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 March 31, 2003
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF EXCHANGE ACT
Commission File Number 000-27699
ePHONE Telecom, Inc.
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(Name of small business issuer as specified in its charter)
Florida 98-0204749
------- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1145 Herndon Parkway
Herndon, Virginia 20170-5535
---------------------------------------
(Address of principal executive offices)
(703) 787-7000
---------------------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. |X|Yes |_| No
As of March 31, 2003 there were 40,476,298 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. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002...............1
Consolidated Statements of Operations for the Three Months Ended
March 31, 2003 and 2002..........................................................2
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2003 and 2002..........................................................3
Notes to Consolidated Financial Statements...........................................4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................8
Item 3. Controls and Procedures.............................................................15
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
Signatures .................................................................................17
Part I. -Financial Information
ePHONE Telecom, Inc.
Consolidated Balance Sheets
(unaudited)
March 31, December 31,
2003 2002
----------------------------------------
Current Assets:
Cash and cash equivalents $ 155,444 $ 1,252,936
Accounts receivable, net of allowance for returns of $270,000 at March 31,
2003 and December 31, 2002. 480,432 419,049
Inventory 358,380 263,608
Other receivables 149,819 86,789
------------------ -----------------
Total Current Assets 1,144,075 2,022,382
Property and equipment, net 1,590,597 1,686,704
Other assets 68,043 68,043
------------------ -----------------
Total Assets $ 2,802,715 $ 3,777,129
================== =================
Liabilities and Stockholders' Equity (Deficit)
Current Liabilities:
Accounts payable $ 1,680,654 $ 961,745
Accrued liabilities 700,223 1,187,355
Deferred revenue 68,098 278,956
Promissory note payable, net of discount of $188,889 11,111 -
Capital lease obligation, current portion 44,857 51,385
------------------ -----------------
Total Current Liabilities 2,504,943 2,479,441
------------------ -----------------
Other long term obligation, net of current portion 46,772 68,126
Stockholders' Equity (Deficit):
Common stock, par value $0.001: 150,000,000 shares authorized,
40,476,298 and 38,084,994 issued and outstanding at March 31, 2003
and December 31, 2002, respectively 40,476 38,085
Other Comprehensive Income 6,203 -
Additional paid-in capital 23,247,134 23,029,524
Accumulated deficit (23,042,813) (21,838,047)
------------------ -----------------
Total Stockholders' Equity (Deficit) 251,000 1,229,562
------------------ -----------------
Total Liabilities and Stockholders' Equity (Deficit) $ 2,802,715 $ 3,777,129
================== =================
See accompanying notes to consolidated financial statements
1
ePHONE Telecom, Inc.
Consolidated Statements of Operations
(unaudited)
Three Months Ended March 31,
2003 2002
---------------- -----------------
Revenues $ 2,090,735 $ 4,061,823
Cost of Revenues 2,073,292 2,485,248
---------------- -----------------
Gross Margin 17,443 1,576,575
Operating expenses:
Sales and Marketing 280,181 200,408
General and Administrative 905,199 1,153,655
---------------- -----------------
Operating Income (Loss) (1,167,937) 222,512
Interest and Other (Income), net 36,829 9,418
---------------- -----------------
Net Loss $ (1,204,766) $ 213,094
================ =================
Earnings (loss) per share--(basic and diluted) $ (0.03) $ 0.01
================ =================
Weighted average number of common shares outstanding 38,536,685 33,022,298
================ =================
See accompanying notes to consolidated financial statements
2
ePHONE Telecom, Inc.
Consolidated Statements of Cash Flows
(unaudited)
Three Months Ended March 31,
2003 2002
------------------- -------------------
Cash Flows from Operating Activities:
Net (loss) income $ (1,204,766) $ 213,094
Adjustments to reconcile net (loss) income to net cash flows from
operating activities
Depreciation and amortization 105,547 72,622
Amortization of debt discount 11,111
Stock issued for services rendered 20,000 37,715
Allowance for returns - 56,000
Changes in operating assets and liabilities:
Accounts receivable and other receivables (124,413) (891)
Inventory (94,772) 16,500
Other assets (50,000)
Accounts payable 718,909 (111,633)
Accrued liabilities (487,132) 52,755
Deferred revenue (210,858) 196,885
------------------- -------------------
Net cash flows (used in) provided by operating activities (1,266,374) 483,047
------------------- -------------------
Cash flows from investing activities:
Purchase of fixed assets (9,440) (102,347)
------------------- -------------------
Net cash flows used in investing activities (9,440) (102,347)
------------------- -------------------
Cash flows provided by financing activities:
Proceeds from exercise of warrants and options - 301,389
Repayments on long-term obligation (15,000) (15,000)
Repayment to related party - (15,000)
Proceeds from Bridge Loan 200,000 -
Repayments on capital lease (12,881) (5,187)
------------------- -------------------
Net cash flows provided by financing activities 172,119 266,202
------------------- -------------------
Effect of Exchange Rates on cash 6,203 -
------------------- -------------------
Net decrease (increase) in cash and cash equivalents (1,097,492) 646,902
Cash and cash equivalents, beginning of period 1,252,936 35,970
------------------- -------------------
Cash and cash equivalents, end of period $ 155,444 $ 682,872
------------------- -------------------
See accompanying notes to consolidated financial statements
3
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". The Company provides telecommunication services to retail and wholesale
customers. The Company is 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 consolidated 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 2002 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.
Net Earnings (Loss) per Share
We report basic and diluted loss per share. Basic loss per share is computed by
dividing net loss by the weighted average number of outstanding shares of common
stock. Diluted earnings per share is computed by dividing net loss by the
weighted average number of shares adjusted for the potential dilution that could
occur if stock options, warrants and other convertible securities were exercised
or converted into common stock.
For the three months ended March 31, 2003, options and warrants to purchase
4,564,916 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.
Inventory
Inventory consists primarily of e-Trans-Port devices held for resale and is
stated at the lower of cost, utilizing the weighted average method, or market.
Stock Based Compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees", and related interpretations, and
comply with the disclosure provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," as amended by SFAS 148, "Stock Compensation -
Transition and Disclosure". Under APB No. 25, compensation expense is based on
the difference, if any, on the date of the grant, between the fair value of our
common stock and the exercise price.
4
The following table illustrates the effect on net income (loss) and net income
(loss) per share had compensation costs for the stock-based compensation plan
been determined based on grant date fair values of awards under the provisions
of SFAS No. 123, for the three month periods ended March 31:
2003 2002
-------------- ---------------
Net income (loss)
As reported: $(1,204,766) $ 213,094
Less total stock-based compensation expense
determined under fair value-based method for
all awards (79,500) (79,500)
-------------- ---------------
Pro forma (1,284,266) 133,594
============== ===============
Net income (loss) per share, basic and diluted
As reported $ (0.03) $ 0.01
Pro forma $ (0.03) $ (0.00)
The Company accounts for non-employee stock-based awards in which services are
the consideration received for the equity instruments issued based on the fair
value of the consideration received or the fair value of the equity instrument
issued, whichever is more reliably measured. The Company determined the value of
stock grants made to both employees and non-employees based on the quoted market
price of our common stock on the date of grant.
Operations
As shown in the accompanying unaudited consolidated financial statements the
Company incurred a net loss for the three months ended March 31, 2003 of
$1,204,766 and since our inception we have an accumulated deficit of
approximately $23,000,000.
We are currently experiencing a significant shortage of working capital. On
March 13, 2003, we received $200,000 from a private investment group under a 9%
short-term promissory note agreement. This note is due in December 2003. The
agreement also required that we issue to this private investment group
unregistered shares of our common stock equal to the face amount of the note.
Based on the market price, we issued 2,173,913 shares of our common stock to
this group.
On May 6, 2003, we entered into a non-binding letter of intent with Champion
Teleport, Inc. ("Champion") under which we would merge with Champion, with the
Champion shareholders receiving 99,641,757 shares of our common stock. This will
cause significant dilution to our current shareholders. Management and the Board
of Directors believes that due to the Company's current financial condition,
this transaction will be in the best interest of the current shareholders of the
Company. The Company has received $200,000 from Champion under a 9% convertible
secured promissory note due in September 2003. This note is convertible into
13,333,333 shares of our common stock. (Exhibit 10.7)
The Company's financial statements have been prepared on a going concern basis,
which contemplates the realization of assets, and the satisfaction of
liabilities in the normal course of business. Our auditors have included in
their Report of Independent Certified Public Accountants, dated February 10,
2003 (except for the third paragraph of Note 2, as to which the date is April
11, 2003), a fourth (explanatory) paragraph drawing attention to factors that
raise substantial doubt about our ability to continue as a going concern.
In the fourth quarter of 2002, we phased out our marketing agreement with our
Unlimited Domestic Calling Program telemarketer. As a result, we experienced a
decline in revenues from our Unlimited Domestic Calling Program when compared to
earlier in 2002. During the three months ended March 31, 2003, we generated
$73,000 in revenue from our Unlimited Domestic Program compared to $2,990,000
and $16,870,000 of revenue generated under this program during the three month
period ended December 31, 2002 and for the year ended December 31, 2002,
respectively.
5
The Company has entered into new a telemarketing agreement with a new
telemarketing organization and is actively seeking new telemarketing agreements.
The Company has reorganized its subscription fulfillment and collection
procedures.
The Company has undertaken significant expense reduction actions during 2003. We
have reduced head count by 60% and senior management salaries have been reduced
by 20%. The company has also reduced and deleted other non-operational costs.
While the Chief Executive and Chief Financial Officers had earned a $200,000
bonus collectively which was accrued on the 2002 10-K, they have forgone payment
of this bonus. The expense has been reversed in this quarter and the bonus
will not be paid. The company is continuing to evaluate other cost
reductions to increase efficiency in the day-to-day operations.
Despite our cost cutting and other efforts described above, our cash shortage
has caused revenues for the 3 months ending June 30, 2003 to run behind the 3
months ending March 31, 2003.
Management believes that, even though it continues to provide both wholesale and
retail services to customers and has taken drastic cost cutting actions during
2003, that with the decline in our Unlimited Domestic Calling Program it needs
to raise additional funding in the short term in order to provide for needed
working capital and for marketing efforts related to the introduction of new
products, including e-TRANSPORT. The Company is currently seeking additional
investment capital and has signed a non-binding letter of intent to merge as
described above. The Company believes that without additional investment capital
it will not have sufficient cash to fund our current activities, and as such,
may not be able to continue operating. Future prospects must be considered in
light of the risks, expenses and difficulties frequently encountered by
companies in the telecommunications industry
The consolidated financial statements do not include any adjustments relating to
the recoverability and classification of liabilities that might be necessary
should we be unable to continue as a going concern.
NOTE 2 - RELATED PARTY TRANSACTIONS
During the three months ended March 31, 2003 we did not incur any related party
transactions. During the three months ended March 31, 2002 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. The 2002 expense represents the fair value of 66,668
shares of our common stock issued in lieu of cash payments.
NOTE 3 - ACCRUED LIABILITIES
Accrued expenses consist of the following at March 31, 2003 and December 31,
2002:
2003 2002
-------- ----------
Accrued vacation 52,402 $ 72,257
Accrued compensation 240,232 631,457
Accrued legal fees 25,000 50,000
Other 382,589 433,641
--------- -----------
700,223 $1,187,355
========= ===========
NOTE 5 - PROMISSORY NOTE PAYABLE
On March 13, 2003, the Company entered into a promissory note agreement for
$200,000 in order to meet its working capital needs. This promissory note bears
interest at 9%, with principal and accrued interest due on December 13, 2003.
The Company also issued to the note holder 2,173,913 shares of its common stock.
The shares of common stock had a fair market value on the date of issuance of
$200,000. The Company has recorded the fair value of the shares of common stock
as a discount to the promissory note and is recognizing the discount as
additional interest expense over the life of the promissory note. The Company
recognized $11,111 of the discount during the three months ended March 31, 2003.
6
NOTE 6 - STOCKHOLDERS' EQUITY
On March 13, 2003, the Company entered into a promissory note agreement for
$200,000 in order to meet its working capital needs. This promissory note bears
interest at 9%, with principal and accrued interest due on December 13, 2003.
The Company also issued to the note holder 2,173,913 shares of its common stock
as additional incentive for the note holder to lend the funds to the Company.
The shares of common stock had a fair market value on the date of issuance of
$200,000. Pursuant to the broker agreement, the agent of record received a
commission of 217,913 shares of common stock. These shares of common stock had a
fair market value on the date of issuance of $20,000.
On May 6, 2003, the Company and Champion entered into a letter of intent to
merge Champion with and into a wholly-owned subsidiary of the Company. In
connection with this proposed transaction, the Company would issue 99,641,757
shares of its common stock to the Champion shareholders in exchange for all of
the issued and outstanding shares of Champion's capital stock. The transaction
is subject to, among other things, the Company's receipt of a "Fairness Opinion"
with respect to the transaction and the completion of due diligence by both
parties. In addition, on May 6, 2003, Champion loaned the Company $200,000
pursuant to a 9% convertible secured promissory note ("Note") due on September
1, 2003. The Note is convertible into an aggregate of 13,333,333 shares of
Company common stock.
NOTE 7 - COMMITMENTS AND CONTINGENCIES
In April 2003, the Company was informed by the Federal Trade Commission that
they have commenced a non-public investigation relating to whether the form of
payment authorization which the Company received from customers who purchased
its Unlimited Domestic Calling Program complied with the requirements of the
Electronic Fund Transfer Act and its implementing Regulation E. Management
believes that at this stage it is too early to determine whether the
investigation will result in a loss to the Company or to estimate the amount of
such loss, if any.
NOTE 8 - SUBSEQUENT EVENTS
On May 6, 2003, the company and Champion entered into a letter of intent to
merge Champion with and into a wholly-owned subsidiary of ePhone (the
"Transaction"). In connection with the Transaction, ePhone will issue 99,641,757
shares of its common stock to the Champion shareholders in exchange for all of
the issued and outstanding shares of Champion's capital stock.
The Transaction is subject to ePhone's receipt of a "Fairness Opinion" with
respect to the Transaction and continued due diligence by both parties.
In addition, on May 6, 2003, Champion loaned $200,000 to ePhone pursuant to a 9%
convertible secured promissory note ("Note") due on September 1, 2003. The Note
is convertible into an aggregate of 13,333,333 shares of ePhone's common stock.
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.
OVERVIEW
We are a provider of advanced Internet-based communications services. We offer
domestic and international voice and other enhanced services that combine the
flexibility and power of the Internet with the simplicity and ubiquity of a
telephone. We are currently based in Herndon, Virginia, has a FCC 214
carrier-to-carrier and resale license, and other telephony licenses required to
operate its domestic and international services.
During late 2002, we began providing retail and wholesale telecommunication
services throughout Canada through its wholly-owned subsidiary, ePHONE Telecom,
Canada.
Our strategy is to continue operations as a next generation global Voice over
Internet Protocol ("VOIP") provider offering a full complement of
telecommunications and data services utilizing the efficiency and reliability of
new generation VOIP based telecommunication technologies.
This entails offering a full complement of telecommunications services,
including a variety of retail services, wholesale arbitrage and data services,
using VOIP technology over both the Internet and private leased circuits. Using
a private Internet Protocol ("IP") network and the public Internet, we have
developed the capability to provide voice and data transmission and other
telephony features at high quality and low cost. Our growing international
network allows us to capitalize on inexpensive wholesale termination rates,
which can be further leveraged into retail products in order to increase overall
margins.
8
We have developed a strategy that builds one element upon the other to decrease
the Company's costs of providing service while increasing market penetration. We
also employ a channel distribution model based on the development of
partnerships both domestically and internationally. Our philosophy is to create
and sustain ourselves as a facilities based marketing and sales oriented
telecommunications company.
We believe we can differentiate ourself from the competition through innovative
marketing approaches and techniques while utilizing state of the art
technologies to provide a comprehensive array of competitive service offerings.
On May 6, 2003, we entered into a non-binding letter of intent with Champion to
merge Champion with and into a wholly-owned subsidiary of ours. Should the
proposed transaction be consummated as currently contemplated, we will issue
99,641,757 shares of its common stock to the Champion shareholders in exchange
for all of the issued and outstanding shares of Champion's capital stock. This
will result in significant dilution to our current shareholders. The proposed
transaction is subject to receipt of a "Fairness Opinion" with respect to
the transaction and completion of due diligence by both parties.
We believe that voice over Internet Protocol (VoIP) services are now forming a
substantial part of the International Voice business, and recent moves by Cisco
among other companies to develop and launch WiFi based VoIP handsets will create
the momentum to move the conversion of Voice into IP packets to the customer's
desk - potentially providing the full bypass of the local loop/RBOC
infrastructure and giving fast agile companies the edge to gain significant
market share in the entire retail voice business. WiFi is creating great
interest but more importantly tremendous opportunities for those companies who
already have in place VOIP and satellite networks. This is because WiFi is a
technology with great capacity, but relatively low reach. Cost effective
solutions require the delivery of the "backbone broadband connection"
to small pockets of deployed antennas, covering an office park or residential
development and the unique "broadcast" capability of satellite can deliver
backbone services ( with VoIP) to many distinct deployments very cost
effectively.
In the International market, especially in South America, Africa, Eastern Europe
and the Middle East, there are many new companies taking opportunity of
liberalizing market places. ePHONE and Champion can deliver a complete packaged
solution to a new carrier in those markets, delivering a backbone IP connection
for Internet services, carrying voice into and out of the country at very low
cost. This integrated package will increase speed to market and give the new
company a significant edge in increasing market share. Demand for such service
packages delivered by satellite broadband connectivity is growing worldwide, and
is especially popular in markets such as Africa and Latin America, where
terrestrial and internet infrastructure is weak or non-existent and phone
calling is cost prohibitive.
This integration of Voice, IP and Broadband Satellite provides ePHONE and
Champion as a combined company the ability to demonstrate the innovation of the
two companies and opens up numerous opportunities as we move forward in
delivering quality products to the a global customer base. In this evolving
market, ePHONE and Champion are uniquely well positioned to take advantage of
their respective technologies to provide a host of innovative, reliable and
affordable services to a broad customer base.
Results of Operations - Three months ended March 31, 2003 and 2002
Our net income (loss) and net income (loss) per share were ($1,205,000) and
($0.03) and $214,000 and $0.01 for the three months ended March 31, 2003 and
2002, respectively.
During the three months ended March 31, 2003, we experienced a significant
overall decline in revenue. In the fourth quarter of 2002, we phased out our
marketing arrangement with the telemarketer of our Unlimited Domestic Calling
Program and entered into new marketing agreements with a new telemarketer. We
can give no assurances that our Unlimited Domestic Calling Program revenue
levels will grow to equal or exceed those we previously experienced.
9
As a direct result of the negotiations and placement of Cisco equipment in
foreign countries, such as Guatemala, the Wholesale revenue increased
significantly.
In December 2002, the Company, through it's wholly owned subsidiary, ePHONE
Canada, Inc., implemented a new prepaid calling card program in the Canadian
market. Because the program was relatively new to the market, the prepaid
calling cards were competitively priced to gain market acceptance. Due to
unforeseen technically difficulties the program resulted in negative margins. As
a result, we designed and implemented an automated cost management system
designed for the calling card industry.
During the end of the quarter, we commenced a program in the reduction of
general and administrative selling and marketing costs. We reduced staff and
instituted layoffs, which accelerated during April 2003. We have reduced head
count by 60% and senior management salaries have been reduced by 20%.
Despite our cost cutting and other efforts described above, our cash shortage
has caused revenues for the 3 months ending June 30, 2003 to run behind the 3
months ending March 31, 2003.
To meet short-term working capital requirements, we negotiated a $200,000 9%
short-term promissory note. The terms of the note required the issuance of the
same value of common shares as the note, which equated to a discounted market
price of 2,173,913 commons shares.
On May 6, 2003, we entered into a non-binding letter of intent with Champion to
merge Champion with and into a wholly-owned subsidiary of ours. Should the
proposed transaction be consummated as currently contemplated, we will issue
99,641,757 shares of its common stock to the Champion shareholders in exchange
for all of the issued and outstanding shares of Champion's capital stock. This
will result in significant dilution to our current shareholders. The proposed
transaction is subject receipt of a "Fairness Opinion" with respect to
the transaction and completion of due diligence by both parties.
In addition, on May 6, 2003, Champion loaned us $200,000 pursuant to a 9%
convertible secured promissory note ("Note") due on September 1, 2003. The Note
is convertible into an aggregate of 13,333,333 shares of our common stock.
Revenues
Revenues decreased from $4,062,000 for the three months ended March 31, 2002 to
$2,090,735 for the same period in 2003. The majority of the decrease is
attributed to our "Unlimited Calling" Program. We generated approximately
$73,000 in revenue from our Unlimited Domestic Program in the three months ended
March 31, 2003 compared to revenue generated from this program for the three
months ended March 31, 2002 totaling $3,738,000.
Through our wholly owned subsidiary, ePHONE Canada, Inc. we launched our new
Canadian prepaid calling card program in late 2002. Due to unforeseen
technically difficulties encountered in the startup of this program and
competitive pricing to gain market acceptance the program generated negative
margins during the three months ended March 31, 2003. Revenue from the Canadian
calling card program for the three months ended March 31,2003 was $864,973 with
a negative gross margin of 14.2%. Due to unforeseen technical difficulties the
program resulted in negative margins. As a result, we designed and implemented
an automated cost management system designed for the calling card industry and
our margins increases significantly. The company is currently evaluating the
Canadian market for profitability on a go forward basis.
The wholesale strategy, including placing equipment directly in foreign
countries, such as Guatemala, resulted in revenue of $1,018,000 for the three
months ended March 31, 2003, generating a positive gross margin of 10.9%. Due to
the company's cash flow requirements, we anticipate that wholesale revenues
will be reduced in the second quarter.
10
The prepaid calling card and wholesale traffic programs accounted for
approximately 90% of our revenue for the three months ended March 31, 2003.
We engaged a new telemarketer and have reorganized subscription fulfillment
and collection procedures related to its domestic unlimited calling program.
While we remain hopeful that this program will once again generate a significant
portion of our revenue, it is not experiencing the same level of growth as it
had experienced in 2002.
As noted above, we have entered into a non-binding letter of intent under which
the company will merge with Champion. We believe that integration of Voice, IP
and Broadband Satellite provides ePHONE and Champion as a combined company the
ability to demonstrate the innovation of the two companies and opens up numerous
opportunities as we move forward in delivering quality products to the a global
customer base. In this evolving market, ePHONE and Champion are uniquely well
positioned to take advantage of their respective technologies to provide a host
of innovative, reliable and affordable services to a broad customer base.
Cost of Revenues
Cost of Revenues decreased from $2,485,000 for the three months ended March 31,
2002 to $2,073,000 for the same period in 2003. The reduction was due both the
to absolute decrease in revenue and the change in our revenue mix. For the three
months ended March 31, 2003 and 2002, cost of goods sold represented
commissions, origination and termination charges, network costs and processing
charges related to our telecommunications services programs. Gross margin for
the three months ended March 31, 2003 was approximately 1% compared to a gross
margin of 35% for the three months ending March 31, 2002. The primary reduction
in our gross margin is due to the change in our revenue mix and the negative
gross margin we experienced during the three month period ended March 31, 2003
in our Canadian calling card program. We anticipate that as our Canadian calling
card program matures and we generate new revenue under our Unlimited Domestic
Calling Program that our gross margin percentage will improve in the future.
Sales and marketing
Sales and marketing expense increased from $200,000 for the three months ended
March 31, 2002 to $280,000 for the same period in 2003. For the three months
ended March 31, 2003 and 2002, sales and marketing expense consists primarily of
marketing commissions and materials, printing costs and salaries. The majority
of the increase was due to increase marketing costs for the Canadian prepaid
calling card program and cost related to our continued efforts to introduce our
e-TRANS-PORT product.
General and administrative
General and administrative expense decreased from $1,154,000 for the three
months ended March 31, 2002 to $905,000 for the same period in 2003. General and
administrative expense included non-cash compensation of $20,000 and $123,000
for the three months ended March 31, 2003 and 2002, respectively from the
issuance of 217,391 shares of our common stock for investment banking services
in 2003 and from the issuance of 171,000 shares of our common stock for
consulting services to two consultants and to two members of our Board of
Directors in 2002. The Company has undertaken significant expense reduction
actions during 2003. We have reduced head count by 60% and senior management
salaries have been reduced by 20%. The company has also reduced and deleted
other non-operational costs. While the Chief Executive and Chief Financial
Officers had earned a $200,000 bonus collectively which was accrued on the 2002
10-K, they have forgone payment of this bonus. The expense has been
reversed in this quarter and will not be paid. The company is continuing to
evaluate other cost reductions to increase efficiency in the day-to-day
operations. We expect general and administrative expenses to increase in the
future in direct proportion to the increase in sales.
11
Income taxes
There was no provision for federal or state income taxes for the three months
ended March 31, 2003 due to the availability of a net operating loss for income
tax purposes. The net operating loss was generated from previous operating
losses incurred since inception. The utilization of our net operating loss
carryforward may be limited pursuant to Internal Revenue Code Section 382 due to
cumulative changes in ownership in excess of 50% within a three year period. 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
We are currently experiencing a significant shortage of working capital. On
March 13, 2003, we have received $200,000 from a private investment group under
a 9% short-term promissory note agreement. This note is due in December 2003.
The agreement also required that we issue to this private investment group
unregistered shares of our common stock equal to the face amount of the note.
Based on the market price, we issued 2,173,913 shares of our common stock to
this group. The shares were issued with a restricted legend and must be
registered within 180 days and become effective within 240 days of closing. On
May 6, 2003, as described above, we entered into a non-binding letter of intent
with Champion under which we would merger with Champion, with the Champion
shareholders receiving 99,641,757 shares of our common stock. This will cause
significant dilution to our current shareholders. Management and the Board of
Directors believes that due to our current financial condition, this transaction
will be in the best interest of the current shareholders of the Company. We
received $200,000 from Champion under a 9% convertible secured promissory note
due in September 2003. This note is convertible into 13,333,333 shares of our
common stock.
Our financial statements have been prepared on a going concern basis, which
contemplates the realization of assets, and the satisfaction of liabilities in
the normal course of business. Our auditors have included in their Report of
Independent Certified Public Accountants, dated February 10, 2003 (except for
the third paragraph of Note 2, as to which the date is April 11, 2003), a fourth
(explanatory) paragraph drawing attention to factors that raise substantial
doubt about our ability to continue as a going concern.
In the fourth quarter of 2002, we phased out our marketing agreement with our
Unlimited Domestic Calling Program telemarketer. As a result, we experienced a
decline in revenues from our Unlimited Domestic Calling Program when compared to
earlier in 2002. During the three months ended March 31, 2003, we generated only
$73,000 in revenue from our Unlimited Domestic Program compared to $2,990,000
and $16,870,000 of revenue generated under this program during the three month
period ended December 31, 2002 and for the year ended December 31, 2002,
respectively.
We have entered into a new telemarketing agreement with a new telemarketing
organization and are actively seeking new telemarketing agreements. We have
reorganized our subscription fulfillment and collection procedures. We have also
undertaken expense reduction actions during 2003, reducing head count and
non-operational costs.
Management believes that, even though it continues to provide both wholesale and
retail services to customers and has taken drastic cost cutting actions during
2003, that with the decline in our Unlimited Domestic Calling Program it needs
to raise additional funding in the short term in order to provide for needed
working capital and for marketing efforts related to the introduction of new
products, including e-TRANS-PORT. We are currently seeking additional investment
capital and have signed a non-binding letter of intent to merge as described
above. We believe that without additional investment capital it will not have
sufficient cash to fund our current activities, and as such, may not be able to
continue operating. Future prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in the
telecommunications industry.
During the three months ended March 31, 2003, we utilized $1,266,000 of cash
from operating activities. Investing activities used $9,400 of cash for the
purchase of fixed assets and financing activities provided $172,000 which
consisted of proceeds from a Promissory Note less payments on long term
obligations during the three month period ended March 31,2003.
We have three equipment commitments totaling $54,000, which expire in 2003 and
2004.
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Recent Accounting Pronouncements
In November 2002, FASB issued Interpretation No. 45 "Guarantor's Accounting and
Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others" which requires the guarantor to recognize at inception
of a guarantee, a liability for the fair value of the obligation undertaken in
issuing a guarantee. We have not guaranteed the indebtedness or obligations of
others so that the adoption of this Interpretation will not have a material
impact upon its Consolidated Financial Statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure ("SFAS 148"). SFAS 148 amends SFAS No.
123, Accounting for Stock-Based Compensation ("SFAS 123"), to provide
alternative methods of transition for an entity that voluntarily changes to the
fair value based method of accounting for stock-based employee compensation. In
addition, it also amends the disclosure provisions of SFAS 123 to require
prominent disclosure about the effects on reported net income of an entity's
accounting policy decisions with respect to stock-based employee compensation.
SFAS 148 also amends APB Opinion No. 28, Interim Financial Reporting, to require
disclosure about the effect in interim financial information. We are currently
evaluating whether to adopt the fair value based method of accounting for
stock-based employee compensation. We have adopted the disclosure provisions of
SFAS 148 as they relate to entities that use the intrinsic method of accounting
for stock-based compensation.
In January 2003, FASB issued Interpretation No. 46 "Consolidation of Variable
Interest Entities" which addresses the consolidation and disclosures of these
entities by business enterprises. Since we do not have any interests in such
types of entities the adoption of this Interpretation will not have a material
impact upon our Consolidated Financial Statements.
Risk Factors
The risks and uncertainties described below are not the only ones facing the
company. Additional risks not presently known or that we currently consider
insignificant may also impair our business operations in the future. Our
business, financial condition and plan of operations could be materially
adversely affected by any of the following risks. The trading price of shares of
our 's common stock could decline due to any of these risks.
o The market for our common stock is limited
There is currently only a limited trading market for our 's common stock. Our
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.
We 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 our common stock
Our 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.
13
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 our common stock. As long as the common stock is subject to the penny stock
rules, holders of our common stock may find it more difficult to sell their
securities.
o An investment in our common stock may be diluted
We may issue a substantial number of shares of our common stock without investor
approval. Any such issuance of our securities in the future could reduce an
investor's ownership percentage and voting rights in our and further dilute the
value of his or her investment.
o We have incurred net losses in the past
Prior to 2002 and during the three months ended March 31, 2003 we incurred net
losses. During the three months ended March 31, 2003 we incurred a net loss of
$1,204,766. Our ability to return to profitability depends on many
circumstances. If we do not return to profitability, our ability to respond
effectively to market conditions, to make capital expenditures and to take
advantage of business opportunities could be affected. In addition, our
prospects must be considered in light of the risks encountered by companies like
ours developing products and services in new and rapidly evolving markets. Our
failure to perform in these areas could have a material adverse effect on the
business plan of operations and financial condition.
o We May Not be a Going Concern
We have experienced a decline in revenues from our Unlimited Domestic Calling
Program. Revenues from that Program generated only $73,000 in the three months
ended March 31,2003. In 2002, revenues from the Unlimited Domestic Calling
Program were approximately $16,870,000 or approximately 88% of our total
revenues. With the decline in revenues from this Program, we need to raise
additional funding in the short term to provide for needed working capital and
for marketing efforts. We are currently seeking additional investment capital
and believe that without such additional funding we will not have sufficient
cash to fund our current activities, and as such may not be able to continue
operating. See Note 1 to our Financial Statements.
o Our 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. We do 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 our business plan cannot be predicted. In addition, it is impossible
for us 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 us 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 We do not presently intend to pay dividends on our common stock
We have never paid dividends on our common stock and do 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 our Board of Directors, subject to
applicable law.
o Telecommunications related stock prices have been especially volatile
and this volatility may depress our stock price
14
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 ours, 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 our common stock. This broad market
and industry volatility may reduce the value of our common stock, regardless of
ePHONE's operating performance. Due to this volatility, the value of our common
stock could decrease.
o Our articles of incorporation provide its officers and directors with certain
indemnification.
Our Articles of Incorporation provide that our directors and officers will not
be personally liable to our or its shareholders for money damages for breach of
their fiduciary duty of care as directors or officers.
ITEM 3 CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Within 90 days prior to
the date of this report, the Company carried out an evaluation, under the
supervision and with the participation of the Company's Principal Executive
Officer and Principal Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures. Based on this
evaluation, our Principal Executive Officer and Principal Financial Officer
concluded that the Company's disclosure controls and procedures are effective in
timely alerting them to material information required to be disclosed in the
Company's periodic reports filed with the SEC. It should be noted that the
design of any system of controls is based in part upon certain assumptions about
the likelihood of future events, and there can be no assurance that any design
will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote.
(b) Changes in internal controls. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
the Company's disclosure controls and procedures subsequent to the date of their
evaluation.
15
PART II - OTHER INFORMATION
Item 1. Legal proceedings - None
Item 2. Changes in securities and use of proceeds - None.
Item 3. Defaults upon senior securities - None.
Item 4. Submission of matters to a vote of security holders - None
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
10.7....... Letter of Intent to merge with Champion Teleport, Inc.
99.1....... 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 May 6, 2003, we filed a current report on Form 8-K related to our
letter of intent with Champion Teleport, Inc.
16
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. May 20, 2003
- -----------------------------------
(Carmine Taglialatela, Jr., CEO, Director)
(Principal Executive Officer)
By /s/ Charlie Rodriguez May 20, 2003
- -----------------------------------
(Charlie Rodriguez, Chief Financial Officer)
(Principal Financial and Accounting Officer)
17
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
I, Carmine Taglialatela, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of ePHONE Telecom,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based upon
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons fulfilling the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 20, 2003
/s/ Carmine Taglialatela
- -------------------------------------
President and Chief Executive Officer
18
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
I, Charlie Rodriguez, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of ePHONE Telecom,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based upon
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons fulfilling the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 20, 2003
/s/ Charlie Rodriguez
- ---------------------------
Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
19