As filed with the Securities and Exchange Commission on ______, 2003
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Florida ePHONE Telecom, Inc. 98-0204749
(State or Other Jurisdiction of (Name of Registrant in Our (I.R.S. Employer Identification No.)
Incorporation Charter)
or Organization)
66 Hawley Road Carmine Taglialatela, Jr.
Oxford, Connecticut 06478 (Primary Standard Industrial Chief Executive Officer
(703) 787-7006 Classification Code Number) 66 Hawley Road
(Address and Telephone number of Principal Oxford, Connecticut 06478
Executive Offices and Principal (703) 787-7006
Place of Business) (Name, address and telephone number
of agent for service)
Copies to:
Clayton E. Parker, Esq. Harris C. Siskind, Esq.
Kirkpatrick & Lockhart LLP Kirkpatrick & Lockhart LLP
201 S. Biscayne Boulevard, Suite 2000 201 S. Biscayne Boulevard, Suite 2000
Miami, Florida 33131 Miami, Florida 33131
(305) 539-3300 (305) 539-3300
Telecopier No.: (305) 358-7095 Telecopier No.: (305) 358-7095
Approximate date of commencement of proposed sale to the public: As
soon as practicable after this registration statement becomes effective.
If any of the securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933 check the following box. |X|
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. |_|
If this Form is a post-effective amendment filed pursuant to Rule
462(c) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. |_|
If delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. |_|
CALCULATION OF REGISTRATION FEE
============================================================================================================================
Proposed Maximum
Proposed Maximum Aggregate Amount Of
Title Of Each Class Of Amount To Be Offering Price Offering Registration
Securities To Be Registered Registered Per Share (1) Price (1) Fee
- ----------------------------------------------------------------------------------------------------------------------------
Common Stock, par value $0.001 per share 62,365,388 shares (2) $0.085 $5,301,057.98 $487.70
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL 62,365,388 shares (2) $0.085 $5,301,057.98 $487.70
============================================================================================================================
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act of 1933. For the
purposes of this table, we have used the average of the closing bid and
asked prices as of July 23, 2003.
(2) Of these shares, 21,020,408 are being registered under the Equity Line
of Credit and 20,000,000 are being registered under the convertible
debentures.
The Registrant hereby amends this Registration Statement on such date
or dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until this Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
PROSPECTUS
Subject to completion, dated _______, 2003
ePHONE TELECOM, INC.
62,365,388 Shares of Common Stock
This prospectus relates to the sale of up to 62,365,388 shares of
ePHONE Telecom, Inc.'s ("ePHONE") common stock by certain persons who are
stockholders of ePHONE. Please refer to "Selling Stockholders" beginning on page
11. ePHONE is not selling any shares of common stock in this offering and
therefore will not receive any proceeds from this offering. ePHONE will,
however, receive proceeds from the sale of common stock under the Equity Line of
Credit which was entered into between ePHONE and Cornell Capital Partners, L.P.
("Cornell Capital Partners") and no other stockholders, and from the issuance of
additional convertible debentures. All costs associated with this registration
will be borne by ePHONE. ePHONE has agreed to allow Cornell Capital Partners to
retain 5% of any proceeds raised under the Equity Line of Credit as more fully
described below.
The shares of common stock are being offered for sale by the selling
stockholders at prices established on the Over-the-Counter Bulletin Board during
the term of this offering. On July 24, 2003, the last reported sale price of our
common stock was $0.08 per share. Our common stock is quoted on the
Over-the-Counter Bulletin Board under the symbol "EPHO." These prices will
fluctuate based on the demand for the shares of common stock.
The selling stockholders consists of Cornell Capital Partners, who
intends to sell up to 42,820,408 shares of common stock, 21,020,408 of which are
under the Equity Line of Credit, 20,000,000 under convertible debentures, and
1,800,000 shares received by Cornell Capital Partners on July 24, 2003, as a
one-time commitment fee under the Equity Line of Credit, TN Capital Equities,
Ltd who intends to sell up to 200,000 shares of common stock, Champion Teleport,
Inc. ("Champion"), who intends to sell up to 13,333,333 shares of common stock
under a convertible secured promissory note, and other investors, who
collectively intend to sell up to 6,011,647 shares of common stock.
Cornell Capital Partners is an "underwriter" within the meaning of the
Securities Act of 1933 in connection with the sale of common stock under the
Equity Line of Credit Agreement. Cornell Capital Partners will pay ePHONE 98%
of, or a 2% discount to, the lowest closing bid price of the common stock during
the five consecutive trading day period immediately following the notice date.
In addition, Cornell Capital Partners will retain 5% of each advance under the
Equity Line of Credit. Cornell Capital Partners also received 1,800,000 shares
of common stock as a one-time commitment fee under the Equity Line of Credit on
July 24, 2003. The 2% discount, the 5% retainage fee and the 1,800,000 shares of
common stock are underwriting discounts payable to Cornell Capital Partners.
ePHONE has engaged TN Capital Equities, Ltd, an unaffiliated registered
broker-dealer, to advise it in connection with the Equity Line of Credit. TN
Capital Equities, Ltd was paid a fee of 200,000 shares of ePHONE's common stock
on July 24, 2003.
Brokers or dealers effecting transactions in these shares should
confirm that the shares are registered under the applicable state law or that an
exemption from registration is available.
These securities are speculative and involve a high degree of risk.
Please refer to "Risk Factors" beginning on page 5.
With the exception of Cornell Capital Partners, which is an
"underwriter" within the meaning of the Securities Act of 1933, no other
underwriter or person has been engaged to facilitate the sale of shares of
common stock in this offering. This offering will terminate twenty-four months
after the accompanying registration statement is declared effective by the
Securities and Exchange Commission. None of the proceeds from the sale of stock
by the selling stockholders will be placed in escrow, trust or any similar
account.
The Securities and Exchange Commission and state securities regulators
have not approved or disapproved of these securities, or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The date of this prospectus is __________ __, 2003.
TABLE OF CONTENTS
PROSPECTUS SUMMARY........................................................................................................1
THE OFFERING..............................................................................................................2
SUMMARY CONSOLIDATED FINANCIAL INFORMATION................................................................................3
RISK FACTORS..............................................................................................................5
FORWARD-LOOKING STATEMENTS...............................................................................................10
SELLING STOCKHOLDERS.....................................................................................................11
USE OF PROCEEDS..........................................................................................................14
DILUTION ................................................................................................................15
EQUITY LINE OF CREDIT....................................................................................................16
PLAN OF DISTRIBUTION.....................................................................................................18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS....................................20
DESCRIPTION OF BUSINESS..................................................................................................32
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT..........41
DESCRIPTION OF PROPERTY..................................................................................................47
LEGAL PROCEEDINGS........................................................................................................47
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...........................................................48
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND OTHER STOCKHOLDER MATTERS...........................50
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...........................................................................52
DESCRIPTION OF SECURITIES................................................................................................53
EXPERTS 54
LEGAL MATTERS............................................................................................................54
HOW TO GET MORE INFORMATION..............................................................................................54
EXHIBIT 5.1...............................................................................................................1
EXHIBIT 23.2..............................................................................................................1
FINANCIAL STATEMENTS....................................................................................................F-1
- ---------------------------------------------------------------------------------------------------------------------------------
i
PROSPECTUS SUMMARY
Overview
ePHONE is a provider of advanced Internet-based communications
services. ePHONE offers 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. ePHONE is currently based in Oxford,
Connecticut, 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, ePHONE began providing retail and wholesale
telecommunication services throughout Canada through its wholly-owned
subsidiary, ePHONE Telecom, Canada. ePHONE is in the process of winding
down the Canadian calling card operation as it previously existed. ePHONE
has started the search for a new Distributor in Canada to allow us to relaunch
services.
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, ePHONE has developed the capability to
provide voice and data transmission and other telephony features at high quality
and low cost. Our international network allows ePHONE to capitalize on
inexpensive wholesale termination rates, which can be further leveraged into
retail products in order to increase overall margins.
ePHONE has developed a strategy that builds one element upon the other
to decrease the ePHONE's costs of providing service while increasing market
penetration. ePHONE also employs 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.
Going Concern
ePHONE's financial statements have been prepared on a going concern
basis that contemplates the realization of assets and the settlement of
liabilities and commitments in the normal course of business. ePHONE's auditors
have included an explanatory paragraph in their auditors' report which states
that the financial statements raise substantial doubt as to ePHONE's ability to
continue as a going concern. Management recognizes that, as a result of the
reduction of most of ePHONE's revenue, ePHONE must generate revenue and access
capital resources to enable it to continue to operate. Ultimately, ePHONE must
maintain profitable operations. Management is planning to obtain additional
capital from revenue generated from operations and through the sale of equity
and debt securities, and is also planning to merge with Champion (discussed
later in this document) to increase the range of products and services that can
be provided The realization of assets and satisfaction of liabilities in the
normal course of business is dependent upon ePHONE obtaining additional
revenues, equity and debt capital and ultimately maintaining profitable
operations. However, no assurances can be given that ePHONE will be successful
in these activities, including the consummation of the merger with Champion.
Should any of these events not occur, we may not be able to continue to operate
and will be required to liquidate some or all of our remaining assets.
About Us
Our principal office is located at 66 Hawley Road, Oxford, Connecticut
06478 Our telephone number is (703) 787-7000.
1
THE OFFERING
This offering relates to the sale of common stock by certain persons
who are stockholders of ePHONE. The selling stockholders consists of Cornell
Capital Partners, who intends to sell up to 42,820,408 shares of common stock,
21,020,408 of which are under the Equity Line of Credit and 20,000,000 are under
convertible debentures, and 1,800,000 shares received by Cornell Capital
Partners on July 24, 2003, as a one-time commitment fee under the Equity Line of
Credit, TN Capital Equities, Ltd., who intends to sell up to 200,000 shares of
common stock, Champion, who intends to sell up to 13,333,333
shares of common stock under a convertible secured promissory note, and other
investors, who collectively intend to sell up to 6,011,647 shares of common
stock.
Pursuant to the Equity Line of Credit, we may, at our discretion,
periodically issue and sell to Cornell Capital Partners shares of common stock
for a total purchase price of $3 million. The amount of each advance is subject
to a maximum advance amount of $85,000, and we may not submit any advance within
seven trading days of a prior advance. Cornell Capital Partners will pay ePHONE
98% of, or a 2% discount to, the lowest closing bid price of the common stock
during the five consecutive trading day period immediately following the notice
date. Of each advance made by ePHONE, Cornell Capital Partners shall retain 5%
of each advance. In addition, Cornell Capital Partners has received 1,800,000
shares of common stock a one-time commitment fee on July 24, 2003. Cornell
Capital Partners intends to sell any shares purchased under the Equity Line of
Credit at the then prevailing market price. Among other things, this prospectus
relates to the shares of common stock to be issued under the Equity Line of
Credit.
We have engaged TN Capital Equities, Ltd, a registered broker-dealer,
in connection with the Equity Line of Credit. TN Capital Equities, Ltd was paid
a fee of 200,000 shares of ePHONE's common stock on July 24, 22003. TN Capital
Equities, Ltd is not participating as an underwriter in this offering.
Common Stock Offered 62,365,388 shares by selling stockholders
Offering Price Market price
Common Stock Outstanding
Before the Offering(1) 42,476,298 shares of July 24, 2003
Use of Proceeds We will not receive any proceeds of the
shares offered by the selling stockholders. Any
proceeds we receive from the sale of common stock
under the Equity Line of Credit will be used for
general working capital purposes. See "Use of
Proceeds."
Risk Factors The securities offered hereby involve a high degree
of risk and immediate substantial dilution. See
"Risk Factors" and "Dilution."
Over-the-Counter
Bulletin Board Symbol EPHO
- ---------------
1 Excludes debentures convertible into up to 2,604,167 shares of common
stock (assuming $125,000 of convertible debentures convertible at a
conversion price equal to 80% of $0.06), a promissory note convertible
into 13,333,333 shares of common stock, up to 21,020,408 shares of
common stock to be issued under the Equity Line of Credit, and
outstanding options to purchase 4,175,249 shares of common stock.
2
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
The selected consolidated financial data for each of the years ended
December 31, 2002 and 2001 have been derived from the audited consolidated
financial statements. The information set forth below in not necessarily
indicative of results of future operations.
For Three Months Ended For the Years Ended
March 31, December 31,
2003 2002 2002 2001
----------- --------- ----------- ----------
(unaudited) (unaudited)
Consolidated Statements of Operations
Revenues $ 2,090,735 $4,061,823 $ 19,221,928 $ 3,589,840
Cost of Revenues 2,073,292 2,485,248 9,696,392 2,501,033
----------- ---------- ------------ -----------
Gross Margin 17,443 1,576,575 9,525,536 1,088,807
Operating expenses:
Sales and marketing 280,181 200,408 1,256,932 1,212,026
General and administrative 905,199 1,153,655 6,384,891 5,607,375
Write off Array Telecom license and the
disposal of obsolete inventory and equipment net -- -- -- 1,188,383
----------- ---------- ------------ -----------
Operating Income (loss) before arbitration cost (1,167,937) 222,512 1,883,713 (6,918,977)
Arbitration cost -- -- 1,374,425 225,576
Income (loss) from operations 509,288 (7,144,553)
Interest and other (income), net 36,829 9,418 6,508 (123,424)
----------- ---------- ------------ -----------
Earnings (loss) before taxes (1,204,766) 213,094 502,780 (7,021,129)
Income tax expense -- -- -- --
----------- ---------- ------------ -----------
Net Income (loss) $(1,204,766) $ 213,094 $ 502,780 $(7,021,129)
=========== ========== ============ ===========
Earnings (loss) per share - (basic and diluted) $ (0.03) $ 0.01 $ 0.01 $ (0.28)
=========== ========== ============ ===========
Weighted average shares used in calculation of earnings
(loss) per share (basis and diluted) 38,536,685 33,022,298 36,251,792 24,910,425
=========== ========== ============ ===========
3
March 31, December 31, December 31,
2003 2002 2001
----------- ------------ ------------
(unaudited)
Consolidated Balance Sheet
Current Assets:
Cash and cash equivalents $ 155,444 $1,252,936 $35,970
Accounts receivable, net of allowance for returns of $270,000, for
March 31, 2003 and for December 31, 2002, and $116,000 for
December 31, 2001 480,432 419,049 155,759
Inventory 358,380 263,608 16,500
Other Receivables 149,819 86,789 65,481
------------ ------ ------
Total current assets 1,144,075 2,022,382 273,710
Property and equipment, net 1,590,597 1,686,704 1,296,561
Other assets 68,043 68,043 18,043
------------ ------------ ------------
Total assets $ 2,802,715 $ 3,777,129 $ 1,588,314
============ ============ ============
Accounts payable $1,680,654 $961,745 $850,179
Accrued liabilities 700,223 1,187,355 429,189
Accrued obligation cost -- -- 225,576
Deferred Revenue 68,098 278,956 367,009
Promissory Note payable, net of discount of $188,889 11,111 -- --
Capital lease obligation, current portion 44,857 51,385 22,663
------------ ------------ ------------
Total current liabilities 2,504,943 2,479,441 1,894,616
------------ ------------ ------------
Other long term obligations, net of current portion 46,772 68,126 142,500
Common stock 40,476 38,085 32,987
Other comprehensive income 6,203 --
Additional paid-in capital 23,247,134 23,029,524 21,843,199
Accumulated deficit (23,042,813) (21,838,047) (22,340,827)
------------ ------------ ------------
Total stockholders' equity (deficit) 251,000 1,229,562 (464,641)
------------ ------------ ------------
Total liabilities and stockholders' equity (deficit) $ 2,802,715 $ 3,777,129 $ 1,588,314
============ ============ ============
4
RISK FACTORS
We are subject to various risks that may materially harm our business,
financial condition and results of operations. You should carefully consider the
risks and uncertainties described below and the other information in this filing
before deciding to purchase our common stock. If any of these risks or
uncertainties actually occurs, our business, financial condition or operating
results could be materially harmed. In that case, the trading price of our
common stock could decline and you could lose all or part of your investment.
Risks Related To Our Business
ePHONE Has Historically Lost Money And Losses May Continue In The Future
Since our inception we have not always been profitable and have lost
money on both a cash and non-cash basis. While we had net income of $502,780 for
the fiscal year ended December 31, 2002, we lost $7,021,129 for the fiscal year
ended December 31, 2001. Additionally, we lost $1,204,766 for the three months
ended March 31, 2003. Our accumulated deficit was $23,042,813 as at the end of
March 31, 2003. Due to the significant reduction in revenue we experienced
during late 2002 and in 2003, we anticipate future losses and negative cash
flows will continue to occur. We are currently experiencing a significant
operating cash flow deficit and need to raise additional capital in order to
have funds to pay for operations. No assurances can be given that we will be
successful in again reaching or maintaining profitable operations. 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. Accordingly, we may experience liquidity and cash flow problems.
ePHONE May Need To Raise Additional Capital Or Debt Funding To Sustain
Operations
Unless ePHONE can become profitable with the existing sources of funds
we have available, we will require additional capital to sustain operations and
we may need access to additional capital or additional debt financing to grow
our sales. In addition, to the extent that we have a working capital deficit and
cannot offset the deficit from profitable sales we may have to raise capital to
repay the deficit and provide more working capital to permit growth in revenues.
We cannot assure you that financing whether from external sources or related
parties will be available if needed or on favorable terms. Our inability to
obtain adequate financing will result in the need to reduce our business
operations. Any of these events could be materially harmful to our business and
may result in a lower stock price.
We Have Been The Subject Of A Going Concern Opinion For Our Fiscal Year Ended
December 31, 2002 From Our Independent Auditors, Which Means That We May Not Be
Able To Continue Operations Unless We Can Become Profitable, Obtain Additional
Funding Or Consummate The Merger With Champion
Our independent auditors have added an explanatory paragraph to their
audit opinions issued in connection with our financial statements for the year
ended December 31, 2002, which states that the financial statements raise
substantial doubt as to ePHONE's ability to continue as 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. Our
ability to make operations profitable or obtain additional funding will
determine our ability to continue as a going concern. Our financial statements
do not include any adjustments that might result from the outcome of this
uncertainty. We expect to be able to continue operations for 12 months with the
cash currently on hand, anticipated from our operations, from additional
debentures to be purchased by Cornell Capital Partners and from the Equity Line
of Credit provided by Cornell Capital Partners. Based on our current budget
assessment, and excluding any acquisitions which may occur in 2003, we believe
that we may need to obtain approximately $3 million in additional debt or equity
capital from one or more sources to fund operations for the next 12 months.
These funds are expected to be obtained from the sale of securities, including
the sale of stock under the Equity Line of Credit. Additionally, if we do not
consummate the merger with Champion, our financial condition may be
negatively affected.
See Note 1 to our Financial Statements.
5
We Are Subject To A Working Capital Deficit, Which Means That Our
Current Assets On March 31, 2003 Were Not Sufficient To Satisfy Our Current
Liabilities
We had a working capital deficit of $1,360,868 at March 31, 2003, which
means that our current liabilities as of that date exceeded our current assets
on March 31, 2003 by $1,360,868. Current assets are assets that are expected to
be converted to cash within one year and, therefore, may be used to pay current
liabilities as they become due. Our working capital deficit means that our
current assets on March 31, 2003 were not sufficient to satisfy all of our
current liabilities on that date. If our ongoing operations do not begin to
provide sufficient profitability to offset the working capital deficit we may
have to raise capital or debt to fund the deficit.
Our Common Stock May Be Affected By Limited Trading Volume And May
Fluctuate Significantly
Prior to this offering, there has been a limited public market for our
common stock and there can be no assurance that a more active trading market for
our common stock will develop. An absence of an active trading market could
adversely affect our shareholders' ability to sell our common stock in short
time periods, or possibly at all. Our common stock has experienced, and is
likely to experience in the future, significant price and volume fluctuations,
which could adversely affect the market price of our common stock without regard
to our operating performance. In addition, we believe that factors such as
quarterly fluctuations in our financial results and changes in the overall
economy or the condition of the financial markets could cause the price of our
common stock to fluctuate substantially. These fluctuations may also cause short
sellers to enter the market from time to time in the belief that ePHONE will
have poor results in the future. We cannot predict the actions of market
participants and, therefore, can offer no assurances that the market for our
stock will be stable or appreciate over time.
Our Common Stock Is Deemed To Be "Penny Stock," Which May Make It More Difficult
For Investors To Sell Their Shares Due To Suitability Requirements
Our common stock is deemed to be "penny stock" as that term is defined
in Rule 3a51-1 promulgated under the Securities Exchange Act of 1934. These
requirements may reduce the potential market for our common stock by reducing
the number of potential investors. This may make it more difficult for investors
in our common stock to sell shares to third parties or to otherwise dispose of
them. This could cause our stock price to decline. Penny stocks are stock:
o With a price of less than $5.00 per share;
o That are not traded on a "recognized" national exchange;
o Whose prices are not quoted on the NASDAQ automated quotation
system (NASDAQ listed stock must still have a price of not
less than $5.00 per share); or
o In issuers with net tangible assets less than $2.0 million (if
the issuer has been in continuous operation for at least three
years) or $10.0 million (if in continuous operation for less
than three years), or with average revenues of less than $6.0
million for the last three years.
Broker/dealers dealing in penny stocks are required to provide
potential investors with a document disclosing the risks of penny stocks.
Moreover, broker/dealers are required to determine whether an investment in a
penny stock is a suitable investment for a prospective investor.
We Could Fail To Attract Or Retain Key Personnel
Our success largely depends on the efforts and abilities of key
executives, including Carmine Taglialatela, Jr., our Chief Executive Officer and
President, and Steven Heap, our Chief Operating Officer. The loss of the
services of Mr. Taglialatela, Jr. and Mr. Heap could materially harm our
business because of the cost and time necessary to replace and train a
replacement. Such a loss would also divert management attention away from
operational issues. We do not presently maintain key-man life insurance
policies. We also have other key employees that manage our operations and if we
were to lose their services, senior management would be required to expend time
and energy to replace and train replacements. To the extent that we are smaller
than our competitors and have fewer resources we may not be able to attract the
sufficient number and quality of staff.
6
Our Limited Operating History Makes It Difficult Or Impossible To Evaluate Our
Performance And Make Predictions About Our Future
ePHONE has been operating for less than four years. Based on this
limited operating history, it is difficult or impossible for us to evaluate our
operational and financial performance, or to make accurate predictions about our
future performance.
Our Failure To Acquire, Integrate And Operate New Technology Could Harm Our
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.
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.
Telecommunications Related Stock Prices Have Been Especially Volatile And This
Volatility May Depress Our 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 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 prospectus, 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.
7
Risks Related To This Offering
Future Sales By Our Stockholders May Adversely Affect Our Stock Price And Our
Ability To Raise Funds In New Stock Offerings
Sales of our common stock in the public market following this offering
could lower the market price of our common stock. Sales may also make it more
difficult for us to sell equity securities or equity-related securities in the
future at a time and price that our management deems acceptable or at all. Of
the 42,476,298 shares of common stock outstanding as of July 24, 2003,
29,986,972 shares are, or will be, freely tradable without restriction, unless
held by our "affiliates." The remaining 12,489,326 shares of common stock which
will be held by existing stockholders, including the officers and directors, are
"restricted securities" and may be resold in the public market only if
registered or pursuant to an exemption from registration. Some of these shares
may be resold under Rule 144. In addition, we have issued, or will issue,
debentures convertible into up to 4,166,667 shares of common stock (assuming a
conversion price equal to 80% of $0.06), a promissory note convertible into
13,333,333 shares of common stock and outstanding options to purchase 4,175,249
shares of common stock, see page 11 for additional details concerning the future
sales noted above.
Possible Lack Of Sufficient Authorized Shares
ePHONE may not currently have sufficient authorized shares to convert
all of the shares of common stock needed under the Equity Line of Credit and a
proposal will be required to be placed before the shareholders to facilitate an
increase in the number of authorized shares if ePHONE decides to draw a majority
of the funds available under the Equity Line of Credit. For example, if the
price of our common stock decreases to $0.02 per share, we would need
153,061,224 shares available to fully utilize the $3 million available under the
Equity Line of Credit. Currently we have authorized 150 million shares of common
stock, and 42,476,298 shares outstanding. Accordingly, we would need to
authorize 45,537,522 additional shares, even without issuing any shares upon
conversion of the debenture, the promissory note or options, to fully utilize
the Equity Line of Credit. We would have to solicit proxies from our
shareholders to approve any increase in authorized shares.
Existing Shareholders Will Experience Significant Dilution From Our Sale Of
Shares Under The Equity Line Of Credit
The sale of shares pursuant to the Equity Line of Credit will have a
dilutive impact on our stockholders. For example, if the offering occurred on
March 31, 2003 at an assumed offering price of $0.0588 per share (98% of a
recent closing bid price of $0.06 per share), the new stockholders would
experience an immediate dilution in the net tangible book value of $0.370 per
share. Dilution per share at prices of $0.0441, $0.0294 and $0.0147 per share
would be $0.0271, $0.0172 and $0.0072, respectively.
As a result, our net income per share could decrease in future periods,
and the market price of our common stock could decline. In addition, the lower
our stock price, the more shares of common stock we will have to issue under the
Equity Line of Credit to draw down the full amount and issue under the
convertible debentures. If our stock price is lower, then our existing
stockholders would experience greater dilution.
Under The Equity Line Of Credit Cornell Capital Partners Will Pay Less Than The
Then-Prevailing Market Price Of Our Common Stock
The common stock to be issued under the Equity Line of Credit will be
issued at a 2% discount to the lowest closing bid price for the five days
immediately following the notice date of an advance. In addition, Cornell
Capital Partners will retain 5% from each advance. These discounted sales could
cause the price of our common stock to decline.
The Selling Stockholders Intend To Sell Their Shares Of Common Stock In The
Market, Which Sales May Cause Our Stock Price To Decline
The selling stockholders intend to sell in the public market 62,365,388
shares of common stock being registered in this offering. That means that up to
62,365,388 shares may be sold pursuant to this registration statement. Such
sales may cause our stock price to decline. The officers and directors of ePHONE
and those shareholders who are significant shareholders as defined by the SEC
will continue to be subject to the provisions of various insider trading and
rule 144 regulations.
8
The Sale Of Our Stock Under Our Equity Line Could Encourage Short Sales By Third
Parties, Which Could Contribute To The Future Decline Of Our Stock Price
In many circumstances the provision of an equity line of credit for
companies that are traded on the OTCBB has the potential to cause a significant
downward pressure on the price of common stock. This is especially the case if
the shares being placed into the market exceed the market's ability to take up
the increased stock or if ePHONE has not performed in such a manner to show that
the equity funds raised will be used to grow ePHONE. Such an event could place
further downward pressure on the price of common stock. Under the terms of our
Equity Line of Credit, ePHONE may request numerous draw downs pursuant to the
terms of the equity line. Even if ePHONE uses the Equity Line of Credit to grow
its revenues and profits or invest in assets which are materially beneficial to
ePHONE, the opportunity exists for short sellers and others to contribute to the
future decline of ePHONE's stock price. If there are significant short sales of
stock, the price decline that would result from this activity will cause the
share price to decline more so which in turn may cause long holders of the stock
to sell their shares thereby contributing to sales of stock in the market. If
there is an imbalance on the sell side of the market for the stock the price
will decline.
It is not possible to predict if the circumstances where by a short
sales could materialize or to what the share price could drop. In some companies
that have been subjected to short sales the stock price has dropped to near
zero. This could happen to ePHONE.
The Price You Pay In This Offering Will Fluctuate And May Be Higher Or Lower
Than The Prices Paid By Other People Participating In This Offering
The price in this offering will fluctuate based on the prevailing
market price of the common stock on the Over-the-Counter Bulletin Board.
Accordingly, the price you pay in this offering may be higher or lower than the
prices paid by other people participating in this offering.
We May Not Be Able To Access Sufficient Funds Under The Equity Line Of Credit
When Needed
We are to a significant extent dependent on external financing to fund
our operations. Our financing needs are expected to be partially provided from
the Equity Line of Credit and the additional debentures to be purchased by
Cornell Capital Partners. No assurances can be given that such financing will be
available in sufficient amounts or at all when needed, in part, because we are
limited to a maximum draw down of $85,000 during any seven trading day period.
In addition, based on an assumed offering price of $0.0588, we will only be able
to draw a total net amount of $1,089,200 under the Equity Line of Credit. This
net amount will utilize all of the 21,020,408 shares of our common stock
registered for the Equity Line of Credit under this registration statement. At
this assumed price, we would need to register 30,000,000 additional shares of
our common stock to fully utilize the funds available under the Equity Line of
Credit. If the price of shares of our common stock decreases, we would need to
register more additional shares of common stock to fully utilize the $3 million
available under the Equity Line of Credit.
We May Not Be Able To Draw Down Under The Equity Line Of Credit If The Investor
Holds More Than 9.9% Of Our Common Stock
In the event Cornell Capital Partners holds more than 9.9% of the
then-outstanding common stock of ePHONE, we will be unable to draw down on the
Equity Line of Credit. Currently, Cornell Capital has beneficial ownership of
9.77% of our common stock and therefore we would be able to draw down on the
Equity Line of Credit so long as Cornell Capital's beneficial ownership remains
below 10%. Currently, we could draw less than $10,000 under the Equity Line of
Credit before Cornell Capital Partners ownership increased to 10%. If Cornell
Capital Partner's beneficial ownership increases above 9.9%, we would be unable
to draw down on the Equity Line of Credit. Because Cornell Capital Partners is
not limited by a percentage ownership limitation with respect to converting the
convertible debentures, a possibility exists that Cornell Capital Partners may
own more than 9.9% of ePHONE's outstanding common stock at a time when we would
otherwise plan to make an advance under the Equity Line of Credit. In that
event, if we are unable to obtain additional external funding or generate
revenue from the sale of our products, we could be forced to curtail or cease
our operations.
9
FORWARD-LOOKING STATEMENTS
Certain information in this report including statements made in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Description of Business" and elsewhere 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. Although ePHONE believes that the expectations reflected in its
forward-looking statements are reasonable, it can give no assurance that such
expectations or any of its forward-looking statements will prove to be correct,
and actual results could differ materially from those projected or assumed in
these forward-looking statements.
o Forward-looking statements include but are not limited to:
o Expectations and estimates as to completion dates of the
Network of Regional gateways ePHONE is installing and the
Network;
o ePHONE's ability to implement successfully ePHONE's operating
strategy as described in the business plan of ePHONE;
o Future financial performance as estimated in ePHONE's
financial projections;
o ePHONE's forecasts of customer or market demand;
o Highly competitive market conditions;
o Changes in or developments under laws, regulations and
licensing requirements in regions ePHONE is installing
gateways; and
o Changes in telecommunications technology.
o This list of categories of forward-looking statements should
not be construed as exhaustive. ePHONE will not update or
revise any forward-looking statements.
Certain factors that could cause ePHONE's forward-looking statements
not to be correct and cause ePHONE's actual results to materially vary from
projections made in forward-looking statements as further described in the "Risk
Factors" section contained in this prospectus.
10
SELLING STOCKHOLDERS
Percentage Percentage
of of Percentage
Outstanding Outstanding of Shares
Shares Shares Shares to be Shares to Be Beneficially
Beneficially Beneficially Acquired Acquired Owned
Owned Owned under the under the Shares to be After
Before Before Equity Line Equity Line Sold in the Offering
Selling Stockholder Offering Offering (1) of Credit of Credit Offering (1)
- --------------------- ------------ ------------- ------------- ------------- ------------ ------------
Shares Acquired in Financing Transactions with Cornell Capital Partners
Cornell Capital
Partners, L.P. 4,404,167(2) 9.77% 21,020,408 33.10% 42,820,408(3) 0%
TN Capital Equities, Ltd 200,000 * -- --% 200,000 0%
Shares Acquired Through the Prior Exercise of Warrants
9060-7177 Quebec, Inc. 180,561 * -- --% 180,561 0%
9084-8953 Quebec, Inc. 285,660 * -- --% 285,660 0%
Can Am Trust Ltd. 150,000 * -- --% 150,000 0%
Dapsilis Enterprises,
Inc. 155,269 * -- --% 155,269 0%
Fraser D. Latta 180,561 * -- --% 180,561 0%
Gestion CD LAM Inc. 90,280 * -- --% 90,280 0%
Grovest Investments 90,285 * -- --% 90,285 0%
Hasanain Panju 120,377 * -- --% 120,377 0%
Kinked Investments
Limited 1,475,750 3.47% -- --% 1,475,750 0%
Melbourne Disraeli
Equities (M.B.) Inc. 90,285 * -- --% 90,285 0%
Nick Geer & Associates
Inc. 90,285 * -- --% 90,285 0%
Philip Vineberg 90,285 * -- --% 90,285 0%
Pierre Arbour 90,280 * -- --% 90,280 0%
Roland Michaud 5,500 * -- --% 5,500 0%
RUSH & Co. (Bank von
Ernst & Cie AG) 90,285 * -- --% 90,285 0%
Stephen Sadler 263,250 * -- --% 263,250 0%
Nino Aidi 33,334 * -- --% 33,334 0%
Robert G. Clarke 33,334 * -- --% 33,334 0%
John Fraser 33,334 * -- --% 33,334 0%
Telecom Ventures 71,428 * -- --% 71,428 0%
Shares Acquired Through Rockwood Group Private Placement
Rockwood Inc. 217,391 * -- --% 217,391 0%
Bridges & Pipes LLC 1,086,957 2.56% -- --% 1,086,957 0%
Chickaree Chick LLC 271,739 * -- --% 271,739 0%
Jolie Papier Ltd 815,217 * -- --% 815,217 0%
Shares Under Promissory Notes with Champion Telephone
Champion Teleport, Inc. 13,333,333 23.89%(4) -- --% 13,333,333 0%
- -------------------------------------------------------------------------------------------------------------------------
Total 23,902,993 40.92% 21,020,408 33.10% 62,365,388 0%
- -----------------------------------------
* Less than 1%.
(1) Applicable percentage of ownership is based on 42,476,298 shares of
common stock outstanding as of July 24, 2003, together with securities
exercisable or convertible into shares of common stock within 60 days
of July 24, 2003, for each stockholder. Beneficial ownership is
determined in accordance with the rules of the Securities and Exchange
Commission and generally includes voting or investment power with
respect to securities. Shares of common stock subject to securities
exercisable or convertible into shares of common stock that are
currently exercisable or exercisable within 60 days of July 24, 2003
are deemed to be beneficially owned by the person holding such
securities for the purpose of computing the percentage of ownership of
such person, but are not treated as outstanding for the purpose of
computing the percentage ownership of any other person. Note that
affiliates are subject to Rule 144 and Insider trading regulations -
percentage computation is for form purposes only.
11
(2) Consists of up to 2,604,167 shares of common stock underlying $125,000
of debentures assuming a conversion price of 80% of $0.06 and 1,800,000
received by Cornell Capital Partners on July 24, 2003 as a one-time
commitment fee under the Equity Line of Credit.
(3) Includes the shares to be acquired by Cornell Capital Partners under
the Equity Line of Credit, the 1,800,000 shares of common stock
received as a one-time commitment fee under the Equity Line of Credit
and a good-faith estimate of the number of shares needed as a result of
conversion of a total of $200,000 of the convertible debentures.
(4) Consists of 13,333,333 shares to be acquired under a 9% convertible
promissory note issued on May 6, 2003 for a $200,000 convertible
debenture.
The following information contains a description of each selling
shareholder's relationship to ePHONE and how each selling shareholder acquired
the shares to be sold in this offering is detailed below. None of the selling
stockholders have held a position or office, or had any other material
relationship, with ePHONE, except John Fraser and Robert Clarke who both
resigned as Board members prior to January 1,2003 and are not affiliated with
the Company in any manner.
Shares Acquired In Financing Transactions With ePHONE
Cornell Capital Partners, L.P. Cornell Capital Partners, L.P. is the
investor under the Equity Line of Credit and a holder of convertible debentures.
All investment decisions of Cornell Capital Partners are made by its general
partner, Yorkville Advisors, LLC. Mark Angelo, the managing member of Yorkville
Advisors, makes the investment decisions on behalf of Yorkville Advisors.
Cornell Capital Partners acquired all shares being registered in this offering
in financing transactions with ePHONE. Those transactions are explained below:
o Equity Line of Credit. On June 24, 2003, we entered into an
Equity Line of Credit with Cornell Capital Partners, L.P.
Pursuant to the Equity Line of Credit, we may, at our
discretion, periodically sell to Cornell Capital Partners
shares of common stock for a total purchase price of up to $3
million. For each share of common stock purchased under the
Equity Line of Credit, Cornell Capital Partners will pay
ePHONE 98% of, or a 2% discount to, the lowest closing bid
price of our common stock on the Over-the-Counter Bulletin
Board or other principal market on which our common stock is
traded for the five days immediately following the notice
date. Further, Cornell Capital Partners will retain 5% of each
advance under the Equity Line of Credit. In connection with
the Equity Line of Credit, Cornell Capital Partners has
received 1,800,000 shares of common stock as a one-time
commitment fee on July 24, 2003. Cornell Capital Partners is
registering 21,020,408 shares in this offering under the
Equity Line of Credit, in addition to the 1,800,000 commitment
fee shares.
o Convertible Debentures. On June 24, 2003, Cornell Capital
partners entered into a securities purchase agreement with
ePHONE under which Cornell Capital Partners agreed to purchase
the total amount of $200,000. Cornell Capital purchased
$125,000 of convertible debentures on June 24, 2003, and shall
purchase $75,000 upon filing of this registration statement
with the Securities and Exchange Commission. The debentures
are convertible at the holder's option any time up to maturity
at a conversion price equal to the lower of (i) 120% of the
closing bid price on the closing date ($0.075) or (ii) 80% of
the average of the two lowest closing bid price of the common
stock for the five trading days immediately preceding the
conversion date. The debentures have a two year term and
accrue interest at 5% per year. At maturity, ePHONE has the
option to either pay the holder the outstanding principal
balance and accrued interest or to convert the debentures into
shares of common stock at a conversion price equal to the
lower of (i) 120% of the closing bid price on the closing date
or (ii) 80% of the average of the two lowest closing bid price
of the common stock for the five trading days immediately
preceding the conversion date. Cornell Capital Partners is
entitled to a 10% discount from the purchase price of the
convertible debentures. Cornell Capital Partners purchased the
convertible debentures from ePHONE in a private placement.
Cornell Capital Partners is registering 20,000,000 shares in
this offering under the convertible debentures.
12
There are certain risks related to sales by Cornell Capital Partners,
including:
o The outstanding shares will be issued based on discount to the
market rate. As a result, the lower the stock price around the
time Cornell is issued shares, the greater chance that Cornell
gets more shares. This could result in substantial dilution to
the interests of other holders of common stock.
o To the extent Cornell sells its common stock, the common stock
price may decrease due to the additional shares in the market.
This could allow Cornell to sell greater amounts of common
stock, the sales of which would further depress the stock
price.
o The significant downward pressure on the price of the common
stock as Cornell sells material amounts of common stocks could
encourage short sales by Cornell or others. This could place
further downward pressure on the price of the common stock.
TN Capital Equities, Ltd. TN Capital Equities, Ltd is an unaffiliated
registered broker-dealer that has been retained by us. John Steinmetz, TN
Capital Equities, Ltd's President, makes the investment decisions on behalf of
TN Capital Equities, Ltd. For its services in connection with the Equity Line of
Credit, TN Capital Equities, Ltd received a fee of 200,000 shares of common
stock on July 24, 2003. These shares are being registered in this offering.
Exercising of Special Warrants. On April 20, 2000, ePHONE closed an
offering of special warrants, receiving net proceeds of approximately
$12,205,000. The shares of common stock received upon the exercise of certain of
these warrants are being registered in this offering. ePHONE is registering a
total of 3,620,343 shares of common stock held by accredited investors as a
result of exercising warrants.
Rockwood Group Private Placement. As the result of a private placement
coordinated by Rockwood Group, ePHONE issued a total of 2,173,913 shares to
accredited investors and issued 217,391 shares to Rockwood, Inc., as the
placement agent. This private placement took place on March 13, 2003 and
resulted in ePHONE raising $200,000 under a 9% short-term promissory note.
ePHONE is registering a total of 2,391,304 shares of common stock in this
offering issued through the Rockwood Group private placement.
Champion Teleport, Inc. Champion Teleport, Inc. is the holder of a 9%
convertible secured promissory note in the amount of $200,000 issued May 6, 2003
due in September 2003 that is convertible into 13,333,333 shares of common
stock. ePHONE is registering 13,333,333 shares of common stock in this offering
under the Champion Teleport convertible secured promissory note.
13
USE OF PROCEEDS
This prospectus relates to shares of our common stock that may be
offered and sold from time to time by certain selling stockholders. There will
be no proceeds to us from the sale of shares of common stock in this offering.
However, we will receive the proceeds from the sale of shares of common stock to
Cornell Capital Partners under the Equity Line of Credit. The purchase price of
the shares purchased under the Equity Line of Credit will be equal to 98% of, or
a 2% discount to, the lowest closing bid price of our common stock on the
Over-the-Counter Bulletin Board for the five days immediately following the
notice date. ePHONE will pay Cornell Capital 5% of each advance as an additional
fee.
Pursuant to the Equity Line of Credit, ePHONE cannot draw more than
$85,000 every seven trading days or more than $3 million over twenty-four
months. In the event Cornell Capital Partners holds more than 9.9% of our
then-outstanding common stock, we will be unable to draw down on the Equity Line
of Credit. Currently, Cornell Capital has beneficial ownership of 9.77% of our
common stock (see Security Ownership of Certain Beneficial Owners and Management
section on page __) and therefore we would be able to draw down on the Equity
Line of Credit so long as Cornell Capital's beneficial ownership remains below
10%. Currently, we could draw less than $10,000 under the Equity Line of Credit
before Cornell Capital Partners interest increased to 10%. If Cornell Capital
Partner's beneficial ownership increases above 9.9%, we would be unable to draw
down on the Equity Line of Credit. Because Cornell Capital Partners is not
limited by a percentage ownership limitation with respect to converting the
convertible debentures, a possibility exists that Cornell Capital Partners may
own more than 9.9% or our outstanding common stock at a time when we would
otherwise plan to make an advance under the Equity Line of Credit. For
illustrative purposes only, we have set forth below our intended use of proceeds
for the range of net proceeds indicated below to be received under the Equity
Line of Credit and for the additional $75,000 from the sale of convertible
debentures to Cornell Capital Partners. The table assumes estimated offering
expenses of $85,000, plus 5% retainage payable to Cornell Capital Partners under
the Equity Line of Credit and a 10% discount for the additional convertible
debentures. The figures below are estimates only, and may be changed due to
various factors, including the timing of the receipt of the proceeds.
Gross proceeds $ 1,075,000 $ 2,075,000 $ 3,075,000
Net proceeds $ 932,500 $ 1,882,500 $ 2,832,500
No. of shares issued under the Equity Line of Credit
at an assumed price of $0.0588 17,006,803 34,013,605(1) 51,020,408 (1)
Use of Proceeds: AMOUNT AMOUNT AMOUNT
- ------------------------------------------------------ ----------------------- ----------------------- ---------------------
Repayment of Notes $ 200,000 $ 200,000 $ 200,000
Sales and Marketing $ 150,000 $ 240,000 $ 265,000
General Working Capital $ 582,500 $ 1,442,500 $ 2,367,500
-------------- -------------- -------------
Total $ 932,500 $ 1,882,500 $ 2,832,500
============== ============== =============
- -------------
(1) This number of shares exceeds the number of shares being registered
under the Equity Line of Credit in the registration statement and,
therefore, would not be issued unless an additional registration
statement was filed. If the bid price for shares of ePHONE's common
stock increased significantly, to over $0.15 for example, ePHONE would
be able to drawn down the entire amount available under the Equity Line
of Credit with the 21,020,408 shares being registered in this
registration statement.
14
DILUTION
The net tangible book value of ePHONE as of March 31, 2003 was $250,000
or $0.0062 per share of common stock. Net tangible book value per share is
determined by dividing the tangible book value of ePHONE (total tangible assets
less total liabilities) by the number of outstanding shares of our common stock.
Since this offering is being made solely by the selling stockholders and none of
the proceeds will be paid to ePHONE, our net tangible book value will be
unaffected by this offering. Our net tangible book value and our net tangible
book value per share, however, will be impacted by the common stock to be issued
under the Equity Line of Credit. The amount of dilution will depend on the
offering price and number of shares to be issued under the Equity Line of
Credit. The following example shows the dilution to new investors at an offering
price of $0.0588 per share which is in the range of the recent share price.
If we assume that ePHONE had issued 21,020,408 shares of common stock
under the Equity Line of Credit at an assumed offering price of $0.0588 per
share (i.e., the number of shares registered in this offering under the Equity
Line of Credit), less retention fees of $61,800 and offering expenses of
$85,000, our net tangible book value as of March 31, 2003 would have been
$1,339,200 or $0.0218 per share. Note that at an offering price of $0.0588 per
share, ePHONE would receive gross proceeds of $1,236,000, or $1,764,000 less
than is available under the Equity Line of Credit. Such an offering would
represent an immediate increase in net tangible book value to existing
stockholders of $0.0162 per share and an immediate dilution to new stockholders
of $0.0381 per share. The following table illustrates the per share dilution:
Assumed public offering price per share $0.0588
Net tangible book value per share before this offering $0.0062
Increase attributable to new investors $0.0156
-------
Net tangible book value per share after this offering $0.0218
-------
Dilution per share to new stockholders $0.0370
=======
The offering price of our common stock is based on the then-existing
market price. In order to give prospective investors an idea of the dilution per
share they may experience, we have prepared the following table showing the
dilution per share at various assumed offering prices:
Dilution
Assumed No. of Shares to be Per Share
Offering Price ISSUED to New Investors PROCEEDS RECEIVED
-------------- ------------------- ---------------- -----------------
$0.0588 21,020,408 (1) $0.0370 $1,089,200
$0.0441 21,020,408 $0.0271 $ 795,650
$0.0294 21,020,408 $0.0172 $ 502,100
$0.0147 21,020,408 $0.0072 $ 208,550
(1) This represents only the maximum number of shares of common stock that
will be registered under the Equity Line of Credit.
15
EQUITY LINE OF CREDIT
Summary
On June 24, 2003, we entered into an Equity Line of Credit with Cornell
Capital Partners, L.P. Pursuant to the Equity Line of Credit, we may, at our
discretion, periodically sell to Cornell Capital Partners shares of common stock
for a total purchase price of up to $3.0 million. For each share of common stock
purchased under the Equity Line of Credit, Cornell Capital Partners will pay 98%
of, or a 2% discount to, the lowest closing bid price of our common stock on the
Over-the-Counter Bulletin Board or other principal market on which our common
stock is traded for the five days immediately following the notice date.
Further, Cornell Capital Partners will retain 5% of each advance under the
Equity Line of Credit. Cornell Capital Partners is a private limited partnership
whose business operations are conducted through its general partner, Yorkville
Advisors, LLC. In addition, we engaged TN Capital Equities, Ltd, a registered
broker-dealer, in connection with the Equity Line of Credit. For its services,
TN Capital Equities, Ltd received 200,000 shares of our common stock on July 24,
2003. The effectiveness of the sale of the shares under the Equity Line of
Credit is conditioned upon us registering the shares of common stock with the
Securities and Exchange Commission. The costs associated with this registration
will be borne by us. There are no other significant closing conditions to draws
under the equity line.
Equity Line Of Credit Explained
Pursuant to the Equity Line of Credit, we may periodically sell shares
of common stock to Cornell Capital Partners to raise capital to fund our working
capital needs. The periodic sale of shares is known as an advance. We may
request an advance every seven trading days. A closing will be held six trading
days after such written notice at which time we will deliver shares of common
stock and Cornell Capital Partners will pay the advance amount. There are no
closing conditions for any of the draws other than the written notice and
associated correspondence. We are limited however, on our ability to request
advances under the Equity Line of Credit based on the number of shares we have
registered in this registration statement and the number of shares we have
authorized. For example, an assumed offering price of $0.0588, we would be able
to draw net proceeds of $1,089,200 under the Equity Line of Credit with the
21,020,408 shares we are registering. In addition, we may to increase our
authorized shares to fully utilize the Equity Line of Credit.
We may request advances under the Equity Line of Credit once the
underlying shares are registered with the Securities and Exchange Commission.
Thereafter, we may continue to request advances until Cornell Capital Partners
has advanced $3.0 million or 24 months after the effective date of the
accompanying registration statement, whichever occurs first.
The amount of each advance is subject to a maximum amount of $85,000,
and we may not submit an advance within seven trading days of a prior advance.
The amount available under the Equity Line of Credit is not dependent on the
price or volume of our common stock. Our ability to request advances is
conditioned upon us registering the shares of common stock with the SEC. In
addition, we may not request advances if the shares to be issued in connection
with such advances would result in Cornell Capital Partners owning more than
9.9% of our outstanding common stock. Based on a recent stock price of $0.0588
Cornell Capital Partners' beneficial ownership of ePHONE common stock is 9.77%.
We would not be permitted to make draws on the Equity Line of Credit if Cornell
Capital Partners' beneficial ownership of our common stock becomes greater than
9.9%. Moreover, Cornell Capital Partners is not limited by a percentage
ownership limitation with respect to converting the convertible debentures, and
therefore a possibility exists that Cornell Capital Partners may own more than
9.9% of ePHONE's outstanding common stock at a time when we would otherwise plan
to request an advance under the Equity Line of Credit.
We do not have any agreements with Cornell Capital Partners regarding
the distribution of such stock, although Cornell Capital Partners has indicated
that intends to promptly sell any stock received under the Equity Line of
Credit.
We cannot predict the actual number of shares of common stock that will
be issued pursuant to the Equity Line of Credit, in part, because the purchase
price of the shares will fluctuate based on prevailing market conditions and we
have not determined the total amount of advances we intend to draw. Nonetheless,
we can estimate the number of shares of our common stock that will be issued
using certain assumptions. Assuming we issued the number of shares of common
stock being registered in the accompanying registration statement at a recent
price of $0.0588 per share, we would issue 21,020,408 shares of common stock to
Cornell Capital Partners for gross proceeds of $1,236,000, or $1,764,000 less
than is available under the Equity Line of Credit. These shares would represent
33.10% of our outstanding common stock upon issuance. We would need to register
additional shares of common stock in order to fully utilize the $3 million
available under the Equity Line of Credit at the current price of $0.0588 per
share. Put another way: we do not have sufficient common-share shares registered
under this registration statement available to draw down the entire $5.0 million
available under the Equity Line of Credit.
16
There is an inverse relationship between our stock price and the number
of shares to be issued under the Equity Line of Credit. That is, as our stock
price declines, we would be required to issue a greater number of shares under
the Equity Line of Credit for a given advance. This inverse relationship is
demonstrated by the following table, which shows the number of shares to be
issued under the Equity Line of Credit at a recent price of $0.0588 per share
and 25%, 50% and 75% discounts to the recent price.
Purchase Price: $0.0588 $0.0441 $0.0294 $0.0147
No. of Shares(1): 21,020,408(4) 21,020,408(4) 21,020,408(4) 21,020,408(4)
Total Outstanding (2): 63,496,706 63,496,706 63,496,706 63,496,706
Percent Outstanding (3): 33.10% 33.10% 33.10% 33.10%
Net Cash to ePHONE: $1,089,200 $795,650 $502,100 $208,550
(1) Represents the number of shares of common stock to be issued to Cornell
Capital Partners under the Equity Line of Credit at the prices
set forth in the table, assuming sufficient authorized shares are
available.
(2) Represents the total number of shares of common stock outstanding after
the issuance of the shares to Cornell Capital Partners under the
Equity Line of Credit, not including shares issued under the
convertible debentures.
(3) Represents the shares of common stock to be issued as a percentage of
the total number shares outstanding. (4) Represents the maximum number
of shares that are issuable under the Equity Line of Credit unless
additional shares are registered.
Proceeds used under the Equity Line of Credit will be used in the
manner set forth in the "Use of Proceeds" section of this prospectus. We cannot
predict the total amount of proceeds to be raised in this transaction because we
have not determined the total amount of the advances we intend to draw.
We expect to incur expenses of approximately $85,000 in connection with
this registration, consisting primarily of professional fees. In connection with
the Equity Line of Credit, Cornell Capital Partners has received 1,800,000
shares of common stock on July 24, 2003 as a one-time commitment fee. In
addition, we issued 200,000 shares of common stock to TN Capital Equities, Ltd,
an unaffiliated registered broker-dealer, as compensation for its services as a
placement agent, on July 24, 2003.
17
PLAN OF DISTRIBUTION
The selling stockholders have advised us that the sale or distribution
of our common stock owned by the selling stockholders may be effected directly
to purchasers by the selling stockholders or by pledgees, donees, transferees or
other successors in interest, as principals or through one or more underwriters,
brokers, dealers or agents from time to time in one or more transactions (which
may involve crosses or block transactions) (i) on the over-the-counter market or
in any other market on which the price of our shares of common stock are quoted
or (ii) in transactions otherwise than on the over-the-counter market or in any
other market on which the price of our shares of common stock are quoted. Any of
such transactions may be effected at market prices prevailing at the time of
sale, at prices related to such prevailing market prices, at varying prices
determined at the time of sale or at negotiated or fixed prices, in each case as
determined by the selling stockholders or by agreement between the selling
stockholders and underwriters, brokers, dealers or agents, or purchasers. If the
selling stockholders effect such transactions by selling their shares of common
stock to or through underwriters, brokers, dealers or agents, such underwriters,
brokers, dealers or agents may receive compensation in the form of discounts,
concessions or commissions from the selling stockholders or commissions from
purchasers of common stock for whom they may act as agent (which discounts,
concessions or commissions as to particular underwriters, brokers, dealers or
agents may be in excess of those customary in the types of transactions
involved). The selling stockholders and any brokers, dealers or agents that
participate in the distribution of the common stock may be deemed to be
underwriters, and any profit on the sale of common stock by them and any
discounts, concessions or commissions received by any such underwriters,
brokers, dealers or agents may be deemed to be underwriting discounts and
commissions under the Securities Act.
Cornell Capital Partners is an "underwriter" within the meaning of the
Securities Act of 1933 in connection with the sale of common stock under the
Equity Line of Credit. Cornell Capital Partners will pay us 98% of, or a 2%
discount to, the lowest closing bid price of our common stock on the
Over-the-Counter Bulletin Board or other principal trading market on which our
common stock is traded for the five days immediately following the advance date.
In addition, Cornell Capital Partners will retain 5% of the proceeds received by
us under the Equity Line of Credit, and has received 1,800,000 shares of common
stock as a one-time commitment on July 24, 2003. The 2% discount, the 5%
retainage and the 1,800,000 shares of common stock are underwriting discounts.
In addition, we engaged TN Capital Equities, Ltd, an unaffiliated registered
broker-dealer, in connection with the Equity Line of Credit. For its services,
TN Capital Equities, Ltd received 200,000 shares of our common stock on July 24,
2003.
Cornell Capital Partners was formed in February 2000 as a Delaware
limited partnership. Cornell Capital Partners is a domestic hedge fund in the
business of investing in and financing public companies. Cornell Capital
Partners does not intend to make a market in our stock or to otherwise engage in
stabilizing or other transactions intended to help support the stock price.
Prospective investors should take these factors into consideration before
purchasing our common stock.
Under the securities laws of certain states, the shares of common stock
may be sold in such states only through registered or licensed brokers or
dealers. The selling stockholders are advised to ensure that any underwriters,
brokers, dealers or agents effecting transactions on behalf of the selling
stockholders are registered to sell securities in all fifty states. In addition,
in certain states the shares of common stock may not be sold unless the shares
have been registered or qualified for sale in such state or an exemption from
registration or qualification is available and is complied with.
We will pay all the expenses incident to the registration, offering and
sale of the shares of common stock to the public hereunder other than
commissions, fees and discounts of underwriters, brokers, dealers and agents. We
have agreed to indemnify Cornell Capital Partners and its controlling persons
against certain liabilities, including liabilities under the Securities Act. We
estimate that the expenses of the offering to be borne by us will be
approximately $85,000. For its services, TN Capital Equities, Ltd received
200,000 shares of our common stock. The offering expenses consist of: a SEC
registration fee of $509.60, printing expenses of $2,500, accounting fees of
$15,000, legal fees of $50,000 and miscellaneous expenses of $16,990.40. We will
not receive any proceeds from the sale of any of the shares of common stock by
the selling stockholders. We will, however, receive proceeds from the sale of
common stock under the Equity Line of Credit.
18
The selling stockholders should be aware that the anti-manipulation
provisions of Regulation M under the Exchange Act will apply to purchases and
sales of shares of common stock by the selling stockholders, and that there are
restrictions on market-making activities by persons engaged in the distribution
of the shares. Under Registration M, the selling stockholders or their agents
may not bid for, purchase, or attempt to induce any person to bid for or
purchase, shares of our common stock while such selling stockholders are
distributing shares covered by this prospectus. Accordingly, except as noted
below, the selling stockholders are not permitted to cover short sales by
purchasing shares while the distribution is taking place. Cornell Capital
Partners can cover any short positions only with shares received from us under
the Equity Line of Credit. The selling stockholders are advised that if a
particular offer of common stock is to be made on terms constituting a material
change from the information set forth above with respect to the Plan of
Distribution, then, to the extent required, a post-effective amendment to the
accompanying registration statement must be filed with the Securities and
Exchange Commission.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward Looking Statements
Certain information in this prospectus including statements made in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and elsewhere 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.
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 have been based in Herndon, Virginia, although are
in the process of moving our operations to Oxford, Connecticut, have a FCC 214
carrier-to-carrier and resale license, and other telephony licenses required to
operate our 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. ePHONE is in the process of winding down the
Canadian calling card operations as it previously existed and has started to
search for a new distributor to allow ePHONE to re-launch services in 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 international services
allows us to capitalize on inexpensive wholesale termination rates, which can be
further leveraged into retail products in order to increase overall margins.
We have developed a strategy that builds one element upon the other to
decrease our 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. Mr.
Mahmoud Wahba who recently became one of our directors is the 20% owner of
Champion. Champion is privately held company. Should the proposed transaction be
consummated as currently contemplated, we will issue a total of 99,641,757
shares of our 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 completion of due diligence by both parties. Should we consummate the
merger as currently contemplated, the issuance of 99,641,757 shares of our
common stock will cause a change in control, since post merger, Mr. Wahba would
beneficially own more than 50% of the outstanding shares of our common stock. As
such if the merger is consummated, the merger will be accounted for as a reverse
acquisition, with Champion being considered the accounting acquirer.
20
Champion brings a variety of assets and capabilities to the Company
which will allow ePHONE to develop and launch new products and extend services
to a broader geographic area. Champion locates its equipment in a building
leased from an associated company and has licenses to operate as a Teleport in
Oxford, Connecticut. ePHONE will lease the large, computer grade,
equipment/office building from that associated company and is planning to house
the ePHONE Executive and Operational Offices, our Global Network Management
Center, our main back office computer systems and some operational network
equipment. The Teleport also is fully equipped with two large 13m satellite
dishes and numerous smaller receive and transmit dishes, that can be used to
provide a range of satellite delivered IP and VoIP services. Finally, the
Teleport is fully equipped with a wide range of audio/visual equipment necessary
to develop and launch streaming media services over the Internet.
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 can often 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. We believe that 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. We believe that 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.
We believe that this integration of Voice, IP and Broadband Satellite
will provide ePHONE and Champion as a combined company with 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, we believe that ePHONE and Champion are
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. We are now entering into new marketing agreements with new
telemarketers to sell e-TRANS-PORT and Unlimited services. We can give no
assurances that our Unlimited Domestic Calling Program revenue levels will grow
to equal or exceed those we previously experienced.
As a direct result of the negotiations and placement of Cisco equipment
in foreign countries, such as Guatemala, the Wholesale revenue increased. Due to
monetary constraints and prepayment requirements in April and May 2003, we
substantially scaled down its wholesale traffic activity. However, we are now in
the process of reestablishing our wholesale business.
In December 2002, through our wholly owned subsidiary ePHONE Canada,
Inc., we 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 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. We are in the process of winding down the Canadian calling card
operation as it previously existed. We have started the search for a new
Distributor in Canada to allow us to relaunch services.
21
Toward the end of our March 2003 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, we
continued during the three months ending June 30, 2003 experienced a significant
cash shortage requiring the we enter into several convertible debt financing
transactions which will cause significant dilution to our existing shareholders
when they are converted into our common stock.
To meet short-term working capital requirements, we negotiated a
$200,000 9% short-term promissory note. The terms of the note require the
issuance of 2,173,913 shares of our common stock. These shares which are being
registered in this prospectus, were priced based on a five day average price of
our common stock. ePHONE will record an expense of $189,000 during 2003 or the
term of the loan relating to the issuance of these 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 to 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 $2,091,000 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
technical 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 increased significantly. We are in the process of winding down the
Canadian calling card operation as it previously existed. and are currently
evaluating the Canadian market and our Distribution strategy.
Our wholesale traffic strategy, included 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 significantly reduced in the second quarter.
The prepaid calling card and wholesale traffic programs accounted for
approximately 90% of our revenue for the three months ended March 31, 2003.
22
We are engaging with new telemarketers and have reorganized
subscription fulfillment and collection procedures related to the sale of
e-TRANS-PORT based services and our domestic unlimited calling program. While we
remain hopeful that these programs 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.
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 to the 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 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.
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.
December 31, 2002 And 2001
We experienced net income from operations before the arbitration award
(see Comdial Arbitration below) for the year ended December 30, 2002 and net
losses from operations for the year ended December 31, 2001.
23
Year Ended Year Ended
December 31, 2002 December 31, 2001
----------------- -----------------
Income (loss) before arbitration award $ 1,884,000 $ (6,919,000)
Arbitration award (1,375,000) (225,000)
--------------- ---------------
Net income (loss) from operations 509,000 (7,144,000)
Other income (expense) (7,000) 123,000
--------------- ---------------
Net income (loss) $ 503,000 $ (7,021,000)
=============== ===============
Net income (loss) per common share $ 0.01 $ (0.28)
=============== ===============
During the year ended December 31, 2002, increasing business from our
retail and wholesale programs that were introduced in Q3 of FY 2001, as
discussed below, coupled with our ability to keep 2002 general and
administrative and selling and marketing expenses consistent with 2001 were the
primary reasons for the overall improvement in operations.
Revenues
Our revenue from operations for the year ended December 31, 2002 and
2001 was as follows:
Year Ended Year Ended
December 31, 2002 December 31, 2001
----------------- -----------------
Service Revenue $ 19,222,000 $ 3,077,000
Product Revenue - 513,000
-------------- -------------
$ 19,222,000 $ 3,590,000
============== =============
The majority of the increase in our revenues is attributed to ePHONE's
retail and wholesale service programs. These programs accounted for all of
ePHONE's revenue for the year ended December 31, 2002 and accounted for 86% or
our revenues during 2001. As ePHONE continues to focus on retail and wholesale
service offerings, sales of equipment are not expected to be significant in the
future. The $513,000 of Array Telecom equipment sales during the year ended
December 31, 2001, will not re-occur.
In the fourth quarter of 2002 we phased out our marketing arrangement
with the telemarketer of our Unlimited Domestic Calling Program. As a result, in
the fourth quarter of 2002 and the first quarter of 2003, we experienced a
decline in revenues from our Unlimited Domestic Calling Program when compared to
earlier periods in 2002. During the 3 months ended March 31, 2003, revenues from
our Unlimited Domestic Calling Program approximated $73,000. Revenues during
2002 from our Unlimited Domestic Calling Program were approximately $16,870,000,
or 88% of our total revenues. We continue to actively seek other telemarketers
to sell our services. However, we can give no assurance that we will be able to
successfully implement new telemarketing arrangements, or should we successfully
implement such arrangements, that we will be able to generate revenues that
equal or exceed those previously experienced.
24
Cost Of Revenues
During the year ended December 31, 2002 and 2001 cost of services
revenue and cost of product revenue were as follows:
Year ended Year ended
December 31, 2002 December 31, 2001
----------------- -----------------
Cost of service revenue $ 9,696,000 $ 2,025,000
Cost of product revenue - 476,000
------------- ------------
$ 9,696,000 $ 2,501,000
============= ============
For the year ended December 31, 2002 and 2001, cost of service revenue
represented commissions, activation fees and processing charges related to our
telecommunications services programs. For the year ended December 31, 2001, cost
of product revenue was related to telecommunications equipment sales. Gross
margin for the year ended December 31, 2002 and 2001 was 50% and 30%,
respectively. During 2001, the product mix consisted of low margin equipment
which was not sold in 2002.
Sales And Marketing
Sales and marketing expense increased from $1,212,000 for the year
ended December 31, 2001 to $1,257,000 for 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 year ended December 31, 2002. Currently, sales
and marketing expense consists primarily of marketing commissions and salaries.
General And Administrative
General and administrative expense increased from $5,607,000 for the
year ended December 31, 2001 to $6,385,000 in 2002. 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
ePHONE's claim against Comdial and awarded damages to Comdial on its counter
claim in the amount of $1,731,000 and $38,000 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 ePHONE agreed to settle
the issue and pay to Comdial $1,600,000. ePHONE has paid this sum to Comdial.
Management believes this avoided a very costly and lengthy appeals process with
no guarantee of success and will enable ePHONE to focus on its operations. This
charge of $1,374,000 is reflected in the accompanying financial statements as of
December 31, 2002, net of approximately $226,000 of arbitration cost accrued in
2001. The company has now resolved all present and future liabilities.
25
Income Taxes
There was no provision for federal or state income taxes for the years
ended December 31, 2001 and 2002 due to the availability of a net operating loss
for income tax purposes.
Years Ended December 31, 2001 And 2000
Revenues
Revenues increased from $590,000 in 2000 to $3,590,000 in 2001. The
majority of the increase is attributed to ePHONE's "Unlimited Access" Program
and our wholesale strategy, which began in mid August. These programs accounted
for 86% of ePHONE's revenue for the year ended December 31, 2001 and did not
account for any revenue during 2000.
Cost Of Revenues
Cost of Revenues increased from $412,000 in 2000 to $2,501,000 in 2001.
For the year ended December 31, 2001, cost of goods sold represented
commissions, activation fees and processing charges related to our
telecommunications services program. Prior to the third quarter of fiscal year
2001, cost of goods sold was related to telecommunications equipment sales.
Gross margin for the year ended December 31, 2001 and 2000 was 30% for each
year.
Sales And Marketing
Sales and marketing expense decreased from $1,853,000 in 2000 to
$1,212,000 in 2001. During 2000, our sales and marketing expenses included
compensation paid to consultants for market studies and competitive intelligence
of the Internet telephony market place in several countries where we were
deploying our network. There were no similar expenditures incurred during 2001.
General And Administrative
General and administrative expense increased from $4,787,000 in 2000 to
$5,607,000 in 2001 primarily due to our changes in the business plan and
non-recurring expenses related to the write off of the Array Telecom license.
Write-Off Of Array Telecom License
In connection with the Comdial Obligation, we decided to discontinue
use of the Array Telecom technology and therefore, wrote off the remaining
balance of the Array Telecom License and related assets and liabilities of
$1,180,000 at December 31, 2001.
Income Taxes
There was no provision for federal or state income taxes for the period
from our inception due to our operating losses. At December 31, 2001, we had net
operating loss carryforwards for income tax purposes. A valuation allowance was
established and, accordingly, no benefits were recognized 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 ePHONE.
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.
26
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.
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 revenues 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 eTRANS-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, we 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 these risks, and 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.
During the year ended December 31, 2002, we received $690,000 for the
purchase of 3,448,913 shares of our common stock from the exercise of warrants
we had issued in connection with the sale of special warrants in 2000. On March
30, 2002, the warrants for the purchase of 9,115,161 shares of our common stock
expired unexercised. We also received $321,000 for the issuance of 1,106,500
shares of our common stock for the exercise of 1,106,500 stock options by our
CEO and CFO at prices ranging from $0.20 to $0.35 per share. Six board members
also exercised options to purchase 253,200 shares of our common stock at
exercise prices ranging from $0.20 to $0.35 with the proceeds totaling $81,000.
The proceeds from the exercise of these warrants and stock options, along with
$890,000 of cash generated from our operations during the year ended December
31, 2002, net of our $1,600,000 settlement payment to Comdial and $664,000 in
property, plant and equipment purchases, increased our cash from $36,000 at
December 31, 2001 to $1,252,936 at December 31, 2002.
It is important to point out that since our inception, we have
accumulated a deficit of $23,042,813, 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.
Investing activities used $664,000 of cash for the purchase of fixed
assets and financing activities provided $959,000 which consisted of $1,093,000
received from the exercise of warrants and employee stock options offset by
payments on obligations for the year ended December 31, 2002.
On June 24, 2003, Cornell Capital Partners entered into a securities
purchase agreement with us under which Cornell Capital Partners agreed to
purchase a total amount of $200,000 of convertible debentures. Cornell Capital
purchased $125,000 of convertible debentures on June 24, 2003, shall purchase
$75,000 upon filing of this registration statement with the Securities and
Exchange Commission. The debentures are convertible at the holder's option any
time up to maturity at a conversion price equal to the lower of (i) 120% of the
closing bid price on the closing date or (ii) 80% of the average of the two
lowest closing bid price of the common stock for the five trading days
immediately preceding the conversion date. The debentures have a two year term
and accrue interest at 5% per year. At maturity, ePHONE has the option to either
pay the holder the outstanding principal balance and accrued interest or to
convert the debentures into shares of common stock at a conversion price equal
to the lower of (i) 120% of the closing bid price on the closing date or (ii)
80% of the average of the two lowest closing bid price of the common stock for
the five trading days immediately preceding the conversion date. Cornell Capital
Partners is entitled to a 10% discount from the purchase price of the
convertible debentures. Cornell Capital Partners purchased the convertible
debentures from ePHONE in a private placement. Cornell Capital Partners is
registering 20,000,000 shares in this offering under the convertible debentures.
On June 24, 2003, we entered into an Equity Line of Credit with Cornell
Capital Partners. Pursuant to the Equity Line of Credit, we may, at our
discretion, periodically sell to Cornell Capital Partners shares of common stock
for a total purchase price of up to $3 million. For each share of common stock
purchased under the Equity Line of Credit, Cornell Capital Partners will pay
ePHONE 98% of, or a 2% discount to, the lowest closing bid price of our common
stock on the Over-the-Counter Bulletin Board or other principal market on which
our common stock is traded for the five days immediately following the notice
date. Further, Cornell Capital Partners will retain 5% of each advance under the
Equity Line of Credit. In connection with the Equity Line of Credit, Cornell
Capital Partners has received 1,800,000 shares of common stock as a one-time
commitment fee on July 24, 2003.
27
Our future capital requirements will depend on many factors, including
growth of our business, economic conditions and other factors, including the
results of future operations. If we are unable to raise sufficient funds to meet
our long-term capital needs, we will be required to cease operations.
Stock Compensation Activity 2002
During March 2002, we issued 89,000 shares of our common stock to
consultants and two members of our Board of Directors. The fair value of the
shares totaled $23,000 and was recorded based upon the market price of the stock
on the date of issuance.
During 2002, we issued 200,000 shares of our common stock and 200,000
options to purchase shares of our common stock to a consultant to whom we had
issued the same amount of shares of common stock and options in 2001 with
similar terms as described under Stock Compensation Activity in 2001. The fair
value of the shares and options was $39,000 and $37,000, respectively, and is
recorded as non-cash compensation expense during the year-ended December 31,
2002.
On November 15, 2002 our Board of Directors approved resolutions to
reduce from $0.35 to $0.20 the exercise price of 586,500 stock options held by
certain Board members and executive officers and to accelerate the vesting
period of 581,667 stock options held by certain executive officers and a former
executive officer.
On various dates during 2002, Management accelerated the vesting on
224,449 stock options held by certain employees.
Since the modifications, we have accounted for these options using
variable accounting. We have not recorded any compensation expense in connection
with these modifications since the new exercise price has been higher than or
equal to the market price.
Stock Compensation Activity During 2001
On February 14, 2001, the Board of Directors approved the issuance of
250,000 stock options to a consultant in an exchange for services rendered under
a consulting agreement. The stock options have an exercise price of $0.50,
vested immediately and expire in three years. The market value of our common
stock at the grant date was $0.23. The fair value associated with these options
totaled $42,500 and was recorded as non-cash compensation during the quarter
ended March 31, 2001.
As further described in Legal Proceedings, we entered into a Settlement
agreement with Charles Yang on March 23, 2001. Pursuant to the terms of the
agreement, we agreed to pay Mr. Yang $400,000 in cash in installments by July
23, 2001, and issue Mr. Yang 400,000 shares of our common stock. We recorded
$180,000 in expense related to this settlement during the three months ended
March 31, 2001. The fair value of the stock issued was $80,000 and is recorded
as non-cash compensation in the statement of operations. We did not make the
required payments to Mr. Yang by July 23, 2001 and therefore were required to
issue an additional 100,000 shares of our common stock in accordance with a
Modification of the original Settlement Agreement entered into between us and
Mr. Yang. The fair value of the additional shares totaled $30,000 and is
recorded as non-cash compensation in the December 31, 2001 statement of
operations.
On September 12, 2001 our Board of Directors approved a resolution to
reduce from $0.50 to $0.35 the exercise price of 3,900,000 stock options held by
certain Board members, executive officers and former employees.
During October and November 2001, we issued 200,000 shares of our
common stock and 200,000 options to purchase shares of our common stock to a
consultant as consideration for marketing and business development consulting
services rendered. The fair value of these shares of common stock totaled
$49,000 and is recorded as non-cash compensation expense as of December 31,
2001. The options have an exercise price of $0.50 and vest immediately. The fair
value associated with these options was $48,045 and is recorded as non-cash
compensation expense during the year ended December 31, 2001. During 2002, under
the terms of a consulting agreement, ePHONE issued this consultant an additional
200,000 shares of our common stock and 200,000 options to purchase shares of our
common stock.
28
On November 29, 2001, we entered into an exclusive Marketing and
Distribution Agreement ("Agreement") with PITRFA Inc., a Florida based sales,
marketing and distribution company. As defined in the Agreement, PITRFA will
market and distribute ePHONE's prepaid 1+ long distance service for a period of
three years. Upon signing the Agreement, we issued PITRFA 500,000 shares of our
common stock. The fair value associated with these shares of common stock
totaled $97,015 and is recorded as non-cash compensation expense in our December
31, 2001 Statement of Operations. The Agreement also contains a provision for
the issuance of additional shares of our common stock if our common stock
reaches certain price levels in the future as follows: a) if the price of our
common stock reaches $2.50 per share we will be required to issue PITRFA a
second tranche of 538,973 shares and; b) if the price of our common stock
subsequently reaches $5.00 per share, we will be required to issue PITRFA a
third tranche of 538,973 shares. The maximum amount of shares that would be
issued if all milestones are met is 1,616,919, which represents 5% of our common
stock outstanding at the signing of the Agreement.
On December 17, 2001, our Board of Directors approved a resolution to
extend the expiration date of a former officer's stock option agreement from
March 31, 2002 to October 1, 2002.
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 August 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 tangible long-lived
assets and the associated asset retirement costs. It applies to (a) all entities
and (b) legal obligations associated with the retirement of long-lived assets
that result from the acquisition, construction, development and/or normal
operation of long-lived assets, except for certain obligations of lessees. SFAS
No. 143 is effective for financial statements issued for fiscal years beginning
after June 15, 2002. The Company does not believe the adoption of this statement
will have a material impact on our financial position or results of operations.
Also in August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which established one accounting
model to be used for long-lived assets to be disposed of by sale and broadens
the presentation of discontinued operations to include more disposal
transactions. SFAS No. 144 supersedes SFAS No. 121, "Accounting for the
Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of" and the accounting and reporting provisions of APB Opinion 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" for the disposal of a segment of a business (as
previously defined in that Opinion). The provisions of SFAS No. 144 are
effective for financial statements issued for fiscal years beginning after
December 15, 2001. The adoption of SFAS No. 144 had no impact on ePHONE's
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," which rescinds SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt" and an amendment of that Statement, and SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS No.
145 also rescinds SFAS No. 44, "Accounting for Intangible Assets for Motor
Carriers." SFAS No. 145 amends SFAS No. 13, "Accounting for Leases," to
eliminate an inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
have economic effects that are similar to sale-leaseback transactions. SFAS No.
145 also amends other existing authoritative pronouncements to make various
technical corrections, clarify meanings, or describe their applicability under
changed conditions. SFAS No. 145 is effective for fiscal years beginning after
May 15, 2002. The Company does not expect the adoption of SFAS No. 145 will have
a material impact on its results of operations or financial position.
29
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses significant issues
regarding the recognition, measurement, and reporting of costs associated with
exit and disposal activities, including restructuring activities. SFAS No. 146
requires that costs associated with exit or disposal activities be recognized
when they are incurred rather than at the date of a commitment to an exit or
disposal plan. SFAS No. 146 is effective for all exit or disposal activities
initiated after December 31, 2002. The Company does not expect the adoption of
SFAS No. 146 to have a material impact on our results of operations or financial
position.
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 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 our Consolidated Financial Statements.
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.
In April 2003, FASB issued SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities which amends and clarifies
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under Statement 133. We
do not currently have any derivative instrument activities the adoption of this
statement will not have a material impact upon our Consolidated Financial
Statements.
In May 2003, FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity which changes
the accounting for mandatorily redeemable shares, put options, forward purchase
contracts and obligations that can be settled with shares. Since we do not have
any interests in such types of instruments the adoption of this statement will
not have a material impact upon our Consolidated Financial Statements.
Critical Accounting Policies And Estimates
Management's discussion and analysis of our financial condition and
results of operations are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires that we make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses and related
disclosure of contingent assets and liabilities. At each balance sheet date,
management evaluates its estimates, including, but not limited to, those related
to accounts receivable, inventories, and deferred revenue. We base our estimates
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances. Actual results may differ from these
estimates under different assumptions or conditions. The estimates and critical
accounting policies that are most important in fully understanding and
evaluating our financial condition and results of operations are discussed
below.
30
Accounts Receivable
We provide an allowance for all individual receivables judged by us to
be unlikely for collection. The effect of the allowance is to reduce the
accounts receivable reported on our balance sheet to an amount we believe will
be collected. Significant management judgments and estimates must be made and
used in connection with establishing this valuation account. We record an
allowance for doubtful accounts and sales and returns based on a combination of
factors in making this judgment. Specifically, we analyze the age of receivable
balances, our historical bad debts write-off, sales and returns history, and our
customer's creditworthiness to determine the appropriate allowance for doubtful
accounts. At December 31, 2002, our allowance for doubtful accounts was
$321,000, up from $116,000 at December 31, 2001. This increase is due primarily
to one large receivable in 2002 in which collection is uncertain. Although we
consider our allowance for doubtful accounts to be adequate and proper, changes
in economic conditions or customer circumstances could have a material effect on
the reserve balance required.
Inventory Valuation
We use certain estimates and judgments to value our inventory. Our
inventory of $264,000 at the year ended December 31, 2002, is recorded at the
lower of cost, using the weighted average method, or market and is comprised
primarily of e-TRANS-PORT devices that are manufactured by a third party. The
e-TRANS-PORT product launch is still in its early stages and Management is in
the process of developing distribution channels for this product. We have not
recorded an allowance against inventory at December 31, 2002 and 2001. Based on
changes in the facts and circumstances, we will periodically assess the need to
establish an allowance for the e-TRANS-PORT units in the future if it is
considered to be obsolete or slow moving. If such an allowance is necessary, it
could have a material effect on the carrying value of inventory. In April 2003,
we reached a settlement with a Consultant which transferred a number of our
e-TRANS-PORT assets to him in recognition of past and future services. This
resulted in a reduction in our Inventory Valuation to $13,936.
Revenue Recognition
We recognize telecommunication services revenues over the period
services are provided. Monthly recurring telecommunications services are billed
in advance and any portion of our services that is billed for which we have not
yet provided services is recorded as deferred revenue. As a result, we defer
recognition of revenues and the proportionate costs of revenues from sales to
distributors until such distributors resell our products to their customers. The
amounts deferred as a result of this policy are reflected as "deferred revenue"
in the accompanying balance sheet.
Submission Of Matters To A Vote Of Security Holders
None.
31
DESCRIPTION OF BUSINESS
A. Overview
ePHONE was incorporated on May 3, 1996 pursuant to the laws of the
State of Florida.
The development of ePHONE's current business plan essentially commenced
in June 2001. From the date of incorporation until December 31, 1999, ePHONE did
no business. From January 1, 2000 to June of 2001, it focused on the development
of a business model that was a precursor to the current business plan.
Today, ePHONE is a provider of advanced Internet-based communications
services. The Company offers 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. The Company is moving to Oxford,
Connecticut from its previous base 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, ePHONE began providing retail and wholesale
telecommunication services throughout Canada through its wholly-owned
subsidiary, ePHONE Telecom, Canada.
B. Strategic Plan
ePHONE's 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 operating as a provider of both wholesale and retail
services. Using a private Internet Protocol ("IP") network and the public
Internet, ePHONE has developed the capability to provide voice and data
transmission and other telephony features at high quality and low cost. ePHONE's
international network allows ePHONE to capitalize on inexpensive wholesale
termination rates, which can be further leveraged into retail products in order
to increase overall margins.
ePHONE has developed a strategy that builds one element upon the other
to decrease ePHONE's costs of providing service while increasing market
penetration. ePHONE also employs a channel distribution model based on the
development of partnerships both domestically and internationally. ePHONE's
philosophy is to create and sustain ePHONE as a facilities based marketing and
sales oriented telecommunications company.
C. Business Plan
ePHONE has become a global telecommunications VOIP provider 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. ePHONE believes it can differentiate
itself 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.
ePHONE's approach has four components:
o Utilization of high quality fiber lines provided by leased
circuits and private IP connections and use of the Internet
where efficiency and economics dictate, to carry
telecommunications traffic and to link nodes in the network.
o Deliver a range of innovative products and services using its
network.
o Compete as a provider of long distance and international
services in an attempt to offer the most competitive rates are
available for the retail products.
o Develop direct international connections and partners to
further enhance our ability to compete in the wholesale market
while further improving margins on retail products.
32
As of the end of fiscal year 2002 ePHONE had deployed network nodes in
El Salvador, Guatemala, Toronto, New York, Los Angeles, Miami, and Reston and is
supporting retail programs as well as wholesale arbitrage traffic. ePHONE is
interconnected with other carriers for origination of revenue generating traffic
and termination of traffic both domestically and internationally. ePHONE still
terminates traffic in El Salvador through commercial relationships although it
no longer has physical assets in those countries. The retail programs consist of
the following: (i) e-Trans-Port, (ii) Unlimited calling plan, (iii) Canadian
Calling Card program, and (iv) eAccess calling cards in the United States and
Canada.
ePHONE formally introduced e-Trans-Port in January 2003. e-Trans-Port
is a totally self-contained piece of equipment, the size of a pack of chewing
gum, which is installed between the phone and the incoming phone line at the
customer premises. ePHONE's service to the customer is the same as the 1+ long
distance service; except that it is prepaid with the added benefit of
portability. e-Trans-Port offers extremely competitive rates and avoids the two
stage dialing by other prepaid services. The customer simply dials the number he
is calling and the e-Trans-Port device automatically routes the call through
ePHONE's network.
ePHONE has worked closely with the designer and manufacturer of
e-Trans-Port and has integrated the device with our network. ePHONE has secured
the exclusive rights to the version of the device that works with our network,
which provides multiple functions and has a speed of connection that is faster
than previous versions of the device. ePHONE is working with marketing entities
to introduce the product to market through home shopping TV channels and large
retail chains as well as the after market distribution channels for products
marketed "As Seen on TV".
ePHONE positions e-Trans-Port so the end user may save as much as 70%
off their equal access based 1+ service. Currently, competitive long distance
services are offered by service providers, who require the customer to authorize
all routing of long distance calls to a specific service provider. The approach
ePHONE is taking does not require any inter carrier or service provider
coordination. The customer can use ePHONE's service regardless of which long
distance carrier they are currently using, and they do not need to change
carriers or inform them that they are using the ePHONE service.
ePHONE believes its aggressive approach to marketing and sales is as
important as the technologies being employed. ePHONE has assembled a management
team with diverse telecommunications experience and expertise. ePHONE is
committed to staying at the leading edge of telecommunications and information
technologies but believes its real competitive advantage will be sustained
through a creative and innovative approach to acquiring and maintaining
customers and channel distribution partners.
ePHONE plans for 2003 and beyond are to continue to build its network
capacity, geographic coverage and utility while continuing to introduce new
products and services. ePHONE's wholesale activities are focused on pursuing
international direct interconnections. Direct interconnections are achieved
either over the Internet, or where economically feasible, over leased circuits
to ePHONE's or a partner's equipment located in other countries. ePHONE believes
the termination rates obtained through "directs" will lower termination costs
which in turn will increase margins on both wholesale and retail programs. The
development of direct interconnections is the focus of the franchise program
wherein partners are solicited to install equipment in their own country but the
equipment becomes a part of the ePHONE network and the revenues generated by the
equipment are shared.
D. Network
ePHONE believes the development of IP telephony as a viable technology
for providing telecommunications services is significant not only because of the
reduction in costs, but also because of the enhanced services that it
facilitates. Unlike legacy telecommunication systems, which are currently used
by most providers of telecommunications services, IP telephony systems are open,
and thereby, allow the integration of numerous services on a single platform.
This integration provides significant cost advantages. Inherent in the
conversion of voice to data over an IP network is an effective and efficient
compression of the conversation. Effectively this means an increase in
utilization of bandwidth or capacity, which translates into a decreased cost.
ePHONE's plan is for their network to be deployed worldwide, and it
will consist of the following main elements:
o The use of a high quality IP backbone provided by a
combination of leased lines and the Internet to carry
telecommunications traffic and to link nodes in the network.
33
o Strategically placing nodes in the network that interface with
end-users and provide the actual services ePHONE will offer
through its Points of Presence (POPs).
o Co-location of Nodes in secure facilities to allow low cost
interconnection to a variety of IP network providers.
o Global Network Management Center (GNMC). From this centralized
point of command, ePHONE's technical staff will use their best
efforts to ensure uninterrupted operation of ePHONE's network
and services. The GNMC will also serve as a collection point
for billing information used in invoicing for services
rendered.
o Data Processing Centers. This duplicated facility provides the
authentication and rating of our retail services.
1. IP Backbone
In order to deliver high quality voice services that are comparable to
traditional public telephone services, ePHONE requires a high quality IP
backbone to carry traffic between its POPs. Currently, ePHONE is utilizing
several different carriers to interconnect its POPs.
The technology ePHONE employs allows for the use of both the public
internet and international and domestic private leased circuits. ePHONE's
network provides the flexibility to move to new technologies as they evolve and
become practical. Because of a VOIP technology called Real Time Protocol "RTP"
header compression, the use of private leased circuits allows ePHONE to double
the amount of traffic ePHONE can carry over a given bandwidth. This technology
enables ePHONE to realize even more savings in the transport of traffic than an
Internet only competitive carrier.
2. Points of Presence (POPs)
In each region where ePHONE establishes a presence, equipment will be
deployed. Each POP will interface to the IP Backbone in order to provide the
numerous services that ePHONE offers. The key components of each of our POPs
will be the following:
o Network routers used to connect the POP as a whole to the IP
backbone. These routers will allow access to our IP backbone
by any device that is part of the company network. Such
devices include gateways, and other sub-components of our
switch.
o The IP gateway that serves as the interface between the local
carrier and our IP backbone. This VOIP gateway is the bridge
between our network and the existing public telephone network.
Application servers are used to deliver actual services to the end
user. Similar to a web server, application servers will be used to host the
applications that end users interact with. These servers are centrally located
and accessed by the POPs either over the Internet or via the ePHONE network.
A second tier of POPs placed under the auspices of the franchise
program is intended to provide direct termination to and access from various
countries where the placement of such POPs is technically feasible and
economically profitable. ePHONE expects to be able to place additional local
access POPs during 2003 if suitable commercial opportunities are identified and
as capital resources are available.
3. Global Network Management Center (GNMC)
The GNMC is the centralized command center from which ePHONE's
technical staff manages the various components of the network, as well as all
other services being provided. The network is monitored 24 hours a day, 7 days a
week. The GNMC, which is connected to the network via a high-speed dedicated IP
connection, provides the following services:
o Bandwidth monitoring and planning activities to determine the
appropriate timing and structure of improvements to our
network infrastructure.
o Coordination of the deployment of new ePHONE POPs, and
extensions of the IP backbone to include new regions.
34
4. Data Processing Center
In a duplicated, secure data processing center, ePHONE provides the
following:
o Real-time collection of call detail record (CDR) information
from all ePHONE POPs.
o Authentication and consolidation of all billing information
generated by ePHONE POPs located throughout the network.
o Back office functions such as account setup, management,
termination and post paid billing.
o IP network monitoring, to ensure that the IP backbone delivers
consistently high quality performance and results.
o Monitoring of the equipment in each POP in the network to
ensure availability.
o Monitoring carrier interconnects to ensure adequate quality of
service and availability of termination to the contracted
destinations.
o Development and deployment of new services to ePHONE POPs.
E. Marketing
ePHONE offers a wide range of telecommunications services to carriers
and end users throughout the world. The fundamental service that ePHONE provides
is the ability to reduce telecommunications costs through the use of IP
telephony technology.
ePHONE has already demonstrated the viability of selling long distance
telephone services using IP telephony technology. To extend that viability,
ePHONE offers significantly differentiated retail products and services. We
believe there are three broad categories in which ePHONE delivers services that
are more compelling than the straightforward long distance calling services
being offered currently by telephony carriers.
These categories are:
o Marketing differentiated services.
These products are differentiated both by how they are distributed and
sold and the underlying technologies. Moving telephony services into
mass marketing channels and adapting the products either technically or
commercially to offer an innovative product tailored to the specific
distribution channel is what distinguishes these products from other
offerings. Examples of this are the Unlimited Domestic Calling Program
and the eCanada and eACCESS range of calling cards.
o Enhanced services.
Through integration of IP telephony products based on open standards,
ePHONE provides a significantly greater depth of services beyond simple
long distance calling, including services such as roaming, 1+ dialing,
online billing and verification. Because of the open architecture,
ePHONE is also positioned to add services such as unified messaging,
"Follow Me" and "Find Me" services. Management anticipates introducing
these services in the 3rd quarter of 2003.
o Access technology.
At present, consumers must either physically change their long distance
provider (at a fee), dial additional access codes or use a pre-paid
card with its access number and PIN to access lower cost services.
ePHONE has developed and deployed the e-TRANS-PORT to allow customers
to generally return to the basic freedom to dial long distance calls in
the normal way, but gain immediate access to ePHONE's low cost and
simple rates. These devices allow ePHONE to deliver services providing
an ease of use only seen with 1+ service.
35
o Marketing Approach.
ePHONE uses a combination of in-house and consultant marketing
resources to develop routes to market its products. The external
resources are primarily focused on expanding ePHONE's penetration of
the retail market for e-TRANS-PORT and the eAccess range of calling
cards.
F. Products And Services
o Specialty Products
These services are customized to the requirements of a specific
distribution channel or marketing program. Examples of these programs are the
Unlimited Domestic Calling Program and the e-TRANS-PORT product.
These products are driven by the marketing approach and the technology.
The underlying technologies are standard prepaid services, however, the
marketing approach and added features and functionalities including on line
review of calls dialed and charges on the card or distribution channel
differentiates the product and thereby creates a competitive advantage resulting
in high margins.
For example, e-TRANS-PORT as to which ePHONE holds an exclusive
license, has a microchip that does not require a separate power source. It is
used to produce a product that works for all practical purposes the same as a 1+
dialing program. In addition, the product is mobile since it can be used from
almost any 1 or 2 line phone in the domestic US including hotels.
As the network is expanded ePHONE believes its products can be exported
to international markets thus leveraging the development effort that has gone
into the definition and launch of the product in the US. Prepaid Calling Cards
Since each POP is capable of providing interactive voice response
("IVR"), balance announcements, real-time billing with automatic cutoff and
other key features, no additional investment is required in order to use the
network to provide prepaid calling card services.
Prepaid calling cards offer a range of products targeted at different
markets and distribution channels. Competitive rates and extensive distribution
channels allow cards to be tailored to each of these markets:
o Local Community Cards
Targeted at local community calling groups with specific
calling destinations distributed through small retail stores
or neighborhood contacts.
o Promotional Cards
Cards sold to a corporate entity to promote their product as a
promotional item.
o Travel Cards
These cards allow a consumer to make calls from a number of
specified countries at rates that are lower than the consumer
would otherwise be required to pay.
o NPO - non profit organization products
These products are tailored to the "affinity" market. They
provide an alternative revenue source for non-profit
organizations.
o International Cards
As additional local access POPs are put in place, franchise
partners are able to market their own prepaid products in
their market or country.
o Customized Online Billing
36
Because ePHONE's network is built on Internet Protocol (IP) technology,
it is able to deliver transactional and e-commerce applications identical to
those used by web-based retailers. Since all POPs collect billing information in
real-time, with immediate transmission of billing information to the GNMC,
ePHONE is able to provide online services, such as, allowing customers to review
their bills, signing up for new plans and services, or making changes to
existing services. This service also provides immediate feedback to end users on
the benefits and savings.
This service has been further extended with the addition of an IVR
(Interactive Voice Response system) that provides similar services for users
over the phone, allowing them to sign up for new services and providing
information on the status of their accounts.
G. Wholesale Carrier And Directs
ePHONE believes the provision of competitive retail products is
dependant on its ability to obtain competitive rates from suppliers. ePHONE
believes it can obtain these competitive rates by positioning itself as a
wholesale service provider. ePHONE establishes relationships with terminating
carriers and sells to other carriers with the intent of making a margin on the
transaction.
Providing these services allows ePHONE to increase traffic volumes as
well as making bilateral arrangements for both the origination and termination
of traffic with a specific carrier, thereby, reducing the financial exposure in
both directions. ePHONE believes this also increases the number of carriers with
whom ePHONE can contract.
ePHONE has established contractual relationships with a base of
carriers who provide services ranging from local access, 800 access and
international terminations. The relationship with other carriers is very dynamic
and requires an ongoing presence in the market to track rates and develop
contractual relationships as new routes or more competitive rates become
available.
ePHONE has established a network of interconnections that is sufficient
for the current business plan purposes and can increase its capacity within
days. ePHONE can terminate calls to any destination in the world and has very
competitive rates through contracted carriers for access and egress in the
domestic US. ePHONE is able to offer competitive products in the retail market
and to terminate traffic on behalf of other carriers competitively.
ePHONE believes it can further improve its rates to international
destinations by interconnecting with carriers or service providers in those
international locations. This is the focus of ePHONE's franchise program. It
encourages companies in international locations to install compatible equipment
and provide access to the local telephone network and to become part of the
ePHONE network. These "directs" bypass intermediaries and allow ePHONE to
benefit from lower termination rates as well as providing access for retail
products in that location. ePHONE connects to these partners via the Internet
and there are no long term transmission commitments to be supported.
H. Suppliers
A significant amount of technology and management experience was
required to create the network and deliver services to end-users. Although
ePHONE has the in house technical expertise to create some systems, its strategy
is to enhance the current technology team by partnering with other companies
that provide the required technology and can meet ePHONE's requirements. A list
of the partners and suppliers that ePHONE uses are:
o Cisco Systems, Inc.
ePHONE maintains a strong, strategic technology and business
relationship with Cisco Systems. ePHONE's network is built end-to-end
with Cisco products and technologies, and meets a high standard of
reliability and performance. Cisco offers an extensive array of VOIP
products, IP routers and switches. These products can be combined in a
variety of different ways to provide the desired network functionality.
ePHONE's technology team believes they have developed an architecture
that provides superior functionality and flexibility. This architecture
has been propagated throughout ePHONE's core network.
37
o Mind CTI, LTD
Mind CTI is an Israeli company that has developed a billing system used
in both data and voice applications. It also provides access control,
authorization and configuration capabilities. It allows ePHONE to
define a hierarchy of relationships between carriers, distributors,
service providers and anyone else with whom ePHONE deals to provide
services, either as a customer or provider. The Cisco equipment handles
the routing and sending of traffic while the Mind CTI system keeps
track of what happened throughout the network and what the cost was and
who should be charged.
o Immix Telecom, Inc.
Immix is a Florida corporation selling autodialers and other access
devices. Immix produces the device being used for the e-Trans-Port
program. ePHONE has developed a very close working relationship with
Immix that has allowed ePHONE to closely integrate the e-Trans-Port
with the ePHONE network to provide seamless customer access. ePHONE's
contract with Immix provides for an exclusive right to distribute the
specific device ePHONE has developed in conjunction with Immix.
o Switch and Data
ePHONE has contracted with Switch and Data to provide co-location
facilities in New York, Miami, Reston and Los Angeles. Switch and Data
operates "Carrier Hotels" which are facilities set up to provide a
location to house telecommunications switches. They possess all the
attributes required in the form of security, uninterruptible power, air
conditioning and proximity to other carriers and telecommunications
facilities.
o Carriers
As a VoIP Services provider, ePHONE interconnects with a number of
other carriers. These relationships are fluid, depending on where
ePHONE can obtain the best rates and to whom ePHONE can sell rates at
any given point in time. Though other carriers as a group are extremely
important to ePHONE, no one carrier is in a position to be considered
critical to ePHONE's success.
I. Competition
The market for Internet voice, fax and other value-added services is
competitive. Internet protocol and Internet telephony service providers, such as
ITXC Corp., route traffic to destinations worldwide and compete directly with
ePHONE, along with Internet telephony service providers Net2Phone. In addition,
major telecommunications carriers, such as AT&T, Deutsche Telekom, MCI WorldCom
and Qwest Communications, have all entered or announced plans to enter the
Internet telephony market. Many of these companies are larger than ePHONE and
have substantially greater managerial and financial resources than we do.
Competition in ePHONE's markets can be expected to continue and may adversely
affect our profitability. ePHONE cannot assure that we will be able to compete
successfully against competitors and may lose customers or fail to grow our
business as a result of this competition.
ePHONE has developed a strategy to take advantage of the current market
conditions while positioning itself to accommodate future developments and
trends. The key elements are simple individually, but require the technology,
management expertise and experience to take advantage of them. ePHONE believes
it has gained a significant competitive advantage through its ability to:
o Capitalize on the current oversupply of bandwidth to
continually build out and improve its network by utilizing
private IP connections and leased lines to provide a reliable,
high quality transmission facility. This is achieved with
slightly higher cost than the cost of using the Internet as
the transport medium while providing a managed network
environment with superior call quality.
o Utilize the latest standards based technologies to deploy a
network capable of interfacing to both legacy networks
(traditional telephone networks) and the variety of VOIP
networks.
o Introduce higher margin retail products such as e-Trans-Port,
Unlimited Domestic Calling Program, reseller program and
prepaid calling cards and continue its new product development
program.
38
o Build traffic volume through wholesaling minutes to other
carriers.
o Aggregate traffic to increase volumes to certain geographic
destinations which results in decreased cost per minute.
o Utilize in-country partners to provide low cost termination
and call origination in high margin, high traffic volume
locations. This allows us to open new markets while decreasing
termination costs. A distinct advantage of ePHONE's technology
is the ability to rapidly and inexpensively deploy nodes or
POPs, which decrease the cost of terminating traffic as well
as providing the opportunity to originate traffic.
For the present, the following companies focusing on the use of VoIP
technology are our main competitors:
o The Internet Telephone Exchange Carrier (ITXC)
ITXC is a clearinghouse for Internet telephony service provider and
operates ITXC.net. Since April of 1998, ITXC has been used to provide
traditional carriers' international call completion with sufficient quality for
carriers to serve their phone-to-phone customers. ITXC has reportedly installed
167 POPs in 45 countries and 101 cities.
o iBasis
iBasis was founded in 1996 to provide Internet Protocol (IP) telephony
service to telecommunication carriers around the globe. The company has POPs in
Asia, Europe, the Middle East, and the Americas. iBasis is in wholesale Internet
telephony service.
o Net2Phone
Net2Phone began as a subsidiary of IDT Corporation and is a provider of
voice over public Internet communications services. Net2Phone enables its
customers to place telephone calls from their computers, telephones, or fax
machines to any telephone or fax machine in the world. By routing calls via the
public Internet, Net2Phone enables users to save money on their international
phone rates. Net2Phone developed a proprietary Gateway technology for IP voice
services offered by the company.
Net2Phone's product offerings include PC-to-phone service, IP telephony
service for phone or fax and Real-time PC-to-fax solution. Its network currently
reaches over 30 countries and continues to expand globally.
o DeltaThree
Founded in 1996, DeltaThree manages a network dedicated to the
transmission of voice over IP. Its services include PC-to-phone, unified
messaging, global access calling cards, and voice greetings accessible from the
company's communications portal. DeltaThree currently operates a network of 37
international POPs.
J. Partnership Programs
A key element in our overall ePHONE strategy is the Partnership
Program. ePHONE's Partnership Program is designed to facilitate the rapid
deployment and sales of products and services with a minimum capital investment
by ePHONE. There are two elements to our Partnership Program, the Franchise
Partner Program and the Sales Agent Program.
o Franchise Partner Program
The Franchise partner program focuses on the rapid expansion of our
network. The program is designed to allow interested parties to participate in
the deployment of ePHONE's network by providing capital used to locate an ePHONE
POP in a given area. Once that POP is deployed, ePHONE's Franchise Partner then
performs marketing of our services, taking a share of any profits generated by
that ePHONE switch.
39
o Sales Partner Program
Under this program, ePHONE recruits resellers who make no capital
investment but specialize in selling services. Sales Partners are required to
commit to minimum sales targets for each of our services that they sell.
However, Sales Partners will be paid a commission based on sales.
K. Government Approvals And Regulations
ePHONE is currently in possession of a Federal Communications
Commission 214 license which allows ePHONE to provide telecommunications
services in the United States and as an international carrier. ePHONE has
obtained, has filed for, or is in the process of filing for licenses with the
individual states within the United States of America for provision of
intrastate services.
ePHONE's need for licenses in other countries will generally depend on
whether ePHONE operates as a foreign company in those locations or whether
ePHONE partners with licensed local partners. ePHONE is licensed to provide
telecommunication services in Canada.
L. Patents, Trademarks And Royalty Agreements
ePHONE does not have any patents, trademarks, licenses or protective
agreements. ePHONE has trademarked its logo in Canada and has the trademark for
name "e-Trans-Port". ePHONE has an exclusive license for the use of the
e-Trans-Port as it is utilized with our system.
M. Research & Development Activities
ePHONE is not undertaking any pure research and development. ePHONE's
activities in this respect consist of working with the products ePHONE has
purchased and licensed from suppliers in order to integrate them into a network
and back office. In this effort ePHONE has found it necessary to develop tools
and processes for its own use in the administration and management of the
Network. These activities will continue as its business requirements grow and
change.
N. Employees
As of July 4, 2003, ePHONE had 9 full-time employees , consisting of 4
in Network Operations, 1 in Marketing and 4 in Administrative and Accounting. In
addition, ePHONE had 1 individual providing service to us as independent
consultant. As ePHONE's business and development efforts expand, additional
personnel will be engaged, either as employees or as contract service suppliers.
40
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Directors And Executive Officers
The directors and executive officers, their ages and positions held as
of July 24, 2003 are listed below. Each director serves until the next annual
meeting of the stockholders or unless they resign earlier. The Board of
Directors elects officers and their terms of office are at the discretion of the
Board of Directors.
Name Age Position Held
- ---- ---- -------------
Lawrence Codacovi 68 Chairman of the Board of Directors
Carmine Taglialatela Jr. 55 President and Chief Executive Officer, Director
Charlie Rodriguez 57 Chief Financial Officer and Director
Steve Heap 52 Chief Operating Officer
Eugene Sekulow 71 Director
Sheldon Kamins 54 Director
Robert Stuart 53 Director
Mahmoud Wahba 62 Director
The following describes the business experience during the past five
years of ePHONE's Directors and Executive Officers, including for each director,
other directorships held in reporting companies. There are no Family
relationships among any of the persons listed.
Carmine Taglialatela, Jr. - President and Chief Executive Officer and
Director. On April 1, 2001 Mr. Taglialatela was appointed President and Chief
Operating Officer of ePHONE and elected to the Board of Directors. Effective
July 1, 2001, Mr. Taglialatela was appointed Chief Executive Officer of ePHONE.
Prior to joining ePHONE, starting in September 1999, Mr. Taglialatela was
President and Chief Operating Officer of TELRON Communications and was
responsible for the day-to-day operations of the company and the development of
service offerings and expansion of services into new markets. From 1997 to 1999,
Mr. Taglialatela held Executive Vice President positions at TELRON and
CompassRose International, Inc. At CompassRose he managed a team of
professionals on a variety of client assignments requiring extensive
international telecommunications experience and expertise in strategic business
development, public policy and regulatory matters. Mr. Taglialatela has secured,
on behalf of clients, service authorizations in off shore markets and advised
senior management on courses of action for the development of their
telecommunications business. Between 1989-1977, he was Director International
Public Policy and Regulatory Affairs at MCI Telecommunications Corporation where
he developed and implemented MCI's regulatory and business strategy for access
to international markets and was a member of an expansion team devoted to
expanding MCI's presence in the global market. Mr. Taglialatela holds a BA
Economics from Hunter College, City University of New York and a MBA
Finance/Marketing from Fordham University.
Charlie Rodriguez - Director, Chief Financial Officer, and Vice
President, Corporate Affairs. On December 1, 2000, Mr. Rodriguez was elected as
a Director and appointed as Chief Financial Officer and Vice President -
Corporate Affairs. Mr. Rodriguez previously served as Vice-President of
Corporate Affairs and Corporate Secretary from June 1999 to April 2000. Mr.
Rodriguez is also the President of Management Services of Arizona, a business
consulting company specializing in mergers, acquisitions and financing. Prior to
joining ePHONE, Mr. Rodriguez served as the Chief Financial Officer for Zephyr
Technologies, Inc., biometrics and smartcard software integration companies. Mr.
Rodriguez was a member of the board of directors of Wave Rider Communications,
Inc. (WAVC - otc.bb), a wireless communication company, from January to November
1997, and served as its President and Chief Executive Officer from May 1995 to
January 1997. Mr. Rodriguez holds a Bachelor of Science in Accounting and
Masters in Business Administration Accounting from the University of Arizona.
Steve Heap - Chief Operating Officer. Mr. Heap joined ePHONE on August
1, 2002 as the Chief Network Officer and on November 1 he was appointed the
Chief Operating Officer and Chief Technology Officer. Mr. Heap's career spans
over 25 years in telecom network strategy, planning, engineering and operations.
His most recent role prior to joining ePHONE was as Chief Network Officer in
Aleron, the next-generation IP backbone operator, where, between late 2000 and
mid 2002 he designed, implemented and operated a high-end IP backbone serving
over 3M dial customers. Between 1998 and 2000, he was VP and General Manager of
Transmission Services at Teleglobe, responsible for the strategy, design and
implementation of Teleglobe's $5B multi-service global infrastructure network,
based on submarine and terrestrial dark fiber and optical technology stretching
from Asia to Europe. Prior to that, he was instrumental in the establishment of
Concert Communications, the BT/MCI joint venture, moving to the USA from the UK
in 1994 as the JV was defined and formed. This followed key roles in the
modernization and operation of British Telecom's digital voice and transmission
network in the UK.
41
Lawrence M. Codacovi - Chairman. Mr. Codacovi was appointed as a member
of the Board of Directors on January 1, 2002 and on September 11, 2002 was
appointed Chairman of the Board. Prior to joining ePHONE, Mr. Codacovi was
Chairman of Pangea Ltd., a pan-European fiber optic network spanning northern
Europe from 1999 to 2002. From 1988 to 1999, Mr. Codacovi served as Senior Vice
President International Services for MCI WorldCom with the responsibility for
expanding MCI's global reach. Mr. Codacovi previously served as Executive Vice
President and a Board Member with RCA Global Communications from 1980 to 1988.
Mr. Codacovi holds a Bachelor of Science in International Business from New York
University and Graduate Studies in Global Markets at NYU Graduate School of
Business.
Eugene A. Sekulow - Vice Chairman. Eugene Sekulow was appointed as a
director of ePHONE Telecom Inc. on February 22, 2002 and on September 11, 2002
was appointed Vice Chairman of the Board. Mr. Sekulow is an independent business
consultant focusing on global telecommunications strategy, policy, planning,
strategic partnering, risk analysis and business development. In January 1995,
Mr. Sekulow was named an Adjunct Professor at Columbia University, Graduate
School of Business. On December 1, 1991, Mr. Sekulow was appointed as Executive
Vice President, International, NYNEX Corporation, where he was also the
President of NYNEX International Company. Prior to that, Mr. Sekulow was
President of RCA International Ltd., responsible for the foreign subsidiary
manufacturing and distribution operations of RCA. He is currently Chairman of
the German American Chamber of Commerce and a director of several corporations.
In addition, he is Co-Chairman of the Board of Trustees of the American
Institute for Contemporary German Studies of The Johns Hopkins University. Mr.
Sekulow earned an MA and PhD in Political Science and Economics at The Johns
Hopkins University.
Sheldon B. Kamins - Director. Mr. Kamins was appointed as a member of
the Board of Directors on October 11, 2001. Mr. Kamins has been a real estate
developer in the greater metropolitan Washington, D.C. area and a venture
capitalist assisting technology and other companies with public and private
financing for more than the last five years. Mr. Kamins holds a Juris Doctor
degree from the Georgetown University Law Center.
Robert W. Stuart - Director. On June 12, 2002, Mr. Stuart was appointed
as a director of ePHONE Telecom Inc. He is currently the President and CEO of
InDepth Financial Advisors, which he founded in 2000. InDepth is an investment
banking/financial advisory firm specializing in the business plan development
and early stage capital raising process for emerging telecommunications firms.
Prior to founding InDepth Financial Advisors, Mr. Stuart spent more than 20
years as a leading telecom banker at Chase Manhattan Bank, Bankers Trust and
most recently as Managing Director and Co-Head of the Global Telecommunications
Industry Group at CIBC World Markets where he led several high visibility
telecom transactions. Mr. Stuart earned a BS in Engineering & Economics at the
US Naval Academy, where he graduated with distinction, and Master Degrees in
International Relations and International Law & Diplomacy from The Fletcher
School of Law & Diplomacy, Tufts University. He was awarded his PhD in
International Economics from The Fletcher School in 1982.
Mahmoud A. Wahba - Director. On May 27,2003, Mr. Wahba was appointed as
a director of ePHONE Telecom Inc. Mr. Wahba is the founder and president of
Champion Holding Company in Greenwich, Connecticut since 1986. Champion Holding
Company is a privately owned management and acquisition company engaged in
acquiring unique and/or niche entities in a variety of industries, both
domestically and worldwide. Acquired companies included retail and wholesale oil
distribution, eyewear manufacturing, flexible packaging, cotton and textile
Included in these companies is Champion Teleport, Inc. which is a satellite
television and broadband broadcasting facility located in Oxford, CT. Mr. Wahba
received his PhD Degree in Business from the University of Minnesota and became
a full Professor of Management at the Graduate School and at the University
Center of the City University of New York. Before changing careers from the
academia to the business world in 1986, Mr. Wahba was the President of the
Eastern Academy of Management and the Director of the Institute of Applied
Research at the Graduate School and University Center at the City University of
New York.
Compliance With Section 16(a) Of The Exchange Act
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"1934 Act") requires officers and directors of a company with securities
registered pursuant to Section 12 of the 1934 Act, and persons who own more than
10% of the registered class of such company's equity securities, to file reports
of ownership and changes in ownership with the Securities and Exchange
Commission (the "SEC"). Officers, directors and greater than 10% stockholders
are required by SEC regulation to furnish the subject company with copies of all
Section 16(a) forms filed. All reports required to be filed under Section 16
during the last fiscal year have been filed.
42
None of ePHONE's directors or executive officers is a director of any
company that files reports with the SEC. None of ePHONE's directors have been
involved in legal proceedings.
ePHONE's directors are elected at the annual meeting of stockholders
and hold office until their successors are elected. ePHONE's officers are
appointed by the Board of Directors and serve at the pleasure of the Board and
are subject to employment agreements, if any, approved and ratified by the
Board.
Executive Compensation
Annual Compensation Long Term Compensation
Name and Principal ------------------------------------------- -------------------------------
Position at Fiscal Awards All Other
Year End Compensation Options Compensation
Year Salary ($) Bonus ($) ($) (Shares) (Shares)
---- ----------- ------------ ------------- ------------- --------------
Carmine Taglialatela 2002 $230,000(1) $250,000 (1) -- 290,000 (1) --
Chief Executive 2002 125,000 (1)
Officer 2002 45,000 (1)
2002 45,000 (1)
2001 185,000 50,000 (1) 1,600,000 (1)
Charlie Rodriguez 2002 149,000 (2) 150,000 (2) -- 250,000 (2) --
Chief Financial 2002 75,000 (2)
Officer 2002 35,000 (2)
2001 137,000 (2) -- 1,350,000 (2) --
2000 19,000 (2) -- -- -- --
Steve Heap 2002 68,000 (3) -- -- -- --
Chief Operating Officer and Chief
Technology Officer
James Meadows 2002 139,000 (4) -- -- -- --
Former Chief Operating Officer 2002 130,000 (5) 15,000 (5) -- 275,000 (5)
Sonny Souvannavong 2001 87,000 (5)
Former Chief Technology Officer
(1) Mr. Carmine Taglialatela, Jr. was appointed President and Chief
Operating Officer and began employment with ePHONE on April 1, 2001.
Mr. Taglialatela was appointed Chief Executive Officer on July 1, 2001.
The amounts paid to Mr. Taglialatela from April through December 2001
are based on an annual salary of $200,000. Of the 1,600,000 stock
options issued to Mr. Taglialatela during 2001, 600,000 were issued in
April with an exercise price of $0.50 and were subsequently repriced to
$0.35. ePHONE also repriced 290,000 of Mr. Taglialatela's stock options
from $0.35 to $0.20 during 2002. The repriced options are shown as 2002
grants for purposes of this presentation.
During 2002, Mr. Taglialatela was paid $45,000 as a bonus earned in
2001 for meeting objectives outlined by the Board of Directors. Also,
during 2002 the Board of Directors approved the 2002 Incentive Bonus
Plan (the "Plan"). Under this plan Mr. Taglialatela was able to earn up
to $500,000 in bonus if certain performance criteria were met measured
on a quarterly basis. For each quarter during 2002, ePHONE met the
performance criteria and Mr. Taglialatela earned his bonus. However,
the bonus for the 4th quarter was earned, not paid and reversed in Q1
of 2003. Under the Plan, Mr. Taglialatela was required to use
approximately 60% of the proceeds from the bonus to exercise previously
issued stock options he had been granted in 2001. To date, the majority
of the options that have been exercised under the plan have been at
$0.35 cents with the balance at $0.20. The remaining portion of the
bonus was to be paid to Mr. Taglialatela in order for him to satisfy
his income tax obligations as a result of this bonus. As such, after
Mr. Taglialatela exercised his options, as required under the Plan and
paid his income tax related to the bonus there was little or no excess
bonus remaining. The following table represents activity as a result of
the bonus earned by Mr. Taglialatela during 2002.
--------- ---------- --------------------------------------------------
Q-1 2002 $125,000 Paid in 2002 (approximately 60% to
exercise options)
Q-2 2002 125,000 Paid in 2002 (approximately 60% to
exercise options)
Q-3 2002 125,000 Accrued for 2002 - Paid in 2003 (approximately
60% to exercise options)
Q-4 2002 0 $125,000 Accrued for 2002 , Unpaid, and Reversed
in Q-1 of 2003
-------- ------------------------------------------------
$375,000
========
43
(2) Mr. Charlie Rodriguez began as ePHONE's Chief Financial Officer in
December 2000. The amounts paid to Mr. Rodriguez in 2000 are based on
an annual salary of $145,000. In 2000, ePHONE paid $36,000 in
consulting payments to a Company controlled by Mr. Rodriguez prior to
his employment with ePHONE. Included in the 1,350,000 options awarded
to Mr. Rodriguez during 2001 are 250,000 stock options that were
originally granted in 1999 in consideration for consulting services
rendered to ePHONE. The exercise price of these options was repriced in
2001 from $0.50 to $0.35 and were exercised by Mr. Rodriguez in 2002.
ePHONE also repriced 250,000 of Mr. Rodriguez's stock options from
$0.35 to $0.20 during 2002 and the amount is shown as a 2002 grant for
purposes of this presentation.
During 2002, Mr. Rodriguez was paid $35,000 as a bonus earned in 2002
for meeting objectives outlined by the Board of Directors. Also during
2002, the Board of Directors approved the 2001 Incentive Bonus Plan
(the "Plan"). Under this plan Mr. Rodriguez was able to earn up to
$300,000 in bonus if certain performance criteria were met measured on
a quarterly basis. For each quarter during 2002, ePHONE met the
performance criteria and Mr. Rodriguez earned his bonus. However, the
bonus for the 4th quarter which was earned, not paid and reversed in Q1
of 2003. Under the Plan, Mr. Rodriguez was required to use
approximately 60% of the proceeds from the bonus to exercise previously
issued stock options he had been granted in 2001. To date, the majority
of the options that have been exercised under the plan have been at
$0.35 cents with the balance at $0.20. The remaining portion of the
bonus was to be paid to Mr. Rodriguez in order for him to satisfy his
income tax obligations as a result of this bonus. As such after Mr.
Rodriguez exercised his options, as required under the Plan and paid
his income tax related to the bonus there was little or no excess bonus
remaining.
The following table represents activity as a result of the
bonus earned by Mr. Rodriguez during 2002.
-------------- ------------ -------------------------------------------
Q-1 2002 $ 75,000 Paid in 2002 (approximately 60% to
exercise options)
Q-2 2002 75,000 Paid in 2002 (approximately 60% to
exercise options)
Q-3 2002 75,000 Accrued for 2002 - Paid in 2003
(approximately 60% to exercise options)
Q-4 2002 0 $75,000 Accrued for 2002 - Unpaid and
Reversed in Q-1 of 2003
---------- -------------------------------------------
$ 225,000
==========
(3) Mr. Heap's employment with ePHONE began August 1, 2002. The amounts
paid to Mr. Heap are based on an annual salary of $185,000. Mr. Heap
became ePHONE's Chief Technology Officer and Chief Operating Officer
effective December 1, 2002. Subject to Management approval, Mr. Heap
may earn $17,000 in additional bonus compensation for 2002, which is
not reflected in the table above.
(4) Mr. Meadow's employment with ePHONE as Chief Operating Officer began in
February 2002. The amounts paid to Mr. Meadows are based on an annual
salary of $150,000. Included in Mr. Meadows compensation is a $75,000
severance payment that was made in connection with his leaving ePHONE
in July 1, 2002.
(5) Mr. Souvannavong began as ePHONE's Chief Technology Officer during
April 2001. The amounts paid to Mr. Souvannavong during 2001 are based
on an annual salary of $125,000. Mr. Souvannavong left ePHONE in
December of 2002.
Report Of The Board Of Directors On Repricing Of Stock Options Held By Named
Executives
During the last fiscal year, ePHONE adjusted the exercise price of
certain stock options held by Carmine Taglialatela and Charlie Rodriguez as
follows:
1. The exercise price of 290,000 stock options held by Mr.
Taglialatela was reduced from $0.35 to $0.20; and
2. The exercise price of 250,000 stock options held by Mr.
Rodriguez was reduced from $0.35 to $0.20.
The Board of Directors, with Messrs. Taglialatela and Rodriguez
abstaining, approved the repricing on November 15, 2002. The Board of Directors
had determined that it was in ePHONE's best interest to align the interests of
its executive management with the shareholders. A major purpose for which the
options were initially granted was to require Messrs., Taglialatela and
Rodriguez to increase their equity ownership in ePHONE. It was determined that
this would provide Messrs., Taglialatela and Rodriguez with additional incentive
to remain with ePHONE and to help maximize shareholder value. However, the
market price of ePHONE's common stock had fluctuated significantly from the
original exercise price of the stock options and reached levels which made it
unrealistic to expect exercise of the options. The Board of Directors determined
that the fluctuation was a result of difficult external economic conditions that
are beyond the control of Messrs., Taglialatela and Rodriguez. In order to
implement ePHONE's incentive strategy, the Board of Directors approved the
reduction of the exercise price to $0.20, a price which reflected the then
current market price of ePHONE's common stock. Contemporaneous with the
repricing, the executives exercised their stock options and paid the exercise
price out of their accrued bonuses earned in 2002.
Option Grants For Fiscal 2002
The following table sets forth as to each of the named Executive
Officers information with respect to option grants during the last fiscal year.
44
Number of Securities
Underlying % of Total Options/
Options/SARs Granted SARs Granted to Exercise or Base
Name (#) Employees in Fiscal Year Price ($/Sh) Expiration Date
- ---- -------------------- ------------------------ ---------------- ---------------
Carmine Taglialatela Jr. 290,000 (1) 15.29% 0.20 4/1/11 - 6/9/11
Charlie Rodriguez 250,000 (1) 13.18% 0.20 2/14/11
Steve Heap 200,000 (2) 10.54% 0.35 8/1/12
Steve Heap 300,000 (2) 15.82% 0.35 8/1/12
(1) These options were repriced as previously described. For purposes of
this presentation, the percentage of total options issued to each
executive officer is based on the proportion that the number of options
granted to each executive bears to the total number of options granted
to all employees during the fiscal year plus the sum of all repriced
options or 1,896,800 (1,310,000 options granted to all employees plus
586,800 repriced options).
(2) As provided for in Mr. Heap's employment agreement with ePHONE
effective August 1, 2002, 200,000 options were granted with a vesting
period of 6 months and 300,000 options were issued with a 3 year
vesting period. During November 2002, the Board approved a resolution
to accelerate the vesting period on the grant of 200,000 options from a
6 month vesting term to immediate vesting.
Option Exercises and Values for Fiscal 2002
The following table sets forth as to each of the named Executive
Officers information with respect to option exercises during Fiscal 2002 and the
status of their options on December 31, 2002.
Value of Unexercised
Acquired on Value Number of Securities Underlying In-The-Money Options at Fiscal
Exercises Realized Options at Fiscal Year End. Year End
----------- --------- --------------------------------- ------------------------------
(#) ($) Exercisable Unexercisable Exercisable Unexercisable
----------- --------- ------------- ------------- ------------- --------------
Carmine Taglialatela, Jr. 718,000 -- 882,000 -- --
Charlie Rodriguez 388,500 -- 750,000 -- -- --
Steve Heap -- 200,000 300,000 -- --
Sonny Sovannavong -- 141,667 -- -- --
Compensation Of Directors
Non-employee directors receive $5,000 for each Board of Directors
meeting attended during 2002, with the exception of Mr. Clarke and Mr. Fraser
who each received an additional 33,334 shares in lieu of cash for business
expenses and consulting fees during the first quarter. The shares had a fair
value of $14,667 as determined based on the price of ePHONE's common stock at
the date of issuance.
Employment Agreements
Steve Heap Employment Agreement
ePHONE has an employment agreement with Mr. Steven Heap (the "Heap
Agreement"). The Heap Agreement is a three-year contract, with a term beginning
on August 1, 2002 and continuing until July 31, 2005. If either ePHONE or Mr.
Heap wants to renew this agreement, a written notice needs to be provided 60
days before termination of the current agreement. Under the terms of the Heap
Agreement, Mr. Heap is required to devote his full-time efforts to ePHONE. His
initial title was Chief Network Officer, and on November 1, 2002 he was
appointed Chief Operating Officer. ePHONE is required to compensate Mr. Heap at
an annual rate of at least $185,000 until EBITDA exceeds $2,500,000 for the year
2002. Upon exceeding the said amount, Mr. Heap's salary will be increased to
$200,000 per year and be reviewed on December 31 of each year of the contract.
Mr. Heap will be granted 200,000 options at the time of employment that will be
vested after 6 months of employment. After 6 months, an additional 300,000
options will be granted to be vested over three years. The Board of Directors
accelerated the vesting on all his options to be vested as of January 1, 2003
and his salary increased to $200,000. ePHONE is also obligated to (i) allow Mr.
Heap to participate in any incentive bonus or option plans approved for senior
management of ePHONE, (ii) provide secretarial services and furnished office,
(iii) provide medical insurance and (iv) pay for all pre-approved reasonable
expenses that Mr. Heap may incur.
45
ePHONE may terminate the Heap Agreement at any time in the event of his
disability or for cause, each as defined in the Heap Agreement. Mr. Heap may
resign from ePHONE at any time without penalty. If ePHONE terminates the Heap
Agreement for disability or cause, ePHONE will have no further obligations to
Mr. Heap. If, however, ePHONE terminates the Heap Agreement other than for
disability or cause, ePHONE must pay Mr. Heap an amount equal to six months of
his base salary in a lump sum payable within 15 days of his termination date.
Mr. Heap must fully cooperate with ePHONE in all matter relating to the winding
up of any pending work after his termination.
Carmine Taglialatela Jr.'s Employment Agreement
ePHONE has an employment agreement with Mr. Carmine Taglialatela, Jr.
(the "Taglialatela Agreement"). The Taglialatela Agreement is a three-year
contract, with a term beginning on April 1, 2001 and continuing until April 1,
2004. If either ePHONE or Mr. Taglialatela want to renew this agreement, a
written notice needs to be provided 60 days before termination of the current
agreement. Under the terms of the Taglialatela Agreement, Mr. Taglialatela is
required to devote his full-time efforts to ePHONE. His initial title was
President and Chief Operating Officer. Effective July 1, 2001, Mr. Taglialatela
was appointed Chief Executive Officer. ePHONE is required to compensate Mr.
Taglialatela at an annual rate of at least $180,000 until EBITDA exceeds
$250,000 for the year 2001. Upon it exceeding the said amount, Mr.
Taglialatela's salary will be increased to $250,000 per year. ePHONE is also
obligated to (i) allow Mr. Taglialatela to participate in any incentive bonus or
option plans approved for senior management of ePHONE, (ii) provide secretarial
services and furnished office, (iii) provide medical insurance and (iv) pay for
all pre-approved reasonable expenses that Mr. Taglialatela may incur.
ePHONE may terminate the Taglialatela Agreement at any time in the
event of his disability or for cause, each as defined in the Taglialatela
Agreement. Mr. Taglialatela may resign from ePHONE at any time without penalty.
If ePHONE terminates the Taglialatela Agreement for disability or cause, ePHONE
will have no further obligations to Mr. Taglialatela. If, however, ePHONE
terminates the Taglialatela Agreement other than for disability or cause, ePHONE
must pay Mr. Taglialatela an amount equal to twelve (12) months of his base
salary in a lump sum payable within 15 days of his termination date, or if
agreed between him and ePHONE, twelve monthly installments may be paid. Mr.
Taglialatela must fully cooperate with ePHONE as relates to any transition
subsequent to his termination.
46
DESCRIPTION OF PROPERTY
We intend to lease approximately 10,000 square feet for the principal
executive offices and Operations Center in the Champion Teleport at 66 Hawley
Road, Oxford, Connecticut, 06478. Base rent for the premises is being negotiated
as part of the Merger agreement mentioned earlier in this document. Management
believes that the current and anticipated facilities are suitable and adequate
for operations. The company also leases a caged area in the Switch and Data
collocation site in Reston, VA, and rents rack space from the same company in
New York, Miami and Los Angeles. These contracts are at normal rates for
equipment space. The company also rents a rack space in Toronto, Canada, from
RACO, LLC.
LEGAL PROCEEDINGS
In April 2003 The Federal Trade Commission commenced a non-public
investigation relating to whether the form of payment authorization which ePHONE
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. At this stage the investigation has not proceeded
beyond a request for voluntary production of documents and it is too early to
determine the outcome.
47
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following tables set forth information, as of July 24, 2003, with
respect to the beneficial owners of our common stock for:
o each person or group of persons, who we know beneficially own
more than 5% of any class of our outstanding stock;
o each of our executive officers named in the Summary
Compensation Table;
o each of our directors; and
o all executive officers and directors as a group.
In general, under the SEC's rules, a person is deemed to be a
"beneficial owner" of a security if that person has or shares the power to vote
or direct the voting of such security or has the power to dispose or direct the
disposition of such security. A person is also deemed to be the beneficial owner
of any securities of which the person has the right to acquire beneficial
ownership within 60 days.
Percent
of Outstanding Shares
Shares of Common Stock of Common Stock
Name and Address of Holder Beneficially Owned Beneficially Owned(5)
- -------------------------- ---------------------- ----------------------
Larry Codacovi
18 Reynolds Lane
Katonah, NY 10536
Chairman of the Board 100,000 (1) 0.24%
Carmine Taglialatela, Jr.
9565 Briar Lane
Delaplane, VA 20144
President and Chief Executive Officer 1,600,000 (2) 3.77%
Charlie Rodriguez
1662 W. Petunia Place
Tucson, AZ 85737
Director, Chief Financial Officer 1,138,500 (2) 2.68%
Steve Heap
12408 Fairfax Station Road
Clifton, VA 20124
Chief Operating Officer and
Chief Technology Officer 500,000 (3) 1.18%
Sheldon Kamins
10220 River Road
Potomac, MD 20854
Director 100,000 (1) 0.24%
Robert Stuart
1237 Balfour Drive
Arnold , MD 21012
Director 100,000 (4) 0.24%
Eugene Sekulow
50 Main Street, Suite 1000
White Plains, NY 10606
Director 100,000 (4) 0.24%
48
Percent
of Outstanding Shares
Shares of Common Stock of Common Stock
Name and Address of Holder Beneficially Owned Beneficially Owned(5)
- -------------------------- ---------------------- ----------------------
Mahmoud Wahba 13,333,333 23.89%
Executive Officers and Directors as a Group of 9 3,638,500 8.57%
Cornell Capital Partners
101 Hudson Street
Suite 3606
Jersey City, NY 07303 4,404,167 9.77%
Champion Teleport, Inc.
88 South Water Street
Greenwich, CT 06830 13,333,333 23.89%
(1) Consists of 50,000 shares of common stock and options to acquire 50,000
shares of common stock.
(2) Consists of 718,000 shares and 882,000 options to acquire shares of
common stock.
(3) Consists of 388,500 shares of common stock and options to acquire
750,000 shares of common stock.
(4) Consists of 43,000 shares of common stock and options to acquire 57,000
shares of common stock.
(5) Applicable percentage of ownership is based on 42,476,298 shares of
common stock outstanding as of July 24, 2003, together
with securities exercisable or convertible into shares of common stock
within 60 days of July 24, 2003, for each stockholder. Beneficial
ownership is determined in accordance with the rules of the Securities
and Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of common stock subject to
securities exercisable or convertible into shares of common stock that
are currently exercisable or exercisable within 60 days of July 24,
2003 are deemed to be beneficially owned by the person holding such
securities for the purpose of computing the percentage of ownership of
such person, but are not treated as outstanding for the purpose of
computing the percentage ownership of any other person. Note that
affiliates are subject to Rule 144 and Insider trading regulations -
percentage computation is for form purposes only.
49
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S
COMMON EQUITY AND OTHER STOCKHOLDER MATTERS
Since June 12, 2000 and prior to December 15, 1999, the shares of
ePHONE's common stock did trade and currently trades on the OTC Bulletin Board -
under the symbol "EPHO". From December 15, 1999 until June 11, 2000, the common
shares traded on the National Quotation Bureau's Electronic Quotation Service
(the "Pink Sheets") under the symbol "EPHO". Shares of the common stock do not
trade on any stock exchange or any other market.
The following table sets forth the closing high and low bid prices of
the common stock for each quarter within the last two years. The quotations
reflect inter-dealer prices and do not represent retail mark-ups, markdowns,
commissions, and may not reflect actual transactions.
Market Information
2001: High Low
----- -----
First Quarter 0.440 0.160
Second Quarter 0.410 0.120
Third Quarter 0.220 0.080
Fourth Quarter 0.350 0.140
2002:
First Quarter 0.270 0.160
Second Quarter 0.420 0.180
Third Quarter 0.300 0.170
Fourth Quarter 0.200 0.120
2003:
First Quarter 0.170 0.075
Second Quarter 0.085 0.015
Third Quarter Through July 22, 2003 0.105 0.055
As of July 22, 2003 there were 203 holders of record of the common
stock. This does not reflect persons or entities that hold stock through various
brokerage firms or depositories.
ePHONE has not paid any cash dividends on common stock and at present
does not intend to pay cash dividends in the foreseeable future. ePHONE plans to
retain earnings, if any, to use in the operation of the business and to fund
future growth.
50
Equity Compensation Plan Information
The following table sets forth information regarding our equity
compensation plans as of December 31, 2002.
Number of
Securities
remaining
available for
Number of future issuance
securities to be Weighted - average under
issued exercise price of equity compensation
upon exercise outstanding plans (excluding
of outstanding option, securities
options, warrants and reflecting in
warrants and rights rights column (a)
Plan category (a) (b) (c)
- ------------- ------------------- ------------------ -------------------
Equity compensation plans approved by security holders 4,214,916 $0.42 1,785,084
Equity compensation plans not approved by security holders 650,000 (1) 0.50 N/A
Total 4,864,916 $0.43 N/A
(1) Below are the individual compensation arrangements not approved by
security holders as described in the footnotes to our audited financial
statements filed with the Commission on form 10-KSB as of December 31,
2000 and form 10-KSB/A as of December 31, 2001.
o Options issued to consultants during 2001...... 450,000
o Options issued to consultants during 2002...... 200,000
-------
Total............................................ 650,000
=======
51
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During the year ended December 31, 2001 we incurred costs for
management services provided by companies in which certain directors of ours
have a controlling interest and incurred consulting fees to certain directors of
ours totaling $68,000.
During the year ended December 31, 2001, we paid $248,000 to ePHONE
Technologies, Inc., a company we hold a 20% equity interest in, for consulting
services. At December 31, 2001, we recognized an impairment write-down of
substantially all of the remaining carrying value of this investment. The
write-down totaled $184,000 and is recorded as general and administrative
expense in the Statement of Operations at December 31, 2001. The remaining
carrying value of this investment is $1,000 and is recorded as a non-current
other asset at December 31, 2002 and 2001.
During 2001 we also paid $100,000, as provided for in a Service and
Deployment Agreement with 7bridge Systems, LTD, a related party, a company in
which our Former Chairman of the Board and Chief Financial Officer have an
interest in.
During 2002, no related party transactions occurred .
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. Mr.
Mahmoud Wahba who recently became one of our directors is the [20%] owner of
Champion. Champion is privately held company. Should the proposed transaction be
consummated as currently contemplated, we will issue a total of 99,641,757
shares of our 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 completion of due diligence by both parties. Should we consummate the
merger as currently contemplated, the issuance of 99,641,757 shares of our
common stock will cause a change in control, since post merger, Mr. Wahba would
beneficially own more than 50% of our common stock . As such if the merger
is consummated, the merger will be accounted for as a reverse acquisition, with
Champion being considered the accounting acquirer.
52
DESCRIPTION OF SECURITIES
General
ePHONE's authorized capital consists of 150,000,000 shares of common
stock, par value $0.001 per share . At July 24, 2003, there were 42,476,298
outstanding shares of common stock. Set forth below is a description of certain
provisions relating to ePHONE's capital stock. For additional information,
please refer to ePHONE's Articles of Incorporation and By-Laws and the Florida
statutes.
Common Stock
Each outstanding share of common stock has one vote on all matters
requiring a vote of the stockholders. There is no right to cumulative voting;
thus, the holder of fifty percent or more of the shares outstanding can, if they
choose to do so, elect all of the directors. In the event of a voluntary of
involuntary liquidation, all stockholders are entitled to a pro rata
distribution after payment of liabilities and after provision has been made for
each class of stock, if any, having preference over the common stock. The
holders of the common stock have no preemptive rights with respect to future
offerings of shares of common stock. Holders of common stock are entitled to
dividends if, as and when declared by the Board out of the funds legally
available therefore. It is ePHONE's present intention to retain earnings, if
any, for use in its business. The payment of dividends on the common stock are,
therefore, unlikely in the foreseeable future.
Preferred Stock
ePHONE currently does not have any authorized shares of preferred
stock.
Warrants
ePHONE currently has no warrants outstanding.
Options
ePHONE currently has 4,175,249 options outstanding, of which 3,928,583
are vested. The options are exercisable at prices ranging from $0.35 to $1.59.
They expire 90 days after termination of services to the Company expect for
directors whose options terminate 24 months after termination of services.
Debentures
ePHONE has outstanding convertible debentures, which were issued in the
original principal amount of $125,000. These debentures accrue interest at a
rate of 5% per year and mature two years from the issuance date. The debentures
are convertible at the holder's option any time up to maturity at a conversion
price equal to the lower of (i) 120% of the closing bid price on the closing
date or (ii) 80% of the average of the two lowest closing bid price of the
common stock for the five trading days immediately preceding the conversion
date. The debentures have a two year term and accrue interest at 5% per year. At
maturity, ePHONE has the option to either pay the holder the outstanding
principal balance and accrued interest or to convert the debentures into shares
of common stock at a conversion price equal to the lower of (i) 120% of the
closing bid price on the closing date or (ii) 80% of the average of the two
lowest closing bid price of the common stock for the five trading days
immediately preceding the conversion date. Cornell Capital Partners is entitled
to a 10% discount from the purchase price of the convertible debentures. Cornell
Capital Partners purchased the convertible debentures from ePHONE in a private
placement.
Transfer Agent
The Transfer Agent for the common stock is Interwest Transfer Company,
Inc. located at 1981 East 4800 South Street, Salt Lake City, Utah, 84117.
53
Limitation Of Liability: Indemnification
Our Articles of Incorporation include an indemnification provision
under which we have agreed to indemnify directors and officers of ePHONE from
and against certain claims arising from or related to future acts or omissions
as a director or officer of ePHONE. Insofar as indemnification for liabilities
arising under the Securities Act of 1933 may be permitted to directors, officers
and controlling persons of ePHONE pursuant to the foregoing, or otherwise,
ePHONE has been advised that in the opinion of the SEC such indemnification is
against public policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable.
Anti-Takeover Effects Of Provisions Of The Articles Of Incorporation
Authorized And Unissued Stock
The authorized but unissued shares of our common are available for
future issuance without our stockholders' approval. These additional shares may
be utilized for a variety of corporate purposes including but not limited to
future public or direct offerings to raise additional capital, corporate
acquisitions and employee incentive plans. The issuance of such shares may also
be used to deter a potential takeover of ePHONE that may otherwise be beneficial
to stockholders by diluting the shares held by a potential suitor or issuing
shares to a stockholder that will vote in accordance with ePHONE's Board of
Directors' desires. A takeover may be beneficial to stockholders because, among
other reasons, a potential suitor may offer stockholders a premium for their
shares of stock compared to the then-existing market price.
The existence of authorized but unissued and unreserved shares of
preferred stock may enable the Board of Directors to issue shares to persons
friendly to current management which would render more difficult or discourage
an attempt to obtain control of our Company by means of a proxy contest, tender
offer, merger or otherwise, and thereby protect the continuity of our Company's
management.
EXPERTS
The consolidated financial statements for the year ended December 31,
2002 included in this prospectus, and incorporated by reference in the
Registration Statement, have been audited by Grant Thornton, LLC,, independent
auditors, as stated in their report appearing with the financial statements
herein and incorporated by reference in the Registration Statement, and are
included in reliance upon the report of such firm given upon their authority as
experts in accounting and auditing.
LEGAL MATTERS
Kirkpatrick & Lockhart LLP, Miami, Florida, will pass upon the validity
of the shares of common stock offered hereby for us.
HOW TO GET MORE INFORMATION
We have filed with the Securities and Exchange Commission a
registration statement on Form SB-2 under the Securities Act with respect to the
securities offered by this prospectus. This prospectus, which forms a part of
the registration statement, does not contain all the information set forth in
the registration statement, as permitted by the rules and regulations of the
Commission. For further information with respect to us and the securities
offered by this prospectus, reference is made to the registration statement.
Statements contained in this prospectus as to the contents of any contract or
other document that we have filed as an exhibit to the registration statement
are qualified in their entirety by reference to the exhibits for a complete
statement of their terms and conditions. The registration statement and other
information may be read and copied at the Commission's Public Reference Room at
450 Fifth Street N.W., Washington, D.C. 20549. The public may obtain information
on the operation of the Public Reference Room by calling the Commission at
1-800-SEC-0330. The Commission maintains a web site at http://www.sec.gov that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the Commission.
54
Index to Consolidated Financial Statements Page
- ------------------------------------------ ----
Consolidated Balance Sheets as of March 31, 2003 (unaudited) ...... F-2
Consolidated Statements of Operations
for the Three Months Ended March 31, 2003 and 2002............... F-3
Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 2003 and 2002............... F-4
Notes to Consolidated Financial Statements F-5
Report of Independent Certified Accountants F-9
Consolidated Balance Sheets as of December 31, 2002 and 2001....... F-10
Consolidated Statements of Operations
for the Two Years Ended December 31, 2002 and 2001............... F-11
Consolidated Statements of Stockholders' Equity (Deficit)
for the Years Ended December 31, 2002 and 2001................... F-12
Consolidated Statements of Cash Flows
for the Years Ended December 31, 2002 and 2001................... F-13
Notes to Consolidated Financial Statements.........................F-14 to F-23
F-1
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
F-2
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
F-3
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
F-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". 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.
F-5
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.
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.
F-6
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.
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.
F-7
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.
F-8
Report of Independent Certified Public Accountants
Board of Directors and Stockholders
ePHONE Telecom, Inc.
We have audited the accompanying consolidated balance sheets of ePHONE Telecom,
Inc. as of December 31, 2002 and 2001, and the related consolidated statements
of operations, stockholders' equity (deficit) and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of ePHONE Telecom,
Inc., as of December 31, 2002 and 2001, and the consolidated results of its
operations and its consolidated cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of
America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2, the Company
has experienced a significant decline in revenue since the phase out of its
marketing agreement for its Unlimited Domestic Calling Program in the fourth
quarter 2002. This factor as discussed in Note 2 to the financial statements,
raises substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/Grant Thornton LLP
Vienna, Virginia
February 10, 2003
(Except for the third paragraph of Note 2, as to which the date is April 11,
2003)
F-9
ePHONE Telecom, Inc.
Consolidated Balance Sheets
December 31,
2002 2001
-------------------- ---------------------
Current Assets:
Cash and cash equivalents $ 1,252,936 $ 35,970
Accounts receivable, net of allowance
of $321,000 and $116,000 at December 31, 2002
and 2001, respectively 419,049 155,759
Inventory 263,608 16,500
Other receivables 86,789 65,481
-------------------- ---------------------
Total Current Assets 2,022,382 273,710
Property and equipment, net 1,686,704 1,296,561
Other assets 68,043 18,043
-------------------- ---------------------
Total Assets $ 3,777,129 $ 1,588,314
-------------------- ---------------------
Liabilities and Stockholders' Equity (Deficit):
Current Liabilities:
Accounts payable $ 961,745 $ 850,179
Accrued liabilities 1,187,355 429,189
Accrued obligation cost -- 225,576
Deferred revenue 278,956 367,009
Capital lease obligation, current portion 51,385 22,663
-------------------- ---------------------
Total Current Liabilities 2,479,441 1,894,616
-------------------- ---------------------
Capital lease obligation, net of current portion 15,626 15,839
Other long term obligation, net of current portion 52,500 142,500
Commitments and Contingencies -- --
Stockholders' Equity (Deficit):
Common stock, par value $0.001:
150,000,000 shares authorized, 38,084,994 and
32,987,381 issued and outstanding at December 31, 2002
and 2001, respectively. 38,085 32,987
Additional paid-in capital 23,029,524 21,843,199
Accumulated deficit (21,838,047) (22,340,827)
-------------------- ---------------------
Total Stockholders' Equity (Deficit) 1,229,562 (464,641)
-------------------- ---------------------
Total Liabilities and Stockholders' Equity (Deficit) $ 3,777,129 $ 1,588,314
-------------------- ---------------------
See accompanying notes to consolidated financial statements
F-10
ePHONE Telecom, Inc.
Consolidated Statements of Operations
Years Ended December 31,
2002 2001
-------------------- --------------------
Revenues $ 19,221,928 $ 3,589,840
Cost of Revenues 9,696,392 2,501,033
-------------------- --------------------
Gross Margin 9,525,536 1,088,807
Operating expenses
Sales and marketing 1,256,932 1,212,026
General and administrative 6,384,891 5,607,375
Write off of Array Telecom license and the disposal of
obsolete inventory and equipment net -- 1,188,383
-------------------- --------------------
Operating income (loss) before arbitration cost 1,883,713 (6,918,977)
Arbitration cost 1,374,425 225,576
-------------------- --------------------
Income (loss) from operations 509,288 (7,144,553)
Interest and other (income), net 6,508 (123,424)
-------------------- --------------------
Earnings (loss) before taxes 502,780 (7,021,129)
Income tax expense -- --
-------------------- --------------------
Net Income (Loss) $ 502,780 $ (7,021,129)
Earnings (loss) per share--(basic and diluted) $ 0.01 $ (0.28)
-------------------- --------------------
Weighted average number of common
shares outstanding 36,251,792 24,910,425
See accompanying notes to consolidated financial statements
F-11
ePHONE Telecom, Inc.
Consolidated Statements of Stockholders' Equity (Deficit)
Common Shares Accumulated
Additional Other
Paid-In Comprehensive Accumulated
Shares Amount Capital Income (Loss) Deficit Total
------------ ---------- -------------- ---------------- --------------- ---------------
Balance, December 31, 2000 17,453,848 $ 17,454 $ 21,204,687 $ 22,221 $ (15,319,698) $ 5,924,664
Stock options issued in
exchange for services -- -- 90,545 -- -- 90,545
Common stock issued in
legal settlement 500,000 500 109,500 -- -- 110,000
Common stock issued in
exchange for services 748,973 749 147,466 -- -- 148,215
Proceeds from issuance
of common stock 848,243 848 304,437 -- -- 305,285
Conversion of Special -- --
Warrants 13,436,317 13,436 (13,436) --
Net Loss -- -- -- -- (7,021,129) (7,021,129)
Change in unrealized gain -- -- -- (22,221) -- (22,221)
--------
Total comprehensive loss -- -- -- -- -- (7,043,350)
------------ ---------- -------------- ---------------- --------------- ---------------
Balance, December 31, 2001 32,987,381 $ 32,987 $ 21,843,199 $ -- $ (22,340,827) $ (464,641)
Stock issued for services 289,000 289 61,426 -- -- 61,715
Stock options issued to
consultant for services -- -- 37,056 -- -- 37,056
Exercise of warrants for cash 3,448,913 3,449 686,334 -- -- 689,783
Exercise of employee stock
options for cash 1,359,700 1,360 401,509 -- -- 402,869
Net Income -- -- -- -- 502,780 502,780
------------ ---------- -------------- ---------------- --------------- ---------------
Balance, December 31, 2002 38,084,994 $ 38,085 $ 23,029,524 $ -- $ (21,838,047) $ 1,229,562
============ ========== ============== ================ =============== ===============
See accompanying notes to consolidated financial statements
F-12
ePHONE Telecom, Inc.
Consolidated Statements of Cash Flows
Years Ended December 31,
2002 2001
-------------------- ------------------------
Cash Flows from Operating Activities:
Net income (loss) $ 502,780 $ (7,021,129)
Adjustments to reconcile net income (loss) to net cash flows from
operating activities:
Depreciation and amortization 345,655 785,575
Stock compensation issued for services rendered 98,771 258,215
Stock option benefits charged to operations -- 90,545
Allowance for returns and uncollectible accounts receivable 205,000 116,405
Write down of investment in ePHONE Technologies, Inc. -- 184,000
Write off of Array Telecom license and the disposal of 1,188,383
obsolete inventory and equipment
Deferred royalty expense -- 193,334
Inventory reserve -- 108,900
Realized gain -- (45,470)
Changes in operating assets and liabilities:
Accounts receivable and other receivables (633,489) (135,661)
Inventory (247,108) 78,175
Other assets (50,000) 85,500
Accounts payable 111,566 540,921
Accrued liabilities 758,166 (371,979)
Accrued obligation cost (225,576) --
Deferred revenue 55,838 223,118
Customer deposits -- (25,853)
-------------------- ------------------------
Net cash flows provided by (used in) operating activities 921,603 (3,747,021)
Cash flows from investing activities:
Purchase of fixed assets (663,563) (813,857)
Purchase of marketable securities -- 2,194,157
Deposit to restricted cash, net -- 579,435
-------------------- ------------------------
Net cash flows (used in) provided by investing activities (663,563) 1,959,735
Cash flows provided by financing activities:
Proceeds received from exercise of warrants 689,783 305,285
Proceeds received from exercise of employee stock options 402,869 --
Repayments on long-term obligation (90,000) --
Repayments on capital lease (43,726) (8,007)
-------------------- ------------------------
Net cash flows provided by financing activities 958,926 297,278
-------------------- ------------------------
Net increase (decrease) in cash and cash equivalents 1,216,966 (1,490,008)
Cash and cash equivalents, beginning of year 35,970 1,525,978
-------------------- ------------------------
Cash and cash equivalents, end of year $ 1,252,936 $ 35,970
-------------------- ------------------------
See accompanying notes to consolidated financial statements
F-13
NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
ePHONE Telecom, Inc. ("ePHONE") was incorporated in 1996 under the laws of the
State of Florida, and is traded on the OTC Electronic Bulletin Board operated by
the National Association of Securities Dealers, Inc. under the trading symbol
"EPHO".
We provide telecommunication services to retail and wholesale customers. Our
vision is to become a global telecommunications carrier providing a full
complement of telecommunications services, including phone-to-phone one-step
dialing, using Voice over Internet Protocol ("VoIP") technology. Using a call
origination approach that involves its own Customer Premise Equipment ("CPE"),
and a combination of its own dedicated Internet Protocol ("IP") network, the
public Internet and the public switched telephone network ("PSTN"), we plan to
develop the capacity to provide voice and fax transmission and other telephony
features at high quality and low cost.
During the fourth quarter of 2002, the Company began offering telecommunication
services to retail customers in Canada through its wholly-owned subsidiary,
ePHONE Telecom, Canada.
PRINCIPLES OF CONSOLIDATION
The financial statements include the accounts of the Company and its
wholly-owned subsidiary. All significant intercompany transactions and balances
are eliminated upon consolidation.
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.
FAIR VALUE INFORMATION
The estimated fair value of the Company's financial instruments, which include
cash, receivables, accounts payable, and long term payables reported in the
balance sheet, approximate their carrying value given the their short
maturities. The carrying value of long-term payables approximates its fair value
since interest on the debt is at market rate.
CASH AND CASH EQUIVALENTS
We consider all highly liquid investments purchased with an original maturity of
three months or less to be cash equivalents.
SUPPLEMENTAL CASH FLOW INFORMATION AND NON CASH INVESTING AND
FINANCING ACTIVITIES
For the years ended December 31, 2002 and 2001, we paid no income taxes or
interest. During the years ended December 31, 2002 and 2001, we entered into
capital lease obligations for property and equipment totaling $72,235 and
$46,509, respectively.
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.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and depreciated using the
straight-line method over the estimated useful lives of the assets, generally 5
to 7 years. Equipment leased under capital leases is stated at the present value
of future lease obligations and is amortized over estimated useful lives.
Routine repairs and maintenance are expensed as incurred.
F-14
IMPAIRMENT OF LONG-LIVED ASSETS
We review long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of the assets to the expected future net cash
flows generated by the assets. If the assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. During the year ended
December 31, 2001, our analyses indicated that there was an impairment of the
long lived assets associated with the Array Telecom License, as described in
Note 7, and our investment in ePHONE Tech, as described in Note 3. There were no
such impairments during 2002.
REVENUE RECOGNITION
We recognize telecommunication services revenues over the period services are
provided. Monthly recurring telecommunications services are billed in advance
and any portion of our services that is billed for which we have not yet
provided services is recorded as deferred revenue. We establish an allowance for
doubtful accounts based upon factors, which include historical trends and other
information.
STOCK-BASED COMPENSATION
We account 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.
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 years ended December 31:
2002 2001
Net income (loss) ----------------- ---------------------
As reported: $ 502,780 $ (7,021,129)
Less total stock-based compensation expense
determined under fair value-based method for all awards, net
of related tax effects (234,603) (702,942)
----------------- ---------------------
Pro forma $ 268,177 $ (7,724,071)
================= =====================
Net income (loss), basic and diluted
As reported $ $0.01 $ (0.28)
Pro forma $ $0.01 $ (0.31)
We account 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. We 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. We determine the fair value of warrants and
options we granted to non-employees using the Black-Scholes option pricing
model.
INCOME TAXES
Deferred income taxes result primarily from temporary differences between
financial and income tax reporting. Deferred tax assets and liabilities are
determined based on the differences between the financial statement bases and
tax bases of assets and liabilities using enacted tax rates. A valuation
allowance is recorded to reduce the deferred tax asset to that portion that is
expected to more likely than not be realized.
F-15
NET INCOME (LOSS) PER SHARE
We report basic and diluted income (loss) per share. Basic income (loss) per
share is computed by dividing net income (loss) by the weighted average number
of outstanding shares of common stock. Diluted earnings per share is computed by
dividing net income (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 years ended December 31, 2002 and 2001, options and warrants to purchase
4,864,916 and 24,661,540 shares of common stock, respectively, were outstanding
but were not included in the computation of diluted earnings per share because
the effect would have been anti-dilutive.
RECENT ACCOUNTING PRONOUNCEMENTS
In August 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 tangible long-lived assets and the
associated asset retirement costs. It applies to (a) all entities and (b) legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development and/or normal operation of long-lived
assets, except for certain obligations of lessees. SFAS No. 143 is effective for
financial statements issued for fiscal years beginning after June 15, 2002. The
Company does not believe the adoption of this statement will have a material
impact on our financial position or results of operations.
Also in August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which established one accounting
model to be used for long-lived assets to be disposed of by sale and broadens
the presentation of discontinued operations to include more disposal
transactions. SFAS No. 144 supersedes SFAS No. 121, "Accounting for the
Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of" and the accounting and reporting provisions of APB Opinion 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" for the disposal of a segment of a business (as
previously defined in that Opinion). The provisions of SFAS No. 144 are
effective for financial statements issued for fiscal years beginning after
December 15, 2001. The adoption of SFAS No. 144 had no impact on the Company's
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,"
which rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of
Debt" and an amendment of that Statement, and SFAS No. 64, "Extinguishments of
Debt Made to Satisfy Sinking-Fund Requirements." SFAS No. 145 also rescinds SFAS
No. 44, "Accounting for Intangible Assets for Motor Carriers." SFAS No. 145
amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency
between the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions. SFAS No. 145 also amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. SFAS No. 145
is effective for fiscal years beginning after May 15, 2002. The Company does not
expect the adoption of SFAS No. 145 will have a material impact on its results
of operations or financial position.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses significant issues regarding
the recognition, measurement, and reporting of costs associated with exit and
disposal activities, including restructuring activities. SFAS No. 146 requires
that costs associated with exit or disposal activities be recognized when they
are incurred rather than at the date of a commitment to an exit or disposal
plan. SFAS No. 146 is effective for all exit or disposal activities initiated
after December 31, 2002. The Company does not expect the adoption of SFAS No.
146 to have a material impact on our results of operations or financial
position.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. 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. The Company is
currently evaluating whether to adopt the fair value based method of accounting
for stock-based employee compensation.
F-16
RECLASSIFICATIONS
Certain 2001 balances and disclosures have been reclassified to conform to the
2002 presentation.
NOTE 2 - GOING CONCERN
The accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America, which
contemplates the realization of assets, and the satisfaction of liabilities in
the normal course of business and the continuation of the Company as a going
concern. Fiscal year 2002 represented our first profitable year. Prior to 2002,
we had incurred losses since inception and at December 31, 2002 had accumulated
a deficit of $21,838,000. We have funded our operations, prior to the successful
launch of our Unlimited Domestic Calling Program leading to a profitable 2002,
primarily with the proceeds we raised in our special warrant offering in 2000,
from the exercise of warrants during 2001, and from limited equipment sales. We
do not currently have a line of credit or any other credit facility available to
us.
In the fourth quarter of 2002, we phased out our marketing arrangement with the
telemarketer of our Unlimited Domestic Calling Program. As a result, we
experienced a very significant 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 $60,000 (unaudited) in revenue from our
Unlimited Domestic Program. Even though we have entered into new marketing
agreements with new telemarketers, we can give no assurances that our revenue
levels will grow to equal or exceed those we previously experienced. Revenues
during 2002 from our Unlimited Domestic Calling Program totaled approximately
$16,870,000 or 88% of our total revenue. Future prospects must be considered in
light of the risks, expenses and difficulties frequently encountered by
companies in the telecommunications industry.
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.
The Company continues to earn revenues for its wholesale traffic and its other
retail programs, including prepaid calling cards it sells in both the United
States and Canada. It has entered into new telemarketing agreements with several
new telemarketing organizations and is reorganizing its subscription fulfillment
and collection procedures. The Company has 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, with the decline in the 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 etrans-port. We are currently seeking
additional investment capital and believe that without additional investment
capital we will not have sufficient cash to fund our current activities, and as
such, may not be able to continue operating.
Management believes that actions presently being taken provide the opportunity
for the Company to continue as a going concern. 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 3 - RELATED PARTY TRANSACTIONS
During the year ended December 31, 2001 we incurred costs for management
services provided by companies in which certain directors of ours have a
controlling interest and incurred consulting fees to certain directors of ours
totaling $68,000, respectively.
During the year ended December 31, 2001, we paid $248,000 to ePHONE
Technologies, Inc., a company we hold a 20% equity interest in, for consulting
services. At December 31, 2001, we recognized an impairment write-down of
substantially all of the remaining carrying value of this investment. The
write-down totaled $184,000 and is recorded as general and administrative
expense in the Statement of Operations at December 31, 2001. The remaining
carrying value of this investment is $1,000 and is recorded as a non-current
other asset at December 31, 2002 and 2001.
During 2001, we also paid $25,000 in consulting fees to one of our officers, and
paid $100,000, as provided for in a Service and Deployment Agreement to 7bridge
Systems, LTD, a company in which both our former Chairman of the Board and Chief
Financial Officer have an interest in.
F-17
NOTE 4 - PROPERTY AND EQUIPMENT AND CAPITAL LEASE OBLIGATION
Property and equipment consisted of the following:
December 31,
2002 2001
------------------------------------- ------------------------------------
Computer equipment........................ $ 220,645 $ 198,785
Furniture and fixtures.................... 340,986 340,986
Telecommunications equipment.............. 939,682 322,303
Other equipment........................... 807,579 711,022
---------- ----------
2,308,892 1,573,096
Less: accumulated depreciation............ (622,188) (276,535)
---------- ----------
Property and equipment, net............... $1,686,704 $1,296,561
========== ==========
At December 31, 2002 and 2001, property and equipment includes capitalized lease
assets of $118,744 and $46,509 and accumulated depreciation on capitalized lease
assets of $25,123 and $7,306, respectively. Payments for the capital lease
obligation by fiscal year are as follows:
Year ending December 31,
2003.............................................. $ 60,676
2004.............................................. 15,736
-----------
Total gross payments.............................. 76,412
Less amount representing interest................. (8,951)
-----------
67,461
Less current portion.............................. (51,835)
-----------
Long-term portion of capitalized lease obligation $ 15,626
===========
Depreciation expense (including depreciation on the capitalized lease asset
during 2001) was $345,655 and $230,928 for the years ended December 31, 2002 and
2001, respectively.
NOTE 5 - ACCRUED LIABILITIES AND LONG TERM OBLIGATION
Accrued expenses consist of the following:
December 31,
2002 2001
------------------------------------- ------------------------------------
Accrued vacation................................ $ 72,257 $ 32,411
Accrued compensation......................... 631,457 35,443
Accrued legal fees............................... 50,000 147,300
Other............................................. 433,641 214,035
--------- -------
$ 1,187,355 $ 429,189
========= =======
During 2001 we were involved in arbitration, resulting from the termination of
our former President and Chief Operating Officer, Mr. Charles Yang. On March 23,
2001, we entered into a Settlement Agreement and Mutual General Release (the
"Settlement Agreement") to resolve all claims and disputes between ePHONE and
Mr. Yang, including all claims relating to Mr. Yang's employment by and
separation from ePHONE. Pursuant to the terms of the Settlement Agreement, we
agreed to pay Mr. Yang $400,000 in cash installments by July 23, 2001, and issue
Mr. Yang 400,000 shares of our common stock as further described in Note 9. We
had previously accrued $300,000 during 1999, and the additional $100,000
liability related to the settlement was accrued during the year ended December
31, 2001.
We did not make the required cash payments by July 23, 2001 and the balance due
Mr. Yang was $150,000 at December 31, 2001. Effective January 29, 2002, we
entered into a Modification Agreement of the original Settlement Agreement and
were required to issue Mr. Yang an additional 100,000 shares of our common
stock, as further described in Note 9, and pay an additional $75,000, which was
recorded as a general and administrative expense as of December 31, 2001. The
total amount due Mr. Yang of $225,000 began being repaid in February 2002 in 30
monthly installments of $7,500. The remaining payments due to Mr. Yang by fiscal
year are as follows:
F-18
Year ending December 31,
2003................................................ $ 90,000
2004................................................ 52,500
----------
142,500
Current portion included in accrued liabilities (90,000)
----------
Long-term obligation................................ $ 52,500
==========
NOTE 6 - STOCKHOLDERS' EQUITY
COMMON STOCK
Beginning in November 1999 and ending in February 2000, we sold a total of
1,350,000 "units" for $0.75 a unit to investors outside the United States
pursuant to Regulation S under the Securities Act of 1933, as amended (referred
to herein as the Securities Act). Each "unit" consisted of one share of our
common stock and one warrant to purchase an additional share of common stock at
$1.25. On September 12, 2001, our Board of Directors approved a resolution to
reduce the exercise price of the warrant included with each unit to $0.35 and
effective February 23, 2002, further reduced the exercise price to $0.20 to
reflect the market price and provide an inducement for the warrant holders to
exercise the warrants. During the year ended December 31, 2001, investors
exercised warrants for the purchase of 848,243 shares with proceeds totaling
$296,885. During December 2001, we also received $8,400 for the exercise of
warrants for which shares of common stock were issued in 2002. The remaining
warrants expired March 30, 2002.
On March 23, 2001, we entered into a Settlement Agreement with Charles Yang,
which was subsequently modified in January 2002 as described in Note 8. In
accordance with the Settlement Agreement and subsequent Modification Agreement,
we issued a total of 500,000 shares of our common stock to Mr. Yang. The fair
value of these shares totaled $110,000 and was recorded as non-cash compensation
expense as of December 31, 2001.
During August 2001, 13,436,317 Special Warrants were converted into 13,436,317
shares of our common stock as described under Special Warrants below.
During October and November 2001, we issued 200,000 shares of our common stock
to a consultant who provided marketing and business development services to
ePHONE. We issued this same consultant 200,000 additional shares of our common
stock during 2002 as further described under non-employee stock compensation
below.
During November 2001, we issued 500,000 shares of our common stock to PITRFA,
Inc., a marketing and distribution company, as further described under
non-employee stock compensation below.
During February 2002, we negotiated a settlement agreement with a former
consultant in which we were required to issue 10,000 shares of common stock in
exchange for past services rendered. The fair value of the common stock was
$2,200 and is recorded as general and administrative expense as of December 31,
2001.
During March 2002, we issued 3,448,913 shares of our common stock for the
exercise of stock purchase warrants as further described under Special Warrants.
Also during March 2002, we issued 89,000 shares of our common stock to
consultants and two members of our Board of Directors. The fair value of the
shares totaled $23,000 and was recorded based upon the market price of the stock
on the date of issuance.
During 2002, we issued 1,106,500 shares of our common stock for the exercise of
1,106,500 stock options by our CEO and CFO at exercise prices ranging from $0.20
to $0.35 per share with proceeds to the company totaling $321,000. Six board
members also exercised options to purchase 253,200 shares of our common stock at
exercise prices ranging from $0.20 to $0.35 with the proceeds totaling $81,000.
F-19
SPECIAL WARRANTS
In early 2000, we sold a total of 13,780,837 special warrants to investors
outside of the United States pursuant to Regulation S under the Securities Act.
Each special warrant was purchased for $1.10, and each special warrant when
exercised entitled the holder to one share of common stock for no additional
consideration and one purchase warrant to purchase an additional share of common
stock for $1.60. Holders of special warrants were originally entitled to receive
up to 13,780,837 shares of common stock in the aggregate upon exercise of the
special warrants and up to an additional 13,780,837 shares of common stock in
the aggregate upon exercise of the purchase warrants. The purchase warrants
expired on March 30, 2002.
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 are holding by the same percentage ("Redemption Right"). In addition, each
special warrant holder had the right to receive an additional 10% of their
original investment in shares of our common stock upon the exercise of the
special warrants. As of December 31, 2001, all special warrant holders exercised
their Redemption Right and we returned $1,894,865 to these investors.
On August 13, 2001 final receipts from the regulators of the British Colombia,
Alberta, Ontario and Quebec provinces in Canada were received for the
registration prospectus dated August 7, 2001. Each Special Warrant was then
deemed converted, as provided for in the special warrant agreement, into one
share of common stock and a warrant to purchase one share of common stock at an
exercise price of $1.60 per share expiring on March 30, 2002. Upon exercise of
the special warrants, taking into consideration the exercise of Redemption
Rights by all the investors, and the issuance of additional shares of our common
stock equal to 10% of the special warrant holders initial investment, we issued
a total of 13,436,317 shares of common stock and stock purchase warrants for the
purchase of up to 13,436,317 shares of our common stock for $1.60 per share to
these investors. On September 26, 2001, our Board of Directors approved a
resolution to reduce the price of the stock purchase warrants to $0.35 and
effective February 23, 2002 further reduced the exercise price to $0.20 to
reflect the market price and provide an inducement for the warrant holders to
exercise the warrants. Proceeds from the Special Warrant offering totaled
$12,149,571, net of $1,114,485 in offering costs and $1,894,865 returned to
shareholders upon the exercise of their Redemption Right.
In March 2002, the Company received approximately $690,000 for the exercise of
the stock purchase warrants issued in connection with the Special Warrants for
the purchase of 3,450,000 shares of common stock. On March 31, 2002, the
remaining warrants for the purchase of 9,115,000 shares of common stock expired
unexercised.
NON-EMPLOYEE STOCK COMPENSATION ISSUED IN EXCHANGE FOR SERVICES RECEIVED
On February 14, 2001, our Board of Directors approved the issuance of 250,000
stock options to a consultant in an exchange for services rendered. The stock
options have an exercise price of $0.50, vest immediately and expire in three
years. The market value of our common stock at the grant date was $0.23. The
fair value associated with these options totaled $42,500 and was recorded as
non-cash compensation during the year ended December 31, 2001.
During 2001, we issued 200,000 shares of our common stock and 200,000 options to
purchase shares of our common stock to a consultant as consideration for
marketing and business development consulting services rendered. The fair value
of these shares of common stock totaled $49,000 and is recorded as general and
administrative expense as of December 31, 2001. The options have an exercise
price of $0.50 and vest immediately. The fair value associated with these
options was $48,045 and is recorded as non-cash compensation expense during the
year ended December 31, 2001. During 2002, we issued this consultant an
additional 200,000 shares of our common stock and 200,000 options to purchase
shares of our common stock with terms similar to the options issued in 2001. The
fair value of the shares and options was $38,800 and $37,056, respectively, and
is recorded as general and administrative expense during the year-ended December
31, 2002.
On November 29, 2001, we entered into an exclusive Marketing and Distribution
Agreement "Agreement" with PITRFA Inc., a Florida based sales, marketing and
distribution company. As defined in the agreement, PITRFA was to market and
distribute ePHONE's prepaid 1+ long distance service for a period of three
years. Upon signing the Agreement, we issued PITRFA 500,000 shares of our common
stock. The fair value associated with these shares of common stock totaled
$97,015 and is recorded as general and administrative expense during the year
ended December 31, 2001. This agreement was mutually terminated during 2002.
F-20
The following table summarizes information for non-employee stock options and
stock purchase warrants granted for services, and issued in connection with
private placements we have completed:
Year Ended December 31, 2002 Year Ended December 31, 2001
------------------------------------------------ --------------------------------------------
Weighted Average Price Weighted Average
Number of Shares Per Share Number of Shares Price Per Share
Beginning balance........ 17,423,758 $0.42 4,385,684 $0.91
Granted (including Special
Warrant Conversion in 2001) 200,000 $0.50 13,886,317 $0.35
Exercised................ (3,448,913) $0.20 (848,243) $0.35
Cancelled................ (13,524,845) $0.44 -- --
------------- -------------- ------------ ------
Ending balance........... 650,000 $0.50 17,423,758 $0.42
============ ============== ============ =====
EMPLOYEE STOCK COMPENSATION
On May 5, 2000, our Board of Directors adopted the 2000 Long-Term Incentive Plan
(the "Plan") and reserved 6,000,000 shares of common stock for issuance under
the Plan. The Plan provides for grants and awards of nonqualified stock options,
incentive stock options, stock appreciation rights, restricted stock and
incentive shares to officers, key employees, directors, persons hired to be
employees, and who the Board determines will be officers or key employees upon
commencement of employment, and consultants or independent contractors for
rendering key services. The Board will determine the exercise price per share of
the Common Stock purchasable under a stock option and the options will have
various vesting schedules ranging from immediate vesting to vesting on specified
dates and over various periods of time. In general, options granted under this
plan will expire in ten years from the date of grant.
On September 12, 2001 our Board of Directors approved a resolution to reduce
from $0.50 to $0.35 the exercise price of 3,900,000 stock options held by
certain Board members, executive officers and former employees.
On November 15, 2002 our Board of Directors approved resolutions to reduce from
$0.35 to $0.20 the exercise price of 586,500 stock options held by certain Board
members and executive officers and to accelerate the vesting period of 581,667
stock options held by certain executive officers and a former executive officer.
On various dates during 2002, Management accelerated the vesting on 224,449
stock options held by certain employees.
Since the modifications, we have accounted for these options using variable
accounting. We have not recorded any compensation expense in connection with
these modifications since the new exercise price has been higher than or equal
to the market price.
The following table summarizes information concerning our stock options:
Years Ended December 31,
---------------------------------------------------------------------------------------------
2002 2001
------------------------------------------------ --------------------------------------------
Number of Shares Weighted Average Price Number of Shares Weighted Average
Per Share Price Per Share
Beginning balance........ 7,197,782 $0.40 5,268,963 $0.81
Granted.................. 1,310,000 0.34 5,713,333 0.41
Exercised................ (1,359,700) 0.28 -- --
Cancelled................ (2,933,166) 0.37 (3,784,244) 0.90
----------- ---- ------------- -----
Ending balance........... 4,214,916 $0.42 7,197,782 $0.40
============ ===== ============ =====
F-21
The following table summarizes information about stock options issued to
employees, outstanding at December 31, 2002:
Options Outstanding Options Exercisable
Weighted-Average
Range of Exercise Number of Remaining Weighted-Average Weighted-Average
Prices Outstanding Contractual Life Exercise Price Number Exercisable Exercise Price
------------------- -------------------- ------------------- -------------------- -------------------
$0.20 - $0.35 3,228,800 8.08 $0.35 2,815,800 $0.35
$0.50 - $0.50 661,667 5.97 $0.50 423,331 $0.50
$0.60 - $1.09 196,449 7.38 $1.09 196,449 $1.09
$1.19 - $1.59 28,000 7.55 $1.44 28,000 $1.44
------ ---- ----- ------ -----
4,214,916 7.71 $0.42 3,463,580 $0.42
========= ==== ===== ========= =====
SFAS No. 123 requires the disclosure of pro forma net income and earnings per
share had the Company adopted the fair value method as disclosed in Note 2.
Under SFAS No. 123, the fair value of stock-based awards to employees is
calculated through the use of option-pricing models. These models require
subjective assumptions, including future stock price volatility and expected
time to exercise, which greatly affect the calculated value. The Company's 2002
and 2001 fair value calculation for pro forma purposes was made using the
Black-Scholes option-pricing model with the following assumptions:
The weighted-average fair values of each option at the date of grant for 2002
and 2001 was $0.19 and $0.16, respectively, and were estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions used in 2002 and 2001: dividend yield of 0%;
expected volatility of 130% in 2002 and 150% in 2001; risk-free interest rate of
3.36% in 2002 and 4.08% in 2001; and expected lives of 3 years.
NOTE 7 - COMDIAL ARBITRATION SETTLEMENT AND IMPAIRMENT CHARGE
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. We also discontinued use of the Array Telecom technology and
therefore, wrote off the remaining balance of the Array Telecom License. The net
impairment charge of $1,188,383 was reflected in the accompanying financial
statements as of December 31, 2001.
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. Management believes this avoided
a very costly and lengthy appeals process with no guarantee of success and will
enable the Company to focus on its operations. This charge of $1,374,425 is
reflected in the accompanying financial statements as of December 31, 2002, net
of approximately $226,000 of arbitration cost accrued in 2001.
NOTE 8 - COMMITMENTS
Herndon Office Lease
The following is a schedule of the future payments with respect to our Herndon,
Virginia non-cancelable office lease:
Year Ending December 31,
2003............................... $ 184,372
2004............................... 62,060
---------------
Total future minimum payments...... $ 246,432
===============
F-22
Rent expense was $196,488 and $165,258 for the years ended December 31, 2002 and
2001, respectively.
As described in note 2, the company has been informed by the Federal Trade
Commission that they have commenced a non public investigation relating to the
form of payment authorization for the Unlimited Domestic Calling. Program.
NOTE 9 - INCOME TAXES
No provision for US federal or state income taxes have been recorded in any
period due to our net operating loss carry forward
Deferred income taxes reflect the net effects of temporary differences between
the carrying amount of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
deferred income tax assets for federal and state income taxes are as follows:
INCOME TAXES
2002 2001
----------- -----------
Deferred income tax assets (liabilities):
Book basis in property over tax basis $ (191,000) $ --
Investment writedown 343,000 343,000
Non-cash compensation 557,000 543,000
Net operating loss carryforward 6,334,000 6,407,000
Other 234,000 46,000
----------- -----------
7,277,000 7,339,000
Valuation allowance (7,277,000) (7,339,000)
----------- -----------
Net deferred tax asset $ -- $ --
----------- -----------
Reconciliation between actual tax expense and tax computed at the statutory
Federal rate of 34 percent for 2002 and 2001 are as follows:
2002 2001
----------- --------------
U.S. Federal Income tax rate at 34% $ 171,000 $ (2,387,000)
State taxes, net of federal tax benefit 25,000 (351,000)
Change in valuation allowance (62,000) 2,845,000
Expenses not deductible for tax purposes 7,000 12,000
Adjustment for prior year taxes (141,000) (119,000)
----------- --------------
Income tax provision (benefit) $ -- $ --
=========== ==============
Realization of deferred tax assets is dependent upon future earnings, if any. We
have recorded a full valuation allowance against our deferred tax assets since
we believe it is more likely than not that these assets will not be realized. No
income tax benefit has been recorded for all periods presented because of the
valuation allowance.
At December 31, 2002, we have available, for U.S. income tax purposes, net
operating loss carryforwards of approximately $16,240,000 which can be used to
offset future taxable income through 2019. There can be no assurance that we
will realize the benefit of the net operating loss carryforward. In addition,
our 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.
F-23
We have not authorized any dealer, salesperson or other person to provide any
information or make any representations about ePHONE Telecom, Inc. except the
information or representations contained in this prospectus. You should not rely
on any additional information or representations if made.
-----------------------
This prospectus does not constitute an offer to sell, or ----------------------
a solicitation of an offer to buy any securities:
PROSPECTUS
o except the common stock offered by this
prospectus; ---------------------
o in any jurisdiction in which the offer or
solicitation is not authorized;
o in any jurisdiction where the dealer or other 62,365,388 Shares of Common Stock
salesperson is not qualified to make the offer
or solicitation;
o to any person to whom it is unlawful to make the ePHONE TELECOM, INC.
offer or solicitation; or
o to any person who is not a United States
resident or who is outside the jurisdiction of
the United States.
The delivery of this prospectus or any accompanying sale ______________, 2003
does not imply that:
o there have been no changes in the affairs of
ePHONE Solutions after the date of this
prospectus; or
o the information contained in this prospectus is
correct after the date of this prospectus.
-----------------------
Until _________, 2003, all dealers effecting transactions in the registered
securities, whether or not participating in this distribution, may be required
to deliver a prospectus. This is in addition to the obligation of dealers to
deliver a prospectus when acting as underwriters.
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Indemnification Of Directors And Officers
Our Articles of Incorporation include an indemnification provision
under which we have agreed to indemnify directors and officers of ePHONE from
and against certain claims arising from or related to future acts or omissions
as a director or officer of ePHONE. Insofar as indemnification for liabilities
arising under the Securities Act of 1933 may be permitted to directors, officers
and controlling persons of ePHONE pursuant to the foregoing, or otherwise,
ePHONE has been advised that in the opinion of the SEC such indemnification is
against public policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable.
Other Expenses Of Issuance And Distribution
The following table sets forth estimated expenses expected to be
incurred in connection with the issuance and distribution of the securities
being registered. ePHONE will pay all expenses in connection with this offering.
Securities and Exchange Commission Registration Fee $ 487.70
Printing and Engraving Expenses $ 2,500.00
Accounting Fees and Expenses $ 15,000.00
Legal Fees and Expenses $ 50,000.00
Miscellaneous $ 17,012.30
TOTAL $ 85,000.00
Sales Of Unregistered Securities
The following are ePHONE's sales of unregistered securities since July
1, 2000:
During May 2003, ePHONE issue 2,173,913 shares pursuant to a promissory
note to unaffiliated, accredited, private investors and 217,391 commission
shares to the agent, Rockwood, Inc.
During March 2002, ePHONE issued 89,000 shares of our common stock to
consultants and two members of our Board of Directors. The fair value of the
shares totaled $23,000 and was recorded based upon the market price of the stock
on the date of issuance.
During 2002, we issued 200,000 shares of our common stock and 200,000
options to purchase shares of our common stock to a consultant to whom we had
issued the same amount of shares of common stock and options in 2001 with
similar terms as described under Stock Compensation Activity in 2001. The fair
value of the shares and options was $39,000 and $37,000, respectively, and is
recorded as non-cash compensation expense during the year ended December 31,
2002.
During October and November 2001, we issued 200,000 shares of our
common stock and 200,000 options to purchase shares of our common stock to a
consultant as consideration for marketing and business development consulting
services rendered. The fair value of these shares of common stock totaled
$49,000 and is recorded as non-cash compensation expense as of December 31,
2001.
On various dates during 2002, ePHONE issued 1,106,500 and 253,200
shares of our common stock for the exercise of stock options by our CEO and CFO
and to six Board Members, respectively, at exercise prices ranging from $0.20 to
$0.35 with the proceeds totaling $434,000.
During February 2002, ePHONE issued 10,000 shares to Rudy Ryckewaert in
exchange for consulting services within rendered valued at $2,200.
During March 2001 and January 2002, ePHONE issued 500,000 shares of
common stock to Mr. Charles Yang in connection with a settlement agreement.
II-1
During November 2001, ePHONE issued 500,000 shares to PITRFA, Inc. in
connection with a marketing and distribution agreement.
As further described in Legal Proceedings, we entered into a Settlement
Agreement with Charles Yang on March 23, 2001. Pursuant to the terms of the
agreement, we agreed to pay Mr. Yang $400,000 in cash installments by July 23,
2001, and to issue Mr. Yang 400,000 shares of our common stock. We recorded
$180,000 in expense related to this settlement during the three months ended
March 31, 2001. The fair value of the stock issued was $80,000 and is recorded
as non-cash compensation in the statement of operations. We did not make the
required payments to Mr. Yang by July 23, 2001 and, therefore, were required to
issue an additional 100,000 shares of our common stock in accordance with a
Modification of the original Settlement Agreement entered into between us and
Mr. Yang. The fair value of the additional shares totaled $30,000 and is
recorded as non-cash compensation in the December 31, 2001 Statement of
Operations.
On November 29, 2001, we entered into an exclusive Marketing and
Distribution Agreement ("Agreement") with PITFRA Inc., a Florida-based sales,
marketing and distribution company. As defined in the Agreement, PITFRA will
market and distribute ePHONE's prepaid 1+ long-distance service for a period of
three years. Upon signing the Agreement, we issued PITFRA 500,000 shares of our
common stock. The fair value associated with these shares of common stock
totaled $97,015 and is recorded as non-cash compensation expense in our December
31, 2001 Statement of Operations.
The issuances were made pursuant to available exemptions from the
registration provisions of the Securities Act of 1933, as amended [specifically,
Section 4(2)of the Securities Act) and relevant Blue Sky statutes].
ITEM 7. EXHIBITS
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)
5.1 Legal Opinion of Kirkpatrick & Lockhart LLP re: Legality (10)
9.1 Arbitration Award (4)
9.2 Press Release issued in connection with the Comdial Arbitration (4)
9.3 Arbitration Settlement Agreement(9)
10.1 Specimen of form of Option Incentive Agreement (1)
10.2 Agency Agreement dated as of March 16, 2000 between ePHONE and
Groome Capital.com, Inc. (5)
10.3 ePHONE Telecom, Inc. 2000 Long-Term Incentive Plan (6)
10.4 Employment Agreement with James Meadows, Chief Operating Officer (8)
10.5 Employment Agreement with Carmine Taglialatela, President and Chief
Executive Officer (8)
10.6 Employment Agreement with Steven Heap ,Chief Operating Officer (8)
10.7 Letter of Intent to merge with Champion Teleport, Inc.(11)
23.1 Consent of Kirkpatrick & Lockhart LLP. (Incorporated by referenced
to Exhibit 5.1 contained in this filing)
23.2 Consent of Grant Thorton LLP (10)
99.1 Settlement Agreement and Mutual General Release between Charlie Yang
and ePHONE Telecom, Inc., dated March 23, 2001 (7)
99.2 Settlement Agreement between Comdial Corporation, Array Telecom
Corporation and ePHONE dated November 13, 2002 (9)
99.3 Equity Line of Credit Agreement dated June 24, 2003 between the
Registrant and Cornell Capital Partners LP(10)
99.4 Registration Rights Agreement dated June 24, 2003 between the
Registrant and Cornell Capital Partners, LP(10)
II-2
99.5 Escrow Agreement dated June 24, 2003 among the Registrant, Cornell
Capital Partners, LP, Butler Gonzalez, LLP(10)
99.6 Securities Purchase Agreement dated June 24, 2003 among the
Registrant and the Buyers(10)
99.7 Escrow Agreement dated June 24, 2003 among the Registrant, the
Buyers, and Butler Gonzalez, LLP(10)
99.8 Debenture Agreement Dated June 24, 2003 between the Registrant and
Cornell Capital Partners LP(10)
99.9 Investor Registration Rights Agreement dated June 24, 2003 between
the Registrant and the Investors(10)
99.10 Placement Agent Agreement dated June 24, 2003 among the Registrant,
NT Capital Equities, Ltd. and Cornell Capital Partners LP(10)
(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.
(5) Previously filed as an exhibit to Amendment No. 5 to ePHONE's Form
10-SB, filed with the Commission on June 5, 2000.
(6) Previously filed as an exhibit to ePHONE's Form SB-2 filed with the
Commission on August 9, 2000.
(7) Previously filed as an exhibit to ePHONE's Form 8-K, filed with the
Commission on April 16, 2001.
(8) Previously filed as an exhibit to ePHONE's Form 10-KSB, filed with the
Commission on April 15, 2001.
(9) Previously filed as an exhibit to ePHONE's Form 10-QSB, filed with the
Commission on November 14, 2002.
(10) Provided herewith.
(11) Previously filed as an exhibit to ePHONE's Form 10-QSB filed with the
Commission on May 20, 2003.
B. Reports on Form 8-K:
On November 8, 2002, ePHONE filed with the Commission a current report
on 8-K related to a court order denying ePHONE's motion to vacate an arbitration
award to Comdial Corporation and its subsidiary Array Telecom Corporation.
On May 9, 2003, we filed a current report on Form 8-K related to our
letter of intent with Champion Teleport, Inc.
On June 30, 2003, ePHONE filed with the Commission a current report of
Form 8-K related to ePHONE's agreement with Cornell Capital Partners concerning
the $200,000 convertible debentures and $3 million Equity Line of Credit
discussed in this registration statement.
II-3
Undertakings
The undersigned registrant hereby undertakes:
(1) To file, during any period in which it offers or sells
securities, a post-effective amendment to this registration statement to:
(i) Include any prospectus required by Sections
10(a)(3) of the Securities Act of 1933 (the "Act");
(ii) Reflect in the prospectus any facts or events
arising after the effective date of the Registration
Statement (or the most recent post-effective amendment thereof) which,
individually or in the aggregate, represent a fundamental change in the
information set forth in the Registration Statement. Notwithstanding the
foregoing, any increase or decrease in volume of securities offered (if the
total dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated maximum
offering range may be reflected in the form of prospectus filed with the
Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume
and price represent no more than 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in the
effective Registration Statement;
(iii) Include any additional or changed material
information on the plan of distribution;
(2) That, for the purpose of determining any liability under
the Act, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the bona fide
offering thereof.
(3) To remove from registration by means of a post-effective
amendment any of the securities that remain unsold at the end of the offering.
Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers and controlling persons of the small business
issuer pursuant to the foregoing provisions, or otherwise, the small business
issuer has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the small business issuer of
expenses incurred or paid by a director, officer or controlling person of the
small business issuer in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the small business issuer will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
II-4
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form SB-2 and authorized this registration
statement to be signed on our behalf by the undersigned, on July 25, 2003.
EPHONE TELECOM, INC.
By: /s/ Carmine Taglialatela, Jr.
-----------------------------------------
Carmine Taglialatela, Jr., CEO, Director
Principal Executive Officer
Pursuant to the requirements of the Securities Act of 1933 this
Registration Statement has been duly signed by the following persons on behalf
of the registrant and in the capacities and on the dates indicated
Signature Date
By: /s/ Carmine Taglialatela, Jr. July 25, 2003
-------------------------------------------------
Carmine Taglialatela, Jr., CEO, Director
Principal Executive Officer
By: /s/ Charlie Rodriguez July 25, 2003
-------------------------------------------------
Charlie Rodriguez, Chief Financial Officer
Principal Financial and Accounting Officer
By: /s/ Lawrence Codacovi* July 25, 2003
-----------------------------------------
Lawrence Codacovi, Chairman
By: /s/ Robert Stuart* July 25, 2003
-----------------------------------------
Robert Stuart, Director
By: /s/ Mahmoud Wahba* July 25, 2003
-----------------------------------------
Mahmoud Wahba, Director
*By: Charlie Rodriguez July 25, 2003
----------------------------------------
Charlie Rodriguez, Director
II-5