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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB/A
QUARTERLY REPORT
UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED JUNE 30, 2000
COMMISSION FILE NO. 0-30124
SONUS COMMUNICATION HOLDINGS, INC.
A DELAWARE CORPORATION
IRS EMPLOYER IDENTIFICATION NO. 54-1939577
55 JOHN STREET, 2ND FLOOR, NEW YORK, NY 10038
TELEPHONE - (212) 285-4300
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, as amended, during the preceding 12 months and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
Common stock $.0001 par value, 7,398,071 shares outstanding as of August 4,
2000
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Sonus Communication Holdings Inc. and Subsidiaries
The undersigned registrant hereby amends its quarterly report on form 10-QSB
for the quarter ending June 30, 2000, as set forth in the pages attached
hereto (see notes to financial statements).
Table of Contents
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PAGE(s)
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PART I. Financial Information:
ITEM 1. Financial Statements
Condensed Balance Sheets - June 30, 2000 (Unaudited)
and December 31, 1999 3.
Condensed Statements of Operations (Unaudited) -
Three and Six Months Ended June 30, 2000 and 1999 4.
Condensed Statements of Cash Flows (Unaudited) -
Six Months Ended June 30, 2000 and 1999 5.
Notes to Interim Condensed Financial Statements (Unaudited) 6.
ITEM 2. Management's Discussion and Analysis of Financial Condition 9.
PART II. Other Information 16.
SIGNATURES 17.
EXHIBITS: Exhibit 4 - Form of Convertible Debenture 18.
Exhibit 27 - Financial Data Schedule
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PART I. FINANCIAL INFORMATION:
ITEM I. FINANCIAL STATEMENTS:
SONUS COMMUNICATION HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
- ASSETS -
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(As restated
see Note 1b)
JUNE 30, December 31,
2000 1999
----------- ------------
(unaudited) (audited)
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CURRENT ASSETS:
Cash and cash equivalents $ 90,017 $ 234,688
Accounts receivable, net 1,147,393 31,936
Installment sales receivable, net of unearned
profit of $105,286 in 2000 and 1999, respectively 185,495 187,430
Loan receivable - 150,000
Prepaid expenses 61,366 166,572
----------- ----------
TOTAL CURRENT ASSETS 1,484,271 770,626
PROPERTY AND EQUIPMENT, NET 1,120,969 721,905
GOODWILL, NET 7,823,167 -
OTHER ASSETS 524,307 62,062
----------- ----------
TOTAL ASSETS $10,952,714 $1,554,593
=========== ==========
- LIABILITIES AND STOCKHOLDERS' EQUITY -
CURRENT LIABILITIES:
Accounts payable $ 2,948,954 $ 382,045
Vendor equipment payable - 364,666
Convertible debentures, net of discount 36,496 -
Long-term debt, current portion 238,388 87,399
Due to shareholders 57,000 113,000
Accrued expenses 157,793 42,510
----------- ----------
TOTAL CURRENT LIABILITIES 3,438,631 989,620
LONG-TERM LIABILITIES:
Long-term debt, net of current portion 947,873 109,550
Other noncurrent liabilities 43,000 43,000
----------- ----------
TOTAL LIABILITIES 4,429,504 1,142,170
----------- ----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.0001 par value;100,000,000 shares
authorized; 7,098,071 and 4,598,850 shares issued and
outstanding in 2000 and 1999, respectively 710 460
Common stock to be issued, $.0001 par value; 300,000
Shares pending issuance 30 -
Additional paid-in capital 11,183,663 2,476,488
Subscriptions receivable - 135,000
Accumulated deficit (4,661,193) (2,199,525)
----------- ----------
TOTAL STOCKHOLDERS' EQUITY 6,523,210 412,423
----------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $10,952,714 $1,554,593
=========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
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SONUS COMMUNICATION HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
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Three Months ended Six Months Ended
June 30, June 30,
------------------------ --------------------------
(As restated (As restated
see Note 1b) see Note 1b)
2000 1999 2000 1999
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OPERATING INCOME:
Telecommunication services $ 2,250,009 $ 386,934 $ 2,417,826 $ 629,372
----------- ---------- ---------- ----------
OPERATING EXPENSES:
Direct expenses 2,078,915 374,761 2,451,309 758,527
General & Administrative 1,658,357 339,133 2,239,900 452,266
Goodwill amortization 132,596 - 132,596 -
Merger related costs - 81,554 - 254,045
----------- ---------- ---------- ---------
3,869,868 795,448 4,823,805 1,464,838
----------- ---------- ---------- ---------
LOSS FROM OPERATIONS (1,619,859) (408,514) (2,405,979) (835,466)
----------- ---------- ---------- ---------
OTHER INCOME (EXPENSE):
Interest income (expense) (57,015) 1,130 (54,565) 1,591
Other expense (1,125) - (1,125) -
----------- ---------- ----------- ---------
(58,140) 1,130 (55,690) 1,591
----------- ---------- ----------- ---------
LOSS BEFORE INCOME TAXES (1,677,999) (407,384) (2,461,669) (833,875)
Provision for income taxes - - - -
----------- ---------- ----------- ---------
NET LOSS $(1,677,999) $ (407,384) $(2,461,669) $(833,875)
=========== ========== =========== =========
LOSS PER SHARE:
Basic and diluted $ (.23) $ (.11) $ (.38) $ (.22)
=========== ========== =========== =========
WEIGHTED AVERAGE SHARES 7,248,071 3,584,980 6,547,662 3,854,478
=========== ========== =========== =========
</TABLE>
See notes to condensed consolidated financial statements.
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SONUS COMMUNICATION HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
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Six Months Ended
June 30,
------------------------------
(As restated
see Note 1b)
2000 1999
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,461,669) $ (833,875)
Adjustments to reconcile net loss to net cash (used in)
operating activities:
Depreciation and amortization 257,229 42,907
Provision for uncollectible accounts receivable 54,671 35,772
Common shares issued for services rendered - 127,500
Time contributed in lieu of salary 56,000 -
Changes in assets and liabilities:
(Increase) in accounts receivable (487,228) (17,814)
Decrease in installment sales receivable 1,935 11,657
Decrease (increase) in prepaid expenses 134,302 (61,116)
Increase in accounts payable 728,690 14,647
Increase in vendor equipment payable - 8,394
(Decrease) increase in accrued expenses (174,476) 35,746
----------- -----------
NET CASH (USED) IN OPERATING ACTIVITIES (1,890,546) (636,182)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment (26,534) (346,799)
Investment in purchased business, net of cash acquired (50,096) -
Deposits for equipment and circuits (313,296) (135,840)
----------- -----------
NET CASH (USED) IN INVESTING ACTIVITIES (389,926) (482,639)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Private placement of common shares, net 1,647,572 626,634
Repurchase of founder shares (56,000) (28,000)
Payment of lease obligation for network equipment 244,229 -
Issuance of convertible debentures 300,000 575,000
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 2,135,801 1,173,634
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS (144,671) 54,813
CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE YEAR 234,688 1,002
----------- -----------
CASH AND CASH EQUIVALENTS AT THE END OF THE YEAR $ 90,017 $ 55,815
=========== ===========
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:
Common stock issued to acquire Empire One $ 3,197,571 -
----------- -----------
Warrants issued to employees and non employees in
Connection with Empire One acquisition $ 3,407,808 -
----------- -----------
Common stock issued with convertible debentures $ 188,393 -
----------- -----------
Beneficial conversion discount recorded $ 75,111 -
----------- -----------
OTHER INFORMATION:
Cash payments for interest $ 78,765 $ 71
----------- -----------
</TABLE>
See notes to condensed consolidated financial statements.
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SONUS COMMUNICATION HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
NOTE 1 a. - BASIS OF PRESENTATION:
The accompanying condensed consolidated financial statements apply to
the Company and its wholly-owned subsidiaries and reflect all
adjustments which are, in the opinion of management, necessary for a
fair presentation of the Company's consolidated financial position as
of June 30, 2000 and the results of operations and changes in cash
flows for the three and six months ended June 30, 2000 and 1999. The
results of operations for such periods, however, are not necessarily
indicative of the results to be expected for a full fiscal year. This
Form 10-QSB should be read in conjunction with the Form 10-KSB for
the fiscal year ended December 31, 1999.
The Company currently has insufficient funds available for operations
and would be required to seek additional funds even though it has
been successful in completing the financings discussed in Note 2. As
a result, management has undertaken another round of funding (the
"Current Round") seeking to provide net proceeds to the Company of
$2.7 million after investment banking, legal and accounting fees. The
offering in the Current Round is for 5,000,000 units consisting of 2
shares of the Company's common stock plus a warrant for one share of
the Company's common stock with an exercise price of $0.60. Each unit
is priced at $0.60. Subsequent to June 30,2000, the Company received
approximately $1 million in proceeds from the Current Round.
Additional commitments have been received for the remaining $2
million and management expects to close the remaining funding in the
Current Round during the third quarter, though there can be no
assurance that it will do so. In the event that the Company is unable
to raise additional funds, the Company could be required to either
substantially reduce or terminate its operations.
1 b. - RESTATEMENT
Subsequent to the issuance of the Company's financial statements as
of and for the quarter ended June 30, 2000, the Company's management
determined that certain adjustments were necessary to more fairly
present the balance sheet and income statement. The adjustments
involve recognition of additional purchase price consideration in
connection with the acquisition of Empire One Telecommunications Inc.
of $3,554,427 (also reflected in restated financial statements of
March 31, 2000), debt discounts of $263,504 recognized from
allocation of fair value in connection with convertible debt issued
with common stock and a beneficial conversion feature embedded in
convertible debt issued, and other balance sheet adjustments. As a
result, the financial statements as of and for the quarter and six
months ended June 30, 2000 have been restated from amounts previously
reported. The adjustments involving debt discounts will impact the
income statement in the third quarter. Other balance sheet
adjustments for the second quarter reduced net loss for the second
quarter by $146,619. As a result of the increase in goodwill of
$3,554,427, net loss for the Second quarter was increased by $57,362
due to increased goodwill amortization. A summary of significant
effects of the restatements follows:
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CONDENSED CONSOLIDATED BALANCE SHEET AT JUNE 30, 2000
Previously reported As restated
------------------- -------------
Property and Equipment, net $ 1,148,670 $ 1,120,969
Goodwill, net $ 4,438,824 $ 7,823,167
Total assets 7,596,072 10,952,714
Accounts Payable 2,976,655 2,948,954
Convertible debt, net of discount 300,000 36,496
Due to shareholders 71,000 57,000
Total liabilities 4,734,709 4,429,504
Common stock issued 740 710
Common stock to be issued - 30
Additional paid-in capital 7,611,073 11,183,663
Accumulated deficit (4,750,450) (4,661,193)
Total liabilities and stockholders'
Equity 7,596,072 10,952,714
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS, THREE AND SIX MONTHS ENDED
JUNE 30, 2000
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Second quarter June 30, 2000 Six months ended June 30, 2000
Previously Previously
reported As restated reported As restated
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Gen'l and admin.
Expenses $1,820,138 $1,658,357 $2,409,681 $2,239,900
Goodwill amort. 75,234 132,596 75,234 132,596
Interest (expense) (41,853) (57,015) (31,043) (54,565)
Net loss (1,767,256) (1,677,999) (2,550,925) (2,461,669)
Net loss per share ($.24) ($.23) ($.39) ($.38)
</TABLE>
NOTE 2 - FINANCING:
In January, 2000, the Company completed its offering of 1,851,504
shares of common stock at $1.35 per share. The aggregate offering
price was $2.5 million with the Company realizing $2,246,000 in cash
proceeds. The offering was completed in three pieces with the first
closing occurring in November 1999 for 418,140 shares resulting in
gross proceeds of $564,000 and net proceeds to the Company of
$502,000. The second closing occurred on January 5, 2000 for
1,088,939 shares and net proceeds to the Company of $1,327,000. The
final closing occurred on January 27, 2000 for 344,425 shares
resulting in gross proceeds of $465,000 and net proceeds to the
Company of $417,000. The difference between gross proceeds and net
proceeds reflects expenses of approximately $11,000 with the
remaining being the cash portion of the investment banking fees. At
December 31, 1999, the Company had received $135,000 of the proceeds
which were shown as subscriptions received.
L. Flomenhaft & Co. ("Flomenhaft") acted as the Company's investment
banker for this financing. For the services rendered, Flomenhaft and
a nominee of Flomenhaft received cash fees of approximately $180,000
plus five-year common stock purchase warrants to acquire a total of
257,762 shares of the Company's common stock at an exercise price of
$1.35 per share. The per share exercise price of the warrants was set
at the same value as the common shares sold in the offering.
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In June 2000, the Company sold (and received proceeds of) $300,000 in
subordinated 8% convertible debentures. Each debenture holder
received one share of common stock for each dollar of debt. The
300,000 shares of common stock have been recorded as common stock to
be issued at September 30, 2000, and were subsequently issued in
November 2000. The debentures will mature at the earlier of one year
from the issue date or upon the completion of an equity financing of
$500,000 or more. Each debenture, principal and accrued interest, is
convertible, at the holder's option, into one share of the Company's
common stock at the Exercise Price. If the holder elects not to
convert, the Company is obligated to redeem the debenture plus
accrued interest at the rate of 8% per annum. If converted at the
time of completion of an equity financing of $500,000 or more, the
holder is entitled to convert the outstanding principal and interest
into common shares based on the price of the common stock sold in the
equity financing. If converted at the time of maturity, the holder is
entitled to convert the outstanding principal and interest into
common shares based on a per share price of $1.35.
As the debentures included one share of common stock for each dollar
of debentures, an allocation of fair value between debt and equity
was recorded based on their relative fair values on issue date. As a
result, a discount on the debentures of $188,393 was recorded, and
this value was ascribed to the common stock, based on the then market
price of $1.688. This discount on the debentures is being amortized
over the term of the loan. Additionally, in accordance with EITF
98-5, an additional discount to the debentures was recognized to
account for an embedded beneficial conversion feature present at the
time of issuance. This beneficial conversion component was measured
as the difference between the market price of the common stock at
issue date of $1.688 and the conversion price of the debentures at
$1.35. The resulting intrinsic value of $75,111 has also been
recorded as a discount at issue date, and is being amortized over the
term of the loan.
In June 2000, the Company cancelled an existing stock option
agreement and replaced it with a warrant agreement for an officer.
The warrants entitle the holder to purchase 100,000 common shares
with an exercise price of $1.91, vested immediately upon issuance,
and have a 5 year term from issue date. In accordance with FASB
Interpretation No. 44 "Accounting for Certain Transactions Involving
Stock Compensation", which became effective July 1, 2000, this
effective modification results in a variable award, which results in
the recognition of compensation expense during the life of the award,
measured as the difference between the closing market price at each
measurement date and the closing common stock price at July 1, 2000,
times the number of outstanding warrants.
NOTE 3 - ACQUISITION:
On March 29, 2000, the Company merged with Empire One
Telecommunications Inc. ("EOT"). The Company exchanged 1,065,857
shares of common stock in exchange for all the outstanding common
shares of EOT plus assumption of debt. The shares were valued at
$3.00 per share. The acquisition was accounted for as a purchase. The
operations of EOT are included with those of the Company
prospectively, effective April 1, 2000. The value of consideration
from the shares exchanged was $3,197,571. Additional costs of the
merger included legal and investment banking fees paid of $122,174,
warrants issued (in the money) to EOT founders with a fair value of
$1,863,810, and warrants issued to investment bankers with a fair
value of $1,543,998. The adjusted book value of EOT at merger, which
approximated fair value, was $(1,228,210). As a result, the Company
recorded $7,955,763 in goodwill related to the merger, which is being
amortized over 15 years. The proforma results of operations for the
three and nine month periods
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ended September 30, 2000 and 1999, respectively, are shown below.
These statements do not purport to represent what the actual results
of operations would have been for the Company had the merger been
consummated at the beginning of the earliest period presented, is not
indicative of actual results and does not purport to represent what
the results of operations of the combined entity may be in the
future.
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PROFORMA Proforma
THREE MONTHS ENDED Six Months Ended
JUNE 30, June 30,
----------------------- ------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues $2,250,009 $1,578,065 $3,644,038 $3,644,035
Direct expenses 2,078,915 951,264 3,428,841 1,980 185
Selling, general and administrative expenses 1,658,357 1,086,272 3,097,602 1,887,472
Goodwill amortization 132,596 132,596 265,192 265,192
Net loss (1,677,999) (612,609) (3,190,172) (1,147,168)
Net loss per share $(.23) $(.13) $(.45) $(.23)
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The Private Securities Litigation Reform Act provides a "safe harbor" for
forward-looking statements. Certain statements included in this Form 10-QSB
are forward-looking and are based on the Company's current expectations and
are subject to a number of risks and uncertainties that could cause actual
results to differ materially from results expressed or implied in any
forward-looking statements made by, or on behalf of the Company. The Company
assumes no obligation to update any forward-looking statements contained
herein or that may be made from time to time by, or on behalf of, the Company.
The following discussion of the financial condition and results of operations
of our company should be read in conjunction with the financial statements and
the notes to those statements and the other financial information included
elsewhere in this Form 10-QSB. The Private Securities Litigation Reform Act
provides a "safe harbor" for forward-looking statements. Certain statements
included in this Form 10QSB are forward-looking and are based on the Company's
current expectations and are subject to a number of risks and uncertainties
that could cause actual results to differ materially from results expressed or
implied in any forward-looking statements made by, or on behalf of, the
Company. The Company assumes no obligation to update any forward-looking
statements contained herein or that may be made from time to time by, or on
behalf of, the Company.
OVERVIEW
We are currently a provider of telecommunications services that utilize the
public switched telephone network ("PSTN") as well as private internet
networks via a combination of owned facilities and those leased from
third-party providers. Since we began offering long distance services in late
1998, our strategy had been to establish routes into underserved geographic
markets such as countries that were formerly part of the Soviet Union (e.g.
Republic of Georgia) and developing countries in Asia, the Pacific Rim and the
Caribbean. This strategy involved establishing a relationship with a local
organization in the destination country that would own the necessary equipment
in that country as well as establish any necessary working relationships with
the local phone company or companies.
More recently, we have adjusted our strategy and are establishing ourselves as
a
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retail provider of "bundled" telecommunications services, including local,
long distance and Internet/data services, over a combination of our own
facilities and those leased from third-party providers, to targeted ethnic
markets in the U.S. As of June 30, 2000, we had decommissioned all but one of
our international circuits largely because of rapidly declining margins in the
markets served by those circuits, and have redirected our resources to our
retail entity, Empire One Telecommunications, Inc. ("EOT").
In furtherance of our retail strategy, we closed the acquisition of EOT on
March 29, 2000. Headquartered in New York City, EOT has focused on the Chinese
ethnic markets in the metropolitan areas of New York City, San Francisco and
Los Angeles since its inception in 1996. In March 2000, we initiated a
marketing program targeted at the Russian communities in the U.S. under the
EOT brand. This initiative has resulted in significant revenue and subscriber
growth for the Company, particularly in the second quarter of 2000. We expect
such growth to continue, adjusted for seasonal fluctuations, as we continue to
build our brand equity in the Russian and Chinese markets, and until our
penetration in each market exceeds 10% of available households. We presently
have less than 2% market penetration in each of the Chinese and Russian
markets.
This retail strategy has also led us to wind-down the wholesale international
circuit portion of our business beginning in the second quarter of 2000. As of
the end of the second quarter of 2000, we had decommissioned two of our three
international circuit operations. Decommissioning of the third circuit
occurred in July 2000. As a result, we no longer employ any personnel in our
Virginia office, and are in severance negotiations with two of our former
Virginia officers and employees. We are in the process of concluding
settlements of open contracts that portion of our business had developed prior
to the wind-down and expect to conclude these negotiations in a
mutually-satisfactory manner by the end of 2000, but can provide no assurances
in that regard.
Throughout the second quarter of 2000, Management has been refining the
Company's strategic growth plans. Most of this effort has been directed to
addressing the Company's ability to deliver value-added services, including
high-speed data services, over the "last mile" of the network--the method by
which the Company connects to its subscribers' premises. The Company has been
working with its existing equipment vendors as well as several other vendors
to design and implement a scalable, broadband "last mile" network that will
take advantage of the dense geographic clustering our markets generally
exhibit. These efforts are ongoing with initial deployment expected to begin
by the end of the current calendar year. Management believes these
initiatives, in conjunction with the brand-building efforts already underway,
will result in significant revenue and subscriber growth through 2001, but can
provide no assurances in that regard.
Since initiating service offerings, we have incurred net operating losses and
expect to incur additional losses for the foreseeable future, primarily as a
result of increased sales and marketing efforts as well as the deployment of
our "last mile" network. As of June 30, 2000, we have accumulated net losses
of approximately $4,661,000.
REVENUES
We began operations by offering wholesale long distance services through
leased circuits to other telecommunications service providers desiring to
terminate U.S.-originated voice, fax and data traffic to the countries in
which our circuits terminated or to "refile" such traffic through those
countries to a third country. As a result of international market conditions,
we experienced rapid deterioration in our ability to sustain this business
particularly in light of rapid and continuing erosion in the wholesale price
for international terminations for U.S.-originating traffic. As a result of
this trend and the addition of EOT, while revenues from such activities
represented 100% of our revenues for both the second quarter of 1999 and the
first six months of 1999 ($386,934 and $629,372, respectively), these
activities only accounted for 18.3% ($411,725) of the second quarter 2000 and
only 16% ($579,542) of revenues for the first six months of 2000. As a result
of the decommissioning of our international circuits and the wind-down of our
wholesale business, the Company
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will no longer generate such revenues after July 2000.
Total revenues for the second quarter of 2000 were $2,250,009, an increase of
581% compared to the same period of 1999 ($386,934). For the first six months
of 2000, total revenues were $2,417,826 , an increase of 384% compared to the
same period of 1999 ($629,372). [1] As between the first and second quarter of
2000, revenues increased from $1,387,522 (on a pro-forma combined basis) in
the first three months to $2,250,009 for the second quarter, a 62% increase
quarter-over-quarter. While much of the gain as between the first quarter of
1999 and the first quarter of 2000 was due to the acquisition of EOT[2], the
increase in the second quarter of this year was due to organic growth
generated by the exclusive focus placed on EOT's retail operations.
While the summer months (June through and including August) have historically
been slow growth months for EOT's retail operations, Management expects, but
cannot assure you, that growth will continue apace, as adjusted for this
seasonal fluctuation. We anticipate that continued growth will be generated
principally by continued development of EOT's brand equity in its target
markets and the deployment of the "last mile" network which may enable the
Company to offer an increasing array of highly value-added voice, data and
video services. Additionally, the Company is in the process of developing an
outside sales force to leverage its brand equity into the commercial sector of
the Company's target markets. We are also seeking opportunistic service
offerings we can make available to our markets by either resale or over our
own facilities. To this end, we are negotiating interconnection agreements
between us and Verizon New York and between us and Verizon New Jersey thereby
enabling the Company to provide local services at significantly higher margins
than we currently enjoy. We cannot provide any assurance that such
negotiations will result in contracts with Verizon New York or Verizon New
Jersey on terms favorable to the Company or at all.
DIRECT OPERATING EXPENSES
Direct operating expenses consist primarily of network costs associated with
the routing and termination of customers' traffic as well as interconnection
fees paid to third-party carriers for use of their networks. These include:
- amounts paid to carriers and internet service providers to carry our traffic
on their networks; and
- costs associated with leased circuits and net-leased equipment utilized in
our network.
Management expects that these expenses will continue to increase as the
Company's sales and marketing efforts continue to expand within its target
markets, resulting in increased subscriber counts generating an increasing
volume of traffic. At the same time, however, Management is actively seeking
new, lower cost carriers with high quality to route its terminating traffic
to. Additionally, the Company is nearly finished deploying its long distance
switching facility based on the scalable DTI-manufactured tandem switching
platform, expected to be operational in August 2000. Once this facility is
fully operational, the Company may be able to substantially lower its
interconnection charges by routing traffic to and from the New York
metropolitan area (which traffic comprises the bulk of that routed by the
Company) through this facility. As a result, as these two related developments
mature, Management believes that, while overall direct operating expenses will
increase, as a proportion of revenues these increases will be smaller, but can
provide no assurances in that regard.
SALES, GENERAL AND ADMINISTRATIVE
Sales, general and administrative expenses include the costs associated with
the delivery of our marketing messages, salaries of our employees and
associated benefits, rent, professional fees including those of accountants,
lawyers and other business consultants, as well as ancillary costs such as
insurance, office equipment maintenance and office expenses. A portion of our
general and
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administrative expenses include the costs associated with technical support
and customer service ("Support and Service"), consisting primarily of employee
compensation. As the results discussed below illustrate, we have experienced
significant absolute and percentage increases in these categories. These have
primarily been due to growth in our Support and Service requirements necessary
to support our rapidly growing subscriber base, particularly the need to
create an entire Russian-language Support and Service organization to manage
our Russian-language subscribers. We expect that sales and general and
administrative costs will continue to increase as our subscriber base
continues to grow, however, at a slower rate than we have experienced in the
second quarter of 2000. We expect that this will be due to increased employee
efficiency as well as the incremental demands continued growth is expected to
have on our already established Support and Service organizations.
RESULTS OF OPERATIONS
Subsequent to the issuance of the Company's financial statements as of and for
the quarter ended June 30, 2000, the Company's management determined that
certain adjustments were necessary to more fairly present the balance sheet
and income statement. The adjustments involve recognition of additional
purchase price consideration in connection with the acquisition of Empire One
Telecommunications Inc. As a result, the financial statements as of and for
the quarters ended March 31, 2000 and June 30, 2000 have been restated from
amounts previously recognized. The adjustments primarily involve increases to
goodwill, decreases to convertible debt and increases to paid-in capital, with
related impact to net loss as a result of increased goodwill amortization and
other adjustments (see Note 1b to financial statements).
At the end of the first quarter of 2000, the Company had approximately 14,000
subscribers. At the end of the second quarter of 2000, the Company's
subscriber base had grown to 23,248, an increase of 65%. This growth is a
direct result of the increased sales/marketing budgets available to the
Company's EOT subsidiary since the acquisition of EOT closed on March 29,
2000. Prior to the EOT acquisition, the Company's operations were limited to
providing wholesale international terminations to five telecommunications
services providers over three separate leased circuits terminating in the
Republic of Georgia, Pakistan and the Peoples' Republic of China. As of the
end of the second quarter of 2000 the Company had withdrawn from all but the
Pakistan circuit business, which circuit was decommissioned in late July 2000.
Since the EOT acquisition closed, the Company's sole focus has been on growing
its retail business under the EOT brand.
The growth of our subscriber base has resulted in a concomitant increase in
our direct operating expenses. For the second quarter of 2000, these expenses
totaled $2,078,915, up 58% from the first quarter of the year ($1,318,783).
For the six months ended June 30, 2000, these expenses totaled $2,451,309 an
increase of 24% from the same period in the prior year ($1,980,185). In part
these increases are due to the acquisition of EOT. As between the first
quarter of this year and the second quarter of this year, however, the
increase is directly attributable to the growth in subscribers resulting from
the new Russian marketing initiatives as well as the continuing Chinese
marketing efforts. Management expects that these expenses will continue to
increase as the Company's sales and marketing efforts continue to expand
within its target markets, resulting in increased subscribers generating
increased traffic through our network. Simultaneously, the Company is
proactive in its on-going cost-cutting efforts as to direct operating expenses
including, but not limited to, the following developments:
- the addition of higher quality, lower cost terminating carriers, including
several first-tier, foreign carriers; and
- renegotiating its nationwide originating contract with Global Crossing
resulting in a decrease of approximately 50% in our US access costs; and
- continuing the deployment of its cost-cutting DTI-based switching platform.
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While Management believes that these three on-going cost-cutting efforts could
have significant and long-term positive effects on this expense category,
several factors could off-set these benefits. Among such factors are the
uncertainties of the wholesale termination costs available to the Company.
While these costs have historically decreased, they have fluctuated both up
and down in the past primarily for causes beyond the Company's control. In
addition, regulatory changes regarding inter-carrier network access charges
could reduce the benefit the Company expects to generate as a result of the
newly renegotiated contract with Global Crossing. Moreover, as of the date of
this Form 10-QSB, Verizon Communications is being struck by several of its
union memberships and has been since August 6, 2000. While previous strikes
against Verizon have been settled in relatively short periods of time, there
can be no assurance that such will be the case in the present action. Should
this strike continue for a prolonged period of time it could materially impair
the Company's ability to complete interconnection agreements it is currently
negotiating with Verizon as well as its ability to order additional facilities
from Verizon as they become required, including additional facilities
currently required to complete the final commissioning of the Company's long
distance switch the completion of which could generate an approximately 50%
additional expense reduction for our access traffic in southern New York
State.
Sales, general and administrative costs for the second quarter of 2000 totaled
$1,658,357. This represents a 16% increase over the $1,431,453 expense for
thefirst quarter of 2000[3]. For the six months ending June 30, 2000, total
expenses in this category were $2,239,900 up 10% from the same period in the
prior year ($2,037,940). The majority of this increase was comprised of
marketing/sales expenses and employee compensation expenses. Additional
expenses were incurred until consolidation of offices and tasks were
accomplished following the EOT acquisition. While several obligations remain,
Management, at the Board of Director's instruction, has closed the Company's
Arlington, Virginia office and transferred all duties to New York City-based
employees. In addition, we no longer employ any personnel at our Virginia
office. We are currently in severance discussions with two former corporate
officers and contract employees of the Company's wholesale subsidiary.
The two largest segments of the sales, general and administrative expense
category is comprised of sales/marketing expenses and employee compensation
expenses. Management expects both of these sub-categories to increase in the
future.
In the second quarter of 2000, the Company spent $500,481 for sales/marketing,
a 192% increase from the first quarter of the year and a 339% increase over
the $113,913 spent in the second quarter of 1999. $171,571 was spent in this
category in the first quarter of 2000 compared to $90,628 in the same period
of the prior year--a 895% increase. On a going-forward basis, Management
expects to maintain its sales/marketing budgets at approximately $600,000 per
quarter, but cannot provide any assurances in that regard. While Management
does not expect the Company's low cost of acquisition to be indefinitely
maintainable, it does expect that it will be able to maintain a very
competitive cost per acquisition in its target markets until it achieves a 10%
household penetration in each of these markets. Currently, the Company has
less than 2% penetration in each of these markets.
Employee compensation costs[4] have dramatically increased over the relevant
periods though the rate of growth has been reduced by 75% in the current
period. In the first quarter of 1999, the Company spent $220,952 in total
compensation. In the following quarter this increased by 100% to $442,420. In
the first quarter of 2000, the Company expensed $463,529 representing a 110%
increase over the analogous period in the prior year. Employee compensation
for the second quarter of 2000 totaled $573,099. This represents a 30%
increase over the second quarter of 1999, and a 24% increase from the first
quarter of 2000.
The increases in employee compensation are primarily a result of the rapid
growth the Company has undergone over the past year. The Company's operations
only began to substantially ramp-up in the second quarter of 1999. At that
point, our employment roster was comprised of seven individuals including four
technicians, the Company's two founders and the then chief financial officer.
Of
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the $442,420 expensed in this sub-category in the second quarter of 1999,
roughly 50% was attributable to the wholesale business and 50% to EOT's retail
operations. Due to the addition of the Russian market to our operations in
March 2000, our staffing has increased to a total of 63 employees including
five senior executives, three bookkeeper/accountants, three administrative
staff and 52 customer service personnel.
Employee compensation is projected to continue to increase, though at a
reduced rate, due to two related developments. The first is the low general
unemployment rate which has had the effect of raising compensation rates for
all companies. The second is the continued emphasis the Company is placing on
attracting and retaining top talent. In addition to the experienced managers
obtained via the EOT acquisition, the Company is currently searching for a new
chief financial officer and expects to shortly commence a search for a chief
executive officer; both positions are currently vacant. In addition, the
Company is actively recruiting experienced outside sales managers and
representatives to staff its commercial sales force, as well as experienced
marketing professionals to augment its marketing staff. Given the caliber of
applicants we seek, Management expects to experience additional increases in
expenses related to employee compensation. Moreover, to retain these
prospective new hires and our existing team of experienced managers, the
Company has undertaken a study of its overall compensation plan to ensure that
the Company can continue to compete for the caliber of personnel it requires
to be successful.
In December of 1999, EOT took delivery of two telecommunications switches
manufactured by DTI, one long distance switch (the "Tandem") and one local
switch. Since that time, EOT has been commissioning both switches to be
interconnected into the public switched telephone network ("PSTN"). The Tandem
is expected to be fully commissioned and on-line by the end of August 2000;
the local switch is scheduled to be fully commissioned and on-line by the end
of September 2000.
At the present time, and until the Tandem is fully commissioned, the Company
will continue to lease switching capacity under contract from General Telecom.
We use this capacity to provide both the interconnection required for the
termination of our subscribers' international traffic as well as for its
least-cost routing ability. The contract with General Telecom is
month-to-month, and the Company expects to realize an approximate savings of
$15,000 per month when this contract terminates upon the complete
commissioning of the Tandem, though there can be no assurance in this regard.
Once the Tandem is fully operational, the Company expects to experience
significant reductions in its costs for terminating its subscribers'
international traffic. Management estimates these reductions to average about
10% for its most heavily used routes. In addition, the Tandem may enable the
Company to significantly reduce its access costs paid to other
telecommunications providers for using their networks to originate and/or
terminate our subscribers' calls. For long distance traffic originating and/or
terminating in the New York metropolitan area (comprising the bulk of the
Company's traffic), these costs are estimated to be reduced by up to 50%. The
Company expects that downward price pressure on its retail services will
continue to keep pace with its aggregate wholesale price reductions, however,
and therefore does not expect that significant increases will be realized on
gross profit margins for this traffic in the future.
Bringing the local switch on-line and concluding our negotiations with the
Bell Atlantic companies in both New York and New Jersey are projected to
significantly increase the Company's ability to effectively market and sell
basic local voice services as well as value-added services such as call
waiting, 3-way calling and caller ID. Presently, we strictly resell the local
services of the incumbent local exchange companies ("ILEC") in New York and
New Jersey, the two states where we currently offer local services. Under this
model, our wholesale cost for these services is, as set by regulation in each
jurisdiction, no more than 19.1% below the retail price offered by the ILEC in
that jurisdiction. As a result, and after giving a 5% discount to our local
subscribers and accounting for our associated costs, local services have not
effectively contributed to our gross margins. Once our interconnection
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agreements are finalized and instituted, expected by late in the fourth
quarter of 2000, the Company will be able to provision local services through
a combination of unbundled network elements ("UNE") leased from the ILECs and
interconnected with the Company's local switch, and via a model known as
unbundled network element platform ("UNE-P"). In both cases, the Company
expects gross margins on its local services business to increase.
On March 4, 1999, Sonus Communications, Inc. merged with and into Sonus Park
Acquisitions, Inc., a newly formed wholly owned subsidiary of The Park Group,
Limited. Sonus Communications, Inc., which was the surviving entity, became a
wholly owned subsidiary of The Park Group, Limited and the only asset of The
Park Group, Limited. On April 7, 1999, The Park Group, Limited organized Sonus
Communication Holdings, Inc. as a Delaware corporation and a wholly owned
subsidiary of The Park Group, Limited. On April 16, 1999, Sonus Communication
Holdings, Inc. merged with and into The Park Group, Limited leaving Sonus
Communication Holdings, Inc. as the surviving corporation. Shares of The Park
Group, Limited were exchanged for shares of Sonus Communication Holdings, Inc.
on a one-for-one basis. The sole purpose of the merger was to re-incorporate
in Delaware. The total merger related costs of $262,000 include $238,000 for
costs related to the Park/Sonus merger consisting of legal fees of
approximately $121,000, investment banking fees of $104,000, and accounting
fees and other miscellaneous fees of $13,000.
As more fully described in Note 3 earlier, on March 29, 2000 the Company
merged with Empire One Telecommunications Inc. ("EOT"). The Company exchanged
1,065,857 shares of common stock in exchange for all the outstanding common
shares of EOT plus assumption of debt. The shares were valued at $3.00 per
share.
As a result of the Company's expanding operations, we had a net loss of
$1,677,999 in the second quarter of this year, an 114% increase from the net
loss of $783,669 incurred in the first quarter of 2000. Compared to the second
quarter 1999 net loss of $407,384, we experienced a 312% increase.
LIQUIDITY
At June 30, 2000 we had cash of $90,017, and negative working capital of
$1,954,360. During the first quarter of 2000, we closed a $2.5 million
offering begun in the fourth quarter of 1999. In the second quarter of 2000,
the Company sold $300,000 in subordinated 8% convertible debentures. In
addition, as of the date of this 10-QSB, we are in the process of closing a
further placement of up to $3,000,000 of units, each unit consisting of two
shares of common stock and one common stock purchase warrant. We expect to
complete the offering by the end of September, 2000. Assuming the $3,000,000
offering is fully subscribed and paid for, Management believes the proceeds of
this funding, combined with operating revenues, will be sufficient to allow us
to conduct our operations during the remainder of the fiscal year ending
December 31, 2000.
In January 2000, we received net proceeds of $1,744,000 on a total raise of
$1,935,068, representing the final traunche of a $2.5 million offering at
$1.35 per share begun in the fourth quarter of 1999.
As more fully described in Note 2 earlier, in June 2000, we sold $300,000 in
subordinated 8% convertible debentures. Each $10.00 principal amount of
debenture included one share of Company common stock. Each debenture,
principal and accrued interest, is convertible, at the holder's option, into
one share of the Company's common stock at the exercise price. If the holder
elects not to convert, the Company is obligated to redeem the debenture plus
accrued interest at the rate of 8% per annum upon the next, subsequent
placement of the Company's common stock resulting in proceeds of at least
$500,000. At September 30, 2000, the latest private equity placement closed.
Even though we have been successful in completing the financings noted above,
prior to the financing completed in January 2000, we had negative working
capital of $219,000 at December 31, 1999 with positive shareholder equity of
$412,000. After giving effect to the financings described above, we had
negative working capital of $2,259,565. As a result, we have undertaken
another round of funding (the "Current Round") seeking to provide net proceeds
to the Company of
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$2.7 million after investment banking, legal and accounting fees. The offering
in the Current Round is for 5,000,000 units consisting of 2 shares of the
Company's common stock plus a warrant for one share of the Company's common
stock with a strike price of $0.60. Each unit is priced at $0.60. The Company
has already received approximately $1 million in proceeds from the Current
Round. Additional commitments have been received for the remaining $2 million
and Management expects to close the remaining funding in the Current Round by
the end of September, 2000, though there can be no assurance that it will do
so.
As noted in the discussion under Results of Operations, above, the acquisition
of Empire One Telecommunications, Inc. was completed on March 29, 2000. As a
result of this acquisition, the Company issued 1,065,857 of its common shares
for all the outstanding common stock of Empire One.
In May 1999, we filed a Form 10-SB with the Securities and Exchange Commission
to register our common stock under the Securities Exchange Act of 1934, as
amended. The Form 10-SB became effective in July 1999 and our stock began
trading publicly on the NASDAQ over the counter bulletin board in August 1999.
During the first half of 2000, we have not acquired any significant additional
equipment either through direct purchase or under lease. As noted in the
discussions above, the Company's plans call for significant expansion of its
network into the "last mile." As a result, Management expects that it will
undertake additional equipment deployment commencing in the last half of 2000,
particularly in the fourth quarter.
As noted above, the continued acquisition of subscribers and opportunistic
expansion of our network, particularly in the "last mile," requires
substantial investment of equipment, marketing exposure and personnel. We
expect that we will have to continue to raise funds in both the private and
public markets to have enough cash to pay for this expected expansion and to
continue our operations. We believe that our ability to raise money in the
public sector will enhance these efforts although there can be no assurance
that this will be the case or that any public offering of our securities will
be made.
--------------
[1] This includes all of EOT's first quarter 2000 revenues of $1,240,826.
[2] This acquisition closed 23 March 27, 2000.
[3] This includes EOT's expenses in this category.
[4] These costs include all relevant payroll taxes, surcharges, insurance
premiums and employee benefits, including Company 401(k) contributions, and
include EOT's expenses for the relevant periods.
Part II. OTHER INFORMATION
Item 2. CHANGES IN SECURITIES As reported previously, in June 2000, the
Company sold (and received proceeds of) $300,000 in subordinated 8%
convertible debentures. Each convertible debenture holder also received one
share of common stock for each dollar in principal amount of debentures
purchased. The 300,000 shares of common stock have been recorded as common
stock to be issued at September 30, 2000, and were subsequently issued in
November 2000. The convertible debentures mature at the earlier of one year
from the issue date or upon the completion of an equity financing of $500,000
or more.
If the convertible debenture holder elects not to convert upon the completion
of an equity financing of $500,000 or more, the Company is obligated to repay
the debenture plus accrued interest at the rate of 8% per annum. If converted
at the time of completion of an equity financing of $500,000 or more, the
convertible debenture holder is entitled to convert the outstanding principal
and interest into common shares at the price of the common stock sold in such
equity financing. If converted at the time of maturity, the convertible
debenture holder is entitled to convert the outstanding principal and interest
into common shares based on a per share price of $1.35.
The convertible debentures and shares of common stock were offered only to
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corporate and individual accredited investors and one director of the Company.
The Company relied upon representations and certifications as to accredited
investor status made by the investors in connection with the convertible
debentures purchased by them, and relied upon Section 4(2) of the Securities
Act and on Rule 506 of Regulation D promulgated under the Securities Act to
provide an exemption from the registration requirements of the Securities Act
for the offering and sale of the convertible debentures and shares. No
commissions or other fees were paid in connection with the offer and sale of
the convertible debentures, the shares of common stock issued together with
the convertible debentures, or the shares of common stock underlying the
convertible debentures.
In June 2000, the Company cancelled an existing stock option agreement to
purchase 100,000 shares of common stock at an exercise price of $1.50 per
share, and issued warrants to an officer pursuant to an agreement with the
officer. The warrants entitle the holder to purchase 100,000 common shares
with an exercise price of $1.91, vested immediately upon issuance, and have a
5 year term from issue date. The Company relied upon Section 4(2) of the
Securities Act and on Rule 701 promulgated under the Securities Act to provide
an exemption from the registration requirements of the Securities Act for the
issuance of the warrants. The Company received no proceeds from this
transaction.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description
4 Form of Convertible Debenture
27 Financial Data Schedule
(b) Reports on Form 8-K
(i) Report on Form 8-K filed April 6, 2000 reporting the acquisition of
Empire One Telecommunications, Inc. under Item 2 of such report.
(ii) Report on Form 8-K filed June 16, 2000 containing the financial and
pro-forma information required to be filed in connection with the acquisition
of Empire One Telecommunications, Inc., including consolidated financial
statements for Empire One Telecommunications, Inc. for fiscal years ended
December 31, 1999 and 1998 and pro-forma financial information relating to the
acquisition.
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
(Registrant)
DATE: December 22, 2000
BY: /s/ John K. Friedman
John K. Friedman, President and Chief Operating Officer
BY: /s/ Frank C. Szabo
Frank C. Szabo, Chief Financial Officer
EXHIBIT INDEX
Exhibit No. Description
4 Form of Convertible Debenture
27 Financial Data Schedule
17
