UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(Amendment No. 1)
(Mark One)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2004
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File No.: 000-33471
YAK COMMUNICATIONS INC.
(Exact name of small business issuer as specified in its charter)
| Florida | 98-0203422 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
300 Consilium Place, Suite 500, Toronto, Ontario, Canada M1H 3G2
(Address of principal executive offices)
(647) 722-2752
(Issuer’s Telephone Number, Including Area Code)
Indicate by a check mark whether the issuer: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ¨ Yes x No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of September 30, 2004, 12,893,250 shares of the issuer’s Common Stock, no par value per share, were outstanding.
YAK COMMUNICATIONS INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q/A
(Amendment No. 1)
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Yak Communications Inc. (the “Company”) is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q/A for the quarter ended September 30, 2004 (the “Report”) to restate its consolidated balance sheets, statements of operations and statements of cash flows for the quarter ended September 30, 2004, and the notes related thereto. As previously disclosed, the Company has reviewed the accounting methodology used with respect to an historical software acquisition transaction and has determined to restate its consolidated financial statements for fiscal years 2003 and 2004, along with the quarterly periods contained in fiscal 2004 and the first quarter of fiscal 2005, to change the accounting treatment for the subject software transaction.
This Amendment No. 1 corrects the Company’s quarterly financial statements to reflect the fair value of certain software acquired by the Company on June 30, 2003, and to revise its assets and liabilities accordingly. The Company is restating its consolidated financial statements to make the following classes of adjustments (the “Restatement”):
| • | changes in accounting treatment of software acquisition transaction |
| • | correct balance sheet amounts to reflect adjustments resulting from change in accounting treatment |
| • | adjust consolidated statement of operations for interest expense, depreciation expense, other income, and related income tax expense to reflect changes in the above-referenced accounting treatment |
For a more detailed description of the Restatement, see Note 5 entitled “Next Generation Software and Financial Restatements” to the accompanying consolidated financial statements.
While the remainder of the Report is unchanged, the Company is reproducing the Report in its entirety to provide a complete presentation to the reader. However, this Amendment No. 1 also amends and restates Item 2 of Part I of the Report, in each case solely as a result of, and to reflect, the Restatement, and no other information in the Report is amended hereby. In addition, pursuant to Rule 12b-15, the Company is also including currently dated certifications of the Chief Executive Officer and Principal Financial Officer. The certifications of the Company’s Chief Executive Officer and Principal Financial Officer are attached to this Amendment No. 1 as Exhibits 31.1, 31.2, 32.1 and 32.2.
This Amendment No. 1 speaks as of the original date of the filing date of the Report, except for certifications, which speak as of their respective dates and the filing date of this Amendment No. 1. Except as specifically indicated, the Report has not been updated to reflect events occurring subsequently to the original filing date. Other events occurring after the filing of the Report or other disclosures necessary to reflect subsequent events will be addressed in reports filed with the U.S Securities and Exchange Commision (“SEC”) subsequent to the date of this filing.
Concurrently with the filing of this Amendment No. 1, the Company is filing (i) Amendment No. 1 on Form 10-KSB/A to its Annual Report on Form 10-KSB for the year ended June 30, 2003, (ii) Amendment No. 1 on Form 10-QSB/A to its Quarterly Report on Form 10-QSB for the quarter ended September 30, 2003, (iii) Amendment No. 1 on Form 10-QSB/A to its Quarterly Report on Form 10-QSB for the quarter ended December 31, 2003, (iv) Amendment No. 1 on Form 10-QSB/A to its Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004 and (v) Amendment No. 1 on Form 10-K/A to its Annual Report on Form 10-K for the year ended June 30, 2004.
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FINANCIAL INFORMATION
Immediately following the signature page in this Form 10-Q/A.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein should be read in conjunction with the Consolidated Financial Statements of Yak Communications Inc. and Subsidiaries, and the related notes to the Financial Statements included in the Company’s Form 10-K/A for the fiscal year ended June 30, 2004, and the Consolidated Financial Statements and the related notes to the Consolidated Financial Statements included in Item 1 of this quarterly report on Form 10-Q/A. Our Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the U.S. and have been audited by our independent auditors.
The financial information in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” refers to our continuing operations.
Significant Transactions and Events
On June 20, 2003, Yak Communications (Canada) Inc., the Company’s wholly-owned subsidiary (“Yak Canada”), acquired certain “next generation” telecommunications software from Consortio, Inc., a Delaware corporation and Convenxia Limited, a corporation organized under the laws of the United Kingdom (the “Sellers”), pursuant to the terms and conditions of a Software Acquisition Agreement. Payments made or due to the Sellers for the software were as follows: (a) $565,000 in cash was paid at the closing of the transaction; (b) delivery of a short term promissory note in the principal amount of $400,000 providing for equal monthly payments of $40,000; and (c) the balance of the purchase price is evidenced by a long-term promissory note executed in favor of Consortio, Inc. with a principal amount of $8,535,000 bearing interest at 7.25% per annum. Interest and principal are payable quarterly in the amount of $174,965 commencing September 30, 2003 and is due July 15, 2012. The sole recourse by the lender is the software. Yak Canada was also issued a warrant to purchase up to 8% of the issued and outstanding common stock of Convenxia Limited.
In addition to the purchase of the software, Yak Canada and the Sellers entered into a joint venture agreement which licensed the use of the software for telecommunication services outside Canada to non-Yak customers. Under the joint venture agreement, Yak Canada is entitled to receive 4% of all gross revenue arising from the sale of services using the acquired software with minimum quarterly payments of $150,000 through June 30, 2006 and, thereafter, 2.75% of gross revenue with minimum quarterly payments of $175,000.
On January 24, 2005, the Company engaged Deloitte & Touche (“Deloitte”) as its new independent certified public accountants. In connection with their review of the historical financial statements, Deloitte identified a software acquisition transaction with respect to which the accounting treatment used by the Company possibly was incorrect.
On February 23, 2005, the Company announced that it was delaying the filing of its Form 10-Q for the third fiscal quarter ended December 31, 2004, beyond the extended filing deadline of February 22, 2005, because the work required to review this matter was not able to be completed.
Also on February 23, 2005, The NASDAQ Stock Market advised the Company that it did not comply with Marketplace Rule 4310(c)(14), which requires it to provide NASDAQ with copies of all reports required to be filed with the SEC. As a result, NASDAQ appended the fifth character “E” to the Company’s common stock trading symbol as of the opening of business on February 25, 2005.
On March 30, 2005, Yak announced that it had presented a written submission to the Office of the Chief Accountant (“OCA”) of the SEC seeking guidance with respect to the accounting issues described above. Due to the judgments involved in the applicable accounting analysis, the Company, in consultation with its Audit Committee, decided to obtain the guidance of the OCA on its analysis and conclusions regarding the subject software transaction. Based on initial discussions with the OCA we have restated various historical financial statements; however, these amended filings are subject to final guidance from the OCA which may result in further restatements.
On April 6, 2005, the Company re-engaged Horwath Orenstein LLP as its new independent certified public accountants.
The Company estimated the “fair value” of the assets and liabilities associated with the Software Acquisition Agreement based on the related estimated cash flows. Statement of Financial Accounting Concepts No. 7 (SFAC No. 7) provides a framework for using future cash flows and present value as the basis for accounting measurements of fair value. In accordance with SFAC No. 7, the Company used the expected cash flow approach to estimate fair value, focusing on explicit assumptions about the range of possible cash outcomes and their respective probabilities. Based on this expected cash flow approach, the fair values of the liabilities are estimated to be significantly less than their face values. The fair value of the Convenxia warrants was derived by using the Black-Scholes valuation model.
Based on the foregoing, the fair value of the Convenxia transaction’s components were estimated for accounting purposes as follows:
Software | $ | 1.7 million | |
Receivable from joint venture | 5.0 million | ||
Warrants | 0.1 million | ||
Total assets acquired | $ | 6.8 million |
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Cash paid | $ | 0.7 million | |
Short-term note payable | 0.4 million | ||
Long-term note payable | 5.7 million | ||
Total consideration paid | $ | 6.8 million |
The Company obtained an independent valuation in the amount of $5.9 million (which is in the mid-point of the range of $5.4 million to $6.4 million as calculated by the independent valuator) for the acquired software. In accordance with Statement of Financial Accounting Standards No. 141 (FAS 141), the excess of fair value assigned to the assets acquired (i.e., $4.2 million) was allocated as a pro rata basis to reduce the amounts that otherwise would have been assigned to all of the non-financial acquired assets (e.g., software). As a result, the fair value of the software acquired was reduced for accounting purposes from its estimated fair value of $5.9 million to its carrying value of $1.7 million.
In the fourth quarter of fiscal 2004, we made the determination that the development of the “next generation” software for our internal use (principally VoIP) would require the full time and effort of all involved parties. We believed that the continuing development of the software for internal use over the next several years would be the key aspect of the software transaction (described above), and not the commercialization. In addition, given this emphasis on internal development, we also became increasingly aware of the fact that whatever software was developed for “next generation” VoIP use, it was more likely than not to become obsolete by 2012 (the due date of the balloon payment on the long-term note given in connection with the next generation software transaction described above) and that the Consortio/Convenxia joint venture would terminate concurrently.
Given the convergence of these two issues, we (in the fourth fiscal quarter) modified the probability assumptions for the range of possible cash outcomes related to the fair value calculations of the receivable from the joint venture and the long-term note payable. The probabilities that the cash flows from the joint venture would be received or that the $7.3 million balloon payment due on the long-term note in 2012 would be paid by the Company were reduced to 0% probability (from 20% probability in prior assumptions).
Accordingly, we reduced the fair value of the long-term note payable at June 30, 2004 by $1.7 million (from $5.8 million to $4.1 million) and concurrently impaired the fair value of the joint venture receivable by $0.6 million (from $4.6 million to $4.0 million). Because the note liability was not legally extinguished and only the expected cash flow inflows and outflows changed, the resultant net gain of $1.1 million was deferred and classified on the June 30, 2004 balance sheet as “Deferred Revenue.” There was no impact on our Consolidated Statements of Income nor on our Consolidated Statements of Cash Flows for the three months ended June 30, 2004.
For further details, refer to Note 5 to the Consolidated Financial Statements.
On July 2, 2003, Yak Canada, acquired Contour Telecom Inc. and Argos Telecom Inc. from Allstream Inc., formerly AT&T Canada Corp., pursuant to the terms and conditions of a Share and Debt Purchase Agreement. Contour Telecom Inc. is a provider of outsourced telecommunications management services and Argos Telecom Inc. is a value added reseller of telecommunications services across Canada. Consideration for this purchase was $5,572,710 in cash plus costs associated with the transaction of $1,258,933. Yak Canada will record goodwill of approximately $1,900,000 in respect of this transaction. The acquired companies had revenues of $21,266,155 for the twelve months ended June 30, 2003. On September 15, 2003, we filed an amendment to our current report on Form 8-K filing certain historical and pro forma financial statements in connection with this transaction.
Overview
We are a facilities-based reseller of discount, long-distance telecommunication services in Canada and the U.S. to residential and small business customers. We primarily concentrate our residential marketing efforts towards consumers that make significant amounts of international calls, directly targeting ethnic markets and communities in major urban centers.
Products
Our primary residential product offering is dial-around services (also known as “casual calling”) at both variable and flat rate pricing. Casual calling allows our customers to dial-around their existing long distance carrier on any call by entering a few digits prior to making the call, without permanently switching long distance carriers. We offer “1+ billing” which allows our customers to permanently switch all of their calls from their existing long distance carrier to our long distance service. We have continued to experience significant year over year growth in our dial-around business. Substantially all of our current dial-around business comes from the Canadian market, in which we are the dominant company as it pertains to market share. According to industry sources, the dial-around market in Canada is expected to double in size to approximately $165 million by 2007. We believe that there still exists an opportunity to further grow the Canadian market, and we continue to increase our focus on this core business in both Canada and the United States in order to provide for the expansion of other areas of the business.
We initially launched into the U.S. market with our dial-around product in 2002 in three metropolitan
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areas: Las Vegas, Miami and Washington, D.C. Since the initial launch into the United States, we have registered with 47 states and have completed the loading and testing of all of our CIC codes i.e. 10-10-925, 10-15-945 and 10-15-565. We have experienced a small but steady volume of dial-around traffic in the U.S. market without a focused and sustained marketing campaign. As a result of the opportunity which we believe exists in the U.S. market, we anticipate launching a 1+ product in the fall of 2004 in addition to targeted campaigns for our dial-around product. We have entered into several contracts with both ethnic-focused spokespersons as well as a targeted internet marketing company in order to further penetrate and expand our U.S. operations. In order to support this expansion, we have opened an office in Aventura, Florida. Although this market is intensely competitive, we believe that through the implementation of a strategically focused approach, there exists an opportunity to grow this market.
In November of 2003, we introduced a dial-around service in Peru. Although currently a very small portion of our total business, we believe this provides us with an opportunity to develop competing long distance services and proactively test the issues relating to the migration to a VoIP platform in international territories.
Our offering to the Canadian SME market consists of competitively priced voice and data products. In the near future, we will also introduce a broadband offering to the SME market. We also offer telecom management services to the mid-to-large customer base in Canada through our subsidiary Contour Telecom.
In September, 2004 we launched our VoIP service – “WorldCity™ VoIP” to residential customers in Canada and the U.S. For our customers who currently have a broadband connection, WorldCity™ VoIP combines bundled local and long distance (within North America) calling packages with ultra-competitive international rates, plus great phone features like Caller ID, Three Way Calling and Voicemail for one flat price. In addition to the basic services to be introduced at launch, we anticipate future releases of the product will make available cutting edge applications to truly differentiate Yak from the competition e.g. unified messaging, virtual international phone numbers, and free member-to-member international calling. Our plan is to develop the residential offering and then develop an offering to the small and medium business market. Our core business is profitable and growing, and it is our plan to utilize the success of our core business to launch an exciting array of value-added products throughout the world.
Networks
Over the past three years, we have established and expanded our own private leased line network throughout all major Canadian provinces. In addition, we have achieved comparable network breadth in the U.S. by interconnecting with a major U.S. carrier. Currently, this coast- to-coast network delivers all of our telephony traffic. In addition to the cost and control advantages of this network, we have purchased a SanteraOne softswitch and Media Gateway. The port density and significantly reduced foot print of this switch has enabled us to transition our traffic from our legacy Teltronics/Harris switches, resulting in significant cost savings. The Santera switch currently has 40,000 ports and is expandable to 200,000 ports. Our current level of traffic is using approximately 20,000 ports; as a result, we anticipate having sufficient switching capacity for the foreseeable future.
Costs
In addition to the direct cost savings associated with the transition to and operation of the SanteraOne platform, the transition has also afforded us the opportunity to bring a greater portion of our traffic onto our own network. There is a savings of approximately $.005 per minute for traffic that is routed over our leased
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line network as compared to a third party carrier’s network. In addition to these savings, we also continually pursue other methods of reducing our variable direct costs including: employing least cost routing of our international traffic; negotiating lower variable costs with multiple carriers to multiple destinations in order to achieve the lowest available cost per minute; and continuing to expand the capacity of our network to accommodate the growing demand in certain areas of the markets we serve.
VoIP
We believe that broadband voice services represent a significant emerging market opportunity in the communications industry. The service enables voice communication over broadband IP networks, significantly reducing costs to end users while bundling a broad array of value-added services, e.g., voicemail, call-waiting, caller-ID, call-forwarding, auto-attendant, find-me/follow-me, etc.
We believe we are uniquely positioned to capture a significant market share as broadband voice gains popularity among traditional phone users. The Company has initiated strong relationships with technology and network providers to incorporate broadband voice into our current offering. We are planning an aggressive marketing campaign to support our VoIP product launch in January 2005. Leveraging its successful dial around business model and the market reach of current advertising, our VoIP initiative is expected to have a higher gross margin than our traditional dial-around service as a result of the potential to carry a portion or all of the calls over the Internet.
Foreign Currency
Currently the overwhelming amount of our net revenue (approximately 99%) is derived from sales and operations in Canada. The functional currency for this revenue is the Canadian dollar. Our reporting currency for our consolidated financial statements is the U.S. dollar. Although we expect to derive less of our total business directly from Canada in the future, exchange rates have had and may continue to have a significant, and potentially adverse, effect on our results of operations. Any strengthening of the U.S. dollar relative to the Canadian dollar could have an adverse impact on our future results of operations.
Results of Operations
Comparison of three months ended September 30, 2004 and 2003
The following information for the quarter ended September 30, 2004, and 2003 is provided for informational purposes and should be read in conjunction with the Consolidated Financial Statements and Notes (all amounts in U.S. dollars).
| For the Quarter Ended September 30, 2004 | |||||||||
Products | Revenue | Customers | Minutes | Calls | |||||
Dial-Around/1+ | $ | 14,775,097 | 772,418 | 244,282,904 | 22,749,977 | ||||
LooneyCall | $ | 2,207,046 | 84,822 | 25,450,583 | 1,966,230 | ||||
Yakcell | $ | 75,875 | 2,623 | 811,396 | 102,836 | ||||
TOTAL | $ | 17,058,018 | 859,863 | 270,544,883 | 24,819,043 | ||||
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| For the Quarter Ended September 30, 2003 | |||||||||
Products | Revenue | Customers | Minutes | Calls | |||||
Dial-Around/1+ | $ | 12,158,261 | 621,348 | 178,860,530 | 16,474,665 | ||||
LooneyCall | $ | 2,006,590 | 84,211 | 24,565,137 | 1,771,785 | ||||
Yakcell | $ | 12,105 | 372 | 106,470 | 14,818 | ||||
TOTAL | $ | 14,176,956 | 705,931 | 203,532,137 | 18,261,268 | ||||
The Average Rate per Minute (ARPM) that we derive from our core dial around services was $0.063 for the quarter ended September 30, 2004, as compared to $0.070 for the quarter ended September 30, 2003. Due to the competitive nature of the business and the fact that long distance services are increasingly a commodity product, we expect gradual, but continuing erosion in our ARPM in the foreseeable future.
Revenue
Net revenue increased $2.4 million, or 12.8%, to $21.2 million for the quarter ended September 30, 2004, from $18.8 million for the quarter ended September 30, 2003. The majority of the growth came from our core dial-around and LooneyCall products, which increased $2.6 million and $0.2 million respectively on a quarter over quarter basis. Our Yakcell product experienced strong sequential quarterly growth, but this product still represents only an insignificant amount of our overall revenue. We believe that this product will continue to increase its relative share of total revenue as it becomes more entrenched in the U.S. marketplace.
Our U.S. revenue was largely flat quarter-over-quarter at $0.2 million. We launched an intense marketing campaign in October 2004 to the Hispanic market in Florida which utilized a variety of media including television and radio commercials, flyers and print media advertising. An intense advertising campaign for the second fiscal quarter (October, November and December 2004) is expected to significantly increase our presence in the U.S. market. In addition to our marketing to the U.S. Hispanic community, we have embarked on a targeted marketing campaign to other ethnic communities in the U.S.; this practice that has been very successful in the Canadian marketplace, and we believe these actions will strengthen our brand in the U.S. market.
The balance of our revenue was derived from our Yak for Business subsidiary. This subsidiary contributed revenue of $2.7 million in the first quarter of fiscal year 2005 which represented a decrease of $0.5 million from the quarter ended September 30, 2003. A large portion of the decrease resulted from the reduction of the customer base that occurred after the acquisition in July, 2003. Due to its overall importance to our long-term strategy, we will focus on growth opportunities in the small and medium business market. Revenue for Contour Telecom was largely flat at $1.4 million for the quarter ended September 30, 2004.
On September 8, 2004 we launched our residential WorldCity™ VoIP product. This product is a basic VoIP offering to the residential market. Revenue associated with this offering is insignificant at the present time; however, in January 2005 we anticipate launching a strategic marketing campaign aimed at capturing a significant market share of the long distance customer. We have positioned this product as the next generation telecommunication service that will transition the company from its origins of a dial-around company. It is anticipated that an increasingly significant proportion of total revenues will be derived from this product and the value-add services that will be offered in the future.
Direct Costs
Our cost of revenue increased 12.8% to $13.8 million for the quarter ended September 30, 2004 from
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$12.2 million for the quarter ended September 30, 2003; however, as a percentage of sales (64.9%) it was “flat” when compared to that for the first quarter of fiscal 2004. Despite the decline in ARPM (discussed above), we have been able to maintain our margins as a result of the increased utilization of our leased line network. We have continued to “build out” our network, which enables us to bring a greater share of our traffic onto our own network, resulting in a higher utilization of our fixed-cost access lines. As a result of the continual downward pressure on the price of long distance telephony, our Company is utilizing real-time, least cost routing algorithms and contracting with various carriers in order to manage the direct costs as efficiently and as cost effectively as possible.
The table below presents a breakdown of the direct costs of our core dial-around business into its long distance and other components for the first quarter of each of the last three fiscal years (all amounts in U.S. dollars):
| Breakdown of Direct Cost for Core Revenue | ||||||||||||||||||
(Thousands) | Sept. 30, 2004 | Sept. 30, 2003 | Sept. 30, 2002 | |||||||||||||||
| $ | % | $ | % | $ | % | |||||||||||||
Core Revenue* | 17,058 | 100.0 | % | 14,177 | 100 | % | 8,179 | 100 | % | |||||||||
Long Distance Charges | 5,684 | 33.3 | 5,039 | 35.5 | 2,904 | 35.5 | % | |||||||||||
Other Fees** | 5,019 | 29.5 | 3,899 | 27.5 | 2,495 | 30.5 | % | |||||||||||
Gross Margin | 6,355 | 37.3 | 5,239 | 37.0 | 2,780 | 34.0 | % | |||||||||||
| * | Core revenue includes dial-around, LooneyCall and YakCell. |
| ** | Other fees include line access charges for our leased line network, occupancy, call processing fees, CRTC contribution fees (fees paid to the Canadian government), and costs to originate and terminate traffic on our leased line network. |
Cost of revenue in our dial-around business is comprised primarily of the cost of long distance services, fees for the processing and transporting of our calls and fixed and variable line access costs. The cost of the pure long distance component of services has increased to $5.7 million or 33.3% for the quarter ended September 30, 2004, from $5.0 million or 35.5% for the quarter ended September 30, 2003. The cost of the “Other” component of services has increased to 29.5% for the quarter ended September 30, 2004, from 27.5% for the quarter ended September 30, 2003. This is largely the result of a relative increase in the cost of access lines and billing and collection fees on a quarter-over-quarter basis.
Gross Margins
The overall gross margin for the Company remained consistent with the quarter ending September 30, 2003 at 35.1%. The gross margin for the core dial-around business was 37.3% for the quarter ending September 30, 2004, compared to 37.0% for the quarter ending September 30, 2003. While we do not anticipate that there will be significant erosion in our core margins in the short term as we continue to optimize our network efficiency and control direct costs through on-going negotiations with various carriers, there can be no assurance that further declines in our gross margins will not occur.
The gross margin in the Yak for Business subsidiary was 24.3% for the quarter ending September 30, 2004, compared to 30.0% for the quarter ending September 30, 2003. This trend is primarily the result of decreases in the gross margin of our local service and Extended Service area (EAS) offerings. The gross margin for Contour Telecom was 27.9% for the quarter ending September 30, 2004, compared to 25.1% for the quarter ending September 30, 2003. This increase in gross margin is largely the result of one-time credits booked in the quarter.
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General & Administrative Expenses
General and administrative expenses (“G&A”) increased 37.5% to $3.1 million for the quarter ending September 30, 2004, from $2.2 million for the quarter ending September 30, 2003. The increase of G&A of $0.9 million can be attributed mainly to increases of salaries ($0.6 million), legal fees ($0.2 million), and occupancy and office related expenses ($0.1 million).
The largest component of the increase in G&A was salaries, a result of hiring additional members of our senior management team and customer service representatives to support the growth of the business in fiscal 2005. To facilitate the future growth of the Company, we added several executives with extensive telecommunications experience to the management team. In addition, as we move aggressively into new markets and introduce new products, we have invested in the front-line customer support organization. Customer service has always been one of the key differentiators of our Company and we expect it will continue to be in the future. We will continue to closely analyze and control the growth of our headcount, in order to maximize the return to the organization.
Legal expenses increased $0.2 million or 203.1% to $0.3 million for the quarter ended September 30, 2004. Approximately half of the increase is a result of tax compliance and other legal matters related to the introduction of our products into the U.S. market. The remaining increase in professional fees included those incurred in connection with regulatory matters and the fees associated with exploring the Company’s new acquisition opportunities. As we continue to evaluate potential acquisitions, become more involved in regulatory proceedings, and launch new products, we do not anticipate a significant reduction in legal expenses on a quarterly basis.
Expenditures for occupancy and office related expenses increased by $0.1 million for the quarter ended September 30, 2004 as a result of the consolidation to our new offices at 300 Consilium Place in Toronto, Ontario. We would anticipate that our needs for more space in the future would increase to match the ultimate growth of the business.
Sales & Marketing
Sales and marketing expenses increased to $1.0 million for the quarter ended September 30, 2004. The cost of advertising in our Canadian territory decreased $0.2 million to $0.7 million for the quarter ended September 30, 2004; however, those costs increased by $0.3 million in U.S. market. It is management’s intention to significantly increase the amount of advertising in the U.S. market to support the launch of our 1+ service and increase brand recognition through a focused campaign of flyers, TV commercials and internet-based advertising.
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Interest on Note Payable and Income from Joint Venture Agreement
Interest and discount amortization expense for the quarter ended September 30, 2004 related to the long-term note payable was $240,189. Income earned under the joint venture agreement for the quarter ended September 30, 2004 was $93,001. See “Significant Transactions, Subsequent Events and Financial Restatements”, above.
Financing
Accounts receivable financing costs related to the factoring of our trade accounts receivable remained flat for the quarter ended September 30, 2004. The increase in the growth of the business and the amount of the receivables that were being financed, was offset by the decrease in the interest rate charged. Despite the amount of cash on hand at the present time, we intend to continue our program of factoring certain of our receivables. This decision is based on the relatively favorable terms that we currently receive under the factoring arrangement, in addition to our desire to use the cash on hand to finance the growth of our VoIP business and for possible future acquisitions.
Organizational & Startup Costs
Organizational and start-up costs for the continued development of our VoIP initiative were $0.5 million for the period ending September 30, 2004. These costs were composed primarily of employee-related expenses ($0.3 million), occupancy and office related expenses ($0.1 million), and legal fees ($0.1 million). The VoIP product was launched September 8, 2004; we do not anticipate further organizational and startup costs related to this portion of our business.
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Depreciation & Amortization
Depreciation and amortization was unchanged at $0.6 million for the quarter ended September 30, 2004, as compared to the quarter ended September 30, 2003. We anticipate that depreciation will increase in the future as the demand for further equipment to support our new products materializes. Amortization of customer lists for the period was $101,824.
Critical Accounting Policies
Yak’s consolidated financial statements and related public financial information are based on the application of accounting principles generally accepted in the United States (“GAAP”). GAAP requires the use of estimates, assumptions, judgments and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenue and expense amounts reported. These estimates can also affect supplemental information contained in our external disclosures including information regarding contingencies, risk and financial condition. We believe our use of estimates and underlying accounting assumptions adhere to GAAP and are consistently and conservatively applied. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. We continue to monitor significant estimates made during the preparation of our financial statements.
Our significant accounting policies are summarized in Note 2 of our consolidated financial statements. While all these significant accounting policies impact its financial condition and results of operations, the Company views certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on the Company’s consolidated financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates. Our management believes that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would cause a material effect on our consolidated results of operations, financial position or liquidity for the periods presented in this report.
Our critical accounting policies are as follows: determining functional currency for the purpose of consolidation; valuation of long-lived assets and estimating fair value.
Determining Functional Currency for the Purpose of Consolidation
We have a foreign subsidiary in Canada that accounts for 99% of our revenue and 93% of our assets as of December 31, 2003. In preparing our consolidated financial statements we translate the accounting records from Canadian dollars into U.S. dollars. This process results in exchange gains and losses which under the provisions of SFAS No. 52 and SFAS No. 130, are included as a separate part of our net equity under the caption “accumulated other comprehensive income.” Under these provisions, the treatment of these translation gains or losses is dependant upon our management’s determination of the functional currency of our subsidiary. The functional currency is determined based on management’s judgment of the currency that its subsidiary conducts substantially all of its transactions, including billings, financing and other expenditures, which also includes the dependency upon the parent and the nature of the subsidiary’s operations.
10
Valuation of Long-lived Assets
We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable from the estimated future cash flows expected to result from their use and eventual disposition. Our long-lived assets subject to this evaluation include property and equipment and amortizable intangible assets. We assess the impairment of goodwill annually in our fourth fiscal quarter and whenever events or changes in circumstances indicate that it is more likely than not that an impairment loss has been incurred. Intangible assets other than goodwill are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. We are required to make judgments and assumptions in identifying those events or changes in circumstances that may trigger impairment. Some of the factors we consider include: (i) significant decrease in the market value of an asset; (ii) significant changes in the extent or manner for which the asset is being used or in its physical condition; (iii) a significant change, delay or departure in our business strategy related to the asset; (iv) significant negative changes in the business climate, industry or economic conditions; and (v) significant changes in technology.
When we determine that the carrying value of property and equipment may not be recoverable, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management. Major factors that influence our cash flow analysis are our estimates for future revenue and expenses associated with the use of the asset. Different estimates could have a significant impact on the results of our evaluation. For example, we may need to revise our estimates to accommodate more rapid depreciation with respect to certain equipment due to expected changes in relevant technologies. Net property and equipment totaled $7,129,072 as of December 31, 2003, representing 24% of our total assets.
Estimating Fair Value
We estimated the fair value of the assets and liabilities associated with the purchase of certain “next generation” telecommunications software from Consortio, Inc and Convenxia Limited noted above, based on the related estimated cash flows. Statement of Financial Accounting Concepts No. 7 (SFAC No. 7) provides a framework for using future cash flows and present value as the basis for accounting measurements of fair value. When observable marketplace-determined values are not available, discounted cash flows are often used to estimate fair value. In accordance with SFAC No. 7, the Company used the expected cash flow approach to estimate fair value, focusing on explicit assumptions about the range of possible cash outcomes and their respective probabilities.
Liquidity and Capital Resources
Our liquidity requirements arise from cash used in operating activities, purchases of capital assets and interest and principal payments on outstanding indebtedness. To date, we have financed our growth through the private placement of equity securities, borrowings, accounts receivable financing, vendor financing and capital lease financing.
Net cash provided from operating activities decreased by $2.1 million to $2.2 million for the quarter ended September 30, 2004, as compared to $4.3 million for the quarter ended September 30, 2003. This was principally due to an increase in the net change of assets and liabilities of $2.7 million, a decrease in net income of $0.3 million, and an increase in deferred taxes of $1.0 million
Net cash used in investing activities was $2.0 million for the quarter ended September 30, 2004, as compared to $7.0 million for the quarter ended September 30, 2003. For the quarter ended September 30, 2004, the Company used cash for acquisition of property and equipment of $2.0 million. It is expected that we
11
will continue to add to our network and network equipment in the coming year to support the growth of the business. In addition, the Company continues to actively pursue potential acquisitions which we believe will be accretive in nature to our existing business.
Significant commitments that will require the use of cash in future periods include obligations under operating leases, capital leases, advances under contract and other agreements, as shown in the following table (in millions):
Payments Due by Period
Contractual Obligations | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | ||||||||||
Operating Leases | $ | 6.2 | $ | 2.5 | $ | 3.3 | $ | 0.4 | $ | 0 | |||||
Capital Leases | 2.1 | 0.6 | 1.3 | 0.2 | 0 | ||||||||||
Telus Advances | 1.4 | 1.3 | 0.1 | 0 | 0 | ||||||||||
Carrier Commitments | 2.7 | 2.7 | 0 | 0 | 0 | ||||||||||
Total | $ | 12.4 | $ | 7.1 | $ | 4.7 | $ | 0.6 | $ | 0 | |||||
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Net cash used in financing activities was $0.3 million for the quarter ended September 30, 2004, as compared to $0.5 million provided by financing activities for the quarter ended September 30, 2003. The decrease largely was a result of a note being issued in the quarter ending September 30, 2003, with no corresponding indebtedness in the first quarter of fiscal 2005.
We believe we have sufficient fixed capacity to meet our anticipated volume of telephony traffic in both Canada and the U.S. during fiscal 2005. Based on our current products, we do not anticipate spending additional capital on our switching platform in fiscal 2005. In addition, with the acquisition of the Santera switch, we believe we are capable of providing for future long-term growth, as well as accommodating anticipated technological changes.
As a result of the continued convergence of voice and data, we believe the introduction of our VoIP product is significant because it is expected to provide the Company a vehicle for future growth. As broadband services gain a critical level of acceptance in the marketplace, the ability to bundle other services with this core offering will become the most important distinguishing factor between the many competitors. We plan to continue to review and, where appropriate, augment our core offerings with value-added services that are priced competitively and address the demands of the market.
United States.During the first fiscal quarter of 2004, we took significant actions to revise and relaunch the development of our dial-around business in the United States; as a result, we lost approximately $0.8 million during that quarter. While we experienced essentially flat revenues in the first quarter, we spent material amounts on marketing, salaries, occupancy costs and legal fees (as described above) in the U.S. Some of these expenses are non-recurring in nature; however, most of them, along with certain “direct costs”, are expected to recur and increase in the foreseeable future as we continue to invest in the development of our U. S. operations. As a result, we expect to experience continuing and increasing losses in the U.S. until we succeed in developing those operations. This activity reflects our decision to acquire U.S. customers through organic growth, while continuing to look for possible synergistic acquisitions in the U.S. market. We believe that our current operations in Canada will be able to continue to generate sufficient cash to meet our obligations and support the growth of the U.S. business.
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New Accounting Pronouncements
In April 2004, the Emerging Issues Task Force issued Statement No. 03-06 (“EITF 03-06”), “Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share.” EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. The Company adopted EITF 03-06 on April 1, 2004, and the adoption did not have a material impact on the Company’s consolidated financial statements.
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003) (“FIN46-R”), Consolidation of Variable Interest Entities, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN No. 46-R replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN” 46”), which was issued in January 2003. FIN 46-R requires that if an entity has a controlling financial interest in a variable interest entity, the assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. The provisions of FIN 46-R are effective immediately to those entities that are considered to be special-purpose entities. For all other arrangements, the FIN 46-R provisions are required to be adopted at the beginning of the first interim or annual period ending after March 15, 2004. As of June 30, 2004 the Company is not a party to transactions contemplated under FIN 46-R.
In November 2003, the Emerging Issues Task Force (“EITF”) reached an interim consensus on Issue No. 03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, to require additional disclosure requirements for securities classified as available-for-sale or held-to-maturity for fiscal years ending after December 15, 2003. In March 2004, the EITF reached a final consensus on this Issue, to provide additional guidance, which companies must follow in determining whether investment securities have an impairment which should be considered other-than-temporary. The guidance is applicable for reporting periods after June 15, 2004. The effective date of the guidance in EITF 03-01 has been delayed until the FASB issues a Staff Interpretation on this matter. The delay does not have a specified date. Until an effective date is determined, existing guidance continues to apply in determining if an impairment is other than temporary. The guidance in EITF 03-01 that was delayed would require making an evidence-based judgment about a recovery of fair value back up to the cost of the investment, considering the severity and duration of the impairment, and about the investor’s ability and intent to hold the investment for a reasonable period of time until the time of the forecasted recovery. The Company does not expect the adoption under the final consensus to have a significant impact on the Company’s consolidated financial statements.
Special Note Regarding Forward Looking Statements
Certain statements in this Quarterly Report on Form 10-Q constitute “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. Such statements are based on current expectations, and are not strictly historical statements. Forward-looking statements include, without limitation, statements set forth in this document and elsewhere regarding, among other things:
| • | The assumptions regarding certain historic transactions and the impact of the recent restatements of historical financial statements with respect thereto; |
| • | expectations of future financial performance; |
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| • | market acceptance of new product introductions; |
| • | plans related to our capital expenditures; |
| • | assumptions regarding exchange rates; and |
| • | potential acquisitions |
Risk Factors
Our actual results could differ materially from those expressed or implied in the forward-looking statements. Important assumptions and other important factors that could cause our actual results to differ materially from those in the forward-looking statements, include, but are not limited to:
| • | Access to sufficient working capital to meet our operating and financial needs; |
| • | our ability to respond to growing competition in our markets for discount long distance services as well as the extent, timing and success of such competition; |
| • | our ability to expand into new markets and to effectively manage our growth; |
| • | profitability of our expansion into the U.S. market; |
| • | customer acceptance and effectiveness of us as a discount long distance provider and our ability to assimilate new technology and to adapt to technological change in the telecommunications industry; |
| • | our ability to develop and provide voice over internet and web-based communications services; |
| • | changes in, or failure to comply with, applicable governmental regulation; |
| • | our reliance on our key personnel and the availability of qualified personnel; |
| • | general economic conditions or material adverse changes in markets we serve; |
| • | risk that our analyses of these risks could be incorrect and that the strategies developed to address them could be unsuccessful; |
| • | changes in our accounting assumptions that regulatory agencies, including the Securities and Exchange Commission, may require or that result from changes in the accounting rules or their application, which could result in an impact on our earnings; |
| • | integrating the operations of newly acquired businesses; |
| • | successful deployment of new equipment and realization of material savings there from; |
| • | various other factors discussed in this filing; and |
| • | restatement of certain of our historical financial statements. |
Industry trends and specific risks may affect our future business and results. The matters discussed below could cause our future results to differ from past results or those described in forward-looking statements and could have a material adverse effect on our business, financial condition, results of operations and stock price.
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Our future growth depends on our ability to attract new customers.Our success will depend on our ability to effectively anticipate and adapt to customer requirements and offer products and services that meet customer demands. Any failure of our current or prospective customers to purchase products from us for any reason, including a downturn in their economic fortunes, would seriously harm our ability to grow our business. Increasingly, our growth will depend on our ability to successfully fund and develop and introduce new and enhanced products. The development of new or enhanced products is a costly, complex and uncertain process that requires us to anticipate accurately future technological and market trends. We cannot be sure whether our new product offerings will be successfully developed and introduced to the market on a timely basis, or at all. If we do not develop these products in a timely manner, our competitive position and financial condition could be adversely affected.
In addition, as we introduce new or enhanced products, we must also manage the transition from older products to newer products. If we fail to do so, we may disrupt customer ordering patterns or may not be able to ensure that adequate supplies of new products can be delivered to meet anticipated customer demand. Any failure to effectively manage this transition may cause us to lose current and prospective customers.
Our business is dependent upon our ability to keep pace with the latest technological changes.The international telecommunications industry is changing rapidly due to deregulation, technological improvements, and expansion of telecommunications infrastructure, privatization and the globalization of national economies. There can be no assurance that one or more of these factors will not vary in a manner that could have a material adverse effect on us. In addition, deregulation of any particular market may cause such market to shift unpredictably. There can be no assurance that we will be able to compete effectively or adjust our contemplated plan of development to meet changing market conditions. The market for our services and the telecommunications industry generally is in a period of rapid technological evolution, marked by the introduction of new product and service offerings and increasing transmission capacity for services similar to those provided by us. Failure to respond in a timely and cost-effective way to these technological developments could result in serious harm to our business and operating results. We have derived, and we expect to continue to derive, a substantial portion of our revenues from providing telecommunications services that are based upon current technologies which are capable of adapting to future technologies. As a result, our success will depend, in part, on our ability to afford the cost of acquiring new hardware and software associated with new technologies, develop and market service offerings that have significant customer demand, respond in a timely manner to the technological advances of our customers, evolving industry standards and changing client preferences. Our profitability will depend on its ability to offer, on a timely and cost-effective basis, services that meet evolving industry standards. There can be no assurance that we will be able to access or adapt to such technological changes at a competitive price, maintain competitive services or obtain new technologies on a timely basis or on satisfactory terms.
The increase of services offered by our competitors could adversely impact our business. Recently, telecommunications providers have increased the range of telecommunication services they offer to customers. This activity and the potential continuing trend towards offering services may lead to a greater ability among our competitors to provide a comprehensive range of telecommunications services, which could lead to a reduction in demand for our services. Moreover, by offering certain services to end users, competitors could reduce the number of our current or potential customers and increase the bargaining power of our remaining customers, which may adversely impact our business.
Our business is susceptible to severe pricing pressures from the larger carriers.The long distance telecommunications industry is significantly impacted by the marketing campaigns and associated pricing
16
decisions of the larger carriers. There has been downward pressure on prices in the industry in recent years, a trend that we expect to continue. Our competitors within the Canadian market include BCE, Telus, and Allstream, and as we launch our products into the U.S. market, our competitors will expand dramatically and will likely include AT&T, MCI, Sprint, the RBOCs, and the major wireless carriers. We would also expect that the competition will be intense in certain emerging markets including that associated with our VoIP product. Many of our competitors are significantly larger than we are and have substantially greater financial, technical and marketing resources, larger networks, a broader portfolio of service offerings, greater control over transmission lines, stronger name recognition and customer loyalty, and long-standing relationships with our target customers. As a result, our ability to attract and retain customers particularly in the United States may be adversely affected.
The success of our broadband initiative is dependent on growth and public acceptance of IP telephony as well as our ability to adapt to rapid technological changes in IP telephony. The development of broadband telephony in Canada and the United States is in its nascent stages. It is uncertain as to how competition in our markets for telephony opportunities provided by broadband applications will develop. The financial models for return on pricing, capital expenditures and return on investment have not been fully developed so it is difficult to gauge what applications will be financially successful. The success of our broadband initiative is dependent upon future demand for IP telephony systems and services which, in turn, will depend on a number of factors including IP telephony achieving a similar level of reliability that users of the public switched telephone network have come to expect from their telephone service. IP telephony service providers must offer cost and feature benefits to their customers that are sufficient to cause the customers to switch away from traditional telephony service providers. If any or all of these factors fail to occur, our broadband business may not grow.
The regulatory environment affecting our broadband initiative is largely unknown.To date VoIP communication services have been largely unregulated in Canada and the United States. The Canadian Radio-television and Telecommunications Commission, or CRTC, has previously decided not to regulate the Internet; therefore, it is unclear if this exemption will apply to VoIP telephone service. The incumbent telephony carriers in Canada, including Bell Canada and Telus, have requested the CRTC to regulate VoIP. Although we expect Canadian regulation of VoIP telephone service to be minimal, such regulations could have an adverse affect on our ability to deploy our broadband initiative effectively. Many regulatory actions are underway or are being contemplated by U.S. federal and state authorities, including the Federal Communications Commission (“FCC”), and state regulatory agencies. To date, the FCC has treated Internet service providers as information service providers. Information service providers are currently exempt from federal and state regulations governing common carriers, including the obligation to pay access charges and contribute to the universal service fund. If the FCC were to determine that internet service providers, or the services they provide, are subject to FCC regulation, including the payment of access charges and contribution to the universal service funds, it could have a material adverse effect on our broadband initiative. In addition, state regulatory authorities may determine that IP telephony service should be subject to local regulation, certification and fees. The effect of potential future VoIP telephony laws and regulations on our broadband initiative cannot be determined.
Any future acquisitions could be difficult to integrate, disrupt our business, dilute stockholder value and adversely affect our operating results. We intend to expand our operations through acquisitions over time. This may require significant management time and financial resources because we may need to integrate widely dispersed operations with distinct corporate cultures. Our failure to manage future acquisitions successfully could seriously harm our operating results. Also, acquisition costs could cause our quarterly operating results to vary significantly. Furthermore, our stockholders would be diluted if we financed the acquisitions by incurring convertible debt or issuing securities.
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The current expansion of the Company will continue to put pressure on management.Our continued growth and expansion may place a significant strain on our management, operational and financial resources, and increase demand on our systems and controls. We entered the SME market in July of 2003, and plan to launch our VoIP service and expand into the U.S. 1+ market in the fall of 2004. To manage our growth effectively, we must continue to implement and improve our operational and financial systems and controls, purchase and utilize other transmission facilities, and expand, train and manage our employee base. If we inaccurately forecast the movement of traffic onto our network, we could have insufficient or excessive transmission facilities and disproportionate fixed expenses. As we proceed with our development, operational difficulties could arise from additional demand placed on customer support, billing and management information systems, on our support, sales and marketing and administrative resources and on our network infrastructure.
We have a significant dependence on Transmission Facilities-Based Carriers. We primarily connect our customers’ telephone calls through transmission lines that we lease under a variety of arrangements with other facilities-based long distance carriers. Many of these carriers are, or may become, our competitors. Our ability to maintain and expand our business depends on our ability to maintain favorable relationships with the facilities-based carriers from which we lease transmission lines. If our relationship with one or more of these carriers were to deteriorate or terminate, it could have a material adverse effect upon our cost structure, service quality, network diversity, results of operations and financial condition.
We are in an industry governed by significant governmental regulation. The telecommunications industry is subject to constantly changing regulation. There can be no assurance that future regulatory changes will not have a material adverse effect on us, or that regulatory bodies will not raise material issues with regard to our compliance or noncompliance with applicable regulations, any of which could have a material adverse effect upon us. Although largely unregulated at the current time, VoIP could face material changes with regards to its regulatory framework that could result in additional fees or price structures that could have a material, adverse effect on our results.
Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and other trading market rules, are creating uncertainty for companies such as ours. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest all appropriate resources to comply with evolving standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.
Our quarterly results may fluctuate causing our stock price to decline. A number of factors, many of which are outside of our control, are likely to cause these fluctuations.
The factors outside of our control include:
| • | long distance telecommunications market conditions as well as economic conditions generally; |
| • | fluctuations in demand for our services; |
| • | reductions in the prices of services offered by our competitors; |
| • | costs of integrating technologies or businesses that we add; and |
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| • | changes in foreign exchange rates. |
The factors substantially within our control include:
| • | the timing of expansion into new markets, both domestically and internationally; and |
| • | the timing and payments associated with possible acquisitions. |
Because our operating results may vary significantly from quarter to quarter, our operating results may not meet the expectations of securities analysts and investors, and our common stock could decline significantly which may expose us to risks of securities litigation, impair our ability to attract and retain qualified individuals using equity incentives and make it more difficult to complete acquisitions using equity as consideration.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Our primary market risk exposures relate to changes in foreign currency exchange rates and to changes in interest rates.
Our international operations could subject us to risks due to currency fluctuations and changes in foreign government regulations, which could harm our business. Our current international (outside of Canada) operations, and any future expansion outside of Canada, are or will be subject to a number of risks, including changes in foreign governmental regulations and telecommunications standards, import and export license requirements, tariffs, taxes and other trade barriers, fluctuations in currency exchange rates, difficulty in collecting accounts receivable, the burden of complying with a wide variety of foreign laws, treaties and technical standards, difficulty in staffing and managing foreign operations, and political and economic instability.
The majority of our sales and expenses have been denominated in U.S. dollars. However, the significant majority of our sales and expenses occur in Canada. As a result, currency fluctuations between the U.S. dollar and the Canadian currency could cause foreign currency translation gains or losses that we would recognize in the period incurred. We cannot predict the effect of exchange rate fluctuations on our future operating results because of the number of currencies involved, the variability of currency exposure and the potential volatility of currency exchange rates. We do not currently engage in foreign exchange hedging transactions to manage our foreign currency exposure.
Item 4. Controls and Procedures
Our management has evaluated the effectiveness of our disclosure controls and procedures with the active participation of our Chief Executive Officer and Chief Financial Officer as of the period ending September 30, 2004. The effectiveness of our or any system of disclosure controls and procedures is subject to certain limitations, including the exercise of judgment in designing, implementing and evaluating the controls and procedures, the assumptions used in identifying the likelihood of future events, and the inability to eliminate misconduct completely. Based on our evaluation, our principal executive officer and principal financial officer have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective.
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There were no significant changes during the quarterly period covered by this report in our internal controls or in other factors that could significantly affect internal controls over financial reporting.
OTHER INFORMATION
None.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
On October 18, 2004, our Board of Directors appointed Kevin Crumbo to serve as a director until the next annual meeting of our shareholders. The Company did not have a nominating committee in place on the date of such appointment.
On October 28, 2004, our Board of Directors appointed R. Gregory Breetz, Jr. to serve as a director until the next annual meeting of our shareholders; our Governance and Nominating Committee of our Board of Directors was established on the same day as Mr. Breetz’s election. He was also appointed to the Audit and the Governance and Nominating Committees of our Board of Directors.
Item 6. Exhibits and Reports on Form 8-K.
| (a) | Exhibits. |
| 31.1 | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification of Principal Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
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| 32.2 | Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| (b) | Reports on Form 8-K. |
None.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date:May 31, 2005 | By: | /s/ Charles Zwebner | ||
Charles Zwebner, Chairman of the Board of Directors & Chief Executive Officer | ||||
By: | /s/ Margaret Noble | |||
Margaret Noble, Principal | ||||
Financial and Accounting Officer | ||||
22
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
| Note | September 30, 2004 (Unaudited) | June 30, 2004 (Audited) (Restated) | ||||
| $ | $ | |||||
| ASSETS | ||||||
CURRENT | ||||||
Cash and cash equivalents | 22,087,728 | 22,149,387 | ||||
Accounts receivable, net | 3 | 15,731,671 | 15,648,419 | |||
Prepaid expenses and sundry | 1,164,122 | 665,031 | ||||
| 38,983,521 | 38,462,837 | |||||
WARRANTS IN CONVEXIA | 59,681 | 59,681 | ||||
JOINT VENTURE RECEIVABLE | 3,975,487 | 4,045,485 | ||||
PROPERTY AND EQUIPMENT, NET | 4 | 11,993,381 | 9,753,029 | |||
LOAN RECEIVABLE | 6 | 413,944 | 445,454 | |||
CUSTOMER LIST (Net of accumulated amortization of $504,970 - September 30, 2004; $414,614 - June 30, 2004) | 1,598,298 | 1,585,386 | ||||
GOODWILL | 486,584 | 457,869 | ||||
DEFERRED INCOME TAXES | 321,428 | 237,853 | ||||
| 57,832,324 | 55,047,594 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
F-1
YAK COMMUNICATIONS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
| Note | September 30, (Unaudited) | June 30, 2004 (Audited) (Restated) | ||||
| $ | $ | |||||
| LIABILITIES | ||||||
CURRENT | ||||||
Accounts payable and accrued liabilities | 2,744,902 | 2,519,591 | ||||
Amounts due for network access and usage | 1,854,682 | 2,071,091 | ||||
Amounts due to long distance carriers | 6,556,184 | 6,144,670 | ||||
Amounts due for equipment | 720,725 | 773,897 | ||||
Due to Factor | 3 | 5,298,017 | 5,657,578 | |||
Income taxes payable | 1,939,768 | 1,234,359 | ||||
Current portion of advances from TELUS Communications Inc. | 7 | 1,312,440 | 1,238,882 | |||
Current portion of obligations under capital leases | 8 | 490,696 | 392,538 | |||
Current portion of note payable | 128,467 | 195,292 | ||||
Deferred revenue - Fair value adjustment | 5 | 1,109,710 | 1,109,710 | |||
Unearned revenue | 999,794 | 950,577 | ||||
| 23,155,385 | 22,288,185 | |||||
LONG-TERM DEBT | ||||||
Advances from TELUS Communications Inc. | 7 | 41,591 | 348,980 | |||
Obligations under capital leases | 8 | 1,297,354 | 1,072,986 | |||
Note payable | 4,053,949 | 3,921,901 | ||||
| 5,392,894 | 5,343,867 | |||||
| 28,548,279 | 27,632,052 | |||||
| STOCKHOLDERS’ EQUITY | ||||||
COMMON STOCK | 10 | 225,415 | 225,415 | |||
ADDITIONAL PAID-IN CAPITAL | 16,595,304 | 16,582,250 | ||||
COMMON STOCK PURCHASE WARRANTS | 2,432,590 | 2,432,590 | ||||
ACCUMULATED OTHER COMPREHENSIVE INCOME - TRANSLATION ADJUSTMENT | 634,277 | 113,161 | ||||
RETAINED EARNINGS | 9,396,459 | 8,062,126 | ||||
| 29,284,045 | 27,415,542 | |||||
| 57,832,324 | 55,047,594 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
F-2
YAK COMMUNICATIONS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
| Note | Common stock | Additional capital | Common stock purchase warrants | Accumulated Other comprehensive income | Retained earnings (deficit) | Stockholders’ Equity (Deficit) | |||||||||||||
| Shares | Amount | ||||||||||||||||||
| $ | $ | $ | $ | $ | $ | ||||||||||||||
Balance, June 30, 2003 (Audited) | 9,133,316 | 199,266 | 2,050,315 | — | 477,080 | 3,001,409 | 5,728,070 | ||||||||||||
Foreign currency translation adjustment | — | — | — | — | (363,919 | ) | — | (363,919 | ) | ||||||||||
Common stock issued to obtain note payable | 20,000 | 100 | 89,900 | — | — | — | 90,000 | ||||||||||||
Common stock issued in exchange for stock options surrendered | 2,260,934 | 11,304 | (11,304 | ) | — | — | — | — | |||||||||||
Common stock issued for services | 9,000 | 45 | 50,987 | — | — | — | 51,032 | ||||||||||||
Stock compensation expense | 11 | — | — | 26,156 | — | — | — | 26,156 | |||||||||||
Common stock issued for cash | 1,470,000 | 14,700 | 14,376,196 | 2,432,590 | — | — | 16,823,486 | ||||||||||||
Net income | — | — | — | — | — | 5,060,717 | 5,060,717 | ||||||||||||
Balance, June 30, 2004 (Audited) | 12,893,250 | 225,415 | 16,582,250 | 2,432,590 | 113,161 | 8,062,126 | 27,415,542 | ||||||||||||
Foreign currency translation adjustment | — | — | — | — | 521,116 | — | 521,116 | ||||||||||||
Stock compensation expense | 11 | — | — | 13,054 | — | — | — | 13,054 | |||||||||||
Net income | — | — | — | — | — | 1,334,333 | 1,334,333 | ||||||||||||
Balance, September 30, 2004 (Unaudited) | 12,893,250 | 225,415 | 16,595,304 | 2,432,590 | 634,277 | 9,396,459 | 29,284,045 | ||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-3
YAK COMMUNICATIONS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
| For the three months ended September 30, | ||||||||
| Note | 2004 | 2003 (Restated) | ||||||
| $ | $ | |||||||
NET REVENUE | 21,197,134 | 18,791,218 | ||||||
COST OF REVENUE | 13,758,307 | 12,196,519 | ||||||
GROSS MARGIN | 7,438,827 | 6,594,699 | ||||||
EXPENSES | ||||||||
General and administration | 3,088,166 | 2,245,139 | ||||||
Sales and marketing | 990,748 | 894,304 | ||||||
Organizational and start-up costs | 521,775 | 33,024 | ||||||
Interest on note payable | 108,140 | 125,873 | ||||||
Interest on short-term loan | — | 11,981 | ||||||
Accounts receivable financing | 122,094 | 150,203 | ||||||
Interest on capital lease obligations | 32,644 | 1,644 | ||||||
Writedown of property and equipment and licence fee | 600 | — | ||||||
Common stock issued to obtain note payable | — | 45,300 | ||||||
Share of net loss of affiliate | — | 35,423 | ||||||
Interest earned | (77,719 | ) | (19,946 | ) | ||||
Income from joint marketing agreement | (93,001 | ) | (71,415 | ) | ||||
Depreciation and amortization | 561,934 | 587,269 | ||||||
Long term note discount amortization | 132,049 | 79,699 | ||||||
| 5,387,430 | 4,118,498 | |||||||
INCOME BEFORE INCOME TAX PROVISION | 2,051,397 | 2,476,201 | ||||||
PROVISION FOR INCOME TAXES | 9 | 717,064 | 797,417 | |||||
NET INCOME | 1,334,333 | 1,678,784 | ||||||
OTHER COMPREHENSIVE INCOME | ||||||||
Foreign currency translation adjustment | 521,116 | (4,426 | ) | |||||
COMPREHENSIVE INCOME | 1,855,449 | 1,674,358 | ||||||
BASIC EARNINGS PER SHARE | 0.10 | 0.18 | ||||||
DILUTED EARNINGS PER SHARE | 0.10 | 0.14 | ||||||
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING | 12,893,250 | 9,149,982 | ||||||
WEIGHTED AVERAGE NUMBER OF COMMON SHARES - ASSUMING DILUTION | 12,984,155 | 11,717,982 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-4
YAK COMMUNICATIONS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| For the three months ended September 30, | ||||||||
| Note | 2004 | 2003 (Restated) | ||||||
| $ | $ | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
Net income | 1,334,333 | 1,678,784 | ||||||
Adjustments to reconcile net income to net cash from operating activities | ||||||||
Amortization of discount | 132,049 | 79,699 | ||||||
Depreciation and amortization | 561,934 | 587,269 | ||||||
Deferred income taxes | (83,575 | ) | (288,293 | ) | ||||
Writedown of property and equipment and licence fee | 600 | — | ||||||
Stock compensation expense | 13,054 | — | ||||||
Common stock issued to obtain note payable | — | 45,300 | ||||||
Share of net loss of affiliate | — | 35,423 | ||||||
Changes in working capital | 13 | 251,239 | 2,080,559 | |||||
Net cash from operating activities | 2,209,634 | 4,218,741 | ||||||
CASH FLOWS USED IN INVESTING ACTIVITIES | ||||||||
Purchase of property and equipment | (2,049,589 | ) | (1,579,304 | ) | ||||
Proceeds from sale of assets | 9,525 | — | ||||||
Purchase of shares of Contour Telecom | — | (6,976,891 | ) | |||||
Foreign exchange difference on purchase of shares of Contour Telecom | — | 86,651 | ||||||
Loan receivable | 31,510 | (90,565 | ) | |||||
Increase in deferred acquisition cost | — | 1,659,458 | ||||||
Join venture receivable | — | — | ||||||
Net cash used in investing activities | (2,008,554 | ) | (6,900,651 | ) | ||||
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES | ||||||||
Principal payments on capital leases | (32,081 | ) | (768 | ) | ||||
Advances from (to) TELUS Communications Inc. | (233,831 | ) | (114,396 | ) | ||||
Issuance of note payable | — | 713,570 | ||||||
Repayments on note payable | — | (108,019 | ) | |||||
Receipt of principal portion of Joint Venture receivable | 69,998 | 91,585 | ||||||
Repayments of principal portion of note payable | (66,826 | ) | (49,093 | ) | ||||
Net cash from (used in) financing activities | (262,740 | ) | 532,879 | |||||
DECREASE IN CASH AND CASH EQUIVALENTS | (61,660 | ) | (2,149,031 | ) | ||||
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD | 22,149,387 | 5,442,538 | ||||||
CASH AND CASH EQUIVALENTS, END OF PERIOD | 22,087,727 | 3,293,507 | ||||||
Supplemental disclosure of cash flow information: | ||||||||
Interest paid | 182,642 | 155,009 | ||||||
Taxes paid | 176,548 | 325,059 | ||||||
Supplemental disclosure of non-cash investing and financing activities | ||||||||
Common stock issued to obtain note payable | — | 90,000 | ||||||
Capital leases for acquisition of furniture and equipment | 354,607 | — | ||||||
Notes payable on purchase of software (Note 5) | 4,182,416 | 5,964,177 | ||||||
Joint venture receivable on purchase of software | 3,975,487 | 4,893,693 | ||||||
Acquisition of software | 1,561,181 | 1,561,181 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-5
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 1. | ORGANIZATION AND BUSINESS |
Yak Communications Inc. is a switch based reseller specializing in offering discounted long-distance services to residential customers and telecommunication services to small and medium sized businesses. The company was incorporated in the State of Florida on December 24, 1998 and operates as a holding company of its wholly-owned subsidiaries in the United States and Canada. The Company began offering its services to consumers in Canada in July 1999 and in the United States commencing December 2001.
The Company began offering its services to consumers in Canada in July 1999 and in the United States commencing December 2001.
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
The consolidated financial statements are represented in United States dollars and have been prepared in accordance with U.S. generally accepted accounting principles and reflect the following policies:
Principles of consolidation
These consolidated financial statements include the accounts of Yak Communications Inc. and its wholly-owned subsidiaries - Yak Communications (America), Inc. and Yak Communications (Canada) Inc., Yak Broadband Inc., and Contour Telecom Inc. (collectively referred to as the “Company”). All intercompany balances and transactions are eliminated upon consolidation.
Use of estimates
The preparation of consolidated financial statements in conformity with U.S. 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 consolidated financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the period in which they become known.
F-6
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont’d) |
Revenue recognition
The Company records revenue using the following recognition policies:
| (a) | Dial-around services and the resale of long-distance services revenues are recorded at the time of customer usage based upon minutes of use. |
| (b) | Revenue from the resale of voice and data telecommunications services to business enterprises is recorded at the time of customer usage based upon amounts billed by the respective service providers. |
| (c) | Management fees of Contour Telecom Inc. are recorded on a monthly basis over the term of the management agreement. |
Cost of revenue
Cost of revenue includes network costs that consist of the cost of long-distance services, processing costs, line access and usage costs. These costs are recognized when incurred
Contour Telecom Inc.’s supplier service costs come directly from the telecommunications carriers and are recorded at the time of customer usage based upon amounts billed by the respective service providers.
Cash and cash equivalents
Cash and cash equivalents are comprised of cash and term deposits with original maturity dates of less than 90 days. Cash and cash equivalents are stated at cost which approximates market value, and are concentrated in three major financial institutions.
F-7
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont’d) |
Accounts receivable
Accounts receivable is reviewed by Management for doubtful amounts, and allowance is provided for against income as follows:
100% on amounts outstanding over 90 days, in collections, or in bankruptcy
50% on amounts outstanding between 61 and 90 days.
Accounts are written off once management determines the amount is uncollectable and will no longer actively pursue collection.
A reconciliation of the allowance for doubtful accounts provision during the quarter is presented below:
For the three months ended September 30, | ||||
| 2004 | 2003 | |||
| $ | $ | |||
Opening balance | 348,470 | 15,000 | ||
Additional allowance provision during the quarter | 28,467 | 475,355 | ||
Ending balance | 376,937 | 490,355 | ||
As at September 30, 2004 and September 30, 2003 there was no interest accrued on overdue amounts.
F-8
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont’d) |
Property and equipment
Property and equipment is stated at cost less accumulated depreciation which is provided over the estimated useful lives of the assets as follows:
“Next Generation” software | 20% declining balance | |
Telecom switching systems | 11% to 20% declining balance | |
Billing, administration and customer service systems | 20% declining balance | |
Installed lines | 20% declining balance | |
Office furniture and equipment | 20% declining balance | |
Broadband equipment | 20% declining balance | |
Carrier identification codes loading | 20% declining balance | |
Computer equipment | 20% declining balance | |
Leasehold improvements | over term of the lease | |
Computer software | 20% declining balance | |
Automobile | 20% declining balance |
Cost includes major expenditures for improvements and replacements which extend useful lives or increase capacity of assets as well as expenditures necessary to place assets into readiness for use. Expenditures for maintenance and repairs are expensed as incurred. In accordance with Statement of Position (“SOP”) 98-1, “Accounting of the Costs of Computer Software Developed or Obtained for Internal Use,” costs for internal use software that incurred in the preliminary project stage and in the post-implementation stage are expensed as incurred. Costs incurred during the application development stage are capitalized and amortized over the estimated useful life of the software. Depreciation is not taken until assets are placed into service.
The Company periodically evaluates the realizability of its property and equipment. In making such evaluations, the Company compares certain financial indicators such as expected undiscounted future revenues and cash flows to the carrying amount of the assets. If the property is impaired then it is written down to fair value.
Assets under capital leases are amortized using rates consistent with similar assets.
F-9
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont’d) |
Intangibles
In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations”, customer lists are stated at cost less accumulated amortization which is provided on the straight-line basis over a weighted life of five years.
Goodwill
Goodwill represents the difference between the purchase price, including acquisition costs, of business acquired and the fair value of the identifiable net assets acquired. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, goodwill is not subject to amortization and is tested for impairment annually, or more frequently if events or circumstances indicate that the asset might be impaired. Impairment is tested by comparing the fair value of the goodwill to its carrying cost. Any excess of carrying value over fair value is charged to income in the period in which the impairment is determined.
Joint Venture
The Company’s proportionate share of revenues, expenses, assets and liabilities in unincorporated joint venture are consolidated in the Company’s accounts.
Unearned revenue
Unearned revenue represents billings in advance of services performed and customer deposits for future services.
Cost of Start-up Activities
The Company expenses the cost of start-up activities and organizational costs as incurred in accordance with SOP 98-5 “Reporting on the Costs of Start-up Activities”.
F-10
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont’d) |
Advertising and promotion expense
The production costs of commercials and programming are charged to operations in the fiscal year during which the production is first aired. The costs of other advertising, promotion and marketing programs are charged to operations in the fiscal year incurred. The cost of promotional marketing materials are deferred and expensed as used.
Income taxes
The Company accounts for income taxes in accordance with SFAS No. 109 “Accounting for Income Taxes” which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The income tax provision is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
Computation of earnings per common share
Basic earnings per share is computed by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share is computed giving effect to all dilutive potential common shares that were outstanding during the period. Dilutive potential common shares consist of incremental common shares issuable upon exercise of stock options.
F-11
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont’d) |
Foreign currency translation and foreign assets
In accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”), No. 52, “Foreign Currency Translation,” assets and liabilities of the Company’s foreign subsidiary were translated into United States dollars at the exchange rates in effect on the reporting date. Income and expenses are translated at an average exchange rate for the respective period. For the foreign subsidiary which utilizes its local currency as its functional currency, the resulting translation gains and losses are included in other comprehensive income. Gains or losses resulting from foreign exchange transactions are reflected in earnings.
Stock-based compensation
At September 30, 2004, 230,000 options were outstanding with an exercise price of $6.50 per share, with a weighted average remaining life of 4.13 years; 50,000 options were outstanding with an exercise price of $6.57 per share, with a weighted average remaining life of 4.61 years; and 50,000 options with an exercise price of 6.41 with a weighted average remaining life of 4.94 years. None of these options are vested at September 30, 2004.
In addition to this Stock Option Plan, on December 21, 2000, nonqualified options for 2,568,000 common shares were granted to an individual who is a director and chief executive officer and are exercisable at $0.78 per share on or before December 31, 2003, or upon the sale of the Company. These options were exchanged for 2,260,934 shares of Common Stock on December 30, 2003 (see Note 10).
F-12
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont’d) |
Stock-based compensation (cont’d)
Compensation expense under stock options is reported using the intrinsic method under the recognition and measurement principles and Accounting Principles Board (“APB”) Option No. 25 “Accounting for Stock Issued to Employees” and related interpretations. Under this method compensation cost is reflected in net income for options granted wit an exercise price less than market price of the underlying common stock at the date of grant. The Company has adopted only the disclosure provision of SFAS 123, “Accounting for Stock-Based Compensation”.
If compensation cost for the Company’s grants for stock-based compensation had been recorded consistent with the fair value-based method of accounting per SFAS No. 123, the Company’s pro forma net income, and pro forma basic and diluted net income for the three months ending September 30, would be as follows:
For the three months ended September 30, | ||||
| 2004 | 2003 | |||
| $ | $ | |||
| Net income as reported | 1,334,333 | 1,678,784 | ||
Pro forma net income | 1,291,056 | 1,678,784 | ||
Basic net income per share | ||||
As reported | 0.10 | 0.18 | ||
Pro forma | 0.10 | 0.18 | ||
Diluted net income per share | ||||
As reported | 0.10 | 0.14 | ||
Pro forma | 0.10 | 0.14 | ||
F-13
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont’d) |
Financial instruments
SFAS No. 107, Disclosures About Fair Value of Financial Instruments, requires disclosure of the fair value of certain financial instruments for which it is practicable to estimate fair value. For purposes of the disclosure requirements, the fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation. The carrying values of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, and other current liabilities are reasonable estimates of their fair value due to the short-term maturity of the underlying financial instruments. The carrying value of the capital leases is a reasonable estimate of its fair value based on current rates for equipment obligations.
The estimated difference between the carrying value and the fair value of the advances from TELUS Communications Inc. in which no interest has been charged is not material.
The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, unbilled revenue, accounts payable and accrued liabilities and deferred revenue. Unless otherwise noted, it is management’s opinion that the Company is not exposed to significant interest or currency risks arising from these financial instruments. The Company has in place systems to minimize credit risk and prevent fraudulent use by customers. On occasion, defaults occur on receivables. The Company makes a provision when deemed necessary. The company places its cash and cash equivalents in high quality financial instruments.
Estimating Fair Value
We estimated the fair value of the assets and liabilities associated with the purchase of certain “next generation” telecommunications software from Consortio, Inc and Convenxia Limited noted above, based on the related estimated cash flows. Statement of Financial Accounting Concepts No. 7 (SFAC No. 7) provides a framework for using future cash flows and present value as the basis for accounting measurements of fair value. When observable marketplace-determined values are not available, discounted cash flows are often used to estimate fair value. In accordance with SFAC No. 7, the Company used the expected cash flow approach to estimate fair value, focusing on explicit assumptions about the range of possible cash outcomes and their respective probabilities.
F-14
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont’d) |
Reclassifications
Certain reclassifications were made to prior year balances to conform to the current period presentation.
New Accounting Pronouncement
In April 2004, the Emerging Issues Task Force issued Statement No. 03-06 (“EITF 03-06”), “Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share.” EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. The Company adopted EITF 03-06 on April 1, 2004, and the adoption did not have a material impact on the Company’s consolidated financial statements.
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003) (FIN46-R”), Consolidation of Variable Interest Entities, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN No. 46-R replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN” 46”), which was issued in January 2003. FIN 46-R requires that if an entity has a controlling financial interest in a variable interest entity, the assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. The provisions of FIN 46-R are effective immediately to those entities that are considered to be special-purpose entities. For all other arrangements, the FIN 46-R provisions are required to be adopted at the beginning of the first interim or annual period ending after March 15, 2004. As of June 30, 2004 the Company is not a party to transactions contemplated under FIN 46-R.
F-15
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont’d) |
New Accounting Pronouncement (cont’d)
In November 2003, the Emerging Issues Task Force (“EITF”) reached an interim consensus on Issue No. 03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, to require additional disclosure requirements for securities classified as available-for-sale or held-to-maturity for fiscal years ending after December 15, 2003. In March 2004, the EITF reached a final consensus on this Issue, to provide additional guidance, which companies must follow in determining whether investment securities have an impairment which should be considered other-than-temporary. The guidance is applicable for reporting periods after June 15, 2004. The effective date of the guidance in EITF 03-01 has been delayed until the FASB issues a Staff Interpretation on this matter. The delay does not have a specified date. Until an effective date is determined, existing guidance continues to apply in determining if an impairment is other than temporary. The guidance in EITF 03-01 that was delayed would require making an evidence-based judgement about a recovery of fair value back up to the cost of the investment, considering the severity and duration of the impairment, and about the investor’s ability and intent to hold the investment for a reasonable period of time until the time of the forecasted recovery. The Company does not expect the adoption under the final consensus to have a significant impact on the Company’s consolidated financial statements.
| 3. | DUE TO FACTOR |
The amounts due to factor are secured by an assignment of the Company’s accounts receivable. The Company has an agreement to finance undivided interest in certain accounts receivable with recourse to the Factor. Payments are received by the Factor from the financed accounts receivable; the collections are reinvested by the Factor in new accounts receivable of the Company, and a yield, as defined in the agreement is transferred to the Factor. At September 30, 2004, the amounts assigned under the agreement, expiring February 2006, that had not been collected was approximately $7,745,583 (June 30, 2004 - $8,271,312) which will be forwarded to the Company once collected after repayment of the Factor’s advances.
F-16
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 4. | PROPERTY AND EQUIPMENT |
Property and equipment consist of the following:
| Net book value | ||||||||
| Cost | Accumulated depreciation | September 30, 2004 | June 30, 2004 | |||||
| $ | $ | $ | $ | |||||
“Next Generation” software (Note 5) | 3,094,471 | 154,723 | 2,939,748 | 2,280,153 | ||||
Telecom switching systems | 6,473,226 | 3,567,225 | 2,906,001 | 2,862,292 | ||||
Billing, administration and customer service systems | 1,852,973 | 556,225 | 1,296,748 | 1,231,851 | ||||
Installed lines | 1,577,882 | 367,946 | 1,209,936 | 798,781 | ||||
Office furniture and equipment | 3,110,780 | 2,025,061 | 1,085,719 | 548,977 | ||||
Broadband Equipment | 814,416 | 37,868 | 776,548 | 591,369 | ||||
Carrier identification codes loading | 814,412 | 140,861 | 673,551 | 466,085 | ||||
Computer equipment | 1,066,570 | 497,521 | 569,049 | 505,465 | ||||
Leasehold improvements | 678,170 | 155,150 | 523,020 | 454,980 | ||||
Computer software | 282,469 | 272,374 | 10,095 | 10,089 | ||||
Automobile | 6,847 | 3,881 | 2,966 | 2,987 | ||||
| 19,772,216 | 7,778,835 | 11,993,381 | 9,753,029 | |||||
Telecom switching systems include assets under capital leases having a net book value of approximately $1,259,065 as at September 30, 2004 and $1,230,320 as at June 30, 2004. Office furniture and equipment includes assets under capital leases having a net book value of approximately $348,697 as at September 30, 2004. At June 30, 2004 there were no such assets under capital lease.
Depreciation expense for equipment under capital leases for the three months ended September 30, 2004 and 2003 was approximately $50,215 and $2,000 respectively.
On June 20, 2003, Yak Communications (Canada) Inc., the Company’s wholly-owned subsidiary, acquired certain “next generation” telecommunications software from Consortio, Inc., and Convenxia Limited, with a fair value, estimated by the Company, of approximately $1.7 million. For more details see Note 5, Next Generation Software and Financial Restatements.
F-17
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 5. | NEXT GENERATION SOFTWARE AND FINANCIAL RESTATEMENTS |
On June 20, 2003, Yak Communications (Canada) Inc., the Company’s wholly-owned subsidiary (“Yak Canada”), acquired certain “next generation” telecommunications software from Consortio, Inc., a Delaware corporation and Convenxia Limited, a corporation organized under the laws of the United Kingdom (collectively, the “Sellers”), pursuant to the terms and conditions of a Software Acquisition Agreement. Payments made or due to the Sellers for the software were as follows: (a) $565,000 in cash was paid at the closing of the transaction; (b) delivery of a short term promissory note in the principal amount of $400,000 providing for equal monthly payments of $40,000; and (c) the balance of the purchase price is evidenced by a long-term promissory note executed in favor of Consortio, Inc. with a principal amount of $8,535,000 bearing interest at 7.25% per annum. Interest and principal are payable quarterly in the amount of $174,965 commencing September 30, 2003 and is due July 15, 2012. The sole recourse by the lender is the software. Yak Canada was also issued a warrant to purchase up to 8% of the issued and outstanding common stock of Convenxia Limited.
In addition to the purchase of the software, Yak Canada and the sellers entered into a joint venture agreement which licensed the use of the software for telecommunication services outside Canada to non-Yak customers. Under the joint venture agreement, Yak Canada is entitled to receive 4% of all gross revenue arising from the sale of services using the acquired software with minimum quarterly payments of $150,000 through June 30, 2006 and, thereafter, 2.75% of gross revenue with minimum quarterly payments of $175,000.
The Company estimated the “fair value” of the assets and liabilities associated with the Software Acquisition Agreement based on the related estimated cash flows. Statement of Financial Accounting Concepts No. 7 (SFAC No. 7) provides a framework for using future cash flows and present value as the basis for accounting measurements of fair value. In accordance with SFAC No. 7, the Company used the expected cash flow approach to estimate fair value, focusing on explicit assumptions about the range of possible cash outcomes and their respective probabilities. Based on this expected cash flow approach, the fair values of the liabilities are estimated to be significantly less than their face values. The fair value of the Convenxia warrants was derived by using the Black-Scholes valuation model.
F-18
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 5. | NEXT GENERATION SOFTWARE AND FINANCIAL RESTATEMENTS (cont’d) |
Based on the foregoing, the fair value of each of the Convenxia transaction’s components were estimated for accounting purposes as follows:
Software | $ | 1.7 million | |
Receivable from joint venture | 5.0 million | ||
Warrants | 0.1 million | ||
Total assets acquired | $ | 6.8 million | |
Cash paid | $ | 0.7 million | |
Short-term note payable | 0.4 million | ||
Long-term note payable | 5.7 million | ||
Total consideration paid | $ | 6.8 million | |
The above fair value estimates are as at June 30, 2003. The following assumptions were made with respect to these fair value estimates:
Software - The Company obtained an independent valuation in the amount of $5.9 million (which is the mid-point of range of $5.4 million to $6.4 million as calculated by the independent valuator) for the acquired software. In accordance with Statement of Financial Accounting Standards No. 141 (FAS 141), the excess of fair value assigned to the assets acquired (i.e., $4.3 million) was allocated on a pro rata basis to reduce the amounts that otherwise would have been assigned to the non-financial acquired asset (e.g. software). As a result, the fair value of the software acquired was reduced for accounting purposes from its estimated fair value of $5.9 million to its carrying value of $1.6 million.
Receivable from joint venture – The range of possible cash outcomes varied based on the expected length of time that the joint venture would remain intact. Contractual cash flows were present-valued using a discount rate equal to 200 basis points higher than the Company’s weighted average cost of capital.
Warrants – The range of possible cash outcomes varied based on estimated future revenues for Convenxia Limited. Because Convenxia is a privately-held entity, enterprise valuation multiples and volatility inputs necessary for the Black-Scholes valuation model were derived from comparable public company statistics.
F-19
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 5. | NEXT GENERATION SOFTWARE AND FINANCIAL RESTATEMENTS (cont’d) |
Short-term note payable – Contractual cash flows were present valued using a discount rate equal to the Company’s weighted average cost of capital.
Long-term note payable – Similar to the joint venture receivable fair value estimate, the range of possible cash outcomes varied based on the expected length of time that the joint venture would remain intact and also on the probabilities that the balloon payment would ultimately be paid in 2012. Contractual cash flows were present valued using a discount rate equal to the Company’s weighted average cost of capital.
In the fourth quarter of fiscal 2004, the Company made the determination that the development of the software for Yak’s own internal use would require the full time and effort of all involved parties. The Company believed that the continuing development of the software for internal use over the next several years would be the key aspect of the Software transaction, and not the commercialization. In addition, even with this emphasis on internal development the Company also became increasingly aware of the fact that whatever software was developed for “next generation” use (e.g. VoIP), it was more likely than not to become obsolete by 2012 (the due date of the balloon payment on the long-term note) and that the joint venture would concurrently terminate.
With the convergence of these two issues, in the fourth fiscal quarter of 2004 the Company modified the probability assumptions for the range of possible cash outcomes related to the fair value calculations of the receivable from the joint venture and the long-term note payable. The probabilities that the cash flows from the joint venture would be received or that the $7.3 million balloon payment due on the long-term note in 2012 would be paid by Yak, were reduced to 0% probability (from 20% in prior assumptions).
Accordingly, the Company reduced the fair value of the long-term note payable at June 30, 2004 by $1.7 million, from $5.8 million to $4.1 million and concurrently impaired the fair value of the joint venture receivable by $0.6 million, from $4.6 million to $4.0 million. Because the note liability was not legally extinguished and that only the expected cash flow inflows and outflows changed, the resultant net gain of $1.1 million was deferred and classified on the June 30, 2004 balance sheet as “Deferred Revenue.” There was no impact on the Company’s Consolidated Statements of Income nor on the Consolidated Statements of Cash Flows for the three months ended June 30, 2004.
On March 3, 2005, the Company entered into a settlement agreement with the Sellers. Pursuant to the settelment agreement, Yak paid $150,000 to the Sellers and committed to complete further development of the software for $350,000 in exchange for a discharge of any further obligation under the long-term note with a principal amount of $ 8.4 million at December 31, 2004.
The following presents the impact on the financial statements presented herein:
Statement of Operations:
| For the three months ended September 30, | ||||||||||||
Prior reported 2004 | As Restated 2004 | Prior Reported 2003 | As Restated 2003 | |||||||||
| $ | $ | $ | $ | |||||||||
Interest on short-term loan | — | — | — | 11,981 | ||||||||
Interest on note payable | 149,998 | 108,140 | 153,465 | 125,873 | ||||||||
Income from joint marketing Agreement | (151,108 | ) | (93,001 | ) | (150,000 | ) | (71,415 | ) | ||||
Depreciation and amortization | 544,038 | 561,934 | 852,968 | 587,269 | ||||||||
Long term note discount amortization | — | 132,049 | — | 79,699 | ||||||||
Income before income tax provision | 2,217,591 | 2,051,397 | 2,353,175 | 2,476,201 | ||||||||
Provision for income taxes | 717,064 | 717,064 | 754,417 | 797,417 | ||||||||
Net income | 1,500,527 | 1,334,333 | 1,598,758 | 1,678,784 | ||||||||
Foreign currency adjustment | 1,120,825 | 521,116 | (31,930 | ) | (4,426 | ) | ||||||
Comprehensive income | 2,621,352 | 1,855,449 | 1,566,828 | 1,674,358 | ||||||||
F-20
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 5. | NEXT GENERATION SOFTWARE AND FINANCIAL RESTATEMENTS (cont’d) |
Balance Sheet:
| As at September 30, | As at June 30, | |||||||||||
Prior Reported 2004 | As Restated 2004 | Prior Reported 2004 | As 2004 | |||||||||
Property and equipment | 12,114,931 | 11,993,381 | 9,243,897 | 9,753,029 | ||||||||
Warrants in Convenxia | — | 59,681 | — | 59,681 | ||||||||
Joint venture receivable | — | 3,975,487 | — | 4,045,485 | ||||||||
Deferred revenue - fair value adjustment | — | 1,109,710 | — | 1,109,710 | ||||||||
Short-term note payable | — | — | — | — | ||||||||
Long-term note payable | — | 4,053,949 | — | 3,921,901 | ||||||||
Income taxes (receivable) payable | (881,712 | ) | 1,939,768 | (665,641 | ) | 1,234,359 | ||||||
Deferred income taxes | 2,500,052 | (321,428 | ) | 1,662,147 | (237,853 | ) | ||||||
Current Portion of note payable | — | 128,467 | — | 195,292 | ||||||||
F-21
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 6. | LOAN RECEIVABLE |
The Company has entered into a commercial services and marketing agreement with the Company’s joint venture participant in Peru to provide financing to assist in its development of dial-around long-distance service for which the Company will process its international traffic and earn 50% of the profits generated by the business. At September 30, 2004 and June 30, 2004 the Company had made advances of $956,191 and $956,191 respectively under this agreement, of which $413,944 ($445,454 - June 30, 2004) is a loan receivable (see Note 12).
| 7. | ADVANCES FROM TELUS COMMUNICATIONS INC. (Telus) |
In fiscal 2003, in return for the Company’s commitment to promote its advertising and marketing activities, Telus provided the Company with a deferral of amounts due to Telus to a total maximum value of $3,250,000. The deferral was calculated as 25% of the value of monthly billed revenue to the Company by Telus in the preceding month to a maximum of $270,000 per month.
Repayment of the deferred amounts commenced September 15, 2003 and is ending October 15, 2005. Repayments are a minimum of $109,370 per month, plus additional amounts based upon volumes. Up to September 30, 2004, the Company’s monthly payments have been the minimum amount. The repayments are non-interest bearing as long as no payments are in default, and are classified as follows:
| $ | $ | |||
Current | 1,312,440 | 1,238,882 | ||
Long-term | 41,591 | 348,980 | ||
| 1,354,031 | 1,587,862 | |||
| 8. | OBLIGATIONS UNDER CAPITAL LEASES |
The Company’s capital leases are for terms of 24 to 48 months at annual interest rates ranging from 8.9% to 15.00%. In addition to regular lease payments, the three months ending June 30, 2007 includes a buyout of $235,597.
F-22
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 8. | OBLIGATIONS UNDER CAPITAL LEASES (cont’d) |
The future minimum lease payments required under the capital lease agreements are as follows:
| $ | |||
Year ending September 30, | |||
2005 | 632,623 | ||
2006 | 584,048 | ||
2007 | 689,787 | ||
2008 | 148,436 | ||
2009 | 35,142 | ||
Total minimum lease payments | 2,090,036 | ||
Amounts representing interest | 301,986 | ||
Principal | 1,788,050 | ||
Current portion | (490,696 | ) | |
| 1,297,354 | |||
| 9. | INCOME TAXES |
The domestic and international components of income (loss) before income taxes are as follows:
For the three months ended September 30, | ||||||
| 2004 | 2003 | |||||
| $ | $ | |||||
United States | (626,585 | ) | (141,225 | ) | ||
Canada | 2,677,982 | 2,617,426 | ||||
Income before income taxes | 2,051,397 | 2,476,201 | ||||
F-23
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 9. | INCOME TAXES (cont’d) |
The components of the income tax expense are as follows:
| For the three months ended September 30, | ||||||
| 2004 | 2003 | |||||
| $ | $ | |||||
Current | ||||||
United States | — | — | ||||
Canada | 800,639 | — | ||||
Deferred | ||||||
United States | (213,039 | ) | (48,017 | ) | ||
Canada | 129,464 | 845,434 | ||||
Income tax expense | 717,064 | 797,417 | ||||
The tax benefits associated with employee exercises of non-qualified stock options, disqualifying dispositions of stock acquired with incentive stock options, and disqualifying dispositions of stock acquired under the employee stock purchase plan generally reduce taxes currently payable. However, no tax benefits were recorded to additional paid-in capital in 2004 and 2003 because their realization was not believed to be more likely than not. Consequently, a valuation allowance was recorded against the entire benefit.
F-24
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 9. | INCOME TAXES (cont’d) |
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, as well as the application of the deferred tax asset acquired and have been recognized in the Company’s accounts as follows:
| September 30, 2004 | June 30, 2004 | |||||
| $ | $ | |||||
Accounting value of assets in excess of tax base/ (tax base in excess of accounting value) | (108,390 | ) | (237,853 | ) | ||
Unrealized tax loss carryforward | (213,038 | ) | — | |||
Net deferred tax (asset) liability | (321,428 | ) | (237,853 | ) | ||
The income tax provision recorded differs from the income tax obtained by applying the statutory income tax rate of 33.12% (2003 - 35.62%) to the Canadian income accounts as follows:
For the three months ended September 30, | ||||||
| 2004 | 2003 | |||||
| $ | $ | |||||
Income (loss) before income taxes: | ||||||
United States | (626,585 | ) | (141,225 | ) | ||
Canada | 2,677,982 | 2,617,426 | ||||
Calculated income tax expenses | 679,423 | 882,023 | ||||
Expenses deductible for tax | 37,641 | (84,606 | ) | |||
Provision for income taxes | 717,064 | 797,417 | ||||
F-25
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 10. | COMMON STOCK |
100,000,000 shares authorized, no par value, stated value $0.01 per share.
On July 15, 2003, 20,000 common shares were issued, as consideration for a short-term loan in the amount of $713,570 due December 31, 2003.
On December 30, 2003, the Company pursuant to a stock option granted on December 2000, issued 2,260,934 shares of its common stock to its chief executive officer and director. The option provided for the issuance of 2,568,000 shares of common stock less the surrender of 307,066 shares of common stock which was the number of shares determined by an independent valuator on December 5, 3003, assuming a discounted market price of $5.67 per share as of November 30, 2003. The transaction was accounted for as a cash less exercise of the option as the option holder held 1,523,800 common shares prior to December 30, 2003.
On December 31, 2003, 9,000 common shares were issued for services rendered of $51,032.
On January 29, 2004 a two-for-one stock split on the Company’s outstanding shares was distributed to shareholders of record at January 15, 2004. For every one share of the Company’s common stock held on the record date, a holder will receive one additional share. All share information has been adjusted retroactively for the stock split.
On March 18, 2004, 1,470,000 common shares were issued for gross proceeds of $18,007,500 less direct cost associated with the transaction of $1,184,014 for net proceeds of $16,823,486. Attached to these shares were common stock warrants issued to purchase 367,500 shares of the Company’s common stock. These warrants have an exercise price of $17.00 and expire March 18, 2010.
F-26
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 11. | STOCK OPTION PLAN |
Effective June 30, 1999, the Company adopted a Stock Option Plan (the “Plan”) which permits the issuance of stock options to selected employees and directors. The Company reserved 640,000 shares of common stock for grant under the Plan. Options granted may be either nonqualified or incentive stock options and will expire no later than 20 years from the date of grant (10 years for incentive options). No options have been issued under this plan.
On November 17, 2003, 230,000 options were granted to three officers of the Company, with an exercise price of $6.50. The market price of the stock on that date was $7.25. The holders may exercise 25% of their options on each anniversary date, and the options expire November 17, 2008. On May 11, 2004, 50,000 options were granted to an officer of the Company, with an exercise price of $6.57. The market price of the stock on that date was $7.30. The holder may exercise 25% of their options on each anniversary date, and the options expire May 11, 2009. On September 7, 2004 50,000 options were granted to an employee of the Company, with an exercise price of $6.41. The market price of the stock on that date was $7.12. The holder may exercise 25% of their options on each anniversary date, and the options expire September 7, 2009. The Company has recorded a deferred compensation expense of $13,054 in connection with the grant of these options for the three months ended September 30, 2004.
F-27
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 12. | JOINT VENTURE |
Included in the consolidated financial statements are the Company’s proportionate share of revenues, expenses, assets and liabilities of the unincorporated joint venture as follows:
September 30, 2004 | June 30, 2004 | |||||
| $ | $ | |||||
Assets | ||||||
Cash | 12,753 | 19,935 | ||||
Accounts Receivable | 32,461 | 30,292 | ||||
Prepaid expenses | 3,500 | 3,500 | ||||
Property and equipment | 98,485 | 103,551 | ||||
| 147,199 | 157,278 | |||||
Liabilities | ||||||
Accounts payable | 148,060 | 90,949 | ||||
Due to Yak Communications Inc. | 413,944 | 445,454 | ||||
| 562,004 | 536,403 | |||||
Deficit | (414,805 | ) | (379,125 | ) | ||
Total liabilities and deficit | 147,199 | 157,278 | ||||
F-28
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 12. | JOINT VENTURE (cont’d) |
| For the three months ended September 30, | ||||||
| 2004 | 2003 | |||||
| $ | $ | |||||
Revenue | 45,860 | — | ||||
Expenses | 81,538 | 16,635 | ||||
Net loss | (35,678 | ) | (16,635 | ) | ||
Cash used in operating activities | (23,692 | ) | (54,432 | ) | ||
Cash used in investing activities | — | (21,125 | ) | |||
Cash provided by financing activities | 16,510 | 75,557 | ||||
Decrease in cash | (7,183 | ) | — | |||
Cash, beginning of period | 19,935 | — | ||||
Cash, end of period | 12,752 | — | ||||
F-29
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 13. | STATEMENT OF CASH FLOWS |
The following recap presents the detail of the net change in working capital presented in the statement of cash flows for the following three months ended:
For the three months ended September 30, | ||||||
| 2004 | 2003 | |||||
| $ | $ | |||||
Increase in: | ||||||
Accounts receivable | (83,252 | ) | (4,548,648 | ) | ||
Prepaid expenses and sundry | (499,091 | ) | (244,107 | ) | ||
Increase (decrease) in: | ||||||
Deferred revenue | 49,217 | 974,061 | ||||
Accounts payable and accrued liabilities | 225,311 | 402,251 | ||||
Amounts due for network access and usage | (216,409 | ) | 1,018,408 | |||
Amounts due to long distance carriers | 411,514 | 2,023,320 | ||||
Amount due for equipment | (53,172 | ) | 428,929 | |||
Due to Factor | (359,561 | ) | (2,614 | ) | ||
Income taxes payable | 584,568 | 790,655 | ||||
Effect of exchange rate changes on working capital | 192,114 | (47,735 | ) | |||
Less: Net assets acquired from Contour | — | 1,286,039 | ||||
| 251,239 | 2,080,559 | |||||
F-30
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 14. | COMMITMENTS |
The Company has operating lease commitments for its premises and commitments for leased lines which expire at various dates through July 2009. The future minimum lease payments (exclusive of operating costs and payments for additional volume) are as follows:
| $ | ||
2005 | 2,540,410 | |
2006 | 1,940,938 | |
2007 | 1,310,114 | |
2008 | 244,228 | |
2009 | 170,055 |
Under the terms of an agreement with one of their long distance providers, the Company is committed to purchasing a minimum amount of long distance for their customers use. The minimum amount of customer use is $1,722,568 for the year ending September 30, 2005.
The Company has a further agreement to pay a minimum of $120,000 per month to March 1, 2005 for long distance services terminating in the United States.
| 15. | RELATED PARTY TRANSACTIONS |
| (a) | The Company made advances for the three months ending September 30, 2004 and 2003 of nil and $2,490 respectively to a corporation of which the Company’s chairman is a shareholder and director. |
| (b) | The Company paid marketing and design fees for the three months ending September 30, 2004 and 2003 of $7,040 and $15,618 respectively to a corporation controlled by a former officer and minority shareholder. |
| (c) | The Company paid professional fees for legal services for the three months ending September 30, 2004 and 2003 of $35,436 and $20,442 respectively to a director and minority shareholder. |
All other related party transactions have been disclosed on the consolidated financial statements. These transactions have all been accounted for at their exchange amounts.
F-31
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 16. | ECONOMIC DEPENDENCE |
The Company is dependent in Ontario, Quebec, British Columbia and Alberta upon carriers to provide billing and collection services to its customers under renewable agreements. The Company is also dependent upon TELUS Communications Inc. to provide billing, transport and handling services under a renewable agreement which expires in June 2007. Management expects that these agreements will automatically renew.
The Company purchases long-distance services from a number of carriers and does not feel there is any economic dependence on any one carrier.
| 17. | CHANGES IN ESTIMATES |
Effective July 1, 2003, the estimated useful life for existing telecom switching systems has been changed to reflect the expected replacement by the new Switch that was purchased in September, 2003.
This change in estimate was applied on a prospective basis and the effect of this change increased amortization for the three months ending September 30, 2003 by approximately $290,000 and reduced net income for the period by approximately $290,000. The tax effect of this change was a deferred tax benefit of approximately $92,840.
F-32
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 18. | SEGMENTED AND RELATED INFORMATION |
The Company operates in one reportable segment in three geographic regions - Canada, United States and International. Summary information with respect to the Company’s operations by geographic regions are as follows:
For the three months ended September 30, | ||||||
| 2004 | 2003 | |||||
| $ | $ | |||||
Net revenue | ||||||
Canada | 20,897,155 | 18,560,890 | ||||
United States | 221,095 | 230,328 | ||||
Peru | 78,884 | — | ||||
| 21,197,134 | 18,791,218 | |||||
Operating profit (loss) | ||||||
Canada | 2,888,254 | 2,816,442 | ||||
United States | (768,258 | ) | (301,422 | ) | ||
Peru | (68,599 | ) | (38,819 | ) | ||
| 2,051,397 | 2,476,201 | |||||
| September 30, 2004 | June 30, 2004 | |||||
| $ | $ | |||||
Assets | ||||||
Canada | 38,355,332 | 37,746,642 | ||||
United States | 19,192,938 | 17,143,674 | ||||
Peru | 284,054 | 157,278 | ||||
| 57,832,324 | 55,047,594 | |||||
The Canadian assets include goodwill as at September 30, 2004 and June 30, 2004 of $486,584 and $457,868 respectively and customer lists of $1,598,298 and $1,585,386 respectively.
F-33
YAK COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 19. | CONTINGENCIES |
Various lawsuits and claims are pending against the Company and estimated provisions have been included in current liabilities where appropriate. It is the opinion of management that the final determination of these claims will not have a material adverse effect on the financial position or the results of the Company.
F-34
Exhibit Index
| Exhibit No. | Description | |
| 31.1 | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification of Principal Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2 | Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
