This Annual Report contains "forward-looking statements" that describe
management's beliefs and expectations about the future. We have identified
forward-looking statements by using words such as "anticipate," "believe,"
"could," "estimate," "may," "expect," and "intend," or words of similar import.
Although we believe these expectations are reasonable, our operations involve a
number of risks and uncertainties and actual results may be materially different
than our expectations.
The following is a discussion of the consolidated financial condition and
results of operations for the fiscal years ended July 31, 2021 and 2020, and
should be read in conjunction with our Consolidated Financial Statements, the
Notes thereto, and the other financial information included elsewhere in this
annual report on Form 10-K. For purposes of the following discussion, FY 2021 or
2021 refers to the year ended July 31, 2021 and FY 2020 or 2020 refers to the
year ended July 31, 2020.
Recent Activity
Acquisitions
On November 17, 2020, the Company closed on the acquisitions of Nexogy, Inc.
("Nexogy"), and ActivePBX ("ActivePBX"), providers of cloud communication,
UCaaS, and broadband solutions tailored for businesses. As a combined business,
Nexogy, ActivePBX, and T3, will serve over 2,600 business customers and
approximately 28,000 users. The business model of the combined entities is
supported by strong and predictable recurring revenue with high gross margins
under contracts with business customers in various industries including banking,
healthcare, financial services, legal, insurance, hotels, real estate, staffing,
municipalities, food services, and education. The contribution from the
acquisitions is expected to have an immediate and positive impact on the
consolidated EBITDA of the Company with additional improvements to be realized
during FY2022 from the anticipated cost synergies and consolidation savings.
8
Sources of revenue:
Cloud Software and Service Revenue: We provide UCaaS or cloud communication
services and managed cloud-based solutions to small and medium size enterprise
customers and to other resellers. Our Internet-based services include fully
hosted IP/PBX services, SIP trunking, call center applications, auto attendant,
voice and web conferencing, call recording, messaging, voicemail to email
conversion, integrated mobility applications that are device and location
agnostic, and other customized IP/PBX features in a hosted or cloud environment.
Other services include enterprise-class data and connectivity solutions through
multiple broadband technologies including cloud WAN or SD-WAN (Software-defined
Wide Area Network), fiber, mobile broadband, and Ethernet over copper. We also
offer remote network monitoring, data backup and disaster recovery.
Direct Costs:
Cloud Software and Service: We incur bandwidth and colocation charges in
connection with our UCaaS or cloud communication services. The bandwidth charges
are incurred as part of the connectivity between our customers to allow them
access to our various services. We also incur costs from underlying providers
for fiber, Internet broadband, and telecommunication circuits in connection with
our data and connectivity solutions.
Results of Operations
Cloud Software and Service Revenue. Cloud software and service revenue increased
by $6,137,000, or 98% from the year ended July 31, 2020, to the year ended July
31, 2021. The increase in revenue is primarily attributed to the increase in
total customers between years due to the acquisitions of Nexogy and ActivePBX.
Our total number of customers increased from 728 for the year ended July 31,
2020, to 2,655 customers for the year ended July 31, 2021.
Cost of Services (exclusive of depreciation and amortization). The cost of
services increased by $2,100,000, or 69% from the year ended July 31, 2020, to
the year ended July 31, 2021. The increase in cost of services is primarily
attributed to the consolidation of various networks and key vendors as part of
the increase in total customers between periods due to the acquisitions of
Nexogy and ActivePBX. Our total number of customers increased from 728 for the
year ended July 31, 2020, to 2,655 customers for the year ended July 31, 2021.
However, our consolidated gross margin improved by $4,037,000 from the year
ended July 31, 2020, to the year ended July 31, 2021.
Selling, General and Administrative (SG&A) Expenses (exclusive of legal and
professional fees and stock compensation expense). SG&A expenses increased by
$3,417,000, from the year ended July 31, 2020, to the year ended July 31, 2021.
The increase in SG&A is attributed to acquisition of Nexogy and ActivePBX, as
part of the consolidation, the Company absorbed all of the employees responsible
for managing the customer base, technical support, sales, customer service, and
administration.
Stock Compensation expense. Stock compensation expense decreased by $504,000, or
45% from the year ended July 31, 2020, to the year ended July 31, 2021. The
decrease between periods is attributed to the recognition of stock option
expense of $377,000 recognized during the year ended July 31, 2020 associated
with the stock options with multiple vesting periods that were awarded to
various employees during FY2018, FY2019 and FY2020. The Company also recognized
$501,000 in stock compensation for stock issued in lieu of cash payments to the
Management team during the year ended July 31, 2020. In addition, the Company
recognized $233,633 in stock compensation expense associated with the funding of
the 401(K)-profit sharing plan and recognized $15,000 in stock compensation
expense to professionals for the year ended July 31, 2020. During the year ended
July 31, 2021, the Company only recognized $135,000 in stock option expense
associated with stock options awarded to various employees, recognized $247,000
in stock compensation expense associated with the funding of the 401(K)-profit
sharing plan, recognized $18,000 in stock compensation for stock issued in lieu
of cash payments to a former employee, and recognized $223,000 in stock issued
to consultants for professional services.
9
Legal and professional fees. Legal and professional fees increased by $252,000,
or 39% from the year ended July 31, 2020, to the year ended July 31, 2021. The
increase between periods is attributed to the recognition during the period
ending July 31, 2021, of $611,000 in legal and professional fees related to due
diligence, audits for the acquisitions, purchase price allocation and investor
relations.
Bad debt. Bad debt increased between the periods by $22,000. The increase is
attributed to the recognition of $17,000 in bad debt during the year ended July
31. 2021. During the year ended July 31, 2020, the Company recognized $5,000 in
bad debt recovery, for accounts that were previously considered uncollectible.
Depreciation and amortization. Depreciation and amortization increased by
$1,136,000, from the year ended July 31, 2020, to the year ended July 31, 2021.
The increase is primarily attributed to the acquisitions and related
amortization of $1,396,000 for intangible assets, and the additional
depreciation related to the depreciation for the assets acquired from Nexogy and
ActivePBX.
Operating loss. The Company reported an operating loss of $2,398,000 for the
year ended July 31, 2021, compared to an operating loss of $2,112,000 for the
year ended July 31, 2020. The increase in operating loss between periods is
primarily due to the increase of $3,417,000 in SG&A, the increase in legal fees
of $252,000, increase in bad debt of $22,000, and the increase in depreciation
of $1,136,000. These increases were slightly offset by the increase in margin of
$4,037,000 and the decrease in stock compensation expense of $504,000.
Gain (loss) on derivative instruments. Loss on derivative instruments increased
by $10,198,000 from the year ended July 31, 2020, to the year ended July 31,
2021. We are required to re-measure all derivative instruments at the end of
each reporting period and adjust those instruments to market, as a result of the
re-measurement of all derivative instruments we recognized an increase between
periods.
Gain on settlement of debt. Gain on settlement of debt improved by $431,000 from
the year ended July 31, 2020, to the year ended July 31, 2021. During the year
ended July 31, 2021, the Company recognized a settlement of $197,000 for an
obligation satisfied with our vendors, in addition, the Company recognized a
gain on settlement of debt for the forgiveness by the U.S Small Business
Administration of three promissory notes with a total principal of $361,600 and
accrued interest of $3,616.
Income tax benefit (expense). During the year ended July 31, 2021, the Company
recognized an income tax expense of $183,000. During the year ended July 31,
2020, the Company recognized an income tax benefit of $33,000.
Other income (expense). Other expense increased by $410,000 from the year ended
July 31, 2020, to the year ended July 31, 2021. During the year ended July 31,
2021, T3 recognized an expense of $300,000 related to a mediated settlement
agreement with Carolina Financial Securities, LLC ("CFS"). Pursuant to the
settlement agreement, T3 agreed to pay CFS a total of $300,000, payable as
follows: $100,000 by October 15, 2021, and $200,000 payable in 15 monthly
installments of $13,333.33 beginning November 15, 2021. During the year ended
July 31, 2020 the Company recognized as other income $100,000 for a settlement
with one of our vendors, in addition the Company recognized $16,000 in interest
income during the year ended July 31, 2020.
Interest expense. Interest income (expense) increased by $2,912,000 from the
year ended July 31, 2020, to the year ended July 31, 2021. During the period
ended July 31, 2021, the Company recognized non-cash interest / accretion
expense of $2,803,000 related to the amortization of debt discount on various
notes and the amortization of debt discount of $6,000 in a related party note.
Additionally, the Company recognized $1,111,000 in interest expense for cash
interest payments on various promissory notes, accrued interest rolled into
principal of $510,000, accrual interest paid as common stock and preferred stock
of $16,000, increase in principal, debt discount, gain on notes directly
recorded as interest expense of $319,000.
Net loss including noncontrolling interest. Net loss including noncontrolling
interest for the year ended July 31, 2021, was $17,015,000, an increase in net
loss of $13,591,000, as compared to a net loss for the year ended July 31, 2020
of $3,424,000. The increase in net loss including noncontrolling interest
between periods is primarily due to the increase of $3,417,000 in SG&A, the
increase in legal fees of $252,000, increase in bad debt of $22,000, and the
increase in depreciation and amortization of $1,136,000. In addition to the
increase in loss on derivative instruments of $10,198,000, increase in interest
expense of $2,912,000, increase in other expense of $410,000 and increase income
tax expense of $216,000. These increases were slightly offset by the increase in
margin of $4,037,000, the decrease in stock compensation expense of $504,000 and
the improvement on gain on settlement of debt of $431,000.
10
Net loss attributable to the noncontrolling interest. During the year ended July
31, 2021, and 2020, the consolidated entity recognized net loss in
noncontrolling interest of $332,000 and $47,000, respectively. The
noncontrolling interest is presented as a separate line item in the Company's
stockholders' equity section of the balance sheet.
Net loss attributable to Digerati's shareholders. Net loss for the year ended
July 31, 2021, was $16,683,000 compared to a net loss for the year ended July
31, 2020, of $3,377,000.
Deemed dividend on Series A Convertible Preferred Stock. Dividend declared on
convertible preferred stock for the year ended July 31, 2021, was $20,000
compared to a deemed dividend on convertible preferred stock for the year ended
July 31, 2020, of $19,000.
Net loss attributable to Digerati's common shareholders. Net loss for the year
ended July 31, 2021, was $16,703,000 compared to a net loss for the year ended
July 31, 2020, of $3,396,000.
Liquidity and Capital Resources
Cash Position: We had a consolidated cash balance of $1,489,000 as of July 31,
2021. Net cash consumed by operating activities during the year ended July 31,
2021 was approximately $708,000, primarily as a result of operating expenses,
that included $624,000 in stock compensation and warrant expense, bad debt
expense of $17,000, amortization of debt discount of $2,809,000, loss on
derivative liability of $9,935,000, depreciation and amortization expense of
$1,707,000, increase in accrued expense of $1,083,000, decrease in accounts
receivable of $69,000 and decrease in deferred revenue of $259,000.
Additionally, we had an increase of $99,000 in accounts payable, decrease in
prepaid expenses and other current assets of $46,000, increase in inventory of
$27,000, the recognition of a gain on settlement of debt of $560,000, the
recognition of $510,000 in accrued interest added to principal, stock issued for
debt extension of $59,000 and the issuance of preferred stock C for settlement
of AP from current year of $333,000.
Cash used in investing activities during the year ended July 31, 2021 was
$10,800,000, which included $410,000 for the purchase of equipment and the cash
paid of $10,390,000, net of cash received, for the acquisitions of VoIP assets
from Nexogy and ActivePBX.
Cash provided by financing activities during the year ended July 31, 2021, was
$12,312,000. The Company secured $1,078,000 from convertible notes, net of
issuance costs and discounts. In addition, the Company secured $13,036,000 from
two promissory notes, net of issuance costs. (See Note10) The Company made
principal payments of $1,338,000 on various notes, principal payments of
$266,000 on convertible notes, principal payments of $169,000 on related party
notes, and $63,000 in principal payments on equipment financing. Overall, our
net operating, investing, and financing activities during the year ended July
31, 2021, contributed approximately $804,000 of our available cash.
Digerati's consolidated financial statements for the year ending July 31, 2021,
have been prepared on a going concern basis, which contemplates the realization
of assets and the settlement of liabilities in the normal course of business.
Since the Company's inception in 1993, Digerati has incurred net losses and
accumulated a deficit of approximately $105,380,000 and a working capital
deficit of approximately $24,228,000 which raises doubt about Digerati's ability
to continue as a going concern.
We are currently taking initiatives to reduce our overall cash deficiencies on a
monthly basis. During fiscal 2021 certain members of our management team have
taken a significant portion of their compensation in common stock to reduce the
depletion of our available cash. To strengthen our business, we intend to adopt
best practices from or recent acquisitions and invest in a marketing and sales
strategy to grow our monthly recurring revenue; we anticipate utilizing our
value-added resellers and channel partners to tap into new sources of revenue
streams, we have also secured various agent agreements to accelerate revenue
growth. In addition, we will continue to focus on selling a greater number of
comprehensive services to our existing customer base. Further, in an effort to
increase our revenues, we will continue to evaluate the acquisition of various
assets with emphasis in VoIP Services and Cloud Communication Services. As a
result, during the due diligence process we anticipate incurring significant
legal and professional fees.
11
Management believes that available resources as of July 31, 2021, will not be
sufficient to fund the Company's operations, debt service and corporate expenses
over the next 12 months. The Company's ability to continue to meet its
obligations and to achieve its business objectives is dependent upon, and other
things, raising additional capital, issuing stock-based compensation to certain
members of the executive management team in lieu of cash, or generating
sufficient revenue in excess of costs. At such time as the Company requires
additional funding, the Company will seek to secure such best-efforts funding
from various possible sources, including equity or debt financing, sales of
assets, or collaborative arrangements. If the Company raises additional capital
through the issuance of equity securities or securities convertible into equity,
stockholders will experience dilution, and such securities may have rights,
preferences, or privileges senior to those of the holders of common stock or
convertible senior notes. If the Company raises additional funds by issuing
debt, the Company may be subject to limitations on its operations, through debt
covenants or other restrictions. If the Company obtains additional funds through
arrangements with collaborators or strategic partners, the Company may be
required to relinquish its rights to certain technologies. There can be no
assurance that the Company will be able to raise additional funds or raise them
on acceptable terms. If the Company is unable to obtain financing on acceptable
terms, it may be unable to execute its business plan, the Company could be
required to curtail its operations, and the Company may not be able to pay off
its obligations, if and when they come due.
Our current cash expenses are expected to be approximately $700,000 per month,
including wages, rent, utilities, corporate expenses, and legal professional
fees associated with potential acquisitions. As described elsewhere herein, we
are not generating sufficient cash from operations to pay for our corporate and
ongoing operating expenses, or to pay our current liabilities. As of July 31,
2021, our total liabilities were approximately $33,375,000, which included
$16,773,000 in derivative liabilities. We will continue to use our available
cash on hand to cover our deficiencies in operating expenses.
We estimate that we need approximately $80,000 per month of additional working
capital to fund our corporate expenses during Fiscal 2022.
We have been successful in raising debt capital and equity capital in the past
and as described in Notes 10, 11, and 12 to our consolidated financial
statements. We have financing efforts in place to continue to raise cash through
debt and equity offerings. Although we have successfully completed financings
and reduced expenses in the past, we cannot assure you that our plans to address
these matters in the future will be successful.
Critical Accounting Policies
Revenue Recognition. On August 1, 2018, we adopted Topic 606 using the modified
retrospective method applied to those contracts which were not completed as of
August 1, 2018. Results for reporting periods beginning after August 1, 2018 are
presented under Topic 606. There was no impact to the opening balance of
accumulated deficit or revenues for the year ended July 31, 2019 as a result of
applying Topic 606.
The Company recognizes cloud-based hosted services revenue, mainly from
subscription services for its cloud telephony applications that includes hosted
IP/PBX services, SIP trunking, call center applications, auto attendant, voice
and web conferencing, call recording, messaging, voicemail to email conversion,
integrated mobility applications that are device and location agnostic, and
other customized applications. Other services include enterprise-class data and
connectivity solutions through multiple broadband technologies including cloud
WAN or SD-WAN (Software-defined Wide Area Network), fiber, and Ethernet over
copper. We also offer remote network monitoring, data backup and disaster
recovery services. The Company applies a five-step approach in determining the
amount and timing of revenue to be recognized: (1) identifying the contract with
a customer, (2) identifying the performance obligations in the contract, (3)
determining the transaction price, (4) allocating the transaction price to the
performance obligations in the contract and (5) recognizing revenue when the
performance obligation is satisfied. Substantially all of the Company's revenue
is recognized at the time control of the products transfers to the customer.
Service Revenue
Service revenue from subscriptions to the Company's cloud-based technology
platform is recognized over time on a ratable basis over the contractual
subscription term beginning on the date that the platform is made available to
the customer. Payments received in advance of subscription services being
rendered are recorded as a deferred revenue. Usage fees, either bundled or not
bundled, are recognized when the Company has a right to invoice. Professional
services for configuration, system integration, optimization, customer training
and/or education are primarily billed on a fixed-fee basis and are performed by
the Company directly. Alternatively, customers may choose to perform these
services themselves or engage their own third-party service providers.
Professional services revenue is recognized over time, generally as services are
activated for the customer.
12
Product Revenue
The Company recognizes product revenue for telephony equipment at a point in
time, when transfer of control has occurred, which is generally upon delivery.
Sales returns are recorded as a reduction to revenue estimated based on
historical experience.
Goodwill, Intangible Assets, and Long-Lived Assets. Goodwill is carried at cost
and is not amortized. The Company tests goodwill for impairment on an annual
basis at the end of each fiscal year, relying on a number of factors including
operating results, business plans, economic projections, anticipated future cash
flows and marketplace data. Company management uses its judgment in assessing
whether goodwill has become impaired between annual impairment tests according
to specifications set forth in ASC 350. The Company completed an evaluation of
goodwill at July 31, 2021 and 2020 and determined that there was no impairment.
The fair value of the Company's reporting unit is dependent upon the Company's
estimate of future cash flows and other factors. The Company's estimates of
future cash flows include assumptions concerning future operating performance
and economic conditions and may differ from actual future cash flows. Estimated
future cash flows are adjusted by an appropriate discount rate derived from the
Company's market capitalization plus a suitable control premium at date of the
evaluation.
The financial and credit market volatility directly impacts the Company's fair
value measurement through the Company's weighted average cost of capital that
the Company uses to determine its discount rate and through the Company's stock
price that the Company uses to determine its market capitalization. Therefore,
changes in the stock price may also affect the amount of impairment recorded.
The Company recognizes an acquired intangible asset apart from goodwill whenever
the intangible asset arises from contractual or other legal rights, or when it
can be separated or divided from the acquired entity and sold, transferred,
licensed, rented or exchanged, either individually or in combination with a
related contract, asset or liability. Such intangibles are amortized over their
useful lives. Impairment losses are recognized if the carrying amount of an
intangible asset subject to amortization is not recoverable from expected future
cash flows and its carrying amount exceeds its fair value.
The Company reviews its long-lived assets, including property and equipment,
identifiable intangibles, and goodwill annually or whenever events or changes in
circumstances indicate that the carrying amount of the assets may not be fully
recoverable. To determine recoverability of its long-lived assets, the Company
evaluates the probability that future undiscounted net cash flows will be less
than the carrying amount of the assets.
Business combinations. Each investment in a business is being measured and
determined whether the investment should be accounted for as a cost-basis
investment, an equity investment, a business combination, or a common control
transaction. An investment in which the Company do not have a controlling
interest and which the Company is not the primary beneficiary but where the
Company has the ability to exert significant influence is accounted for under
the equity method of accounting. For those investments that we account for in
accordance ASC 805, Business Combinations, the Company records the assets
acquired and liabilities assumed at the management's estimate of their fair
values on the date of the business combination. The assessment of the estimated
fair value of each of these can have a material effect on the reported results
as intangible assets are amortized over various lives. Furthermore, according to
ASC 805-50-30-5, when accounting for a transfer of assets or exchange of shares
between entities under common control, the entity that receives the net assets
or the equity interests shall initially measure the recognized assets and
liabilities transferred at their carrying amounts in the accounts of the
transferring entity at the date of transfer.
Stock-based compensation. In June 2018 FASB adopted the Accounting Standards
Update No. 2018-07, Compensation - Stock Compensation (Topic 718): Improvements
to Non-employee Share-Based Payment Accounting. This update simplifies the
accounting for non-employee share-based payment transactions by expanding the
scope of Topic 718, Compensation-Stock Compensation, to include share-based
payment transactions for acquiring goods and services from non-employees. The
guidance is effective for annual periods beginning after December 15, 2018, and
interim periods within that reporting period. The Company adopted the updated
standard as of May 1, 2018, adopting this guidance did not have a material
effect on its consolidated financial statements. During FY 2021 and 2020, the
Company issued 7,858,820 common shares and 21,811,100 common shares,
respectively to various employees as part of our profit sharing-plan
contribution and stock in lieu of cash. At the time of issuance during FY 2021
and 2020 we recognized stock-based compensation expense of $264,712 and
$801,891, respectively equivalent to the market value of the shares issued
calculated based on the share's closing price at the grant dates.
13
Treasury Shares. As a result of entering into various convertible debt
instruments which contained a variable conversion feature with no floor,
warrants with fixed exercise price, and convertible notes with fixed conversion
price or with a conversion price floor, we reserved 25,000,000 treasury shares
for consideration for future conversions and exercise of warrants. The Company
will evaluate the reserved treasury shares on a quarterly basis, and if
necessary, reserve additional treasury shares. As of July 31, 2021, we believe
that the treasury share reserved are sufficient for any future conversions of
these instruments. As a result, these debt instruments and warrants are excluded
from derivative consideration.
Derivative financial instruments. Digerati does not use derivative instruments
to hedge exposures to cash flow, market, or foreign currency risks. However,
Digerati analyzes its convertible instruments and free-standing instruments such
as warrants for derivative liability accounting.
For derivative financial instruments that are accounted for as liabilities, the
derivative instrument is initially recorded at its fair value and is then
re-valued at each reporting date. Any changes in fair value is recorded as
non-operating, non-cash income or expense for each reporting period. For
derivative notes payable conversion options Digerati uses the Black-Scholes
option-pricing model to value the derivative instruments.
The classification of derivative instruments, including whether such instruments
should be recorded as liabilities or as equity, is re-assessed at the end of
each reporting period. Derivative instrument liabilities are classified in the
balance sheet as current or non-current based on whether or not net-cash
settlement of the derivative instrument is probable within the next 12 months
from the balance sheet date.
Fair Value of Financial Instruments. Fair value is defined as the exchange price
that would be received for an asset or paid to transfer a liability (an exit
price) in the principal or most advantageous market for the asset or liability
in an orderly transaction between market participants on the measurement date. A
fair value hierarchy is used which requires an entity to maximize the use of
observable inputs and minimize the use of unobservable inputs when measuring
fair value. The fair value hierarchy based on the three levels of inputs that
may be used to measure fair value are as follows:
Level 1- Quoted prices in active markets for identical assets or liabilities.
Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for
similar assets or liabilities; or other inputs that are observable or can be
corroborated by observable market data for substantially the full term of the
assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity
and that are financial instruments whose values are determined using pricing
models, discounted cash flow methodologies, or similar techniques, as well as
instruments for which the determination of fair value requires significant
judgment or estimation.
For certain of our financial instruments, including cash and cash equivalents,
accounts receivable, accounts payable and accrued expenses, the carrying amounts
approximate fair value due to the short maturity of these instruments. The
carrying value of our long-term debt approximates its fair value based on the
quoted market prices for the same or similar issues or the current rates offered
to us for debt of the same remaining maturities.
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DIGERATI TECHNOLOGIES, INC. 
