NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2016
(Unaudited)
NOTE
1 – BASIS OF PRESENTATION
The
accompanying unaudited interim consolidated financial statements of Digerati Technologies, Inc. (“Digerati” or the
“Company”) have been prepared in accordance with accounting principles generally accepted in the United States of
America and the rules of the United States Securities and Exchange Commission. In the opinion of management, these interim financial
statements contain all adjustments, consisting of normal recurring adjustments necessary for a fair presentation of financial
position and the results of operations for the interim periods presented. The results of operations for interim periods are not
necessarily indicative of the results to be expected for the full year. Notes to the consolidated financial statements, which
would substantially duplicate the disclosure contained in the audited consolidated financial statements for the year ended July
31, 2016 contained in the Company’s Form 10-K filed on October 27, 2016 have been omitted.
Income
Taxes
The
effective tax rate was 0% for the six months ended January 31, 2017 and 2016, respectively. The Company recognizes deferred tax
assets and liabilities based on differences between the financial reporting and tax bases of assets and liabilities using the
enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered. The Company provides
a valuation allowance for deferred tax assets for which it does not consider realization of such assets to be more likely than
not.
Since
January 1, 2007, the Company accounts for uncertain tax positions in accordance with the authoritative guidance issued by the
Financial Accounting Standards Board on income taxes which addresses how an entity should recognize, measure and present in the
financial statements uncertain tax positions that have been taken or are expected to be taken in a tax return. Pursuant to this
guidance, the Company recognizes a tax benefit only if it is “more likely than not” that a particular tax position
will be sustained upon examination or audit. To the extent the “more likely than not” standard has been satisfied,
the benefit associated with a tax position is measured as the largest amount that is greater than 50% likely of being realized
upon settlement. We had $2,622,867 in accrued liabilities as of January 31, 2017 and July 31, 2016, respectively, for the purpose
of settling a potential tax obligation.
Cash
and cash equivalents
The
Company considers all bank deposits and highly liquid investments with original maturities of three months or less to be cash
and cash equivalents.
Oil
and gas property
The
Company follows the successful efforts method of accounting for its oil and gas properties and, accordingly, exploration costs,
other than the costs of drilling exploratory wells, are charged to expense as incurred. The costs of drilling exploratory wells
are capitalized pending determination of whether the wells have discovered proved commercial reserves. If proved commercial reserves
are not discovered, such drilling costs are expensed. Other exploration costs, including geological and geophysical costs and
delay rentals on unproved leaseholds are charged to exploration expense as incurred. The costs of all development wells and related
equipment used in the production of oil and gas are capitalized. Costs to operate and maintain field equipment are expensed as
incurred. Direct costs of acquiring developed or undeveloped leasehold acreage, including lease bonuses, brokerage and other fees,
are capitalized. A gain or loss is recognized when a property is sold or an entire field ceases to produce and is abandoned.
The
Company annually reviews its oil and gas properties for impairment whenever events or changes in circumstances indicate that the
carrying value of such properties may not be recoverable. When it is determined that an oil and gas property’s estimated
future net cash flows will not be sufficient to recover its carrying amount, an impairment charge is recorded to reduce its carrying
value to its estimated fair value. No impairment loss was recognized on the Company’s oil and gas properties during the
period ended.
Unproved
properties are assessed periodically on a property-by-property basis and any impairment in value recognized. If the unproved properties
are determined to be productive, the appropriate related costs are transferred to proved oil and gas properties. Unproved properties
are not subject to depletion, depreciation and amortization. The Company had no proved properties as of January 31, 2017.
NOTE
2 – GOING CONCERN
Financial
Condition
Digerati’s
consolidated financial statements for the period ending January 31, 2017 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. Digerati has incurred net losses
and accumulated a deficit of approximately $79,071,000 and a working capital deficit of approximately $3,167,000 which raises
substantial doubt about Digerati’s ability to continue as a going concern.
Management
Plans to Continue as a Going Concern
Management
believes that current available resources will not be sufficient to fund the Company’s operations over the next 12
months. The Company’s ability to continue to meet its obligations and to achieve its business objectives is dependent
upon, among other things, raising additional capital, stock-based compensation for certain member of the executive management
team or generating sufficient revenue in excess of costs. At such time as the Company requires additional funding, the
Company will seek to secure such additional funding from various possible sources, including the public equity market,
private financings, sales of assets, collaborative arrangements and debt. 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 delay or reduce the scope of its operations, and the Company may not be able to pay off its obligations, if and when they
come due.
The
Company will continue to work with various funding sources to secure additional debt and equity financings. However, Digerati
cannot offer any assurance that it will be successful in executing the aforementioned plans to continue as a going concern.
Digerati’s
consolidated financial statements as of January 31, 2017 do not include any adjustments that might result from the inability to
implement or execute Digerati’s plans to improve our ability to continue as a going concern.
NOTE
3 – PURCHASE AND SALE AGREEMENT AND JOINT OPERATING AGREEMENT
On
February 29, 2016 Flagship Energy Company ("Flagship"), a wholly-owned subsidiary of Digerati, entered into a Purchase
and Sale Agreement (“PSA”) with a Texas-based contract-for-hire oil and gas operator (“Operator”). Under
the PSA, Flagship has utilized Operator for the drilling, completion and initial operations of a shallow oil and gas well in conjunction
with the purchase of 100% of Operator’s working interest and 80% of its Net Revenue Interest. Under the PSA, the Operator
has agreed to transfer all field-level operations and assign 100% of a certain oil, gas and mineral lease to Flagship upon demand,
which includes a tract of land located in South Texas. Additionally, Flagship entered into a Joint Operating Agreement ("JOA")
with Operator, whereby the parties agree to develop the oil and gas well or wells for the production and retrieval of oil and
gas commodities as provided for in the oil, gas and mineral lease.
As
of January 31, 2017 and July 31, 2016 the Company has capitalized approximately $248,000 and $210,000, respectively in oil and
gas property.
NOTE
4 - REVOLVING LINE OF CREDIT
On
June 10, 2016, the Company extended a Revolving Line of Credit to one of its Strategic Partners. The Revolving Line of Credit
is for $50,000 with an effective interest rate of 10% and maturity date of June 9, 2017. The Company has a secondary lien on accounts
receivables, fixed assets and all other assets of the Strategic Partner. In addition, the Company also secured a personal guarantee
from the largest shareholder and CEO. As of January 31, 2017 the outstanding balance on the Revolving Line of Credit
was $0.
NOTE
5 – STOCK-BASED COMPENSATION
In
November 2015, Digerati adopted the Digerati Technologies, Inc. 2015 Equity Compensation Plan (the “Plan”). The Plan,
authorizes the grant of up to 7.5 million stock options, restricted common shares, non-restricted common shares and other awards
to employees, directors, and certain other persons. The Plan is intended to permit Digerati to retain and attract qualified individuals
who will contribute to the overall success of Digerati. Digerati’s Board of Directors determines the terms of any grants
under the Plan. Exercise prices of all stock options and other awards vary based on the market price of the shares of common stock
as of the date of grant. The stock options, restricted common stock, non-restricted common stock and other awards vest based on
the terms of the individual grant.
During
the six months ended January 31, 2017, we issued:
|
●
|
1,003,966
common shares to various employees as part of the Company’s profit sharing plan
contribution. The Company recognized stock-based compensation expense of approximately
$240,952 equivalent to the value of the shares calculated based on the share’s
closing price at the grant dates.
|
|
|
|
|
●
|
541,182
common shares to various employees for services. The Company recognized stock-based compensation
expense of approximately $98,495 equivalent to the value of the shares calculated based
on the share’s closing price at the grant dates.
|
|
|
|
|
●
|
1,000,000
options to purchase common shares to various employees with an exercise price of $0.24
per share and a term of 5 years. The options vest equally over a period of one year.
The options have a fair market value of $188,000.
|
|
|
|
|
●
|
150,000
options to purchase common shares to various employees with an exercise price of $0.24
per share and a term of 5 years. The options vest equally over a period of two years.
The options have a fair market value of $33,000.
|
|
|
|
|
●
|
20,000
options to purchase common shares to an employee with an exercise price of $0.24 per
share and a term of 5 years. The options vest equally over a period of three years. The
options have a fair market value of $4,600.
|
The
fair market value of all options issued was determined using the Black-Scholes option pricing model which used the following assumptions:
Expected dividend yield
|
|
|
0.00
|
%
|
Expected stock price volatility
|
|
|
245.47
|
%
|
Risk-free interest rate
|
|
|
1.73
|
%
|
Expected term
|
|
|
1.0 - 3.0 years
|
|
Digerati
recognized approximately $374,000 and $23,000 in stock based compensation expense to employees during the six months ended January
31, 2017 and 2016, respectively. Unamortized compensation cost totaled $191,000 and $0 at January 31, 2017 and January 31, 2016,
respectively.
NOTE
6 – NON-STANDARDIZED PROFIT SHARING PLAN
We
currently provide a Non-Standardized Profit Sharing Plan, adopted September 15, 2006. Under the plan our employees qualify to
participate in the plan after one year of employment. Contributions under the plan are based on 25% of the annual base salary
of each eligible employee up to $54,000 per year. Contributions under the plan are fully vested upon funding. During the period
ended January 31, 2017 and January 31, 2016, the Company issued 1,003,966 and 121,135, respectively, common shares to various
employees as part of the Company’s profit sharing plan contribution. The Company recognized stock-based compensation expense
for January 31, 2017 and January 31, 2016 of $240,952 and $23,000 respectively, equivalent to the value of the shares calculated
based on the share’s closing price at the grant dates.
NOTE
7 – SIGNIFICANT CUSTOMERS
During
the six months ended January 31, 2017, the Company derived a significant amount of revenue from four customers, comprising 31%,
24%, 11% and 5% of the total revenue for the period, respectively, compared to four customers, comprising 31%, 24%, 15%, and 11%
of the total revenue for the six months ended January 31, 2016.
During
the six months ended January 31, 2017, the Company derived a significant amount of accounts receivable from three customers, comprising
52%, 13% and 12% of the total accounts receivable for the period, compared to three customers, comprising 83%, 7% and 4% of the
total accounts receivable for the six months ended January 31, 2016.
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This
Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. “Forward-looking statements”
are those 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,” “plan,” and “intend.” Although we believe these expectations
are reasonable, our operations involve a number of risks and uncertainties. Some of these risks include the availability and capacity
of competitive data transmission networks and our ability to raise sufficient capital to continue operations. Additional risks
are included in our Annual Report on Form 10-K for the fiscal year ended July 31, 2016 filed with the Securities and Exchange
Commission on October 27, 2016.
The
following is a discussion of the unaudited interim consolidated financial condition and results of operations of Digerati for
the six months ended January 31, 2017 and 2016.
It should be read in conjunction with our audited Consolidated
Financial Statements, the Notes thereto, and the other financial information included in the Company’s Annual Report on
Form 10-K
for the fiscal year ended July 31, 2016 filed with the Securities and Exchange Commission on October 27, 2016.
For purposes of the following discussion, fiscal 2017 or 2017 refers to the year ended July 31, 2017
and fiscal 2016 or 2016 refers to the year ended July 31, 2016.
History
Digerati
Technologies, Inc., a Nevada corporation (including our subsidiaries, “we,” “us,” or “Digerati”),
was formed in 2004 as the successor to a business originally commenced by Latcomm International, Inc., a Canadian company formed
in 1994. We began providing communication services in 1995 along the U.S.-Mexico corridor to capitalize on the opportunities created
by the deregulation of the telecommunication industries within Latin America. Through FY 2012 our principal business was providing
transportation of voice traffic for other telecommunication service providers, wireless carriers and regional Internet telephony
providers using Voice over Internet Protocol (“VoIP”) technologies. Our wholly-owned subsidiary, Shift8 Technologies,
Inc. (“Shift8”), offers a portfolio of Internet-based telephony products and services through our cloud application
platform and session-based communication network, which is interconnected to numerous U.S. and foreign service providers.
During
FY 2016 Flagship Energy Company ("Flagship"), a wholly-owned subsidiary of Digerati, entered into a Purchase and Sale
Agreement (“PSA”) with a Texas-based contract-for-hire oil and gas operator (“Operator”). Under the PSA,
Flagship has utilized Operator for the drilling, completion and initial operations of a shallow oil and gas well in conjunction
with the purchase of 100% of Operator’s Working Interest and 80% of its Net Revenue Interest. Under the PSA, the Operator
has agreed to transfer all field-level operations and assign 100% of a certain oil, gas and mineral lease to Flagship upon demand,
which includes a tract of land located in South Texas. Additionally, Flagship entered into a Joint Operating Agreement ("JOA")
with Operator, whereby the parties agree to develop the oil and gas well or wells for the production and retrieval of oil and
gas commodities as provided for in the oil, gas and mineral lease.
Until
July 2014, Digerati owned a waste disposal business focused on disposing of solid and liquid wastes from drilling sites and an
oilfield services business providing skid houses, telecommunication services, booster booths, portable restrooms, generators,
potable water, and mess halls to drilling contractors and oil companies in the Bakken region of Montana and North Dakota.
Sources
of Revenue and Direct Cost
Sources
of revenue:
Global
VoIP Services:
We currently provide VoIP communication
services on a limited basis to U.S. and foreign telecommunications companies that lack transmission facilities, require additional
capacity or do not have the regulatory licenses to terminate traffic in Mexico, Asia, the Middle East and Latin America.
Typically,
these telecommunications companies offer their services to the public for domestic and international long distance services.
Cloud-based
hosted Services
: We provide
enhanced VoIP
services to resellers and enterprise customers. The service includes fully hosted IP/PBX services, IP trunking, call center applications,
interactive voice response auto attendant, call recording, simultaneous calling, voicemail to email conversion, and multiple customized
IP/PBX features in a hosted environment for specialized applications.
Direct
Costs:
Global
VoIP Services:
We incur transmission and termination charges from our suppliers and the providers of the infrastructure and
network. The cost is based on rate per minute, volume of minutes transported and terminated through the network. Additionally,
we incur fixed Internet bandwidth charges and per minute billing charges. In some cases we incur installation charges from certain
carriers. These installation costs are passed on to our customers for the connection to our VoIP network.
Cloud-based
hosted Services
: We incur bandwidth and co-location charges in connection with enhanced VoIP Services. The bandwidth charges
are incurred as part of the connection between our customers to allow them access to our services.
Results
of Operations
Three
Months ended January 31, 2017 Compared to Three Months ended January 31, 2016
Global
VoIP Services.
Global VoIP services revenue decreased by $9,000, or 100%, from the quarter ended January 31, 2016 to the quarter
ended January 31, 2017. The decrease in revenue is attributed primarily to deemphasizing this product, as a result no Global VoIP
revenue was generated during the quarter ended January 31, 2017.
Cloud-based
hosted Services
. Cloud-based hosted services revenue decreased by $6,000, or 13%, from the quarter ended January 31, 2016
to the quarter ended January 31, 2017. The decrease in revenue between periods is primarily attributed to the decrease in customers
that generated monthly recurring services revenue unrelated to the Company's core sales strategy and product line. Hosted services include fully hosted IP/PBX services, IP
trunking, call center applications, interactive voice response auto attendant, call recording, simultaneous calling, voicemail
to email conversion, SIP trunking and multiple other IP/PBX features in a hosted environment.
C
ost
of Services (exclusive of depreciation and amortization).
The consolidated cost of services decreased by $6,000, or 15%, from
the quarter ended January 31, 2016 to the quarter ended January 31, 2017. The decrease in cost of services is as a result of decrease
in revenue during the quarter ended January 31, 2017.
Selling,
General and Administrative (SG&A) Expenses (exclusive of legal and professional fees).
SG&A expenses increased by
$280,000, or 83%, from the quarter ended January 31, 2016 to the quarter ended January 31, 2017. The increase is attributed to
$374,000 in stock compensation expense recognized during the quarter ended January 31, 2017.
Legal
and professional fees
. Legal and professional fees increased by $45,000, or 83%, from the quarter ended January 31, 2016 to
the quarter ended January 31, 2017. The increase is attributed to $99,000 in legal fees recognized during the quarter ended January
31, 2017 related to professionals conducting due diligence on a potential acquisition.
Depreciation
and amortization
. Depreciation and amortization remained comparable between periods.
Operating
loss.
The Company reported an operating loss of $712,000 for the three months ended January 31, 2017 compared to an operating
loss of $379,000 for the three months ended January 31, 2016. The increase in operating loss between periods is primarily attributed
to the increase in legal and professional fees related to professionals conducting due diligence on a potential acquisition.
Net
loss.
Net loss increased by $333,000 or 88%, from the quarter ended January 31, 2016 to the quarter ended January 31, 2017.
The increase in net loss is primarily attributed to the increase in legal and professional fees related to professionals conducting
due diligence on a potential acquisition.
Six
Months ended January 31, 2017 Compared to Six Months ended January 31, 2016
Global
VoIP Services.
Global VoIP services revenue decreased by $16,000, or 100%, from the six months ended January 31, 2016 to the
six months ended January 31, 2017. The decrease in revenue is attributed primarily to deemphasizing this product, as a result
no Global VoIP revenue was generated during the six months ended January 31, 2017.
Cloud-based
hosted Services
. Cloud-based hosted services revenue decreased by $14,000, or 14%, from the six months ended January 31, 2016
to the six months ended January 31, 2017. The decrease in revenue between periods is primarily attributed to the decrease in customers
that generated monthly recurring services revenue unrelated to the Company's core sales strategy and product line. Hosted services include fully hosted IP/PBX services, IP
trunking, call center applications, interactive voice response auto attendant, call recording, simultaneous calling, voicemail
to email conversion, SIP trunking and multiple other IP/PBX features in a hosted environment.
C
ost
of Services (exclusive of depreciation and amortization).
The consolidated cost of services decreased by $11,000, or 14%,
from the six months ended January 31, 2016 to the six months ended January 31, 2017. The decrease in cost of services is as a
result of decrease in revenue during the six months ended January 31, 2017.
Selling,
General and Administrative (SG&A) Expenses (exclusive of legal and professional fees).
SG&A expenses increased by
$340,000, or 63%, from the six months ended January 31, 2016 to the six months ended January 31, 2017. The increase is attributed
to $374,000 in stock compensation expense recognized during the period ended January 31, 2017.
Legal
and professional fees
. Legal and professional fees decreased by $5,000, or 4%, from the six months ended January 31, 2016
to the six months ended January 31, 2017.
Depreciation
and amortization
. Depreciation and amortization remained comparable between periods.
Operating
loss.
The Company reported an operating loss of $995,000 for the six months ended January 31, 2017 compared to an operating
loss of $641,000 for the six months ended January 31, 2016. The increase in operating loss between periods is primarily attributed
to $374,000 in stock compensation expense recognized during the period ended January 31, 2017.
Other
income (expense)
. Other income (expense) decreased by $5,000 from the six months ended January 31, 2016 to the six months
ended January 31, 2017. The primary reason for the decrease in other income (expense) is attributed to the decrease between periods
in interest expense of approximately $3,000.
Net
loss.
Net loss increased by $359,000 or 56%, from the six months ended January 31, 2016 to the six months ended January 31,
2017. The increase in net loss is primarily attributed to $374,000 in stock compensation expense recognized during the period
ended January 31, 2017.
Liquidity
and Capital Resources
Cash
Position:
We had a consolidated cash balance of $578,000 as of January 31, 2017. Net cash consumed by operating activities
during the period ended January 31, 2017 was approximately $553,000, primarily as a result of operating expenses. Cash used in
investing activities was $38,000 for the purchases of oil and gas property. Overall, our net operating, investing and financing
activities during the period ended January 31, 2017 consumed approximately $591,000 of cash.
We
are currently taking initiatives to reduce our overall cash deficiencies on a monthly basis. During fiscal 2017 we anticipate
reducing fixed costs, professional fees and general expenses, in addition, certain members of our Management Team will take
a significant portion of their compensation in common stock to reduce the depletion of our available cash. To strengthen
our business, we intend to invest in a new marketing and sales strategy to grow our monthly recurring revenue; we
anticipate utilizing our value added resellers 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.
Our
current cash expenses are expected to be approximately $85,000 per month, including wages, rent, utilities and corporate professional
fees.
As described elsewhere herein, we are not generating sufficient cash from operations to pay for
our ongoing operating expenses, or to pay our current liabilities. As of January 31, 2017 our total liabilities were approximately
$3,912,000. We will continue to use our available cash on hand to cover our deficiencies in operating expenses.
We
estimate that we need approximately $500,000 of additional working capital to fund our ongoing operations. Additionally, we have
an
accumulated deficit of approximately $79,071,000,
which raises substantial doubt about our ability to continue as a going concern.
We
will continue to work with various funding sources to secure additional debt and equity financings. However, there can be no assurance
that we will be successful in executing the aforementioned plans and be able to continue as a going