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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended March 31, 2003
--------------
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
-------- --------
Commission file number: 333-37654
---------
9278 COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-4165136
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1942 Williamsbridge Road, Bronx, New York 10461
-----------------------------------------------
(Address of principal executive offices)
(718) 887-9278
--------------
(Registrant's telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant filed all documents and reports
required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act
of 1934 after the distribution of securities under a plan confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the registrant's classes
of common equity, as of the latest practicable date:
Common Stock, $.001 par value - 100 shares issued and outstanding as of June 20,
2003
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
9278 Communications, Inc. and Subsidiaries
INDEX TO FINANCIAL STATEMENTS
Page
----
Consolidated Condensed Balance Sheets as of March 31, 2003
(unaudited) and December 31, 2002 F-2 - F-3
Consolidated Condensed Statements of Operations for the three
months ended March 31, 2003 and 2002 (unaudited) F-4
Consolidated Condensed Statement of Shareholders' Equity for
the three months ended March 31, 2003 (unaudited) F-5
Consolidated Condensed Statements of Cash Flows for the
three months ended March 31, 2003 and 2002 (unaudited) F-6 - F-7
Notes to Consolidated Condensed Financial Statements F-8 - F-14
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED CONDENSED BALANCE SHEETS
March 31, December 31,
2003 2002
--------------- --------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 6,974,587 $ 7,527,098
Restricted cash - 1,020,809
Accounts receivable, net of allowance of $678,000
at March 31, 2003 and $760,000 at December 31, 2002 15,092,164 14,711,918
Accounts receivable-related party 4,964,653 4,963,508
Inventories 19,932,413 18,041,063
Prepaid expenses and other current assets 141,315 32,622
----------- -----------
Total current assets 47,105,132 46,297,018
PROPERTY AND EQUIPMENT, NET 1,720,405 1,801,798
NOTE RECEIVABLE - STRATEGIC PARTNER 3,982,823 1,530,975
GOODWILL, NET 3,624,071 3,624,071
OTHER ASSETS 730,830 690,831
----------- -----------
$57,163,261 $53,944,693
=========== ===========
The accompanying notes are an integral part of these statements.
F-2
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED CONDENSED BALANCE SHEETS
March 31, December 31,
2003 2002
---- ----
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 61,984,754 $ 57,510,096
Accounts payable - related party 2,700 41,752
Current maturities of capital lease obligations 31,779 44,934
Current maturities of convertible notes payable 52,520 50,020
Income taxes payable - 14,145
------------ ------------
Total current liabilities 62,071,753 57,660,947
CAPITAL LEASE OBLIGATIONS, less current maturities 23,460 41,051
CONVERTIBLE NOTES PAYABLE, less current maturities 75,126 90,126
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY (DEFICIT)
Common stock - $.001 par value; 40,000,000
shares authorized; 23,932,912 shares issued and outstanding
at March 31,2003 and December 31,2002 23,933 23,933
Additional paid-in capital 8,247,458 8,247,458
Accumulated deficit (13,278,469) (12,118,822)
------------ ------------
Total Shareholders' Equity (deficit) (5,007,078) (3,847,431)
------------ ------------
$ 57,163,261 $ 53,944,693
============ ============
The accompanying notes are an integral part of these statements.
F-3
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
March 31,
2003 2002
---- ----
Net sales $ 72,949,014 $ 57,365,454
Cost of sales 67,986,011 53,069,185
------------ ------------
Gross profit 4,963,003 4,296,269
------------ ------------
Operating expenses
Selling 3,151,419 1,466,587
General and administrative 2,859,017 2,418,929
Depreciation and amortization 111,732 72,606
Provision for bad debts - 51,792
6,122,168 4,009,914
------------ ------------
Operating profit/(loss) (1,159,165) 286,355
Other expenses
Interest expense, net 482 10,778
------------ ------------
482 10,778
------------ ------------
Earnings/(loss) before income taxes (1,159,647) 275,577
Income tax provision - 15,000
------------ ------------
Net income/(loss) $ (1,159,647) $ 260,577
============ ============
Earnings/(loss) per common share
Basic and diluted $(0.05) $0.01
====== =====
Weighted-average shares
Basic and diluted 23,932,912 23,932,912
============ ============
The accompanying notes are an integral part of these statements.
F-4
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENT OF SHAREHOLDERS' EQUITY
Three months ended March 31, 2003
Common stock Additional
------------------------- paid-in Accumulated
Shares Amount capital deficit Total
--------- -------- ---------------- ----------- --------
Balance at January 1,2002 22,932,912 $ 22,933 $ 8,248,458 $ (6,149,017) $ 2,122,374
Issuance of common stock in
connection with acquisition
of Reliable Networks, Inc. 1,000,000 1,000 (1,000)
Net loss for the year ended
December 31, 2002 (5,969,805) (5,969,805)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2002 23,932,912 23,933 8,247,458 (12,118,822) (3,847,431)
Net loss for the three months
ended March 31, 2003 (1,159,647) (1,159,647)
------------ ------------ ------------ ------------ ------------
Balance at March 31, 2003 23,932,912 $ 23,933 $ 8,247,458 $(13,278,469) $ (5,007,078)
============ ============ ============ ============ ============
The accompanying notes are an integral part of this statement.
F-5
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
March 31, March 31,
2003 2002
---- ----
Cash flows from operating activities
Net income (loss) $(1,159,647) $ 260,577
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 111,732 72,606
Provision for doubtful accounts - 51,792
Changes in assets and liabilities
Restricted cash 1,020,809 (4,629)
Accounts receivable (381,391) 339,235
Inventories (1,891,350) (6,239,028)
Prepaid expenses and other current assets (108,693) (218,610)
Other assets (40,000) (11,569)
Accounts payable and accrued expenses 4,435,606 4,572,826
Income taxes payable (14,145) (44,250)
----------- -----------
Net cash provided by (used in) operating activities 1,972,921 (1,221,050)
----------- -----------
Cash flows from investing activities
Acquisition of property and equipment (30,340) (195,312)
Notes Receivable, Strategic Partner (2,451,848) -
----------- -----------
Net cash used in investing activities (2,482,188) (195,312)
----------- -----------
Cash flows from financing activities
Notes and advances payable, shareholder, net - (292,825)
Principal payments on capital lease obligations (30,744) (9,412)
Principal payments on convertible notes payable, net (12,500) (10,689)
----------- -----------
Net cash used in financing activities (43,244) (312,926)
----------- -----------
Net decrease in cash and cash equivalents (552,511) (1,729,288)
Cash and cash equivalents, beginning of period 7,527,098 4,335,936
----------- -----------
Cash and cash equivalents, end of period $ 6,974,587 $ 2,606,648
=========== ===========
F-6
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (continued)
(UNAUDITED)
March 31, March 31,
2003 2002
---- ----
Supplemental disclosures of cash flow information:
Cash paid during the period for
Interest $ 482 $ 17,130
----------- ----------
Income taxes $ 14,145 $ 67,381
=========== ==========
The accompanying notes are an integral part of these statements.
F-7
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTION
The accompanying consolidated unaudited financial statements of 9278
Communication Inc. and subsidiaries (collectively, the "Company") have been
prepared pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC") for quarterly reports on Form 10-Q and do not
include all of the information and footnote disclosures generally required
by accounting principles generally accepted in the United States and should
be read in conjunction with our consolidated financial statements and notes
thereto for the fiscal year ended December 31, 2002, included in the
Company's Form 10-K as filed with the SEC. The accompanying condensed
consolidated unaudited financial statements have been prepared in
accordance with accounting principles generally accepted in the United
States and reflect all adjustments (consisting of normal recurring
accruals) which are, in the opinion of the management, considered necessary
for a fair presentation of results for these interim periods. Operating
results for the three month periods ended March 31, 2003 and 2002 are not
necessarily indicative of the results that may be expected for the fiscal
year ending December 31, 2003.
The accompanying condensed financial statements have been prepared in
conformity with accounting principles generally accepted in the United
States of America, which contemplate continuation of the Company as a going
concern. The Company sustained substantial losses from operations and its
current liabilities exceeded its current assets by approximately
$14,967,000 as of March 31, 2003. The company is largely dependent upon the
extension of credit from its vendors, in particular on credit granted by a
significant supplier. These factors raise substantial doubt about the
Company's ability to continue as a going concern.
In the event sufficient vendor credit is no longer available, the Company
would be required to seek other financing, however there can be no
assurance that the Company will be able to obtain such financing on
commercially reasonable terms, or otherwise or that the Company would be
able to satisfy short-term cash flow needs. The Company is continuously
renegotiating credit terms with its suppliers and, to date, has received
favorable terms. The Company believes its relationships with its vendors
are satisfactory; however, the Company's creditors currently have the right
to modify credit terms.
NOTE 2 - NATURE OF BUSINESS
The Company distributes prepaid telephone calling cards to distributors and
retail establishments through its various sales locations throughout the
United States. In addition, the Company markets certain prepaid calling
cards directly to consumers via its internet websites.
On January 31, 2003, the Company announced the execution of a Merger
Agreement with NTSE Holding Corp., a corporation wholly owned by the
Chairman, Chief Executive Officer and the principal stockholder, which will
result in the Company becoming a privately held corporation, owned by the
Company's Chairman. Pursuant to this agreement, all of the existing
stockholders will receive a cash payment of $0.10 per share. The
transaction was approved by its public stockholders on June 3, 2003 and the
merger was consummated on June 4, 2003. Total payment in terms of the
merger agreement amounted to approximately $1,092,000.
F-8
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies consistently applied in
the preparation of the accompanying consolidated financial statements
follows:
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
9278 Communications, Inc. and its wholly owned subsidiaries, 9278
Distributors, Inc., 9278 Dot Com Inc., E-Store Solutions Inc., Inc., 9278
Mobile, Inc., 9278 Technologies, Inc., NTSE Communications, Inc., 9278
Distributors Illinois, Inc., 9278 California, Inc., 9278 Distributors
Maryland Inc., 9278 Distributors New Jersey Inc., Reliable Acquisition
Corp., 9278 Distributors Ohio Inc., 9278 Distributors Florida Inc., and
9278 Distributors North Carolina Inc. (hereinafter, the "Company"). All
significant inter-company transactions and balances have been eliminated in
consolidation.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include all cash and highly liquid investments
with an original maturity of three months or less.
INVENTORIES
Inventories, which consist of prepaid telephone cards, are stated at the
lower of cost (first-in, first-out) or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization
are provided for, using straight-line and accelerated methods, in amounts
sufficient to relate the cost of depreciable assets to operations over
their estimated service lives. Leased property under capital leases is
amortized over the shorter of the service lives of the assets or the term
of the lease. Repairs and maintenance are charged to operations as
incurred.
INCOME TAXES
Income taxes are accounted for under the Financial Accounting Standards
Board Statement of Financial Accounting Standards No. 109 ("SFAS No. 109"),
"Accounting of Income Taxes." Under SFAS No. 109, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax basis. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are
F-9
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
expected to be recovered or settled. Under SFAS No. 109, the effect on
deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date. The company has
made provision for various minimum state and local taxes. The provision, in
2002, for federal taxes has been offset against the company's net operating
losses carried forward from prior years. A valuation allowance has been
established as the likelihood of realizing net deferred tax benefits is
presently doubtful.
EARNINGS/LOSS PER SHARE
Basic earnings per share are determined by dividing the Company's net
earnings/loss by the weighted-average shares outstanding. Diluted earnings
per share include the dilutive effects of outstanding stock option and
warrants. Excluded from the calculation of diluted earnings per share are
210,000 options and warrants to purchase the Company's common stock as
their inclusion would have been antidilutive.
GOODWILL
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141 ("SFAS No. 141"), "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets"
("SFAS No. 142"). For all business combinations initiated after June 30,
2001, SFAS No. 141 eliminates the pooling-of-interests method of accounting
and requires the purchase method of accounting, including revised
recognition criteria for intangible assets other than goodwill. Under SFAS
No. 142, which is effective for years beginning after December 15, 2001,
goodwill and indefinite-lived intangible assets are no longer amortized but
are reviewed annually, or more frequently if impairment indicators arise,
for impairment. Intangible assets that have finite lives will continue to
be amortized over their useful lives and reviewed for impairment in
accordance with Statement of Financial Accounting Standards No. 144 ("SFAS
No. 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets." The Company has adopted SFAS No. 142 for the year beginning
January 1, 2002.
LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset or group of
assets may not be fully recoverable. If an impairment indicator is present,
we evaluate recoverability by a comparison of the carrying amount of the
assets to future undiscounted net cash flows that we expect to generate
from these assets. If the assets are impaired, we recognize an impairment
charge equal to the amount by which the carrying amount exceeds the fair
value of the assets. Assets to be disposed of are reported at the lower of
carrying values or fair values, less estimated costs of disposal.
F-10
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No.148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement
No.123." SFAS No.148 amends SFAS No.123,"Accounting for Stock-Based
Compensation," to provide alternative methods of transition for an entity
that voluntarily changes to the fair value-based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions
of that Statement to require prominent disclosure about the effects on
reported net income of an entity's accounting policy decisions with respect
to stock-based employee compensation. The Company has chosen to continue to
account for stock-based compensation using the intrinsic value method
prescribed in APB Opinion No.25 and related interpretations as provided for
under SFAS No.148. Accordingly, compensation expense is only recognized
when the market value of the Company's stock at the date of the grant
exceeds the amount an employee must pay to acquire the stock.
Proforma earnings (loss) and earnings (loss) per share are not presented as
the proforma information is equal to the Company's reported results.
In January 2003, the FASB issued FASB Interpretation No.46 "Consolidation
of Variable Interest Entities." In general, a variable interest entity is a
corporation, partnership, trust, or any other legal structure used for
business purposes that either (a) does not have equity investors with
voting rights or (b) has equity investors that do not provide sufficient
financial resources for the entity to support its activities. A variable
interest entity often holds financial assets, including loans or
receivables real estate or other property. A variable interest entity may
be essentially passive or it may engage in activities on behalf of another
company. Until now, a company generally has included another entity in its
consolidated financial statements only if it controlled the entity through
voting interests. FIN No.46 changes that by requiring a variable interest
entity to be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity's activities
or entitled to receive a majority of the entity's residual returns or both.
FIN No. 46's consolidation requirements apply immediately to variable
interest entities created or acquired after January 31, 2003. The
consolidation requirements apply to older entities in the first fiscal year
on interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply to all financial statements issued after January 31,
2003, regardless of when the variable interest entity was established. The
Company has not adopted FIN No.46 for the three months ended March 31,
2003, however the Company has provided for the required disclosures
required by FIN No. 46 (see Note 5). The Company has not completed its
Decembers 31, Estimated useful life March 31, of the effects of adopting
FIN No. 46.
F-11
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
Revenue is recognized from sales when products are shipped and title passes
to the customer. Sales incentives in the form of free products given to the
Company's distributors are classified as a reduction of revenues.
ADVERTISING
Advertising costs are expensed as incurred and totaled $1,051,149 and
$776,317 for the three months ended March 31, 2003 and 2002, respectively.
SHIPPING AND HANDLING FEES AND COSTS
The Company includes fees billed to a customer relating to shipping and
handling costs in net sales. All shipping and handling expenses incurred by
the Company are included in cost of sales.
USES OF ESTIMATES AND FAIR VALUE OF FINANCIAL INSTRUMENTS
In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required
to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
Management of the Company believes that the fair value of financial
instruments, consisting of cash, accounts receivable and debt, approximates
carrying value due to the immediate or short-term maturity associated with
its cash and accounts receivable and the interest rates associated with its
debt.
ACCOUNTS RECEIVABLE
Accounts receivable are due within contractual payment terms and are stated
at amounts due from customers net of an allowance for doubtful accounts.
Credit is extended based on evaluation of a customer's financial condition.
Accounts outstanding longer than the contractual payment terms are
considered past due. The Company determines its allowance by considering a
number of factors, including the length of time trade accounts receivable
are past due, the Company's previous loss history, the customer's current
ability to pay its obligation to the Company, and the condition of the
general economy and the industry as a whole. The Company writes off
accounts receivable when they become uncollectible, and payment
subsequently received on such receivables are credited to the allowance for
doubtful debts.
F-12
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
Estimated useful life March 31, December 31,
(years) 2003 2002
------- ---- ----
Furniture and equipment 5 - 7 $ 709,945 $ 698,345
Automobiles 5 - 7 270,065 270,064
Computer equipment 5 1,287,920 1,269,182
Leasehold improvements 3 - 8 325,100 325,100
----------- -----------
2,593,030 2,562,691
Less accumulated
depreciation and amortization 872,625 760,893
----------- -----------
$ 1,720,405 $ 1,801,798
----------- -----------
Depreciation and amortization expense for property and equipment for the
three months ended March 31, 2003 and 2002 was approximately $111,732 and
$72,606 respectively.
NOTE 5 - NOTE RECEIVABLE - STRATEGIC PARTNER
On December 1, 2002, the Company entered into an agreement with a newly
established telecommunications carrier ("Telecom") whereby the Company
agreed to advance a minimum of $3 million to establish a switching platform
(the "platform") to provide telecommunication services in exchange for
certain preferential rights to the said services. Such advances are
evidenced by a promissory note which bears interest at 10% and is
collateralized by all current and future assets of Telecom. The Company
further agreed to utilize a minimum of $10 million of these services during
the year ended December 31, 2003.
In the event that Telecom is not successful in establishing the platform or
does not provide the aforementioned services to the Company in terms of the
agreement, they will be required to repay all monies previously advanced to
them and all equipment and infrastructure purchased with the said funds
will revert to the Company.
Presently, the Company is Telecom's sole source of funds and sole customer.
As a result, the operations of Telecom may be required to be consolidated
with those of the Company in terms of FASB Interpretation No.46,
"Consolidation of Variable Interest Entities". As of March 31, 2003, the
Company had advanced approximately $4.0 million to Telecom. In addition, as
of March 31, 2003, the Company had outstanding billings from Telecom for
services aggregating approximately $2.6 million.
F-13
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 6 - RELATED PARTY TRANSACTIONS
Sales of inventory to a customer who is related to an officer of the
Company were approximately $9,261,000 and $6,171,000 for the three
months ended March 31, 2003 and 2002, respectively. The Company also
purchased inventory from this customer in the amount of $240,000 and
$2,763,000 during the nine months ended March 31, 2003 and 2002,
respectively.
NOTE 7 - CONTINGENCIES
The Company from time to time is subject to other certain legal
proceedings and claims which have arisen in the ordinary course of its
business. These aforementioned actions when ultimately concluded will
not, in the opinion of management, have a material adverse effect upon
the financial position, results of operations or liquidity of the
Company.
F-14
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto set forth in Item 1of this Quarterly
Report. In addition to historical information, this discussion and analysis
contains forward-looking statements that involve risks, uncertainties and
assumptions, which could cause actual results to differ materially from
Management's expectations. Factors that could cause differences include, but are
not limited to, expected market demand for the Company's products, fluctuations
in pricing for products distributed by the Company and products offered by
competitors, as well as general conditions of the telecommunications
marketplace.
OVERVIEW
To date, our principal source of revenue has been the marketing and distribution
of prepaid phone cards. We market and distribute branded prepaid phone cards,
which are produced by a variety of telecommunications long distance carriers and
resellers, as well as private label proprietary prepaid phone cards produced
exclusively for us by various long distance carriers and/or resellers.
Prepaid phone cards are distributed through a vast network of retail
outlets, including convenience stores, newsstands, grocery stores and discount
stores. The retail outlets are serviced by independent distributors, which often
distribute newspapers or other items to the retail outlets. We purchase large
volumes of branded prepaid phone cards from the long distance carrier or
reseller and sell the cards in smaller quantities, together with cards from
other carriers and/or private label cards we distribute, to the independent
distributor, for ultimate distribution to retailer outlet.
We purchase branded cards at a discount from the face value of the
card, and resell them to the distributor at a slightly lower discount. The
difference between the two discount rates, typically from 1% to 8%, represents
the gross margin we retain. We purchase branded cards on varying terms, from
C.O.D. to an as used basis. Sales of our products are generally made on a net 21
day basis.
Private label cards are generally designed and produced by us,
utilizing card numbers and PINs provided by the telecommunications carrier or
reseller providing the long distance service for the card. We incur the upfront
expense of printing the phone cards. However, we do not pay the long distance
carrier until it activates the cards, which occurs upon our sale to the
distributor. Accordingly, through the use of private label cards, our cost of
inventory is significantly reduced, as purchases are effectively made on an
as-needed basis. In addition, private label cards generally provide us with the
ability to achieve a greater gross margin percentage, typically ranging from 3%
to 8%. During the past two years, we have continued to increase our sales of
private label cards, both on an absolute dollar volume and as a percentage of
our sales. During the three months ended March 31, 2003, we sold over 300
varieties of private label cards, which accounted for in excess of 80% of our
total revenues.
We continue to seek to expand our geographic reach and to increase our
sales. In recent years, we have established distribution centers in California,
Connecticut, Florida, Illinois, Maryland, Michigan, North Carolina, Ohio,
Upstate New York, as well as additional distribution centers in the New York
metropolitan area, and we have established strategic relationships with
distributors in Canada and United Kingdom. In addition, in 2001, we commenced
pre-paid phone card sales through our Internet Websites. Through our websites,
consumers worldwide can purchase 9278 phone cards over the Internet from a
selection of over 100 cards, searchable by various criteria, e.g., rates, brand
name, country, etc., and receive immediate delivery of the card's access number
and PIN codes via e-mail.
We are seeking to develop and acquire rights to additional prepaid
telecommunications services and other prepaid products or services to diversify
our product offerings and increase our overall gross margin. In the short-term,
additional costs related to the development or acquisition of such products may
have an impact on our net profits.
RESULTS OF OPERATIONS
The following table sets forth certain financial data as a percentage
of net revenues for the periods indicated:
For the three months
ended March 31,
2003 2002
---- ----
Net revenues 100.00% 100.00%
Cost of services 93.20 92.51
------- ------
Gross margin 6.80 7.49
Selling expenses 4.32 2.56
General and administrative expenses 3.92 4.22
Depreciation and amortization 0.15 0.13
Provision for bad debts - 0.09
Interest expense, net - 0.02
------- ------
Earnings (loss) before income taxes (1.59)% 0.47%
------- ------
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
NET REVENUES. Net revenues for the three months ended March 31, 2003 increased
$15.5 million, or 27.2%, to $72.9 million from $57.4 million for the same period
in 2002. Except for the Queens and Connecticut offices, same location sales in
each other location increased during the three months ended March 31, 2003 as
compared to the same period in 2002. Sales for our California office increased
54.8% over previous year as we opened an additional office in Orange County and
hired additional salespersons to promote the sales. Internet sales recorded a
39.6% increase over its previous year levels. In 2002 and during the quarter
ended March 31, 2003, we added additional websites selling our cards to the
consumers. Our office in Chicago, IL, recorded 70.2% increase in sales over
previous year sales as it expanded its operations by opening a sales office in
Dearborn, Michigan. The Maryland office recorded a 29.1% increase in sales over
the same period in 2002 as it expanded its operations by opening a sales office
in Richmond, Virginia. The Company opened new offices in Miami, Florida and
Charlotte, North Carolina in October 2002, which accounted for 7.0% and 1.3%
respectively of the total sales for the three months ended March 31, 2003. In
February 2003, the Company opened its new sales office in Columbus, Ohio. The
same store revenues increased primarily as a result of extensive marketing
efforts and continued expansion of market share for our private label cards.
However, sales in some of the NY Metro area offices and Connecticut have
declined by as much as 47.6% over the same period in 2002. The Company has
primarily been focusing its sales efforts outside the NY Metro area during the
past year. Intense competition and slowing economy in the region have also
contributed to this decline.
GROSS MARGIN. Gross margin increased by $0.67 million, or 15.5%, to $4.96
million from $4.30 million, for the three months ended March 31, 2003. As a
percentage of sales, the gross margin dropped to 6.8% of net revenues for the
three months ended March 31, 2003, as compared to 7.5% of net revenues for the
same period in 2002. The Company's continued efforts to gain market share by
giving up gross margins is attributable to this decline.
SELLING EXPENSES. Selling expenses for the three months ended March 31, 2003
increased $1.68 million or 115% to $3.15 million from $1.47 million for the
three months ended March 31, 2002. Of this, $0.71 million was attributable to
increase in advertising and promotion costs incurred to promote our new private
label cards in new markets and to promote sales over the Internet. Commission
expense increased by $1.06 million as we hired commissioned salespersons to
promote sales, starting in 2001.
Selling expenses as a percentage of net revenues increased to 4.3% for the three
months ended March 31, 2003, from 2.56%, for the same period in 2002.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses for the
three months ended March 31, 2003, increased by $0.44 million or 18.2% to $2.86
million from $2.42 million for the same period in 2002. This increase was
primarily due to the increase in costs of salaries and related taxes by $286,000
in 2003 as compared to 2002 as we hired additional staff in our new locations.
Included in the general and administrative expenses is the cost of rent expense
increased by $31,000, telephone expense increased by $71,000 and travel expense
by $64,000 in 2003 as compared to 2002 as the Company continued to add new
locations and expand existing facilities.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the three
months ended March 31, 2003 totaled $111,732, an increase of $39,000 as compared
to the same period in 2002. Increase is due to acquisition of fixed assets for
our new locations.
NET INCOME (LOSS) FROM OPERATIONS. We had a net loss of $1.16 million for the
three months ended March 31, 2003 as compared to a net profit of $0.26 million
for the three months ended March 31, 2002. The decrease in net income was due to
the increase in selling expenses and operating expenses. Our geographical
expansion by opening up new offices nationwide has led to increase in selling,
general and administrative costs. We also adopted an aggressive pricing policy
by discounting our cards and giving away promotional cards in these new
locations to gain market share. We believe that our loss from operations is a
temporary phenomenon and that there should be a turnaround once these new
offices are established.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2003, we had total current assets of $47.1 million. This
included $6.97 million in cash, $19.93 million in inventories and $20.06 million
in accounts receivable. Our cash balances vary significantly from day-to-day due
to the large volume of purchases made by us from the various prepaid phone cards
companies and sales to numerous distributors to whom we sell cards. Although we
had accounts payable of $62.0 million at March 31, 2003, we believe that
continued support from our trade creditors will provide us with adequate
liquidity to fund our continued growth.
We provided $1.97 million in cash from operating activities during the
three months ended March 31, 2003 as compared to using $1.2 million during the
same period in 2002. Increase in cash flows during
the three months ended March 31, 2003 are related to increase in accounts
payable by $4.5 million and release of restricted cash by the bank in the amount
of $1.0 million, offset by increase in inventories and accounts receivables of
$1.9 million and $0.4 million respectively and a net loss of $1.16 million
incurred during the three months ended March 31, 2003. Our working capital
decreased by $3.6 million during the three months ended March 31, 2003. The
decrease in working capital is attributable to our net loss from operations and
to a lesser extent to our opening of new offices, which involve carrying of
additional inventories and accounts receivable. We believe our working capital
shortfalls will decline once these offices are established and profitable.
Investing activities used $2.5 million during the three months ended
March 31, 2003 to acquire additional fixed assets and amounts paid to finance a
strategic partner in setting up a switching platform, which is expected to
benefit the Company in the future. Financing activities used $43,000 during the
three months ended March 31, 2003 to pay down principal on debt obligations.
We believe that existing cash and cash equivalents, cash flow from
operations and available vendor credit will be sufficient to meet our planned
working capital and capital expenditure budget through the next twelve months.
However, circumstances could arise which would require the payment to our
vendors sooner than we currently expect. We are largely dependent upon the
credit granted to us by our vendors. In the event sufficient vendor credit is
not available to us we would require other sources of financing. If we are
required to seek other financing, there can be no assurance that we will be able
to obtain such financing on commercially reasonable terms, or otherwise, or that
we will be able to otherwise satisfy our short-term cash flow needs from other
sources in the future which would have a material adverse effect on our
operations. These factors raise substantial doubt about the Company's ability to
continue as a going concern.
We are continuously renegotiating credit terms with our telephone card
suppliers. The favorable changes in terms from our vendors has eliminated the
temporary cash crunches that have occurred in the past, due to the restrictive
credit terms previously made available to us from the telecommunications
companies we buy branded cards from, as compared to the credit terms we make
available to our customers. The Company believes its relationships with its
vendors are satisfactory; however, the Company's creditors currently have the
right to modify credit terms.
OBLIGATIONS AND COMMITMENTS
As of March 31, 2003, the Company had the following obligations and commitments
to make future payments under contracts, contractual obligations, and commercial
commitments:
Less than
Total 1 year 1-3 years 4-7 years
----- ------ --------- ---------
Operating leases $2,056,000 $522,000 $1,088,000 $446,000
---------- -------- ---------- --------
CRITICAL ACCOUNTING POLICIES
Financial Reporting Release No. 60, published by the SEC, recommends
that all companies include a discussion of critical accounting policies used in
the preparation of their financial statements. The Company's significant
accounting policies are summarized in Note 3 of its financial statements. While
all
these significant accounting policies impact its financial condition and results
of operations, the Company views certain of these policies as critical. Policies
determined to be critical are those policies that have the most significant
impact on the Company's financial statements and require management to use a
greater degree of judgment and/or estimates. Actual results may differ from
those estimates.
The Company believes that given current facts and circumstances, it is
unlikely that applying any other reasonable judgments or estimate methodologies
would cause a material effect on the Company's consolidated results of
operations, financial position or liquidity for the periods presented in this
report.
The accounting policies identified as critical are as follows:
REVENUE RECOGNITION. The Company recognizes revenues in accordance with
generally accepted accounting principles as outlined in SAB No. 101 which
requires that four basic criteria be met before revenue can be recognized: (1)
persuasive evidence of an arrangement exists, (2) product delivery, including
customer acceptance, has occurred or services have been rendered, (3) the price
is fixed or determinable and (4) collectibility is reasonably assured. The
Company believes that its revenue recognition policy is critical because revenue
is a very significant component of its results of operations. Decisions relative
to criteria (4) regarding collectibility are based upon management judgments and
should conditions change in the future and cause management to determine these
criteria are not met, the Company's recognized results may be affected.
INCOME TAXES. In preparing the Company's consolidated financial statements,
income tax expense is calculated for each of the jurisdictions in which the
Company operates. This process involves estimating actual current taxes due plus
assessing temporary differences arising from differing treatment for tax and
accounting purposes which are recorded as deferred tax assets and liabilities.
Deferred tax assets are periodically evaluated to determine their recoverability
and where their recovery is not likely, a valuation allowance is established and
a corresponding additional tax expense is recorded in the Company's statement of
operations. In the event that actual results differ from the Company's estimates
given changes in assumptions, the provision for income taxes could be materially
impacted. As of March 31, 2003, the company had a deferred tax asset of
approximately $5,600,000 and a full valuation allowance due to uncertainty
surrounding the company's ability to realize its deferred tax asset.
INVENTORIES. Inventories, which are composed of prepaid calling cards, are
valued at the lower of cost (first in, first out) or market. On a periodic
basis, we compare the amount of inventory on hand and under commitment with our
latest forecasted requirements to determine whether write-downs for excess or
obsolete inventory are required. Although we consider the amounts on hand at
quarter-end to be realizable, there can be no assurance that these amounts will
prove to be realizable over time.
GOODWILL AND OTHER INTANGIBLES. Purchase accounting requires extensive use of
accounting estimates and judgments to allocate the purchase price to the fair
market value of the assets and liabilities purchased, with the excess value, if
any, being classified as goodwill. In addition, as described in Notes 3 of the
Company's financial statements, as a result of the Company's acquisitions,
values were assigned to intangible assets for customer lists and related
relationships. Finite useful lives were assigned to these intangibles and they
will be amortized over their remaining life. As with any intangible asset,
future write-downs may be required if the value of these assets become impaired.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. The Company performs ongoing credit evaluations
of its customers and adjusts credit limits based upon payment history and the
customer's current credit
worthiness, as determined by a review of their current credit information. The
Company continuously monitors collections and payments from customers and a
provision for estimated credit losses is maintained based upon its historical
experience and any specific customer collection issues that have been
identified. While such credit losses have historically been within the Company's
expectations and the provisions established, the Company cannot guarantee that
the same credit loss rates will be experienced in the future. Concentration risk
exists relative to the Company's accounts receivable, as 24.8% of the Company's
total accounts receivable balance at March 31, 2003 is concentrated in one
affiliated customer. While the accounts receivable related to this customer may
be significant, the Company does not believe the credit loss risk to be
significant given the consistent payment history by this customer.
RECENT ACCOUNTING PRONOUNCEMENTS.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which addresses accounting for
restructuring and similar costs. SFAS 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force Issue No. 94-3. The Company
will adopt the provisions of SFAS 146 for restructuring activities initiated
after December 31, 2002. SFAS 146 requires that the liability for costs
associated with an exit or disposal activity be recognized when the liability is
incurred. Under Issue 94-3, a liability for an exit cost was recognized at the
date of the Company's commitment to an exit plan. SFAS 146 also establishes that
the liability should initially be measured and recorded at fair value.
Accordingly, SFAS 146 may affect the timing of recognizing future restructuring
costs as well as the amounts to be recognized.
In December 2002, the FASB issued SFAS No.148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of FASB
Statement No.123." SFAS No.148 amends SFAS No.123,"Accounting for Stock-Based
Compensation," to provide alternative methods of transition for an entity that
voluntarily changes to the fair value-based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. The Company has chosen to continue to account for
stock-based compensation using the intrinsic value method prescribed in APB
Opinion No.25 and related interpretations as provided for under SFAS No.148.
Accordingly, compensation expense is only recognized when the market value of
the Company's stock at the date of the grant exceeds the amount an employee must
pay to acquire the stock. The adoption of SFAS No.148 did not have material
impact on the Company's financial position or results of operations.
In November 2002, the FASB issued FASB Interpretation No.45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN No.45 requires that upon issuance of
a guarantee, a guarantor must recognize a liability for the fair value of an
obligation assumed under a guarantee. FIN No. 45 also requires additional
disclosures by a guarantor in its interim and annual financial statements about
the obligations associated with guarantees issued. The recognition provisions of
FIN No.45 are effective for any guarantees issued or modified after December 31,
2002. The disclosure requirements are effective for financial statements of
interim or annual period ending December 15, 2002. The adoption of the
disclosure requirements of FIN No. 45 did not have a material impact on the
Company's financial position or results of operations. The Company is currently
evaluating the effects of the recognition provision of FIN No. 45, but does not
expect the adoption to have a material impact on the Company's financial
position or results of operations.
In January 2003, the FASB issued FASB Interpretation No.46 "Consolidation of
Variable Interest Entities." In general, a variable interest entity is a
corporation, partnership, trust, or any other legal structure used for
business purposes that either (a) does not have equity investors with voting
rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. A variable interest entity
often holds financial assets, including loans or receivables, real estate or
other property. A variable interest entity may be essentially passive or it may
engage in activities on behalf of another company. Until now, a company
generally has included another entity in its consolidated financial statements
only if it controlled the entity through voting interests. FIN No.46 changes
that by requiring a variable interest entity to be consolidated by a company if
that company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the entity's
residual returns or both. FIN No.46's consolidation requirements apply
immediately to variable interest entities created or acquired after January 31,
2003. The consolidation requirements apply to older entities in the first fiscal
year on interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply to all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company has
not adopted FIN No.46 for the quarter ended March 31, 2003, however the Company
has provided for the required disclosures required by FIN No. 46. The Company
has not completed its analysis of the effects of adopting FIN No. 46.
On April 30, 2003, FASB issued Statement No. 149 ("SFAS No. 149"), "Amendment of
Statement 133, on Derivative Instruments and Hedging Activities." SFAS No. 149
amends and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under Statement No. 133. In particular, this statement clarifies under what
circumstances a contract with an initial net investment meets the characteristic
of a derivative as discussed in Statement No. 133, and it clarifies when a
derivative contains a financing component that warrants special reporting in the
statement of cash flows. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after June
30, 2003 and is to be applied prospectively. The Company has not yet completed
its analysis of SFAS No. 149 and therefore, the effect on the Company's combined
financial statements of the implementation of SFAS No. 149, when effective, has
not yet been determined.
On May 15, 2003, FASB issued Statement No. 150 ("SFAS No. 150"), Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities and
Equity. SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that
pursuant to its terms can be a liability or an asset depending on certain
circumstances. SFAS No 150 affects the issuer's accounting for three types of
free-standing financial instruments:
-- mandatorily redeemable shares, which the issuing company is obligated
to buy back in exchange for cash or other assets;
-- instruments that do or may require the issuer to buy back some of its
shares in exchange for cash or other assets; includes put options and
forward purchase contracts; and
-- obligations that can be settled with shares, the monetary value of
which is fixed, tied solely or predominantly to a variable such as a
market index, or varies inversely with the value of the issuers'
shares.
SFAS No. 150 does not apply to features embedded in a financial instrument that
is not a derivative in its entirety. Most of the guidance in SFAS No. 150 is
effective for all financial instruments entered into or modified after May 31,
2003 and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The Company has not yet completed its analysis of
SFAS No. 150 and therefore, the effect on the Company's combined financial
statements of the implementation of SFAS 150, when effective,
has not yet been determined.
ITEM 3. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURES. The Company maintains disclosure controls and
procedures designed to provide reasonable assurance that information required to
be disclosed in the reports filed with the SEC is recorded, processed,
summarized and reported within the time periods specified in the rules of the
SEC. Within 90 days prior to the filing of this Quarterly Report on Form 10-Q,
an evaluation, was completed under the supervision and participation of
management, including the Chief Executive Officer and Principal Accounting
Officer, of the design and operation of this disclosure controls and procedures
pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief
Executive Officer and Principal Accounting Officer concluded that our disclosure
controls and procedures are effective in timely alerting them to material
information relating to the company (including the Company's consolidated
subsidiaries) required to be included in the periodic SEC filings.
CHANGES IN INTERNAL CONTROLS. There were no significant changes in internal
controls or other factors that could significantly affect the Company's internal
controls subsequent to the date of our evaluation.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are subject to certain legal proceedings and claims which have arisen in the
ordinary course of our business. These actions when ultimately concluded will
not, in the opinion of management, have a material adverse effect on our
financial position, results of operations or liquidity. We are also subject to
other legal proceedings which we have previously disclosed.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------ ----------------------
99.1 Certification of 9278 Communications, Inc. Chief Executive
Officer and Principal Accounting Officer pursuant to Sec 906 of
the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
9278 COMMUNICATIONS, INC.
Date: June 20, 2002 By /s/ Sajid Kapadia
---------------------------
Sajid Kapadia
Chief Executive Officer/
Principal Accounting Officer
CERTIFICATIONS
I, Sajid B. Kapadia, certify that:
1. I have reviewed this quarterly report on Form 10-Q of 9278 Communications,
Inc. (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
4. I am responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the a registrant, including its
consolidated subsidiaries, is made known to me by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. I have disclosed, based on our most recent evaluation, to the registrant's
auditors and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect a the registrant's ability to
record, process, summarize, and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. I have indicated in this quarterly report whether there were significant
changes in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluations, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: June 20, 2003
/s/ SAJID B. KAPADIA
-----------------------
SAJID B. KAPADIA
CHIEF EXECUTIVE OFFICER AND PRINCIPAL
ACCOUNTING OFFICER