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 JUNE 30, 2002
-----------------
[ ] 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 -23,932,912 shares issued and outstanding as of
August 26, 2002
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
9278 Communications, Inc. and Subsidiaries
INDEX TO FINANCIAL STATEMENTS
Page
----
Consolidated Balance Sheets as of June 30, 2002 (unaudited) and
December 31, 2001 2 - 3
Consolidated Statements of Operations for the three months ended
June 30, 2002 and 2001 and six months ended June 30, 2002
and 2001 (unaudited) 4
Consolidated Statement of Shareholders' Equity for the six months
ended June 30, 2002 (unaudited) 5
Consolidated Statements of Cash Flows for the six months ended
June 30, 2002 and December 31, 2001 (unaudited) 6 - 7
Notes to Consolidated Financial Statements 8 - 13
Management's Discussion and Analysis 14 - 20
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
--------------- --------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 3,318,992 $ 4,335,936
Restricted cash 1,061,161 1,051,215
Accounts receivable, net of allowance of $835,000
at June 30, 2002 and $760,000 at December 31, 2001 11,053,016 13,058,773
Accounts receivable-related party 2,315,507 1,315,011
Inventories 14,601,327 12,969,347
Prepaid expenses and other current assets 395,378 149,044
------------- -------------
Total current assets 32,745,381 32,879,326
------------- -------------
PROPERTY AND EQUIPMENT, NET 1,648,561 1,306,884
GOODWILL, NET 3,624,071 3,624,071
OTHER ASSETS 178,544 158,187
------------- -------------
$ 38,196,557 $ 37,968,468
============= =============
The accompanying notes are an integral part of these statements.
2
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
---- ----
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $37,645,517 $34,590,301
Accounts payable - related party 101,486 318,950
Current maturities of notes and advances payable,
Shareholder 65,407 570,100
Current maturities of capital lease obligations 42,150 45,549
Current maturities of convertible notes payable 44,696 35,824
Income taxes payable 30,000 59,250
------------ ------------
Total current liabilities 37,929,256 35,619,974
------------ ------------
CAPITAL LEASE OBLIGATIONS, less current maturities 70,235 85,974
CONVERTIBLE NOTES PAYABLE, less current maturities 109,626 140,146
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Common stock - $.001 par value; 40,000,000
shares authorized; 22,932,912 shares issued and
outstanding 22,933 22,933
Capital in excess of par value 8,248,458 8,248,458
Accumulated deficit (8,183,951) (6,149,017)
------------ ------------
87,440 2,122,374
------------ ------------
$ 38,196,557 $37,968,468
============ ============
The accompanying notes are an integral part of these statements.
3
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
Net sales $ 65,912,322 $ 49,578,900 $ 123,277,776 $ 87,017,630
Cost of sales 63,865,090 46,387,665 116,934,276 81,102,970
------------- ------------- ------------- -------------
Gross profit 2,047,232 3,191,235 6,343,500 5,914,660
------------- ------------- ------------- -------------
Operating expenses
Selling 1,330,675 278,362 2,797,262 759,843
General and administrative 2,575,504 1,576,149 4,994,433 2,739,597
Depreciation 98,051 119,110 170,658 234,112
Provision for bad debts 317,610 69,347 369,401 121,617
------------- ------------- ------------- -------------
4,321,840 2,042,968 8,331,754 3,855,169
------------- ------------- ------------- -------------
Operating profit/(loss) (2,274,608) 1,148,267 (1,988,254) 2,059,491
Other income/(expense)
Realized gain on investment securities -- 6,428 -- 9,121
Interest expense, net (5,902) (24,881) (16,680) (70,339)
------------- ------------- ------------- -------------
(5,902) (18,453) (16,680) (61,218)
------------- ------------- ------------- -------------
Earnings/(loss) before income taxes (2,280,510) 1,129,814 (2,004,934) 1,998,273
Income tax provision 15,000 6,175 30,000 9,746
------------- ------------- ------------- -------------
Net income/(loss) $ (2,295,510) $ 1,123,639 $ (2,034,934) $ 1,988,527
============= ============= ============= =============
Earnings/(loss) per common share
Basic and diluted $ (0.10) $ 0.05 $ (0.09) $ 0.09
============= ============= ============= =============
Weighted-average shares
Basic and diluted 23,932,912 23,643,089 23, 932,912 23,394,762
============= ============= ============= =============
The accompanying notes are an integral part of these statements.
4
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Six months ended June 30, 2002
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
Net loss for the six months
ended June 30, 2002 (2,034,934) (2,034,934)
---------- ------- ---------- ----------- ------------
Balance at June 30, 2002 22,932,912 $22,933 $8,248,458 $(8,183,951) $ 87,440
========== ======= ========== =========== ============
The accompanying notes are an integral part of this statement.
5
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
June 30, June 30,
2002 2001
---- ----
Cash flows from operating activities
Net income (loss) $(2,034,934) $ 1,988,527
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 170,658 234,112
Provision for doubtful accounts 369,401 35,000
Changes in assets and liabilities, net of
assets acquired and liabilities assumed
Restricted cash (9,946) --
Accounts receivable 635,859 (3,754,480)
Inventories (1,631,980) (3,296,802)
Prepaid expenses and other current assets (246,334) (84,534)
Other assets (20,356) (2,628)
Accounts payable and accrued expenses 2,837,752 9,488,075
Income taxes payable (29,250) (21,255)
----------- -----------
Net cash provided by operating activities 40,870 4,586,015
----------- -----------
Cash flows from investing activities
Acquisition of property and equipment (512,337) (350,292)
Acquisition of businesses -- (207,741)
Disposition of marketable securities -- 20,962
----------- -----------
Net cash used in investing activities (512,337) (537,071)
----------- -----------
Cash flows from financing activities
Notes and advances payable, shareholder, net (504,692) (960,289)
Notes payable - other -- (900,000)
Principal payments on capital lease obligations (19,137) (26,547)
Principal payments on convertible notes payable (21,648) --
----------- -----------
Net cash used in financing activities (545,477) (1,886,836)
----------- -----------
NET (DECREASE) INCREASE IN CASH
AND CASH EQUIVALENTS (1,016,944) 2,162,108
Cash and cash equivalents, beginning of period 4,335,936 4,114,651
----------- -----------
Cash and cash equivalents, end of period $ 3,318,992 $ 6,276,759
=========== ===========
6
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
June 30, June 30,
2002 2001
---- ----
Supplemental disclosures of cash flow information:
Cash paid during the period for
Interest $ 17,130 $ 70,339
========== ==========
Income taxes 67,381 6,746
========== ==========
Noncash investing and financing activities:
Conversion of preferred stock to common stock $ 505,000
The accompanying notes are an integral part of these statements.
7
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED 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, 2001, 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 six month periods ended June 30, 2002 and 2001 are not
necessarily indicative of the results that may be expected for the fiscal
year ending December 31, 2002.
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.
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
Solution, Inc., 9278 Distributors Illinois, Inc. and Reliable
Acquisition Corp. (hereinafter, the "Company"). All significant
intercompany 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.
8
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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 2000, for federal taxes has been
offset against the company's net operating losses carried forward from
prior years.
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 warrants issued in March 2001 to purchase 210,000 shares of
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
9
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. Therefore, annual and quarterly amortization of goodwill of
approximately $260,000 and $65,000 are no longer recognized. The Company
has performed a transitional fair value based impairment test and has
determined that no impairment of goodwill exist as of January 1, 2002.
The following table presents a reconciliation of net income (loss) and
earnings (loss) per share amounts, as reported in the financial
statements, to those amounts adjusted for goodwill and intangible asset
amortization determined in accordance with the provisions of SFAS No.
142.
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
Reported net income (loss) $(2,295,510) $1,123,639 $(2,034,934) $1,988,527
Add back: goodwill amortization 0 66,689 0 132,916
Income tax effect 0 0 0 0
----------- ---------- ----------- ----------
Adjusted net income (loss) $(2,295,510) $1,190,328 $(2,034,934) $2,121,443
=========== ========== =========== ==========
BASIC EARNINGS (LOSS) PER SHARE:
Reported net income (loss) $(0.10) $0.05 $(0.09) $0.10
Goodwill amortization 0 0.01 0 0
Income tax effect 0 0 0 0
----------- ---------- ----------- ----------
Adjusted net income (loss) $(0.10) $0.06 $(0.09) $0.10
=========== ========== =========== ==========
DILUTED EARNINGS (LOSS) PER SHARE:
Reported net income (loss) $(0.10) $0.05 $(0.09) $0.09
Goodwill amortization 0 0.01 0 0
Income tax effect 0 0 0 0
----------- ---------- ----------- ----------
Adjusted net income (loss) $(0.10) $0.06 $(0.09) $0.09
=========== ========== =========== ==========
10
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
In June 2001, the Financial Accounting Standards Board issued Statements
of Financial Accounting Standards No. 143 ("SFAS No. 143"), "Accounting
for Asset Retirement Obligations," which is effective for years beginning
after June 15, 2002. SFAS No. 143 addresses legal obligations associated
with the retirement of tangible long-lived assets that result from the
acquisition, construction, development or normal operation of a
long-lived asset. The standard requires that the fair value of a
liability for an asset retirement obligation be recognized in the period
in which it is incurred if a reasonable estimate of fair value can be
made. Any associated asset retirement costs are to be capitalized as part
of the carrying amount of the long-lived asset and expensed over the life
of the asset. The Company will adopt SFAS No. 143 for the year beginning
January 1, 2003. The impact of adopting SFAS No. 143 will have no impact
to the consolidated financial statements.
In August 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 144 ("SFAS No. 144"),
"Accounting for the Impairment or Disposal of Long-Lived Assets,"
which is effective for fiscal years beginning after December 15, 2001.
SFAS No. 144 clarifies accounting and reporting for assets held for
sale, scheduled for abandonment or other disposal, and recognition of
impairment loss related to the carrying value of long-lived assets.
The Company has adopted SFAS No. 144 for the year beginning January 1,
2002. There has been no impact of adopting SFAS No. 144 to the
consolidated financial statements.
REVENUE RECOGNITION
Revenue is recognized from sales when a product is shipped and title
passes to the customer.
ADVERTISING
Advertising costs are expensed as incurred and totaled $1,396,433 and
$196,067 for the six months ended June 30, 2002 and 2001, 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.
11
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year financial
statements to conform to the current year presentation.
NOTE 4 - RESTRICTED CASH
Restricted cash consists of the following at June 30, 2002:
Amounts invested in certificate of deposit, which is
pledged as collateral for a letter of credit issued by the bank $ 1,008,843
Amounts invested in certificate of deposit, held by bank as
collateral for deposited funds returned for insufficient funds 52,318
-------------
$ 1,061,161
=============
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
Estimated useful life June 30, December 31,
(years) 2002 2001
------- ---- ----
Furniture and equipment 5 - 7 $ 607,962 $ 483,164
Automobiles 5 - 7 232,431 224,566
Computer equipment 5 1,059,857 731,685
Leasehold improvements 3 - 8 297,229 245,729
---------- -----------
2,197,479 1,685,144
Less accumulated
depreciation and amortization 548,918 378,260
---------- -----------
$1,648,561 $ 1,306,884
---------- -----------
12
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Depreciation and amortization expense for property and equipment for the
six months ended June 30, 2002 and 2001 was approximately $170,658 and
$101,196, respectively.
NOTE 6 - NOTES PAYABLE - SHAREHOLDER
On December 10, 1999, the Company declared $3,000,000 in dividends, of
which $1,000,000 was paid. On December 13, 1999, the Company executed a
promissory note for $2,000,000 for the declared but unpaid dividends,
payable to the Company's chief executive officer, who is also a
shareholder. A principal payment of $1,000,000 was originally due on June
13, 2000, and the second payment originally payable on December 13, 2001.
On March 22, 2001, the Company amended the terms of these promissory notes
to defer both payments to June 30, 2002 and December 31, 2002,
respectively. The final payment is accelerated if the Company's gross
revenue exceeds $10 million in each of any six consecutive calendar months
or exceeds $60 million in any six-month period. During the six months ended
June 30, 2002, the Company made principal payments aggregating $504,692.
Interest is payable at a rate of 8%. For the six months ended June 30,
2002, interest expense on this note was $11,650 and was paid in full as of
that date.
NOTE 7 - RELATED PARTY TRANSACTIONS
Sales of inventory to a customer who is related to an officer of the
Company were approximately $14,143,000 and $11,628,000 for the six months
ended June 30, 2002 and 2001, respectively. The Company also purchased
inventory from this customer in the amount of $3,190,000 and $5,839,000
during the six months ended June 30, 2002 and 2001, respectively.
NOTE 8 - 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.
13
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 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 year ended December 31, 2001, we sold over 120 varieties of private
label cards, which accounted for in excess of 70% 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,
Maryland, Connecticut, Illinois, 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
Website 9278.com(TM). Through our website, consumers
14
worldwide can purchase 9278 phone cards over the Internet from a selection of
over 40 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 For the six months
ended June 30, ended June 30,
2002 2001 2002 2001
---- ---- ---- ----
Net revenues 100.00% 100.00% 100.00% 100.00%
Cost of services 96.89 93.56 94.85 93.21
------ ------ ------ ------
Gross margin 3.11 6.44 5.15 6.79
Selling expenses 2.02 0.56 2.27 0.87
General and administrative expenses 3.91 3.18 4.05 3.15
Depreciation and amortization 0.15 0.24 0.14 0.27
Provision for bad debts 0.48 0.14 0.30 0.14
Interest expense, net 0.01 0.05 0.01 0.08
Other expense/(income) -- (0.01) -- (0.01)
------ ------ ------ ------
Net Income (loss) before income taxes (3.46)% 2.28% (1.62)% 2.29%
------ ------ ------ ------
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
NET REVENUES. Net revenues for the three months ended June 30, 2002 increased
$16.3 million, or 33.0%, to $65.9 million from $49.6 million for the same period
in 2001. During quarter ended June 30, 2002, we introduced several new calling
cards to expand its private label brand offerings and to increase market share.
In addition, geographical expansions made by the Company during the past one
year added to the increase in sales. Sales for our Los Angeles, California
office accounted for 43.1% of the increase in sales for the three months ended
June 30, 2002. In August 2001, we opened two new locations, one in Brooklyn, New
York, which accounted for 16.4% of the increase in sales, and the second in
Chicago, Illinois, which accounted for 22.4% of the increase in sales for the
three months ended June 30, 2002. Starting July 2001, we began actively selling
phone cards over the Internet. Internet sales accounted for 28.4% of the
increase in sales for the three months ended June 30, 2002. In November 2001, we
opened a new office in
15
Poughkeepsie, New York, which accounted for 7.5% of the increase in sales for
the three months ended June 30, 2002. For the three months ended June 30, 2002,
same location sales for our Maryland office accounted for 6.8% of the increase
in sales, Connecticut office accounted for 0.6% of the increase in sales,
whereas our Bronx office recorded a marginal decrease of 3.0% in sales and the
Queens office recorded a 12.4% decrease in sales for the three months ended June
30, 2002 over the same period in 2001. Same store revenues increased primarily
as a result of extensive marketing efforts and continued expansion of market
share for our private label cards. Our Queens office experienced a decrease in
sales due to intense competition by other distributors in that market and
sharing its revenue with the Brooklyn, New York office.
GROSS MARGIN. Gross margin decreased by $1.14 million, or 36%, to $2.05 million,
or 3.11% of net revenues, for the three months ended June 30, 2002, from $3.2
million, or 6.44% of net revenues, for the same period in 2001. The decrease in
gross margin percentage was due to our aggressive sales efforts to increase our
market share by selling cards at a reduced margin during the three months ended
June 30, 2002.
SELLING EXPENSES. Selling expenses for the three months ended June 30, 2002
increased $1,052,000 or 378% to $1,331,000 from $278,000 for the three months
ended June 30, 2002. Of this, $502,000 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 $563,000 as we hired commissioned salespersons to promote sales,
starting in 2001.
Selling expenses as a percentage of net revenues increased to 2.02% for the
three months ended June 30, 2002, from 0.56% for the same period in 2001.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses for the
three months ended June 30, 2002, increased $999,355, or 63.4% to $2,576,000
from $1,576,000 for the same period in 2001. This increase was primarily due to
the increase in salaries and related taxes by $666,000 to $1,330,000 in 2002 as
compared to $663,000 in 2001. Included in the general and administrative
expenses is the cost of processing credit card sales over the Internet in the
amount of $153,000 for the three months ended June 30, 2002. Rent expense
increased by $85,000 to $130,000 in 2002 as compared to $45,000 in 2001 and
telephone expense increased by $93,000 to $126,000 in 2002 as compared to
$33,000 in 2001 as continued to add new locations and expand our existing
facilities. We opened additional offices during the past one-year, for which we
had to incur start-up and establishment expenses that resulted in the increase.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the three
months ended June 30, 2002 totaled $98,000; a decrease of $21,000 as compared to
the same period in 2001. The decrease is the result of the is the fact that we
no longer amortize goodwill as a result of the adoption, as of January 1, 2002,
of SFAS No. 142 of the Financial Accounting Standards Board. This decrease was
offset by an increase in depreciation expense of $46,000 due to acquisition of
fixed assets for our new locations.
INCOME (LOSS) FROM OPERATIONS. We had a net loss of $2,296,000 for the three
months ended June 30, 2002 as compared to a net profit of $1,242,000 for the
three months ended June 30, 2001. The decrease in net income was due to the
increase in operating expenses coupled by a decrease in gross profit margins.
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.
16
SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
NET REVENUES. Net revenues for the six months ended June 30, 2002 increased
$36.3 million, or 41.7%, to $123.3 million from $87.0 million for the same
period in 2001. During 2002, we introduced several new calling cards in its bid
to take market share from its competitors. The increase in revenues was also due
to our acquisitions and geographic expansion since the third quarter of calendar
year 2000 and continuing during the year 2001. In May 2001, we opened a new
office in Los Angeles, California, which accounted for 42.1% of increase in
sales for the six months ended June 30, 2002. In August 2001, we opened two new
locations, one in Brooklyn, New York, which accounted for 12.7% of increase in
sales, and the second in Chicago, Illinois, which accounted for 18.3 % of the
increase in sales for the six months, ended June 30, 2002. Starting July 2001,
we began actively selling phone cards over the Internet. Internet sales
accounted for 12.8% of the increase in sales for the six months ended June 30,
2002. In November 2001, we opened a new office in Poughkeepsie, New York, which
accounted for 5.3% of increase in sales for the six months ended June 30, 2002.
For the six months ended June 30, 2002, same location sales for our Bronx office
accounted for 17.2% of the increase in sales, Maryland office accounted for 6.9%
of increase in sales, Connecticut office accounted for 2.0% of increase in
sales, whereas the Queens office recorded a 16.6% decrease in sales for the six
months ended June 30, 2002 over the same period in 2001. Same store revenues
increased primarily as a result of extensive marketing efforts implemented us
and continued expansion of market share for our private label cards. Our Queens
office experienced a decrease in sales due to intense competition by other
distributors in that market.
GROSS MARGIN. Gross margin increased $0.44 million, or 7.3%, to $6.34 million,
or 5.15% of net revenues, for the six months ended June 30, 2002, from $5.91
million, or 6.63% of net revenues, for the same period in 2001. The decrease in
gross margin percentage was attributable to intense competition from other
distributors and our aggressive sales efforts to increase its market share by
selling cards at a reduced gross margin during the six months ended June 30,
2002. Our gross margin varies from period to period depending upon discounts and
promotions employed from time to time to stimulate sales.
SELLING EXPENSES. Selling expenses for the six months ended June 30, 2002
increased $2,037,000 or 268% to $2,797,000 from $760,000 for the six months
ended June 30, 2002. Of this, $1,200,000 was an increase in advertising costs
incurred to promote our new private label cards in new markets and sales over
the Internet. Included in selling expenses are costs related to sales, marketing
and promotion campaigns organized to build our brand in new markets. Commission
expenses increased by $722,000 as we hired commissioned salespersons to promote
sales, starting in 2001. Trade show expenses increased by $115,000, as we
participate in more trade shows.
Selling expenses as a percentage of net revenues increased to 2.27% for the
six months ended June 30, 2002, from 0.87% for the same period in 2001.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses for the
six months ended June 30, 2002, increased $2,492,000, or 100% to $4,994,000 from
$2,502,000 for the same period in 2001. This increase was primarily due to the
increase in salaries and related taxes by $1,435,000 to $2,518,000 in 2002 as
compared to $1,083,000 in 2001. Included in the general and administrative
expenses is the cost of
17
processing credit card sales over the Internet in the amount of $392,000 for the
six months ended June 30, 2002. Rent expense increased by $178,000 to $268,000
in 2002 as compared to $90,000 in 2001 and telephone expense increased by
$169,000 to $228,000 in 2002 as compared to $60,000 in 2001 as we continued to
add new locations and expand our existing facilities. Other general and
administrative expenses increased due to our opening additional locations and
expenses related to increase in sales volume.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the six months
ended June 30, 2002 totaled $171,000; a decrease of $63,000 as compared to the
same period in 2001. The decrease is the result of the is the fact that we no
longer amortizes goodwill as a result of the adoption, as of January 1, 2002, of
SFAS No. 142 of the Financial Accounting Standards Board. This decrease was
offset by an increase in depreciation expense of $69,000 due to acquisition of
fixed assets on opening new locations.
INCOME (LOSS) FROM OPERATIONS. We had a net loss of $2,035,000 for the six
months ended June 30, 2002 as compared to a net profit of $2,226,000 for the six
months ended June 30, 2001. The decrease in net income was due to the increase
in operating expenses coupled by a decrease in gross profit margins. 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 June 30, 2002, we had total current assets of approximately $32,745,000.
This included $3,319,000 in cash, $1,061,000 in restricted cash, $14,601,000 in
inventories and $13,369,000 in accounts receivable. Our cash balances vary
significantly from day-to-day due the large volume of purchases and sales made
by us from the various prepaid phone cards companies and the numerous
distributors to whom we sells cards.
We provided $41,000 in cash from operating activities during the six months
ended June 30, 2002 as compared to $4,586,015 during the same period in 2001.
Decreases in cash flows during the six months ended June 30, 2002 are related to
a net loss incurred in 2002 and increase in inventories, offset by increase
accounts payable and decrease in accounts receivables. Our decrease in working
capital is attributable to our opening of new offices, which involve carrying of
additional inventories and accounts receivables. We believe our working capital
shortfalls will be alleviated once these offices are established and profitable.
Investing activities used $512,000 during the six months ended June 30,
2002 to acquire additional fixed assets. Financing activities used $545,000
during the six months ended June 30, 2001 to pay down notes payable and
principal on debt obligations.
We believe that existing cash and cash equivalents, cash flow from
operations and available vendor credit and recently negotiated more favorable
payment terms will be sufficient to meet its planned working capital and capital
expenditure budget through the remainder of 2002. However, there are no
assurances that we will not be required to seek other financing. If we is
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
it will be able to otherwise satisfy it short-term cash flow needs from other
sources in the future.
18
CRITICAL ACCOUNTING POLICIES
Financial Reporting Release No. 60, which was recently 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 June 30, 2002, the company had a
deferred tax asset of approximately $1,600,000 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
19
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.
PROPERTY AND EQUIPMENT. Property and equipment are depreciated over their useful
lives. Useful lives are based on management's estimates of the period that the
assets will generate revenue. Any change in conditions that would cause
management to change its estimate as to the useful lives of a group or class of
assets may significantly impact the Company's depreciation expense on a
prospective basis.
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
17.0% of the Company's total accounts receivable balance at June 30, 2002 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 July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, (SFAS No. 143), "Accounting for Asset
Retirement Obligations". This standard addresses the financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The standard is effective for
fiscal years beginning after June 15, 2002. We will adopt this standard
effective January 1, 2003. We do not expect the adoption of SFAS No. 143 to have
a material impact on the company's financial results.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the requirement under SFAS 4 to
aggregate and classify all gains and losses from extinguishment of debt as an
extraordinary item, net of related income tax effect. This statement also amends
SFAS 13 to require that certain lease modifications with economic effects
similar to sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. In addition, SFAS No. 145 requires reclassification
of gains and losses in all prior periods presented in comparative financial
statements related to debt extinguishment that do not meet the criteria for
extraordinary item in Accounting Principles Board Opinion ("APB") 30. The
statement is effective for fiscal years beginning after May 15, 2002 with early
adoption encouraged. The Company will adopt SFAS No. 145 effective January 1,
2003. The Company is currently evaluating the requirements and impact of this
statement on our consolidated results of operations and financial position.
On July 30, 2002, The FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." The statement requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the statement include lease termination costs and
20
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity. SFAS
No. 146 is to be applied prospectively to exit or disposal activities initiated
after December 31, 2002. The Company is currently evaluating the requirements
and impact of this statement on our consolidated results of operations and
financial position
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
------ ----------------------
3.1 Certificate of Incorporation of the Company(1)
3.2 Bylaws of the Company(1)
4.1 2001 Stock Option Plan of the Company(2)
99.1 Certification of Officers
--------------------
(1) Incorporated by reference from the Company's report on Form 10-QSB for the
three-month period ended March 31, 2000
(2) Incorporated by reference from the Company's report on Form 10-KSB for the
year ended December 31, 2000
(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: September 5, 2002 By /s/ Sajid Kapadia
-----------------
Sajid Kapadia
Chief Executive Officer
(Principal Financial and
Accounting Officer)
CERTIFICATIONS
I, Sajid B. Kapadia, Chief Executive Officer of 9278 Communications, Inc.
certify that:
1. I have reviewed this quarterly report on Form 10-Q of 9278 Communications,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report; and
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.
Date: September 12, 2002
/s/ Sajid B. Kapadia
-------------------------------
Sajid B. Kapadia
Chief Executive Officer
(Principal Executive Officer)
I, Jim Scigliano, Chief Financial Officer of 9278 Communications, Inc., certify
that:
1. I have reviewed this quarterly report on Form 10-Q of 9278 Communications,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report; and
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.
Date: September 12, 2002
/s/ Jim Scigliano
-------------------------------
Jim Scigliano
Chief Financial Officer
(Principal Financial Officer)
CERTIFICATION(1)
Pursuant to Section 906 of the Public Company Accounting Reform and Investor
Protection Act of 2002 (18 U.S.C.ss. 1350, as adopted), Sajid B. Kapadia, Chief
Executive Officer and President of 9278 Communications, Inc. (the "Company"),
and Jim Scigliano, the Chief Financial Officer of the Company, each hereby
certifies that, to the best of his or her knowledge:
1. The Company's Quarterly Report on Form 10-Q for the period ended June 30,
2002, and to which this Certification is attached as Exhibit 99.1 (the "PERIODIC
REPORT") fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934, as amended; and
2. The information contained in the Periodic Report fairly presents, in all
material respects, the financial condition of the Company at the end of the
period covered by the Periodic Report and results of operations of the Company
for the period covered by the Periodic Report.
Dated: September 12, 2002
/s/ Sajid B. Kapadia /s/ Jim Scigliano
--------------------------- ---------------------------
Sajid B. Kapadia Jim Scigliano
Chief Executive Officer Chief Financial Officer
(1) THIS CERTIFICATION ACCOMPANIES THIS REPORT PURSUANT TO SS. 906 OF THE
SARBANES-OXLEY ACT OF 2002 AND SHALL NOT BE DEEMED "FILED" BY THE COMPANY FOR
PURPOSES OF SECTION 18 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED.