<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
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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Table of Contents
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PAGE(s)
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PART I. Financial Information: 3.
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 8.
PART II. Other Information 14.
SIGNATURES 16.
EXHIBITS: Exhibit 4 - Form of Convertible Debenture 17.
Exhibit 27 - Financial Data Schedule 24.
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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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JUNE 30, December 31,
2000 1999
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(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
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TOTAL CURRENT ASSETS 1,484,271 770,626
PROPERTY AND EQUIPMENT, NET 1,148,670 721,905
EXCESS OF PURCHASE PRICE OVER ASSETS ACQUIRED, NET 4,438,824 -
OTHER ASSETS 524,307 62,062
----------- ----------
TOTAL ASSETS $ 7,596,072 $1,554,593
=========== ==========
- LIABILITIES AND STOCKHOLDERS' EQUITY -
CURRENT LIABILITIES:
Accounts payable $ 2,976,655 $ 382,045
Vendor equipment payable - 364,666
Lease obligation and note payable, current portion 538,388 87,399
Due to shareholders 71,000 113,000
Accrued expenses 157,793 42,510
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TOTAL CURRENT LIABILITIES 3,743,836 989,620
LONG-TERM LIABILITIES:
Long-term debt, net of current portion 947,873 109,550
Other noncurrent liabilities 43,000 43,000
----------- ----------
TOTAL LIABILITIES 4,734,709 1,142,170
----------- ----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.0001 par value;100,000,000 shares
authorized; 7,398,071 and 4,598,850 shares issued and
outstanding in 2000 and 1999, respectively 740 460
Additional paid-in capital 7,611,073 2,476,488
Subscriptions received - 135,000
Accumulated deficit (4,750,450) (2,199,525)
----------- ----------
TOTAL STOCKHOLDERS' EQUITY 2,861,363 412,423
----------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 7,596,072 $1,554,593
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</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,
------------------------ --------------------------
2000 1999 2000 1999
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OPERATING INCOME:
Telecommunication services $ 2,250,009 $ 386,934 $ 2,415,484 $ 629,372
Installment sales - - 2,342 -
----------- ---------- ----------- ----------
TOTAL 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 1,895,372 339,133 2,484,914 452,266
Merger related costs - 81,554 - 254,045
----------- ---------- ----------- ----------
3,974,287 795,448 4,936,223 1,464,838
----------- ---------- ----------- ----------
LOSS FROM OPERATIONS (1,724,278) (408,514) (2,518,397) (835,466)
----------- ---------- ----------- ----------
OTHER INCOME (EXPENSE):
Interest income (expense) (41,853) 1,130 (31,403) 1,591
Other expense (1,125) - (1,125) -
----------- ---------- ----------- ----------
(42,978) 1,130 (32,528) 1,591
----------- ---------- ----------- ----------
LOSS BEFORE INCOME TAXES (1,767,256) (407,384) (2,550,925) (833,875)
Provision for income taxes - - - -
----------- ---------- ----------- ----------
NET LOSS $(1,767,256) $ (407,384) $(2,550,925) $ (833,875)
=========== ========== =========== ==========
LOSS PER SHARE:
Basic and diluted $ (.24) $ (.11) $ (.39) $ (.22)
=========== ========== =========== ==========
WEIGHTED AVERAGE SHARES 7,248,071 3,584,980 6,609,517 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,
-------------------------
2000 1999
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,550,925) $ (833,875)
Adjustments to reconcile net loss to net cash (used in)
operating activities
Depreciation 210,337 42,907
Common shares issued for services rendered - 127,500
Time contributed in lieu of salary 42,000 -
Changes in assets and liabilities:
(Increase) decrease in accounts receivable (453,393) 17,958
Decrease in installment sales receivable 1,935 11,657
Decrease (increase) in prepaid expenses 302,137 (61,116)
Increase in accounts payable 1,421,507 14,647
Increase in vendor equipment payable - 8,394
(Decrease) increase in accrued expenses (538,694) 35,746
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NET CASH (USED BY OPERATING ACTIVITIES (1,565,096) (636,182)
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment (110,487) (346,799)
Investment in purchased business, net of cash acquired (334,298) -
Deposits for equipment and circuits - (135,840)
----------- ----------
NET CASH (USED) IN INVESTING ACTIVITIES (444,785) (482,639)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Private placement of common shares, net 1,647,572 626,634
Repurchase of founder shares (42,000) (28,000)
Payment of lease obligation for network equipment (40,362) -
Issuance of convertible debentures 300,000 575,000
----------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,865,210 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 INFORMATION
Cash payments for interest $ - $ -
Cash payments for taxes - -
</TABLE>
The Company issued 1,065,857 shares of its common stock in exchange for all the
outstanding shares of Empire One Telecommunications in a stock-for-stock
transaction recorded under the purchase method of accounting. See footnote 3 for
more details.
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SONUS COMMUNICATION HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
NOTE 1 - 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.
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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SONUS COMMUNICATION HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
NOTE 2 - FINANCING (CONTINUED):
In June 2000, the Company sold (and received proceeds of) $300,000 in
subordinated 8% convertible debentures. Each debenture included one
share of Company common stock as well as a warrant to purchase a share
of Company common stock at an exercise price equal to that of the next,
subsequent equity placement of the Company's common stock (the
"Exercise Price"). 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 netting the Company at least
$500,000.
NOTE 3 - ACQUISITION:
On November 15, 1999, the Company signed a definitive merger agreement
to acquire Empire One Telecommunications, Inc. ("EOT") subject to
regulatory and EOT shareholder approval. EOT is a domestic Competitive
Local Exchange Carrier ("CLEC"), Interexchange Carrier and Internet
Service Provider that offers a full range of services including local,
long-distance, internet access and web hosting services to ethnic
communities located mostly in the New York City/New Jersey metropolitan
area and California. The customer base has traditionally been mostly
Chinese and Irish groups with EOT launching a campaign in March 2000
aimed at the Russian speaking communities in the New York City/New
Jersey, San Francisco and Los Angeles metropolitan areas.
To acquire EOT, the Company agreed to exchange 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.
Shareholder approval and all regulatory approvals were received during
the first quarter of 2000 and the merger was completed at the end of
March 2000. The acquisition was accounted for under the purchase
accounting rules and as a result, the operations of EOT are
consolidated with those of the Company beginning April 1, 2000. The
proforma results of operations for the three and six month periods
ended June 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
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<S> <C> <C> <C> <C>
Revenues $2,256,516 $1,578,065 $3,644,038 $3,019,035
Direct expenses 2,110,058, 951,264 3,428,841 1,980,185
Selling, general and administrative expenses 1,816,614 1,161,506 3,248,070 2,037,940
Net loss (1,695,706) (555,247) (3,075,448) (1,032,444)
Net loss per share $(.23) $(.15) $(.47) $(.22)
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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
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.
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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 $4,750,000.
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
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.
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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
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
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
$1,895,372. This represents a 32% increase over the $1,431,453 expense for the
first quarter of 2000[3]. For the six months ending June 30, 2000, total
expenses in this category were $2,484,914 up 22% 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
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.
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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
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
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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.
On November 15, 1999, Sonus Communication Holdings, Inc. and Empire One
Telecommunications, Inc. entered into a definitive merger agreement for the
merger of Empire One Telecommunications, Inc., a New York corporation, with
and into EOT Acquisition Corporation, a Delaware corporation and a
wholly-owned subsidiary of Sonus Communication Holdings, Inc. Regulatory
approvals and the approval of Empire One Telecommunications, Inc.'s
shareholders were obtained in the first quarter of 2000. Following these
approvals, the merger closed on March 29, 2000. Immediately upon closing, EOT
Acquisition Corp. changed its name to Empire One Telecommunications, Inc.
Under the terms of the Sonus/Empire One Telecommunications, Inc. merger
agreement, 1,065,857 shares of Sonus Communication Holdings, Inc. common stock
was issued for all of the issued and outstanding shares of Empire One
Telecommunications, Inc. In addition, the Company incurred a total of $145,000
in fees associated with this transaction, including $78,000 in legal fees,
$62,000 in investment banking fees and a total of $85,000 in accounting fees and
other miscellaneous fees. It is expected that these fees will be capitalized as
part of the acquisition of Empire One Telecommunications, Inc. Please see the
Footnotes to Consolidated Financial Statements for additional information on the
mergers.
As a result of the Company's expanding operations, we had a net loss of
$1,765,256 in the second quarter of this year, an 125% 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 334% increase.
LIQUIDITY
At June 30, 2000 we had cash of $90,017, and negative working capital of
$2,259,565. 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 August, 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. In June 2000, we sold $300,000 in
subordinated 8% convertible debentures. Each debenture included one share of
Company common stock as well as a warrant to purchase a share of Company common
stock at an exercise price equal to that of the next, subsequent equity
placement of the Company's common stock (the "Exercise Price"). 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. We expect to
redeem the convertible debentures in the current round of financing. The Company
received net proceeds of $300,000 from the sale of the debentures by placing
them itself.
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
$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
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received for the remaining $2 million and Management expects to close the
remaining funding in the Current Round by the end of August, 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.
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Part II. OTHER INFORMATION
Item 2. CHANGES IN SECURITIES
In June 2000, the Company sold $300,000 in units (totaling 222,222 units), each
unit consisting of one share of common stock and $1 original principal amount of
its convertible debentures. The convertible debentures, by their terms, mature
and must be repaid in their entirety, including accumulated interest, in one
year from the date of issuance or upon the completion of an equity financing of
the Company of $500,000 or more. The convertible debentures bear an 8% rate of
annual interest. The holders of the convertible debentures also have the right
to convert the principal and accumulated interest into the next equity financing
of the Company of $500,000 or more. The Company is currently conducting an
offering in which it expects to satisfy the criteria for conversion of the
debentures. If no additional equity financing has occurred within one year from
closing of the loan, however, the convertible debentures may be converted into
the Company's common stock at $1.35 per share, subject to customary adjustments
for stock splits, stock dividends, recapitalizations and the like. The Company
granted standard piggy-back registration rights relating to the common stock
issued as part of the unit offering. The units were offered only to corporate
and individual accredited investors. The sale of the units was exempt from
registration under the Securities Act pursuant to Section 4(2) of the Securities
Act and under Rule 506 of Regulation D promulgated under the Securities Act. The
Company relied upon representations and warranties made by investors in the
subscription agreements executed by them.
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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: August 14, 2000
BY: /s/ John K. Friedman
John K. Friedman, President and Chief Operating Officer and Chief
Accounting Officer
EXHIBIT INDEX
Exhibit No. Description
4 Form of Convertible Debenture
27 Financial Data Schedule
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