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, 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 September 30, 2002 there were 37,439,068 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 September 30, 2002 and December 31, 2001........................1
Statements of Operations for the Nine Months Ended
September 30, 2002 and 2001......................................................2
Statements of Operations for the Three Months Ended
September 30, 2002 and 2001......................................................3
Statements of Cash Flows for the Nine months Ended
September 30, 2002 and 2001......................................................4
Notes to Financial Statements........................................................5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................8
Item 3 Controls and Procedures.............................................................10
Part II - Other Information
Item 1. Legal Proceedings...................................................................16
Item 2. Changes in Securities and Use of Proceeds...........................................16
Item 3. Defaults Upon Senior Securities.....................................................16
Item 4. Submission of Matters to a Vote of Security Holders.................................16
Item 5. Other Information...................................................................16
Item 6. Exhibits and Reports on Form 8-K.................................................16-17
Signatures .................................................................................18
ePHONE Telecom, Inc.
Balance Sheets
(unaudited)
September 30, December 31,
2002 2001
----------------------------------------
Current Assets:
Cash and cash equivalents $ 2,744,626 $ 35,970
Accounts receivable, net of allowance for returns
of $243,000 and $116,000 at September 30, 2002
and December 31, 2001, respectively 311,394 155,759
Inventory 151,104 16,500
Other receivables 88,900 65,481
----------------------------------------
Total Current Assets 3,296,024 273,710
Property and equipment, net 1,645,240 1,296,561
Other assets 68,043 18,043
----------------------------------------
$ 5,009,307 $ 1,588,314
----------------------------------------
Liabilities and Stockholders' Equity (Deficit):
Current Liabilities:
Accounts payable $ 938,596 $ 850,179
Accrued liabilities 1,322,668 429,189
Accrued Comdial arbitration award 1,600,000 225,576
Deferred revenue 629,092 367,009
Capital lease obligation, current portion 59,161 22,663
----------------------------------------
Total Current Liabilities 4,549,517 1,894,616
----------------------------------------
Capital lease obligation, net of current portion 22,811 15,839
Other long term obligation, net of current portion 67,500 142,500
Commitments and contingencies -- --
Stockholders' Equity (Deficit):
Common stock, par value $0.001:
150,000,000 shares authorized, 37,439,068 and
32,987,381 issued and outstanding at September 30, 2002
and December 31, 2001, respectively. 37,439 32,987
Additional paid-in capital 22,850,735 21,843,199
Accumulated deficit (22,518,695) (22,340,827)
----------------------------------------
Total Stockholders' Equity (Deficit) 369,479 (464,641)
----------------------------------------
$ 5,009,307 $ 1,588,314
Total Liabilities and Stockholders' Equity (Deficit) ----------------------------------------
See accompanying notes to financial statements
1
ePHONE Telecom, Inc.
Statements of Operations
(unaudited)
Nine Months Ended September 30,
2002 2001
-------------------------------------------
Service revenue $ 15,502,135 1,138,627
Product revenue -- $ 512,720
-------------------------------------------
Total Revenues 15,502,135 1,651,347
Operating expenses:
Cost of service revenue 8,400,397 744,851
Cost of product revenue -- 475,826
Sales and marketing 899,472 1,049,700
General and administrative 5,000,362 4,156,793
Write off of Array Telecom license and the disposal of
Obsolete inventory and equipment net -- 871,471
-------------------------------------------
Operating Income (Loss) Before Comdial Arbitration Award 1,201,904 (5,647,294)
Comdial arbitration award 1,374,425 220,082
-------------------------------------------
Loss From Operations (172,521) (5,867,376)
Interest and other (income), net 5,347 (119,286)
-------------------------------------------
Net Loss (177,868) $ (5,748,090)
$ (0.00) $ (0.26)
Earnings (loss) per share--(basic and diluted)
-------------------------------------------
Weighted average number of common
shares outstanding 35,630,753 22,355,401
-------------------------------------------
See notes to accompanying financial statements
2
ePHONE Telecom, Inc.
Statements of Operations
(unaudited)
Three Months Ended September 30,
2002 2001
-------------------------------------------
Service revenue $ 6,358,883 $ 1,138,627
Product revenue -- --
-------------------------------------------
Total Revenues 6,358,883 1,138,627
Operating expenses:
Cost of service revenue 3,138,652 744,851
Cost of product revenue -- --
Sales and marketing 334,579 134,349
General and administrative 2,317,827 941,873
Write off of Array Telecom license and the disposal of
Obsolete inventory and equipment net -- 871,471
-------------------------------------------
Operating Income (Loss) Before Comdial Arbitration Award 567,825 (1,553,917)
Comdial arbitration award 1,374,425 220,082
-------------------------------------------
Loss From Operations (806,600) (1,773,999)
Interest and other (income), net (10,731) (7,836)
-------------------------------------------
(795,869)
Net Loss $ $ (1,766,163)
$ (0.02) $ (0.06)
Earnings (loss) per share--(basic and diluted)
-------------------------------------------
Weighted average number of common
shares outstanding 36,944,596 31,718,947
-------------------------------------------
See accompanying notes to financial statements
3
ePHONE Telecom, Inc.
Statements of Cash Flows
(unaudited)
Nine Months Ended September 30,
2002 2001
------------------------------------------------
Cash Flows from Operating Activities:
<c>
Net loss $ (177,868) $ (5,748,090)
Adjustments to reconcile net loss to net cash flows from
operating activities:
Depreciation and amortization 249,000 772,764
Stock issued for services rendered 37,715 122,500
Allowance for returns 244,000 --
Deferred royalty expense -- 193,334
Inventory reserve -- 108,900
Write off of Array Telecom license and disposal of
Obsolete inventory and equipment -- 871,471
Other -- (8,769)
Changes in operating assets and liabilities:
Accounts receivable and other receivables (494,763) (51,707)
Inventory (134,604) 14,632
Other assets (50,000) 65,500
Accounts payable 88,418 357,145
Accrued liabilities 893,479 (734,274)
Accrued Comdial arbitration award 1,374,424 220,082
Deferred revenue 333,792 279,958
-------------------------------------------------------
Net cash flows provided by (used in) operating activities 2,363,593 (3,536,554)
-------------------------------------------------------
Cash flows from investing activities:
Purchase of fixed assets (525,445) (805,737)
Purchase of marketable securities -- 2,194,157
Deposit to restricted cash, net -- 579,435
-------------------------------------------------------
Net cash flows (used in) provided by investing activities (525,445) 1,967,855
Cash flows provided by financing activities:
Proceeds from exercise of warrants and options 989,273 296,885
Repayments on long-term obligation (75,000) --
Repayment to related party (15,000) --
Repayments on capital lease (28,765) (4,712)
-------------------------------------------------------
Net cash flows provided by financing activities 870,508 292,173
-------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 2,708,656 (1,276,526)
Cash and cash equivalents, beginning of year 35,970 1,525,978
-------------------------------------------------------
$ 2,744,626 $ 249,452
Cash and cash equivalents, end of year
-------------------------------------------------------
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 are a global Voice over Internet Protocol ("VOIP") service provider to retail
and wholesale customers, offering a full complement of telecommunications
services, including phone-to-phone and one-step dialing. This technology is
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, 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 $629,092 in deferred revenue at September 30, 2002,
approximately $590,000 was fully earned during the month of October 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 based
upon factors, which include historical trends and other information.
For the nine months ended September 30, 2001, product sales 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 nine months ended September 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 the nine months ended September 30, 2002, options and warrants to purchase
5,777,249 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 exceed the average market price of our stock
during this period.
NOTE 2 - OPERATIONS
As shown in the accompanying unaudited financial statements, income from
operations before the award incurred in connection with the Comdial Corporation
("Comdial") arbitration proceeding (see Note 5) for the nine months ended
September 30, 2002 of $1,201,904 represents the first three profitable fiscal
quarters in our operating history. Also, of $629,092 recorded as deferred
revenue at September 30, 2002, approximately $590,000 was fully earned during
October 2002. Our continued success is dependent upon our ability to maintain
profitable operations and successfully introduce our products to market. Since
inception we have an accumulated deficit of $22,518,695 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 and 2003 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 nine months ended September 30, 2002, we generated net revenues of
$15,502,135 with a gross margin of $7,101,738 (46%).
NOTE 3 - RELATED PARTY TRANSACTIONS
During the nine months ended September 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 and business expenses
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 in Note 4 Stockholders'
Equity.
During the nine months ended September 30, 2002, we repaid $15,000 that was
advanced to us during 2001 by our then Chairman of the Board, Mr. Robert Clarke.
During the nine months ended September 30, 2001, the Company paid $248,000 to
ePHONE Technologies, Inc., a company in which registrant owns a 20% interest,
for consulting services. These services terminated in May 2001 and are no longer
needed.
During the nine months ended September 30, 2001, the Company paid $100,000 as
provided for in a Service and Deployment Agreement with 7bridge Systems, LTD, a
company owned by the then Chairman of the Board.
During the nine months ended September 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 March 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 approximately
$38,000 and was recorded based upon the market price of the stock on the date of
issuance.
During the nine months ended September 30, 2002, the CEO and CFO exercised
options to purchase 685,000 shares of our common stock at an exercise price of
$0.35 with the proceeds totaling $233,000. Six board members also exercised
options to purchase 189,200 shares of our common stock at an exercise price of
$0.35 with the proceeds totaling $66,220.
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 were 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 added an additional
counterclaim alleging that the agreement was still valid and sought the value of
the future royalty payments which were to be made under the agreement. We
gave back the licensed products to Comdial, and consequently, did not believe
that we had an obligation for any additional future royalties based upon the use
of the licensed products.
On August 27, 2002, the American Arbitration Association (AAA) rejected the
Company's claim against Comdial and awarded damages to Comdial on its counter
claim in the amount of $1,730,903 and $38,192 in administrative fees. The
Company had attempted to have the award reconsidered by the AAA and to have the
award vacated by the circuit court for the county of Fairfax, Virginia. Both of
these efforts were unsuccessful. Hence, on November 13th the Company agreed to
settle the issue and pay to Comdial $1,600,000. This will avoid a very costly
and lengthy appeals process with no guarantee of success and enable the Company
to focus on its operations. This amount is reflected in the accompanying
financial statements.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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
Overview
Our core strategy is to be a next generation global facilities based marketing
and sales oriented VOIP Services provider offering a full complement of
telecommunications and data services utilizing the efficiency and reliability of
next generation VOIP based telecommunication technology. This entails
operating as a wholesale 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 a VOIP Services provider 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
$18,000,000 and have increased service revenue every month. The success of our
retail programs and increasing wholesale business has enabled us to attain
operating profitability during 2002. While we have increased revenue every
quarter for the past four quarters, there is no guarantee that this will
continue in the future.
Given the current difficult economic conditions facing the telecommunications
industry and the delays inherent in bringing new products to market, there is no
assurance that the company will continue to experience in the near-term, the
rate of growth it has enjoyed in the past. While the company has experienced
nine months of profitability and has gained significant market intelligence from
its operations, we are constantly reviewing our product mix to determine those
products best suited to contribute to our long-term financial well-being.
We believe our 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. 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 TV commercials,
direct mail marketing, home shopping TV channels and large retail chains that
are the after market distribution channels for products marketed "As Seen on
TV".
We have received a Carrier Registration and International Telecommunications
Class A License from the Canadian Radio-television and Telecommunications
Commission. This allows us to provide international telecommunication services
anywhere in Canada. A Point-of-Presence (POP) has been deployed in Toronto;
Ontario and will enable ePHONE to offer the eTRANSPORT and other prepaid long
distance calling services to Canadians.
Results of Operations - Three and Nine months ended September 30, 2002 and 2001
-------------------------------------------------------
We experienced net income from operations before the arbitration award (see
Comdial Arbitration below) for the three and nine months ended September 30,
2002 and net losses from operations for the three and nine months ended
September 30, 2001.
Three months Three months Nine months Nine months
ended ended ended ended
September September September September
30, 2002 30, 2001 30, 2002 30, 2001
-------------- -------------- -------------- --------------
Income (loss) before arbitration award $ 567,825 $ (1,553,917) $ 1,201,904 $ (5,647,294)
Arbitration award (1,374,425) (220,082) (1,374,425) (220,082)
Net loss (795,869) (1,766,163) (177,868) (5,748,090)
Net loss per common share (0.02) (0.06) (0.00) (0.26)
9
During the nine months ended September 30, 2002, increasing business from our
retail and wholesale programs that were introduced in Q3 of FY 2001, as
discussed below, coupled with the significant reduction of general and
administrative and selling and marketing costs were the primary reasons for the
overall improvement in operations.
Revenues
Our revenue from operations for the three and nine months ended September 30,
2002 and 2001 were as follows.
Nine
Three months Three months Nine months months
ended ended ended ended
September September September September
30, 2002 30, 2001 30, 2002 30, 2001
-------------- -------------- -------------- -------------
Service Revenue $ 6,358,883 $ 1,138,627 $ 15,502,135 $ 1,138,627
Product Revenue - - - 512,720
-------------- -------------- -------------- -------------
$ 6,358,883 $ 1,138,627 $ 15,502,135 $ 1,651,347
============== ============== ============== =============
The majority of the increase in our revenues is attributed to the Company's
Retail and Wholesale Programs. These programs accounted for all of ePHONE's
revenue for the nine months ended September 30, 2002 and accounted for 69% or
our revenue during the same period in 2001. As of September 2002, cash
collections of $629,092 were considered pre-paid and are reflected in the
Current Liability section of the Balance Sheet as "Deferred Revenue". Of this
amount, we earned approximately $590,000 during October 2002. As ePHONE
continues to focus on retail and wholesale offerings, sales of equipment, with
the exception of sales of our eTRANSPORT devices that are sold along with
prepaid VOIP services, are not expected to be significant in the future. The
$512,720 of Array Telecom equipment sales during the nine months ended September
30, 2001, will not reoccur.
Cost of Revenues
During the three and nine months ended September 30, 2002 and 2001 cost of
services revenue and cost of product revenue were as follows.
Three months Three months Nine months Nine months
ended ended ended ended
September September September September
30, 2002 30, 2001 30, 2002 30, 2001
-------------- -------------- -------------- -------------
Cost of service revenue $ 3,138,652 $ 744,851 $ 8,400,397 $ 744,851
Cost of product revenue - - - 475,826
-------------- -------------- -------------- -------------
$ 3,138,652 $ 744,851 $ 8,400,397 $ 1,220,677
============== ============== ============== =============
For the nine months ended September 30, 2002 and 2001, cost of service revenue
represented commissions, activation fees and processing charges related to our
telecommunications services programs. For the nine months ended September 30,
2001, cost of product revenue was related to telecommunications equipment sales.
Gross margin for the three months ended September 30, 2002 and 2001 was 51% and
35%, respectively, and gross margin for the nine months ended September 30, 2002
and 2001 was approximately 46% and 26%, respectively.
10
Sales and marketing
Sales and marketing expense decreased from $1,049,700 for the nine months ended
September 30, 2001 to $899,472 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 deploying our network was anticipated. There
were no similar expenditures incurred during the nine months ended September 30,
2002. Currently, sales and marketing expense consists primarily of marketing
commissions and salaries.
General and administrative
General and administrative expense increased from $4,156,793 for the nine months
ended September 30, 2001 to $5,000,362 for the same period in 2002. General
and administrative expense included non-cash compensation of $38,000 and
$123,000 for the nine months ended September 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 proportion to the increase in sales.
Comdial Arbitration
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 were 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 added an additional
counterclaim alleging that the agreement was still valid and sought the value of
the future royalty payments which were to be made under the agreement. We
gave back the licensed products to Comdial, and consequently, did not believe
that we had an obligation for any additional future royalties based upon the use
of the licensed products.
On August 27, 2002, the American Arbitration Association (AAA) rejected the
Company's claim against Comdial and awarded damages to Comdial on its counter
claim in the amount of $1,730,903 and $38,192 in administrative fees. The
Company had attempted to have the award reconsidered by the AAA and to have the
award vacated by the circuit court for the county of Fairfax, Virginia. Both of
these efforts were unsuccessful. Hence, on November 13th the Company agreed to
settle the issue and pay to Comdial $1,600,000. This will avoid a very costly
and lengthy appeals process with no guarantee of success and enable the Company
to focus on its operations. This amount is reflected in the accompanying
financial statements.
Income taxes
There was no provision for federal or state income taxes for the nine months
ended September 30, 2001 due to the availability of a net operating loss (NOL)
for income tax purposes. This NOL was generated from operating losses incurred
since inception.
11
Liquidity And Capital Resources
During the nine months ended September 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 nine months of
2002 increased our cash from $36,000 at December 31, 2001 to $2,744,626 at
September 30, 2002. We also received $299,220 in connection with employee stock
options exercised by the CEO, CFO and members of the Board of Directors of
ePHONE to purchase 874,200 shares of ePHONE's common stock at $0.35 per share.
For the nine months ended September 30, 2002, utilizing our new strategy based
upon a Cisco-based network we have generated service revenue of $15,502,135. Our
liquidity continues to improve and as of September 30, 2002 we had a total of
$2,744,626 of cash in the bank. We plan to expand our current products. 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 largely dependent upon our ability to achieve our revenue and
gross profit objectives from our current products and services and introduction
of new products. 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 $22,518,695, 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. We do
not currently have a line of credit or any other credit facility available to
us.
While our service revenues increased during the first three quarters of 2002, we
cannot assure you that this will continue to 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 of our existing products.
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 nine months ended September 30, 2002, we generated $2,363,593 of cash
from our operating activities. The amount of cash provided by operations for the
nine months ended September 30, 2002 in excess of the $1,201,904 of income
before the arbitration award for that same period is attributed to increases in
deferred revenue, accrued liabilities and depreciation expense partially offset
by increases in our accounts receivable and inventory balances.
Investing activities used $525,445 of cash for the purchase of fixed assets and
financing activities provided $870,508 which consisted of $989,273 received from
the exercise of warrants and employee stock options offset by payments on
obligations for the nine months ended September 30, 2002.
We have three equipment commitments totaling $82,000 which expire in 2003 and
2004.
12
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 September 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.
Recent Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of intangible long-lived assets and
the associated asset retirement costs. SFAS No. 143 is effective for fiscal
years beginning after June 15, 2002. The Company has not completed the process
of evaluating the impact that will result from the adoption of SFAS No. 143, but
does not believe that its adoption will have a significant impact on its
financial position or results of operations.
In October 2001, the Financial Accounting Standards Board issued SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144
supersedes previous guidelines for financial accounting and reporting for the
impairment or disposal of long-lived assets and for segments of a business to be
disposed of. The adoption of SFAS No. 144 on January 1, 2002 is not expected to
have a material impact on our financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
SFAS No. 145 requires the classification of gains and losses from
extinguishments of debt as extraordinary items only if they meet certain
criteria for such classification in AAPB No. 30, Reporting the Results of
Operations, Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual, and Infrequently Occurring Events and Transactions. Any
gain or loss on extinguishments of debt classified as an extraordinary item in
prior periods that does not meet the criteria must be reclassified to other
income or expense. These provisions are effective for fiscal years beginning
after May 15, 2002. Additionally, SFAS No. 145 requires sale-leaseback
accounting for certain lease modifications that have economic effects similar to
sale-leaseback transactions. These lease provisions are effective for
transactions occurring after May 15, 2002. The Company has not completed the
process of evaluating the impact that will result from the adoption of SFAS No.
145, but does not believe that its adoption will have a material effect on its
financial position or results of operations.
13
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. SFAS No. 146 replaces Emerging Issues Task Force
Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). SFAS No. 146 requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan. Examples of costs covered by the
standard include lease termination costs and certain employee severance costs
that are associated with a restructuring, discontinued operation, plant closing,
or other exit or disposal activity. SFAS No. 146 is to be applied prospectively
to exit or disposal activities initiated after December 31, 2002. The Company
has not completed the process of evaluating the impact that will result from the
adoption of SFAS No. 146, but does not expect its adoption to have a material
effect on its financial position or results of operations.
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.
14
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.
o ePHONE has incurred net losses in the past
In 2001 and 2000, ePHONE incurred net losses of approximately $7,021,129 and
$13,701,000, respectively. During the nine months ended September 30, 2002,
ePHONE generated net income before the arbitration award of $1,201,904. 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.
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 its 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.
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 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 its 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 their fiduciary duty of care as directors or officers.
15
ITEM 3 CONTROLS AND PROCEDURES
As of September 30, 2002, an evaluation was performed under the supervision and
with the participation of the Company's management, including the CEO and the
CFO, of the effectiveness of the design and operation of the Company's internal
controls. Based on that evaluation, the Company's management, including the CEO
and CFO, concluded that the Company's internal controls were effective as of
September 30, 2002. There have been no significant changes in the Company's
internal controls or in other factors that could significantly affect internal
controls.
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 were 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 added an additional
counterclaim alleging that the agreement was still valid and sought the value of
the future royalty payments which were to be made under the agreement. We
gave back the licensed products to Comdial, and consequently, did not believe
that we had an obligation for any additional future royalties based upon the use
of the licensed products.
On August 27, 2002, the American Arbitration Association (AAA) rejected the
Company's claim against Comdial and awarded damages to Comdial on its counter
claim in the amount of $1,730,903 and $38,192 in administrative fees. The
Company had attempted to have the award reconsidered by the AAA and to have the
award vacated by the circuit court for the county of Fairfax, Virginia. Both of
these efforts were unsuccessful. Hence, on November 13th the Company agreed to
settle the issue and pay to Comdial $1,600,000. This will avoid a very costly
and lengthy appeals process with no guarantee of success and enable the Company
to focus on its operations. This amount is reflected in the accompanying
financial statements.
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 -
The Company held its annual meeting of shareholders on September 12, 2002. There
were four proposals on the agenda, two of which were withdrawn at the meeting by
the Board of Directors and the remaining two items, listed below, were submitted
to a vote of security holders:
1. Election of Mr.Robert W. Stuart, Eugene A. Sekulow and Lawrence M.
Codacovi to the Board of Directors and reelection of Mr. Robert Clarke,
Charlie Rodriguez, Carmine Taglialatela, Jr. and Sheldon B. Kamins to
the Board of Directors.
2. Proposal to ratify Grant Thornton, LLP as ePHONE's independent public
accountants for fiscal year 2002.
16
The result of the voting stockholders were as follows:
1. Directors Stuart Sekulow Codacovi Clarke Rodriguez Taglialatela Kamins
--------- ------ ------- -------- ------ --------- ------------ ------
Against 1,000 1,000 0 1,296,118 400 114,400 1,000
For 20,795,400 20,794,400 20,795,400 19,499,282 20,795,000 20,681,000 20,794,400
Abstain 56,650 56,650 56,650 56,650 56,650 56,650 56,650
2. Proposal For Against Abstain
-------- --- ------- -------
20,802,050 47,000 3,000
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)
9.1.............. Arbitration Award (4)
9.2.............. Press Release issued in connection with the
Comdial Arbitration (4)
9.3.............. Arbitration Settlement Agreement
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.
(4) Previously filed as an exhibit to ePHONE's form 8-K filed with the
Securities and Exchange Commission on September 9, 2002.
B. Reports on Form 8-K:
On September 9, 2002, ePHONE filed with the Commission a current report
on Form 8-K related to the Arbitration between ePHONE and Comdial
Corporation.
On September 24, 2002, ePHONE filed with the Commission a current
report on Form 8-K related to the Arbitration between ePHONE and
Comdial Corporation.
On November 8, 2002, ePHONE filed with the Commission a current report
on Form 8-K related to the Arbitration between ePHONE and Comdial
Corporation.
17
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. November 14, 2002
-------------------------------------------
(Carmine Taglialatela, Jr., CEO, Director)
(Principal Executive Officer)
By /s/ Charlie Rodriguez November 14, 2002
--------------------------------------------
(Charlie Rodriguez, Chief Financial Officer)
(Principal Financial and Accounting Officer)
18