UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION L3 OR L5(D)
OF THE SECURITIES EXCHANGE ACT OF L934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
or
|_|TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from________ to_______
COMMISSION FILE NUMBER 011-15489
EPIXTAR CORP.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
FLORIDA 65-0722193
- ---------------------------------------- -----------------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
11900 BISCAYNE BOULEVARD, SUITE 700
MIAMI, FLORIDA 33181
- ---------------------------------------- -----------------------------------
(Address of principal executive offices) (Zip Code)
305-503-8600
------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (l) has filed all reports required
to be filed by Section l3 or l5 (d) of the Securities Exchange Act of l934
during the preceding l2 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| NO |X|
The number of shares of the registrant's common stock, $0.001 par value,
outstanding as of August 15, 2005, was 12,344,066 shares.
1
The Registrant's Form 10Q for the quarter ended June 30, 2005 has been amended
in the following respects:
o Management's Discussion and Analysis of the Results of Financial Condition
and Results of Operations has been expanded to explain in more detail what
steps management is taking to stem the recent losses from its BPO business
activities and to explain why its reported number of "enabled seats" (call
center seats) has declined from prior reports.
o Certain reclassifications have been made in the 2004 financial statements to
conform to 2005 presentation.
EPIXTAR CORP.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2005
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION (UNAUDITED) PAGE
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 7 - 21
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 22 - 31
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
Item 4. Controls and Procedures 32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 34
Item 5. Other Information 34
Item 6. Exhibits 34
Signatures 36
Exhibits Index 37
2
ITEM 1. FINANCIAL STATEMENTS
EPIXTAR CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2005 2004
----------------------- ----------------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents (includes amounts held in escrow
of $1,357,200 at June 30, 2005 and $1,110,000 at December 31, 2004) $ 1,437,065 $ 1,530,052
Restricted cash 175,000 175,000
Accounts receivable, net 5,383,510 4,454,152
Deferred loan costs, current portion 623,452 423,777
Prepaid expenses and other current assets 670,128 201,045
Deferred billing costs 68,465 70,454
-------------- -------------
Total current assets
8,357,620 6,854,480
Property and Equipment, net 7,267,995 5,103,409
Other Assets:
Note receivable -- 900,000
Goodwill 4,275,987 3,360,272
Intangibles 5,348,500 -
Deferred loan costs, net of current portion 784,958 540,886
Deposits and other 4,341,461 1,289,668
-------------- -------------
Total other assets 14,750,906 6,090,826
-------------- -------------
Total assets $ 30,376,521 $ 18,048,715
============== =============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current Liabilities:
Accounts payable $ 4,279,173 $ 2,666,713
Accounts payable, related party 2,125,000 975,000
Deferred revenue 617,455 722,328
Accrued expenses and other liabilities 5,199,765 1,277,565
Accrued interest 661,155 460,104
Current portion of debt and capital leases 21,868,571 6,312,758
Note payable, stockholder 2,474,000 2,474,000
-------------- -------------
Total current liabilities 37,225,119 14,888,468
Long-Term Liabilities:
Debt and capital leases, net of current portion 1,933,605 3,893,470
-------------- -------------
Total liabilities 39,158,724 18,781,938
-------------- -------------
Commitments and Contingencies
- -
Stockholders' Deficiency:
Convertible preferred stock, $.001 par value;
10,000,000 shares authorized; 14,500 and 16,500 shares issued
and outstanding (liquidation preference of $2,900,000 and
$3,300,000) 15 17
Common stock, $.001 par value, 50,000,000 shares authorized;
12,271,643 and 11,544,219 shares issued and outstanding 12,272 11,544
Additional paid-in capital 26,512,398 22,114,353
Accumulated deficit (35,267,003) (22,838,853)
Accumulated other comprehensive loss (39,885) (20,284)
-------------- -------------
Total stockholders' deficiency (8,782,203) (733,223)
-------------- -------------
Total liabilities and stockholders' deficiency $ 30,376,521 $ 18,048,715
============== =============
See Notes to Consolidated Financial Statements.
3
EPIXTAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended June 30, Six Months Ended June 30,
2005 2004 2005 2004
------------ ------------ ------------ -----------
Revenues $ 9,099,332 $ 4,287,336 $ 18,179,406 $ 9,163,484
------------ ------------ ------------ ------------
Cost of production employees 4,056,688 259,577 7,307,189 429,864
Billing costs 291,587 705,385 568,403 1,641,744
Other costs of revenue 1,439,242 268,114 2,106,106 465,822
------------ ------------ ------------ ------------
Total costs of revenue 5,787,517 1,233,076 9,981,698 2,537,430
------------ ------------ ------------ ------------
Gross profit 3,311,815 3,054,260 8,197,708 6,626,054
------------ ------------ ------------ ------------
Expenses:
Compensation and benefits 4,016,492 1,950,638 7,442,821 3,605,408
Other selling, general and administrative 2,108,665 1,428,834 5,207,474 2,998,441
Consulting fees and reimbursements -
related party 2,001,250 675,000 3,126,250 1,350,000
Provision for doubtful accounts (25,866) 206,765 162,034 293,678
Depreciation and amortization 637,768 270,670 1,422,153 371,664
Amortization of intangible assets 373,250 -- 746,500 --
------------ ------------ ------------ ------------
Total operating expenses 9,111,559 4,531,907 18,107,232 8,619,191
------------ ------------ ------------ ------------
Loss from operations (5,799,744) (1,447,647) (9,909,524) (1,993,187)
Other Income (Expense):
Other income (expense) (12,319) (5,502) 29,593 (14,328)
Gain on extinguishment of debt 56,267 281,250 56,267 281,250
Factoring fees on accounts receivable (96,479) (251,652) (150,103) (371,003)
Interest expense (341,455) (118,258) (562,319) (480,827)
Amortization, debt discounts (196,586) (442,917) (334,749) (356,226)
Amortization, cost of borrowings (145,150) (234,814) (290,303) (234,814)
Amortization of beneficial conversion
feature of convertible debt (14,587) (1,248,975) (28,071) (1,248,975)
Warrants issued in lieu of finance
charges (303,073) -- (1,169,805) --
Other finance charges -- (1,971) (100,000) (1,971)
------------ ------------ ------------ ------------
Other income (expense), net (1,053,382) (2,186,148) (2,549,490) (2,530,212)
------------ ------------ ------------ ------------
Loss before income taxes (6,853,126) (3,663,795) (12,459,014) (4,523,349)
Provision for income taxes -- -- -- --
Net loss $ (6,853,126) $ (3,663,795) $(12,459,014) $ (4,523,349)
Cumulative dividends on preferred stock (38,795) (44,020) (85,813) (88,040)
------------ ------------ ------------ ------------
Loss Assignable to Common Stockholders $ (6,891,921) $ (3,707,815) $(12,544,829) $ (4,611,359)
============ ============ ============ ============
Loss per common share:
Basic and Dilutive $ (0.56) $ (0.34) $ (1.05) $ (0.43)
============ ============ ============ ============
See Notes to Consolidated Financial Statements.
4
EPIXTAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30,
2005 2004
------------ ------------
OPERATING ACTIVITIES:
Net loss $(12,459,014) (4,523,349)
Adjustments to reconcile net loss to net cash
and cash equivalents used in operating
activities:
Depreciation and amortization 1,422,153 371,664
Provision for doubtful accounts 162,034 293,678
Stock-based compensation 1,086,800 159,375
Warrants issued in lieu of finance charges 1,169,805 --
Amortization of beneficial conversion feature 28,071 1,412,285
Amortization of discount on convertible debt 334,749 442,917
Amortization of cost of borrowings 290,303 234,815
Amortization of discount on stockholder loan -- 52,325
Amortization of intangible assets 746,500 --
Gain on extinguishment of debt (56,267) (281,250)
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable 72,818 298,415
Prepaid expenses and other (450,299) (53,931)
Deferred billing costs 1,989 132,786
Deposits and other 59,654 (70,604)
Increase (decrease) in:
Accounts payable, accrued expenses and other liabilities 2,631,690 (1,487,577)
Accounts payable - related party 1,148,008 975,000
Accrued interest payable 201,051 --
Deferred revenues (104,872) (411,465)
------------ ------------
Net cash and cash equivalents used in
operating activities (3,714,827) (2,454,918)
------------ ------------
INVESTING ACTIVITIES:
Cash paid for acquisition of IMS (50,000) --
Cash paid for acquisition of property and equipment (622,164) (1,917,824)
------------ ------------
Net cash and cash equivalents used in
investing activities (672,164) (1,917,824)
------------ ------------
FINANCING ACTIVITIES:
Proceeds from the issuance of debt, net of loan costs 7,033,450 6,671,500
Repayment of notes payable and capital lease obligations (2,719,845) (1,105,298)
------------ ------------
Net cash and cash equivalents provided by
financing activities 4,313,605 5,566,202
------------ ------------
Net effect of exchange rates on cash (19,601) (23,190)
------------ ------------
Net (Decrease) Increase in Cash and Cash Equivalents (92,987) 1,170,270
Cash and Cash Equivalents, beginning of period 1,530,052 1,342,186
------------ ------------
Cash and Cash Equivalents, ending of period $ 1,437,065 $ 2,512,456
============ ============
(Cont.)
5
EPIXTAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Cont.)
Six Months Ended June 30,
2005 2004
---------- ----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Income Tax Paid $ -- $ --
========== ==========
Interest Paid $ 361,268 $ 111,570
========== ==========
Non Cash Transactions
Issuance of 550,290 shares of common stock as part of guaranteed
agreement related to the Company's acquistion of IMS $ 385,000 $ --
Conversion of 2,050 shares of preferred stock into
249,557 shares of common stock 265,000 --
Purchase commitment of equipment secured by promissory note 3,070,000 --
Equipment purchased under capital leases 247,832 339,476
See Notes to Consolidated Financial Statements.
6
EPIXTAR CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIODS ENDED JUNE 30, 2005 AND 2004 (UNAUDITED)
NOTE 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Epixtar Corp. (Epixtar) was incorporated in Florida in June 1994 and was
previously known as Global Asset Holdings, Inc. (Global). Epixtar and its
subsidiaries are collectively known as the "Company".
Epixtar, through its subsidiaries, operates primarily in two lines of business:
business process outsourcing and contact center services (BPO) and internet
service provider services (ISP).
SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation
The Company's basis of consolidation is to include in the consolidated financial
statements all of the accounts of its wholly-owned subsidiaries and those of its
more-than-50%-owned subsidiaries. All significant intercompany transactions and
account balances have been eliminated.
Basis of Presentation
The accompanying unaudited consolidated financial statements of the Company as
of and for the periods ended June 30, 2005 and 2004 have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with the rules and regulations of the
Securities and Exchange Commission (SEC). Accordingly, they do not include all
information and footnotes necessary for a complete presentation of financial
position, results of operations and changes in cash flows in accordance with
accounting principles generally accepted in the United States of America.
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 that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
In the opinion of management, all adjustments (consisting of normal recurring
entries) considered necessary for a fair presentation have been included. These
statements should be read in conjunction with the Company's Annual Report on
Form 10-K for the year ended December 31, 2004, filed with the SEC on April 15,
2004. Operating results for the three and six months ended June 30, 2005, are
not necessarily indicative of the results expected for the year ending December
31, 2005. See Note 2.
Stock-Based Compensation
In accordance with Accounting Principles Board Opinion No. 25 (APB 25),
"Accounting for Stock Issued to Employees", the Company currently uses the
intrinsic-value method of accounting for its employee and board of director
stock options and, accordingly, does not recognize compensation expense for
stock option awards in the Consolidated Statement of Operations, as all option
exercise prices are 100 percent of market value on the date the options are
granted. See Recent Accounting Pronouncements below.
The following table illustrates the pro forma effect on net loss and loss per
share assuming we had applied the fair value recognition provisions of Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" to all previously granted stock-based awards after giving
consideration to potential forfeitures. The fair value of each option grant is
estimated at the grant date using the Black-Scholes option-pricing model.
Reference is made to "Note 15: Stock Option Plan" in the Company's Annual Report
on Form 10-K for Fiscal 2004, for the assumptions used in the Black-Scholes
option-pricing model. The estimated fair value of options granted is amortized
to expense over their vesting period, which is generally 3 years.
7
Three Months Ended Six Months Ended
--------------------------- -----------------------------
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
----------- ----------- ------------- -----------
Net loss assignable to common shareholders $(6,891,921) $(3,707,815) $(12,544,829) $(4,611,389)
Deduct: Total stock-based compensation expense
determined under fair value based method for
all awards, net of related tax effects (536,218) (969,788) (1,313,305) (1,928,003)
----------- ----------- ------------ -----------
Pro forma net loss $(7,428,139) $(4,677,603) $(13,858,134) $(6,539,392)
=========== =========== ============ ===========
Loss per share:
Basic and Diluted
As reported $ (0.56) $ (0.34) $ (1.05) $ (0.43)
=========== =========== ============ ===========
Pro forma $ (0.61) $ (0.43) $ (1.16) $ (0.61)
=========== =========== ============ ===========
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123(R), "Share-Based Payment" (SFAS 123R), which requires all companies to
measure compensation cost for all share-based payments (including employee stock
options) at fair value and to recognize cost over the vesting period. In April
2005, the SEC announced that companies may implement SFAS 123R at the beginning
of their next fiscal year starting after June 15, 2005 (or December 15, 2005 for
small business issuers). This new rule moves the Company's implementation date
for SFAS 123R to the first quarter of 2006.
An illustration of the impact on the Company's net loss and loss per share is
presented under "Stock-Based Compensation" in this Note, assuming the Company
had applied the fair value recognition provisions of SFAS 123R using the
Black-Scholes methodology. The Company has not yet determined whether it will
use the Black-Scholes method upon adoption of Statement 123R. Also, the Company
is unable to estimate the future impact that SFAS 123R will have on its
financial position, results of operations or cash flows due to unknown events,
such as the type and number of share-based payments that will be granted, their
terms, and their vesting periods.
In May 2005, the FASB issued Statement of Financial Accounting Standards No.
154, "Accounting Changes and Error Corrections" (SFAS No. 154), which is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. SFAS 154 replaces APB Opinion No. 20,
"Accounting Changes," and FASB Statement No. 3, "Reporting Accounting Changes in
Interim Financial Statements," and changes the requirements for the accounting
for and reporting of a change in accounting principle. SFAS 154 requires
retrospective application to prior periods' financial statements of changes in
accounting principle, unless it is impracticable to do so, in which case other
alternatives are required. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005, or
for the Company's fiscal 2006. The Company is evaluating the effect that the
adoption of SFAS No. 154 will have on its results of operations and financial
position, but does not believe it will have a material impact.
In April 2005, the SEC announced that companies may implement SFAS 123R at the
beginning of their next fiscal year. In March 2005, the SEC released SEC Staff
Accounting Bulletin No. 107, "Share-Based Payment" (SAB 107). SAB 107 provides
the SEC staff's position regarding the application of SFAS 123R, which contains
interpretive guidance related to the interaction between SFAS 123R and certain
SEC rules and regulations, and also provides the staff's views regarding the
valuation of share-based payment arrangements for public companies. SAB 107
highlights the importance of disclosures made related to the accounting for
share-based payment transactions. The Company is currently reviewing the effect
of SAB 107, but it does not believe SAB 107 will have a material impact on its
financial position, results of operations or cash flows.
8
In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations" ("FIN 47"), which clarifies the term
"conditional asset retirement obligations" as used in FASB Statement No. 143,
"Accounting for Asset Retirement Obligations." FASB Statement No. 143 refers to
an entity's legal obligation to perform an asset retirement activity in which
the timing and/or method of settlement are conditional on a future event that
may or may not be within the control of the entity. If an entity can reasonably
estimate a liability for the fair value of a conditional asset retirement
obligation, the entity is required to recognize the fair value of the liability
when incurred. A company normally incurs this liability upon acquisition,
construction, or development of the asset at issue. FIN 47 is effective for
fiscal years ending after December 15, 2005. The Company is currently reviewing
FIN 47, and at the current time it does not believe that FIN 47 will have a
material impact on its financial position, results of operations or cash flows.
Reclassifications
Certain reclassifications have been made in the 2004 financial statements to
conform to the 2005 presentation.
NOTE 2. GOING CONCERN CONSIDERATIONS
At June 30, 2005, the Company reflected stockholders' deficiency of
approximately $8,782,203 as a result of net losses in each period of operation
except calendar year 2003. The Company had negative cash flows from operations
for the six months ended June 30, 2005 and 2004. The Company reported net losses
of $6,853,126 and $12,459,014 during the three and the six months ended June
30, 2005, respectively, compared with $3,663,795 and $4,523,349 during the same
periods in 2004, respectively. The Company continues to experience certain
liquidity issues primarily as a result of the Company's costs associated with
the execution of its BPO operations business plan. All these factors raise
significant concern about the Company's ability to continue as a going concern.
The Company has taken several steps since April 2005 to ensure that it addresses
and resolves its liquidity problems in order to continue with the planned
expansion of its business outsourcing and call center segment as well as to
retain its ISP customers. Since April 2005, management has (1) taken cost
cutting procedures including a reduction in staff, (2) obtained additional debt
financing, and (3) entered into a consulting agreement with a firm that
specializes in companies with liquidity problems. The consulting company has
been engaged to help develop a plan that is intended to bring the Company to a
cash break-even level within the next three months. See Notes 5 and 11.
The realization of assets and satisfaction of liabilities in the normal course
of business is dependent upon the Company generating additional operating
capital through debt and equity financing, and ultimately reaching profitable
operations. No assurances can be given that the Company will be successful in
these activities. Should any of these events not occur, the Company's financial
condition and results of operations would be materially adversely affected. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
NOTE 3. ACQUISITION
In November 2004, the Company entered into an agreement to purchase all of the
outstanding common shares of Innovative Marketing Strategies, Inc. (IMS), a
privately-held Florida corporation with six years experience providing business
process outsourcing and contact center services to the financial services
market. IMS customers include banks, credit card companies and mortgage
companies. These services are delivered from three call center facilities
located in the U.S. and one facility located in the Philippines. Select
operational functions are conducted from its network operations center (NOC) in
North Carolina.
In July 2004, the Company had advanced IMS $600,000 and advanced an additional
$300,000 in November 2004. On January 3, 2005, the Company completed the
purchase of all of the outstanding common shares of IMS. This acquisition has
been accounted for under the purchase method of accounting and accordingly, the
results of operations of IMS have been included in the Company's consolidated
financial statements since the date of acquisition. IMS is a wholly-owned
subsidiary of Voxx Corporation, a majority-owned subsidiary of the Company, and
is being operated within its BPO business segment. The purchase price of
approximately $6.5 million, excluding net liabilities assumed of approximately
$1.1 million, is calculated as follows:
9
Cash consideration paid $1,017,000
Non-interest bearing Collateral Promissory Note,
payable over 24 months 5,105,000
Acquisition costs 375,000
----------
$6,497,000
==========
As part of the acquisition of IMS, the Company issued on January 3, 2005, a
$5,104,594 non-interest bearing Collateral Promissory Note payable to the IMS
shareholders over two years. At June 30, 2005, the principal amount of the note
was $4,593,828. On August 4, 2005, this Note was restructured. See Note 11.
The amount of consideration to the former shareholders of IMS amounted to
$6,121,884, including $50,000 paid at closing. The purchase price allocation of
the IMS acquisition resulted in goodwill of approximately $1.0 million and
identifiable intangible assets of $6.1 million. The identifiable intangible
assets include customer relationships of approximately $4.0 million, non-compete
contracts of approximately $1.7 million and value of call center locations of
approximately $375,000 and these are being amortized on a straight-line basis
over 5, 3 and 3 years, respectively.
The IMS balance sheet as of acquisition date, January 3, 2005, is as follows:
ASSETS
Accounts Receivable - Net $ 1,164,000
Prepaid Expenses and Other Current Assets 68,000
-----------
Total current assets 1,232,000
Property and Equipment - Net 2,401,000
Goodwill 915,000
Intangible Assets 6,095,000
Other Assets 42,000
-----------
Total Assets $10,685,000
===========
LIABILITIES
Accounts Payable $ 2,025,000
Accrued Expenses and Other Liabilities 1,385,000
Amounts due Epixtar and Voxx 1,050,000
Debt - Current 3,278,000
-----------
Total current liabilities 7,738,000
Debt - Long Term 2,947,000
-----------
TOTAL LIABILITIES $10,685,000
===========
Pro Forma Results
The following summary, prepared on a pro forma basis, presents unaudited
consolidated results of operations as if IMS had been acquired as of January 1,
2004, after including the impact of adjustments such as amortization of
intangibles. This pro forma presentation does not include any impact of
acquisition synergies.
10
Three Months Ended Six Months Ended
June 30, 2004 June 30, 2004
------------------ ----------------
Revenue - as reported $ 4,287,336 $ 9,163,484
Revenue- pro forma $ 8,441,878 $17,888,216
Net loss - as reported $(3,663,794) $(4,523,349)
Net loss - pro forma $(4,477,100) $(6,251,233)
Net income (loss) per diluted
common share - as reported $ (0.34) $ (0.43)
Net income (loss) per diluted
common share - pro forma $ (0.39) $ (0.56)
The pro forma results are not necessarily indicative of the Company's results of
operations had it owned IMS during the entire period presented.
NOTE 4. ACCOUNTS RECEIVABLE
Accounts receivable, net, amounted to $5,383,510 and $4,454,152 at June 30, 2005
and December 31, 2004, respectively. At June 30, 2005, $1,215,696 of the
accounts receivable relates to Epixtar Marketing Corp., formerly IMS.
The Company's accounts receivables serve as collateral for certain debt of the
Company (see Note 5).
NOTE 5. DEBT AND CAPITAL LEASES
At June 30, 2005 and December 31, 2004, debt and capital leases consisted of the
following:
June 30, December 31,
2005 2004
----------- -----------
Non-interest bearing collateral promissory note due January 2007,
payable in monthly installments, net of unamortized discount of $229,249 $4,364,579 $ --
7% secured convertible notes due on demand, secured by accounts
receivable 450,000 450,000
6% Notes due on demand, secured by equipment 500,000 500,000
8% unsecured convertible promissory notes, due April 2005, net of
unamortized discount of $46,631 -- 953,369
Secured convertible term note due May 2007, payable in monthly
installments of $ 90,909, commencing October 2004, bearing annual
interest at 2.5% over prime, not to exceed 8%, collateralized by the
assets of the Company, net of unamortized discount of $432,799 and $546,860 3,839,928 4,271,322
Secured convertible term note due April 2008, payable in monthly
installments commencing November 2005, bearing annual interest at 2%
over prime, collateralized by the assets of the Company, net of
unamortized discount of $1,485,937 5,514,063 --
5% unsecured joint and several subordinated convertible promissory
notes, due May 2007, net of unamortized discount of $100,984 and $111,899 3,614,016 2,835,601
11
June 30, December 31,
Debt and Capital Leases, Continued 2005 2004
- ---------------------------------- ----------- -----------
Non-interest bearing note payable, due June 2006, payable in monthly
installments 127,487 127,487
Non-interest bearing promissory note, due September 2005, payable in
monthly installments 323,893 404,762
Non-interest bearing assumption of equipment financing on acquisition
of call center, payable through 2005 137,987 158,301
11.9% promissory notes due August 2007, secured by automobiles,
payable in monthly installments 64,773 77,738
Non-interest bearing note pursuant to asset purchase agreement,
payable on demand 88,692 88,692
11% equipment financing agreement, with maturities from September 2005
through March 2006 116,182 124,248
Notes assumed from IMS acquisition:
10% Note due August 2009, payable in monthly installments 271,203 --
Non-interest bearing Promissory Note, payable over 18 months, secured
by certain equipment 3,423,000 --
Non-interest bearing equipment financing due March 2006, payable in
monthly installments 206,715 --
Equipment financing Note due March 2007, bearing annual interest at
3.25% over prime 28,206 --
4% West Virginia Economic Development Note due April 2008, secured by
certain assets, as defined in security agreement 187,004 --
5% Ohio Valley Industrial and Business Development Note due January
2013, secured by certain assets, as defined in security agreement 137,247 --
Non-interest bearing promissory note from the Kansas Department of
Commerce & Housing due May 2005, forgiven if defined job creation
requirements are met 65,702 --
Capitals leases, at interest rates ranging from 9.0% to 11% in 2004
and 7% to 14% in 2003 341,499 214,708
----------- -----------
23,802,176 10,206,228
Less current portion 21,868,571 6,312,758
----------- -----------
$ 1,933,605 $ 3,893,470
=========== ===========
On January 3, 2005, the Company completed its purchase of all of the outstanding
common shares of IMS. As part of the acquisition, the Company issued a
$5,104,594 non-interest bearing Collateral Promissory Note payable to the IMS
shareholders. This note is payable monthly over two years. At June 30, 2005, the
note amounted to $4,364,579, net of unamortized discount of $229,249. On August
4, 2005, this Note was restructured. See Note 11.
In December 2003, the Company issued 7% Secured Convertible Notes in the amount
of $500,000 to accredited investors. During 2004, $50,000 was repaid and the
remaining notes amounting to $450,000, matured in December 2004. In October
2004, in connection with the purchase of equipment related to the contact center
business, the Company issued 6% Notes maturing in December 2004, in the amount
of $500,000 to the same accredited investors. The Company obtained from these
lenders extensions to the 7% Secured Convertible Notes and the 6% Notes through
April 29, 2005. As consideration for the extension, on April 22, 2005, a related
party to the Company transferred to the lender detachable warrants it held to
purchase 200,000 shares of the Company's common stock for $0.50 per share,
exercisable at any time over a five year period from the date of issuance. Using
the Black-Scholes model the Company estimated the fair value of the 200,000
warrants and allocated $173,314, or $0.87 per common share to the warrants,
which was recognized as expense on the accompanying Consolidated Statement of
Operations for the six months ended June 30, 2005. Additionally, as part of the
extension, the Company issued 145,000 shares of common stock, in Voxx, a
majority-owned subsidiary of the Company for no additional consideration. The
Company estimated the fair value of the 145,000 Voxx shares at $88,530, or $0.61
per common share which was expensed during the three months ended June 30, 2005.
The extension to the Notes matured on April 29, 2005, and the Company is
currently negotiating with the lenders to obtain another extension of the
maturity date. To the extent the Company is unsuccessful in any such
negotiations and/or the Company otherwise defaults on the terms of this or any
of its other long term debt, the result of such default, if not cured in
accordance with any applicable grace period, will be to accelerate the due date
of all of the Company's other long term indebtedness with the result that all
such debt will become immediately due and payable.
12
In May 2004, the Company issued 8% Unsecured Convertible Promissory Notes in the
amount of $1,000,000 to accredited investors. As part of the issuance of the
convertible notes, the Company issued detachable warrants to purchase 132,722
shares of the Company's common stock exercisable at any time over a five year
period from the date of issuance. As of June 30, 2005 these warrants were
exercisable at $1.58 per share. At December 31, 2004, these notes amounted to
$953,369, net of unamortized discount of $46,631, resulting from the issuance of
the warrants. On April 29, 2005, the Company repaid these notes, including
interest of $82,789.
On May 14, 2004, the Company issued a Secured Convertible Term Note in the
amount of $5,000,000 at 2.5% over prime (not to exceed 8%) to an accredited
institutional investor. As part of the convertible term note, the Company issued
detachable warrants to purchase 492,827 shares of the Company's common stock
exercisable at any time over a seven-year period from the date of issuance. As a
result of financing facility entered into with Laurus Master Fund, Ltd and
affiliates of Laidlaw & Company (UK) Ltd., on April 29, 2005 these warrants are
now exercisable at $1.00 per share. In connection with the issuance of the
convertible term note, the Company entered in to a registration rights agreement
with the lender. Under the terms of the agreement, the Company was required to
pay the lender $100,000 for each 30 day period after 120 days from the original
issuance of the note if a registration statement filed with the Securities and
Exchange Commission (SEC) covering the common stock underlying the convertible
term note and detachable warrants was not declared effective (Liquidated
Damages). Additionally, in accordance with the terms of the agreement, at
December 31, 2004, approximately $1,110,000 of the principal amount of the note
was held in a restricted account to be released upon the effectiveness of a
registration statement filed with the SEC. On February 28, 2005, the Company
entered into an Amendment and Waiver agreement with the lender, resulting in the
waiver of the Liquidated Damages under the agreement and the authorization to
release the $1,110,000 held in the restricted account at December 31, 2004. As
consideration for the waiver, the Company issued to the lender warrants to
purchase 1,900,000 shares of the Company's common stock at an exercise price of
$2.15 per share, exercisable at any time over a seven-year period. Using the
Black-Scholes model the Company estimated the fair value of the 1,900,000
warrants and allocated $1,101,049, or $0.58 per common share to the warrants.
This amount, net of $193,333 of previously accrued Liquidated Damages was
recognized as expense on the accompanying Consolidated Statement of Operations
for the six months ended June 30, 2005. At June 30, 2005 and December 31, 2004,
these notes amounted to $3,839,928 and $4,271,322, respectively, net of
unamortized discount of $432,799 and $546,860, respectively, resulting from the
issuance of warrants. Because of default provisions contained in the agreement,
the entire principal balance as of June 30, 2005 is classified as current in the
accompanying Consolidated Balance Sheet.
On April 22, 2005, the Company issued an 8% Promissory Note in the amount of
$280,000 to an accredited investor. The note was payable on demand and in the
event the Company was unable to repay the note upon written demand, the interest
rate on the unpaid amount would increase to 18% per annum. The Note was re-paid
on May 2, 2005.
On April 29, 2005, the Company, and its majority-owned subsidiary, Voxx
Corporation, entered into a financing facility with Laurus Master Fund, Ltd and
affiliates of Laidlaw & Company (UK) Ltd., pursuant to which the Company and
Voxx borrowed $7,000,000 represented by Senior Secured Convertible Notes (the
Notes) that mature on April 29, 2008, and bear annual interest at 2% over prime.
Interest payments began June 1, 2005, and principal payments begin on October
29, 2005 at the monthly rate of $166,667 plus accrued but unpaid interest.
Payments may, in certain circumstances, be made in shares of the Company and/or
Voxx common stock, and the Notes may be prepaid at any time at 130% of the then
outstanding principal balance due at the time of prepayment. The Notes are
secured by all of the assets of Voxx Corporation and its subsidiaries, the
Company's shareholdings in Voxx Corporation and significantly all of its other
subsidiaries, by a pledge of the Company and Voxx's contract revenues from
certain sources and by certain other assets of the Company and its subsidiaries.
The Notes significantly restrict the ability of Epixtar, Voxx and their
subsidiaries from borrowing additional monies without the consent of the
lenders.
13
The Notes are convertible into the common stock of Epixtar at $1.00 per share
and/or into the common stock of Voxx in the event Voxx conducts an initial
public offering of its own securities at a 15% discount to the IPO price. As
additional consideration for the making of the loan, the lenders received
options to purchase 31% or 4,167,028 shares of Voxx Corporation common stock
computed on a fully diluted basis at the time of closing at a price of $.001 per
share, warrants to purchase 556,596 shares of Voxx common stock at a price,
generally, equal to the IPO price, and payments and reimbursements to the
lenders and related parties of approximately $640,000. The options and warrants
both provide the holder with anti-dilution protection in the event of stock
splits, stock dividends and other extraordinary corporate events. Using the
Black-Scholes model the Company estimated the fair value of the options to
purchase 4,167,028 shares of common stock and allocated $1,573,345 of the debt
proceeds, which was recorded as a discount on the convertible notes, and is
being amortized over the life of the Note. Prior to the Voxx IPO date, the
warrants are exercisable at price per share equal to capitalization of Voxx,
divided by the aggregate number of shares of Voxx common stock issued and
outstanding on the date of exercise, calculated on a fully diluted basis. Based
on this calculation, at June 30, 2005, the 556,596 warrants are estimated to be
exercisable at $3.35 per share. As a condition of the making of this loan, the
Company was also required to (1) amend the terms of its existing $5,000,000 loan
facility with Laurus to reprice to $1.00 per common share approximately
3,148,144 of previously issued warrants originally issued at prices ranging from
$2.15 to $4.66 per share, including 1.9 million warrants issued for the
Company's common stock on February 28, 2005 in connection with the Amendment and
Waiver agreement of the facility, and (2) to further secure the facility with
certain additional contract revenues from the Company's ISP business. At June
30, 2005, approximately $1,357,200 of ISP contract revenue was being held in
escrow.
The Notes provide that it is an "event of default" in the event of, among other
things, non-payment, a breach of a covenant or any other agreement made by the
borrowers in the note purchase agreements, the appointment of a receiver, an
unsatisfied money judgment against one of the borrowers or any of their
subsidiaries in excess of $150,000 for more than 30 days, a change in control of
the Company or Voxx (other than in connection with a Voxx IPO), the institution
of a government regulatory proceeding which prevents the borrowers from
utilizing a substantial portion of their assets , or the occurrence of an "event
of default" in certain other agreements to which the borrowers are parties. If
an "event of default" should occur and continue beyond any applicable grace
period, 110% of the then outstanding principal balance of the Notes plus accrued
but unpaid interest becomes immediately due and payable. Because of default
provisions and lockbox requirements contained in the agreements, the entire
outstanding principal amount as of June 30, 2005 is classified as current on the
accompanying Consolidated Balance Sheet.
During the three months ended March 31, 2005, the Company and its majority-owned
subsidiary, Voxx, sold to accredited investors, in a private placement, an
additional $767,500 principal amount of 5% Joint Unsecured Subordinated
Convertible Promissory Notes due May 2007. Pursuant to the notes, in the event
Voxx becomes a public company, the then outstanding notes are immediately
converted into shares of Voxx common stock. The rate of interest will be
increased to an annual rate of 10% if Voxx does not become a public corporation
on or before October 15, 2005. Until Voxx is a public company a holder may
convert his entire note into shares of the Company's Common Stock for one year
at a fixed conversion price related to market but not less than $2.25.
Thereafter the exercise price will be the lesser of $1.00 or the average market
price for a period preceding the one-year anniversary of the notes, as specified
in the agreement. The notes are subordinate in all respects to the senior debt.
In addition to the note each unit also consists of the right to receive in the
future (i) warrants to purchase the Company's Common Stock and/or (ii) warrants
to purchase Voxx's common stock. Based on the terms of the conversion associated
with the notes, there was an intrinsic value associated with the beneficial
conversion feature of the additional $767,500 principal amount issued during the
March 2005 quarter estimated at $12,153, which was recorded as deferred interest
and presented as a discount on the convertible notes, net of amortization to be
taken over the terms of the notes. At June 30, 2005 and December 31, 2004, these
notes amounted to $3,614,016 and $2,835,601, respectively, net of unamortized
discount of $100,984 and $111,899, respectively, resulting from the intrinsic
value of the beneficial conversion feature. Because of default provisions
contained in the agreement, the entire principal balance as of June 30, 2005 is
classified as current in the accompanying Consolidated Balance Sheet.
On June 23, 2005, the Company entered into an agreement with SER Solutions, Inc.
(SER) that provides for the purchase by the Company of $3,070,000 of dialer
equipment for its call centers over the next 18 months. In connection with the
agreement, the Company has executed a non-interest bearing Promissory Note in
the amount of $3,423,000, representing the purchase commitment of $3,070,000 and
$353,000 due on prior note for dialer equipment. See Note 10.
14
NOTE 6. CAPITAL STOCK
EPIXTAR
Conversion of Preferred Stock
During the three months ended June 30, 2005, a holder of the Company's preferred
stock converted 1,050 shares of preferred stock into 121,287 shares of the
Company's common stock. The holder of the preferred stock originally purchased
the shares for $105,000, or $100 per share. Pursuant to the provisions of the
Company's Amended Certificate of Incorporation relating to the preferred stock,
cumulative dividends were added to the original purchase price and the adjusted
value was converted into common stock using a conversion price of $1.00 per
share. During the three months ended March 31, 2005, 1,000 shares of preferred
stock were converted into 55,847 shares of the Company's common stock. These
shares were originally purchased for $100,000, or $100 per share. Pursuant to
the provisions of the Company's Amended Certificate of Incorporation relating to
the preferred stock, cumulative dividends were added to the original purchase
price and the adjusted value was converted into common stock using a conversion
price of $2.00 per share.
Common Stock
On February 28, 2005, the Company issued 550,290 shares of common stock pursuant
to its acquisition of IMS in January 2005. As part of the acquisition of IMS,
the Company guaranteed an agreement for approximately $770,000 due an IMS
shareholder for commissions, and issued the 550,290 shares of common stock as
payment for $385,000 of the amount guaranteed. The valuation assigned to the
common stock was based on the average volume and price of the Company's stock
for the month of November 2004, as provided in the acquisition agreement.
Warrants
On April 22, 2005, a related party to the Company transferred to a lender
detachable warrants it held to purchase 200,000 shares of the Company's common
stock for $0.50 per share, exercisable at any time over a five year period from
the date of issuance. The Company estimated the fair value of the warrants,
using the Black-Scholes model at $173,314, or $0.87 per common share, which was
recognized as expense on the accompanying Consolidated Statement of Operations
during the three months ended June 30, 2005. See Note 5
On February 28, 2005, the Company issued warrants to purchase 1,900,000 shares
of the Company's common stock at an exercise price of $2.15 per share,
exercisable at any time over a seven-year period. In connection with the
financing facility entered into with Laurus Master Fund, Ltd and affiliates of
Laidlaw & Company (UK) Ltd., on April 29, 2005 the warrants became exercisable
at $1.00 per share. The Company estimated the fair value of the warrants, using
the Black-Scholes model, at $1,101,049, or $0.58 per common share. This amount,
net of $193,333 of previously accrued fees was charged to earnings on the
accompanying Consolidated Statement of Operations for the six months ended June
30, 2005. See Note 5.
VOXX
Common Stock
On April 22, 2005, as consideration for extending the maturity date of certain
notes, the Company issued 145,000 shares of Voxx common stock to lenders. The
Company estimated the fair value of the 145,000 Voxx shares at $88,530, or $0.61
per common share. This amount was recognized as expense on the accompanying
Consolidated Statement of Operations for the three months ended June 30, 2005.
See Note 5.
Options
On April 29, 2005, in connection with the issuance of convertible debt, the
Company granted to Laurus options to purchase 4,167,028, or 31% of Voxx common
shares, at $0.001 per share, on a fully diluted basis. The options provide the
holder with anti-dilution protection in the event of stock splits, stock
dividends and other extraordinary corporate events. The Company estimated the
fair value of the options to purchase stock using the Black-Scholes model and
allocated $1,573,345, or $0.49 per common share, which was recorded as a
discount on the convertible notes and is being amortized over the life of the
Notes. See Note 5.
15
Warrants
On April 29, 2005, in connection with the issuance of convertible debt, the
Company issued warrants to purchase 556,596 shares of Voxx common stock at $3.35
per share. The warrants provide the holder with anti-dilution protection in the
event of stock splits, stock dividends and other extraordinary corporate events.
Prior to the Voxx IPO date, the warrants are exercisable at price per share
equal to capitalization of Voxx, divided by the aggregate number of shares of
Voxx common stock issued and outstanding on the date of exercise, calculated on
a fully diluted basis. Based on this calculation, at June 30, 2005, the 556,596
warrants are estimated to be exercisable at $3.35 per share. See Note 5.
Restricted Stock
On April 20, 2005, the Board of Directors of the Company granted an aggregate of
2,000,000 shares of Voxx Corporation common stock owned by the Company (the
Restricted Shares), to certain employees and consultants of the Company,
including 1.5 million of the shares issued to a related party. As of June 30,
2005, there were 1,760,000 Restricted Shares outstanding. The Company estimated
the fair value of the Restricted Shares at $1,086,800, or $0.62 per common
share, which was recognized as expense on the accompanying Consolidated
Statement of Operations during the three months ended June 30, 2005.
Each grantee, as a condition of the grant, was required to elect, within 30 days
of the date of grant, and upon written notice delivered to the Internal Revenue
Service with a copy delivered to the Company, to recognize income for federal
income tax purposes equal to the fair market value of the shares as of the date
the shares were transferred to the grantee. Grantees that made the timely
required election, will receive on December 31, 2005, as an additional incentive
payment, an amount equal to $0.30 per Restricted Share. The Company accrued
$600,000 related to the incentive payment.
Incentive Stock Options
On April 20, 2005, Voxx Corporation adopted the Voxx Corporation 2005 Stock
Incentive Plan which permits the granting of awards of non-statutory stock
options, incentive stock options, stock appreciation rights, restricted stock
and performance shares with respect to Voxx common stock. The Incentive Plan was
approved by the Company as the sole stockholder of Voxx on April 20, 2005.
Awards under the Incentive Plan may be granted or awarded to employees of Voxx
or its affiliates including the Company, persons who are hired to be employees
of Voxx or its affiliates, non-employee directors of Voxx or any of its
affiliates, and consultants and independent contractors who render key services
to Voxx or its affiliates. The maximum number of shares of common stock of Voxx
that may be issued under the Incentive Plan or pursuant to awards made under the
plan is 2,375,000 shares, subject to adjustment in the event of a change in
corporate capitalization of Voxx. The Incentive Plan will be administered by the
Board of Directors of Voxx. On April 20, 2005, the Board of Directors of Voxx
granted 2,000,000 options to purchase Voxx Corporation common stock at $3.00 per
share. As of June 30, 2005, there were 1,675,000 incentive stock options
outstanding.
Dilutive Effect of Issuances
The dilutive effect of the issuance of Epixtar Corp. equity securities and the
re-pricing of certain previously issued securities, as per the $7,000,000 Senior
Secured Convertible Notes (see Note 5), could, if all of the debt was converted
and all of the warrants were exercised, result in an increase in the Company's
issued and outstanding common stock by 10,249,345, shares or an increase of
83.5% of the number of common shares outstanding as of June 30, 2005. This
dilutive effect includes the effects from re-pricing other equity securities,
but it excludes the potential dilutive effect on the Company's percentage
ownership of its Voxx subsidiary as a result of equity securities held by the
lender to purchase Voxx common stock.
16
NOTE 7. RELATED PARTY TRANSACTIONS
On October 31, 2001, the Company issued a 7% note in the amount of $2,474,000,
collateralized by accounts receivable, to a then unrelated entity. In August
2002, the creditor became a stockholder of the Company and in. November 2002,
the Company entered into an agreement whereby the stockholder agreed to release
its security interest in the Company's accounts receivable to the extent
required to secure additional debt financing and agreed not to demand payment
before January 2005 in exchange for certain consideration. Except for the demand
deferral and the release of the security interest, all other terms of the note
stayed in effect. The consideration given consisted of warrants to purchase
4,000,000 shares of Company common stock at an exercise price of $0.50 per share
for a term of three years beginning in May 2003. To the extent the Company is
unsuccessful in negotiating an extension to the agreement and/or the Company
otherwise defaults on the terms of this or any of its other long term debt, the
result of such default, if not cured in accordance with any applicable grace
period, will be to accelerate the due date of all of the Company's other long
term indebtedness with the result that all such debt will become immediately due
and payable. At June 30, 2005 and December 31, 2004, the outstanding principal
balance of the Note was $2,474,000.
In October 2001, the Company entered into an agreement with Transvoice, whereby
Transvoice provided certain services related to the development of the Company's
internet service provider business. The Company incurred expenses of $900,000
and $1,800,000 during the three and six months ended June 30, 2005,
respectively, and $450,000 and $900,000, respectively, during the three and six
months ended June 30, 2004, for services under this agreement. At June 30, 2005
and December 31, 2004, $1,800,000 and $750,000, respectively of these amounts
remained unpaid and are included in accounts payable-related party.
On April 20, 2005, Transvoice was granted an aggregate of 1,500,000 shares of
Voxx Corporation common stock owned by the Company (the Restricted Shares). The
Company estimated the fair value of the Restricted Shares, at $926,250, or $0.62
per common share, which was recognized as consulting fees and
reimbursements-related party expense on the accompanying Consolidated Statement
of Operations during the three months ended June 30, 2005.
In April 2003, the Company entered into an agreement with Transvoice, whereby
Transvoice provides consulting services related to the development of marketing
and telemarketing aspects of the Company. Transvoice is not compensated for its
services but is reimbursed for payments made to a related party subcontractor
performing services associated with the agreement. The subcontractor is 100%
owned, indirectly, or directly, by a previous executive of the Company. The
Company incurred expenses of $225,000 and $400,000, respectively, for the three
and six months ended June 30, 2005, and $225,000 and $450,000, respectively, for
the three and six months ended June 30, 2004 for services under this agreement.
At June 30, 2005 and December 31, 2004, $325,000 and $225,000 remained unpaid
and is included in accounts payable-related party. The agreement was terminated
during the second quarter of 2005.
NOTE 8. EARNINGS (LOSS) PER SHARE
The Company presents both basic and diluted EPS. Basic EPS is calculated by
dividing net income or loss by the weighted average number of common shares
outstanding during the period. Diluted EPS is based upon the weighted average
number of common and common equivalent shares outstanding during the period
which is calculated using the treasury stock method for stock options and
warrants, and assumes conversion of the Company's convertible notes. Common
equivalent shares are excluded from the computation in periods in which they
have an anti-dilutive effect. Stock options for which the exercise price exceeds
the average market price over the period have an anti-dilutive effect on EPS
and, accordingly, are excluded from the calculation. Weighted average number of
shares used to compute basic and diluted loss per share for the three and six
months ended June 30, 2005 and 2004 is the same, since the effects of the
preferred stock, common stock options, warrants and convertible debt were
anti-dilutive.
A reconciliation of net loss and the weighted average number of common and
common equivalent shares outstanding for calculating diluted earnings per share
is as follows:
17
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net loss $ (6,853,126) $ (3,663,795) $(12,459,014) $ (4,523,349)
Preferred stock dividends (38,795) (44,020) (85,515) (88,040)
------------ ------------ ------------ ------------
Net loss for basic and diluted EPS calculations $ (6,891,921) $ (3,707,815) $(12,544,829) $ (4,611,389)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF SHARES FOR BASIC AND
DILUTED EPS 12,231,658 10,899,305 11,993,906 10,787,920
LOSS PER SHARE
Basic and Diluted $ (0.56) $ (0.34) $ (1.05) $ (0.43)
============ ============ ============ ============
NOTE 9. BUSINESS SEGMENTS
The Company operates primarily in two segments: business process outsourcing and
contact center operations (BPO) and internet service provider services (ISP).
Information concerning the revenues and operating income for the three and six
months ended June 30, 2005 and 2004, and the identifiable assets for the two
segments in which the Company operates are shown in the following table:
BPO ISP Consolidated
------------ ------------ ------------
OPERATING REVENUE - SEGMENT (1)
Quarter - June 2005 $ 6,581,190 $ 2,518,142 $ 9,099,932
Quarter - June 2004 103,810 4,183,526 4,287,336
Six Months - June 2005 12,561,705 5,617,701 18,179,406
Six Months - June 2004 292,031 8,871,453 9,163,484
INCOME (LOSS) FROM OPERATIONS
Quarter - June 2005 (7,198,127) 1,398,382 (5,799,744)
Quarter - June 2004 (2,170,804) 355,025 (1,815,779)
Six Months - June 2005 (12,888,362) 2,978,838 (9,909,524)
Six Months - June 2004 (4,005,309) 1,674,040 (2,331,269)
DEPRECIATION AND AMORTIZATION
Quarter - June 2005 607,800 29,968 637,768
Quarter - June 2004 206,552 64,118 270,670
Six Months - June 2005 1,363,433 58,720 1,422,153
Six Months - June 2004 243,394 128,270 371,664
18
(Cont.) BPO ISP Consolidated
------------ ------------ ------------
CAPITAL EXPENDITURES (2)
Quarter - June 2005 543,829 1,476 545,305
Quarter - June 2004 1,694,319 179,370 1,873,689
Six Months - June 2005 3,419,693 140,827 3,560,520
Six Months - June 2004 2,492,178 179,370 2,671,548
IDENTIFIABLE ASSETS
At June 30, 2005 20,167,767 10,208,754 30,376,521
At December 31, 2004 11,963,124 6,085,591 18,048,715
(1) The Company allocates its geographic revenue based on customer
location. All of the Company's customers are U.S based companies.
Services performed for call center customers are performed in the
Philippines and three call centers in the U.S.
(2) The six months ended June 30, 2005, includes capital assets of
$2,401,415 acquired as a result of the IMS acquisition.
NOTE 10. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
All the Company's current significant legal proceedings arise out of its ISP
business. The Company believes the proceedings and their settlement will not
have a significant effect on its operations since the Company no longer actively
markets its ISP business and the Company believes it is in substantial
compliance with the law.
In addition to the legal proceeding discussed above, the Company is exposed,
from time to time, to other claims, legal actions, and regulatory actions in the
normal course of business, some of which are initiated by the Company.
Management believes that any such additional outstanding issues will be resolved
without impairing the financial condition of the Company.
Purchase Commitments
On June 23, 2005, the Company entered into an agreement with SER Solutions, Inc.
(SER) that provides for the purchase by the Company of $3,070,000 of dialer
equipment for its call centers over the next 18 months. The agreement also
resolved certain licensing and payment disputes between the parties related to
previous purchases by the Company from SER. In connection with the agreement,
the Company has executed a promissory note in the amount of $3,423,000 to SER,
representing the purchase commitment of $3,070,000 and $353,000 due on prior
purchases of dialer equipment. See Note 5.
NOTE 11. SUBSEQUENT EVENTS
1. On July 15, 2005, the Company entered into a Securities Purchase Agreement
(the "Purchase Agreement") and certain related agreements with Laurus
Master Fund, Ltd. (Laurus) providing for the issuance to Laurus by the
Company of a Secured Convertible Term Note in the aggregate principal
amount of $6,200,000 (the "Note"). At June 30, 2005, Laurus and its
affiliates held approximately $9,773,000 of outstanding convertible debt of
the Company.
Laurus may advance up to $6,200,000 to the Company for use by the Company
for working capital and to continue the build out of its Philippine-based
call center business. All advances under the Note are subject to the
satisfaction of certain conditions. The note bears interest at the rate of
10% per annum. The Note may be prepaid at any time at 100% of the then
outstanding principal balance at the time of prepayment plus accrued
interest. See 6. below.
19
The outstanding principal due under the Note is convertible into common
stock of the Company at a conversion price of $1.00 per share, which
conversion price is subject to adjustment for stock splits, stock dividends
or other similar transactions or if new rights to acquire common stock of
the Company are issued at a price less than the then existing conversion
price under the Note. Laurus has certain rights to require the Company to
register the sale of the shares of common stock into which the principal of
the Note is convertible under federal and state securities laws.
In connection with the issuance of the Note, the Company has placed into
escrow resignations from its existing directors and proxies in favor of
Laurus from the holders of a majority of the Company's presently
outstanding common stock. Such instruments are to be released to Laurus
from escrow and may be exercised by Laurus in the event of a default by the
Company under the Purchase Agreement or the Note or under any other
agreement of the Company or its subsidiaries with Laurus. The effect of
such instruments would be to allow Laurus to replace the board of directors
of the Company with persons selected by it.
The Note is secured by all of the assets of Voxx Corporation, a subsidiary
of the Company, and the subsidiaries of Voxx Corporation, the Company's
shareholdings in Voxx Corporation and significantly all of its other
subsidiaries, by a pledge of the Company's contract revenues and those of
its subsidiaries from all sources and by certain other assets of the
Company and its subsidiaries. The Note significantly restricts the ability
of the Company and its subsidiaries from borrowing additional monies
without the consent of the Laurus.
The Company is presently obligated to place all revenues from its internet
service provider businesses into a lock box, which revenues may be used by
the Company only with the prior approval for payment of expenses approved
by Laurus and its affiliates. In connection with the Purchase Agreement and
the Note, the Company and its subsidiaries have agreed to place all
revenues from its call center business in a lock box as well and have
agreed that such revenues may only be withdrawn from the lock box for
payment of expenses approved by Laurus.
2. On January 3, 2005, as part of the acquisition of IMS, the Company issued a
$5,104,594 non-interest bearing Collateral Promissory Note payable to the
IMS shareholders over two years. At June 30, 2005, the principal amount of
the note was $4,593,828.
On August 4, 2005, this Note was restructured. The IMS shareholders have
agreed to reduce the outstanding balance by 50% to $2,296,914 (the New
Debt). The New Debt is payable in two installments of $112,691.41 in August
2005, and in weekly installments of $28,172.85 beginning September 5, 2005,
until paid in full January 29, 2007. In August 2005, the Company paid the
IMS shareholders $225,388.82.
3. On January 3, 2005, as part of the IMS acquisition, the Company guaranteed
commissions payable owed by IMS under the DDM Consulting, Inc (DDM)
agreement. At June 30, 2005, amounts due under DDM agreement totaled
$192,601.
On August 4, 2005, this agreement was restructured. DDM has agreed to
reduce the outstanding balance by 50% to $96,301, (the New DDM Agreement).
The New DDM Agreement is payable in two installments of $16,050.13 in
August 2005, and in monthly installments of $16,050.13 beginning September
5, 2005, until paid in full December 5, 2005. In August 2005, the Company
paid DDM $32,100.26.
4. On August 1, 2005, the Company entered into a new Broker Agreement with DDM
whereby the service fee and commission structures were re-defined. At June
30, 2005, commissions due under the previous agreement totaled $629,175.
As part of the new agreement, on August 4, 2005, DDM agreed to reduce the
outstanding balance of commissions due by 50% to $314,587.50, (the New
Broker Agreement), provided, however, that in the event Voxx Corporation
and its subsidiaries are cash flow positive, exclusive of debt or equity
financing, during any thirty (30) day period through December 12, 2005 and
for the month of December 2005, an additional lump sum in the amount of
$314,587.50 shall be paid to DDM. Such payment will be made on or before
January 15, 2006.
20
The New Broker Agreement is payable in weekly installments of $50,000
until paid in full. Through August 12, 2005, the Company paid DDM $100,000.
5. On July 20, 2005, the Company entered into an agreement with Realization
Services, Inc. (RS), a consulting firm. RS has been retained to develop a
plan that will attempt to bring the Company's activities in the United
States and the Philippines to a cash break-even level within three months
and on an overall operating and non-operating basis by the end of 2005. In
connection with such plan, RS will assist (1) in identifying the Company's
customers that are profitable, (2) recommend reductions in operating
expenses, (3) propose restructure of certain debt agreements and (4) assist
in implementing the plan and improving the operating efficiencies. RS's
role shall be strictly limited to that of an advisor to the Company.
6. On August 15, 2005, the Company entered into an Amendment Agreement with
Laurus whereby the Securities Purchase Agreement entered into on July 15,
2005, was amended to increase the amount of the advance, from $6,200,000 to
$14,200,000. All other terms, covenants and conditions of the Securities
Purchase Agreement remain un-amended.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
The following Management's Discussion and Analysis (MD&A) is intended to help
the reader understand Epixtar. MD&A is provided as a supplement to, should be
read in conjunction with and is qualified in its entirety by reference to, the
Company's Consolidated Financial Statements and related Notes to Consolidated
Financial Statements (Notes) appearing under Item 1 in this report. In addition,
reference is made to the Company's audited Consolidated Financial Statements and
related Notes thereto and related MD&A included in its Annual Report on Form
10-K for Fiscal 2004. Except for the historical information contained herein,
the discussions in MD&A contain forward-looking statements that involve risks
and uncertainties. The Company's actual results could differ materially from
those discussed herein. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed under
"Forward-Looking Statements" .
The following are the sections of MD&A contained in this report, together with
the Company's perspective on the contents of these sections of MD&A, which it
hopes will make reading these pages and understanding of the Company's
operations more beneficial.
Recent Events - description of financing obtained on July 15, 2005 and of
various debt agreements that were restructured, and consulting firm engaged to
help develop a plan that is intended to bring the Company to a cash break-even
level within the next three months.
Operations Review - an analysis of the Company's consolidated results of
operations and of the results in each of our two operating segments, to the
extent the operating segment results are material to an understanding of the
Company's business as a whole, for the periods presented in its Consolidated
Financial Statements.
Liquidity and Capital Resources - an analysis of cash flows, capital structure
and resources, off-balance sheet arrangements, commercial commitments and
contractual obligations.
Discussion of Critical Accounting Policies and New Accounting Pronouncements - a
discussion of accounting policies that require critical judgments and estimates,
and of accounting pronouncements that have been issued but not yet implemented
by the Company and their potential impact.
Forward-Looking Statements - cautionary information about forward-looking
statements.
RECENT EVENTS
On July 15, 2005, the Company entered into a Securities Purchase Agreement (the
"Purchase Agreement") and certain related agreements with Laurus Master Fund,
Ltd. (Laurus) providing for the issuance to Laurus by the Company of a Secured
Convertible Term Note in the aggregate principal amount of $6,200,000 (the
"Note"). At June 30, 2005, Laurus and its affiliates held approximately
$9,773,000 of outstanding convertible debt of the Company.
Laurus may advance up to $6,200,000 to the Company for use by the Company for
working capital and to continue the build out of its Philippine-based call
center business. All advances under the Note are subject to the satisfaction of
certain conditions. The note bears interest at the rate of 10% per annum. The
Note may be prepaid at any time at 100% of the then outstanding principal
balance at the time of prepayment plus accrued interest.
The outstanding principal due under the Note is convertible into common stock of
the Company at a conversion price of $1.00 per share, which conversion price is
subject to adjustment for stock splits, stock dividends or other similar
transactions or if new rights to acquire common stock of the Company are issued
at a price less than the then existing conversion price under the Note. Laurus
has certain rights to require the Company to register the sale of the shares of
common stock into which the principal of the Note is convertible under federal
and state securities laws.
22
In connection with the issuance of the Note, the Company has placed into escrow
resignations from its existing directors and proxies in favor of Laurus from the
holders of a majority of the Company's presently outstanding common stock. Such
instruments are to be released to Laurus from escrow and may be exercised by
Laurus in the event of a default by the Company under the Purchase Agreement or
the Note or under any other agreement of the Company or its subsidiaries with
Laurus. The effect of such instruments would be to allow Laurus to replace the
board of directors of the Company with persons selected by it.
The Note is secured by all of the assets of Voxx Corporation, a subsidiary of
the Company, and the subsidiaries of Voxx Corporation, the Company's
shareholdings in Voxx Corporation and significantly all of its other
subsidiaries, by a pledge of the Company's contract revenues and those of its
subsidiaries from all sources and by certain other assets of the Company and its
subsidiaries. The Note significantly restricts the ability of the Company and
its subsidiaries from borrowing additional monies without the consent of the
Laurus.
The Company is presently obligated to place all revenues from its internet
service provider businesses into a lock box, which revenues may be used by the
Company only with the prior approval for payment of expenses approved by Laurus
and its affiliates. In connection with the Purchase Agreement and the Note, the
Company and its subsidiaries have agreed to place all revenues from its call
center business in a lock box as well and have agreed that such revenues may
only be withdrawn from the lock box for payment of expenses approved by Laurus.
On August 15, 2005, the Company entered into an Amendment Agreement with Laurus
whereby the Securities Purchase Agreement entered into on July 15, 2005, was
amended to increase the amount of the advance, from $6,200,000 to $14,200,000.
All other terms, covenants and conditions of the Securities Purchase Agreement
remain un-amended.
On January 3, 2005, as part of the acquisition of IMS, the Company issued a
$5,104,594 non-interest bearing Collateral Promissory Note payable to the IMS
shareholders over two years. At June 30, 2005, the principal amount of the note
was $4,593,828. On August 4, 2005, this Note was restructured. The IMS
shareholders have agreed to reduce the outstanding balance by 50% to $2,296,914
(the New Debt). The New Debt is payable in two installments of $112,691 in
August 2005, and in weekly installments of $28,173 beginning September 5, 2005,
until paid in full on January 29, 2007. In August 2005, the Company paid the IMS
shareholders $225,388.
On January 3, 2005, as part of the IMS acquisition, the Company guaranteed
commissions payable owed by IMS under the DDM Consulting, Inc (DDM) agreement.
At June 30, 2005, amounts due under DDM agreement totaled $192,601. On August 4,
2005, this agreement was restructured. DDM has agreed to reduce the outstanding
balance by 50% to $96,301, (the New DDM Agreement). The New DDM Agreement is
payable in two installments of $16,050 in August 2005, and in monthly
installments of $16,050 beginning September 5, 2005, until paid in full on
December 5, 2005. In August 2005, the Company paid DDM $32,100.
On August 1, 2005, the Company entered into a new Broker Agreement with
DDM whereby the service fee and commission structures were re-defined. At June
30, 2005, commissions due under the previous agreement totaled $629,175. As part
of the new agreement, on August 4, 2005, DDM agreed to reduce the outstanding
balance of commissions due by 50% to $314,587, (the New Broker Agreement),
provided, however, that in the event Voxx Corporation, is cash flow positive,
exclusive of debt or equity financing, during any thirty (30) day period through
December 12, 2005 and for the month of December 2005, an additional lump sum in
the amount of $314,587 shall be paid to DDM. Such payment will be made on or
before January 15, 2006. The New Broker Agreement is payable in weekly
installments of $50,000 until paid in full. Through August 12, 2005, the Company
paid DDM $100,000.
On July 20, 2005, the Company entered into an agreement with Realization
Services, Inc. (RS), a consulting firm. RS has been retained to develop a plan
that will attempt to bring the Company's activities in the United States and the
Philippines to a cash break-even level within three months and on an overall
operating and non-operating basis by the end of 2005. In connection with such
plan, RS will assist (1) in identifying the Company's customers that are
profitable, (2) recommend reductions in operating expenses, (3) propose
restructure of certain debt agreements and (4) assist in implementing the plan
and improving the operating efficiencies. RS's role shall be strictly limited to
that of an advisor to the Company.
23
OPERATIONS REVIEW
Highlights
Operations highlights for the second quarter of fiscal 2005 include:
Revenues increased 112.2% to $9,099,332 in the second quarter of fiscal 2005,
from $4,287,336 in the second quarter of fiscal 2004.
BPO segment achieved revenue growth of $6,477,380. The Company's new IMS
acquisition contributed $5,972,716 to the increase. Operating income declined
$5,027,323, compared to the second quarter of fiscal 2004 primarily as a result
of costs associated with the Company's expansion of its BPO operations in 2004
and continuing through the first quarter of 2005. In the June 2005 quarter, the
Company began to curtail its expansion efforts and is presently evaluating
various cost reductions options and analyzing client profitability levels.
ISP segment revenue declined $1,665,384 as a result of its declining customer
base. Operating income increased $1,043,355, or 293.9%, compared to the second
quarter of fiscal 2004 primarily due to lower direct and administrative costs as
the Company has suspended its marketing efforts.
Loss from continuing operations increased $3,533,968, to $5,799,744, in the
second quarter of fiscal 2005, from $1,580,965 in the second quarter of fiscal
2004;
In response to this situation, current management has embarked on an aggressive
program intended to restore the Company to profitability. This program includes
steps to (1) increase revenues and the profitability of its existing BPO
programs, (2) accelerate the migration of BPO service contract fulfillment from
the Company's U.S. call centers to its Philippine locations, (3) curtail costs
and eliminate unnecessary expenses, (3) restructure the Company's payables and
loan obligations (see Recent Events), and (4) temporarily suspend its plan for a
rapid expansion of its Philippine call center operations pending the completion
of additional financing. To date, this program has achieved an aggregate of
approximately $600,000 per month in salary expense reductions and approximately
$200,000 per month in selling, general and administrative cost reductions.
Management anticipates that it will be able to achieve significant additional
reductions in both of these expense categories in the months to come.
To further assist it in the accomplishment of the objectives of this program,
management has engaged the services of a consulting firm specializing in
turnarounds to assist it with the implementation of its plan and the improvement
of operational efficiencies in all of these areas. In cooperation with the
consulting firm, the goal of management's near term program in this regard is to
return the Company to a cash break-even position by the end of the year.
Notwithstanding the Company's recent history of significant, recurring losses
from operations, management continues to believe that the decision to get into
the business of offshore call center operation was a sound one and that, when
fully implemented and properly operated, will enable the Company to successfully
execute its long term business plan and enable it to realize attractive returns
for its investors. However, management can provide no assurance that it will be
able to execute its long range business plan
Business Segments
The Company engages in two primary lines of business: business process
outsourcing concentrating on contact center activities (BPO) and internet
service provider services (ISP). Through 2003, the Company's revenues were
primarily derived from its ISP business, which provides Internet services,
including unlimited Internet access and email, to small business subscribers. As
a result of the ISP's ongoing business interaction with the contact center
industry, combined with extensive analysis of the contact center industry,
management made the strategic decision to focus the Company's energies and
resources in developing and operating offshore contact centers. BPO services
complement the ISP business and consequently, the Company continues to maintain
and service its ISP business customers while concentrating the Company's efforts
in growing the business process outsourcing and contact center services
business.
Business Processing Outsourcing and Contact Center Business
The Company began developing its contact center business in the latter part of
2003 and continued throughout 2004 and now has approximately 1,052 enabled seats
in the Philippines and the United States, including approximately 384 seats
added through the Company's acquisition of IMS which service several major
clients, and encompasses supporting personnel. This number is somewhat below
that reported in one or more prior periods because current management has
elected to take a much more conservative view of what, in fact, constitutes an
"enabled seat." Seats that now require any additional amount of investment to
become fully operational, no matter how insignificant, are no longer categorized
as "enabled." The Company continues to actively market its contact center
services. Due to recent liquidity concerns the Company has recently delayed
building out additional infrastructure. See Current Trends, below.
Revenues from contact center operations are derived from telemarketing,
tele-verification, and customer support services provided to clients based on
individual business requirements. Depending on the contract under which services
are provided, the company may earn revenues on a commission basis, a performance
basis, an hourly basis, or a blend of the three.
Cost of generating revenue consists of direct payroll costs, recruitment and
training of personnel and communication costs. On an ongoing basis, the most
significant expense of the Company's contact center business will be labor costs
for agents, supervisors and administrators as well as commissions paid to
brokers, and rental expense for leased facilities.
24
ISP Business
While the Company is not presently marketing its ISP business, it is continuing
to service its existing customer base. The Company's ISP operations consisted
essentially of the marketing of value-added internet service provider services,
primarily through third party facilities. The Company does not operate its own
network but uses third parties to obtain access to the Internet for its clients.
Prior to 2004 when the Company suspended its marketing efforts, the customer
base kept growing as a direct result of the marketing efforts. ISP revenues are
derived from monthly fees charged customers for value-added internet services.
Cost of generating revenue associated with ISP operations include the costs of
maintaining the Company's customer base including customer care and
telecommunication costs for Internet access. Because the Company is not
marketing the ISP business, cost of revenue has and should continue to decline
thereby increasing gross profit margins for this business. The ISP customer base
now consists of seasoned customers and based on current attrition rates the
Company believes it will continue to derive revenues on a declining basis for
several years.
Current Trends
The trend of the Company's revenue and income over the next several quarters
depends upon several variables, some of which cannot at this time be ascertained
definitively. Revenue from ISP sources will decline as a result of suspended ISP
marketing activity and a declining customer base. The Company will continue to
incur losses as a result of development costs associated with contact center
operations. In January 2005, the Company acquired IMS to increase its contact
center penetration. BPO revenues and overall revenue should continue to increase
as a result of this acquisition; however, since IMS has been incurring losses,
there is no assurance we will be able to operate this new subsidiary profitably.
As a result of the IMS acquisition, and depending on obtaining additional new
contracts and implementing existing ones, the Company believes revenue from its
contact centers will increase, offsetting declining ISP revenues in the future.
The Company's management is taking steps to curtail increasing costs and reduce
its current losses. The Company has engaged a consulting firm that will assist
it in implementing a plan that will improve the operational efficiencies of the
Company by reducing costs, restructuring some or all of its debt agreements and
identifying customers that are profitable. This is anticipated to bring the
Company to a cash break-even position within the next three months. During this
period of reorganization, the Company's is attempting to ensure that the quality
and level of services provided to its customers are not adversely impacted.
Results of Operations
The Company reported a net loss of $6,853,126 or $0.56 per basic and diluted
common share, for the three months ended June 30, 2005, compared with a net loss
of $3,663,795, or $0.34 per basic and diluted common share for the comparable
period in 2004. For the six month period of 2005, the Company reported a net
loss of $12,459,014, or $1.05 per basic and diluted common share, compared with
a net loss of $4,523,349, or $0.43 per basic and diluted common share for the
comparable period in 2004. The increase in the losses for the three and six
month periods on quarter compared with the same periods in 2004 was due to the
Company's expansion during 2004 and the first quarter of 2005 of its business
process outsourcing and contact center services operations (BPO), including its
acquisition of IMS in January 2005, and a decline of approximately 37% in the
gross profit of its internet service provider services operations (ISP) during
the six month period of 2005, as a result of a declining customer base.
In response to this situation, current management has embarked on an aggressive
program intended to restore the Company to profitability. This program includes
steps to (1) increase revenues and the profitability of its existing BPO
programs, (2) accelerate the migration of BPO service contract fulfillment from
the Company's U.S. call centers to its Philippine locations, (3) curtail costs
and eliminate unnecessary expenses, (3) restructure the Company's payables and
loan obligations (see Recent Events), and (4) temporarily suspend its plan for a
rapid expansion of its Philippine call center operations pending the completion
of additional financing. To date, this program has achieved an aggregate of
approximately $600,000 per month in salary expense reductions and approximately
$200,000 per month in selling, general and administrative cost reductions.
Management anticipates that it will be able to achieve significant additional
reductions in both of these expense categories in the months to come.
To further assist it in the accomplishment of the objectives of this program,
management has engaged the services of a consulting firm specializing in
turnarounds to assist it with the implementation of its plan and the improvement
of operational efficiencies in all of these areas. In cooperation with the
consulting firm, the goal of management's near term program in this regard is to
return the Company to a cash break-even position by the end of the year.
Notwithstanding the Company's recent history of significant, recurring losses
from operations, management continues to believe that the decision to get into
the business of offshore call center operation was a sound one and that, when
fully implemented and properly operated, will enable the Company to successfully
execute its long term business plan and enable it to realize attractive returns
for its investors. However, management can provide no assurance that it will be
able to execute its long range business plan
On a pro forma basis, assuming the acquisition of IMS had been in January 2004,
the Company would have reported a net losses of $4,477,100, or $0.39 per basic
and diluted common share, and $6,251,233, or $0.56 per share, respectively,
during the three and six months ended June 30, 2004. IMS' gross profit margin
for the three and six months period of 2004 were approximately $2,151,881, or
51.8%, and $3,975,182, or 45.6%, respectively; however, high administrative
expenses resulted in a loss from operations of approximately $299,000 and
$700,000, respectively, during the three and six month ended June 30, 2004.
25
Set forth below are comparisons of financial results of operations for the three
months and six months ended June 30, 2005 and 2004. These comparisons are
intended to aid in the discussion that follows. This discussion and analysis
should be read in conjunction with the Consolidated Financial Statements and
accompanying Notes, which appear in Item 1. Financial Statements, in this
Quarterly Report on Form 10-Q.
THREE AND SIX MONTHS ENDED JUNE 30, 2005 COMPARED WITH THREE AND SIX MONTHS
ENDED JUNE 30, 2004
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------------------------------------- -----------------------------------------------------
Variance Variance
2005 2004 $ % 2005 2004 $ %
------------ ------------ ------------ ------- ------------ ------------ ------------ -------
Revenue $ 9,099,332 $ 4,287,336 $ 4,811,996 112.2% $ 18,179,406 $ 9,163,484 $ 9,015,922 98.4%
Cost of revenue 5,787,517 1,233,076 4,554,441 369.4% 9,981,698 2,537,430 7,444,268 293.4%
------------ ------------ ------------ ------- ------------ ------------ ------------ -------
Gross profit 3,311,815 3,054,260 257,555 8.4% 8,197,708 6,626,054 1,571,654 23.7%
------------ ------------ ------------ ------- ------------ ------------ ------------ -------
Operating expenses
(exclusive of
depreciation, and
amortization of
intangibles) 8,100,541 4,364,555 3,735,986 85.6% 15,938,580 8,350,845 7,587,335 90.9%
Depreciation,
and amortization of
intangibles 1,011,018 270,670 740,348 273.5% 2,168,653 371,664 1,796,989 483.5%
Other non operating
expenses, net 1,053,382 2,082,830 (1,029,448) -49.4% 2,549,489 2,426,894 122,595 5.1%
------------ ------------ ------------ ------- ------------ ------------ ------------ -------
Net loss
$ (6,853,126) $ (3,663,795) $ (3,189,331) 87.0% $(12,459,014) $ (4,523,349) $ (7,485,665) 165.5%
------------ ------------ ------------ ------- ------------ ------------ ------------ -------
Net loss per share $ (0.56) $ (0.34) $ (1.05) $ (0.43)
============ ============ ============ ============
Revenue for the second quarter of 2005 increased to $9,099,332 in 2005 from
$4,287,336, or 112.2%. The Company's BPO operations contributed $6,581,190 to
the increase, partially offset by a decline of approximately $1,665,384 in
revenue from ISP operations. For the six month period of 2005, revenue increased
to $18,179,406 in 2005 from $9,163,484, or 98.4%. The Company's BPO operations
provided $12,269,674 of the increase, partially offset by a decline of
approximately $3,253,752, or 36.7%, in revenue from ISP operations. The
increases for the three and six month periods of 2005 were primarily
attributable to EMC, formerly IMS, the Company's acquisition in the first
quarter, which contributed approximately $5,972,716 and $11,129,714,
respectively, during the periods. The decline in ISP revenue reflects no growth
in the ISP customer base as the Company is no longer marketing its ISP services.
The Company expects a gradual continued decline of revenues from its ISP
operations offset by growth in its BPO business revenue.
Cost of revenue for the second quarter of 2005 increased to $5,787,517 in 2005
from $1,233,076 in 2004, or a 369.4% increase. The increase in the cost or
revenue is due primarily to a $5,310,140 increase in costs associated with BPO
operations, offset in part by reduced ISP costs of approximately $755,500. For
the six month period of 2005 cost of revenue increased to $9,981,698 in 2005
from $2,537,430 in 2004, or a 293.4% increase, partially offset by a $1,516,570
decline in ISP costs. For the three and six months ended June 30, 2005, EMC's
acquisition contributed $4,892,033 and $8,564,637, respectively, towards the
increase in cost of revenue primarily due the costs associated with production
personnel
Gross profit for the second quarter of 2005 was $3,311,815 compared with
$3,054,260 in 2004, or an increase of 8.4%. For the six month period of 2005,
gross profit was $8,197,708 compared with $6,626,054 in 2004, or an increase of
23.7%. BPO gross profit increased approximately $1,167,240, of which $1,080,683
was attributable to EMC during the second quarter of 2005, and $3,305,836 during
the six month period of 2005, of which $2,565,077 was contributed by EMC. The
gross profit margin for ISP declined during the there and six months ended June
30, 20005, approximately $909,684 and $1,737,182, respectively, as a result of
lower sales and fixed direct costs associated with the operations.
26
Operating expenses, exclusive of depreciation, and amortization of
intangibles, were $8,100,541, or an 85.6% increase for the second quarter of
2005 compared with $4,364,555 in 2004. For the six months ended June 30, 2005,
operating expenses, excluding depreciation, and amortization of intangibles,
were $15,938,580 or a 90.9% increase for compared with $8,350,845 in the same
period of 2004. Compensation and employees benefits increased $2,065,859 or
105.9%, to $4,016,492 during the June 2005 quarter, compared with $1,950,638,
for the same period in 2004. For the six months ended June 30, 2005,
compensation and employees benefits increased $3,837,413 or 106.4%, to
$7,442,821, compared with $3,605,408, for the same period in 2004. These
increases were primarily the result of a higher number of BPO sales, marketing
and administrative employees, including 384 EMC employees added in 2005 through
the Company's acquisition of IMS. Consulting fees-related party increased
$1,326,250 and $1,776,250, respectively, during the three and six months ended
June 30, 2005. On April 20, 2005, Transvoice, a related party, was granted an
aggregate of 1,500,000 shares of Voxx Corporation common stock. The Company
estimated the fair value of these shares at $926,250, or $0.62 per share, which
was recognized as consulting fees. Occupancy, advertising and marketing, travel
and professional fees contributed to the increases in other selling, general and
administrative expenses during the June 2005 quarter and the six month period.
The increases in these costs are reflective of the Company's expansion of its
BPO operations in the Philippines and its acquisition of three call centers in
the U.S.
Depreciation and amortization expense increased $367,098, or 135.6%, and
$1,050,489, or $282.6%, respectively, during the three and six months ended June
30, 2005. These increases reflect the significant acquisitions of property and
equipment related to the development of call centers in the Philippines in 2004
and through the first quarter of 2005, and the acquisition of property and
equipment on the IMS purchase.
Amortization of intangibles resulting from the valuation of IMS acquired assets
and liabilities amounted to $373,250 and $746,500 for the three and six months
ended June 30, 2005. This represents the amortization of identifiable intangible
assets, which include customer relationships, non-compete contracts and the
value of call center locations.
Non-operating expenses, net, are primarily comprised of expenses associated with
the issuance of equity and debt securities during the first half of 2005 and
2004. Warrants issued in lieu of finances charges amounted to $303,073 and
$1,169,805 during the three and six months ended June 30, 2005, respectively.
Amortization of debt discounts was $1,605,201 for the three and six months ended
June 30, 2004. On April 22, 2005, as consideration for the extension of certain
debt agreements, warrants to purchase 200,000 shares of the Company's common
stock for $0.50 per share, where given to the lender by a related party on
behalf of the Company. The Company estimated the fair value of the 200,000
warrants at $173,314, or $0.87 per common share to the warrants, which was
recognized as expense during the June 2005 quarter. Additionally, as part of the
extension, the Company issued 145,000 shares of common stock, in Voxx, a
majority-owned subsidiary of the Company for no additional consideration. On
February 28, 2005, the Company entered into an Amendment and Waiver agreement
with a lender. As consideration for this agreement, the Company issued to the
lender warrants to purchase 1,900,000 shares of the Company's common stock at an
exercise price of $2.15 per share. In connection with the financing facility
entered into with Laurus Master Fund, Ltd and affiliates of Laidlaw & Company
(UK) Ltd., on April 29, 2005 the warrants became exercisable at $1.00 per share.
The fair value of these warrants were estimated to be approximately $1,101,049.
This amount, net of $193,333 of previously accrued Liquidated Damages was
recognized as expense during the six months ended June 30, 2005. During the
second quarter of 2004, the Company entered into three convertible debt
agreements. Purchasers of the convertible debt also received warrants to
purchase 630,576 shares of the Company's common stock. The amortization of debt
discounts was $1,605,201, which was charged to expense in the second quarter of
2004.
Liquidity and Capital Resources
The Company currently has significant liquidity problems. Cash from operations
is inadequate to cover operating costs, past liabilities and past indebtness
incurred in connection with the expansion of its call center business. The short
fall is presently being covered by the expanded and revised financing
arrangements with Laurus (see Notes 5 and 11), on which the Company is
completely dependent upon for continued operations. The Company's present
liquidity difficulties arose because it was unable to obtain substantial equity
financing it thought was available to meet the expansion needs of the Company.
As a result, the Company committed to the expansion without adequate financing.
Indebtedness aggregating approximately $26,051,000 was outstanding at June 30,
2005, excluding related party financing of $2,474,000. See Recent Events.
In response to this situation, current management has embarked on an aggressive
program intended to restore the Company to profitability. This program includes
steps to (1) increase revenues and the profitability of its existing BPO
programs, (2) accelerate the migration of BPO service contract fulfillment from
the Company's U.S. call centers to its Philippine locations, (3) curtail costs
and eliminate unnecessary expenses, (3) restructure the Company's payables and
loan obligations (see Recent Events), and (4) temporarily suspend its plan for a
rapid expansion of its Philippine call center operations pending the completion
of additional financing. To date, this program has achieved an aggregate of
approximately $600,000 per month in salary expense reductions and approximately
$200,000 per month in selling, general and administrative cost reductions.
Management anticipates that it will be able to achieve significant additional
reductions in both of these expense categories in the months to come.
To further assist it in the accomplishment of the objectives of this program,
management has engaged the services of a consulting firm specializing in
turnarounds to assist it with the implementation of its plan and the improvement
of operational efficiencies in all of these areas. In cooperation with the
consulting firm, the goal of management's near term program in this regard is to
return the Company to a cash break-even position by the end of the year.
Notwithstanding the Company's recent history of significant, recurring losses
from operations, management continues to believe that the decision to get into
the business of offshore call center operation was a sound one and that, when
fully implemented and properly operated, will enable the Company to successfully
execute its long term business plan and enable it to realize attractive returns
for its investors. However, management can provide no assurance that it will be
able to execute its long range business plan
27
CASH SOURCES AND USES
The primary sources of cash for the Company have been proceeds from the issuance
of long-term debt and equity securities. The primary uses of cash have been
working capital, and capital expenditures.
Operations
The Company's cash and cash equivalents as of June 30, 2005 were $1,437,065
compared with $1,530,052 at December 31, 2004. Amounts held in escrow at June
30, 2005 and December 31, 2004, were $1,537,200 and $1,100,000, respectively.
The working capital deficit was approximately $28,867,500 as of June 30, 2005,
compared with $8,033,988 at December 31, 2004, a 259.3% increase. During the six
months ended June 30, 2005, the Company used $3,714,827 of cash for operations
compared with $2,454,918 used during the comparable period of 2004. The increase
in negative cash flow from operations for 2005 was primarily the result of a
$12,459,014 loss from operations compared with a loss of $4,523,349 in 2004, a
change of $7,935,665, which included increases in non cash charges of
$1,050,489, $1,169,805, $1,086,800 and $746,500 relating to depreciation and
amortization expense, to the issuances of warrants and restricted stock, and to
the amortization of intangibles, respectively. An increase of $4,119,264 in
accounts payable and accrued expenses partially offset the decline in cash
resources during the quarter.
INVESTING ACTIVITIES
Net cash used for investing activities during the six months ended June 30,
2005, was $672,164 compared to $1,917,824 in 2004. The reduction in capital
spending in 2005, compared to 2004 reflects the Company's intent to curtail
costs and limit spending.
FINANCING ACTIVITIES
Net cash provided by financing activities during the six months ended June 30,
2005, was $4,313,605 compared with $5,566,202 in 2004.
2005 Financing
1. During the March 2005 quarter the Company sold to accredited
investors, in a private placement, an additional $767,500 principal
amount of 5% Joint Unsecured Subordinated Convertible Promissory Notes
due May 2007.
2. On April 22, 2005, the Company issued an 8% Promissory Note in the
amount of $280,000 to an accredited investor. The note was payable on
demand and in the event the Company was unable to repay the note upon
written demand, the interest rate on the unpaid amount would increase
to 18% per annum. The Note was re-paid on May 2, 2005.
3. On April 29, 2005, the Company, and its majority-owned subsidiary,
Voxx Corporation, entered into a financing facility with Laurus Master
Fund, Ltd and affiliates of Laidlaw & Company (UK) Ltd., pursuant to
which the Company and Voxx borrowed $7,000,000 represented by Senior
Secured Convertible Notes (the Notes) that mature on April 29, 2008,
and bear annual interest at 2% over prime. Interest payments began
June 1, 2005, and principal payments begin on October 29, 2005 at the
monthly rate of $166,667 plus accrued but unpaid interest.
28
2004 Financing
1. In April 2004, the Company issued unsecured convertible promissory
notes in the amount of $1,500,000 to accredited investors. The notes
accrue interest at 8% annually and mature in April 2005.
2. In May 2004, the Company issued 8% Unsecured Convertible Promissory
Notes, maturing May 2005, in the amount of $1,000,000 to accredited
investors.
3. On May 14, 2004, the Company issued a Secured Convertible Term Note,
maturing May 2007, in the amount of $5,000,000 at 2.5% over prime (not
to exceed 8%) to an accredited institutional investor.
During the six months ended June 30, 2005 and 2004, the Company repaid
approximately $2,719,845 and $1,105,298, respectively, of notes and capital
leases.
29
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements, investments in
special purpose entities or undisclosed borrowings or debt. In addition, the
Company has not entered into any derivative contracts.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND NEW ACCOUNTING PRONOUNCEMENTS
Critical Accounting Policies
The Company has made a number of estimates and assumptions relating to the
reporting of results of operations and financial position in the preparation of
its financial statements in conformity with accounting principles generally
accepted in the United States of America. Actual results could differ
significantly from those estimates under different assumptions and conditions.
The Company included in its Annual Report on Form 10-K for the year ended
December 31, 2004 a discussion of the Company's most critical accounting
policies, which are those that are most important to the portrayal of the
Company's financial condition and results of operations and require management's
most difficult, subjective and complex judgments, often as a result of the need
to make estimates about the effect of matters that are inherently uncertain.
The Company has not made changes in any critical accounting policies during the
six months of 2005. Any changes in critical accounting policies and estimates
are discussed with the Audit Committee of the Board of Directors of the Company
during the quarter in which a change is made.
New Accounting Pronouncements
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123(R), "Share-Based Payment" (SFAS 123R), which requires all companies to
measure compensation cost for all share-based payments (including employee stock
options) at fair value and to recognize cost over the vesting period. In April
2005, the SEC announced that companies may implement SFAS 123R at the beginning
of their next fiscal year starting after June 15, 2005 (or December 15, 2005 for
small business issuers). This new rule moves the Company's implementation date
for SFAS 123R to the first quarter of 2006.
In May 2005, the FASB issued Statement of Financial Accounting Standards No.
154, "Accounting Changes and Error Corrections" (SFAS No. 154), which is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. SFAS 154 replaces APB Opinion No. 20,
"Accounting Changes," and FASB Statement No. 3, "Reporting Accounting Changes in
Interim Financial Statements," and changes the requirements for the accounting
for and reporting of a change in accounting principle. SFAS 154 requires
retrospective application to prior periods' financial statements of changes in
accounting principle, unless it is impracticable to do so, in which case other
alternatives are required. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005, or
for the Company's fiscal 2006. The Company is evaluating the effect that the
adoption of SFAS No. 154 will have on its results of operations and financial
position, but does not believe it will have a material impact.
In April 2005, the SEC announced that companies may implement SFAS 123R at the
beginning of their next fiscal In March 2005, the SEC released SEC Staff
Accounting Bulletin No. 107, "Share-Based Payment" (SAB 107). SAB 107 provides
the SEC staff's position regarding the application of SFAS 123R, which contains
interpretive guidance related to the interaction between SFAS 123R and certain
SEC rules and regulations, and also provides the staff's views regarding the
valuation of share-based payment arrangements for public companies. SAB 107
highlights the importance of disclosures made related to the accounting for
share-based payment transactions. The Company is currently reviewing the effect
of SAB 107, but it does not believe SAB 107 will have a material impact on its
financial position, results of operations or cash flows.
30
In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations" ("FIN 47"), which clarifies the term
"conditional asset retirement obligations" as used in FASB Statement No. 143,
"Accounting for Asset Retirement Obligations." FASB Statement No. 143 refers to
an entity's legal obligation to perform an asset retirement activity in which
the timing and/or method of settlement are conditional on a future event that
may or may not be within the control of the entity. If an entity can reasonably
estimate a liability for the fair value of a conditional asset retirement
obligation, the entity is required to recognize the fair value of the liability
when incurred. A company normally incurs this liability upon acquisition,
construction, or development of the asset at issue. FIN 47 is effective for
fiscal years ending after December 15, 2005. The Company is currently reviewing
FIN 47, and at the current time it does not believe that FIN 47 will have a
material impact on its financial position, results of operations or cash flows.
Forward-Looking Statements
This report contains "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. All forward-looking statements
which may be contained in this Quarterly Report on Form 10-Q, are made as of the
date that such statements are originally published or made, and the Company
undertakes no obligation to update any such forward-looking statements. No undue
reliance should be placed on forward-looking statements, which reflect
management's opinions only as of the date made. Forward-looking statements are
made in reliance upon the safe harbor provisions of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended (the "Exchange Act") and the Private Securities
Litigation Reform Act of 1995.
Such forward looking statements are subject to various known and unknown risks
and uncertainties, as well as assumptions that, if they do not materialize or
prove correct, could cause the Company's results to differ materially from those
expressed or implied by such forward-looking statements. All statements other
than statements of historical fact are statements that could be deemed
forward-looking statements, including, but not limited to, statements: of the
Company's plans, strategies and objectives for future operations; concerning new
products, services or developments; regarding future economic conditions,
performance or outlook, including statements relating to the outcome of
contingencies; as to the value of Company contract awards and programs; of
expected cash flows or capital expenditures; of belief or expectation; and of
assumptions underlying any of the foregoing. Forward-looking statements may be
identified by their use of forward-looking terminology, such as "believes,"
"expects," "may," "should," "would," "will," "intends," "plans," "estimates,"
"anticipates" or similar words. The Company's consolidated results and the
forward-looking statements could be affected by many factors, including:
o the ability to achieve growth in markets that are highly competitive
where the Company may be unable to compete with businesses that have
greater resources;
o the ability to raise capital, when needed;
o participation in markets that are often subject to uncertain economic
conditions, which makes it difficult to estimate growth in the Company's
markets and, as a result, future income and expenditures;
o the consequences of future geo-political events, which may affect
adversely the markets in which the Company operates, its ability to
insure against risks, to protect its operations and profitability;
o strategic acquisitions and the risks and uncertainties related thereto,
including the Company's ability to manage and integrate acquired
businesses and
o customer credit risk.
31
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to certain market risks that arise in the ordinary course
of business. A discussion of the Company's primary market risk exposure and
interest rate risk is presented below.
Interest Rate Sensitivity - At June 30, 2005, the Company had cash, cash
equivalents totaling $1,437,065, of which $1,357,200 were held in escrow. These
amounts were invested primarily in money market funds. The unrestricted cash and
cash equivalents are held for working capital requirements, general corporate
purposes and potential acquisition of assets. The Company does not enter into
financial instrument transactions for trading or speculative purposes. Some of
the Company's borrowings are through floating rate debt, subject to changes in
the prime rate. Accordingly, the Company's interest expense will increase with
any future increase in prime rates. The Company however, believes that it has no
material exposure to changes in interest rates.
Effect of Changing Prices - The principal effect of inflation on the Company's
operating results is to increase costs. The Philippines has historically
experienced periods of high inflation but the inflation rate has been below 10%
since 1999. For the six months ended June 30, 2005, inflation averaged 8.3% and
we anticipate this inflation trend to continue the remainder of 2005 The high
inflation rates experienced in the Philippines have historically been offset the
deflationary force on wages due to the fast growing population, high
unemployment rate and high number of college graduates entering a market that
can not absorb them. A reversal of this trend could result in increased costs
that could harm the Company's operating results. However, subject to normal
competitive market conditions, the Company believes it has the ability to raise
selling prices to offset cost increases over time. In recent years the general
rate of inflation has not had a significant adverse impact on the Company.
Foreign Currency Exchange Risk - The Company's results of operations and cash
flows are subject to fluctuations due to changes in foreign currency exchange
rates, particularly changes in the Philippine peso. The Company generates
expenses in the Philippines, primarily in Philippine pesos and derives all of
its revenues in U.S. dollars. An increase in the value of the U.S. dollar
relative to the Philippine peso would reduce the expenses associated with the
Company's Philippine operations, and conversely a decrease in the relative value
of the U.S. dollar would increase the cost associated with these operations.
Expenses relating to the Company's operations outside the United States have
increased since June 30, 2004 due to increased costs associated with higher
revenue generation and customer management services partially offset by the
increase in the value of the U.S. dollar relative to the Philippine peso. The
Company funds its Philippine operations through U.S. dollar denominated accounts
held in the Philippines. Payments for employee-related costs, facilities
management, other operational expenses and capital expenditures are converted
into Philippine pesos on an as-needed basis. To date, the Company has not
entered into any hedging contracts. Historically, the Company have benefited
from the ongoing decline in the Philippine peso against the U.S. dollar.
ITEM 4. CONTROLS AND PROCEDURES.
a. Evaluation of disclosure controls and procedures:
The Company maintains "disclosure controls and procedures," as such term is as
defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the Exchange
Act) pursuant to Rule 13a-15 of the Exchange Act that are designed to ensure
that information required to be disclosed in reports that are filed or submitted
under the Exchange Act are recorded, processed, summarized, and reported within
the time periods specified by the SEC rules and forms, and that such information
is accumulated and communicated to the Company's management, including its Chief
Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to
allow timely decisions regarding required disclosure.
The Company's internal control over financial reporting is a process designed
under the supervision of the Company's principal executive and principal
financial officers to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of the Company's consolidated financial
statements for external purposes in accordance with accounting principles
generally accepted in the United States of America.
32
In designing internal control over financial reporting and evaluating the
Company's disclosure controls and procedures, management recognizes that
disclosure controls and procedures, no matter how well conceived and operated,
can provide only reasonable, not absolute, assurance that the objectives of the
disclosure controls and procedures are met. There are inherent limitations to
the effectiveness of any system of disclosure controls and procedures, including
the possibility of human error and the circumvention or overriding of the
controls and procedures. Accordingly, even effective disclosure controls and
procedures can provide only reasonable assurance of achieving their control
objectives, and management is required to use its judgment in evaluating the
cost-benefit relationship of possible controls and procedures Because of its
inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to
future periods are subject to the risk that controls may become inadequate due
to changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
As required by the rules of the Exchange Act, as of the end of the June 30, 2005
quarter, management of the Company carried out an evaluation, with the
participation of the Company's current CEO and CFO, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
upon that evaluation, the Company's current CEO and CFO concluded that, as of
the end of the period covered by this Quarterly Report on Form 10-Q, the
Company's disclosure controls and procedures were not adequate or effective, at
a reasonable assurance level. At the same time, the Company's current CEO and
CFO also concluded that there were material weaknesses in the Company's system
of internal controls. These conclusions were arrived at based on management's
determination that, prior to the recent departure of certain management
personnel, there was an ineffective and/or improper "tone" at the executive
management level of the Company at the time relating to the discouragement,
prevention, detection and disclosure of actual and/or apparent improper
transactions coupled with the ability of certain members of management to
override legitimate concerns about such transactions, as well as inadequate
emphasis by such departed management personnel on the requirements for a
thorough and proper analysis of all accounts and financial transactions by or on
behalf of the Company. Current management is convinced that the abrupt departure
of certain of these management personnel has sent a clear and convincing message
throughout the Company that these type practices will no longer be tolerated.
Management has also conducted and is continuing to conduct various internal
audits and considering the adoption of additional policies and procedures in
order to be able to ensure itself and the Company's audit committee and board of
directors that these instances of oversight and failures of properly functioning
internal controls will not recur.
b. Changes in Internal Control over Financial Reporting
The Company reviews its internal control over financial reporting as part of its
on going efforts to ensure compliance with the requirements of Section 404 of
the Sarbanes-Oxley Act of 2002. In addition, the Company routinely reviews its
system of internal control over financial reporting to identify potential
changes to its processes and systems that may improve controls and increase
efficiency, while ensuring that it maintains an effective internal control
environment. Changes may include such activities as implementing new, more
efficient systems, consolidating the activities of acquired business units,
formalizing policies and procedures, improving segregation of duties, and adding
additional monitoring controls. In addition, when the Company acquires new
businesses, it incorporates its controls and procedures into the acquired
business as part of the Company's integration activities. Except as discussed in
the immediately preceding paragraph, there have been no changes (including
corrective actions with regard to significant deficiencies or material
weaknesses) in the Company's internal control over financial reporting during
the quarter ended June 30, 2005, that materially affected, or are reasonably
likely to materially affect, the Company's internal control over financial
reporting.
The Company will be required to evaluate its internal controls over financial
reporting in order to comply with the requirements of the Sarbanes-Oxley Act of
2002 and expects to incur significant costs in meeting these requirements. The
Company is required to meet the requirements of the Sarbanes-Oxley Act by
December 31, 2006.
33
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
All the Company's current materially significant legal proceedings arise out of
its ISP business. While the results of these proceedings cannot be predicted
with certainty, management believes that the final outcome of these proceedings
and their settlement will not have a material adverse effect on the Company's
consolidated financial statements, results of operations or cash flows, as the
Company no longer actively markets its ISP business and the Company believes it
is in substantial compliance with the law.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Please refer to Form 8-K filed with the Securities and Exchange Commission on
July 15, 2005, which is incorporated herein by reference.
ITEM 5. OTHER INFORMATION
During the three months ended June 30, 2005, the Company filed with the
Securities and Exchange Commission Current Reports on Form 8-K on April 26, May
5, June 28 and June 29, 2005.
ITEM 6. EXHIBITS
(a) Exhibits:
The following exhibits are filed herewith:
EXHIBIT NO. DESCRIPTION OF DOCUMENT
- ----------- -----------------------
4.14.1* Form of Epixtar Securities Purchase Agreement with Laurus Master
Fund, Ltd.
4.14.2* Form of Epixtar Secured Convertible Term Note
4.15.1* Form of Amendment Agreement with Laurus
4.15.2* Form of Reaffirmation and Ratification Agreement with Laurus
10.18* Form of Epixtar Settlement Agreement with SER Solutions, Inc.
10.19* Form of Epixtar Consulting Agreement with Realization Services,
Inc.
10.20.1* Form of Epixtar Payment Agreement with former Innovative Marketing
Strategies, Inc. shareholders
10.20.2* Form of Epixtar Payment Agreement with DDM Consulting, Inc. re:
Assumed Debt
10.20.3* Form of Epixtar Payment Agreement with DDM Consulting re:
Commissions
10.20.4* Form of Epixtar Broker Agreement with DDM Consulting, Inc
11 Statement re Computation of Per Share Earnings is incorporated by
reference to Part I., Item 1. Financial Statements, Note 8,
Earnings (Loss) Per Share.
34
EXHIBIT NO. DESCRIPTION OF DOCUMENT - CONT.
- ----------- -------------------------------
31.1* Certification of Chief Executive Officer
31.2* Certification of Chief Financial Officer
32.1* Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350 as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2* Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350 as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
* Incorporated by reference to Form 10Q for the quarter ended June 30, 2005
filed with the SEC on August 22, 2005.
35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EPIXTAR CORP.
(Registrant)
Dated: By: /s/ Irving Greenman
August 23, 2005 Irving Greenman,
-------------------------------------
President and Chief Financial Officer
36
EXHIBITS
TABLE OF CONTENTS
EXHIBIT NO. DESCRIPTION OF DOCUMENT
4.14.1 Form of Epixtar Securities Purchase Agreement with Laurus Master Fund, Ltd.
4.14.2 Form of Epixtar Secured Convertible Term Note
4.15.1 Form of Amendment Agreement with Laurus
4.15.2 Form of Reaffirmation and Ratification Agreement with Laurus
10.18 Form of Epixtar Settlement Agreement with SER Solutions, Inc.
10.19 Form of Epixtar Consulting Agreement with Realization Services, Inc.
10.20.1 Form of Epixtar Payment Agreement with former Innovative Marketing Strategies, Inc.
shareholders
10.20.2 Form of Epixtar Payment Agreement with DDM Consulting, Inc. re: Assumed Debt
10.20.3 Form of Epixtar Payment Agreement with DDM Consulting re: Commissions
10.20.4 Form of Epixtar Broker Agreement with DDM Consulting, Inc.
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
37