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EPIXTAR CORP.
(FORMERLY GLOBAL ASSET HOLDINGS, INC.)
United States
Securities and Exchange Commission
Washington, DC 20549
Form 10Q
X Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934 for the period ending September 30, 2004
- --- 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 011-15499
Epixtar Corp.
(Exact name of issuer as specified in its Charter)
Florida 65-0722193
(State or other jurisdiction of (IRS Employer Identification No.)
Incorporation or organization)
11900 Biscayne Blvd. Suite 700, Miami, FL 33181
(Address of Principal executive office)
305-503-8600
(Telephone)
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 preceding 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 ____
Table of Contents
Part I: Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2004 (unaudited) and
December 31, 2003 F-1
Unaudited Consolidated Statements of Operations for the three months
and nine months ended September 30, 2004 and September 30, 2003 F-2
Unaudited Consolidated Statements of Cash Flows for the nine months
ended September 30, 2004 and September 30, 2003 F-3
Notes to Consolidated Financial Statements
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risks
Item 4. Controls and Procedures
Part II. Other Information
Item 2. Changes in Securities
Item 6. Exhibits and Reports on Form 8-K
Part I: Financial Information
EPIXTAR CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30,
2004 December 31,
(Unaudited) 2003
-------------- -------------
ASSETS
Current Assets:
Cash and cash equivalents (includes amounts held in escrow $ 1,723,305 $ 1,342,186
of $1,082,116 and $855,502)
Restricted cash 175,000 416,721
Accounts receivable - net 4,213,795 5,609,675
Note receivable 600,000 -
Deferred loan costs, current portion 317,203 -
Prepaid expenses and other current assets 293,690 227,203
Deferred billing costs 68,032 271,256
------------ ------------
Total current assets 7,391,025 7,867,041
------------ ------------
Property and Equipment, Net 4,949,249 1,263,844
------------ ------------
Other Assets:
Goodwill 3,360,272 3,360,272
Deferred loan costs, net of current portion 397,549 -
Deposits and other 1,164,222 491,637
------------ ------------
Total other assets 4,922,043 3,851,909
------------ ------------
Total assets $ 17,262,317 $ 12,982,794
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Debt, current portion $ 3,492,243 $ 121,513
Accounts payable 2,907,887 3,009,932
Accrued interest 367,362 175,185
Accrued expenses and taxes 1,240,334 146,566
Deferred revenue 784,749 1,459,657
Note payable - stockholder 2,447,838 -
------------ ------------
Total current liabilities 11,240,413 4,912,853
------------ ------------
Long-Term Liabilities:
Note payable - stockholder - 2,369,350
Debt, net of current portion 3,552,345 23,603
Common stock to be issued - 279,000
------------ ------------
Total long - term liabilities 3,552,345 2,671,953
------------ ------------
Stockholders' Equity:
Convertible preferred stock, $.001 par value per share,
10,000,000 shares authorized; 16,500 and 23,510
shares issued and outstanding
(liquidation preference of $3,300,000 and $4,702,000 ) 17 24
Common stock, $.001 par value per share, 50,000,000 shares authorized;
11,544,219 and 10,643,734 shares issued and outstanding 11,544 10,644
Additional paid-in capital 21,985,297 18,442,395
Accumulated deficit (19,528,595) (13,055,075)
Accumulated Comprehensive Income 1,296 -
------------ ------------
Total stockholders' equity 2,469,559 5,397,988
------------ ------------
Total liabilities and stockholders' equity $ 17,262,317 $ 12,982,794
============ ============
See accompanying notes to the consolidated financial statements.
Part I - Financial Information
F-1
EPIXTAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2004 2003 2004 2003
---- ---- ---- ----
(Restated) (Restated)
Revenues $ 4,360,539 $ 8,557,326 $ 13,529,770 $ 30,192,199
------------ ------------ ------------ ------------
Cost of Sales
Billing costs 397,352 1,369,909 2,039,096 5,101,958
Other cost of sales 924,325 1,946,498 1,830,271 8,344,891
------------ ------------ ------------ ------------
Total Cost of Sales 1,321,677 3,316,407 3,869,367 13,446,849
------------ ------------ ------------ ------------
Gross Profit 3,038,862 5,240,919 9,660,403 16,745,350
------------ ------------ ------------ ------------
Expenses:
Selling, general and administrative 3,895,846 2,929,119 11,263,494 7,333,044
Consulting fees and reimbursements-
related party 675,000 549,689 2,025,945 1,918,167
Provision for doubtful accounts 77,643 486,891 318,078 1,892,451
Depreciation 417,230 51,003 788,895 128,380
------------ ------------ ------------ ------------
Total Expenses 5,065,719 4,016,702 14,396,412 11,272,042
------------ ------------ ------------ ------------
Income (Loss) from Operations (2,026,857) 1,224,217 (4,736,009) 5,473,308
------------ ------------ ------------ ------------
Other Income (Expense):
Interest expense (739,415) (73,820) (2,825,443) (316,470)
Gain on extinguishment of debt, net 859,287 - 1,140,537 -
Other income (expense) 1,612 - (7,813) -
------------ ------------ ------------ ------------
Total Other Income (Expense) 121,484 (73,820) (1,692,719) (316,470)
------------ ------------ ------------ ------------
Income (Loss) Before Income Taxes (1,905,373) 1,150,397 (6,428,728) 5,156,838
Income Tax Provision - (74,827) - (491,172)
------------ ------------ ------------ ------------
Net Income (Loss) (1,905,373) 1,075,570 (6,428,728) 4,665,666
Cumulative dividends on preferred stock (88,792) (47,020) (176,852) (54,857)
Beneficial conversion feature of
preferred stock - - - (1,884,375)
------------ ------------ ------------ ------------
Income (Loss) Available to Common
Stockholders $ (1,994,165) $ 1,028,550 $ (6,605,580) $ 2,726,434
============ ============ ============ ============
Net Income (Loss) per Common Share:
Basic $ (0.17) $ 0.10 $ (0.62) $ 0.26
============ ============ ============ ============
Diluted $ (0.17) $ 0.07 $ (0.62) $ 0.19
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
Part I - Financial Information
F-2
EPIXTAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
UNAUDITED
2004 2003
---- ----
(Restated)
Cash Flows from Operating Activities:
Net Income (Loss) $(6,428,728) $ 4,665,666
Adjustments to Reconcile Net Income (Loss) to Net Cash
Used in Operating Activities:
Depreciation 788,895 128,380
Provision for doubtful accounts 318,078 1,892,451
Stock-based compensation 158,208 125,446
Amortization of beneficial conversion feature 1,812,434 -
Amortization of discount on convertible debenture 600,288 -
Amortization of loan costs 362,609 -
Amortization of discount on stockholder loan 78,488 -
Gain on extinguishment of debt (1,140,537) -
Changes in Assets and Liabilities:
(Increase) decrease in:
Accounts receivable 1,077,802 (3,723,399)
Prepaid expenses and other (54,987) 243,225
Deferred billing costs 203,224 (488,519)
Deposits (130,207) (336,657)
(Decrease) increase in:
Accounts payable and accrued expenses 1,204,126 (1,406,472)
Income taxes payable - 491,172
Deferred revenues (674,908) (1,518,178)
----------- -----------
Net cash (used in) provided by operating activities (1,825,215) 73,115
----------- -----------
Cash Flows from Investing Activities:
Cash paid for acquisition of property and equipment (3,079,784) (344,350)
Cash paid for acquisition of net assets of Philippines call center 269,745 -
Investment in note receivable (600,000) -
Release of cash restricted by governmental agency 241,721 -
----------- -----------
Net cash used in investing activities (3,168,318) (344,350)
----------- -----------
Cash Flows from Financing Activities:
Proceeds from the issuance of preferred stock, net of offering costs - 2,136,400
Proceeds from the issuance of common stock - 14,000
Proceeds from the issuance of debt, net of loan costs 6,671,499 -
Repayment of notes payable and capital lease obligations (1,298,143) (60,886)
----------- -----------
Net cash provided by financing activities 5,373,356 2,089,514
----------- -----------
Effect of exchange rate changes on cash 1,296 (2,760)
Net Increase in cash 381,119 1,815,519
Cash and cash equivalents, beginning of period 1,342,186 722,674
----------- -----------
Cash and cash equivalents, end of period 1,723,305 2,538,193
=========== ===========
Supplemental Disclosure of Cash Flow Information:
Income Tax Paid - -
Interest Paid $ 220,543 $ 588,282
=========== ===========
See accompanying notes to the consolidated financial statements.
Part I - Financial Information
F-3
EPIXTAR CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements as of September 30,
2004 and for the periods then ended have been prepared in accordance with
accounting principles generally accepted in the United States for interim
financial information on Form 10-Q and reflect all adjustments which, in the
opinion of management, are necessary for a fair presentation of the financial
position as of September 30, 2004 and results of operations for the three months
and nine months ended September 30, 2004 and 2003 and cash flows for the nine
months ended September 30, 2004 and 2003. All such adjustments are of a normal
recurring nature.
The results of operations for interim periods are not necessarily indicative of
the results to be expected for a full year. The statements should be read in
conjunction with the audited consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-KSB for the year
ended December 31, 2003.
On March 31, 2004, the Financial Accounting Standards Board (FASB) issued its
Exposure Draft, "Share-Based Payment," which is a proposed amendment to FASB
Statement No. 123, "Accounting for Stock-Based Compensation." The Exposure Draft
would require all share-based payments to employees, including grants of
employee stock options, to be recognized in the income statement based on their
fair values. FASB expects that a final standard would be effective for public
companies for fiscal years beginning after December 15, 2004. The Company does
not intend to adopt a fair-value based method of accounting for stock-based
employee compensation until a final standard is issued by the FASB that requires
this accounting. Pro forma disclosures of quarterly earnings are included in
Note 11 of this quarterly statement.
NOTE 2. PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Epixtar Corp. and
its wholly owned subsidiaries ("the Company"). All material intercompany
accounts and transactions have been eliminated in consolidation.
In August 2004, the Company created a wholly owned subsidiary, Voxx Corporation
("Voxx"), incorporated in the state of Florida. Voxx is the Company's holding
company for its wholly owned subsidiaries that operate its overseas contact
center business.
NOTE 3. RESTATEMENT OF 2003 CONSOLIDATED FINANCIAL STATEMENTS
The prior consolidated financial statements of the Company have been restated as
a result of management re-evaluating the accounting treatment of a previously
recorded transaction as follows:
On October 31, 2001, the Company entered into a loan agreement to borrow up to
$5,000,000 from a then unrelated entity. The note provided for interest at 7%,
was collateralized by accounts receivable and was due on demand. In August and
September 2002, the creditor became a stockholder of the Company when the entity
acquired a total of 770,000 common shares. In November 2002, the Company entered
into an agreement, which was executed on December 6, 2002 and amended on March
3, 2003, whereby the creditor released the collateral and agreed not to demand
payment before January 2005 in exchange for certain consideration. That
consideration consisted of warrants to purchase 4,000,000 shares of Company
common stock at an exercise price of $.50 per share for a term of three years
beginning in May 2003. Pursuant to EITF 96-19, management has determined that
the transaction should have been treated as an extinguishment of the original
instrument and an execution of a new note at December 6, 2002. The fair value of
the warrants, determined on the grant date (March 3, 2003), should have been
treated as a component of the calculation of the loss associated with that
extinguishment and should have been recognized in the statement of operations in
December 2002. In addition, the new note should have been recorded at fair value
on the date that it was entered into (December 6, 2002). The new note was
recorded at fair value, which resulted in our recording a discount. The 2003
financial statements have been restated to reflect the amortization of the
discount over the two-year life of the new loan.
In 2002, the Company originally recorded the fair value of the warrants at the
date the agreement was negotiated (November 2002) as deferred financing costs
and began amortizing those costs over the new life of the loan (two years). The
2002 consolidated financial statements were restated to reflect the loss on debt
extinguishment in 2002, measured by the fair value of the warrants on the date
of grant, reduced by the discount on the note required to reflect that note at
fair value at the date it was executed.
For the three months and nine months ended September 30, 2003, amortization
expense was reduced by $125,000 and $375,000, respectively, due to the reversal
of amortization of the originally recorded loan restructuring costs.
Amortization expense was increased for the amortization of the discount on the
new loan.
F-4
NOTE 4. LIQUIDITY
We had a working capital deficit of $3,849,387 as of September 30, 2004 compared
to working capital of $953,406 as of June 30, 2004 and working capital of
approximately $2,954,188 on December 31, 2003. We had negative cash flow from
operations for the nine-month period ended September 30, 2004. We used cash of
approximately $4,993,534 during the nine months ended September 30, 2004 in
connection with operations and the acquisitions of property and equipment
including the requirements of commencing and expanding our contact center
business. The net proceeds from loans in 2004 of $6,671,500 created positive
cash flow for the nine-month period ended September 30, 2004. The issuance of
preferred stock in 2003 of $1,911,400 and positive cash flow from operations
created positive cash flow for the nine-month period ended September 30, 2003.
NOTE 5. NOTE RECEIVABLE
In July 2004 the Company advanced $600,000 to an entity with which the Company
entered into a letter of intent to acquire. The note was payable in July 2005
and accrued no interest. During the fourth quarter of 2004, pursuant to the
terms of the note, the total amount of $600,000 became due in December 2004,
after which time, interest will accrue at an annual rate of 18%.
NOTE 6. DEBT
In April and May of 2004, the Company issued unsecured convertible promissory
notes in the amount of $2,500,000 to unrelated parties. The notes accrue
interest at 8% annually and mature in April and May of 2005. The outstanding
principal and interest on the notes are convertible at any time into shares of
the Company's common stock. On the dates of the issuance of the convertible
notes, the Company's common stock had closing prices per share on the Over-the
Counter Bulletin Board ranging from $4.25 to $4.75. Based on the terms of the
conversion associated with the notes, there was an intrinsic value associated
with the beneficial conversion features estimated at $1,817,787, which was
recorded as deferred interest and presented as a discount on the convertible
debentures, net of amortization to be taken over the one-year terms of the
notes. Also, as part of the convertible notes, the Company issued detachable
warrants to purchase 136,749 shares of the Company's common stock for $5.05 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
warrants and allocated $401,852 of the proceeds from the notes to the warrants
which was recorded as deferred interest and presented as a discount on the
convertible notes, net of amortization to be taken over the one-year terms of
the notes. In May 2004, certain holders of the convertible debt exercised their
rights to convert principal and accrued interest valued at $578,833 into 195,552
shares of common stock. $925,000 of the principal amount, plus accrued interest
was repaid with cash.
In May 2004, the Company issued a secured convertible term note in the amount of
$5,000,000 to an unrelated party. Approximately $1,930,000 of the principal
amount of the note was held in escrow pursuant to the terms of the note.
Interest accrues on the unrestricted principal balance of the note at an annual
interest rate equal to the prime rate plus 2.5%, and shall not exceed 8%.
Interest accrues on the restricted balance of the note at 1% annually. The note
matures in May 2007 with equal monthly principal payments of $90,900 beginning
in October 2004 until the maturity date. The outstanding principal and interest
on the note is convertible at any time into shares of the Company's common
stock. On the date of the issuance of the convertible note, the Company's common
stock had a closing price per share on the Over-the Counter Bulletin Board of
$4.10. Based on the terms of the conversion associated with the notes, there was
an intrinsic value associated with the beneficial conversion feature estimated
at $3,089,585, which was recorded as deferred interest and presented as a
discount on the convertible debenture, net of amortization to be taken over the
three-year term of the note. Also, as part of the convertible note, the company
issued detachable warrants to purchase 492,827 shares of the Company's common
stock at exercise prices ranging from $4.05 to $4.65 per share exercisable at
any time over a seven-year period from the date of issuance. Using the
Black-Scholes model, the Company estimated the fair value of the warrants and
allocated $1,163,910 of the proceeds from the note to the warrants which was
recorded as deferred interest and presented as a discount on the convertible
note, net of amortization to be taken over the three-year term of the note.
In August 2004, the Company agreed to reduce the conversion prices of the
convertible notes issued in April and May of 2004 and the exercise prices of the
related detachable warrants to $2.10 and $2.15 per share, respectively, as
consideration for the release of $400,384 of funds held in escrow. Also, as
additional consideration, the Company issued, to the holders of the notes,
additional five-year warrants to purchase 600,000 shares of common stock at an
exercise price of $2.15 per share. Additionally, the Company decreased the
exercise prices of warrants to purchase 254,317 of common stock, previously
issued to private placement agents, to $2.15 compared to original conversion
prices ranging from $4.55 to $5.55. The modification of the terms of the
convertible notes was accounted for as an extinguishment of the original notes
and the issuance of new notes in accordance with the requirements of EITF 96-19:
Debtor's Accounting for a Modification or Exchange of Debt Instruments ("EITF
96-19"). On the date of the modification of the terms of the convertible notes,
the Company's common stock had a closing price per share on the Over-the Counter
Bulletin Board of $0.90. Based on the terms of the conversion associated with
the notes, there was no longer beneficial conversion features associated with
the notes. In accordance with EITF 96-19, the notes are reflected on the balance
sheet as if they were originally issued on the date of modification, resulting
in the elimination of the discounts related to the intrinsic value of the
beneficial conversion features of the notes on the dates of issuance. The
elimination of the discounts was offset by a charge to additional paid-in
capital and resulted in a gain on extinguishment of $859,287. Using the
Black-Scholes model, the Company estimated the fair value of the additional and
modified original warrants as of the date of modification and allocated $711,688
of the proceeds from the notes to the warrants which was recorded as deferred
interest and presented as a discount on the convertible notes, net of
amortization to be taken over the period from the modification date to the
maturity dates of the notes.
F-5
NOTE 6. DEBT (continued)
The exercise prices of the warrants and conversion prices of the convertible
debt are subject to adjustment in accordance with anti-dilution provisions and
performance criteria contained in the debt agreements.
In September 2004, the Company issued a promissory note in the amount of
$485,714, payable over a period of one-year. The note was executed in
conjunction with the purchase of software licenses related to the Company's call
center business and bears no interest. The licenses will be delivered to the
Company as the Company determines the need for such licenses and principal
payments will occur in proportion to the number of licenses delivered compared
to the total number of licenses purchased.
During the nine months ended September 30, 2004, the Company purchased property
and equipment valued at $808,869 through capital leases, promissory notes, and
arrangements with vendors that allow for payment over 18 months.
In October 2004, in connection with the purchase of equipment related to the
contact center business, the Company issued a note in the amount of $500,000,
which accrues interest at an annual rate of 6% and matures in December 2004.
In October 2004, the Company issued an unsecured subordinated convertible note
in the amount of $550,000. The note accrues interest at 5% annually and matures
in May 2007. The outstanding principal and accrued interest on the note are
convertible at any time into shares of the Company's common stock. The
outstanding principal and interest on the note are subject to automatic
conversion upon the occurrence of certain events as set forth in the note
agreement. Contingent upon the occurrence, or non occurrence, of certain events,
the holder may be entitled to receive warrants to purchase a number of shares of
the Company's common stock at variable exercise prices as defined in the
agreement.
NOTE 7. NON-CASH INVESTING AND FINANCING ACTIVITIES
In May 2003, the Company issued 13,617 shares of common stock as compensation
for consulting services valued at $85,000. The shares were valued based upon the
value of services provided as provided for in the agreement. The total amount
was charged to expense during the second quarter of 2003.
In June 2003, the Company issued warrants to purchase 329,140 shares of common
stock at an exercise price of $7.87 per share, exercisable over five years,
relating to the issuance of preferred stock. The exercise price of the warrants
has been reduced to $3.46 per share, and may be further reduced, in accordance
with anti-dilution provisions contained in the purchase agreements and the
non-occurrence of certain events in accordance with a registration rights
agreement entered into with the purchasers of the preferred stock. Based upon
the Black-Scholes option price calculation, the value of each warrant was $6.63
and the transaction was valued at $2,183,157, which was accounted for as
offering costs, resulting in offsetting charges to additional paid-in capital.
In August 2003, the Company entered into a consulting agreement, providing for
the issuance of 50,000 shares of common stock as compensation for services
valued at $175,000 as specified in the agreement. The total amount was charged
to expense during 2003. The shares were issued in April 2004.
In September 2003, the Company issued 127,117 shares of common stock in
settlement of debt and accrued interest totaling $404,506 and $40,406,
respectively. The shares were valued based upon the outstanding amounts related
to the loan and were accounted for as a reduction in debt and a charge to
accrued interest.
In April 2004, the Company issued 75,000 shares of common stock as compensation
for consulting services valued at $159,375. The services were valued based on
the closing price of the shares as listed on Over-the-Counter Bulletin Board on
the date of the agreement. The total amount was charged to expense during 2004.
In April, 2004, accounts payable of $191,230 was settled with the issuance of a
non-interest bearing note payable over 30 months.
F-6
NOTE 7. NON-CASH INVESTING AND FINANCING ACTIVITIES (Continued)
In May 2004, the Company issued 65,030 shares of common stock as consideration
valued at $296,554 related to the acquisition of the net assets of a call center
located in the Philippines. The shares were valued based upon the terms of the
purchase agreement and recorded in accordance with the allocation of the
purchase price to the assets and certain liabilities as specified in the
purchase agreement.
In May and July 2004, holders of the Company's preferred stock converted 7,010
shares of preferred stock into 377,926 shares of the Company's common stock. The
holders of the preferred stock originally purchased the shares for $701,000.
Pursuant to the preferred stock purchase agreement, 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.
In connection with the convertible debt issued in April and May 2004, private
placement agents received warrants to purchase 254,317 shares of the Company's
common stock at exercise prices ranging from $4.45 to $5.55 per share,
exercisable over five years. As part of the modification of the terms of the
convertible debt in August 2004, the exercise prices of the warrants were
reduced to $2.15 per share. Based upon the Black-Scholes option price
calculation, the value of the warrants on the date of modification was $183,108,
which was accounted for as loan costs, and is being amortized over the period
from the modification date to the maturity dates of the notes.
In May 2004, certain holders of the convertible debt exercised their rights to
convert principal and accrued interest valued at $578,833 into 195,552 shares of
common stock.
In July 2004, the Company issued 87,982 shares of common stock pursuant to an
agreement related to the March 2004 acquisition of certain assets and assumption
of certain liabilities of I-Call Global Services Corporation (I-Call). The
shares were valued at $357,054 based on the value of services provided as
specified in the agreement. The additional value was allocated to the assets
originally purchased in March 2004 (See Note 12).
NOTE 8. RELATED PARTY TRANSACTIONS
The Company has entered into two agreements with Transvoice Investment, Inc.
("Transvoice"), the managing member of Transvoice Investment LLC, the Company's
majority stockholder. The two stockholders of Transvoice are also employees of
the Company.
In October 2001, the Company entered into an agreement with Transvoice, whereby
Transvoice had provided certain services related to the development of the
Company's internet service provider business. Under the terms of the agreement,
the Company is to pay Transvoice $150,000 per month plus $1.00 for each customer
in excess of 100,000 customers computed monthly, until such time that the
Company is no longer generating revenues from its internet service provider
business. The Company incurred expenses of $2,637,618, $2,111,438 and $625,000
during 2003, 2002 and 2001, respectively, for services under this agreement. The
Company incurred expenses of $1,350,000 (unaudited) during the nine month period
ended September 30, 2004.
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. Certain employees of the Company have
a controlling interest in the subcontractor. The Company incurred expenses under
this agreement in the amount of $1,050,000 during the year ended December 31,
2003. The Company incurred expenses of $675,000 (unaudited) under this agreement
for the nine months ended September 30, 2004.
NOTE 9. COMMITMENTS, CONTINGENCIES AND OTHER MATTERS
STATE PROCEEDINGS AND INQUIRIES
The Company previously used telemarketing services to obtain customers for its
ISP business. During the normal course of business, the Company has received
inquiries or complaints from regulatory agencies. Despite its attempts to
minimize complaints, certain states have issued fines or temporary restraining
orders.
F-7
NOTE 9. COMMITMENTS, CONTINGENCIES AND OTHER MATTERS (Continued)
STATE PROCEEDINGS AND INQUIRIES (Continued)
In January 2004, a Class Action Complaint for Declaratory and Injunctive Relief
was filed, alleging that the Company engaged in the improper practice of
cramming, or assessing charges against a customer without the customer's
consent. In February 2004, the Company's legal counsel filed a Notice of Removal
to Federal Court. In August 2004, a United States District Court remanded the
case back to the county circuit court. Management estimates that the relief
sought shall not exceed $75,000.
In March 2003, a subsidiary of the Company was subject to complaints from the
Attorney General of Florida related to its ISP business. In the third quarter of
2004, the Company entered into an agreement with Florida which contained similar
terms and conditions as the FTC agreement. A monetary settlement of $100,000 was
accrued for as of June 30, 2004 and paid during the third quarter of 2004.
FEDERAL TRADE COMMISSION RELATING TO ISP BUSINESS
During 2003, the Company was the subject of a proceeding by the Federal Trade
Commission ("FTC"). The FTC complaint brought in the United States District
Court for the Southern District of Florida alleged that the Company was
misleading potential customers of their internet service businesses through the
use of third party telemarketers. Specifically, the FTC alleged that the Company
was signing up customers for free thirty day trial periods without appropriate
consent and failing to inform these customers that unless the service is
cancelled before the end of the thirty day trial period, the customers would be
billed through their local phone companies. As part of the proceeding, the
Company was subject to a temporary restraining order, asset freeze, order
permitting expedited discovery, order appointing temporary receiver, and order
to show cause as part of the proceeding. In November 2003, without any finding
of wrongdoing, the Company entered into a preliminary injunction with the FTC.
As a result, the Company was allowed to resume its business and the asset freeze
was partially lifted. As part of the agreement, the Company was required to
establish an escrow account for the payment of future customer refunds and
amounts subject to further resolution of the dispute with the FTC into which
$1,701,684 was deposited. As of December 31, 2003, $416,721 of funds held
remained subject to the asset freeze (restricted). During 2003, $75,000 was
charged to the Company as fees.
As of December 31, 2003, the total amount held in escrow was $ 855,502 and the
total amount of cash still restricted totaled $416,721. In January 2004, the
Company received approximately $755,000 of the funds remaining in escrow, which
were returned to the Company as reimbursement for monies refunded to customers
under the stipulation agreement. Approximately $105,000 of the escrowed amount
was charged to the Company as fees. There were no amounts remaining in escrow as
of June 30, 2004. In July 2004, a final resolution of the matter, pending final
approval by the FTC, resulted in the release of the restricted funds, with the
exception of $175,000, which continues to be restricted and is designated for
consumer refunds for a two-year period.
OTHER LITIGATION
In October 2004, the Company agreed in principle with eTelecare International
("eTelecare"), which provided call center services to the Company related to its
ISP business. eTelecare claimed that $167,167 was due from the Company for
services rendered. The parties agreed in writing that the Company would pay
eTelecare $85,000 in settlement of all claims. The Company has accrued the
excess of the settlement payment over the existing accounts payable balance as
of September 30, 2004.
In November 2004, the Company agreed in principle with Lawstar, Inc.
("Lawstar"), which provided a legal services access plan, marketed in a private
label environment to a subsidiary's small business customer base. Lawstar
claimed that the Company's subsidiary failed to pay for services rendered and
was seeking $1,000,000 plus attorney's fees. The settlement will result in the
Company paying Lawstar $225,000 in settlement of all claims. The Company has
accrued the settlement amount as of September 30, 2004.
F-8
NOTE 9. COMMITMENTS, CONTINGENCIES AND OTHER MATTERS (Continued)
OTHER LITIGATION (Continued)
In November 2004, a subsidiary of the Company filed a complaint in the Federal
District Court for the Southern District of Florida against a former customer of
its call center business, demanding payment of $1,263,706 for services rendered
between March 2004 and September 2004, including interest and attorneys fees.
The Company cannot determine the likelihood of the outcome of this matter and
has not recorded these amounts as revenue. Approximately $206,000 related to
this issue is included in accounts receivable as of September 30, 2004.
LEASES
During the first quarter of 2004, the Company entered into a lease agreement for
residential property to be utilized by its traveling employees. The lease
requires monthly payments of $4,500 and is for a one-year period beginning in
June 2004.
In July 2004, the Company entered into a lease agreement for a facility to be
utilized as a call center in the Philippines. The agreement is for a five-year
period beginning in January 2005 and requires monthly payments of $11,088.
In September 2004, the Company entered into a lease agreement for approximately
4,990 square feet of space to be constructed in Dumaquete City, Philippines. The
agreement requires the completion of construction by August 2005 and is for a
five-year term beginning three months after the delivery of the premises to the
Company. The lease is renewable at the option of the Company with written
notices at least ninety days prior to the end of the lease term. The lease
requires to the Company to pay a security deposit of 1,368,900 (US$24,258 at
September 30, 2004) pesos within 15 days of the execution of the lease and
monthly rental payments of 456,300 (US$8,086 at September 30, 2004) pesos
commencing three months after delivery of the property. Pursuant to the lease,
rental payments and required security deposit will increase 5% per year
beginning with the third year of the lease term.
NOTE 10. SEGMENT REPORTING
The following is selected unaudited financial information by segment:
Three Months Ended September 30, 2004
ISP and Others Contact Centers Total
-------------- --------------- -----------
Revenue $ 3,481,985 $ 878,554 $4,360,539
Cost of Sales 672,622 649,055 1,321,677
Operating Expenses 2,949,411 2,116,309 5,065,720
Net Income Loss (10,338) (1,895,037) (1,905,375)
Fixed Assets 736,762 4,212,487 4,949,249
Total Assets 9,305,866 7,956,451 17,262,317
Nine Months Ended September 30, 2004
ISP and Others Contact Centers Total
-------------- --------------- -----------
Revenue $ 12,510,475 $ 1,019,295 $ 13,529,770
Cost of Sales 3,035,098 834,269 3,869,367
Operating Expenses 7,348,165 7,048,247 14,396,412
Net Income (Loss) 648,480 (7,077,208) (6,428,728)
Fixed Assets 736,762 4,212,487 4,949,249
Total Assets 9,305,866 7,956,451 17,262,317
F-9
NOTE 11. EARNINGS (LOSS) PER COMMON SHARE
The Company has adopted SFAS Statement No. 128, "Earnings per Share". The
statement establishes standards for computing and presenting earnings per share
(EPS). It requires dual presentation of basic and diluted EPS on the face of the
income statement. There is no presentation of diluted loss per share in 2004 as
the effects of stock options, warrants and convertible debt amounts were
antidilutive.
The following table sets for the reconciliation of the numerator and denominator
of the basic and diluted EPS computations (unaudited):
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2003 2003
2004 (Restated) 2004 (Restated)
------------ ------------ ------------ ------------
Numerator:
Net income (loss) $ (1,905,375) $ 1,075,570 $ (6,428,728) $ 4,665,666
Preferred stock dividends (88,792) (47,020) (176,852) (1,939,232)
------------ ------------ ------------ ------------
Numerator for basic income (loss) per
share - income (loss) available
to common stockholders (1,994,176) 1,028,550 (6,605,580) 2,726,434
Effect of dilutive securities
Interest on convertible debt - - - -
------------ ------------ ------------ ------------
Numerator for diluted income (loss)
per share - income available to common
stockholders after assumed conversions $ (1,994,176) $ 1,028,550 $ (6,605,580) $ 2,726,434
============ ============ ============ ============
Denominator:
Denominator for basic income (loss) per
Share - weighted average shares 11,443,198 10,558,989 11,006,346 10,524,689
Effect of dilutive securities:
Stock options - 1,253,240 - 1,005,505
Warrants - 3,658,802 - 2,811,289
------------ ------------ ------------ ------------
Dilutive potential common shares:
Denominator for diluted income
(loss) per share - adjusted
weighted-average shares and assumed
conversions 11,443,198 15,471,031 11,006,346 14,341,483
============ ============ ============ ============
Basic income (loss) per share $ (0.17) $ 0.10 $ (0.62) $ 0.26
============ ============ ============ ============
Diluted income (loss) per share $ (0.17) $ 0.07 $ (0.62) $ 0.19
============ ============ ============ ============
Pro forma information regarding net income and earnings per share is required by
SFAS No. 123, "Accounting for Stock-Based Compensation," and has been determined
as if the Company had accounted for its stock options under the fair value
method of that Statement. The fair value for these options was estimated at the
grant date using a Black-Scholes option pricing model with the following
weighted average assumptions for 2003: risk-free interest rate of 3.04%,
dividend yield of 0%, volatility factors of the expected market price of the
Company's common stock of 214%; and a weighted average expected life of the
options of 5 years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options. For purposes of pro
forma disclosures, the estimated fair value of the options is amortized to
expense over the options' vesting period.
F-10
NOTE 11. EARNINGS (LOSS) PER COMMON SHARE (Continued)
No stock-based employee compensation cost is reflected in net income (loss), as
all options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of the grant. The following
table illustrates the effect on net income (loss) and income (loss) per share if
the Company had applied the fair value recognition provisions of FASB Statement
No. 123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
Three Months Ended Nine Months Ended
---------------------------------- ----------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
----------- ----------- ----------- -----------
Net income (loss) available to
common stockholders $ (1,994,176) $ 1,028,550 $ (6,605,580) $ 2,726,434
Deduct: total stock-
based compensation
expense determined
under fair value based
method for all awards,
net of related tax effects (695,450) (275,450) (2,303,717) (1,481,650)
-------------- ------------ -------------- -------------
Pro forma net income (loss) $ (2,689,626) $ (753,100) $ (8,909,297) $ 1,244,784
============== ============ ============== =============
Loss per share:
Basic:
As reported $ (0.17) $ 0.10 $ (0.62) $ 0.26
============== ============ ============== =============
Pro forma $ (0.23) $ 0.07 $ (0.80) $ 0.11
============== ============ ============== =============
Diluted:
As reported $ (0.17) $ 0.07 $ (0.62) $ 0.19
============== ============ ============== =============
Pro forma $ (0.23) $ 0.04 $ (0.80) $ 0.08
============== ============ ============== =============
NOTE 12. - PHILIPPINE OPERATIONS
In September of 2003, the Company began operating a call center located in the
Philippines for its benefit. In accordance with the terms of an Asset Purchase
Agreement (the "Agreement") dated March 2, 2004, a subsidiary of the Company,
Epixtar Philippines IT-Enabled Services Corporation (EPISC), agreed to acquire
certain assets and assume certain liabilities of I-Call Global Services
Corporation (I-Call). This acquisition took place in May 2004. The purchase
price of approximately $821,000 was payable $55,000 upon execution of the
Agreement; $150,000 at closing subject to certain conditions as defined in the
Agreement, plus 65,030 common shares of Epixtar Corp.; and a total of $196,000
at various times up to sixty days after closing date. In July 2004, the Company
issued an additional 87,983 shares of common stock as consideration valued at
$357,054 pursuant to an agreement directly related to the acquisition. The
shares were valued based upon the terms of the purchase agreement and allocated
the purchase price of the net assets, resulting in a total purchase price of
$1,178,054. The acquisition of I-Call is not considered a business combination
in accordance with generally accepted accounting principles.
F-11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
HISTORICAL
While we are now primarily a contact center company, substantially all our
revenue has been derived from our ISP operations. In March 2001, we acquired
National Online Services, Inc. ("NOL"), which developed and marketed internet
provider services ("ISP") for small businesses. A majority of the shares of NOL
was acquired from our then principal stockholder. The operations of NOL
commenced during 2001. We continued and expanded the operations of NOL as well
as other ISP subsidiaries operating similar businesses primarily with funds
generated from operations, making considerable expenditures for staffing and
infrastructure. In the fourth quarter of 2003, we determined to focus our
energies on our contact center business providing services for third parties
using facilities we operate or will develop or acquire. Despite this continued
focus, our contact center business represents a small percentage of our revenue.
The effect of this transition on our revenues, income and capital requirements
is discussed below.
Prior to the acquisition of NOL, in November 2000 we acquired and then operated
Savoncalling.com LLC a telecommunication "dial around" company. We ceased
Savon's operations in early 2001 and petitioned for bankruptcy protection for
this entity thereafter. While Savon's reorganization was approved, Savon
presently has no business.
OVERVIEW
We presently derive our revenues from our contact center business and our ISP
business. Our recent and immediate financial condition and prospects have been
and will be effected by three significant factors:
o The FTC Proceeding
o Our decision to concentrate our focus and resources on our contact
center business
o The suspension of marketing of our ISP Services
FTC Proceeding
The proceeding commenced in October 2003, temporarily enjoining our ISP
operations, resulted in a reduction of our revenue and substantial legal
expenses. This contributed to resulting losses and deprived us of cash from
operations which was compounded by the temporary asset freeze and escrow. All
these factors resulted in significantly reduced working capital and delayed
implementation of our new business direction and compelled us to initiate
certain cost cutting measures in early 2004. The Proceeding has no additional
long term effect on our business operations especially as we are no longer
actively marketing ISP services. We however will never recover the lost revenue
or the time our contact center plans and related financing opportunities were
delayed.
Contact Center Business
While we have begun operations, our contact center business is still in its
initial stages. We have approximately 850 seats in the Philippines and are
performing several service agreements. We are actively marketing our contact
center services and, depending on financing, continue to build out the infra
structure and hire additional personnel.
In connection with our change to a contact center business, before operating our
own contact centers we hired additional executives and personnel for the
development and management of contact centers and to obtain sales for new
services. We also incurred costs for due diligence, as well as professional fees
and travel in conjunction with the establishment of these contact centers prior
to opening any center. During a substantial portion of this start up period, our
revenues were interrupted or were declining.
We began operations at two facilities owned by us in the Philippines in the
Spring of 2004. We incurred substantial costs and used substantial funds for
equipment and acquisition and build out of these facilities and will incur
similar costs and use significant funds as we endeavor to open new facilities.
Some of our capital expenditures may be satisfied with equipment leases and
financing arrangements with landlords. The amortization of these build out costs
will be included in future rental payments. In addition to these capital
expenses, we are incurring and will continue to incur increased operation
expenses such as rental, payroll and other administrative expenses. We are also
just beginning to enter into contracts for our services. Because of integration
and training issues there is generally is a lag between significant revenue
producing operations under the contracts and the date of the contract. While we
may control some of these costs, as payroll costs by only hiring as required,
we anticipate losses during this period because of the aforesaid high initial
costs and lag of significant revenue.
The revenues for our contact center business should depend upon several factors
including:
o The degree to which we successfully obtain contracts.
o The length of start up period to performing these contracts, including
any required training period.
o The pace of our expansion of additional capacity.
o The rate of compensation and, for certain programs, programs
performance and success.
Our contact center market may be affected by general economic conditions,
business requirements for telemarketing programs and the effect of any
future governmental regulations.
Revenues from contact center operations are derived from telemarketing and
verification services provided to customers based on customer-specific terms.
Depending on the contract under which telemarketing services are provided, the
company may earn revenues on commission basis or hourly basis, or both.
Cost of sales consists of direct payroll costs, recruitment and training of
personnel and communication costs.
On an ongoing basis, the most significant expense of our contact center
business, will be labor costs for callers, supervisors and administrators as
well as commission paid to brokers. As indicated above, direct labor costs are
part of cost of sales and other labor costs will be expensed under selling,
general and administrative expenses. We also shall incur substantial rental
payments for our leased facilities. Depreciation expenses shall continue to
increase because of increased equipment purchases. Equipment lease payments will
also increase for the same reason as well as amortization of landlord financed
facility improvements. Because of increased borrowing for our facilities and
equipment, interest expenses should rise.
ISP Business
While we are not presently marketing our ISP business, we are continuing to
service our existing customers. Our ISP business essentially consisted of the
marketing of ISP services primarily through third party facilities with
additional value added items provided by us. We do not operate our own network
but use third parties to obtain access to the internet for our clients. The key
to this business before 2004 was the marketing effort to obtain customers. The
greater the marketing efforts, the greater the number of customers. We derived
our revenues from monthly fee charges through local exchange carrier (LEC)
customers. Our revenues and cash flow were affected by several factors in
addition to the extent of our marketing efforts:
o The hold backs and reserves of our billing houses and LECS
o Regulatory actions
o The number of customers canceling in this period
Our cost of sales include: (1) the direct costs of acquiring a new customer as
telemarketing and fulfillment costs and (2) the costs of maintaining our
customer base including customer care costs and telecommunication costs for our
internet provider services. The telemarketing and fulfillment costs are initial
upfront charges incurred when a customer signs up and represent the most
significant component of cost of sales. Conversely, the costs of maintaining our
customer base represent a much smaller component of cost of sales
Historically, we experienced a high rate of cancellation of our ISP customers
which necessitated ever increasing marketing efforts to replace and enhance our
base. The size of our base was critical from cash flow standpoints. Because of
the free trial period, high selling costs and the length of the collection
period, we had to make substantial outlays of cash for our initial customers
before receipt of revenues from our new customers.
The efforts to increase our customer base were thwarted to a substantial degree
by the regulatory action which prevented marketing in certain areas and for a
period of time prohibited marketing. As discussed above on October 30, 2003, the
Federal Trade Commission enjoined us and certain of our subsidiaries from
marketing and billing our ISP services. In November 2003, we were permitted to
resume marketing. We have limited marketing of our ISP services after November
2003 and in early 2004 elected to concentrate our efforts on our contact center
business suspending the marketing of ISP services. We are still servicing our
existing customer base for relatively nominal cost. We also found that there
were higher rates of attrition for new customers. Since our customer base now
consists of seasoned customers both our rate of attrition and bad debt write-off
are lower. Based on current attrition rates we believe we will continue to
derive revenues on a declining basis for several years.
Because we are not marketing the ISP business, our cost of sales has and should
continue to decline, thereby increasing gross profit margins for the business.
Current Trends
The trend of our 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 result of suspended ISP
marketing activity and declining customer base. During our initial phase of
contact center operations we will incur development and startup losses.
Depending on obtaining new contracts and implementing existing ones, we believe
revenues from our contact centers will increase thereby offsetting lost ISP
revenues in the future. We believe contact center revenue will become
substantial in the first quarter of next year. Because of the variables
involved, we can give no assurance that our projected result will be met within
this time frame. Because we have elected to proceed with the expansion of our
contact center business, we have a need for substantial capital (as discussed
under "Liquidity")
ACCOUNTING ISSUES
RESTATEMENT
We have restated our previously issued financial statements for 2002 as follows:
o In 2002 we entered into an agreement to restructure certain debt to a
stockholder. We have determined that the transaction should have been
treated as the issuance of a new note with a loss on debt
extinguishment which includes the value of warrants as of the date of
grant. For the three months and nine months ended September 30, 2003,
amortization expense was reduced by $125,000 and $375,000,
respectively, due to the reversal of amortization of the originally
recorded loan restructuring costs. The new note was recorded at fair
value, which resulted in our recording a discount. The 2003 financial
statements have been restated to reflect the amortization of the
discount of the new loan over 2 years.
o We have recorded the new note resulting from the debt restructuring at
fair value net of a discount.
The foregoing restatement is described in further detail in Note 3 to the
financial statements.
Accounting Policies and Procedures
On an on-going basis, management evaluates its estimates and judgments,
including those related to revenue recognition, allowance for uncollectible
amounts, impairments of intangible assets, recognition of deferred income tax
items, stock-based compensation, bad debts, and intangible assets. Management
bases its estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions.
Management believes the following critical accounting policies, among others,
affect its more significant judgments and estimates used in the preparation of
its consolidated financial statements.
Revenue recognition
Our ISP revenues are derived primarily from fees for providing small businesses
with Internet access, websites, and e-mail addresses through reselling dial-up
internet access technology. Customers are billed monthly, following an initial
thirty-day free trial, and the revenue is recorded over the period in which the
services are provided. Deferred revenue represents the unearned, billed revenue
at the end of an accounting period. We contract with external entities for
billing and collection services. Those entities require that certain holdbacks
and reserves be maintained to allow for the possibility that amounts will not be
collected, refunds will be made, or adjustments to customer accounts will be
allowed. These holdbacks and reserves are included in accounts receivable. We
provide an allowance for lack of collectability of these amounts approximately
equal to fifty percent of the amounts held or reserved. This allowance is
estimated based on historical experience.
In most cases for our contact center business, the revenues generated under
these types of arrangements are billed on a weekly basis, for the preceding
week, and are recognized as revenue during the period in which the services were
provided. In general, customers are required to remit payment to the Company
within seven days of invoicing.
In other instances, when the Company is compensated based on the percentage of
sales revenue generated for its customers over a predetermined period of time.
In other instances for our contact center business the Company's customers
report billings for sales generated by the Company on a monthly basis, at which
time the Company invoices the customer for the preceding month's activity. The
customer is required to remit payment within 60 days of the close of the month
in which the billings occur. The Company recognizes revenue during the periods
in which its customers bill for the services sold through the telemarketing
efforts. The Company also earns an additional "bonus commission" equal to a
predetermined percentage of estimated annual sales for each sale generated. The
Company receives the payment within 60 days of the initial sale and may be
required to return a pro rata portion of the payments in the event a customer
cancels the service sold within a one-year period. The Company recognizes the
revenue related to these commissions over a one year period beginning with the
date the initial sale was made. The portion of the payments received that are
subject to be returned to the customer are recorded as deferred revenue.
Individual contracts are negotiated on a case by case basis and the terms of
future arrangements may vary from the foregoing.
Impairment of intangible assets
In connection with the acquisition of a minority interest in National Online we
recorded goodwill. SFAS No. 142 "Goodwill and Other Intangible Assets" requires
that goodwill no longer be amortized, but rather be evaluated for possible
impairment at least annually. Our policy calls for the assessment of any
potential impairment whenever events or changes in circumstances indicate that
the carrying value may not be recoverable or at least annually. If an evaluation
of undiscounted cash flows indicates impairment, the asset is written down to
its estimated fair value which is based on discounted cash flows. We did not
recognize any impairment charges for goodwill during the nine month periods
ended September 30, 2004 and 2003.
Deferred income taxes
Through December 31, 2003 we incurred significant net operating losses for
income tax purposes. As of December 31, 2003 we had net operating loss carry
forwards available of approximately $19 million. As a result of ownership
changes which occurred in June 2002, our operating tax loss carry forwards are
subject to certain limitations.
In addition, tax laws require items to be included in our tax return at
different times than those items are reflected in our financial statements. Some
of these differences are permanent and some differences reverse over time. These
timing differences, as well as the net operating loss carry forwards, create
deferred tax assets and liabilities. Deferred tax assets generally represent
items that can be used as a tax deduction in our tax return in future years. We
establish valuation allowances for our deferred tax assets when we believe
expected future taxable income to offset those deductions is not likely. Based
on our historical earnings history, we have established a 100% valuation
allowance for our net deferred tax assets.
Stock based compensation
Historically we have used stock options and warrants as a method of compensating
employees, contractors, and creditors for services provided. We account for
options and warrants granted to nonemployees at fair value. We account for
options granted to employees using the intrinsic value method. The intrinsic
value method measures the value of the option as the difference between the
exercise price of the option and our stock price on the date of grant. Usually
we do not recognize any compensation expense in connection with employee options
as the exercise price is generally equal to the stock price on the date of
grant. Under the fair value method we measure the option or warrant at the date
of grant using the Black-Scholes valuation model. The model estimates the
expected value of the option or warrant based on a number of assumptions, such
as interest rates, our stock price, the expected life of the option or warrant
and dividend yield.
Related party transactions
The Company conducts significant transactions with related parties. All material
relationships with related parties are disclosed in notes to the financials
statements in accordance with generally accept accounting principles and the
rules and regulations of the Securities and Exchange Commission.
Comparison of Third Quarter 2004 to Third Quarter 2003 and
Nine Months Ended September 30, 2004 to Nine Months Ended September 30, 2003
General
Set forth below are comparisons of financial results for the quarter ended
September 30, 2004 and 2003 and the nine months ended September 30, 2004 and
2003. These comparisons are intended to aid in the discussion that follows. This
discussion and analysis should be read in conjunction with the financial
statements and related notes contained elsewhere in this report.
Three Months Ended
September 30,
2004 2003 Changes % of Changes
------------- ------------- ------- ------------
(Restated)
----------
Item
Revenue 4,360,539 8,557,326 (4,196,787) -49.0%
Cost of Sales 1,321,677 3,316,407 (1,994,730) -60.2%
Gross Profit 3,038,862 5,240,919 (2,202,057) -42.0%
Expense (exclusive of
Depreciation) 4,648,489 3,965,699 682,790 17.2%
Depreciation
417,230 51,003 366,227 718.1%
Interest Expense
739,415 73,820 665,595 901.7%
Other Income 860,899 - 860,899 -
Net Income
(Loss) (1,905,373) 1,075,570 (2,980,943) -277.2%
Cash, Accounts Receivable and Prepaid
Expense, etc 7,876,739 7,867,041 9,698 1.2%
Property and
Equipment
(Net of Depreciation) 4,949,249 1,263,844 3,685,405 291.6%
Nine Months Ended
September 30,
2004 2003 Changes % of Changes
------------- ------------- ------- ------------
(Restated)
----------
Item
Revenue 13,529,770 30,192,199 (16,662,429) -55.2%
Cost of Sales 3,869,367 13,446,849 (9,577,482) -71.2%
Gross Profit 9,660,403 16,745,350 (7,084,947) -42.3%
Expense (exclusive of
Depreciation) 13,607,517 11,143,662 2,463,855 22.1%
Depreciation
788,845 128,380 660,515 514.5%
Interest Expense 2,825,443 316,470 2,508,973 792.8%
Other Income 1,132,724 - 1,132,724 -
Net Income
(Loss) (6,428,728) 4,665,666 (11,094,394) -237.8%
Our revenues decreased from $8,557,326 in the third quarter 2003 to $4,360,539
in the third quarter 2004. The revenue for the nine month period decreased from
$ 30,192,199 in 2003 to $13,529,770 in 2004. Since we determined to focus our
resources solely on our contact center business, we are no longer marketing our
ISP services, therefore no new customers have been added. As a result, our ISP
Revenue has been declining. Our attrition rate has been stabilized at a low
percentage. We expect a gradual continued decline of revenues from the ISP
business and an increase in revenue from our contact center business. Our
overall decline in revenues occurred notwithstanding that our revenue from our
contact center business for the three month and nine month periods were $878,554
and $1,019,295 respectively.
Our cost of sales for 2004 includes the costs of maintaining our service to our
customer base which includes customer care costs and telecommunication costs for
our internet provider services. The costs of maintaining service to our customer
base represent a much smaller component of cost of sales but are an on-going
cost. As a result, our cost of sales have declined significantly in 2004. Our
costs of sales in the third quarter of 2004 were $1,994,730 lower than costs in
the third quarter 2003 and $9,577,482 lower for the nine month period. These
decreases resulted because of a decline in telemarketing efforts due to our
emphasis on our new business direction. The forgoing decline occurred
notwithstanding an increase in our contact center business costs, consisting
primarily of labor, telecommunication and broker costs. The cost of sales for
2003 reflects high telemarketing costs resulting from increased ISP marketing
efforts in the third quarter of 2003.
Our gross profit was $3,038,862 in the third quarter of 2004 compared to
$5,240,919 in the third quarter of 2003. The gross profit for the nine month
period for 2004 was $9,660,403 compared to $16,745,330 for the nine month period
in 2003. The decrease in gross profit resulted from lower sales not withstanding
a reduction in costs of sales. Notwithstanding the decrease in gross profit our
gross profit margins increased substantially from 61.2% in the third quarter of
2003 to 69.7% for the third quarter of 2004 and the gross profit margin for the
nine month period for 2003 was 55.5% as compared to the nine month period for
2004 of 71.4%. Our increased gross profit margins are a result of decreased
telemarketing and fulfillment costs as described above.
Depreciation expense was $417,230 in the third quarter of 2004 compared to
$51,003 in the third quarter of 2003. Depreciation expense for the nine month
period of 2004 was $788,895 compared to $128,380 for the nine month period in
2003. The increase in depreciation expense is due to depreciation of significant
acquisitions of property and equipment related to the development of call
centers in the Philippines in 2004.
Total expense (exclusive of depreciation) increased from $3,965,699 in the third
quarter 2003 to $4,648,489 in the third quarter 2004. Total expense for the nine
month period for 2003 (exclusive of depreciation) was $11,143,662 as compared to
$13,607,517 for 2004. Included in these expenses is an increase of $966,727 in
selling, general and administrative expenses resulting from increased salary,
travel and professional fees for our contact center business. This was in part
offset by a decline in bad debt expense due to a decrease in the amount of
charges to the holdback and reserves of our billing houses as a result of
decreased billings from our ISP business.
As a result of the foregoing we had a loss from operations of $2,026,857 in the
third quarter 2004 compared to income from operations of $1,224,217 in the third
quarter 2003. The nine month period for 2004 reflects a loss of $ 4,736,009 as
compared to a profit of $5,473,308 for 2003.
Interest expense was $739,415 in the third quarter of 2004 compared to $73,820
in the third quarter of 2003. Interest expense for the nine month period of 2004
was $2,825,443 compared to $316,470 for the nine month period in 2003. The
increase in interest expense is mainly due to the amortization of discounts on
convertible debt issued during the second quarter of 2004. $7,500,000 of
convertible notes with detachable warrants were issued during the second quarter
of 2004. Fair values assigned to the warrants and beneficial conversion features
are charged to interest expense over the lives of the notes. $1,500,000 of the
notes were repaid or converted in the second quarter, resulting in approximately
$1,220,000 of interest related to the warrants and beneficial conversion
features being charged to expense in the second quarter of 2004.
During the third quarter of 2004, we had a gain on extinguishment of debt in
the amount of $859,287 as a result of the modification of the terms of
$6,500,000 of convertible debt. The modification was treated, in accordance with
generally accepted accounting purposes as an extinguishment of the old notes and
the re-issuance of new notes. See the Note 6 to the financial statements
included herein.
We did not have any provision for income taxes in 2004 because of the operating
losses. We had an income tax provision of $491,172 for the nine month period in
2003 and $74,827 for the third quarter of 2003.
As a result of all of the foregoing, we had a loss of $1,905,373 for the third
quarter 2004 compared to net income for the third quarter of 2003 of $1,075,570.
The nine month period in 2004 shows a loss of $6,428,728 compared to net income
for the nine month period for 2003 of $4,665,666.
LIQUIDITY
Liquidity
We had working capital of approximately $2,954,188 as of December 31, 2003 and a
working capital deficit of $3,363,674 on September 30, 2004. We had negative
cash flow from operations in 2004 but had positive cash flow through September
30, 2004 as a result of financings during 2004.
HISTORICAL CAUSE OF PRIOR LIQUIDITY ISSUES OF ISP BUSINESS
At the inception of our ISP business we experienced substantial liquidity
problems due to the gap between the receipt of revenue and the payment of
expenses. This resulted from the long collection cycle of billing houses and the
one month free service provided to the customer. In addition, the liquidity
issue was partly exacerbated by uncollectible receivables, which reduced the
potential cash available. The size of the customer base during the initial
period was not sufficient to overcome the foregoing gap. During 2002, we had a
large enough customer base to overcome the gap.
Liquidity Issues
Prior to the FTC Proceeding in October 2003, we believed we would be able to
continue to meet our obligations arising from our existing ISP business through
cash flow from operations but would need additional financing to fund our entry
to the contact center business. As a result of the proceeding we were deprived
of substantial cash because of the asset freeze and escrow and incurred
substantial expenses and interruption of revenue and billing. As a consequence
we were unable to pay all of our expenses in the normal course of business. We
therefore were compelled to take several measures including the reduction of
personnel, temporary reduction of executive salaries, and postponement of most
activity relating to our new business initiative. Notwithstanding a resolution
of the FTC matter our liquidity problems continued particularly as we determined
to proceed with our new contact center business. This direction required
increased capital expenditures and operating expenses in excess of cash flow.
While we proceeded with our plan irrespective of financing, we were only able to
implement our plan in a meaningful way with additional financing. In 2004 we
received additional financing (described under "2004 Financing") which enabled
us to begin implementation of our plans. We have proceeded with the next level
of plans in the belief that financing would be available and we have made
commitments based on that belief. Since some obligations were due ahead of
financing receipts we are experiencing significant cash flow problems. There is
no assurance we will obtain adequate financing. In addition there are notes
aggregating over $3,400,000 which are due or may become due by January 2005.
Development Milestones
Depending on financing and other factors we intend to add approximately 3,800
additional seats to our existing and new Philippine facilities in the next two
quarters. The following discussion sets forth our anticipated milestones, a two
phase plan for achieving our goals together with the required funds, in excess
of receipts from our service contracts.
Phase 1, to be completed in the first quarter of 2005, calls for the completion
of the balance of approximately 1,700 seats at our flagship center, Epixtar
House, at Eastwood in Manila as well as the completion of 1,100 seats at newly
leased Epixtar Plaza on the site of the former Clark Air Force Base. The total
cash outlay to build out Epixtar Plaza is forecast at approximately is
2,000,000.
During Phase 2, the Company contemplates completion of (a) Epixtar Court, a 200
seat center located in Dumaguete in the province of Negros Oriental and Epixtar
Centre for which we have entered into a lease and (b) Epixtar Centre a 1,250
seat center located in the Aseana Business Park in the Makati section of Manila
for which we have a signed letter of intent.
The total cash outlay of completing Epixtar Court and Epixtar Centre is
estimated at $2,893,000.
We also have determined to commence the build out at an additional 900 seats at
a site to be determined.
CAPITAL TRANSACTIONS
NOTE PAYABLE - STOCKHOLDER
As of October 31, 2001 we entered into a Security Agreement and issued a
promissory note to Brookfield Investment Ltd. in the amount of $2,474,000 to
cover the prior advances made by Brookfield. The note was to be increased to
reflect any future advances which ultimately were never made. The note is
payable by us on demand and the principal amount (exclusive of interest accrued
prior to the date of the note) accrues interest at a rate of 7% per year. The
Security Agreement granted Brookfield a security interest in our accounts
receivable as well as those of all our subsidiaries.
The parties agreed in principle on November 2, 2002, to modify the Brookfield
Agreement and related note obligations to defer demand for payment (except on
non payment defaults) until January 2005. Brookfield also agreed to subordinate
its security interest to financing lenders. We agreed to pay accrued interest on
the note by July 2003 and issued Brookfield a warrant to purchase 4,000,000
shares of our common stock at an exercise price of $.50 per share. In 2003
Brookfield also surrendered its entire security interest so that the note is
presently unsecured.
FACTORING AGREEMENTS
In 2003, two of our ISP subsidiaries entered into a factoring and security
agreement with Thermo Credit, LLC. We were able to sell receivables for half
face with the balance paid upon collection. We paid fees to the factor depending
upon the length of collection of the receivable sold. Upon completion of our
note financing we terminated our factoring arrangements and paid the factor
approximately $708,600.
One of our billing agents also continues to advance a portion of the amount
billed on a factoring basis.
PREFERRED STOCK
In a June 2003 private placement, we sold 23,510 shares of our convertible
preferred stock for an aggregate gross consideration of $2,351,000. For each
share sold, the purchasers received five year warrants to purchase fourteen
shares of our common stock of a total of an exercise price of $7.00 per share
(which has since been reduced to $3.46 pursuant to the terms of the Warrant).
The preferred shares are convertible at an initial conversion price of $3.50
which has been reduced to $2.00 pursuant to performance standards. The price is
subject to further anti-dilution provisions. Approximately 7,010 shares have
been converted into shares of our common stock.
CONVERTIBLE DEBENTURES
In December 2003, we received $500,000 from a small group of primarily
institutional lenders. We issued to the lenders seven percent one year secured
notes convertible into shares of our Common Stock at $4.00 per share. We also
issued to the lenders five year warrants to purchase 62,500 shares of our common
stock at an exercise price of $5.00 per share. Both the notes and warrants are
subject to anti-dilution provisions, including price dilution, which as of
September 30, 2004 have resulted in the reduction in the conversion rates and
exercise prices to $2.39 and $4.09, respectively. The lenders have received a
security interest but subject to certain conditions it is second to existing and
future security interests. We have the right to compel conversion or exercise of
a portion of the notes and warrants depending upon market condition and other
factors.
2004 FINANCINGS
We have received $7.5 million in new financings. Laurus Master Fund, Ltd.
provided $5 million of this financing to us pursuant to a secured convertible
term note, of which $1,930,000 was to be held in a restricted cash account under
the sole control of Laurus and may be released upon the fulfillment of certain
conditions more fully described in the agreements with Laurus.
The term note matures in May 2007 and is convertible at an initial fixed
conversion price of $2.96. In connection with the issuance of the convertible
term note, we also issued to Laurus seven year warrants to purchase up to
493,827 shares of our common stock at prices ranging from $4.05 to $4.66. Of
these warrants to purchase 197,531 shares, were non-exercisable until the cash
in the restrictive account is released.
The remaining $2,500,000 was raised through the private sale of convertible
notes and common stock purchase warrants to accredited investors. Notes in the
principal amount of $1,000,000 or "Bridge Notes" were convertible at a price of
$2.37 per share and are secured. The holders of the remaining $1.5 million of
convertible notes had the right to convert their notes into shares of our common
stock at a price of $2.96 per share or receive the repayment of their principal
amount, plus interest. We have repaid $925,000 of the principal of these notes
with the balance converted into 195,552shares of common stock.
In addition, the holders of the notes received five year warrants to purchase an
aggregate of 136,073 shares of our common stock at initial exercise prices of
between $5.05 and $4.66. The Bridge Notes and these warrants are required to be
converted or exercised in certain circumstances.
We also issued placement agent warrants in connection with each of the above
transactions. An aggregate of 254,316 shares of our common stock is subject to
these warrants of which warrants to purchase approximately 67,564 shares was
deferred until the restrictive cash account referred to above is released. The
terms of the placement agent warrants are varied, as a portion of these warrants
were issued in connection with each transaction and the price and the number of
shares were determined in connection with each such transaction.
The exercise and conversion prices of all the above securities are subject to
price and other adjustment.
Each of the Notes contain restrictions on certain actions we may take, including
restrictions on dividends, stock repurchases, incurring indebtedness, creating
security interests in our assets and changing of our business.
All the above described securities are restricted and we have undertaken to file
a registration statement covering the resale of shares of Common Stock issuable
upon conversion of these notes and exercise of these warrants. Pursuant to a
registration rights agreement entered into with the holders of the above
convertible notes, beginning in October 2004, the Company must pay the holders
of the notes $100,000 for every 30 days until such time that the registration
statement covering the resale of the common stock issuable upon conversion of
the notes and exercise of the warrants becomes effective.
Because of our continuing capital requirements, we were required to obtain
release of amounts from some of the restricted accounts. In August 2004, Laurus
agreed to release $1,000,000 of the restricted amount of their Note in return
for the reduction of the conversion price of the note and the exercise price of
all their warrants to $ 2.15. We have also agreed to similarly reduce the
exercise price of the placement warrants associated with the Laurus transaction.
In September 2004, we received approximately $400,000 from Laurus previously
held in a restricted reserve account securing in part notes held by Laurus and
Bridge Note Holders aggregating $6,000,000. In consideration for the release, we
(i) adjusted the conversion price of the these notes to $2.10 per share and (ii)
granted new warrants to purchase 600,000 shares of our common stock at an
exercise price of $2.15. The Laurus Note is convertible into 2,380,952 shares of
our common stock. Laurus received 500,000 of the additional warrants. The Bridge
Notes are now convertible into 476,190 shares of common stock and the holders
received an additional 100,000 of the additional warrants at $2.15 per share.
In connection with the purchase of equipment for our contact center business, on
October 12 2004, we borrowed $500,000 pursuant to a 6% note due December 15,
2004. In connection with the loan, one of our stockholders agreed to transfer to
the lenders warrants currently held by such stockholder to purchase 200,000
shares of our Common Stock at an exercise price of fifty cents per share.
On October 15 2004 we and our wholly subsidiary Voxx Corporation sold a $550,000
Joint 5% Unsecured Subordinated Convertible Promissory Note due May 2007. Voxx
is a wholly-owned subsidiary of Epixtar and is the holding company for our
subsidiaries that are operating our contact center business. Pursuant to the
agreement, 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
has been increased to 10% per annum based upon the non-occurrence of Voxx
becoming a public corporation. Until Voxx is a public company the holder may
convert his entire note into shares of our Common Stock at a fixed conversion
price related to market but not less than $1.00 The Notes shall be subordinate
in all respects to the Senior Debt.
Other Financing
We have also financed our expansion with equipment leases and landlord
financing for facility improvements. The latter are repayable through
amortization payments added to or paid with the rent for the facility.
COMPARISON OF CASH FLOW OF Third QUARTER 2004 WITH 2003
Our cash and cash equivalents as of September 30, 2004 were $1,723,305 compared
to $2,538,193 as of September 30, 2003 and $1,342,186 as December 31, 2003.
We had negative cash flows from operations of $2,310,924 for the nine month
period of 2004 compared to a positive cash flow of $73,115 for the nine month
period of 2003. The negative cash flow for 2004 was the result of the $6,428,728
net loss offset by non-cash charges to income related to the amortization of
beneficial conversion features and discounts on convertible debt of $2,412,722,
depreciation expense of $788,895, a gain on extinguishment of debt of 1,140,537
and other non-cash charges amounting to $917,383. Uses of cash that did not
affect net income included adecrease n accounts receivable of $1,077,802, a
decrease in accounts payable and accrued expenses of $1,204,126 and a decrease
of deferred revenues of $674,908. These decreases in liabilities resulted from
decreased ISP activity. Cash flows from operations, of $73,115 for the nine
month period in 2003 resulted from a $3,723,399 increase in accounts receivable
during a period of increasing revenues from our ISP business. The $4,665,666 of
net income was further offset by a decrease in deferred revenues of $1,518,178
due to a large amount of 2002 billings being recognized in 2003.
Net cash used in investing activities for the nine month period in 2004 was
$2,682,604 compared to $344,350 in 2003. The increase in capital spending is a
result of the development of the Company's contact center business in the
Philippines.
Net cash provided by financing activities for the nine month period in 2004 was
$5,373,356 compared to $1,868,328 in 2003. The increase in cash flows provided
by financing activities for the nine months in 2004 is a result of the
$7,500,000 of debt financing, net of loan costs and the repayment of $925,000 of
the financing in 2004. In 2003, the cash provided by financing activities was a
result of the sales of preferred stock.
Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
FOREIGN CURRENCY RISK
We are exposed to market risk associated primarily with changes in foreign
currency exchange rates. We have operations in the Philippines; however, both
revenue and expenses of those operations are typically denominated in the
currency of the country of operations, providing a natural hedge.
Our financial statements are presented in U.S. dollars and can be impacted by
foreign exchange fluctuations through both (i) translation risk, which is the
risk that the financial statements for a particular period or as of a certain
date depend on the prevailing exchange rates of the various currencies against
the U.S. dollar, and (ii)transaction risk, which is the risk that the functional
currency of cost and liabilities fluctuates in relation to the currency of our
revenue and assets, which fluctuation may adversely affect operating margins.
With respect to translation risk, even though the fluctuations of currencies
against the U.S. dollar can be substantial and therefore significantly impact
comparisons with prior periods, the translation impact is recorded as a
component of stockholders' equity and does not affect the underlying results of
operations.
INTEREST RATE RISK
A significant portion of our debt is subject to interest at rates that vary
according to changes in the prime rate, which rate has been increasing recently.
Accordingly, the Company's interest expense will be increasing with the rise in
prime rates.
ITEM 4. CONTROLS AND PROCEDURES
This section of the report contains information concerning the evaluation of
disclosure controls and controls over financial reporting as required by Section
302 of the Sarbanes-Oxley Act of 2002. The information contained herein should
be read in conjunction with the Certification filed with this report.
Controls are designed with the objective of ensuring that assets are
safeguarded, transactions are authorized, and financial reports are prepared on
a timely basis in accordance with generally accepted accounting principals in
the United States. The disclosure procedures are designed to comply with the
regulations established by the Securities and Exchange Commission. It is
management's responsibility for establishing and maintaining adequate internal
control over our financial reporting.
Controls, no matter how designed, have limitations. While our chief executive
officer is not aware of any material weaknesses in the issuer's control over
financial reporting, it is the Company's intent that the controls be conceived
to provide adequate, but not absolute, assurance that the objectives of the
controls are met on a consistent basis. Management plans to continue its review
of internal controls and disclosure procedures on an ongoing basis.
Our chief executive officer, after supervising and participating in an
evaluation of the effectiveness of our controls and procedures, has concluded
that as of the evaluation date, the Company's internal and disclosure controls
and procedures were effective.
There were no significant changes in our internal and disclosure controls or in
other factors that could significantly affect such internal and disclosure
controls subsequent to the dates of their evaluation.
PART II
ITEM 1: LEGAL PROCEEDINGS
ITEM 2. CHANGES IN SECURITIES
In July 2004, we issued 87,982 shares of common stock related to the acquisition
of the net assets of a call center located in the Philippines and 15,652 shares
for the acquisition of a prepaid phone card company. The issuance of these
securities was exempt from the registration requirements of the Securities Act
pursuant to Section 4(2) thereof.
IN the third quarter the holders of our convertible preferred stock elected to
convert 5,510 shares of preferred stock into 297,896 shares of the common stock.
The issuance of these securities was exempt from the registrations requirements
of the Securities Act pursuant to the provisions of Section 3(a) (9) thereof.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(b) Reports on Form 8k
The Company filed an 8-K dated July 30 2004 relating to Item 5.
The Company filed an 8-K dated August 18, 2004 relating to Items 5.
The company filed an 8-K dated September 16,2004.
SIGNATURES
In accordance with the requirements of the Securities Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Epixtar Corp.
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(Registrant)
Date November 19, 2004 David Srour
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(Signature)*
Date November 19, 2004 Irving Greenman
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(Signature)*
*Print the name and title of each signing officer under his signature