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 June 30, 2002
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF EXCHANGE ACT
Commission File Number 000-27699
ePHONE Telecom, Inc.
(Name of small business issuer as specified in its charter)
Florida 98-020-4749
------- -----------
(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
As of June 30, 2002 there were 37,907,368 shares of Common Stock issued and
outstanding.
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 June 30, 2002 and December 31, 2001.............................1
Statements of Operations for the Six Months Ended
June 30, 2002 and 2001...........................................................2
Statements of Operations for the Three Months Ended
June 30, 2002 and 2001...........................................................3
Statements of Cash Flows for the Six months Ended
June 30, 2002 and 2001...........................................................4
Notes to Financial Statements........................................................5
Forward Looking Statements...........................................................8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................9
Part II - Other Information
Item 1. Legal Proceedings...................................................................14
Item 2. Changes in Securities and Use of Proceeds...........................................15
Item 3. Defaults Upon Senior Securities.....................................................15
Item 4. Submission of Matters to a Vote of Security Holders.................................15
Item 5. Other Information...................................................................15
Item 6. Exhibits and Reports on Form 8-K....................................................15
Signatures .................................................................................16
ePHONE Telecom, Inc.
Balance Sheets
(unaudited)
June 30, December 31,
2002 2001
-------------------------------------------
Current Assets:
Cash and cash equivalents $ 1,508,086 $ 35,970
Accounts receivable, net of allowance for returns
of $246,000 and $116,000 at June 30, 2002
and December 31, 2001, respectively 407,683 155,759
Inventory 49,294 16,500
Other receivables 118,336 65,481
-------------------------------------------
Total Current Assets 2,083,399 273,710
Property and equipment, net 1,684,801 1,296,561
Other assets 68,043 18,043
-------------------------------------------
Total Assets $ 3,836,243 $ 1,588,314
-------------------------------------------
Liabilities and Stockholders' Equity (Deficit):
Current Liabilities:
Accounts payable $ 670,295 $ 850,179
Accrued liabilities 1,178,204 654,765
Deferred revenue 806,710 367,009
Capital lease obligation, current portion 63,210 22,663
-------------------------------------------
Total Current Liabilities 2,718,419 1,894,616
-------------------------------------------
Capital lease obligation, net of current portion 34,376 15,839
Other long term obligation, net of current portion 97,500 142,500
Commitments and Contingencies -- --
Stockholders' Equity (Deficit):
Common stock, par value $0.001:
150,000,000 shares authorized, 36,907,368 and
32,987,381 issued and outstanding at June 30, 2002
and December 31, 2001, respectively. 36,907 32,987
Additional paid-in capital 22,671,867 21,843,199
Accumulated deficit (21,722,826) (22,340,827)
-------------------------------------------
Total Stockholders' Equity (Deficit) 985,948 (464,641)
-------------------------------------------
Total Liabilities and Stockholders' Equity (Deficit) $ 3,836,243 $ 1,588,314
-------------------------------------------
See accompanying notes to financial statements
1
ePHONE Telecom, Inc.
Statements of Operations
(unaudited)
Six Months Ended June 30,
2002 2001
------------------------------------------
Service revenue $ 9,143,252 --
Product revenue -- $ 512,720
------------------------------------------
Total revenues 9,143,252 512,720
Operating expenses
Cost of service revenue 5,261,745 --
Cost of product revenue -- 475,826
Sales and marketing 564,893 915,351
General and administrative 2,682,535 3,214,920
------------------------------------------
Total operating expenses 8,509,173 4,606,097
------------------------------------------
Income (loss) from operations 634,079 (4,093,377)
Interest and other (income), net 16,078 (111,450)
------------------------------------------
Income (loss) before taxes 618,001 (3,981,927)
Income tax expense -- --
-----------------------------------------
Net Income (loss) $ 618,001 $ (3,981,927)
Earnings (loss) per share--(basic and diluted) $ 0.02 $ (0.23)
------------------------------------------
Weighted average number of common
shares outstanding 34,792,640 17,672,633
------------------------------------------
See notes to accompanying financial statements
2
ePHONE Telecom, Inc.
Statements of Operations
(unaudited)
Three months ended June 30,
2002 2001
----------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Service revenue $ 5,081,429 $ --
Product revenue -- 93,520
-------------------------------------------
Total revenues 5,081,429 93,520
Operating expenses
Cost of service revenue 2,776,497 --
Cost of product revenue -- 203,434
Sales and marketing 364,485 232,800
General and administrative 1,528,880 1,370,597
-------------------------------------------
Total operating expenses 4,669,862 1,806,831
-------------------------------------------
Income (loss) from operations 411,567 (1,713,311)
Interest and other (income), net 6,660 (14,851)
-------------------------------------------
Income (loss) before taxes 404,907 (1,698,460)
Income tax expense -- --
-------------------------------------------
Net Income (loss) $ 404,907 $ (1,698,460)
Earnings (loss) per share--(basic and diluted) $ 0.01 $ (0.10)
-------------------------------------------
Weighted average number of common
shares outstanding 36,543,528 17,853,848
-------------------------------------------
See accompanying notes to financial statements
3
ePHONE Telecom, Inc.
Statements of Cash Flows
(unaudited)
Six Months Ended June 30,
2002 2001
-----------------------------------------
Cash Flows from Operating Activities:
Net income (loss) $ 618,001 $ (3,981,927)
Adjustments to reconcile net income (loss) to net cash flows from
operating activities:
Depreciation and amortization 156,622 492,182
Stock issued for services rendered 37,715 122,500
Allowance for returns 129,810 --
Deferred royalty expense -- 193,334
Inventory reserve -- 108,900
Realized gain -- (45,470)
Changes in operating assets and liabilities:
Accounts receivable and other receivables (450,655) 38,980
Inventory (32,794) 44,648
Other assets (50,000) 65,500
Accounts payable (179,884) (198,501)
Accrued liabilities 523,439 (602,466)
Deferred revenue 455,767 --
-----------------------------------------
Net cash flows provided by (used in) operating activities 1,208,021 (3,762,320)
-----------------------------------------
Cash flows from investing activities:
Purchase of fixed assets (472,627) (467,172)
Purchase of marketable securities -- 2,194,157
Deposit to restricted cash, net -- 529,435
-----------------------------------------
Net cash flows (used in) provided by investing activities (472,627) 2,256,420
Cash flows provided by financing activities:
Proceeds from exercise of warrants and options 809,873 45,000
Repayments on long-term obligation (45,000) --
Repayment to related party (15,000) --
Repayments on capital lease (13,151) --
-----------------------------------------
Net cash flows provided by financing activities 736,722 45,000
-----------------------------------------
Net increase (decrease) in cash and cash equivalents 1,472,116 (1,460,900)
Cash and cash equivalents, beginning of period 35,970 1,525,978
-----------------------------------------
Cash and cash equivalents, end of period $ 1,508,086 $ 65,078
-----------------------------------------
See accompanying notes to financial statements
4
NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
ePHONE Telecom, Inc. ("ePHONE") 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 provide telecommunication services to retail and wholesale customers. We are
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 and adaptable to legacy and
future technologies.
The Company has 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 in the Company's 2001 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.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions about amounts that affect the reported amounts in the
financial statements and accompanying notes. Actual results could differ from
those estimates.
REVENUE RECOGNITION
In accordance with generally accepted accounting principles generally accepted
in the United States of America, we recognize prepaid telecommunication services
revenues over the period services are provided. We bill monthly recurring
telecommunications services in advance and the majority of our customers prepay
for their services. Therefore, any portion of our services billed and collected
but not yet provided is recorded as deferred revenue. Of the $807,000 in
deferred revenue at June 30, 2002, $768,000 will be fully earned during the
month of July 2002. Revenue for sale of telecommunications equipment sold with
prepaid telecommunications services is recognized when the equipment is
delivered and accepted by customers. We establish an allowance for doubtful
accounts and chargebacks under our Unlimited Calling Program based upon factors,
which include historical trends and other information.
For the six months ended June 30, 2001, product sales of Array Telecom equipment
were recognized upon shipment. Typical terms of sale did not provide the
customer with the right of return except for defective products, which were
covered by the warranty of the original equipment manufacturer. The Company also
generated revenues from product licenses and services. Product license revenues
were generally recognized upon product shipment provided that no significant
post-delivery obligations existed and payment was due within one year. Advance
payments of product licenses and services were reported as unearned revenue
until all conditions for revenue recognition were met.
INCOME TAXES
We had no income tax expense during the six months ended June 30, 2002 due to
the availability of net operating losses for U.S. income tax purposes. There can
be no assurance that we will continue to realize the benefit of the net
operating loss carryforward.
5
NET EARNINGS (LOSS) PER SHARE
We report basic and diluted earnings (loss) per share. Basic earnings (loss) per
share is computed by dividing net earnings (loss) by the weighted average number
of outstanding shares of common stock. Diluted earnings per share is computed by
dividing net earnings (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 both the six months and the three months ended June 30, 2002, options and
warrants to purchase 9,094,000 shares of common stock were outstanding but were
not included in the computation of diluted earnings per share because the
exercise price of all outstanding options and warrants exceeded the average
market price of our stock during both of these this periods. As of June 30, 2002
there are no outstanding warrants.
NOTE 2 - OPERATIONS
As shown in the accompanying unaudited financial statements, net income for the
six months ended June 30, 2002 of $618,000 represents the first two profitable
fiscal quarters in our operating history. Also, of $807,000 recorded as deferred
revenue at June 30, 2002, $768,000 will be fully earned during July 2002. Since
inception we have an accumulated deficit of $21,723,000, which will be used to
offset income taxes related to our current and future earnings.
Management believes that together with our cash on hand and cash flow from our
planned level of 2002 operations that we have sufficient resources to enable us
to sustain our current and planned level of operations for at least the next 12
months without the need for additional investment capital.
During the six months ended June 30, 2002, we generated net revenues of
$9,143,000 with a gross margin of $3,881,000 (42%).
NOTE 3 - RELATED PARTY TRANSACTIONS
During the six months ended June 30, 2002 and 2001 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 $15,000 and $74,000, respectively. The 2002 expense represents the
fair value of 66,668 shares of our common stock issued in lieu of cash payments
as further described under Stockholders' Equity.
During the six months ended June 30, 2002, we repaid a $15,000 amount that was
advanced to ePHONE during 2001 by our Chairman of the Board, Mr. Robert Clarke.
During the six months ended June 30, 2001, the Company paid $248,000 to ePHONE
Technologies, Inc., a related party, for consulting services.
During the six months ended June 30, 2001, the Company paid $100,000 as provided
for in a Service and Deployment Agreement with 7bridge Systems, LTD, a related
party for the repurchase of certain equipment.
During the six months ended June 30, 2001, the Company paid $25,000 in
consulting fees to an officer of the Company.
6
NOTE 4 - STOCKHOLDERS' EQUITY
In late March and early April 2002, we received approximately $690,000 for the
exercise of warrants for the purchase of 3,448,913 shares of common stock which
had been issued in connection with the sale of Special Warrants originally
issued in early 2000. On June 30, 2002, the remaining warrants for the purchase
of 9,115,000 shares of common stock expired unexercised.
During March 2002, we issued 171,431 shares to two consultants and two members
of our Board of Directors. The fair value of the shares totaled $38,000 and was
recorded based upon the market price of the stock on the date of issuance.
During the six months ended June 30, 2002, two executive officers exercised
options to purchase 342,500 shares of our common stock at an exercise price of
$0.35 with the proceeds totaling $120,000.
NOTE 5 - COMMITMENTS AND CONTINGENCIES
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 of $10,000,000
due to what we believe to have been violations by Comdial of the Array Telecom
License Agreement. Comdial initially responded to our arbitration demand with a
counterclaim seeking relief from all of our claims and the payment of $215,000
in accrued royalties plus interest. Subsequently, Comdial has also added an
additional counterclaim alleging that the agreement is still valid and is
seeking the value of the future royalty payments which were to be made under the
agreement. Comdial terminated the agreement in 2001 and we have given back
the licensed products to Comdial, and consequently, do not believe that we have
an obligation for any additional future royalties based upon the use of the
licensed products. We believe the $215,000 plus accrued interest of
approximately $21,000 is our maximum exposure in the event of an unfavorable
outcome and have recorded these amounts as accrued liabilities at June 30, 2002.
An Arbitration hearing was completed in Washington D.C. on May 29, 2002. The
company has subsequently filed briefs related to its position in this case with
the Arbitrators and we are currently awaiting a decision, which is expected to
be handed down in September 2002.
7
FORWARD LOOKING STATEMENTS
Certain information in this report including statements made in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
elsewhere in this Form 10-QSB contain "forward-looking statements". All
statements other than statements of historical fact are "forward-looking
statements", including any projections of earnings, revenues or other financial
items, any statements of the plans and objectives of management for future
operations, any statements concerning proposed new products or services, any
statements regarding future economic conditions or performance, and any
statements of assumptions underlying any of the foregoing. In some cases,
forward-looking statements can be identified by the use of terminology such as
"may", "will", "expects", "plans", "anticipates", "estimates", "potential", or
"continue", or the negative thereof or other comparable terminology. These
statements involve known and unknown risks, uncertainties and other factors
which may cause our actual results, performance or achievements to be materially
different from any future results, performance or achievements expressed or
implied by the forward-looking statements.
In addition to factors that may be described in this Form 10-QSB, the following
factors, among others, could cause our actual results to differ materially from
those expressed in any forward-looking statements we make:
o the rate of expansion of our network and/or customer base
o introduction of new products
o inaccuracies in our forecasts of customer or market demand
o highly competitive market conditions
o changes in or developments under laws, regulations and licensing
requirements
o changes in telecommunications technology
o changes in economic conditions in the countries in which we plan to
operate
These factors should not be construed as exhaustive. We will not update or
revise any forward-looking statements. See also "Risk Factors" for additional
cautionary statements identifying important factors with respect to
forward-looking statements contained in this Form 10-QSB that could cause actual
results to differ materially from results or expectations referred to in the
forward-looking statements.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Our core strategy is to become a next generation global facilities based
marketing and sales oriented telecommunications carrier providing a full
complement of telecommunications and data services utilizing the efficiency and
reliability of new generation VOIP based telecommunication technologies.
This entails operating as a wholesale carrier, interexchange carrier and as a
retail services provider. Using a private Internet Protocol ("IP") network, the
public Internet and the public switched telephone network ("PSTN"), we have
developed the capability to provide voice and data transmission and other
telephony features at high quality and low cost. Our role as an Interexchange
Carrier allows us to capitalize on inexpensive wholesale termination rates,
which are further leveraged into retail products in order to increase overall
margins.
Since we commenced commercial operations utilizing our new strategy based upon a
Cisco-based network in August of 2001 we have generated service revenue of over
$12,000,000 since that date and are continuing to increase service revenue every
month. The success of our retail programs and increasing wholesale business has
enabled us to attain profitability during the first quarter.
We believe our aggressive approach to marketing and sales is as important as the
technologies being employed. We are committed to staying at the leading edge of
telecommunications and information technologies but believe our real competitive
advantage will be sustained through a creative and innovative approach to
acquiring and maintaining customers and channel distribution partners
For example, we have begun to introduce a new product called eTRANSPORT
("eTRANSPORT"). The eTRANSPORT is a piece of equipment that is installed between
the phone and the incoming phone line at the customer premises. Our service to
the customer is virtually the same as the 1+ long distance service, however it
is prepaid with the added benefit of portability.
We have worked closely with the designer and manufacturer of eTRANSPORT and have
integrated the device with our network. We have secured the exclusive rights to
the version of the device that works with our network, which provides features
and the functionalities that customers' desire. We are also working with
marketing entities to introduce the product to market through home shopping TV
channels and large retail chains that are the after market distribution channels
for products marketed "As Seen on TV".
Results of Operations - Three and Six months ended June 30, 2002 and 2001
-------------------------------------------------
We experienced net income from operations for the three and six months ended
June 30, 2002 and net losses from operations for the three and six months ended
June 30, 2001.
Three months Three months Six months Six months
ended June ended June ended June ended June
30, 2002 30, 2001 30, 2002 30, 2001
-------------- -------------- -- -------------- -- --------------
Net income (loss) from operations $ 405,000 $ (1,698,000) $ 618,000 $ (3,982,000)
Net income (loss) per common share 0.01 (0.10) 0.02 (0.23)
9
Revenues
- --------
Our revenue from operations for the three and six months ended June 30, 2002 and
2001 were as follows.
Three months Three months Six months Six months
ended June ended June ended June ended June
30, 2002 30, 2001 30, 2002 30, 2001
-------------- -------------- -------------- -------------
Service Revenue $ 5,081,000 $ - $ 9,143,000 $ -
Product Revenue - 94,000 - 513,000
-------------- -------------- -------------- -------------
$ 5,081,000 $ 94,000 $ 9,143,000 $ 513,000
============== ============== ============== =============
During the six months ended June 30, 2002, increasing business from our retail
and wholesale programs that were introduced in Q3 of FY 2001, coupled with the
significant reduction of general and administrative and selling and marketing
costs were the primary reasons for the overall improvement in operations.
The majority of the increase in our revenues is attributed to the Company's
"Unlimited Calling" Program. Prepaid calling card programs and our wholesale
strategy also contributed to the increase. These programs accounted for all of
ePHONE's revenue for the six months ended June 30, 2002 and did not account for
any revenue during the same period in 2001. As of June 2002, cash collections of
$807,000 were considered pre-paid and are reflected in the Current Liability
section of the Balance Sheet as "Deferred Revenue". Of this amount, we will earn
$768,000 during July 2002. The $419,000 of Array Telecom equipment sales in Q1
of 2001 will not reoccur.
Cost Of Revenues
- ----------------
During the three and six months ended June 30, 2002 and 2001 cost of services
revenue and cost of product revenue were as follows.
Three months Three months Six months Six months
ended June ended June ended June ended June
30, 2002 30, 2001 30, 2002 30, 2001
-------------- -------------- -------------- -------------
Cost of service revenue $ 2,776,000 $ - $ 5,262,000 $ -
Cost of product revenue - 203,000 - 476,000
-------------- -------------- -------------- -------------
$ 2,776,000 $ 203,000 $ 5,262,000 $ 476,000
============== ============== ============== =============
For the six months ended June 30, 2002, cost of goods sold represented
commissions, activation fees and processing charges related to our
telecommunications services programs. For the six months ended June 30, 2001,
cost of goods sold was related to telecommunications equipment sales. Gross
margin for the three months ended June 30, 2002 and 2001 was 45% and (116%),
respectively, and gross margin for the six months ended June 30, 2002 and 2001
was approximately 42% and 7%, respectively.
10
Sales and marketing
- -------------------
Sales and marketing expense decreased from $915,000 for the six months ended
June 30, 2001 to $565,000 for the same period in 2002. During 2001, 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 the six months ended June 30, 2002. Currently,
sales and marketing expense consists primarily of marketing commissions and
salaries.
General and administrative
- --------------------------
General and administrative expense decreased from $3,215,000 for the six months
ended June 30, 2001 to $2,683,000 for the same period in 2002. General and
administrative expense included non-cash compensation of $38,000 and $123,000
for the six months ended June 30, 2002 and 2001, respectively. The 2002 expense
represented the fair value of 171,000 shares of our common stock issued for
consulting services to two consultants and to two members of our Board of
Directors. A portion of the 2001 non-cash compensation was incurred in
connection with a settlement between us and a former officer under which 400,000
shares of common stock with a fair value of $80,000 were issued to this former
officer. The remaining $43,000 of non-cash compensation in 2001 represents the
fair value of 250,000 stock options issued to a consultant in exchange for
services rendered. We expect general and administrative expenses to increase in
the future in direct proportion to the increase in sales.
Income taxes
- ------------
There was no provision for federal or state income taxes for the six months
ended June 30, 2002 due to the availability of a net operating loss (NOL) for
income tax purposes. This NOL was generated from previous operating losses
incurred since inception. A valuation allowance has been established and,
accordingly, no asset has been recorded for our net operating losses and other
deferred tax assets.
Liquidity And Capital Resources
- -------------------------------
During the six months ended June 30, 2002, we received $690,000 from the
exercise of warrants we had issued in connection with the sale of special
warrants in 2000 for the purchase of 3,448,913 shares of our common stock. On
March 30, 2002, the warrants for the purchase of 9,115,161 shares of our common
stock expired unexercised. The proceeds from the exercise of these warrants,
along with cash generated from our operations during the first six months of
2002 increased our cash from $36,000 at December 31, 2001 to $1,508,000 at June
30, 2002. We also received $120,000 in connection with employee stock options
exercised by two executive officers of ePHONE to purchase 342,500 shares of
ePHONE's common stock at $0.35 per share.
For the six months ended June 30, 2002, utilizing our new strategy based upon a
Cisco-based network we have generated service revenue of over $ 9,100,000. Our
liquidity continues to improve and as of June 30, 2002 we had a total of
$1,508,000 of cash in the bank. We plan to expand our current products and
services in 2002. We have been successful in generating net income from
operations since we deployed our new Cisco-based network in August 2001. Our
anticipated future cash flows from operations is dependent upon our ability to
achieve our revenue and gross profit objectives from our current products and
services and introduction of new products we plan to launch in 2002. We believe
that our cash on hand and positive cash flows from operations is sufficient for
our current operations.
It is important to point out that since our inception, we have accumulated a
deficit of $21,723,000, and that we funded our operations, prior to our
generating service revenues beginning in August 2001, primarily with the
proceeds we raised in our special warrant offering in 2000, from the exercise of
warrants during 2001 of $305,000, and from limited equipment sales. The
company does not currently have a line of credit or any other credit facility.
11
While our service revenues continue to increase during the first two quarters of
2002, and while management anticipates that growth in service revenues will
continue throughout the remainder of 2002, we cannot assure you that this will
happen. Future prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in the telecommunications
industry. To address these risks and achieve profitability and increased sales
levels, we must, among other things, continue to establish and increase market
acceptance of our products, respond effectively to competitive pressures, offer
high quality customer service and support, and successfully introduce, on a
timely basis, new products and enhancements to our existing product set.
We anticipate, based on our present plans and assumptions, that our current cash
balances and projected level of 2002 operations will be sufficient to enable us
to sustain our current and planned operations for at least the next 12 months,
and will not need to raise additional funding. However, we cannot assure you
that this will hold true.
For the six months ended June 30, 2002, we generated $1,208,000 of cash from our
operating activities. The amount of cash provided by operations for the six
months ended June 30, 2002 in excess of the $618,000 net income for that same
period is attributed to increases in deferred revenue, accrued liabilities and
depreciation expense partially offset by decreases in our accounts payable and
increases in our accounts receivable balances.
Investing activities used $473,000 of cash for the purchase of fixed assets and
financing activities provided $737,000 which consisted of $810,000 received from
the exercise of warrants and employee stock options offset by payments on
obligations for the six months ended June 30, 2002.
We have three equipment commitments totaling $80,000 which expire in 2003 and
2004.
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 received an
additional 10% of their original investment in shares of our common stock upon
the exercise of the special warrants. As of June 30, 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 13,436,317 shares
of our common stock and warrants to purchase 13,436,317 shares of our common
stock for $1.60 per share.
During the year ended December 31, 2001, we raised $305,000 from the exercise of
warrants for the purchase of 848,243 shares of our common stock.
During the third quarter of 2001, we decided to provide our warrant holders with
an enticement to exercise their warrants by reducing the exercise price of the
warrants we issued on the exercise of the special warrants and for all other
outstanding warrants from exercise prices ranging between $1.60 - $0.50 per
share to $0.35 per share. We further reduced the exercise price of the warrants
to $0.20 in 2002 to better reflect the market price of our common stock. As
noted above, during 2002 warrant holders exercised warrants for the purchase of
3,448,913 shares of our common stock for $690,000.
12
Risk Factors
- ------------
The risks and uncertainties described below are not the only ones facing the
company. Additional risks not presently known or that ePHONE currently considers
insignificant may also impair ePHONE's business operations in the future.
ePHONE's business, financial condition and plan of operations could be
materially adversely affected by any of the following risks. The trading price
of shares of ePHONE's common stock could decline due to any of these risks.
o The market for ePHONE's common stock is limited
There is currently only a limited trading market for ePHONE's common stock.
ePHONE common stock trades on the OTC Bulletin Board under the symbol "EPHO,"
which is a limited market in comparison to the NASDAQ National Market, the
American Stock Exchange and other national securities exchanges.
ePHONE cannot assure investors that the common stock will ever qualify for
inclusion on the NASDAQ National Market or that more than a limited market will
ever develop for the common stock.
o Penny stock rules limit the liquidity of ePHONE's common stock
ePHONE's common stock may now and in the future be subject to the penny stock
rules under the Securities Exchange Act of 1934, as amended (referred to herein
as the Exchange Act). These rules regulate broker-dealer practices for
transactions in "penny stocks." Penny stocks generally are equity securities
with a price of less than $5.00. The penny stock rules require broker-dealers to
deliver a standardized risk disclosure document that provides information about
penny stocks and the nature and level of risks in the penny stock market. The
broker-dealer must also provide the customer with current bid and offer
quotations for the penny stock, the compensation of the broker-dealer and its
salesperson and monthly account statements showing the market value of each
penny stock held in the customer's account. The bid and offer quotations and the
broker-dealer and salesperson compensation information must be given to the
customer orally or in writing prior to completing the transaction and must be
given to the customer in writing before or with the customer's confirmation.
In addition, the penny stock rules require that prior to a transaction, the
broker and/or dealer must make a special written determination that the penny
stock is a suitable investment for the purchaser and receive the purchaser's
written agreement to the transaction. These additional penny stock disclosure
requirements are burdensome and may reduce the trading activity in the market
for ePHONE's common stock. As long as the common stock is subject to the penny
stock rules, holders of such ePHONE common stock may find it more difficult to
sell their securities.
o An investment in ePHONE may be diluted
ePHONE may issue a substantial number of shares of ePHONE common stock without
investor approval. Any such issuance of ePHONE securities in the future could
reduce an investor's ownership percentage and voting rights in ePHONE and
further dilute the value of his or her investment.
In 2001 and 2000, ePHONE incurred net losses of approximately $7,021,000 and
$13,701,000, respectively. During the six months ended June 30, 2002, ePHONE
generated net income of $618,000. ePHONE's ability to sustain profitable
operations depends on many circumstances. If ePHONE does not sustain
profitability, its ability to respond effectively to market conditions, to make
capital expenditures and to take advantage of business opportunities could be
affected. In addition, ePHONE's prospects must be considered in light of the
risks encountered by companies like ours developing products and services in new
and rapidly evolving markets. ePHONE's failure to perform in these areas could
have a material adverse effect on the business, plan of operations and financial
condition.
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o ePHONE's failure to acquire, integrate and operate new technology could
harm their competitive position
The telecommunications industry is characterized by rapid and significant
technological advancements and the related introduction of new products and
services. ePHONE does not possess significant intellectual property rights with
respect to the technologies we use, and we are dependent on third parties for
the development of and access to new technology. The effect of technological
changes on ePHONE's business plan cannot be predicted. In addition, it is
impossible for ePHONE to predict with any certainty whether demand for VoIP
services in the future markets will develop or will prove to be an economical
and efficient technology that is capable of attracting customer usage. Failure
by ePHONE to obtain and adapt to new technology in the future markets could have
a material adverse effect on their business and plan of operations.
o ePHONE does not presently intend to pay dividends on our common stock
ePHONE has never paid dividends on our common stock and does not presently
intend to pay cash dividends on our common stock. Any future decisions as to the
payment of dividends will be at the discretion of ePHONE's Board of Directors,
subject to applicable law. See "Dividend Policy."
o Telecommunications related stock prices have been especially volatile
and this volatility may depress ePHONE's stock price
The stock market has from time to time experienced significant price and volume
fluctuations which have particularly affected the market prices of the stocks of
high technology and Telecommunications-related companies, including companies
like ePHONE, and which may be unrelated or disproportionate to the operating
performance of particular companies. Factors such as quarterly variations in
actual or anticipated operating results, changes in earnings estimates by
analysts, market conditions in the industry, analysts' reports, announcements by
competitors, regulatory actions or other events or factors, including the risk
factors described in this annual report and general economic conditions may have
a significant effect on the market price of ePHONE's common stock. This broad
market and industry volatility may reduce the value of ePHONE's common stock,
regardless of ePHONE's operating performance. Due to this volatility, the value
of ePHONE's common stock could decrease.
o ePHONE's Articles of Incorporation provide their Officers and Directors
with certain indemnification.
ePHONE's Articles of Incorporation provide that our directors and officers will
not be personally liable to ePHONE or its shareholders for money damages for
breach of the fiduciary duty of care as a director or officer.
PART II - OTHER INFORMATION
Item 1. Legal proceedings -
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 of $10,000,000
due to what we believe to have been violations by Comdial of the Array Telecom
License Agreement. Comdial initially responded to our arbitration demand with a
counterclaim seeking relief from all of our claims and the payment of $215,000
in accrued royalties plus interest. Subsequently, Comdial has also added an
additional counterclaim alleging that the agreement is still valid and is
seeking the value of the future royalty payments which were to be made under the
agreement. We have given back the licensed products to Comdial, and
consequently, do not believe that we have an obligation for any additional
future royalties based upon the use of the licensed products. We believe the
$215,000 plus accrued interest of approximately $16,000 is our maximum exposure
in the event of an unfavorable outcome and have recorded these amounts as
accrued liabilities at December 31, 2001. An Arbitration hearing was completed
in Washington D.C. on May 29, 2002. The company has subsequently filed briefs
related to its position in this case with the Arbitrators and we are currently
awaiting a decision, which is expected to be handed down in September 2002.
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Item 2. Changes in securities and use of proceeds - None.
Item 3. Defaults upon senior securities
Item 4. Submission of matters to a vote of security holders - None.
Item 5. Other information - None.
Item 6. Exhibits and reports on Form 8-K
A. Exhibits
Exhibit No. Description
- ----------- --------------------------------------------------------------
3.1........ Articles of Incorporation (1)
3.2........ Amendment to Articles of Incorporation (1)
3.3........ Bylaws (1)
3.4........ Amended and Restated Articles of Incorporation (2)
3.5........ Amended and Restated Articles of Incorporation (3)
99.1....... Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2....... Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(1) Previously filed as an exhibit to ePHONE's Form 10-SB, filed with the
Securities and Exchange Commission on October 15, 1999.
(2) Previously filed as an exhibit to Amendment No. 2 to ePHONE's Form
10-SB, filed with the Securities and Exchange Commission on January 5,
2000.
(3) Previously filed as an exhibit to Amendment No. 1 to ePHONE's
preliminary proxy filed with Securities and Exchange Commission on July
24, 2002.
B. Reports on Form 8-K: None
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SIGNATURE PAGE
Pursuant to the requirements of Section 12 of the Securities Exchange Act of
1934, the registrant has duly caused this registration statement to be signed on
its behalf by the undersigned, thereunto duly authorized.
Signature Date
By /s/ Carmine Taglialatela, Jr. August 13, 2002
- --------------------------------------------
(Carmine Taglialatela, Jr., CEO, Director)
(Principal Executive Officer)
By /s/ Charlie Rodriguez August 13, 2002
- --------------------------------------------
(Charlie Rodriguez, Chief Financial Officer)
(Principal Financial and Accounting Officer)
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