of fax-capable personal computers. The proliferation of fax machines and fax capable computers, and improvements in the transmission quality of domestic and international telephone networks, have resulted in facsimile transmission being the preferred means of immediate business-to-business document delivery.
Traditional International Facsimile Transmission
A facsimile message typically is transmitted by means of a telephone call from one fax machine to another over the voice telephony network. Once a connection has been established between the two machines, the scanned image from the originating fax machine is electronically transmitted to the destination fax machine. Facsimile transmissions historically have been, and substantially all of such transmissions continue to be, implemented on a real-time continuous connection basis using the voice telephony network as a transmission medium.
An international facsimile transmission from the United States typically is routed as follows: (i) the sending fax machine accesses the local exchange carrier (an "LEC"), which then routes the fax to the customer's long distance carrier; (ii) the long distance carrier then routes the fax via its voice telephony network to the telephone company of the destination country; and (iii) the foreign telephone company then routes the fax to a local telephone number to which the destination fax machine is attached. In this example, the long distance company will bill the customer to cover the LEC access fee, the fee for use of its
voice telephony network and the fee for the connection between the long distance carrier's network and the foreign telephone company, which includes the fee for delivery to the destination fax machine. The majority of the cost for international transmissions from the United States to destinations outside of North America is attributable to the inter-country connection fee.
Document Delivery Over The Internet
Substantially all inter-country facsimile traffic worldwide is transmitted through voice telephony networks at rates which are largely dictated by the inter-country connection fees. Unlike traditional public and private telecommunications networks, which are individually managed, the Internet is a collection of connected computer systems and networks that link millions of public and private computers to form what is essentially the largest computer network in the world and enables businesses, educational institutions, government agencies and individuals to transmit data internationally without incurring inter-country voice telephony connection fees.
Although the Internet has been used for a number of years as a medium for the international delivery of documents from computer to computer, substantially all facsimile traffic worldwide continues to originate and terminate on fax machines. The ability to effectively capture the savings enabled by Internet document delivery in the international facsimile market therefore requires the deployment, on a global basis, of a network of Internet-capable facsimile nodes to bridge the gap between the Internet and the fax machine.
The FaxSav Solution
FaxSav has deployed an international network of Internet-capable facsimile nodes in twenty-one countries as of December 31, 1998 which are designed to provide a reliable means to deliver facsimile transmissions to fax machines worldwide at substantially reduced costs. This global Internet backbone, which seamlessly integrates with FaxSav's telephony-based network, enables the Company to bypass inter-country connection fees for transmissions originating and terminating through such nodes.
FaxSav, through its integrated Internet and telephony network, provides a comprehensive range of services for the global transmission of documents and images, including computer-to-fax, fax-to-fax, enhanced fax and broadcast fax services. In addition, to position itself in the emerging desktop-to-fax market, the Company has developed several proprietary software products which enable the transmission of documents or images created in any Windows, Macintosh or e-mail application to be routed directly from an Internet-connected computer desktop through the FaxSav network to fax machines worldwide.
The FaxSav solution provides substantial ease of use to the customer. Customers may begin transmitting faxes at substantially reduced costs without any upfront investment or complex system installation. FaxSav is quickly and easily installed by the customer and does not require any changes in customer business practices. Customers connect to the FaxSav network from a fax machine by simply installing a faxSAV Connector, a small proprietary device that easily plugs between the customer's fax machine and the wall jack, or by simply installing FaxSav's proprietary desktop software on an Internet-connected personal computer. FaxSav's proprietary routing algorithms then automatically deliver each facsimile transmission, through either FaxSav's telephony network or Internet backbone in order to optimize the lowest cost and the highest transmission quality available on the FaxSav network. Additionally, the FaxSav solution is both modular and scalable to meet customer business needs in that it can be easily deployed across multiple fax machines or personal computers within an organization on an unlimited basis.
The FaxSav Network
Overview
Traditional International Facsimile Transmission. In the United States, traditional international facsimile transmission begins when the originating fax machine places a call over the local telephone network. Because the number dialed has an international prefix, the Local Exchange Carrier ("LEC") switches the call to the sender's long distance carrier (typically AT&T Corp. ("AT&T") MCI WorldCom ("MCI"), or Sprint Corp., ("Sprint"). The long distance carrier ("LDC") delivers the call to the corresponding long distance company (the "PTT") in the country of destination, which in turn completes the call by providing a connection through the local telephone network to the receiving fax machine. Thus a real-time connection is established over the traditional telephony networks, and the originating fax machine sends a data stream, comprising a scanned image, to the receiving fax machine.
Facsimile Transmission via FaxSav's Network. FaxSav's services, which are targeted at businesses and professionals, are designed to reduce the cost of sending international faxes, and to make the process of sending faxes easier and less
time-consuming. The FaxSav network offers its customers the benefits of increased savings and convenience by bypassing parts or all of the traditional network described above. For example, an international fax-to-fax message delivered through FaxSav's Internet-based network utilizes the Internet as a delivery medium, bypassing the long distance carriers and thereby avoiding expensive inter-country connection fees. In addition, a customer using the faxSAV for Internet suite of services accesses the FaxSav network through its Internet service provider (an "ISP") rather than through the local telephone network; the Company's proprietary software then either routes the call over FaxSav's telephony network or bypasses the long distance carriers and the associated inter-country connection fees by routing the call through FaxSav's Internet-based network.
The FaxSav Network
The FaxSav network is designed to minimize the cost of sending faxes internationally by selecting the optimal route and carrier for each facsimile transmission. Currently FaxSav provides its customers with the ability to reach fax machines worldwide via its telephony-based network. FaxSav's telephony-based services are competitively priced and, on faxes to most international destinations, FaxSav customers are expected to realize substantial savings as compared to the rates charged by traditional long distance carriers.
In addition to its telephony-based network, FaxSav has deployed an Internet-based network which connects key telecommunications markets worldwide. FaxSav's Internet-based network complements its telephony-based network and provides the Company with the opportunity to further lower the retail price of its customers' international facsimile transmissions while increasing its market share. As FaxSav continues to deploy its Internet nodes internationally, it will be able to route an increasing portion of its customers' traffic over the Internet.
FaxSav believes that the combination of its telephony-based network and its Internet-based network is critical to achieving its objective of emerging as the leading provider of comprehensive low-cost global faxing solutions. Therefore FaxSav intends to maintain both a telephony-based and an Internet-based network but with an increasing level of customer traffic being routed through the Internet.
Network Infrastructure
At the core of the FaxSav network are three main switching nodes, installed in New York, New Jersey and Washington, D.C. These switching nodes utilize FaxSav's proprietary messaging software to provide the full range of the Company's service offerings, including real-time delivery, "virtual real-time (Internet fax)" delivery, least cost fax routing, e-mail to fax conversion, Internet access, broadcast delivery, customer registration and customer query capabilities. Each switching node employs switch-to-host architecture and fully redundant hardware and software, and is interconnected to the others through a private intranet utilizing T1 links. A backup connection is also provided through separate T1 links to the Internet via firewalls. The switching nodes are installed in secure locations and are supported by uninterruptible power supplies with emergency power generators as further backup. The main switching nodes are connected through the Internet to the Internet facsimile nodes installed by FaxSav overseas, extending access to the Company's service in the markets where such nodes are located. Internet nodes provide "virtual real-time" fax delivery, least-cost fax routing via the best node, e-mail to fax conversion and broadcast delivery capabilities. FaxSav has designed a network-wide redundancy into its nodes, such that if any particular node fails for any reason to complete a transmission, an alternative route through the FaxSav network will automatically be selected. In addition, in the event of an Internet failure, the Internet nodes have a spanning (multiple simultaneous calling) dial backup capability to connect via telephony lines to the nearest node. This node-based and network wide redundancy is designed to allow FaxSav to reliably provide service to its customers without interruption. Additionally, RSA encryption is provided in each Internet node such that each file delivered through FaxSav's Internet nodes is encrypted, addressing security concerns of its customers. All nodes are designed for unattended operation, provide a full range of system monitoring and control capability and can be upgraded and maintained remotely.
Services
faxSAV
faxSAV, the Company's first fax-to-fax service, is a real-time fax transmission service that is delivered through the Company's telephony-based network. The faxSAV service is accessed by customers through the installation of a faxSAV Connector, a small proprietary device which is plugged between the fax machine and the telephone jack. The faxSAV Connector, which is programmable directly from FaxSav headquarters based on the customer's specified needs, automatically identifies each outgoing call which the customer has pre-selected for delivery by the Company and routes the call to the FaxSav network. The faxSAV Connector is provided by FaxSav free of charge with no installation cost to the customer. The Company believes that, depending on the volume and destinations of the customer's traffic, the faxSAV service provides significant savings to customers on fax usage costs in comparison to the international rates charged by the major long distance carriers. faxSAV customers are charged on a per-minute basis for the transmission time to the destination fax machine, and are billed monthly. The Company also offers customized pricing plans based on the customer's volume of traffic to individual countries.
faxSAV Assured
faxSAV Assured is a "virtual real-time" enhanced delivery option available to all faxSAV customers through the faxSAV Connector which may be selected for all of the customer's traffic or on a call by call basis. faxSAV Assured shifts the responsibility for repetitive completion attempts to the FaxSav network, thereby reducing indirect costs and increasing the reliability, timeliness and predictability of difficult facsimile deliveries. The standard faxSAV Assured service immediately begins to attempt delivery, and makes multiple attempts for a period of one hour. If the fax has not been successfully completed within that time, the customer is sent a "Non-Delivery" notice. The Company also offers customized faxSAV Assured services to meet customer-specific delivery schedules.
faxSAV EZ-List
faxSAV EZ-List is an easy to use fax broadcast service which, from a fax machine, utilizes the capabilities of the faxSAV Connector to capture the fax message and the customer's list identification number in a single transmission. During 1997, the Company introduced its Broadcast List Manager software product which enables customers to manage and submit broadcast lists from their desktops. faxSAV EZ-List enables customers to send the same fax message to multiple recipients by transmitting a single fax message to the FaxSav network and identifying a specific list of fax addresses previously stored in the Company's customer database. faxSAV EZ-List customers are charged on a per-minute basis for the transmission time to each destination fax machine, and are billed monthly. The Company also offers customized pricing plans based on the customer's volume of traffic to individual countries.
faxSAV PLUS
In the third quarter of 1996 the Company introduced faxSAV PLUS, a new "virtual real-time" Internet fax service which is designed to provide reliable delivery of facsimile transmissions at substantially reduced costs. This service is designated as Internet fax because the Company utilizes a combination of its traditional telephony-based network and its growing Internet-based network to deliver faxSAV PLUS transmissions to fax machines worldwide. The Company is currently implementing the faxSAV PLUS service with a two-tiered pricing structure. Pricing for delivery to the key telecommunications markets that either have Internet nodes installed or are currently targeted for Internet node deployment is based on the economics of delivery through a planned Internet backbone. Pricing for delivery to other destinations worldwide continues to be based on the economics of delivery through the Company's telephony-based network, which prices may or may not be reduced in the event that the Company deploys Internet-capable facsimile nodes in such markets. faxSAV PLUS customers are charged on a per-minute basis for the transmission time to the destination fax machine, and are billed monthly.
faxSAV for Internet Suite of Services
The faxSAV for Internet suite of services, introduced in stages during the first half of 1996, enables Internet-connected customers to send faxes directly from their computer desktops, either from their e-mail package or from a Windows or Macintosh software application, through the Internet to fax machines worldwide via the FaxSav network. The Company's World Wide Web site includes a detailed explanation of these services, installation instructions and service registration forms. Customers are charged on a per-page basis for the faxSAV for Internet suite of services and generally are billed in advance of use. The faxSAV for Internet suite of services includes the following discrete services:
o faxLauncher enables customers to fax documents created in any Windows or Macintosh application directly from an
Internet-connected computer desktop to fax machines worldwide. faxLauncher also supports documents scanned through sheet-fed scanners manufactured by Visioneer, Inc., Hewlett-Packard Co. or Compaq Computer Corporation. A new version of this software, faxLauncher Pro, provides users with additional features including on-line fax status checking, off-line queuing, account code support and storage of sent faxes. faxLauncher software is provided to customers in diskette form or it may be downloaded from the Company's World Wide Web site.
o faxMailer using FaxSav's patented e-mail security technology, enables customers to transmit messages from e-mail packages over the Internet to the FaxSav network for delivery to fax machines worldwide. faxMailer provides the desktop e-mail customer with the ability to reach the fax machine of anyone not yet connected to the Internet without the necessity of creating hard copy and manually sending a fax. Customers may register for the faxMailer service through the Company's World Wide Web site.
o faxScan enables customers to send documents scanned in any TWAIN-compliant scanner over the Internet to the FaxSav network for delivery to fax machines worldwide. The combination of a scanner and faxScan software puts a virtual fax machine at the desktop for the customer. faxScan software is provided to customers in diskette form.
o Serverlink enables any fax software or applications developer the flexibility of linking to the FaxSav Network in order to facilitate the seamless distribution of fax documents worldwide. Use of Serverlink results in least cost-routing and expanded availability of fax software or applications to multiple users. Serverlink is provided to potential partners and customers electronically.
o faxCourier which was introduced in the first quarter of 1998 enables customers to route faxes straight to their email address. A local or toll-free fax number in the FaxSav Network is allocated to the user. All faxes sent to these numbers are automatically converted to a standard TIFF file format and forwarded as attachments to email to the customer's email address. Users can view or print their faxes using standard, freely available TIFF viewing software.
faxSAV Custom Corporate Solutions
faxSAV Custom Corporate Solutions are specialized services developed by the Company to meet customer needs for specific volume fax applications. FaxSav will custom tailor a software, networking and telecommunications solution designed to provide the customer with additional savings in time and money.
Customer Support Services
The Company believes that customer support is important in differentiating its facsimile delivery services from other delivery approaches. The customer support services provided by the Company include installation assistance on an as-requested basis, facilitation of international fax completion and monitoring the performance of faxSAV Connectors. The Company currently provides customer support and network/faxSAV Connector monitoring functions twenty-four hours a day, seven days a week. The Company's support personnel respond to telephone inquiries and e-mail inquiries. The Company also provides information about its services and new desktop software upgrades on its World Wide Web site.
To provide immediate response to customer inquiries, the Company has developed a wide area network that provides a real-time fax tracking system and allows network operations and customer service personnel to redirect, reschedule or repair fax transmissions that are experiencing completion difficulty. The system accesses fax traffic information via an Oracle database that is updated from the Company's three switching nodes in the United States and provides an on-line connectivity to the Company's master customer database.
Sales and Marketing
Domestic Sales and Marketing
The Company offers its services in the United States through multiple sales channels which include a direct field sales force, an agent and dealer distribution network, and promotional activities at trade shows and on the FaxSav World Wide Web site. Through the first quarter of 1997, the Company had employed a direct mail and direct response program supported by multiple third party telemarketing firms. However, thereafter the Company changed its focus by expanding its direct sales approach to reach larger prospective customers.
During 1995 the Company established a direct field sales force to address the specialized faxing needs of major accounts
and to manage and support the Company's agent channel. The Company's agent and dealer distribution network consists of organizations which sell office equipment, office supplies and telephony services, as well as independent marketing companies. These agents offer FaxSav services as a companion offering to their other products lines. The Company has also entered into agreements for the bundling faxSAV for Internet suite of services with the products of computer hardware, software and Internet services companies although revenues from these agreements have been insignificant.
The Company has used computer and Internet trade shows as forums to introduce the faxSAV for Internet suite of services to prospective customers and partners. The Company's promotions have included the distribution of free software to access its services and free faxing during a trial period and the Company currently offers 5 free pages of faxes to each new subscriber that registers through the company's World Wide Web home page. The Company has promoted its faxLauncher software on the World Wide Web since February 1996.
International Alliances
In connection with the installation of Internet-capable facsimile nodes in certain foreign countries, the Company has formed strategic sales and marketing alliances with local Internet service providers, telecommunications companies and resellers. The Company anticipates that these organizations will use their knowledge of the local market, language, customs and regulations, as well as their existing distribution, customer support and billing infrastructures, to establish, grow and properly service an international FaxSav customer base. In return, the Company is offering these organizations either exclusive or non-exclusive rights to market the Company's services in their territories and offering to provide such services at a discount to the Company's retail prices.
In addition to the strategic alliances, the Company has developed a network of commission-based agents to sell the faxSAV for Internet suite of services in foreign markets. To date, this network consists of over 200 agents representing the Company in over 70 foreign markets. The Company has also implemented a reseller program for those agents who have the infrastructure to generate invoices and perform collections. Under this program, participating agents are provided detailed billing information on their accounts from which they can create and distribute invoices in the local language and currency, and locally service customer billing inquiries.
Customers
The Company sells its services primarily to businesses throughout the world. Customers can install FaxSav's services at individual fax machine or desktop locations, across departments or throughout organizations by simply plugging the faxSAV Connector, a small proprietary device, between their fax machine and the telephone jack or by simply installing FaxSav's desktop software on an Internet connected personal computer. Through 1995, all of the Company's customers were located in the United States. In 1996, with the introduction of the faxSAV for Internet suite of services, the Company began to expand its customer base to include foreign desktop customers. In the first quarter of 1997, the Company began offering fax-to-fax services through its international marketing alliances in certain countries where an Internet node was installed. In 1997, revenues from these international customers amounted to $2.3 million or 13.2% of total revenues and in 1998, revenues from these international customers amounted to $5.9 million or 27.9% of total revenues.
Competition
The market for facsimile transmission services is intensely competitive and there are limited barriers to entry. The Company expects that competition will intensify in the future. The Company believes that its ability to compete successfully will depend upon a number of factors, including market presence; the capacity, reliability and security of its network infrastructure; the pricing policies of its competitors and suppliers; the timing of introductions of new services and service enhancements by the Company and its competitors; and industry and general economic trends. A key element of the Company's strategy is to expand its market presence by leveraging its price leadership strategy both domestically and internationally. The Company intends to maintain and improve the capacity, reliability and security of its network infrastructure through continued research and development activities and will continue to place significant emphasis on the ongoing development of new services and applications of its existing services.
The Company's current and prospective competitors generally fall into the following groups: (i) telecommunication companies, such as AT&T, MCI WorldCom, Sprint, and the regional Bell operating companies, and telecommunications resellers, (ii) Internet service providers, such as Uunet Technologies, Inc. (an affiliate of MCI WorldCom) and NETCOM On-Line Communications Services, Inc.; (iii) on-line services providers, such as Microsoft Corporation and America Online, Inc. and (iv) direct fax delivery competitors, including Premiere Document Distribution (formerly Xpedite Systems, Inc.), and IDT Corporation. Many of these competitors have greater market presence, engineering and marketing capabilities, and financial,
technological and personnel resources than those available to the Company. As a result, they may be able to develop and expand their communications and network infrastructures more quickly, adapt more swiftly to new or emerging technologies and changes in customer requirements, take advantage of acquisition and other opportunities more readily, and devote greater resources to the marketing and sale of their products and services than can the Company. Further, the foundation of the Company's telephony network infrastructure consists of the right to use the telecommunications lines of several of the above-mentioned long distance carriers, including MCI WorldCom . There can be no assurance that these companies will not discontinue or otherwise alter their relationships with the Company in a manner that would have a material adverse effect upon the Company's business, financial condition and results of operations. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their services to address the needs of the Company's current and prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. In addition to direct competitors, many of the Company's larger potential customers may seek to internally fulfill their fax communication needs through the deployment of their own computerized fax communications systems or network infrastructures for intra-company faxing.
Intellectual Property
The Company's success is dependent upon its proprietary technology. The Company relies primarily on a combination of contract, copyright and trademark law, trade secrets, confidentiality agreements and contractual provisions to protect its proprietary rights. The Company has been granted patents related to its faxSAV Connector and for its "e-mail Stamps" security technology incorporated into its faxMailer service. There can be no assurance that the present or future patents will provide sufficient protection to the Company's present or future technologies, products and processes. In addition, there can be no assurance that others will not independently develop substantially equivalent proprietary information or obtain access to the Company's know-how. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's services or to obtain and use information that the Company regards as proprietary. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. There can be no assurance that the steps taken by the Company to protect its proprietary rights will be adequate or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technologies.
Effective September 22, 1998 the Company settled all outstanding litigation with AudioFAX IP, L.L.P. ("AudioFAX") to avoid the expense and disruption of protracted litigation. In 1997 the Company had filed a lawsuit against AudioFAX seeking declaratory relief that FaxSav services did not infringe on any valid claims in certain AudioFAX's patents relating to store-and-forward technology or that certain claims of the AudioFAX patents are not valid. Immediately after the filing of FaxSav's complaint, AudioFAX filed a lawsuit against FaxSav alleging patent infringement. The terms of the settlement agreement required the Company to issue 275,000 shares of common stock to AudioFAX and to register such shares for resale in exchange for a fully paid-up license to the patents in the dispute. Although under certain circumstances the Company would have been required to issue additional shares or pay a certain amount of cash to AudioFAX, these requirements are no longer applicable. The Company has recorded a charge of $1,025,000 in 1998 representing all costs associated with the settlement. No costs have been capitalized, as the Company could not determine the future economic benefit, if any, to the Company of the patent licenses acquired.
There can be no assurance that other third parties will not assert infringement claims against the Company in the future. Patents have been granted recently on fundamental technologies in the communications and desktop software areas, and patents may issue which relate to fundamental technologies incorporated in the Company's services. As patent applications in the United States are not publicly disclosed until the patent issues, applications may have been filed which, if issued as patents, could relate to the Company's services. The Company could incur substantial costs and diversion of management resources with respect to the defense of any claims that the Company has infringed upon the proprietary right of others, which costs and diversion could have a material adverse effect on the Company's business, financial condition and results of operations. Furthermore, parties making such claims could secure a judgment awarding substantial damages, as well as injunctive or other equitable relief which could effectively block the Company's ability to license and sell its services in the United States or abroad. Any such judgment could have a material adverse effect on the Company's business, financial condition and results of operations. In the event a claim relating to proprietary technology or information is asserted against the Company, the Company may seek licenses to such intellectual property. There can be no assurance, however, that licenses could be obtained on terms acceptable to the Company, or at all. The failure to obtain any necessary licenses or other rights could have a material adverse effect on the Company's business, financial condition and results of operations.
Government Regulation
The Company is subject to regulation by various state public service and public utility commissions and by various international regulatory authorities. FaxSav is licensed by the FCC as an authorized telecommunications company and is classified as a "non-dominant interexchange carrier." Generally, the FCC has chosen not to exercise its statutory power to closely regulate the charges or practices of non-dominant carriers. Nevertheless, the FCC acts upon complaints against such carriers for failure to comply with statutory obligations or with the FCC's rules, regulations and policies. The FCC also has the power to impose more stringent regulatory requirements on the Company and to change its regulatory classification. There can be no assurance that the FCC will not change the Company's regulatory classification or otherwise subject the Company to more burdensome regulatory requirements.
On August 7, 1997, the FCC issued new rules which may significantly reduce the cost of international calls originating in the United States. Such rules are scheduled to be phased in over a five-year period starting on January 1, 1998. To the extent that these new regulations are implemented and result in reductions in the cost of international calls originating in the United States, the Company will face increased competition for its international fax services which may have a material adverse effect on the Company's business, financial condition or results in operations.
In connection with the deployment of Internet-capable nodes in countries throughout the world, the Company is required to satisfy a variety of foreign regulatory requirements. The Company intends to explore and seek to comply with these requirements on a country-by-country basis as the deployment of Internet-capable facsimile nodes continues. There can be no assurance that the Company will be able to satisfy the regulatory requirements in each of the countries currently targeted for node deployment, and the failure to satisfy such requirements may prevent the Company from installing Internet-capable facsimile nodes in such countries. The failure to deploy a number of such nodes could have a material adverse effect on the Company's business, operating results and financial condition.
The Company's nodes and its faxLauncher service utilize encryption technology in connection with the routing of customer documents through the Internet. The export of such encryption technology is regulated by the United States government. The Company has authority for the export of such encryption technology other than to Cuba, Iran, Iraq, Libya, North Korea, and Rwanda. Nevertheless, there can be no assurance that such authority will not be revoked or modified at any time for any particular jurisdiction or in general. In addition, there can be no assurance that such export controls, either in their current form or as may be subsequently enacted, will not limit the Company's ability to distribute its services outside of the United States or electronically. While the Company takes precautions against unlawful exportation of its software, the global nature of the Internet makes it virtually impossible to effectively control the distribution of its services. Moreover, future Federal or state legislation or regulation may further limit levels of encryption or authentication technology. Any such export restrictions, the unlawful exportation of the Company's services, or new legislation or regulation could have a material adverse effect on the Company's business, financial condition and results of operations.
Employees
As of December 31, 1998, the Company had 133 full-time employees, including 17 in research and development, 45 in network operations and support, 55 in sales and marketing and 16 in finance and administration. The Company's employees are not covered by any collective bargaining agreements. The Company believes that its relations with its employees are good.
ITEM 2.
ITEM 2. PROPERTIES
The Company's corporate headquarters are located in Edison, New Jersey in facilities consisting of approximately 18,900 square feet of office space occupied under two leases expiring in August 1999 and May 2002. The Company's three U.S. Network facilities are co-located in telehousing facilities under short term leases. In addition, the Company leases offices for its sales staff in the Chicago, Dallas, Ft. Lauderdale, Los Angeles, New York and San Francisco metropolitan areas. While it believes that these facilities are adequate for its present needs, the Company is continually reviewing its needs and may add facilities in the future. The Company believes that any required additional space would be available on commercially reasonable terms. Finally, in connection with its deployment of Internet-capable facsimile nodes, the Company has entered into, and will continue to enter into, short-term leases in telehousing facilities worldwide.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Effective September 22, 1998 the Company settled all outstanding litigation with AudioFAX IP, L.L.P. ("AudioFAX") to avoid the expense and disruption of protracted litigation. In 1997 the Company had filed a lawsuit against AudioFAX seeking
declaratory relief that FaxSav services did not infringe on any valid claims in certain AudioFAX's patents relating to store-and-forward technology or that certain claims of the AudioFAX patents are not valid. Immediately after the filing of FaxSav's complaint, AudioFAX filed a lawsuit against FaxSav alleging patent infringement. The terms of the settlement agreement required the Company to issue 275,000 shares of common stock to AudioFAX and to register such shares for resale in exchange for a fully paid-up license to the patents in the dispute. Although under certain circumstances the Company would have been required to issue additional shares or pay a certain amount of cash to AudioFAX, these requirements are no longer applicable. The Company has recorded a charge of $1,025,000 in 1998 representing all costs associated with the settlement. No costs have been capitalized, as the Company could not determine the future economic benefit, if any, to the Company of the patent licenses acquired.
ITEM 4.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock has been quoted on the Nasdaq National Market under the symbol "FAXX." The following table sets forth for 1997 and 1998, the range of high and low sales prices for the Common Stock of the Company on the Nasdaq National Market. These prices do not include retail mark-up, mark-down or commissions.
1997 High Low
First Quarter.........................................$7.50 $4.00 Second Quarter.........................................5.25 1.25 Third Quarter..........................................1.75 1.00 Fourth Quarter.........................................3.00 1.00
First Quarter.........................................$4.00 $2.38 Second Quarter.........................................5.06 2.56 Third Quarter..........................................8.31 2.38 Fourth Quarter........................................11.00 3.00
On December 31, 1998, the last reported sale price of the common stock on the Nasdaq National Market was $6.19 per share. On March 24, 1999 the last reported sale price of the common stock on the Nasdaq National Market was $8.44 per share.
HOLDERS
As of March 24, 1999, there were approximately 132 holders of record of the common stock.
DIVIDEND POLICY
FaxSav has never declared or paid any cash dividends on its capital stock. FaxSav currently intends to retain future earnings, if any, to finance the operation and expansion of its business and does not expect to pay any cash dividends for the foreseeable future.
SALES OF UNREGISTERED SECURITIES DURING THE YEAR ENDED DECEMBER 31, 1998
During the year ended December 31, 1998, the Company issued and sold the following securities without registration under the Securities Act of 1933, as amended (the "Securities Act"):
(1) In September 1998, the Company issued to AudioFAX 275,000 shares of Common Stock in consideration for a fully paid-up license to certain AudioFAX patents in settlement of a dispute between the parties.
(2) In July 1998, the Company issued 2,000,000 shares of Common Stock for cash consideration of $7,000,000.
(3) In December 1998, the Company issued to the Tail Wind Fund Ltd. 645,161 shares of Common Stock and warrants to purchase 64,516 shares of Common Stock for aggregate cash consideration of $3,500,000.
No underwriter was involved in any of the above sales of securities. All of the above securities were issued in reliance upon the exemption set forth in Section 4(2) of the Securities Act on the basis that they were issued under circumstances not involving a public offering.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below with respect to FaxSav's statement of operations for the five years ended December 31, 1998, and with respect to FaxSav's balance sheet as of December 31, 1998, 1997, 1996, 1995 and 1994, are derived from the audited financial statements of FaxSav which are included elsewhere herein. The selected consolidated financial data set forth below is qualified in its entirety by, and should be read in conjunction with, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and the notes to those statements included elsewhere herein.
- ----------
(1) See Note 2 of Notes to Financial Statements: "Summary of Significant Accounting Policies -- Earnings Per Share" and " -- Pro Forma Earnings Per Share."
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF FAXSAV TOGETHER WITH THE FINANCIAL STATEMENTS AND THE NOTES TO SUCH STATEMENTS INCLUDED ELSEWHERE IN THIS REPORT. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS BASED ON OUR CURRENT EXPECTATIONS, ASSUMPTIONS, ESTIMATES AND PROJECTIONS ABOUT FAXSAV AND OUR INDUSTRY. THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES. FAXSAV'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, AS MORE FULLY DESCRIBED IN THE "RISK FACTORS" SECTION AND ELSEWHERE IN THIS REPORT. WE UNDERTAKE NO OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS FOR ANY REASON, EVEN IF NEW INFORMATION BECOMES AVAILABLE OR OTHER EVENTS OCCUR IN THE FUTURE.
Overview
FaxSav derives its revenues from the provision of a variety of facsimile services largely to businesses and professionals. Through the end of 1995, the Company offered its services exclusively to customers located in the United States. In the first quarter of 1996, the Company began to focus on the broader worldwide market for facsimile services through the introduction of client software to enable faxing from the computer desktop using the Internet as the means to access the FaxSav network. In the first quarter of 1997, the Company also expanded its fax-to-fax service offerings to certain international markets where it had installed an Internet node. In 1998, revenues from international customers were $5.9 million, or 27.9% of total revenues.
The Company's network includes interconnection in the United States with the existing worldwide telephony network through three network sites enabling delivery of facsimile transmissions to virtually any domestic or international destination. The Company also had Internet nodes installed in twenty-one countries as of December 31, 1998.
As the Company's customer base has expanded, the Company has invested in the design, development and marketing of its newer services, including the faxSAV for Internet suite of services and faxSav EZ-List, a fax broadcast service.
Results of Operations
The following table sets forth certain operating data expressed as a percentage of total revenues for the periods indicated (subtotals not adjusted for rounding):
Years Ended December 31, ------------------------------ 1998 1997 1996 ---- ---- ---- Percentages of Revenues: Revenues ................................ 100.0% 100.0% 100.0% Cost of service ......................... 52.7 59.8 59.2 ----- ----- ----- Gross margin ............................ 47.3 40.2 40.8 Operating expenses: Network operations and support ........ 17.0 13.1 13.2 Research and development .............. 9.4 11.0 11.8 Sales and marketing ................... 31.4 30.2 40.3 General and administrative ............ 15.6 18.0 16.6 Depreciation and amortization ......... 7.1 9.8 9.6 Other ................................. 4.9 -- -- ----- ----- ----- Total operating expenses ........... 85.4 82.1 91.5 ----- ----- ----- Operating loss .......................... (38.1) (41.9) (50.7) Interest income (expense), net .......... (0.6) 0.5 0.3 Other income (expense), net ............. 0.5 0.5 0.6 ----- ----- ----- Loss before income taxes ................ (38.2) (40.9) (49.8) Provision for income taxes .............. -- -- -- ----- ----- ----- Net loss ................................ (38.2)% (40.9)% (49.8)% ===== ===== =====
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenues. Revenues, which consist primarily of customer usage charges, grew 21.3% to $21.1 million in the year ended December 31, 1998 from $17.4 million in the year ended December 31, 1997 primarily as a result of the continued expansion of the Company's customer base, particularly in international markets. The increased revenues resulted largely from the Company's Internet desktop-to-fax and faxSAV EZ-List broadcast services. Fax volumes in total, representing faxes delivered to domestic and international destinations, grew 58.0% to 62.4 million minutes in 1998 as compared with 39.5 million minutes in 1997, while faxes routed through the internet grew 127.4% to 50.7 million minutes in 1998 from 22.3 million minutes in 1997.
Cost of service. Cost of service consists of local access charges, leased network backbone circuit costs and long distance and international termination charges. These are primarily variable costs based on actual facsimile volumes. Cost of service increased in 1998 as a result of the increase in facsimile volume for the year but decreased as a percentage of revenues to 52.7% in 1998 from 59.8% in 1997. The decreased percentage is a result of transmitting an increased level of customer faxes over the Company's Internet Fax Network and lower costs for international fax charges.
Network operations and support. Network operations and support costs consist primarily of the expenses of operating and expanding the network infrastructure, monitoring network traffic and quality of service and providing customer support in service installations, fax deliveries and message reporting and billing. Network operations and support costs increased to $3.6 million in the year ended December 31, 1998 from $2.3 million in the year ended December 31, 1997 as a result of hiring additional personnel to implement the Internet fax node deployment plan and to support the Company's expanding customer base on a 7 days per week / 24-hour basis. As a percentage of revenues, these costs increased to 17.0% from 13.1% in 1997.
Research and development. Research and development expenses consist primarily of salaries and consulting fees paid to software engineers and development personnel. Research and development expenses increased to $2.0 million for the year ended December 31, 1998 compared with $1.9 million for the year ended December 31, 1997 due to the continuing development efforts for enhancements to the Company's Internet desktop-to-fax services both in client software and network enhancements, and continuing development of the Company's faxSAV EZ-List broadcast service. As a percentage of revenues, these expenses decreased to 9.4% in 1998 from 11.0% in 1997 as a result of increased revenues in 1998.
Sales and marketing. Sales and marketing expenses consist primarily of salaries and commissions for sales and marketing staffs, promotion material preparation and mailing costs, third-party telemarketing charges and agent and dealer commissions. Sales and marketing expenses increased to $6.6 million and 31.4% of revenues for the year ended December 31, 1998 compared with $5.3 million and 30.2% for the year ended December 31, 1997. The higher costs in 1998 relate to
additional expenses to support the growth in international revenues, the expansion of the Company's direct sales staff in the U.S. and increased spending for U.S. marketing programs.
General and administrative. General and administrative expenses consist of expenses associated with the Company's management, accounting, finance, billing and administrative functions. General and administrative expenses increased to $3.3 million in the year ended December 31, 1998 from $3.1 million in the year ended December 31, 1997. The increases in total expenses result from personnel increases to support the increased customer base and expenses incurred for management information systems improvements. As a percentage of revenues, these expenses decreased to 15.6% in 1998 from 18.0% in 1997 as a result of increased revenues in 1998.
Depreciation and amortization. Depreciation and amortization decreased to $1.5 million and 7.1% of revenues in the year ended December 31, 1998 in comparison to $1.7 million and 9.8% of revenues in the year ended December 31, 1997, primarily reflecting reduced charges for faxSAV Connectors installed on fax machines at customer premises, resulting from the Company's shift in its business to desktop originated services.
Other. The Company incurred other expenses in 1998 of $1.0 million or 4.9% of revenues for settlement of the AudioFAX litigation. No such expenses were incurred in 1997.
Provision for income taxes. The Company had losses for income tax purposes for the years ended December 31, 1998 and 1997. Accordingly, there was no provision or credit for income taxes. Any income tax benefits at the Company's expected effective tax rate for these losses has been offset by a valuation allowance for deferred tax assets.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenues. Revenues, which consist primarily of customer usage charges, grew 15.8% to $17.4 million in the year ended December 31, 1997 from $15.0 million in the year ended December 31, 1996 primarily as a result of increased revenues from (i) the Company's faxSAV for Internet suite of services first introduced in 1996, (ii) the Company's faxSAV EZ-List broadcast service and (iii) an international fax-to-fax customer base developed in 1997. Fax volumes in total, representing faxes delivered to domestic and international destinations, grew 40.0% to 39.5 million minutes in 1997 as compared to 28.3 million minutes in 1996, while faxes to international destinations grew 33.0% to 22.0 million minutes in 1997 from 16.5 million minutes in 1996.
Cost of service. Cost of service consists of local access charges, leased network backbone circuit costs and long distance and international termination charges. These are primarily variable costs based on actual facsimile volumes. Cost of service increased in 1997 as a result of the increase in facsimile volume for the year and also increased as a percentage of revenues to 59.8% in 1997 from 59.2% in 1996. The increased percentage is a result of a higher cost of service for the revenues generated from the Company's lower priced Internet services. These revenues were generated without the complete benefit of the lower cost Internet network deployment that is still in process. As of December 31, 1997 the Company had completed the installation of Internet nodes in eighteen of the planned thirty countries.
Network operations and support. Network operations and support costs consist primarily of the expenses of operating and expanding the network infrastructure, monitoring network traffic and quality of service and providing customer support in service installations, fax deliveries and message reporting and billing. Network operations and support costs increased to $2.3 million in the year ended December 31, 1997 from $2.0 million in the year ended December 31, 1996 as a result of hiring additional personnel to implement the Internet fax node deployment plan and to support the Company's expanding customer base. As a percentage of revenues, these costs remained relatively unchanged amounting to 13.1% in 1997 and 13.2% in 1996.
Research and development. Research and development expenses consist primarily of salaries and consulting fees paid to software engineers and development personnel. Research and development expenses increased to $1.9 million for the year ended December 31, 1997 in comparison to $1.8 million for the year ended December 31, 1996 due to the continuing development efforts for enhancements to the Company's Internet desktop-to-fax services both in client software and network enhancements, and enhancements to the Company's faxSAV EZ-List broadcast service. As a percentage of revenues, these expenses decreased to 11.0% in 1997 from 11.8% in 1996 as a result of increased revenues in 1997.
Sales and marketing. Sales and marketing expenses consist primarily of salaries and commissions for sales and marketing staffs, promotion material preparation and mailing costs, third-party telemarketing charges and agent and dealer commissions. Sales and marketing expenses decreased to $5.3 million and 30.2% of revenues for the year ended December 31,1997 in comparison to $6.1 million and 40.3% for the year ended December 31, 1996. These costs decreased as a result of reduced spending for third party telemarketing programs in 1997 in connection with the Company's change in focus to a direct selling staff and as a result of higher expenses incurred in 1996 for trade shows and an advertising and promotion campaign for
the introduction of the faxSAV for Internet suite of services.
General and administrative. General and administrative expenses consist of expenses associated with the Company's management, accounting, finance, billing and administrative functions. General and administrative expenses increased to $3.1 million and 18.0% of revenues in the year ended December 31, 1997 from $2.5 million and 16.6% of revenues for the year ended December 31, 1996. The increases in total expenses and in the percentage of revenues result from personnel increases to support the increased customer base, expenses incurred for management information systems improvements and from expenses incurred in 1997 related to the public ownership of the Company's common stock.
Depreciation and amortization. Depreciation and amortization increased to $1.7 million and 9.8% of revenues in the year ended December 31, 1997 in comparison to $1.4 million and 9.6% of revenues in the year ended December 31, 1996, primarily reflecting depreciation of the company's increased investment in international Internet nodes as part of the Company's strategy to deploy a global Internet network and in faxSAV Connectors installed at customer premises to allow access to the FaxSav network.
Provision for income taxes. The Company had losses for income tax purposes for the years ended December 31, 1997 and 1996. Accordingly, there was no provision or credit for income taxes. Any income tax benefits at the Company's expected effective tax rate for these losses has been offset by a valuation allowance for deferred tax assets.
Liquidity and Capital Resources
The Company has financed its cash requirements for operations and investments in equipment through public and private sales of equity securities, bank borrowings and capital lease financing. During the year ended December 31, 1997, the Company entered into (1) an agreement for a $0.8 million secured equipment line of credit with Silicon Valley Bank and (2) an agreement for a $0.5 million equipment loan facility from Phoenix Growth Capital Corp. In 1998 both of these agreements were amended to increase available borrowings by $0.5 million and $1 million for Silicon Valley Bank and Phoenix Growth Capital Corp. respectively. All amounts available to the Company under these agreements had been advanced by December 31, 1998. The net proceeds from the Company's initial public offering completed in October 1996 amounted to $10.6 million. Cash flows from the private sales of equity securities amounted to $10.5 million in 1998, $2.1 million in 1997 and $7.9 million in 1996, net of issuance costs. $2.2 million of the 1996 proceeds were used to repurchase shares of the Company's Series D Preferred Stock from a major stockholder pursuant to a pre-existing option.
As a result of operating losses, cash used in operating activities amounted to $6.6 million in 1998, as compared with $5.5 million in 1997. Cash used for the purchase of equipment amounted to $3.1 million in 1998 and $2.9 million in 1997. The equipment includes network equipment and faxSAV Connectors (in 1997) purchased by the Company for installation at customer locations. The Company has committed to minimum monthly usage levels with its primary telecommunications carriers. The commitments require minimum monthly payments, exclusive of usage discounts, of $0.7 million per month through June 1999 and $0.5 million per month thereafter through January 2001.
The Company's principal sources of liquidity at December 31, 1998 included cash and cash equivalents of $5.3 million. In February 1999, the Company entered into a $1 million equipment line of credit. Draw downs are to be paid over a term of 42 months with an effective interest rate of 16%. The Company believes that its current cash and cash equivalents and available equipment financing facility will be sufficient to meet its anticipated cash needs for working capital and capital expenditure requirements through at least the end of 1999. However, our cash requirements may vary materially from those now planned as a result of unforeseen changes that could consume a significant portion of our available resources before such time. To the extent that funds expected to be generated from our operations are insufficient to meet current or planned operating requirements or to maintain a Nasdaq listing, we will seek to obtain additional funds through bank facilities, equity or debt financing, collaborative or other arrangements with corporate partners and from other sources. Additional funding may not be available when needed or on terms acceptable to us, which could have a material adverse effect on our business, financial condition and results of operations. If adequate funds are not available, we may be required to delay or to eliminate certain expenditures or to license to third parties the rights to commercialize technologies that we would otherwise seek to develop ourselves. In addition, in the event that we obtain any additional funding, such financings may have a dilutive effect on the holders of our securities.
YEAR 2000 COMPLIANCE
OVERVIEW
Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than a year, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" requirements or risk system failure or miscalculations causing disruptions of normal business activities.
STATE OF READINESS. We have conducted a study of the Year 2000 readiness of our information technology systems, including our computing and networking systems, and our non-information technology systems. Our study consisted of:
o Inventory and Assessment - conducting an inventory and review of faxSAV software, third-party software and hardware, and telecommunications and Internet service providers; contacting third-party vendors and licensors of material hardware, software and services that are both directly and indirectly related to the delivery of the our faxSAV for internet suite of services and the faxSAV Connector; contacting third-party vendors and licensors of material hardware, software and services that are both directly and indirectly related to the delivery of the our faxSAV for internet suite of services and the faxSAV Connector
o Review - conducting a review of faxSAV's application and product software code to determine Year 2000 compliance; assessment of repair or replacement requirements
o Correction and Testing - implementing code modifications and complete system re-testing where necessary; modification, upgrade, repair or replacement of all non-compliant systems
We have completed a test our information technology systems to verify the results of our study. We are currently in the process of remedying certain minor discrepancies that were discovered and plan to complete this process during the first half of 1999. We have been informed by many of our vendors of material hardware and software components of our information technology systems that the products that we use are currently Year 2000 compliant. The computing systems that provide application layer services (i.e., FaxSav customer services) within the FaxSav network are based upon some variant of the Unix operating system, which adequately represents dates beyond the year 2000. Many of the computing systems that support the internal operations of our business have the similar capacity to represent dates beyond the year 2000. In addition, for all of our internal accounting applications, we have purchased new accounting system software that the manufacturer specifies as Year 2000 compliant. We will require vendors of our other material hardware and software components of our information technology systems to provide assurances of their Year 2000 compliance, and we plan to complete this process during the first half of 1999. We will also seek assurances of Year 2000 compliance from providers of our material non-information technology systems.
COSTS. To date, we have not incurred any material expenditures in connection with identifying or evaluating Year 2000 compliance issues. Most of our expenses have related to, and are expected to continue to relate to, the operating costs associated with time spent by employees in the evaluation process and Year 2000 compliance matters generally. Our expected cost to purchase and implement the new accounting software mentioned above is approximately $0.2 million.
RISKS. We are not currently aware of any Year 2000 compliance problems relating to the faxSAV for internet suite of services, the faxSAV Connector or our other information technology or non-information technology systems that would have a material adverse effect on our business, financial condition and results of operations, without taking into account our efforts to avoid or fix such problems. There can be no assurance that our software contains all necessary date code changes or that all problems can be identified by our study and subsequent testing. Compliance with Year 2000 requirements may disrupt our ability to continue developing and marketing facsimile transmission products and services. The failure to adequately address Year 2000 compliance issues in our products and services, and in our information technology and non-information technology systems could result in claims of mismanagement, misrepresentation or breach of contract and related litigation, which could be costly and time-consuming to defend. In addition, there can be no assurance that governmental agencies, utility companies, Internet access companies, third-party service providers and others outside of our control will be Year 2000 compliant. The failure by such entities to be Year 2000 compliant could result in a systemic failure beyond our control, such as a prolonged Internet, telecommunications or electrical failure, which could also prevent us from delivering services to our customers, which could have a material adverse effect on our business, financial condition and results of operations.
CONTINGENCY PLAN. As discussed above, we intend to conduct further tests of our Year 2000 compliance to confirm the results of our study, including frequent re-testing of the integrity of the FaxSav network, and have not yet developed any
contingency plans. The results of our tests and the responses received from third-party vendors and service providers will be taken into account in determining the nature and extent of any contingency plans.
FORWARD-LOOKING STATEMENTS. The foregoing Year 2000 discussion and the information contained herein is provided as a "Year 2000 Readiness Disclosure" as defined in the Year 2000 Information and Readiness Disclosure Act of 1998 (Public Law 105-271, 112 Stat. 2386) enacted on October 19, 1998 and contains "forward-looking statements" within the meaning of the Private Securities Litigation reform Act of 1995. Such statements, including without limitation, anticipated costs and the dates by which FaxSav expects to complete certain actions, are based on management's best current estimates, which were derived utilizing numerous assumptions about future events, including the continued availability of certain resources, representations received from third parties and other factors. However, there can be no guarantee that these estimates will be achieved, and actual results could differ materially form those anticipated. Specific factors that might cause such material difference include, but are not limited to, the ability to identify and remediate all relevant systems, results of Year 2000 testing, adequate resolution of Year 2000 issues by governmental agencies, businesses and other third parties who are outsourcing service providers, suppliers, and vendors of FaxSav, unanticipated system costs, the adequacy of and ability to implement contingency plans and uncertainties. The "forward-looking statements" made in the foregoing Year 2000 discussion speak only as of the date on which such statements are made, and FaxSav undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. governmental agencies, businesses and other third parties who are outsourcing service providers, suppliers, and vendors of FaxSav, unanticipated system costs, the adequacy of and ability to implement contingency plans and uncertainties. The "forward-looking statements" made in the foregoing Year 2000 discussion speak only as of the date on which such statements are made, and FaxSav undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.
RISK FACTORS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS BASED ON OUR CURRENT EXPECTATIONS, ASSUMPTIONS, ESTIMATES AND PROJECTIONS ABOUT FAXSAV AND OUR INDUSTRY. THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES. FAXSAV'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN SUCH FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, AS MORE FULLY DESCRIBED IN THIS SECTION AND ELSEWHERE IN THIS REPORT. FAXSAV UNDERTAKES NO OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS FOR ANY REASON, EVEN IF NEW INFORMATION BECOMES AVAILABLE OR OTHER EVENTS OCCUR IN THE FUTURE.
RISK FACTORS
Risks Related to our Business
We have a history of net losses and expect future losses.
From our inception in 1989 through the year ending December 31, 1998, we have experienced significant net losses. We incurred net losses of $7.5 million, $7.1 million and $8.1 million during the years ended December 31, 1996, 1997 and 1998, respectively. We currently anticipate that we will have additional net losses as we attempt to expand our business and we may not have positive operating or net income in the future. As of December 31, 1998, we had an accumulated deficit of $40.3 million.
Since inception, we have incurred substantial costs to develop and enhance our technology and to create, introduce and enhance our service and product offerings. We intend to continue these efforts and, in addition, to increase our marketing spending. In early 1999, we announced a new marketing campaign which will involve significant expenditures by us, including the hiring of an outside advertising agency. As a result of these expenditures, we expect to continue to experience operating losses. There can be no assurance that these expenditures will result in any increase in revenues.
We may not be able to use our net operating loss carryforwards which could increase the amount of taxes that we are required to pay when we become profitable
We generated net operating loss carryforwards for income tax purposes of approximately $35.0 million through December 31, 1998. These net operating loss carryforwards have been recorded as a deferred tax asset of approximately $13.7 million. Based on our history of operating losses and overall financial condition, management has determined that it is more likely than not that we will be unable to generate sufficient taxable income prior to the expiration of these net operating loss carryforwards in order to receive the benefit of them and has accordingly reduced our deferred tax assets to zero with a full valuation allowance. Additionally, as we have experienced a change in ownership of over 50% of our common stock, the amount of net operating loss carryforwards that we will be able to use to offset any future taxable income will be limited.
We have many competitors and we may not be able to compete effectively against them.
The market for facsimile transmission services is intensely competitive and the industry is characterized by low barriers to entry. We expect that competition will intensify in the future. Our failure to compete successfully could have a material adverse affect on our business, financial condition and results of operations.
We believe that our ability to compete successfully will depend upon a number of factors, including:
o market presence; o the capacity, reliability and security of our network infrastructure; o the pricing policies of our competitors and suppliers; o the timing of introductions of new services and service enhancements by us and our competitors; and o industry and general economic trends.
Our current and future competitors generally fall into the following groups:
o telecommunications companies, such as AT&T, MCI WorldCom, Sprint, the regional Bell operating companies and telecommunications resellers; o Internet service providers, such as Uunet Technologies, Inc., a subsidiary of MCI WorldCom, and NETCOM On-Line Communications, Inc.; o on-line services providers, such as Microsoft Corporation and America Online, Inc.; and o direct fax delivery competitors, including Premiere Document Distribution (formerly Xpedite Systems, Inc.) and IDT Corporation.
Many of these competitors have greater market presence, engineering and marketing capabilities, and financial, technological and personnel resources than we do. As a result, they may be able to:
o develop and expand their communications and network infrastructures more quickly; o adapt more swiftly to new or emerging technologies and changes in customer requirements; o take advantage of acquisition and other opportunities more readily; and o devote greater resources to the marketing and sale of their products and services than we can.
Further, the foundation of our telephony network infrastructure consists of the right to use the telecommunications lines of several of the above-mentioned long distance carriers, including MCI WorldCom. There can be no assurance that these companies will not discontinue or otherwise change their relationships with us in a manner that would have a material adverse effect upon our business, financial condition and results of operations. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their services to address the needs of our current and prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share.
In addition to direct competitors, many of our larger potential customers may seek to internally fulfill their fax communication needs through the deployment of their own computerized fax communications systems or network infrastructures for intra-company faxing. Increased competition is likely to result in price reductions and could result in reduced gross margins and erosion of our market share, any of which would have a material adverse effect on our business, financial condition and results of operations. There can be no assurance that we will be able to compete successfully against current or future competitors or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations.
On August 7, 1997, the Federal Communications Commission issued new rules which may significantly reduce the cost of international calls originating in the United States. The five-year phase-in period began on January 1, 1998. To the extent that these new regulations are implemented and result in reductions in the cost of international calls originating in the United States, we will face increased competition for our international fax services which may have a material adverse effect on our business, financial condition or results of operations.
We are uncertain about our need for and availability of additional funds.
We believe that our current cash and cash equivalents will be sufficient to meet our presently anticipated cash needs for working capital and our capital expenditure requirements through at least December 31, 1999. However, our cash requirements may vary materially from those now planned as a result of unforeseen changes that could consume a significant portion of our available resources before such time. To the extent that funds expected to be generated from our operations are insufficient to meet current or planned operating requirements or to maintain a Nasdaq listing, we will seek to obtain additional funds through bank facilities, equity or debt financing, collaborative or other arrangements with corporate partners and from other sources. See "--We may be delisted from Nasdaq which would affect your ability to sell our stock." Additional funding may not be available when needed or on terms acceptable to us, which could have a material adverse effect on our business, financial condition and results of operations. If adequate funds are not available, we may be required to delay or to eliminate certain expenditures or to license to third parties the rights to commercialize technologies that we would otherwise seek to develop ourselves. In addition, in the event that we obtain any additional funding, such financings may have a dilutive effect on the holders of our securities.
We may be unable to protect our intellectual property rights.
Our success is dependent upon our proprietary technology. We rely primarily on a combination of contract, copyright and trademark law, trade secrets, confidentiality agreements and contractual provisions to protect our proprietary rights. We were granted patents related to our faxSAV Connector and our "e-mail Stamps" security technology incorporated into our faxMailer service. There can be no assurance that present or future patents will provide sufficient protection to our present or future technologies, services and processes. In addition, there can be no assurance that others will not independently develop substantially equivalent proprietary information or obtain access to our know-how. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our services or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. There can be no assurance that the steps taken by us to protect our proprietary rights will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies.
There can be no assurance that other third parties will not assert infringement claims against us in the future. Patents have been granted recently on fundamental technologies in the communications and desktop software areas, and patents may issue which relate to fundamental technologies incorporated in our services. As patent applications in the United States are not publicly disclosed until the patent issues, applications may have been filed which, if issued as patents, could relate to our services. We could incur substantial costs and diversion of management resources with respect to the defense of any claims that we have infringed upon the proprietary rights of others, which costs and diversion could have a material adverse effect on our business, financial condition and results of operations. Furthermore, parties making such claims could secure a judgment awarding substantial damages, as well as injunctive or other equitable relief, which could effectively block our ability to license and sell our services in the United States or abroad. Any such judgment could have a material adverse effect on our business, financial condition and results of operations. In the event a claim relating to proprietary technology or information is asserted against us, we may seek licenses to such intellectual property. There can be no assurance, however, that licenses could be obtained on terms acceptable to us, or at all. The failure to obtain any necessary licenses or other rights could have a material adverse effect on our business, financial condition and results of operations.
We are dependent on the reliability and expansion of our network infrastructure.
Our future success will depend in part upon the capacity, reliability and security of our network infrastructure and in part upon our ability to expand the deployment of an international network of Internet-capable facsimile nodes. We must continue to expand and adapt our network infrastructure as the number of customers and the volume of traffic they wish to transmit increases. The expansion and adaptation of our network infrastructure will require substantial financial, operational and management resources.
There can be no assurance that we will be able to expand or adapt our network infrastructure to meet any additional demand on a timely basis, at a commercially reasonable cost, or at all. In addition, there can be no assurance that we will be able to deploy
additional contemplated Internet-capable facsimile nodes on a timely basis, at a commercially reasonable cost, or at all. Any failure to expand our network infrastructure on a timely basis, to adapt it to changing customer requirements or evolving industry standards or to expand our Internet-capable facsimile node infrastructure on a timely basis would have a material adverse effect on our business, financial condition and results of operations. Further, there can be no assurance that we will be able to satisfy the regulatory requirements in each of the countries currently targeted for node deployment, which may prevent us from installing Internet-capable facsimile nodes in such countries and may have a material adverse effect on our business, financial condition and results of operations.
Our failure to manage growth could adversely affect us.
We have rapidly and significantly expanded our operations and anticipate that significant expansion will continue to be required in order to address potential market opportunities. There can be no assurance that such expansion will be successfully completed or that it will generate sufficient revenues to cover our expenses. Our inability to promptly address and respond to these circumstances could have a material adverse effect on our business, financial condition and results of operations.
Because we are dependent on computer systems, a systems failure could cause a significant disruption to our business.
Our business depends upon the efficient and uninterrupted operation of our computer and communications hardware systems and infrastructure. We currently maintain our computer hardware and switching equipment, including our processing equipment, at three sites. While we have taken precautions against systems failure, interruptions could result from natural disasters as well as power loss, telecommunications failure and similar events. Any damage or failure that disrupts or delays our operations could have a material adverse effect on our business, financial condition and results of operations.
If our security measures are inadequate, our business will be adversely affected.
We have taken measures to protect the integrity of our infrastructure and the privacy of confidential information. Nonetheless, our infrastructure is potentially vulnerable to physical or electronic break-ins, viruses or similar problems. If a person circumvents our security measures, he or she could jeopardize the security of confidential information stored in and transmitted through the computer systems of the individual, businesses and financial institutions utilizing our services. This may result in significant liability to us and may also deter potential customers from using our services. Any security breach that causes interruptions or data loss in our operations or in the computer systems of our customers could have a material adverse effect on our business, financial condition and results of operations.
We are dependent upon our current suppliers, and may not be able to obtain some products or services from other suppliers.
We rely on third parties to supply key components of our network infrastructure, including long distance telecommunications services and telecommunications node equipment, many of which are available only from sole or limited sources. MCI WorldCom is our primary provider of long distance telecommunications services. We have from time-to-time experienced partial interruptions of service from our telecommunications carriers which have temporarily prevented customers in limited geographical areas from reaching the FaxSav network. There can be no assurance that we will not experience partial or complete service interruptions in the future. There can be no assurance that MCI WorldCom and our other telecommunications providers will continue to provide long distance services to us at attractive rates, or at all, or that we will be able to obtain such services in the future from these or other long distance providers on the scale and within the time frames we require. Any failure to obtain such services on a timely basis at an affordable cost, or any significant delays or interruptions of service from such carriers, would have a material adverse effect on our business, financial condition and results of operations.
All of the faxboards used in our telecommunications nodes are supplied by Brooktrout Technology, Inc. We purchase Brooktrout faxboards on a non-exclusive basis pursuant to purchase orders placed from time-to-time, carry a limited inventory of faxboards and have no guaranteed supply arrangement with Brooktrout. In addition to faxboards, many of the routers, switches and other hardware components used in our network infrastructure are supplied by sole or limited sources on a non-exclusive, purchase order basis. There can be no assurance that Brooktrout or our other suppliers will not enter into exclusive arrangements with our competitors, or cease selling these components to us at commercially reasonable prices, or at all.
The anticipated expansion of our network infrastructure is expected to place a significant demand on our suppliers, some of which may have limited resources and production capacity. In addition, certain of our suppliers, in turn, may rely on sole or limited sources of supply for components included in their products. Should our suppliers fail to adjust to meet such increasing demand, they may be unable to continue to supply components and products in the quantities and quality and at the times required by us, or at all. Our inability to obtain sufficient quantities of sole or limited source components or to develop alternative sources if required could result in delays and increased costs in the expansion of our network infrastructure or in our inability to properly maintain the existing network infrastructure, which would have a material adverse effect on our business, financial condition and results of operations.
We may experience development delays or have software defects which could adversely affect our business.
Software-based services and equipment, such as our faxSAV for Internet suite of services and the faxSAV Connector, may contain undetected errors or failures when introduced or when new versions are released. There can be no assurance that, despite testing by us and by current and potential customers, errors will not be found in such software or other releases after commencement of commercial shipments, or that we will not experience development delays, resulting in delays in the shipment of software and a loss of or delay in market acceptance, any of which could have a material adverse effect on our business, financial condition and results of operations.
We may not be able to retain the key personnel we need to succeed.
Our future performance depends in significant part upon the continued service of our key technical, sales and senior management personnel, none of whom is bound by an employment agreement. Competition for such personnel is intense, and there can be no assurance that we can retain our key technical, sales and managerial employees or that we can attract, assimilate or retain other highly qualified technical, sales and managerial personnel in the future.
We depend on our international strategic alliances to expand our international customer base.
We have established and intend to expand an international customer base by forming strategic sales and marketing alliances with foreign Internet service providers, telecommunications companies and resellers. There can be no assurance that we will be able to establish additional strategic alliances or to maintain such strategic alliances. Our success in expanding our international customer base depends not only on the formation of additional strategic alliances but also on the success of these partners and their ability to market our services. The failure to maintain such strategic alliances or the failure of these partners to successfully develop and sustain a market for our services will have a material adverse effect on our ability to expand our international customer base, which could have a material adverse effect on our business, financial condition and results of operations.
We face risks associated with international operations which could materially and adversely affect our business.
In 1998, we derived approximately $5.9 million, or 27.9% of our total revenues from customers outside of the United States. We expect that such revenues will represent an increasing percentage of our total revenues in the future. Risks inherent in our international business activities generally include unexpected changes in regulatory requirements, tariffs and other trade barriers, costs of localizing products for foreign countries, lack of acceptance of localized products in foreign markets, longer accounts receivable payment cycles, difficulties in managing international operations, potentially adverse tax consequences, and the burdens of complying with a wide variety of foreign laws. There can be no assurance that such factors will not have a material adverse effect on our future international revenues and, consequently, on our business, financial condition and results of operations.
Problems relating to the "Year 2000 Issue" could adversely affect our business.
Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than a year, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" requirements or risk system failure or miscalculations causing disruptions of normal business activities.
We have conducted a study of the Year 2000 readiness of our information technology systems, including our computing and networking systems, and our non-information technology systems and believe that they are currently Year 2000 compliant. Additionally, We have been informed by many of our vendors of material hardware and software components of our information technology systems that the products that we use are currently Year 2000 compliant. Despite our efforts, there can be no assurance that our software contains all necessary date code changes or that all Year 2000 problems were identified by our study
and subsequent testing. Compliance with Year 2000 requirements may disrupt our ability to continue developing and marketing facsimile transmission products and services. The failure to adequately address Year 2000 compliance issues in our products and services, and in our information technology and non-information technology systems could result in claims of mismanagement, misrepresentation or breach of contract and related litigation, which could be costly and time-consuming to defend.
In addition, there can be no assurance that governmental agencies, utility companies, Internet access companies, third-party service providers and others outside of our control will be Year 2000 compliant. The failure by such entities to be Year 2000 compliant could result in a systemic failure beyond our control, such as a prolonged Internet, telecommunications or electrical failure, which could also prevent us from delivering services to our customers, which could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to Our Industry
Our future growth depends upon an increase in the use of the Internet as a medium for facsimile transmissions.
We believe that our future success will depend in part upon our ability to significantly expand our base of Internet-capable nodes and route more of our customers' traffic through the Internet. Our success is therefore largely dependent upon the viability of the Internet as a medium for the transmission of documents. There can be no assurance that document transmission over the Internet will continue to be reliable or that Internet capacity constraints will not develop which inhibit efficient document transmission.
We access the Internet from our Internet-capable nodes by dedicated connection to third party internet service providers. We pay fixed monthly fees for such Internet access, regardless of our usage or the volume of our customers' traffic. There can be no assurance that the current pricing structure for access to and use of the Internet will not change unfavorably. If material capacity constraints develop on the Internet or the current Internet pricing structure changes unfavorably, our business, financial condition and results of operations would be materially and adversely affected. In addition, our future success is dependent upon the increased acceptance by potential customers of the Internet as the preferred medium for transmission of documents. There can be no assurance that such market acceptance shall continue to increase. Lack of increased market acceptance would materially and adversely affect our business, financial condition and results of operations.
Our success depends on keeping up with rapid technological changes in our markets.
The telecommunications industry in general, and the facsimile transmission business in particular, are characterized by rapid and continuous technological change. Future technological advances in the telecommunications industry may result in the availability of new services or products that could compete with the facsimile transmission services we provide or reduce the cost of existing products or services, any of which could enable our existing or potential customers to fulfill their fax communications needs more cost efficiently. There can be no assurance that we will be successful in developing and introducing new services that meet changing customer needs and respond to technological changes or evolving industry standards in a timely manner, if at all, or that services or technologies developed by others will not render our services noncompetitive. Our inability to respond to changing market conditions, technological developments, evolving industry standards or changing customer requirements, or the development of competing technology or products that render our services noncompetitive would have a material adverse effect on our business, financial condition and results of operations.
We are subject to extensive government regulation which could negatively impact our business.
We are subject to regulation by various state public service and public utility commissions and by various international regulatory authorities. We are licensed by the FCC as an authorized telecommunications company and are classified as a "non-dominant interexchange carrier." Generally, the FCC has chosen not to exercise its statutory power to closely regulate the charges or practices of non-dominant carriers. Nevertheless, the FCC acts upon complaints against such carriers for failure to comply with statutory obligations or with the FCC's rules, regulations and policies. The FCC also has the power to impose more stringent regulatory requirements on us and to change our regulatory classification. There can be no assurance that the FCC will not change our regulatory classification or otherwise subject us to more burdensome regulatory requirements.
In connection with the deployment of Internet-capable nodes in countries throughout the world, we are required to satisfy a variety of foreign regulatory requirements. We intend to explore and seek to comply with these requirements on a country-by-country basis as the deployment of Internet-capable facsimile nodes continues. There can be no assurance that we will be able to satisfy the regulatory requirements in each of the countries currently targeted for node deployment, and the failure to satisfy such
requirements may prevent us from installing Internet-capable facsimile nodes in such countries. The failure to deploy a number of such nodes could have a material adverse effect on our business, operating results and financial condition.
Our nodes and FaxLauncher service utilize encryption technology in connection with the routing of customer documents through the Internet. The export of such encryption technology is regulated by the United States government. We have the authority to export such encryption technology except to Cuba, Iran, Iraq, Libya, North Korea and Rwanda. Nevertheless, there can be no assurance that such authority will not be revoked or modified at any time for any particular jurisdiction or in general. In addition, there can be no assurance that such export controls, either in their current form or as may be subsequently enacted, will not limit our ability to distribute our services outside of the United States or electronically. While we take precautions against unlawful exportation of our software, the global nature of the Internet makes it virtually impossible to effectively control the distribution of our services. Moreover, future Federal or state legislation or regulation may further limit levels of encryption or authentication technology. Any such export restrictions, the unlawful exportation of our services, or new legislation or regulation could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to our Common Stock
We may be delisted from Nasdaq which would affect your ability to sell our stock.
Our common stock is currently traded on the Nasdaq National Market. In order to continue to trade on Nasdaq, we need to maintain at least $4.0 million in net tangible assets. In the past, we have not been in compliance with this requirement. We believe that we are currently in compliance with Nasdaq's requirements. However, if in the future we are unable to satisfy Nasdaq's requirements, our securities may be delisted from Nasdaq. There can be no assurance that our common stock will not be delisted, which would materially affect your ability to buy or sell shares of our common stock.
Fluctuations in our quarterly results may negatively impact our stock price.
We may experience significant quarter to quarter fluctuations in our results of operations, which may result in volatility in the price of our common stock. Quarterly results of operations may fluctuate as a result of a variety of factors, including:
o demand for our services;
o the introduction of new services and service enhancements by us or our competitors;
o market acceptance of new services;
o the mix of revenues between Internet-based versus telephony-based deliveries;
o the timing of significant marketing programs;
o the number and timing of the hiring of additional personnel;
o competitive conditions in the industry; and
o general economic conditions.
Our revenues are difficult to forecast. Shortfalls in revenues may adversely and disproportionately affect our results of operations because a high percentage of our operating expenses are relatively fixed, and planned expenditures, such as the anticipated expansion of our Internet infrastructure, are based primarily on sales forecasts. In addition, the stock market in general has experienced extreme price and volume fluctuations which have affected the market price of securities of many companies in the telecommunications and technology industries and which may have been unrelated to the operating performance of such companies. These market fluctuations may adversely affect the market price of our common stock. Accordingly, we believe that period to period comparisons of results of operations are not necessarily meaningful and should not be relied upon as an indication of future results of operations. There can be no assurance that we will be profitable in any future quarter. Due to the foregoing factors, it is likely that in one or more future quarters our operating results will be below the expectations of public market analysts and investors. Such an event would have a material adverse effect on the price of our common stock.
Future sales of our common stock could cause the price of our shares to decline and affect our ability to raise capital.
The market price of our common stock could drop as a result of sales of substantial amounts of common stock in the public market or the perception that such sales could occur. Registration statements are in effect covering the sale of up to 2,000,000 shares of our common stock. In addition, we have also filed a registration statement covering the sale of up to 709,677 shares of our common stock which has not yet been declared effective by the Securities and Exchange Commission. Such a price drop may make it more difficult for us to raise the capital necessary to fund our future operations by selling common stock. As of
March 24, 1998, without taking into account shares of common stock issued upon exercise of stock options, warrants or other rights to acquire common stock after such date, we had outstanding 14,067,105 shares of common stock.
Substantially all of the shares of common stock already outstanding will be freely tradeable in the public market without restriction under the Securities Act, except that any shares held by our "affiliates", as such term is defined in Rule 144(a) under the Securities Act, may generally only be sold in compliance with the applicable provisions of Rule 144 of the Securities Act. In general, under Rule 144 an "affiliate" is entitled to sell within any three-month period a number of shares that does not exceed the greater of 1% of the then outstanding shares of our common stock, approximately 140,671 shares, or the average weekly trading volume in our common stock on Nasdaq during the four calendar weeks preceding the date on which notice of such sale was filed under Rule 144. Sales under Rule 144 are also subject to certain provisions relating to the manner and notice of sale and the availability of current public information about us. Additional shares of common stock, including shares issuable upon exercise of options, warrants and other rights to acquire common stock, will also become eligible for sale in the public market from time to time in the future. Furthermore, certain holders of common stock have the right to cause us to register their shares under the Securities Act in the future. We are required to bear the expenses of all such required registrations, except underwriting discounts and commissions. We are required to use our best efforts to effect such registrations, subject to certain conditions and limitations.
Our certificate of incorporation and bylaws, and Delaware laws make it more difficult for a third party to acquire us.
Our sixth amended and restated certificate of incorporation authorizes the board of directors to issue, without stockholder approval, up to 1,000,000 shares of preferred stock with voting, conversion and other rights and preferences that could adversely affect the voting power or other rights of the holders of common stock. Our certificate of incorporation also provides for staggered terms for the members of the board of directors. In addition, we will be subject to the provisions of Section 203 of the Delaware General Corporation Law, which will generally prohibit us from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. The foregoing and other provisions of our certificate of incorporation and our by-laws, as amended and the application of Section 203 of the Delaware General Corporation Law could have the effect of deterring certain takeovers or delaying or preventing certain changes in our control or management, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices.
We do not intend to pay cash dividends and, as a result, stockholders will need to sell shares to realize a return on their investment.
We have never paid any cash dividends on our common stock and do not intend to pay any cash dividends in the foreseeable future.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information in response to this item is set forth in the Financial Statements beginning on page [F-3] of this report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is made to the information contained in the Company's Proxy Statement to be mailed to Stockholders on or about April 29, 1999, which information is incorporated herein by reference. Information on compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the Company's Proxy Statement to be mailed to Stockholders on or about April 29, 1999, which information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Reference is made to the information contained in the Company's Proxy Statement to be mailed to Stockholders on or about April 29, 1999, which information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is made to the information contained in the Company's Proxy Statement to be mailed to Stockholders on or about April 29, 1999, which information is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is made to the information contained in the Company's Proxy Statement to be mailed to Stockholders on or about April 29, 1999, which information is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements Page No. --------
Report of Independent Accountants ......................................F-2 Balance Sheets as of December 31, 1998 and 1997 ........................F-3 Statements of Operations for the years ended December 31, 1998, 1997 and 1996 .....................................................F-4 Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996......................................................F-5 Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996 ..................................F-6 Notes to Financial Statements ..................................F-7 to
(2) Financial Statement Schedule
Report of Independent Accountants on Financial Statement Schedule .....F-20 Supplemental Schedule to Financial Statements .........................F-21
(b) Reports on Form 8-K
None
(c) Exhibits
3.1 Registrant's Sixth Amended and Restated Certificate of Incorporation (incorporated by reference to exhibit 3.3 to the Registrant's Registration Statement on Form S-1, Registration No. 333-09613 ("Registrant's Registration Statement")).
3.2 By-laws of the Registrant (incorporated by reference to exhibit 3.4 and 3.5 to the Registrant's Registration Statement and Exhibit 3.3 to the Registrants. Report on Form 10-Q for the quarter ended June 30, 1997).
4.1 Specimen Common Stock Certificate (incorporated by reference to exhibit 4.1 to the Registrant's Registration Statement).
4.2 See Exhibits 3.1 and 3.2 for provisions of the Certificate of Incorporation and Bylaws of the Registrant defining rights of holders of Common Stock of the Registrant.
10.1 Fifth Amended and Restated Investor Rights Agreement, as amended (incorporated by reference to exhibits 10.1 and 10.2 to the Registrant's Registration Statement).
10.2 1990 Stock Option Plan (incorporated by reference to exhibit 10.3 to the Registrant's Registration Statement).
10.3 1996 Stock Option/Stock Issuance Plan (incorporated by reference to exhibit 10.4 to the Registrant's Registration Statement).
10.4 Form of Officer Severance Agreement (incorporated by reference to exhibit 10.5 to the Registrant's Registration Statement).
10.5 Form of Director Severance Agreement (incorporated by reference to exhibit 10.6 to the Registrant's Registration Statement).
10.6* Telecommunications Services Agreement, between LDDS WorldCom and the Registrant, dated
December 1, 1996 (incorporated by reference to exhibit 10.8 to the Registrant's Report on Form 10-Q for the quarter ended March 31, 1997).
10.7* Agreement between MCI Telecommunications Corporation and the Registrant, effective March 1, 1996 (incorporated by reference to exhibit 10.9 to the Registrant's Registration Statement).
10.8 Lease Agreement, dated May 28, 1992, between Metro Four Associates Limited Partnership, Thornall Associates and the Registrant (the "Metro Four Lease"), as extended and amended prior to May 5, 1997 (incorporated by reference to exhibit 10.10 to the Registrant's Registration Statement).
10.9 Amendment to Metro Four Lease, dated May 5, 1997.
10.10 Loan and Security Agreement, dated September 26, 1997, between the Company and Silicon Valley Bank.
10.11 Letter Agreement, dated November 1, 1994 between Telstra Incorporated and the Registrant (incorporated by reference to exhibit 10.12 to the Registrant's Registration Statement).
10.12 Series B Preferred Stock Warrant between the Registrant and Comdisco, Inc., dated May 30, 1991 (incorporated by reference to exhibit 10.14 to the Registrant's Registration Statement).
10.13 Series B Preferred Stock Warrant between the Registrant and Comdisco, Inc., dated September 16, 1992 (incorporated by reference to exhibit 10.15 to the Registrant's Registration Statement).
10.14 Series D Preferred Stock Warrant between the Registrant and Comdisco, Inc., dated October 28, 1993 (incorporated by reference to exhibit 10.16 to the Registrant's Registration Statement).
10.15 Common Stock Warrant between the Registrant and LTI Ventures Leasing Corp., dated February 15, 1993 (incorporated by reference to exhibit 10.17 to the Registrant's Registration Statement).
10.16 Common Stock Warrant between the Registrant and LTI Ventures Leasing Corp., dated May 5, 1994 (incorporated by reference to exhibit 10.18 to the Registrant's Registration Statement).
10.17 Common Stock Warrant between the Registrant and Silicon Valley Bancshares, dated April 6, 1992 (incorporated by reference to exhibit 10.19 to the Registrant's Registration Statement).
10.18 Common Stock Warrant between the Registrant and Silicon Valley Bancshares, dated July 7, 1995 (incorporated by reference to exhibit 10.20 to the Registrant's Registration Statement).
10.19 Form of Common Stock Purchase Agreement, dated November 21, 1997 (incorporated by reference to Exhibit 10.1 to the Registrant's Registration Statement on Form S-3, Registration No. 333-43929).
10.20** Loan and Security Agreement, dated March 27, 1998, between the Company and Silicon Valley Bank.
10.21 Form of Common Stock Purchase Agreement, dated July 22, 1998. (incorporated by reference to Exhibit 10.1 to the Registrant's Registration Statement on Form S-3, Registration No. 333-64515).
10.22 Rights Agreement, dated September 17, 1998 between the Registrant and AudioFax IP LLC. (incorporated by reference to Exhibit 10.1 to the Registrant's Registration Statement on Form S-3, Registration No. 333-67355).
10.23 Purchase Agreement, dated December 24, 1998, between the Registrant and the Tail Wind Fund Ltd. (incorporated by reference to Exhibit 10.1 to the Registrant's Registration Statement on Form S-3, Registration No. 333-70915).
10.24 Common Stock Warrant between the Registrant and the Tail Wind Fund Ltd., dated December 28, 1998 (incorporated by reference to Exhibit 10.2 to the Registrant's Registration Statement on Form S-3, Registration No. 333-70915).
23.** Consent of PricewaterhouseCoopers LLP, independent accountants
27.** Financial Data Schedule.
99. Proxy Statement of FaxSav Incorporated relative to the 1999 Annual Meeting of the Stockholders to be held on June 4, 1999, which is incorporated by reference into Part III of this Form 10-K.
- ---------- * Confidential treatment granted. ** Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf of the undersigned, thereunto duly authorized.
FAXSAV INCORPORATED
By: /s/ Thomas F. Murawski ----------------------------------------------- Thomas F. Murawski Chief Executive Officer, President and Chairman of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated on March 25, 1999:
Signature Title(s) - --------- --------
/s/ Thomas F. Murawski Chief Executive Officer (Principal Executive - --------------------------- Officer), President and Chairman of the Board of Directors
/s/ Peter S. Macaluso Chief Financial Officer (Principal Financial - --------------------------- and Accounting Officer), Vice President, Treasurer and Secretary
/s/ Jeffrey M. Drazan Director - ---------------------------
/s/ Peter A. Howley Director - ---------------------------
/s/ Robert Labant Director - ---------------------------
/s/ Richard Miller Director - ---------------------------
FaxSav Incorporated (Formerly Digitran Corporation)
Page ----
Report of Independent Accountants ...........................................F-2
Balance Sheets as of December 31, 1998 and 1997 .............................F-3
Statements of Operations for the years ended December 31, 1998, 1997 and 1996 ...........................................................F-4
Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996............................................................F-5
Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996 .........................................F-6
Notes to Financial Statements .......................................F-7 to
Report of Independent Accountants on Financial Statement Schedule ..........F-20
Supplemental Schedule to Financial Statements ..............................F-21
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of FaxSav Incorporated:
In our opinion, the accompanying balance sheets and the related statements of operations, stockholders' equity and cash flows present fairly, in all material respects, the financial position of FaxSav Incorporated (formerly Digitran Corporation) (the "Company") at December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP Florham Park, New Jersey
February 3, 1999
FaxSav Incorporated
Balance Sheets as of December 31, 1998 and 1997
The accompanying notes are an integral part of the financial statements.
FaxSav Incorporated
Statements of Operations for the years ended December 31, 1998, 1997 and 1996
The accompanying notes are an integral part of the financial statements.
FaxSav Incorporated
Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996
The accompanying notes are an integral part of the financial statements.
FaxSav Incorporated
Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996
The Company has 1,000,000 authorized shares of preferred stock at $0.01 par value. No preferred stock is currently issued or outstanding
The accompanying notes are an integral part of the financial statements.
FaxSav Incorporated Notes to Financial Statements:
1. Organization and Nature of Operations:
FaxSav Incorporated, formerly known as Digitran Corporation (the "Company"), was formed in November 1989 to engage in the sale of network services customized for the transmission of data, facsimile and graphical information. In February 1996, the Company changed its name to FaxSav Incorporated.
The Company designs, develops, and markets a variety of business-to-business facsimile transmission services, including desktop to fax, enhanced fax and broadcast fax services. Through the use of its integrated Internet-based and telephony-based network and its proprietary software, the Company enables its customers to send documents and images to fax machines worldwide. The Company initially offered services (the "legacy fax services") through its telephony-based network with termination by long distance carriers. In early 1996, the Company began to deploy a global Internet-based network of nodes that enable it to bypass the long distance carriers' networks when sending faxes to or from international areas serviced by these nodes. Prior to 1997, most of the Company's revenues have been derived from delivering facsimile transmissions to locations outside the United States from customers located throughout the United States. In 1997, the Company expanded its customer base in international markets through the development of a wholesale business in desktop to fax services and a fax-to-fax business in certain markets in the Asia Pacific region. In 1997, revenues from international customers amounted to $2.3 million or 13.2% of total revenues and in 1998, revenues from international customers amounted to $5.9 million or 27.9% of total revenues.
In 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information". Although the services provided to its customers are the same in the U.S. and international markets, management views the two as separate businesses and measures the results for both to the gross margin level. The ubiquitous nature of the Company's network and its centralized operations in the U.S. prohibit the allocation of expenses beyond that level. Accordingly, 1998 and 1997 segment Gross Margin and Assets for the Company were as follows:
FaxSav Incorporated Notes to Financial Statements (Continued):
1. Organization and Nature of Operations (Continued):
The Company is subject to risks common to rapidly growing technology-based companies, including limited operating history, dependence on key personnel, raising capital, rapid technological change, dependence on network infrastructure, competition from substitute products and larger companies, and the successful development and marketing of commercial products and services.
The Company currently believes its cash and cash equivalents will be sufficient to meet its presently anticipated cash needs through at least the end of 1999. Even if the Company's cash requirements vary materially from those now planned as a result of unforeseen changes, management believes that its current sources of liquidity are sufficient for it to continue operations through the end of 1999. In this regard, the Company is prepared to limit its network expansion and reduce or eliminate research and development activities, and sales and marketing expenditures, if necessary.
Fax boards used in the Company's telecommunications network are supplied by one vendor on a non-exclusive basis. Other components of the Company's operating network are supplied by a limited number of vendors, also on a non-exclusive basis. Management believes that other suppliers could be identified to provide this equipment at a competitive price if this supplier was unable to provide equipment.
Operation of the Company's network is dependent upon long distance telecommunications companies transmitting information for the Company. The Company has typically utilized only a limited number of these providers to generate volume discounts. The Company's business strategy is also dependent upon providing this service at the lowest possible cost which is greatly affected by the cost of long distance transmission service. Management believes that its long-distance transmissions could be made at competitive rates with any number of companies providing long distance service.
In October 1996, the Company completed an initial public offering of 1.6 million shares of its common stock. The aggregate gross proceeds of the offering were approximately $12 million.
In connection with the offering, the Company filed an amendment to its Fifth Amended and Restated Certificate of Incorporation to effect a one-for-nine reverse stock split at a par value of $0.01 and to change the authorized number of common shares to 40,000,000. All share and per share amounts in the financial statements have been retroactively restated to reflect the reverse stock split. The Company also filed immediately prior to the closing of the offering its Sixth Amended and Restated Certificate of Incorporation which changed the authorized amount of preferred stock. All outstanding shares of preferred stock were converted at the consent of the holders into an aggregate of 7,791,981 shares of common stock.
FaxSav Incorporated Notes to Financial Statements (Continued):
2. Summary of Significant Accounting Policies:
A. Revenue Recognition and Cost of Service:
The Company recognizes revenue as services are provided to customers and records the related cost of service as incurred. Cost of service consists of local access charges, leased network backbone circuit costs and long distance domestic and international termination charges.
B. Estimates:
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates made by management and included in the financial statements are the allowance for bad debts, the valuation allowance for deferred tax assets, and the accrual for legal defense.
C. Reverse Stock Split and Conversion of Preferred Stock:
In October 1996, in connection with an initial public offering of the Company's common stock, the Company effectuated a reverse stock split for common shares of one-for-nine shares. The effect of this reverse stock split on all share and per share amounts has been retroactively restated in the financial statements.
The Company also converted all of its outstanding preferred stock at the election of the holders into 7,791,981 shares of common stock in connection with the offering.
D. Earnings Per Share:
In February 1998, the SEC issued Staff Accounting Bulletin No. 98 ("SAB 98"), which revised the views of the staff contained in previous staff accounting bulletins, to be consistent with the provisions of SFAS 128. All prior periods have been restated in accordance with SAB 98.
Stock options outstanding of approximately 2,065,000, 1,523,000 and 1,256,000 for the years ended December 31, 1998, 1997, and 1996, respectively, have been excluded from the calculation of diluted earnings per share, since their effect would be antidilutive.
In addition, approximately 169,000 warrants outstanding for the year ended December 31, 1998, and 100,000 warrants for the two years ended December 31, 1997 have been excluded from diluted earnings per share, since their effect would be antidilutive.
FaxSav Incorporated Notes to Financial Statements (Continued):
2. Summary of Significant Accounting Policies (Continued):
E. Pro Forma Earnings Per Share:
Pro forma basic and diluted net loss per common shares is based on the weighted average number of shares outstanding during the periods presented, including the effect of pro forma conversion for all periods of all outstanding preferred stock into 7,791,981 shares of common stock in October 1996 in connection with the initial public offering of the Company. Pro forma basic and diluted net loss per share has been presented as additional information to enhance the comparability of results for all periods presented assuming conversion of the preferred stock into common shares of the Company.
F. Cash Equivalents:
The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
G. Property and Equipment:
Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation of furniture and equipment, except enhanced fax equipment, is calculated using the straight-line method over their estimated useful lives of five years. Enhanced fax equipment is included in equipment and is depreciated over its estimated life of 30 months. Leasehold improvements are amortized using the straight-line method over the lesser of the lease term or the estimated useful life of the related asset. Repairs and maintenance costs are expensed as incurred; major renewals and betterments are capitalized.
When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any gain or loss on the disposition is reflected in current operations. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the asset, a loss is recognized for the difference between the estimated fair value and carrying value of the assets.
H. Income Taxes:
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". This statement requires an asset and liability approach for deferred taxes that recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns.
I. Concentration of Credit Risk:
Statement of Financial Accounting Standards No. 105, "Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentration of Credit Risk" requires disclosure of any significant off-balance-sheet and
FaxSav Incorporated Notes to Financial Statements (Continued):
2. Summary of Significant Accounting Policies (Continued):
I. Concentration of Credit Risk (Continued):
credit risk concentrations. Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. From time to time, the Company had concentrations of cash in several banks in the form of demand deposits and money market accounts. The Company believes that concentrations of credit risk with respect to trade accounts receivable are limited due to the large number of entities comprising the Company's customer base.
J. Financial Instruments:
The estimated fair value of the Company's financial instruments, which include cash, cash equivalents, accounts receivable, and amounts outstanding under line of credit, approximates their carrying value.
The fair value of cash and cash equivalents and accounts receivable approximates their carrying value because their maturity is generally less than one year in duration. The fair value of amounts outstanding under the line of credit was determined using valuation techniques that considered cash flow discounted at current rates.
K. Legal Defense:
The Company accrues the estimated future cost of defending itself against lawsuits or other claims when management has determined, in consultation with its legal counsel, that these matters are probable of assertion against the Company.
L. Reclassification:
Certain items in 1997 have been reclassified to conform to the 1998 presentation.
3. Property and Equipment:
Property and equipment is comprised of the following:
December 31, ------------------------- 1998 1997 ----------- -----------
Equipment $10,232,895 $ 7,844,450 Computer software 625,413 364,385 Furniture and fixtures 132,609 113,386 Leasehold improvements 168,265 160,008 ----------- ----------- 11,159,182 8,482,229 Less, accumulated depreciation and amortization 5,671,961 4,306,965 ----------- ----------- $ 5,487,221 $ 4,175,264 =========== ===========
FaxSav Incorporated Notes to Financial Statements (Continued):
3. Property and Equipment (Continued):
Included in the equipment balance is certain equipment under capital leases of approximately $966,058 at December 31, 1998 and 1997. Accumulated amortization of equipment under capital leases approximated $588,079 and $394,867 as of December 31, 1998 and 1997, respectively. Depreciation and amortization expense for owned property and equipment for the years ended December 31, 1998, 1997, and 1996, amounted to $1,420,208, $1,674,554 and $1,388,753, respectively.
4. Accrued Expenses and Other Liabilities:
Accrued expenses and other liabilities is comprised of the following:
December 31, ----------------------- 1998 1997 ---------- ---------- Accrued carrier charges $1,834,894 $1,926,925 Accrued salaries, bonuses and commissions 224,933 195,688 Excise and state taxes payable 132,219 269,245 Accrual for legal defense 251,917 Insurance premiums payable 79,449 Other 462,612 496,622 ---------- ---------- $2,654,658 $3,219,846 ========== ==========
5. Notes Payable:
Long-term debt includes the following:
December 31, ----------------------- 1998 1997 ---------- ---------- 1996 notes payable to bank - $750,000 $ 126,760 $ 278,871 1997 notes payable to bank - $800,000 559,935 799,908 1997 notes payable - $500,000 418,009 473,628 1998 notes payable to bank - $500,000 449,942 1998 notes payable - $1,000,000 978,795 ---------- ---------- Total notes payable 2,533,441 1,552,407 Less current portion 992,960 469,217 ---------- ---------- Non-current portion $1,540,481 $1,083,190 ========== ==========
As of December 31, 1998, the Company had $126,760 outstanding under a line of credit established in 1996, which will be repaid in equal installments over the first ten months of 1999.
During 1997, the Company entered into two new loan agreements. The first agreement was an equipment line of credit with the Bank, in the form of a promissory note, in the amount of $800,000. In 1998 this agreement was amended to increase available borrowings by an additional $500,000. The new line is also evidenced by the Company's promissory notes which are payable over 30 months. Interest on advances, if any, are at the Bank's prime rate plus an applicable margin, as defined in the credit agreement, which resulted in a borrowing rate of 9.5% for 1997 and 8.9% in 1998. Among the covenants stated in the agreement, specific liquidity ratios, debt service ratios, and net worth ratios are required to be maintained and
FaxSav Incorporated Notes to Financial Statements (Continued):
5. Notes Payable (Continued):
disclosed to the Bank on a monthly basis. As of December 31, 1998, the Company had fully utilized these lines of credit.
The second agreement in 1997 was for an equipment loan line of $500,000 with another lender and is in the form of two secured promissory notes, both of which the Company is required to pay over a term of forty-eight months with an effective interest rate of 16%. In 1998 this agreement was amended to increase available borrowings by an additional $1,000,000. The new line is also evidenced by the Company's promissory notes which are payable over 42 months at an effective interest rate of 16%. The new line was fully utilized by December 31, 1998. The equipment purchased with the proceeds of these loans serve as collateral.
6. Related Party Transactions:
During 1998 the Company loaned two officers a total of $203,598. These recourse loans bear interest at a rate of 5% and are collateralized by approximately 61,000 shares of the Company's common stock. The loans are due and payable in November 2003.
7. Commitments:
Telecommunications Lines
The Company has committed to minimum monthly usage levels with its primary telecommunications carriers. The commitments require minimum monthly payments, exclusive of usage discounts, of $700,000 per month through June 1999 and $500,000 per month thereafter through January 2001. The Company also leases space under co-locate agreements for certain of its telecommunications equipment.
Leases
Total rent expense for office facilities for the years ended December 31, 1998, 1997 and 1996 amounted to $470,959, $302,643 and $181,594, respectively.
The Company leases certain computer equipment pursuant to operating leases which expire through 2000. Rent expense related to these leases for the years ended December 31, 1998, 1997 and 1996 amounted to $69,313, $120,085 and $168,666, respectively.
The Company acquired equipment for $421,805 under capital lease obligations during the year ended December 31, 1996. Interest paid for capital lease obligations during the years ended December 31, 1998, 1997 and 1996 was $27,064, $59,658 and $69,682, respectively.
FaxSav Incorporated Notes to Financial Statements (Continued):
7. Commitments (Continued):
The Company was obligated under these agreements to make the following payments for office facilities and equipment:
8. Capital Stock and Warrants:
Convertible Preferred Stock
Prior to October 1996, the Company was authorized to issue 1,400,000 shares of Series A Preferred Stock, 4,000,000 shares of Series B Preferred Stock, 8,700,000 shares of Series C Preferred Stock, 26,600,000 shares of Series D Preferred Stock, 19,500,000 shares of Series E Preferred Stock and 20,000,000 shares of Series F Preferred Stock (collectively, "the Preferred Stock"). Holders of the Preferred Stock were entitled to dividends at the rate of $0.075 per share for Series A, $0.10 per share for Series B, $0.06 per share for Series C, $0.01733 per share for Series D, $0.022 per share for Series E and $0.04 per share for Series F when and if declared by the Company's Board of Directors. Such dividends were not cumulative. Holders of the Series A, B, C, D, E and F Preferred Stock were entitled to a liquidation preference per share of $0.75, $1.00, $0.60, $0.1733, $0.22 and $0.40, respectively. No dividends had been declared on the Preferred Stock.
In February 1996 and March 1996, the Company issued 19,999,988 shares of Series F Preferred Stock for an aggregate purchase price of $7,979,998 to certain existing as well as other new investors in the Company. In accordance with a December 1995 Stock Option Agreement between the Company and Telstra, the Company on March 18, 1996 repurchased 8,655,510 shares of Series D Preferred Stock held by Telstra for $0.25 per share for a total of $2,163,878.
All shares of Series A, B, C, D, E, and F Preferred Stock were converted into common stock of the Company in connection with the initial public offering of its common stock in October 1996.
FaxSav Incorporated Notes to Financial Statements (Continued):
8. Capital Stock and Warrants (Continued):
Warrants
On July 8, 1993, the Company agreed to grant warrants to purchase 5,556 shares of common stock to a firm providing equipment to the Company under a Master Lease Agreement. The exercise price was $5.40 per share and the warrants were to expire ten years from the date of grant. On May 5, 1994, the Company granted additional warrants, which were to expire ten years from the date of grant, to purchase 9,889 shares of common stock at $1.80 per share to this firm in connection with an increase in the equipment covered by the Master Lease Agreement. On July 7, 1995, the Company granted warrants to purchase 28,889 shares of common stock to a bank in connection with the issuance of the working capital line of credit. The exercise price was $1.98 per share and the warrants were to expire five years from the date of grant.
The number and purchase price of the shares could have been adjusted by the occurrence of certain events, as defined in the warrant agreements.
On December 30, 1998, the Company granted warrants to purchase 64,516 shares of common stock to an investor in connection with a private placement of 645,161 new unregistered shares of common stock. The exercise price is $5.425 per share and the warrants will expire three years from the date of grant.
9. Stock Options:
The Company has a stock option plan which authorized up to 1,794,175 shares of common stock to be issued. During 1998, the shareholders approved an amendment to the plan increasing the authorized number of shares by 650,000 to 2,444,175. Under the stock option plan, the Company may grant incentive stock options or nonqualified stock options. The option exercise price of stock options may not be less than 85% of the fair value of a share of common stock on the date of the option grant, and the options expire in ten years. The shares issuable upon the exercise of nonqualified options generally vest over one or two years from the date of grant. The shares issuable upon the exercise of incentive stock options generally vest 20% upon completion by the optionee of one year of service and the remaining 80% over 48 equal months of service thereafter based on continued service. Stock option transactions under the plan are as follows:
FaxSav Incorporated Notes to Financial Statements (Continued):
9. Stock Options (Continued):
At December 31, 1998, 1997 and 1996, options for 905,483, 785,584 and 626,277 shares were vested and exercisable.
In October 1995, The Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation." The standard establishes a fair value method for accounting for or disclosing stock-based compensation plans. The Company discloses the pro forma net loss and loss per share amounts assuming the fair value method.
Accordingly, if the Company had elected to recognize compensation costs in accordance with SFAS No. 123 the reported net loss and loss per share for 1998, 1997 and 1996, respectively, would have been as follows:
FaxSav Incorporated Notes to Financial Statements (Continued):
9. Stock Options (Continued):
The Company estimated the fair value, as of the date of grant, of options outstanding in the plan using the Black-Scholes option pricing model with the following assumptions:
1998 1997 1996 ------------- ------------- -------------
Expected life 5 years 5 years 10 years Risk free interest rate 5.3% 6.3% 4.9% Expected future dividend yield 0% 0% 0% Expected volatility 127.2% 85.2% 34.4%
In accordance with SFAS 123, the Company has utilized peer information when using the Black-Scholes option pricing model. As the Company develops historical information, the Company will modify these assumptions accordingly.
10. Patent Litigation Settlement:
Effective September 22, 1998 the Company settled all outstanding litigation with AudioFAX IP,L.L.P. ("AudioFAX") to avoid the expense and disruption of protracted litigation. In 1997 the Company had filed a lawsuit against AudioFAX seeking declaratory relief that FaxSav services did not infringe on any valid claims in certain AudioFAX's patents relating to store-and-forward technology or that certain claims of the AudioFAX patents are not valid. Immediately after the filing of FaxSav's complaint, AudioFAX filed a lawsuit against FaxSav alleging patent infringement.
The terms of the settlement agreement required the Company to issue 275,000 shares of common stock to AudioFAX and to register such shares for resale in exchange for a fully paid-up license to the patents in the dispute. Although under certain circumstances the Company
FaxSav Incorporated Notes to Financial Statements (Continued):
10. Patent Litigation Settlement (Continued):
would have been required to issue additional shares or pay a certain amount of cash to AudioFAX, these requirements are no longer applicable.
The Company has recorded a charge of $1,025,000 in 1998 representing all costs associated with the settlement. No costs have been capitalized, as the Company could not determine the future economic benefit, if any, to the Company of the patent licenses acquired.
11. Income Taxes:
The Company continues to incur operating losses and currently pays no income taxes and no provision or benefit for income taxes has been recorded.
The income tax benefit at the United States federal statutory rate on the Company's operating loss, for all periods presented, has been eliminated by an increase in the valuation allowance for deferred tax assets and operating losses not recognized.
At December 31, 1998, the Company had net operating loss carryforwards available for income tax purposes of approximately $35,000,000 which start to expire in 2005. Net operating loss carryforwards are subject to review and possible adjustment by the Internal Revenue Service and may be limited in the event of certain cumulative changes in the ownership interests of significant stockholders over a three-year period in excess of 50%. The Company has experienced changes in ownership in excess of 50% but does not believe that these changes in ownership will significantly impact the Company's ability to utilize its net operating loss carryforwards assuming the Company can generate sufficient taxable income. The components of the Company's deferred tax asset are as follows:
December 31, ----------------------------- 1998 1997 ------------ ------------
Operating loss carryforwards $ 12,765,029 $ 10,225,730 Temporary differences 914,450 691,560 ------------ ------------ 13,679,479 10,917,290
Less - valuation allowance (13,679,479) (10,917,290) ------------ ------------ $ 0 $ 0 ============ ============
In evaluating the realization of these deferred tax assets, management has considered the market in which the Company operates, the operating losses incurred to date and the operating losses anticipated for the future, and believes that given the significance of this evidence, a full valuation allowance against its deferred tax assets is required as of December 31, 1998, 1997, and 1996.
FaxSav Incorporated Notes to Financial Statements (Continued):
12. Contingencies:
The Company is involved in various disputes, claims or legal proceedings related to its normal course of business. In the opinion of management, all such matters are without merit or involve amounts, if disposed of unfavorably, which would not have a material adverse effect on the financial position or results of operations of the Company.
13. Subsequent Event (Unaudited):
In February 1999, the company entered into a new $1,000,000 equipment line of credit with a lender. Draw-downs are to be paid over a term of 42 months with an effective interest rate of 16%.
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors of FaxSav, Incorporated
Our audits of the financial statements referred to in our report dated February 3, 1999 appearing on page of the 1998 Annual Report to Shareholders of FaxSav, Incorporated (formerly Digitran Corporation) also included an audit of the financial statement schedule listed in Item 14(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements.
PRICEWATERHOUSECOOPERS LLP
Florham Park, New Jersey February 3, 1999
FaxSav Incorporated Supplemental Schedule
Valuation and Qualifying Accounts
(a) Recoveries of accounts receivable (b) Write-offs