United States
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
(MARK ONE)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2001
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF EXCHANGE ACT
Commission File Number 000-27699
ePHONE Telecom, Inc.
(Exact Name of small business issuer as specified in its charter)
Florida 98-0204749
------- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1145 Herndon Parkway
Herndon, Virginia 20170-5535
(Address of principal executive offices)
(703) 787-7000
--------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. |X| Yes _____ |_| No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: As of September 30, 2001, we
had 32,138,408 outstanding shares of Common Stock, $.001 par value.
Transitional Small Business Disclosure Format (check one): |_| Yes |X| No
ePHONE Telecom, Inc.
FORM 10-QSB
INDEX
Part I - Financial Information Page
Item 1. Financial Statements (Unaudited)
Balance Sheets as of September 30, 2001 and December 31, 2000........................1
Statements of Operations for the
Nine Months Ended September 30, 2001 and 2000........................................2
Statements of Operations for the
Three Months Ended September 30, 2001 and 2001.......................................3
Statements of Cash Flows for the
Nine Months Ended September 30, 2001 and 2000........................................4
Notes to Consolidated Financial Statements...........................................5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................8
Part II - Other Information
Item 1. Legal Proceedings...................................................................14
Item 2. Changes in Securities and Use of Proceeds...........................................14
Item 3. Defaults Upon Senior Securities.....................................................14
Item 4. Submission of Matters to a Vote of Security Holders.................................14
Item 5. Other Information...................................................................14
Item 6. Exhibits and Reports on Form 8-K....................................................14
Signatures ....................................................................................15
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ePHONE Telecom, Inc.
Balance Sheets
(Unaudited)
September 30, December 31,
2001 2000
----------------- -----------------
----------------- -----------------
ASSETS
Current Assets:
Cash and cash equivalents $ 249,452 $ 1,525,978
Investment in marketable securities - 2,170,908
Restricted cash - 579,435
Accounts receivable 87,088 39,200
Inventory 110,007 553,218
Other receivables 22,712 18,893
----------------- -----------------
----------------- -----------------
Total current assets 469,259 4,887,632
Property and equipment, net 1,551,499 999,902
Array Telecom license, net - 1,663,942
Investment in ePHONE Technologies, Inc. 185,000 185,000
Other assets 37,043 102,543
----------------- -----------------
----------------- -----------------
Total assets $ 2,242,801 $ 7,839,019
================= =================
================= =================
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 666,403 $ 309,258
Accrued liabilities 655,052 1,169,244
Customer advances 25,853 25,853
Deferred revenue 279,958 -
Capital lease obligation 21,810 -
----------------- -----------------
----------------- -----------------
Total current liabilities 1,649,076 1,504,355
Capital lease obligation, net of current portion 19,987 -
Deferred royalty obligation - 410,000
Stockholders' Equity:
Common stock, $0.01 par value, 150,000,000 shares authorized; 32,138,408 and
17,453,848 shares issued and outstanding at September 30, 2001 and
December 31, 2000,
respectively 32,138 17,454
Additional paid in capital 21,609,388 21,204,687
Accumulated other comprehensive income - 22,221
Accumulated deficit (21,067,788) (15,319,698)
----------------- -----------------
----------------- -----------------
Total stockholders' equity 573,738 5,924,664
----------------- -----------------
----------------- -----------------
Total liabilities and stockholders' equity $ 2,242,801 $ 7,839,019
================= =================
See accompanying notes to unaudited financial statements.
ePHONE Telecom, Inc.
Statements of Operations
For The Nine Months Ended September 30, 2001 and 2000
(Unaudited)
2001 2000
----------------- -----------------
----------------- -----------------
Revenues $ 1,651,347 $ 325,865
Cost of revenues 1,220,677 181,646
----------------- -----------------
----------------- -----------------
Gross Profit 430,670 144,219
Sales and marketing expenses 1,049,700 1,541,011
General and administrative expenses 4,253,155 2,206,865
Non-cash compensation expenses - general and administrative 123,720 7,433,445
Write off of Array Telecom license and the disposal of
obsolete inventory and equipment, net 871,471 -
----------------- -----------------
----------------- -----------------
Loss from operations (5,867,376) (11,037,102)
Interest and other income, net 119,286 116,060
----------------- -----------------
----------------- -----------------
Net loss $ (5,748,090) $ (10,921,042)
================= =================
================= =================
Loss per share (basic and diluted) $ (0.26) $ (0.80)
================= =================
================= =================
Weighted shares outstanding used in calculation - Basic and
Diluted 22,355,401 13,602,306
================= =================
================= =================
See accompanying notes to unaudited financial statements.
2
ePHONE Telecom, Inc.
Statements of Operations
For The Three Months Ended September 30, 2001 and 2000
(Unaudited)
2001 2000
----------------- -----------------
----------------- -----------------
Revenues $ 1,138,627 $ 273,624
Cost of revenues 744,851 159,494
----------------- -----------------
----------------- -----------------
Gross Profit 393,776 114,130
Sales and marketing expenses 134,349 623,911
General and administrative expenses 1,160,735 742,927
Non-cash compensation expenses - general and administrative 1,220 3,599,634
Write off of Array Telecom license and the disposal of
obsolete inventory and equipment, net 871,471 -
----------------- -----------------
----------------- -----------------
Loss from operations (1,773,999) (4,852,342)
Interest and other income, net 7,836 96,019
----------------- -----------------
----------------- -----------------
Net loss $ (1,766,163) $ (4,756,323)
================= =================
================= =================
Loss per share (basic and diluted) $ (0.06) $ (0.34)
================= =================
================= =================
Weighted shares outstanding used in calculation - Basic and
Diluted 31,718,947 13,988,853
================= =================
================= =================
See accompanying notes to unaudited financial statements.
3
ePHONE Telecom, Inc.
Statements Of Cash Flows
For The Nine Months Ended September 30, 2001 And 2000
(Unaudited)
2001 2000
----------------- -----------------
----------------- -----------------
Cash flows from operating activities:
Net loss $ (5,748,090) $ (10,921,042)
Adjustments to reconcile net loss to cash used in operations:
Depreciation and amortization 772,764 290,904
Fair value of stock issued charged to operations 122,500 4,435,098
Stock option benefits charged to operations - 3,002,403
Deferred royalty expense 193,334 -
Inventory reserve 108,900 -
Write off of Array Telecom license and the disposal of
obsolete inventory and equipment 871,471 -
Other (8,769) -
Changes in operating assets and liabilities:
Accounts receivable and other receivables (51,707) (104,313)
Inventory 14,632 (601,988)
Prepaid and other assets 65,500 160,162
Accounts payable 357,145 62,644
Accrued liabilities (514,192) 26,653
Due to related parties - (91,995)
Deferred revenue 279,958 -
Customer deposits - 31,327
----------------- -----------------
Net cash used in operating activities (3,536,554) (3,710,147)
----------------- -----------------
----------------- -----------------
Cash flows from investing activities:
Purchase of fixed assets (805,737) (747,996)
Purchase of Array Telecom license - (2,207,383)
Purchase of Investments - (2,780,990)
Redemption of marketable securities 2,194,157 -
Deposit to restricted cash, net 579,435 (1,894,865)
----------------- -----------------
Net cash provided by (used in) investing activities 1,967,855 (7,631,234)
----------------- -----------------
----------------- -----------------
Cash flows from financing activities:
Proceeds from issuance of common stock 296,885 250,000
Proceeds from issuance of special warrants, net - 14,044,438
Repayments on capital lease (4,712) -
----------------- -----------------
----------------- -----------------
Net cash provided by financing activities 292,173 14,294,438
----------------- -----------------
----------------- -----------------
Net (decrease) increase in cash (1,276,526) 2,953,057
Cash, beginning of period 1,525,978 82,747
----------------- -----------------
----------------- -----------------
Cash, end of period $ 249,452 $ 3,035,804
================= =================
See accompanying notes to unaudited financial statements.
4
ePHONE Telecom, Inc.
Notes To Financial Statements
(Unaudited)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
ePHONE Telecom, Inc. was incorporated in 1996 under the laws of the State of
Florida, and is traded on the OTC Electronic Bulletin Board operated by the
National Association of Securities Dealers, Inc. under the trading symbol
"EPHO". We were a development stage company, as defined in Statement of
Financial Accounting Standard No. 7 until we began generating revenues from our
principal business activities during the three month-period ended September 30,
2001.
Our vision is to become a global telecommunications carrier providing a full
complement of telecommunications services, including phone-to-phone one-step
dialing, using Voice over Internet Protocol ("VoIP") technology. Using a call
origination approach that involves its own Customer Premise Equipment ("CPE"),
and a combination of its own dedicated Internet Protocol ("IP") network, the
public Internet and the public switched telephone network ("PSTN"), our plans to
develop the capacity to provide voice and fax transmission and other telephony
features at high quality and low cost.
We have prepared the accompanying unaudited financial statements pursuant to the
rules and regulations of the Securities and Exchange Commission. These financial
statements should be read together with the financial statements and notes
thereto contained in our 2000 Annual Report on Form 10-KSB filed with
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted. The accompanying financial statements reflect
all adjustments and disclosures, which in our opinion are necessary for fair
presentation. All such adjustments are of a normal recurring nature. The results
of operations for the interim periods are not necessarily indicative of the
results of the entire year.
Basis of Presentation
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets, and the satisfaction of
liabilities in the normal course of business. As shown in the financial
statements, we have incurred losses since our inception and have accumulated a
deficit of $21,068,000 (unaudited) at September 30, 2001.
At September 30, 2001, we had a $1,179,817 working capital deficit. At the
current level of operations, we believe that we have the ability to continue as
a going concern. However, without raising additional captail we will not be able
to expand our network as quickly as planned. The financial statements do not
include any adjustments relating to the recoverability and classification of
assets and liabilities that might be necessary should we be unable to continue
as a going concern.
Certain 2000 balances have been reclassed to conform to the 2001 presentation.
Revenue Recognition
We recognize telecommunication services revenues over the period services are
provided. Monthly recurring telecommunications services are billed in advance
with any portion that is billed for which we have not yet provided services is
recorded as deferred revenue.
5
Net Loss Per Share
The Company reports basic and diluted loss per share. Basic loss per share is
computed by dividing net loss by the weighted average number of outstanding
shares of common stock. Diluted earnings per share is computed by dividing net
loss by the weighted average number of shares adjusted for the potential
dilution that could occur if stock options, warrants and other convertible
securities were exercised or converted into common stock. For the three and nine
months ended September 30, 2001 options and warrants to purchase 27,316,000
shares of common stock were outstanding but were not included in the computation
of diluted earnings per share because the effect would have been anti-dilutive.
NOTE 2 - ARRAY TELECOM LICENSE
In March, 2000, we entered into a Strategic Alliance Agreement and a License
Agreement with Comdial Corporation ("Comdial") and Array Telecom Corporation
("Array Telecom"), a wholly owned subsidiary of Comdial. In connection with the
Agreement and the License, we made an initial payment to Comdial of $2.65
million and received the fixed assets of Array Telecom, assumed the lease of
Array Telecom's Herndon, Virginia facility and an exclusive license for all
Voice over Internet Protocol (VoIP) technology that had been developed by Array
Telecom for a period of five years. The License Agreement required that we pay
additional minimum royalty fees for the VoIP technology over a five-year period.
During the fourth quarter of 2000, we determined that due to the rapidly
changing technology in the VOIP industry, a shorter amortization life for the
License Agreement was appropriate and shortened the expected life to three
years. The shortened life gave rise to a deferred royalty obligation
representing the difference between the straight-line expense over the shortened
three-year life of the License Agreement and the actual royalty payments which
were scheduled to be made over a five-year period.
During the third quarter of 2001, we filed for arbitration against Comdial
seeking rescission of the Array Telecom License Agreement, return of the $2.65
million paid to Comdial, and compensatory and punitive damages due to what we
believe to have been violations by Comdial of the Array Telecom License
Agreement. Comdial has responded to our arbitration demand with a counterclaim
seeking relief from all of our claims and the payment of $215,000 accrued
royalty plus interest. We believe the $215,000 plus interest is our maximum
exposure in the event of an unfavorable outcome. Since Comdial has terminated
the License Agreement, we have reversed the previously recorded deferred royalty
obligation of $603,000 during the three months ended September 30, 2001.
We have also decided to discontinue use of the Array Telecom technology and
therefore, have written off the remaining balance of the Array Telecom License
of $1,109,295 at September 30, 2001. We have presented the net effect of the
write off of the Array License and the reversal of the deferred royalty
obligation along with a write-off of other Array Telecom technology assets in
the statement of operations.
NOTE 3 - RELATED PARTY TRANSACTIONS
During the nine months ended September 30, 2001 and 2000 we incurred costs for
management services provided by companies in which certain directors of ours
have a controlling interest and incurred consulting fees to certain directors of
ours totaling $74,000 and $110,000, respectively.
During the nine months ended September 30, 2001, we paid $248,000 to ePHONE
Technologies, Inc., a company we hold a 20% equity interest in , for consulting
services. We also paid $25,000 in consulting fees to one of our officers, and
paid $100,000 as provided for in a Service and Deployment Agreement with 7bridge
Systems, LTD, a related party.
6
NOTE 4 - MARKETABLE INVESTMENTS
Our available-for -sale investments consisted of debt instruments issued by
federal and state government agencies. During the nine months ended September
30, 2000, we redeemed the remaining $2,194,000 of available-for-sale debt
securities.
NOTE 5 - STOCKHOLDER'S EQUITY
During the nine months ended September 30, 2001, the Board of Directors approved
the grant of 3,975,000 stock options pursuant to our 2000 Long Term Incentive
Plan. The exercise price of the options was $.50 and the vesting periods range
from immediate to 3 years.
On February 14, 2001, the Board of Directors approved the issuance of 250,000
stock options to a consultant in exchange for services to be provided. The stock
options have an exercise price of $0.50 and expire in three years. The vesting
terms are subject to management's discretion and have not yet been determined.
The market value of our common stock at the grant date was $0.23. The fair value
associated with these options totaled $42,500 and was recorded as non-cash
compensation during the three-month period ended March 31, 2001.
On March 23, 2001, we entered into a Settlement Agreement and Mutual General
Release (the "Settlement Agreement") with Charles Yang to resolve all claims and
disputes between us and Mr. Yang, including all claims relating to Mr. Yang's
employment by and separation from us . Pursuant to the terms of the Settlement
Agreement, we agreed to pay Mr. Yang $400,000 in cash in installments by July
23, 2001, and issue Mr. Yang 400,000 shares of our common stock. We recorded
$180,000 in expense related to this settlement during the three month period
ended March 31, 2001. The fair value of the stock on the date of issuance was
$80,000 and is recorded as non-cash compensation in the statement of operations.
In early 2000, we sold a total of 13,436,316 Special Warrants, as adjusted for
redemptions and penalties, to investors. On August 13, 2001 final receipts
from the regulators of the British Colombia, Alberta, Ontario and Quebec
provinces in Canada were received for the registration prospectus dated August
7, 2001. Each Special Warrant was then deemed converted, as provided for in the
special warrant agreement, into one share of common stock and a warrant to
purchase one share of common stock at an exercise price of $1.60 per share
expiring on March 31, 2002, for no additional consideration.
On October 1, 2001, The Board of Directors approved the repricing of all
outstanding warrants including the warrants which were issued upon the exercise
of the Special Warrants to a price of $0.35 per share. Subsequent to September
30, 2001, we received $297,000 for the exercise of warrants to purchase 848,243
shares of our common stock.
NOTE 6 - MAJOR CUSTOMER
For the nine months ended September 30, 2001, all of our hardware sales,
representing approximately 31% of our total sales revenue were to one customer.
7
ITEM II. MANAGEMENT'S DISCUSSION AND ANALYSIS AND PLAN OF OPERATION.
Certain statements made by our management may be considered to be
"forward-looking statements" within the meaning of the Private Securities
Litigation Act of 1995. Forward-looking statements are based on various factors
and assumptions that include known and unknown risks and uncertainties. The
words "believe," "expect," "anticipate" and "project," and similar expressions
identify forward-looking statements, which speak only as of the date the
statement was made. Such statements may include, but not be limited to,
projections of revenues, income or loss, expenses, plans, as well as assumptions
relating to the foregoing. Forward-looking statements are inherently subject to
risks and uncertainties, some of which cannot be predicted or quantified. Future
results could differ materially from those described in forward-looking
statements as a result of the risks set forth in the following discussion, among
others.
Our financial statements have been presented on a going concern basis, which
contemplates the realization of assets and settlement of liabilities and
commitments in the normal course of business. We have experienced losses since
our inception, however due to the change in strategy we expect to have positive
cash flow in the near future. Our auditors included a paragraph in their
Report of Independent Certified Public Accountants on our December 31, 2000
financial statements drawing special attention to several factors that raise
doubt about our ability to continue as a going concern.
OVERVIEW
The third quarter of FY 2001 was one of transition for us. Management's decision
in the second quarter to introduce Cisco equipment and to begin implementing a
private network, as opposed to exclusively using the Internet for transport,
proved to be fundamental to the generation of our telephony based revenues. We
began carrying production traffic, both wholesale and retail, on this new
network in the third quarter of 2001. This major milestone marks the first time
we have produced revenue from the provision of telecommunications services in
our history.
Our core strategy had been to deploy and manage a global Internet telephony
services network using the Array series of products and customer premises
equipment (Business Direct and Business Connect services). Our decision to
deploy the new network was based on several underlying factors that were
initially seen as providing a broader based business strategy but one that
worked in conjunction with our original plan and supplemented the existing Array
network in areas where it was deficient, primarily carrier interconnectivity and
billing functionality. Our new network was intended to interconnect with the
Array network providing supplemental revenues by allowing wholesale arbitrage
and providing increasingly competitive rates for the retail programs being
deployed in Europe.
Our new network was deployed and brought into production in 75 days. The Array
network, after more than 12 months of effort was still not able to support
production traffic. This called into question the viability of the Array
technology as well as our original strategy. The respective time and effort
spent on the implementation of the two networks led management quickly to the
conclusion that the Array network should be abandoned and to commit fully to a
network based on Cisco equipment. This decision in turn demanded a complete
review of our strategy and consideration of changes in the market. The market
was re-evaluated and determined to have evolved in several significant
dimensions:
o The Public Internet was no longer the least expensive source of
transport in all instances. Depending on routes it could be more
economical and provide a much higher quality of service to use VoIP
protocol and interconnecting network nodes or points of presence (POPs)
using leased lines.
o Participation in the wholesale telecommunications market was becoming
necessary to obtain competitive rates and access to direct
international routes.
o The dot.net (used to refer to the telecommunications service providers
using the internet) downturn substantially damaged the credibility of
companies dealing in the international telecommunications market. As a
result of these companies going out of business many carriers were left
with substantial bad debts.
8
o The dot.net downturn had driven many dot.net service providers out of
the US market and made it increasingly difficult for the retail service
providers to obtain credit from carriers. The sudden decrease in the
number of service providers was providing domestic opportunities in
what had previously been a cutthroat market.
In addition, this re-evaluation led to the realization of several key elements
unique to our specific circumstances:
o We do not have the resources to pursue marketing efforts in both Europe
and the United States simultaneously.
o Due to proximity and the current market dynamics we have a stronger
position to pursue opportunities in the United States.
o As an inter-exchange carrier we could acquire international termination
more economically by locating POPs in certain key "Carrier Hubs" than
by distributing POPs in each country in which we chose to operate.
o While customer premises equipment (CPE ) has a role to play in
integrating voice and data services the complexities of deployment,
configuration and support are significant. This market is defined by
facilities providers that provide high speed Internet access and
therefore requires a specific geographic presence in a market to be
developed. These issues raised the cost of entry into this market to a
level we could not sustain.
OUR PLAN
Early in the third quarter, management made the decision to implement a new
business plan. We would be rapidly re-engineered to become an inter-exchange
carrier and retail services provider with an initial focus on the domestic
market in the United States. We identified one of our strengths as the
innovative marketing and selling abilities of our current management team. A key
element of the new plan was to use these abilities to focus on less competitive
market segments where high margins could be realized. During the third quarter
of 2001, the new plan was executed and the following actions taken:
o Interconnections with 10 new carriers in New York were negotiated,
provisioned and activated. These interconnections provided competitive
rates to Africa, Eastern Europe, Asia and South America. Additional
carrier interconnections were arranged to provide substantial 800
access to the switch and A to Z (world) termination at competitive
rates.
o The ePHONE "Unlimited" program was launched. This retail program is a
telemarketing driven unlimited domestic long distance program for the
US. It is a recurrent program, meaning a client signs up and is billed
at a set monthly fee enabling them to make an unlimited number of long
distance calls to the 48 continental states during that month. The
client is automatically billed each month until the service is
terminated. This program began producing revenues in August.
o Wholesale arbitrage opportunities were identified and closed. Key
destinations being sold are Eastern Europe, China and Africa. These
activities began producing revenue in August.
o A call center was established and staffed to deal with the customer
service issues arising from the Unlimited program.
o A carrier class Global Network Management Center (GNMC) was built and
equipped to manage the new network. This facility was operational by
July. It monitors the network status and responds to technical issues
24 hours a day 7 days a week.
9
o A relationship was developed with Global eTelecom to process checking
account transactions through an Automatic Clearing House (ACH) to
facilitate monthly billing transactions.
o Our monthly cash burn rate was decreased by:
o Negotiating settlements with all service providers in Europe and
de-installing the Array equipment. o Selling off all residual equipment
and inventory associated with the Array equipment. o Negotiating the
sale of our CPE inventory. o Downsizing and re-engineering the
organization to meet our new needs.
o Marketing, public and investor relation activities were dramatically
increased to ensure shareholders, analysts and the market in general
were made aware of our new focus and activities.
o Outsourcing alternatives were evaluated to improve customer service
response times and to implement customer relationship management
systems. We are in the process of making a decision on the appropriate
system and approach, with implementation to begin immediately
thereafter.
During the third quarter of 2001 we were firmly established as a new, but
active, Inter-exchange carrier, developing a reputation for innovative retail
programs. Our "Unlimited" program and wholesale arbitrage revenues continued to
increase since we introduced the program in mid-August 2001. We expect revenues
from these programs to continue to increase in the foreseeable future.
We have attended two trade shows during the fourth quarter of 2001 and are
planning to further expand our network to encompass "Carrier Hubs" in both Miami
and Los Angeles. We believe that establishing points-of-presence in these two
locations is fundamental to further improving our competitive position, and will
allow us to provide more competitive carrier interconnects. Miami is a nexus for
carriers focused on South America and the Caribbean and Los Angeles is a hub for
Asian termination.
Our decision to move to a new technology necessitated a review of our license
agreement with Comdial, the licensor of the Array technology. This contract
provided for an initial payment and quarterly payments for the ensuing 5 years
based on revenues produced from the sale of Array Gateways. The contract review
and discussions with customers of the Array 3000 Gateway yielded some unexpected
results. It began to appear that there might have been some improprieties in the
sale/transfer of the Array intellectual property to which we purportedly
purchased the exclusive license. We have retained legal counsel and this issue
has now been submitted for arbitration according to the provisions of the
contract. According to advice from counsel, management believes it has cause and
is requesting a refund of all monies paid to Comdial plus damages, including the
amounts originally paid to purchase the license.
We are optimistic about our future opportunities. Our strong focus on sales and
marketing activities began producing results during the third quarter of 2001.
Our achievements in the third quarter of 2001 demonstrates that we have the
expertise and ability to adapt to changing market conditions and the commitment
to critically review programs to ensure they are achieving the desired results.
Notwithstanding the turnaround we realized in the third quarter of 2001, the
ground to make up in the fourth quarter of 2001 to achieve the goals set for
entire year of 2001 may not be achieved because we were forced to rebuild our
network to be in a position to generate ongoing revenue. We expect revenues will
continue to increase through the fourth quarter of 2001 and new programs will
continue to be launched which we believe will further increase our revenue
growth in the future. We believe that we are now well positioned for a solid
revenue base developing in FY 2002.
10
RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
Our net loss and net loss per share were as follows for the three months and
nine months ended September 30, 2001:
Three months Three months Nine months ended Nine months ended
ended September ended September September September
30, 2001 30, 2000 30, 2001 30, 2000
Net loss $ (1,766,000) $ (4,756,000) $ 5,748,000) $(10,921,000)
Net loss per share $ (0.06) $ (0.34) $ (0.26) $ (0.80)
During the three and nine month periods ended September 30, 2001, we began
recognizing revenue under our "Unlimited Access" telecommunications program.
This coupled with the significant reduction on non-cash general and
administrative costs during 2001 compared to 2000 were the primary reasons for
the significant decrease in our net loss
Revenues
The increase for both periods is attributed to the Company's "Unlimited Access"
Program, which began in mid August. As shown in the table below, this program
accounted for all of ePHONE's revenue during the three months ended September
30, 2001 and did not account for any revenue during 2000. During September 2001,
cash collections of $279,958 were considered pre-paid and are reflected in the
Current Liability section of the Balance Sheet as "Deferred Revenue". As ePHONE
continues to focus on retail and wholesale offerings, sales of equipment are not
expected to be significant in the future.
Three Three Nine months Nine months
months months ended ended
ended ended September September
September September 30, 2001 30, 2000
30, 2001 30, 2000
Telecommunications Services $ 1,139,000 $ - $ 1,139,000 $ -
Telecommunications Equipment Sales - 274,000 512,000 326,000
------------- -- ------------- -- -------------- --- --------------
Total $ 1,139,000 $ 274,000 $ 1,651,000 $ 326,000
Cost of revenues
Three months Three months Nine months Nine months
ended September ended September ended September ended September
30, 2001 30, 2000 30, 2001 30, 2000
Telecommunications
Services $ 745,000 $ - $ 745,000 $ -
Telecommunications
Equipment Sales - 159,000 476,000 182,000
------------------ -- ------------------ -- ------------------ -- ------------------
------------------ -- ------------------ -- ------------------ -- ------------------
Total $ 745,000 $ 159,000 $ 1,221,000 $ 182,000
For the three months ended September 30, 2001, cost of goods sold represented
commissions, activation fees and processing charges related to our
telecommunications services program. Prior to the three month period ended
September 30, 2001, cost of goods sold was related to telecommunications
equipment sales. Gross margin for the three months and nine months ended
September 30, 2001 totaled $394,000 (34.6%) and $430,000 (26.0%), respectively,
and the change in our gross margin percentage from the prior year is due to the
change in our sales mix.
11
Sales and marketing
Sales and marketing expense decreased from $624,000 to $134,000 for the three
months ended September 30, 2001 and 2000, respectively, and from $1,541,000 to
$1,050,000 for the nine months ended September 30, 2001 and 2000, respectively.
During 2000, our sales and marketing expenses included compensation paid to
consultants for market studies and competitive intelligence of the Internet
telephony market place in several countries where we were deploying our network.
There were no similar expenditures incurred during 2001. Currently, sales and
marketing expense consists primarily of marketing commissions and salaries.
General and administrative
General and administrative expense increased from $743,000 to $1,161,000 for the
three months ended September 30, 2001 and 2000, respectively, and from
$2,207,000 to $4,253,000 for the nine months ended September 30, 2001 and 2000,
respectively. We expect general and administrative expenses to level off or
decrease in the future due to our changes in the business plan which resulted in
non-recurring expenses for nine months ending September 30, 2001.
Write-off of Array Telecom License
In March 2000, we entered into a Strategic Alliance Agreement and a License
Agreement with Comdial Corporation ("Comdial") and Array Telecom Corporation
("Array Telecom"), a wholly owned subsidiary of Comdial. In connection with the
Agreement and the License, we made an initial payment to Comdial of $2.65
million and received the fixed assets of Array Telecom, assumed the lease of
Array Telecom's Herndon, Virginia facility and an exclusive license for all
Voice over Internet Protocol (VoIP) technology that had been developed by Array
Telecom for a period of five years. The License Agreement required us to pay
additional minimum royalty fees for the VoIP technology over a five-year period.
During the fourth quarter of 2000, we determined that due to the rapidly
changing technology in the VOIP industry, a shorter amortization life for the
License Agreement was appropriate and shortened the expected life to three
years. The shortened life gave rise to a deferred royalty obligation
representing the difference between the straight-line expense over the shortened
three-year life of the License Agreement and the actual royalty payments, which
were scheduled to be made over a five-year period.
During the third quarter of 2001, we filed for arbitration against Comdial
seeking rescission of the Array Telecom License Agreement, return of the $2.65
million paid to Comdial, and compensatory and punitive damages due to what we
believe to have been violations by Comdial of the Array Telecom License
Agreement. Comdial has responded to our arbitration demand with a counterclaim
seeking relief from all of our claims and the payment of $215,000 accrued
royalty plus interest. We believe that $215,000 plus interest is our maximum
exposure in the event of an unfavorable outcome. Since Comdial has terminated
the License Agreement, We have reversed the previously recorded deferred royalty
obligation of $603,000 during the three months ended September 30, 2001. We have
also decided to discontinue using the Array Telecom technology and have written
off the remaining balance of the Array Telecom License of $1,109,000 at
September 30, 2001.
Income taxes
There was no provision for federal or state income taxes for the period from our
inception due to our operating losses. At September 30, 2001, we had net
operating loss carryforwards for income tax purposes. A valuation allowance has
been established and, accordingly, no benefit has been recognized for our net
operating losses and other deferred tax assets.
12
LIQUIDITY AND CAPITAL RESOURCES
We have funded operations primarily through equity financing. We do not have a
line of credit or similar credit facility available to us. During the nine
months ended September 30, 2001, we raised $297,000 from the exercise warrants
for the purchase of 848,000 shares of our common stock. On April 20, 2000, we
closed an offering of Special Warrants, receiving net proceeds of approximately
$12,205,000. The total number of Special Warrants we sold in that offering was
13,780,837. The special warrant agreements contained certain penalties in the
event that we did not meet the prescribed deadlines for registration of common
stock to be issued on the exercise of the special warrants in both Canada and
the United States. We failed to meet these deadlines, and consequently; each
special warrant holder was entitled to exercise their right to have 12.5% of
their original investment returned to them and reduce the number of special
warrants they held by the same percentage ("Redemption Right"). In addition,
each special warrant holder will receive an additional 10% of their original
investment in shares of our common stock upon the exercise of the special
warrants. As of March 31, 2001, all special warrant holders exercised their
Redemption Rights, and we returned $1,895,000 to these investors. We completed
the registration of our common stock in Canada, and our investors exercised
their special warrants causing us to issue 13,436,316 shares of our common stock
and warrants to purchase 13,436,316 shares of our common stock for $1.60 per
share.
During the third quarter of 2001, we undertook several initiatives to raise
additional capital, including reducing the price of the warrants issued on
exercise of the special warrants, along with all other outstanding warrants
exercising between $1.60 - $0.50, to $0.35 in an effort to encourage investors
to exercise these warrants. The warrants were repriced to better reflect the
current market price
For the nine months ended September 30, 2001, our operating activities used
$3,537,000 of cash. Our net loss for the period was offset by non-cash expenses
and increases in our accounts payable. For the nine months ended September 30,
2001, investing activities provided $1,968,000 of cash as a result of the
redemption of marketable securities offset by payments to purchase fixed assets,
with financing activities generating $292,000 in cash from the exercise of stock
purchase warrants. We had cash totaling $249,000 at September 30, 2001, which we
believe is sufficient to enable us to operate until we raise additional equity
financing. However, should such financing not be available to us when needed or,
available on terms favorable to us we may need to scale back operations and
planned expansion. If additional funds are received from the sale of shares of
our common stock, existing stockholders may experience significant dilution.
Our financial statements have been prepared on a going concern basis, which
contemplates the realization of assets, and the satisfaction of liabilities in
the normal course of business. Our auditors have included in their Report of
Independent Certified Public Accountants a fourth (explanatory) paragraph
drawing attention to factors that raise substantial doubt about our ability to
continue as a going concern. We have experienced net losses since our inception,
currently have a working capital deficit, and are in need of additional
investment capital to expand our operation and introduce new products to market.
Although we believe that our operating results will improve, there can be no
assurances that positive results will occur and we may experience adverse
results of operation in the future. Should this occur, we will not be able to
satisfy our current obligations in the normal course of business and may not be
able to obtain additional investment capital on terms acceptable to us, or at
all. At the current level of operations, we believe that we have the ability to
continue as a going concern. However, without raising additional capital, we
will not be able to expand our network as quickly as planned. Our anticipated
cash flows from future operations is largely dependent upon our ability to
achieve our sales and gross profit objectives from our current products and the
new products we launched in 2001. We are actively pursuing additional equity
financing to provide the funds for expansion and for working capital, however we
cannot be assured that we will be able to secure the needed funds or that should
we be able to obtain these funds that they will be on terms acceptable to us.
13
STOCK COMPENSATION ACTIVITY DURING 2001
On February 14, 2001, the Board of Directors approved issuance of 2,250,000
stock options pursuant to ePHONE's 2000 Long Term Incentive Plan. The exercise
price of the options was $.50 and the vesting periods range from immediate to 3
years.
On February 14, 2001, the Board of Directors approved the issuance of 250,000
stock options to a consultant in an exchange for services to be provided. The
stock options have an exercise price of $0.50 and expire in three years. The
vesting terms are subject to Management's discretion and have not yet been
determined. The market value of ePHONE's common stock at the grant date was
$0.23. The fair value associated with these options totaled $42,500 and was
recorded as non-cash compensation during the three-month period ended March 31,
2001.
As further described in Legal Proceedings, we entered into a Settlement
agreement with Charles Yang on March 23, 2000. Pursuant to the terms of the
agreement, we agreed to pay Mr. Yang $400, 000 in cash in installments by July
23, 2001, and issue Mr. Yang 400,000 shares of our common stock. We recorded
$180,000 in expense related to this settlement during the three months ended
March 31, 2001. The fair value of the stock issued was $80,000 and is recorded
as non-cash compensation in the statement of operations.
14
OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
On March 23, 2001, we entered into a Settlement Agreement and Mutual General
Release (the "Settlement Agreement") with Charles Yang to resolve all claims and
disputes between the Company and Mr. Yang, including all claims relating to Mr.
Yang's employment by and separation from the Company. Pursuant to the terms of
the Settlement Agreement, the Company agreed to pay Mr. Yang $400, 000 in cash
in installments by July 23, 2001, and issue Mr. Yang 400,000 shares of our
common stock.
During the third quarter of 2001, we filed for arbitration against Comdial
seeking rescission of the Array Telecom License Agreement, return of the $2.65
million paid to Comdial, and compensatory and punitive damages due to what
ePHONE believes to have been violations by Comdial of the Array Telecom License
Agreement. Comdial has responded to ePHONE's arbitration demand with a
counterclaim seeking relief from all of our claims and the payment of $215,000
accrued royalty plus interest. We anticipate that this arbitration will be
settled during 2002.
ITEM 2 - CHANGES IN SECURITIES
Not applicable
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5 - OTHER INFORMATION
Not applicable
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
Exhibit No. Description
--------------- -------------------------------------------------------------------------------------
--------------- -------------------------------------------------------------------------------------
3 Articles of Incorporation. (Incorporated by reference to the Form 10-SB filed on
October 15, 1999)
3.1 Amendment to Articles of Incorporation (Incorporated by reference to the Form 10-SB
filed on October 15, 1999)
3.2 Amendment to Articles of Incorporations (Incorporated by reference to the Form
10-SB filed on January 5, 2000)
3.3 Bylaws (Incorporated by reference to the Form 10-SB filed on October 15, 1999)
B. Reports on Form 8-K: None
15
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ePHONE Telecom, Inc.
(Registrant)
By /s/ Carmine Taglialatela
- ------------------------------------------------
(Carmine Taglialatela, President and Chief Executive Officer)
Date: November 12, 2001
By /s/ Charlie Rodriguez
- ------------------------------------------------
(Charlie Rodriguez, Chief Financial Officer)
Date: November 12, 2001