UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission file number: 333-37654
9278 COMMUNICATIONS, INC.
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(Name of business registrant in its charter)
DELAWARE 13-4165136
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(State or jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1942 WILLIAMSBRIDGE ROAD, BRONX, NEW YORK 10461
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(Address of principal executive offices)
Registrant's telephone number, including area code: (718) 887-9278
Securities registered pursuant to Section 12(b) of the Act:
Title of each Name of each exchange on which registered
None Not applicable
------------------------------- ------------------------------------------
Securities registered pursuant to Section 12(g) of the Act:
None
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Indicate by checkmark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate by checkmark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the common stock held by non-affiliated
stockholders of the registrant, as of March 28, 2003, was $1,009,053.
APPLICABLE ONLY TO CORPORATE REGISTRANTS
The number of shares outstanding of the registrant's common stock, as of
March 28, 2002, was 23,932,912.
DOCUMENTS INCORPORATED BY REFERENCE
None
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PART I
ITEM 1. BUSINESS.
General
We are a value-added distributor of telecommunications services and
technologies, specializing in the distribution of prepaid phone cards. We offer
over 700 different prepaid card products, including 300 private label cards,
through a network of over 1,000 primary distributors. Our headquarters is in New
York City and historically a majority of our sales were generated in the New
York metropolitan area. In recent years, we have established a nationwide
network of 18 distribution centers, including centers in California, Virginia,
Connecticut, Illinois, Michigan, North Carolina, Florida, Maryland, New Jersey
and Ohio. Through this network we estimate that our products are sold through
over 150,000 retail outlets. Several of our private label products are marketed
under national or international brand names, such as Absolute(TM) or Extra(TM),
and in some cases also under localized product variations and names tailored to
meet the needs or preferences of localized markets. We are continuously seeking
to introduce new proprietary or third-party telecommunications related products
into our growing distribution channels, including prepaid wireless products and
prepaid direct dial long distance services, and to expand upon our existing
business relationships with the United States telecommunications companies and
large national prepaid card providers we work with. We now offer direct pre-paid
phone card sales through our Internet Websites 9278.com(TM), Callnation.com(TM)
and Let's Dial.com(TM). Through our website, consumers can purchase 9278 phone
cards over the Internet from a selection of hundreds of cards, searchable by
various criteria, e.g., rates, brand name, country, etc., and receive immediate
delivery of the card's access number and PIN codes via e-mail.
Recent Developments - Proposed Going Private Transaction
On January 31, 2003, we announced the execution of a Merger Agreement
with NTSE Holding Corp., a corporation wholly owned by Sajid Kapadia, our
Chairman, Chief Executive Officer and principal stockholder, which will result
in 9278 Communications becoming a privately held corporation, owned by Kapadia.
Pursuant to this agreement, all of the outstanding shares of 9278 Communications
will be cancelled and our existing stockholders will receive a cash payment of
$.10 per share. The transaction is subject to numerous conditions, including the
approval by the our public stockholders. It is expected that a stockholders
meeting to approve the transaction will be held in May, and that the closing of
the transaction, if approved, will occur immediately thereafter.
Industry Overview
Prepaid phone cards were introduced into the North American marketplace
by small long distance consolidators and resellers, which purchase a high volume
of long distance minutes from major carriers at rates significantly lower than
those that could be obtained by individuals and small businesses and which then
resell those minutes to their established customer base. Originally introduced
to meet very specific telephony applications, prepaid telecommunications
services have evolved into a widely accepted solution by both businesses
3
and consumers. More recently, major long distance carriers such as AT&T,
WorldCom and Sprint have committed considerable resources to the prepaid phone
card market.
Prepaid phone cards are a reliable, convenient and cost-effective
alternative to coin-operated calling, collect calling, operator assisted calls
and standard credit calling cards. Unlike credit calling cards, which provide
virtually unlimited credit and impose surcharges on long distance services,
prepaid phone cards are paid for in advance and provide finite amounts of
calling time. Shaped like a credit card, the prepaid phone card easily fits into
a standard wallet. Generally, the front face denotes the denomination of the
card, and the back of the cards contains a scratch-off surface covering the card
number and personal identification number (a "PIN").
Most domestic prepaid cards utilize remote memory technology, which
permits users to place local, long distance and international calls from any
touch-tone phone by dialing a toll-free or local access number to connect to a
prepaid phone card switching platform. After being prompted to enter a PIN, the
caller is advised of the value remaining on the card and is prompted to enter
the telephone number to be called. The call is then routed to its destination.
The per-minute charges for the call are automatically deducted from the prepaid
account corresponding to the PIN as the call progresses.
Prepaid phone cards are distributed through a vast network of retail
outlets, including convenience stores, newsstands, grocery stores and discount
stores. While prepaid phone card products are also sold through vending machines
and, more recently, over Internet websites, the vast majority of phone card
sales are still made through retail outlets.
The retail outlets are serviced by independent distributors, which
often distribute newspapers or other items to the retail outlets. Typically, a
wholesale distributor, like us, purchases large quantities of prepaid phone
cards from a long distance carrier or reseller, or purchases PIN codes from the
carrier to be printed by the distributor on private label cards, and sells the
cards in smaller quantities, together with cards from other carriers, to the
independent distributor for ultimate distribution to the retail outlet. The
discount from face value at which cards are bought and sold by the participants
in the distribution chain varies depending upon the carrier and the features of
the card, such as local versus toll free dial-up access, or the rates and
geographic regions for which the card can be used.
Products and Services
We are primarily a wholesale distributor of prepaid phone cards,
distributing over 700 different types of prepaid phone cards issued from a
variety of telecommunications carriers, including 300 private label cards. The
long distance rates available to users of these cards are significantly less
than the rates for domestic and international calls placed by traditional
methods. Generally, each type of prepaid phone card is available in $5 and $10
denominations, and sometimes in smaller denominations of $2 or $3. We print our
private label cards with PIN's purchased from the telecommunications carrier
pursuant to a program established by the carrier and coordinate the activation
of the cards with the carrier. For third party cards, we purchase pre-printed,
pre-activated phone cards from the card provider. In either case, we distribute
the cards through our network distribution centers though over 1,000 independent
primary distributors.
We currently offer over 300 private label cards, serviced by several
long distance carriers, including, "Extra(TM)", "Arroz Con Pollo(TM)" and
"Bollywood(TM)". Generally, we determine the design and target market of the
cards based upon our perception of market demand and seek appropriate
4
rates from the carriers. Many private label cards, such as the "Absolute" and
"Extra" brand names are marketed in numerous varieties (e.g., "Absolute Europe,"
"Absolute New York," and "Absolute Chicago") designed to target the needs of
certain markets or provide localized features. For example, our "Arroz con
Pollo(TM)" card, with attractive rates to the Dominican republic, had become one
of the most popular cards for use to place calls to that country, and has become
one of the best selling phone cards in Florida. These private label cards are
exclusive to us and, unlike the other types of prepaid phone cards which we
distribute, we control the discounts for these products, leading to higher
margins. Private label cards constituted over 75% of our sales in 2002 and over
70% of our sales in 2001.
Our retail customers can use the prepaid phone cards we distribute at
any touch tone telephone by dialing an access number, followed by a PIN assigned
to each card and the telephone number the customer seeks to reach. The carrier's
switch completes the call, and its debit card platform reduces the outstanding
balance of the card during the call. We believe that many of our customers use
prepaid cards as their primary means of making long distance calls due to:
o Attractive rates;
o Reliable service;
o Ease of monitoring and budgeting long distance spending; and
o The appealing variety of calling cards offered to different
market segments.
One of our focuses has been on distribution in certain ethnic markets
in the U.S. that generate high levels of international traffic to specific
countries. As a result, we have become one of the premiere phone card
distribution channels in the New York City area, which has many such ethnic
markets. Recent immigrants and members of ethnic communities are heavy users of
international long distance, given their desire to keep in touch with family
members and friends back home. In addition, recent immigrants often do not have
established credit histories necessary to establish accounts with traditional
long distance carriers. An example of one of our products marketed to a specific
ethnic group is the Bollywood Phone Card, from which we generated over
$11,000,000 in revenues in 2002. There are approximately 500,000 Indians,
Pakistanis, and Bengalis residing in the vicinity of New York City. The
Bollywood Phone Card is designed for and has become a household name for peoples
from the sub-continent of India, who, by using the card to place long distance
calls to that region, receive deep discounts on rates. Other examples are La
Ranchera(TM), with attractive rates to Central and South America.
We have over 1,000 independent primary wholesale distributors who
purchase from us for resale directly to retail outlets or sub-distributors.
These customers serve as a network, purchasing cards from us and further
distributing them to an estimated 150,000 retail outlets. In 2002, one of our
customers, Sohel Distributor, Inc., accounted for approximately 12% of our
revenues. Sohel Distributor Inc. is owned by the brother of our Chief Executive
Officer and controlling stockholder.
In February 2003, we introduced a pre-paid mobile phone product through
our 9278 Mobile subsidiary. Our pre-paid mobile phones are purchased by
consumers who must also purchase monthly service plans which permit the user to
utilize the phone for a thirty day period, subject to limitations on
5
minute usage. Available minute usage may be increased through the purchase of
"extended airtime" cards, and additional monthly service can be obtained from
monthly access cards. To date, we have conducted such sales efforts on an
introductory basis to allow us to better determine the best distribution
processes and to allow us to test consumer acceptance, pricing and customer care
issues. Although some of our existing distributor base will be viable outlets
for this product, it is likely that new distribution channels will need to be
established to maximize the potential sales of this product. Unlike our existing
phone card business, the sale of mobile phones requires significant up front,
out-of-pocket expenses to acquire the phones and the reliance on third party
software vendors and carrier service providers for the continued functionality
of the phones.
Strategy
Our goal is to solidify our position as a dominant player in the
pre-paid distribution industry by continuously expanding the breadth of our
distribution network and by offering the most sought after pre-paid products to
the marketplace. Our focus also continues to be on building brand name awareness
for "9278" with the consumer base, the distribution networks, and with
telecommunications carriers. By shifting our product offerings to include a
greater percentage and variety of 9278 private label cards, and by expanding our
number of regional branch offices, we have strengthened our position as premiere
provider of pre-paid calling cards.
Our goal is to continue our growth in our client base and market share
of the prepaid card industry through internal expansion and by strategic
expansion into new regional markets. We believe that this presents the
opportunity for us to secure a significant share of the North American market
and to expand into international markets such as Europe, Asia and the Pacific
Rim.
In 2001 we implemented a retail e-commerce strategy that has expanded
the geographic reach of our distribution. As this distribution channel expands,
we expect that this distribution channel will also create operational
efficiencies and ultimately increase margins. E-commerce sales accounted for
approximately 7.8% of our gross sales in 2002.
In 2002, we significantly expanded our direct sales efforts to
penetrate markets not directly serviced by our existing branch offices. Our
telemarketing team of almost 20 salespersons engages in telemarketing efforts as
well as pursuing customer leads, both retail outlets and distributors, attracted
by our advertising or public relations efforts or by word of mouth.
To date, the ultimate consumer of mass market prepaid phone cards have
been predominantly immigrants needing access to the North American and/or
international telecommunications systems and who have a need for competitive
pricing for international calls to their native country, as well as other
consumers making a significant volume of overseas or long distance calls. To a
lesser extent, cards are purchased by travelers and niche market card
collectors. Of our numerous private label cards, many are directed to specific
geographic regions to gain market share and brand awareness with these
consumers. To remain competitive, we will be conducting a targeted marketing
program to distributors, retailers and corporations. In addition, we will seek
out strategic partners who currently provide distribution and marketing of
prepaid cards to different customers or regions as a means of increasing overall
market share.
We recently established a strategic relationship with IBGH
Communications, a New York based telecommunications carrier which will provide
us with flexible utilization of IBGH's
6
telecommunications facilities to provide carrier services to cards developed and
marketed by us. This relationship, in addition to providing flexibility and
attractive rates, will provide us with a right of first refusal on IBGH's
capacity which we expect will provide us with additional security against the
risks of relying on many third party carriers for switching facilities. To
facilitate this arrangement, we have made significant prepayments to IBGH to
fund the establishment of the network to our specifications. Such prepayments
are to be offset against future PIN purchases by us, and IBGH has agreed to
repay the unused advance payment on or before December 31, 2003. Such repayment
obligation is evidenced by a secured promissory note executed by IGBH.
Competition
The telecommunications services industry generally, and the prepaid
phone card industry specifically, is intensely competitive, rapidly evolving and
subject to constant technological change. There are several large and numerous
small competitors in the industry, and we expect to face continuing competition
based on price and service offerings from existing competitors and new market
entrants. In addition, the increasing prevalence of the Internet and emerging
technologies seeking to establish Internet telephony pose potential competitive
threats to the market for long distance telephone services. The principal
competitive factors in the market include:
o Price;
o Quality of service;
o Breadth of geographic presence;
o Customer service;
o Reliability;
o Network capacity; and
o Availability of enhanced communications services.
Our competitors include:
o Other distributors of prepaid products, such as Union
Telecard Alliance and Blackstone Calling Card;
o Telecommunications companies that produce their own prepaid
products, such as IDT and Qwest; and
o Other telecommunications companies, such as AT&T, and
WorldCom.
Some of our competitors have substantially greater financial, technical
and marketing resources, larger customer bases, longer operating histories,
greater name recognition and more established relationships in the industry than
we have. As a result, certain of these competitors may be able to adopt more
aggressive pricing policies, which could hinder our growth.
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Government Regulation
The provision of telecommunications services is regulated by the
federal and state governments of the United States. Federal laws and regulations
promulgated by the Federal Communications Commission apply to interstate and
international telecommunications, while state regulatory authorities have
jurisdiction over telecommunications services that originate and terminate
within the same state. Various other international authorities also may seek to
regulate telecommunications services originating in their respective countries.
However, as of the date of this report, we are not aware of any requirement for
government approval to manufacture, distribute and/or market prepaid phone
cards.
Employees
As of March 15, 2003, we had 188 full-time employees. Of these, 25 were
sales and marketing personnel, 13 were management and finance personnel, 24 were
customer service personnel, 10 were information technology personnel, 11 were
warehouse and shipping personnel, 12 were general and administrative personnel,
and 93 were employed in our branch offices in a variety of roles. None of our
personnel are covered by a collective bargaining agreement. We have never
experienced an employment-related work stoppage and consider our employee
relations to be satisfactory.
ITEM 2. PROPERTIES
Our executive offices are located at 1942 Williamsbridge Road, Bronx,
New York, where we lease approximately 3,500 square feet, pursuant to a sublease
agreement that expires on November 30, 2008. The aggregate annual base rental
for this space is $63,000. We sublet these premises from an officer and director
of ours, on terms substantially the same as those under which the officer leases
the space.
We also lease approximately 2,600 square feet, located at 1938
Williamsbridge Road, Bronx, New York, pursuant to a lease that expires in March
2008. This space is used as additional office space and as a warehouse location
for the off-site storage of our products. The annual rent for such space is
$102,000.
In addition, we lease approximately 2,700 square feet, located at 1965
Williamsbridge Road, Bronx, New York to house our ecommerce, telemarketing and
customer service operations. We lease this space pursuant to a lease agreement
that expires on November 30, 2003. The aggregate annual base rental for this
space is $60,000.
We also maintain sales and distribution offices in 13
additional sites, in the states of CT, FL, NC, MI, CA, MD, VA, NJ and OH
servicing principally their respective local markets. These branch offices
combine office and warehouse facilities and range in size from approximately 750
square feet to approximately 3,500 square feet, at annual rentals ranging from
approximately $10,000 to $105,000.
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ITEM 3. LEGAL PROCEEDINGS.
We are subject to certain legal proceedings and claims which have
arisen in the ordinary course of our business. These actions when ultimately
concluded will not, in the opinion of management, have a material adverse effect
on our financial position, results of operations or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
9
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Market Information
During the fiscal year ended December 31, 2002, our common stock was
quoted on the over-the-counter bulletin board ("OTCBB") of the Nasdaq Stock
Market under the symbol "NTSE". The following table sets forth the range of the
high and low bid quotations for our common stock for the periods indicated. Such
market quotations reflect inter-dealer prices, without mark-up, mark-down or
commission and may not necessarily represent actual transactions. Since January
6, 2003, our common stock has been traded in the "pink sheets"
High Low
---- ---
2002
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First quarter $0.42 $0.25
Second quarter 0.36 0.10
Third quarter 0.10 0.04
Fourth quarter 0.08 0.04
2001
-------
First quarter $1.59 $0.61
Second quarter 0.74 0.40
Third quarter 0.51 0.36
Fourth quarter 0.37 0.20
As of March 28, 2003, there were approximately 370 holders of record of
our common stock and the closing bid quotation of our common stock on the pink
sheets was $0.079 per share.
On January 31, 2003, we announced the execution of a Merger Agreement
with NTSE Holding Corp., a corporation wholly owned by Sajid Kapadia, our
Chairman, Chief Executive Officer and Principal Stockholder, which will result
in 9278 Communications becoming a privately held corporation, owned by NTSE
Holding Corp. Pursuant to this agreement, all of the outstanding shares of 9278
Communications will be cancelled and existing stockholders will receive a cash
payment of $.10 per share. The transaction is subject to numerous conditions,
including the approval by the stockholders of 9278 Communications. It is
expected that a stockholders meeting to approve the transaction will be held in
late May, and that the closing of the transaction, if approved, will occur
immediately thereafter.
10
Dividend Policy
We do not intend to pay future dividends and intend to reinvest any
earnings into our business to finance future growth. Accordingly, our Board of
Directors does not anticipate declaring any cash dividends in the foreseeable
future.
ITEM 6. SELECTED FINANCIAL DATA
For the Year Ended December 31,
-------------------------------
(in thousands, except share data)
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Net Sales $246,980 $200,177 $80,763 $78,090 $22,169
Cost of Sales 233,800 189,212 77,793 75,473 21,487
Operating Expenses 19,141 9,924 5,599 2,028 602
Earnings (loss) before $(5,961) $721 $(3,419) $12 $80
income taxes
Earnings (loss) per $(0.25) $.03 $(0.16) $(0.02) $0.00
common share
Weighted-average 23,932,912 24,500,881 20,902,060 19,659,629 14,900,000
shares
As at December 31,
Current Assets $47,828 $32,879 $14,562 $6,827 $3,400
Total assets 53,945 37,968 19,141 7,144 3,543
Convertible notes 140 176 - - -
payable
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto set forth in Item 7 of this Annual
Report. In addition to historical information, this discussion and analysis
contains forward-looking statements that involve risks, uncertainties and
assumptions, which could cause actual results to differ materially from
management's expectations. Factors that could cause differences include, but are
not limited to, expected market demand for the Company's products, fluctuations
in pricing for products distributed by the Company and products offered by
competitors, as well as general conditions of the telecommunications
marketplace.
OVERVIEW
To date, our principal source of revenue has been the marketing and distribution
of prepaid phone cards. We market and distribute branded prepaid phone cards,
which are produced by a variety of telecommunications long distance carriers and
resellers, as well as private label proprietary prepaid phone cards produced
exclusively for us by various long distance carriers and/or resellers.
Prepaid phone cards are distributed through a vast network of retail outlets,
including convenience stores, newsstands, grocery stores and discount stores.
The retail outlets are serviced by independent distributors, which often
distribute newspapers or other items to the retail outlets. We purchase large
volumes of branded prepaid phone cards from the long distance carrier or
reseller and sell the cards in smaller quantities, together with cards from
other carriers and/or private label cards we distribute, to the independent
distributor, for ultimate distribution to retailer outlet.
We purchase branded cards at a discount from the face value of the card, and
resell them to the distributor at a slightly lower discount. The difference
between the two discount rates, typically from 1% to 8%, represents the gross
margin we retain. We purchase branded cards on varying terms, from C.O.D. to an
as used basis. Sales of our products are generally made on a net 21 basis.
Private label cards are generally designed and produced by us, utilizing card
numbers and PINs provided by the telecommunications carrier or reseller
providing the long distance service for the card. We incur the upfront expense
of printing the phone cards. However, we do not pay the long distance carrier
until it activates the cards, which occurs upon our sale to the distributor.
Accordingly, through the use of private label cards, our cost of inventory is
significantly reduced, as purchases are effectively made on an as-needed basis.
In addition, private label cards generally provide us with the ability to
achieve a greater gross margin percentage, typically ranging from 5% to 8%.
During the past two years, we have continued to increase our sales of private
label cards, both on an absolute dollar volume and as a percentage of our sales.
During the year ended December 31, 2001, we sold over 120 varieties of private
label cards which accounted for in excess of 70% of our total revenues.
We continue to seek to expand our geographic reach and to increase our sales. In
recent years, we have established distribution centers in California,
Connecticut, Florida, Illinois, Maryland, Michigan, North Carolina, New Jersey,
Virginia, Upstate New York, as well as additional distribution centers
12
in the New York metropolitan area, and we have established strategic
relationships with distributors in Canada and United Kingdom. In addition, we
sell pre-paid phone card through our Internet Website 9278.com(TM). Through our
website, consumers worldwide can purchase 9278 phone cards over the Internet
from a selection of over 40 cards, searchable by various criteria, e.g., rates,
brand name, country, etc., and receive immediate delivery of the card's access
number and PIN codes via e-mail.
We are seeking to develop and acquire rights to additional prepaid
telecommunications services and other prepaid products or services to diversify
our product offerings and increase our overall gross margin. In the short-term,
additional costs related to the development or acquisition of such products may
have an impact on our net profits.
RESULTS OF OPERATIONS
The following table sets forth certain financial data as a percentage of net
revenues for the periods indicated:
For the Years
ended December 31,
2002 2001
---- ----
Net revenues 100.00% 100.00%
Cost of services 94.66 94.52
------ ------
Gross margin 5.34 5.48
------ ------
Selling expenses 3.07 1.11
General and administrative expenses 4.20 3.15
Depreciation and amortization 0.16 0.26
Provision for bad debts 0.32 0.44
Interest expense, net 0.01 0.06
Litigation settlement - 0.10
------ ------
7.76 5.12
------ ------
Earnings (loss) before income taxes (2.42)% 0.36%
------ ------
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
NET REVENUES. Net sales increased by approximately $47 million to $247 million
for the year ended December 31, 2002, up over 23.4% from net sales of $200.0
million for the year ended December 31, 2001. The increase in net sales was
primarily due to our geographic expansion since the third quarter of calendar
year 2000 and continuing since then. New locations opened during 2002
contributed $9.1 million or 19.4% of the total increase in sales during 2002.
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GROSS MARGIN. Gross margin increased to approximately $13.2 million in 2002, as
compared to approximately $11 million in 2001, principally as a result of
increased volume. As a percentage of sales, gross profit for 2002 and 2001
remained virtually flat, decreasing to 5.34% as compared to 5.48% for the year
ended December 31, 2001. The no change in gross margin percentage was
attributable to the Company's aggressive sales efforts to increase its market
share by selling cards at a reduced gross margin during this period. Our gross
margin varies from period to period depending upon discounts and promotions
employed from time to time to stimulate sales.
SELLING EXPENSES. Selling expenses increased by $5,347,000 or 240% to $7,576,000
in 2002 as compared to $2,229,000 during the year 2001. Of this, $2,700,000 was
increase in advertising costs incurred in connection with the Company promoting
its private label cards and sales over the Internet during the year 2002. The
commission expense increased by $2,461,000 as the Company hired additional
commissioned salespersons in 2002 to promote its sales. Trade shows expense was
increased by $186,000 as a result of negotiated packages, and cost of printing
of trade publications were reduced by $63,000 as the company utilized its
in-house facilities in designing these publications.
Selling expenses as a percentage of net revenues increased to 3.07% for the year
ended December 31, 2002, from 1.11%, for the same period in 2001.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased by $3,964,000 or 58% to $10,774,000 for 2002 as compared to $6,810,000
for 2001. This increase was primarily due to the increase in salaries by
$2,165,000 to $5,412,000 in 2002 as compared to $3,247,000 in 2001 resulting
from additional personnel required for new offices, direct sales efforts and
Internet customer service. Included in the general and administrative expenses
is the cost of processing credit card sales over the Internet which increased by
$440,000 to $666,000, for the year 2002 as compared to $226,000 for the year
2001. In addition the Computer services expense increased by $370,000 to
$445,000 in 2002 as compared to $75,000 in 2001.Rent expenses increased by
$252,000 to $560,000 in 2002 as compared to $308,000 in 2001 as the company
continued to add new locations and expand its existing facilities. Telephone and
utilities increased by $268,000. Other general and administrative expenses
increased by $469,000 due to the company opening additional locations and
expenses related to increase in sales volume.
General and administrative expenses as a percentage of net revenues increased to
4.20% for the year ended December 31, 2002, from 3.15%, for the same period in
2001.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the year ended
December 31, 2002 totaled $393,000; a decrease of $119,000 as compared to the
same period in 2001. The decrease is due to the fact that we no longer amortize
goodwill as a result of the adoption, effective January 1, 2002, of SFAS No. 142
of the Financial Accounting Standards Board. This decrease was offset by an
increase in depreciation expense of $138,000 due to acquisition of fixed assets
for our new locations.
PROVISION FOR DOUBTFUL ACCOUNTS. Provision for bad and doubtful debts decreased
by $95,000 to $790,000 in 2002 as compared to $885,000 in 2001. This decrease is
due the Company's aggressive collection efforts of its accounts receivable.
NET INCOME (LOSS) FROM OPERATIONS. We had a net loss of $5,970,000 for the year
ended December 31, 2002 as compared to a net profit of $656,000 for the year
ended December 31, 2001. The decrease in net income was due to the increase in
selling expenses and operating expenses. Our
14
geographical expansion by opening up new offices nationwide has led to increase
in selling, general and administrative costs. We also adopted an aggressive
pricing policy by discounting our cards and giving away promotional cards in
these new locations to gain market share. We believe that our loss from
operations is temporary and that there should be a turnaround once these new
offices are established.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Net sales increased by approximately $120 million to $200.2 million for the year
ended December 31, 2001, up over 148% from net sales of $80.7 million for the
year ended December 31, 2000. The increase in net sales was primarily due to our
geographic expansion since the third quarter of calendar year 2000 and
continuing in the first three quarters of 2001. In the third quarter of 2000 we
acquired two businesses (in Yonkers, New York and Silver Springs, Maryland) that
accounted for $27,437,000 of sales for the year ended December 31, 2001. In
December 2000, we acquired Reliable Networks, Inc., a competitor of ours located
in Queens, New York, which accounted for $36,342,000 of sales for the year ended
December 31, 2001. In January 2001, we opened an office in Connecticut, which
accounted for an aggregate of $8,469,000 in sales for the year ended December
31, 2001. In May 2001, we opened a new office in Los Angeles, California, which
accounted for $14,991,000 in sales for the year ended December 31, 2001. In
August 2001, we opened a new location in Brooklyn, New York, which accounted for
$3,655,000 in sales since its inception and in September 2001 we opened a new
location in Chicago, Illinois, which accounted for $5,079,000 in sales since its
inception. Starting July 2001, we began actively selling phone cards over the
Internet. Internet sales accounted for $6,649,000 for the year ended December
31, 2001. For the year ended December 31, 2001, same location sales for our
Bronx office increased by approximately $21,939,000 or 29% to $98,667,000 in
2001 from $76,728,000 in the prior year.
Gross profit increased to approximately $11 million in 2001, as compared to
approximately $3 million in 2000, principally as a result of increased volume
and as a result of higher gross margins. As a percentage of sales, gross profit
for 2001 increased to 5.48%, as compared to 3.68% for the year ended December
31, 2000. This increase in gross profit was attributable to the addition of
higher margin private label cards, slightly offset by the decrease in margins
attributable to branded products and increasing competition from additional
cards entering the marketplace.
Operating expenses for the year ended December 31, 2001 increased by $4,325,000
to $9,924,000, an increase of 77% over operating expenses of $5,599,000 for the
year ended December 31, 2000. Of this, general and administrative expenses
increased by $2,358,000 or 53% to $6,810,000 for 2001 as compared to $4,452,000
for 2000. This increase was primarily due to the increase in salaries by
$969,000 to $1,998,000 in 2001 as compared to $1,029,000 in 2000 resulting from
additional personnel required for new offices, direct sales efforts and Internet
customer service. Included in the general and administrative expenses is the
cost of processing credit card sales over the Internet in the amount of $225,000
for the year 2001. Rent expenses increased by $180,000 to $308,000 in 2001 as
compared to $128,000 in 2000 as the company continued to add new locations and
expand its existing facilities. Professional fees increased by $393,000 to
$1,172,000 in 2001 as compared to $779,000 in 2000. The increase in professional
fees was due to legal and accounting fees incurred primarily in connection with
lawsuits settled in 2001 and legal and accounting costs incurred in connection
with opening new locations during the year. Travel and related expenses
increased by $197,000 whereas telephone and
15
utilities increased by $189,000. Other general and administrative expenses
increased due to the company opening additional locations and expenses related
to increase in sales volume.
Selling expenses increased by $1,680,000 or 306% to $2,229,000 in 2001 as
compared to $549,000 during the year 2000. Of this, $330,000 was increases in
promotional expenses incurred in connection with the Company promoting its
private label cards during the year 2001. The commission expense increased by
$892,000 as the Company hired commissioned salespersons in 2001 to promote its
sales. Advertising costs increased by $658,000 to $817,000 in 2001 from $159,000
in 2000 as the company increased the sales of its private label cards and sales
over the Internet. Trade shows expense was reduced by $138,000 as a result of
negotiated packages, and cost of printing of trade publications were reduced by
$63,000 as the company utilized its in-house facilities in designing these
publications.
Provision for bad and doubtful debts increased by $287,000 to $885,000 in 2001
as compared to $598,000 in 2000 an increase of 48% over prior year. This
increase is nominal compared to the 148% increase in sales.
Other Expenses decreased by $470,000 to $320,000 in 2001, as compared to
$790,000 during the year 2000. Included in other expenses is a one-time charge
for amount payable to an ex-vendor in connection with a litigation settlement in
the amount of $203,000.
We had net earnings of $656,000 for 2001 as compared to net loss of $3,444,000
for the year ended December 31, 2000.
CAPITAL RESOURCES AND LIQUIDITY
At December 31, 2002, we had total current assets of approximately $47,828,000.
This included $7,527,000 in cash, $1,021,000 in restricted cash, $18,041,000 of
inventory and $19,675,000 of accounts receivable. Our cash balances vary
significantly from day-to-day due the large volume of purchases and sales we
make from the various prepaid phone card companies and the numerous distributors
to whom we sell cards. Although we had current liabilities of $57,661,000 at
December 31, 2002, we believe that continued support from our trade creditors
will provide us with adequate liquidity to fund our operations.
We provided $5,108,000 in cash from operating activities during the year ended
December 31, 2002 as compared to $3,485,000 during the same period in 2001.
Increases in cash flows during the year ended December 31, 2002 are related to
an increase in accounts payable by $22,643,000, offset by increase in accounts
receivables and inventories. Our decrease in working capital is attributable to
our net loss from operations and to a lesser extent to our opening of new
offices, which involve carrying of additional inventories and accounts
receivable. We believe our working capital shortfalls will decline once these
offices are established and profitable.
Investing activities used $1,266,000 during the year ended December 31,
2002 to acquire additional fixed assets and acquisition of business of a
distributor in Virginia. Financing activities used $651,000 during the year
ended December 31, 2002 to pay down notes payable and principal on debt
obligations.
We believe that existing cash and cash equivalents, cash flow from
operations and available vendor credit, including recently negotiated more
favorable payment terms will be sufficient to meet its
16
planned working capital and capital expenditure budget through the year 2003.
However, circumstances could arise which would require the payment to our
vendors sooner than we currently expect. We are largely dependent upon the
credit granted to us by our vendors. In the event sufficient vendor credit is
not available to us we would require other sources of financing. If we are
required to seek other financing, there can be no assurance that we will be able
to obtain such financing on commercially reasonable terms, or otherwise, or that
we will be able to otherwise satisfy our short-term cash flow needs from other
sources in the future which would have a material adverse effect on our
operations. These factors raise substantial doubt about the Company's ability to
continue as a going concern.
We are continuously renegotiating credit terms with our telephone card
suppliers. The favorable changes in terms from our vendors has eliminated the
temporary cash crunches that have occurred in the past, due to the restrictive
credit terms previously made available to us from the telecommunications
companies we buy branded cards from, as compared to the credit terms we make
available to our customers. The Company believes its relationships with its
vendors are satisfactory, however, the Company's creditors currently have the
right to modify credit terms.
CRITICAL ACCOUNTING POLICIES
Financial Reporting Release No. 60, published by the SEC, recommends
that all companies include a discussion of critical accounting policies used in
the preparation of their financial statements. The Company's significant
accounting policies are summarized in Note A of its financial statements. While
all these significant accounting policies impact its financial condition and
results of operations, the Company views certain of these policies as critical.
Policies determined to be critical are those policies that have the most
significant impact on the Company's financial statements and require management
to use a greater degree of judgment and/or estimates. Actual results may differ
from those estimates.
The Company believes that given current facts and circumstances, it is
unlikely that applying any other reasonable judgments or estimate methodologies
would cause a material effect on the Company's consolidated results of
operations, financial position or liquidity for the periods presented in this
report.
The accounting policies identified as critical are as follows:
REVENUE RECOGNITION. The Company recognizes revenues in accordance with
generally accepted accounting principles as outlined in SAB No. 101 which
requires that four basic criteria be met before revenue can be recognized: (1)
persuasive evidence of an arrangement exists, (2) product delivery, including
customer acceptance, has occurred or services have been rendered, (3) the price
is fixed or determinable and (4) collectibility is reasonably assured. The
Company believes that its revenue recognition policy is critical because revenue
is a very significant component of its results of operations. Decisions relative
to criteria (4) regarding collectibility are based upon management judgments and
should conditions change in the future and cause management to determine these
criteria are not met; the Company's recognized results may be affected.
INCOME TAXES. In preparing the Company's consolidated financial statements,
income tax expense is calculated for each of the jurisdictions in which the
Company operates. This process involves estimating actual current taxes due plus
assessing temporary differences arising from differing treatment for tax and
accounting purposes which are recorded as deferred tax assets and liabilities.
Deferred tax assets are periodically evaluated to determine their recoverability
and where their recovery is not likely, a valuation allowance is established and
a corresponding additional tax expense is recorded
17
in the Company's statement of operations. In the event that actual results
differ from the Company's estimates given changes in assumptions, the provision
for income taxes could be materially impacted. As of December 31, 2002, the
company had a deferred tax asset of approximately $4,059,000 and a full
valuation allowance due to uncertainty surrounding the company's ability to
realize its deferred tax asset.
INVENTORIES. Inventories, which are composed of prepaid calling cards, are
valued at the lower of cost (first in, first out) or market. On a periodic
basis, we compare the amount of inventory on hand and under commitment with our
latest forecasted requirements to determine whether write-downs for excess or
obsolete inventory are required. Although we consider the amounts on hand at
quarter-end to be realizable, there can be no assurance that these amounts will
prove to be realizable over time.
GOODWILL AND OTHER INTANGIBLES. Purchase accounting requires extensive use of
accounting estimates and judgments to allocate the purchase price to the fair
market value of the assets and liabilities purchased, with the excess value, if
any, being classified as goodwill. In addition, as described in Notes A of the
Company's financial statements, as a result of the Company's acquisitions,
values were assigned to intangible assets for customer lists and related
relationships. Finite useful lives were assigned to these intangibles and they
will be amortized over their remaining life. As with any intangible asset,
future write-downs may be required if the value of these assets become impaired.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. The Company performs ongoing credit evaluations
of its customers and adjusts credit limits based upon payment history and the
customer's current credit worthiness, as determined by a review of their current
credit information. The Company continuously monitors collections and payments
from customers and a provision for estimated credit losses is maintained based
upon its historical experience and any specific customer collection issues that
have been identified. While such credit losses have historically been within the
Company's expectations and the provisions established, the Company cannot
guarantee that the same credit loss rates will be experienced in the future.
Concentration risk exists relative to the Company's accounts receivable, as
25.2% of the Company's total accounts receivable balance at December 31, 2002 is
concentrated in one affiliated customer. While the accounts receivable related
to this customer may be significant, the Company does not believe the credit
loss risk to be significant given the consistent payment history by this
customer.
RECENT ACCOUNTING PRONOUNCEMENTS.
In June 2001, the Financial Accounting Standards Board, or FASB, issued SFAS No.
141, "Business Combinations", and SFAS No. 142, "Goodwill and Intangible
Assets". Major provisions of these Statements are as follows: all business
combinations initiated after June 30, 2001 must use the purchase method of
accounting; the pooling of interest method of accounting is prohibited except
for transactions initiated before July 1, 2001; intangible assets acquired in a
business combination must be recorded separately from goodwill if they arise
from contractual or other legal rights or are separable from the acquired entity
and can be sold, transferred, licensed, rented or exchanged, either individually
or as part of a related contract, asset or liability; goodwill and intangible
assets with indefinite lives are not amortized but are tested for impairment
annually using a fair value approach, except in certain
18
circumstances, and whenever there is an impairment indicator; other intangible
assets will continue to be valued and amortized over their estimated lives; all
acquired goodwill must be assigned to reporting units for purposes of impairment
testing and segment reporting; effective January 1, 2002, existing goodwill will
no longer be subject to amortization. The adoption of SFAS No. 142 in January
2002 did not have a material impact on our operating results or financial
condition.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" which establishes one accounting
model to be used for long-lived assets to be disposed of by sale and broadens
the presentation of discontinued operations to include more disposal
transactions. SFAS No. 144 supercedes SFAS 121, "Accounting for the Impairment
of Long-Lived Assets to Be Disposed Of" and the accounting and reporting
provisions of APB Opinion No. 30. SFAS No. 144 requires that those long-lived
assets be measured at the lower of carrying amount or fair value less cost to
sell, whether reported in continuing operations or in discontinued operations.
Therefore, discontinued operations will no longer be measured at net realizable
value or include amounts for operating losses that have not yet occurred. The
adoption of SFAS No. 144 in January 2002 did not have a material impact on our
operating results or financial condition.
In July 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement rescinds FASB Statement No. 4, Reporting Gains and
Losses from Extinguishment of Debt, and an amendment of that Statement, FASB
Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements. This Statement also rescinds FASB Statement No. 44, Accounting for
Intangible Assets of Motor Carriers. This Statement amends FASB No. 13,
Accounting for Leases, to eliminate an inconsistency between the required
accounting for sale-leaseback transactions. This Statement also amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. We
have not yet determined the effect that the provisions of SFAS No. 145 would
have on our operating results or financial position, if any.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities", which addresses accounting for restructuring
and similar costs. SFAS 146 supersedes previous accounting guidance, principally
Emerging Issues Task Force Issue No. 94-3. The Company will adopt the provisions
of SFAS 146 for restructuring activities initiated after December 31, 2002. SFAS
146 requires that the liability for costs associated with an exit or disposal
activity be recognized when the liability is incurred. Under Issue 94-3, a
liability for an exit cost was recognized at the date of the Company's
commitment to an exit plan. SFAS 146 also establishes that the liability should
initially be measured and recorded at fair value. Accordingly, SFAS 146 may
affect the timing of recognizing future restructuring costs as well as the
amounts to be recognized.
In November 2002, the EITF reached a consensus on Issue No. 00-21
"Accounting for Revenue Arrangements with Multiple Deliverables". The EITF
concluded that revenue arrangements with multiple elements should be divided
into separate units of accounting if the deliverables in the arrangement have
value to the customer on a standalone basis, if there is objective and reliable
evidence of the fair value of the undelivered elements, and as long as there are
no rights of return or additional performance guarantees by us. The provisions
of EITF Issue No. 00-21 are applicable to agreements entered into in fiscal
periods beginning after June 15, 2003. We are currently determining
19
what effect, if any, the provisions of EITF Issue No. 00-21 will have on our
operating results or financial condition.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that
upon issuance of a guarantee, the guarantor must recognize a liability for the
fair value of the obligation it assumes under that guarantee. The recognition
and measurement provisions will be applied to guarantees issued or modified
after December 31, 2002. We have not determined the impact of FIN 45 on our
operating results or financial condition.
In January 2003, the FASB issued FASB Interpretation No.46
"Consolidation of Variable Interest Entities." In general, a variable interest
entity is a corporation, partnership, trust, or any other legal structure used
for business purposes that either (a) does not have equity investors with voting
rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. A variable interest entity
often holds financial assets, including loans or receivables real estate or
other property. A variable interest entity may be essentially passive or it may
engage in activities on behalf of another company. Until now, a company
generally has included another entity in its consolidated financial statements
only if it controlled the entity through voting interests. FIN No.46 changes
that by requiring a variable interest entity to be consolidated by a company if
that company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the entity's
residual returns or both. FIN No. 46's consolidation requirements apply
immediately to variable interest entities created or acquired after January 31,
2003. The consolidation requirements apply to older entities in the first fiscal
year on interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply to all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company has
not adopted FIN No.46 for the year ended December 31, 2002 and has not completed
its analysis of the effects of adopting FIN No. 46.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of FASB Statement No.
123." This statement amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We have not
yet determined the effect that the transition provisions of SFAS No. 148 would
have on our operating results or financial position, if any.
20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
9278 Communications, Inc. and Subsidiaries
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Independent Certified Public Accountants F-2 - F-3
Consolidated Balance Sheets as of December 31, 2002 and 2001 F-4 - F-5
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000 F-6
Consolidated Statement of Shareholders' Equity (Deficit) for the
years ended December 31, 2002, 2001 and 2000 F-7
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000 F-8 - F-9
Notes to Consolidated Financial Statements F-10 - F-28
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders of
9278 COMMUNICATIONS, INC.
We have audited the accompanying consolidated balance sheets of 9278
Communications, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the
related consolidated statements of operations, shareholders' equity (deficit)
and cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of 9278
Communications, Inc. and Subsidiaries as of December 31, 2002, and the
consolidated results of their operations and their consolidated cash flows for
the years then ended, in conformity with accounting principles generally
accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note A, the Company
incurred a net loss of $5,970,000 during the year ended December 31, 2002 and
its current liabilities exceeded its current assets as of December 31, 2002.
These factors, among others, raise substantial doubt about its ability to
continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
We have also audited Schedule II - Valuation and Qualifying Accounts for the
year ended December 31, 2002. In our opinion, this schedule presents fairly, in
all material respects, the information required to be set forth therein.
Grant Thornton LLP
New York, New York
April 11, 2003
F-2
(LETTERHEAD OF FRIEDMAN ALPREN & GREEN LLP)
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
9278 Communications Inc.
We have audited the accompanying consolidated statements of operations, changes
in shareholders' equity and cash flows for the year ended December 31, 2000 of
9278 Communications, Inc. and Subsidiaries. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations and cash flows of
9278 Communications, Inc. and Subsidiaries for the year ended December 31,
2000, in conformity with accounting principles generally accepted in the United
States of America.
New York, New York
March 23, 2001
F-3
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31,
ASSETS 2002 2001
------------ ------------
CURRENT ASSETS
Cash and cash equivalents $ 7,527,098 $ 4,335,936
Restricted cash 1,020,809 1,051,215
Accounts receivable, net of allowance of $760,000
in 2002 and $760,000 in 2001 14,711,918 13,058,773
Accounts receivable - related party 4,963,508 1,315,011
Inventories 18,041,063 12,969,347
Prepaid expenses and other current assets 32,622 149,044
------------ ------------
Total current assets 46,297,018 32,879,326
PROPERTY AND EQUIPMENT, NET 1,801,798 1,306,884
NOTE RECEIVABLE-STRATEGIC PARTNER 1,530,975
GOODWILL 3,624,071 3,624,071
OTHER ASSETS 690,831 158,187
------------ ------------
$53,944,693 $37,968,468
============ ============
The accompanying notes are an integral part of these statements.
F-4
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 2002 2001
----------- -----------
CURRENT LIABILITIES
Accounts payable and accrued expenses $57,510,096 $34,590,301
Accounts payable - related party 41,752 318,950
Current maturities of notes and advances payable, Shareholder - 570,100
Current maturities of capital lease obligations 44,934 45,549
Current maturities of convertible notes payable 50,020 35,824
Income taxes payable 14,145 59,250
----------- -----------
Total current liabilities 57,660,947 35,619,974
CAPITAL LEASE OBLIGATIONS, less current maturities 41,051 85,974
CONVERTIBLE NOTES PAYABLE, less current maturities 90,126 140,146
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Common stock - $.001 par value; 40,000,000 shares authorized; 23,932,912 and
22,932,912 shares issued and outstanding in 2002 and 2001,
respectively 23,933 22,933
Capital in excess of par value 8,247,458 8,248,458
Accumulated deficit (12,118,822) (6,149,017)
----------- -----------
(3,847,431) 2,122,374
------------ -----------
$53,944,693 $37,968,468
=========== ===========
The accompanying notes are an integral part of these statements.
F-5
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
2002 2001 2000
------------- ------------ -----------
Net sales $246,979,717 $200,177,380 $80,763,042
Cost of sales 233,800,151 189,212,225 77,792,807
------------- ------------ -----------
Gross profit 13,179,566 10,965,155 2,970,235
------------- ------------ -----------
Operating expenses
Selling 7,575,872 2,228,816 549,336
General and administrative 10,774,408 6,809,862 4,451,533
Provision for bad debts 790,402 885,282 598,474
------------- ------------ -----------
19,140,682 9,923,960 5,599,343
------------- ------------ -----------
Operating profit (loss) (5,961,116) 1,041,195 (2,629,108)
Other expense
Interest expense 33,638 116,821 175,994
Litigation settlement - 203,000 -
Loss on disposal of assets - - 555,447
Unrealized loss on investment - - 58,473
------------- ------------ -----------
33,638 319,821 789,914
------------- ------------ -----------
Earnings (loss) before income taxes (5,994,754) 721,374 (3,419,022)
Income tax provision (benefit) (24,949) 65,400 25,404
------------- ------------ -----------
NET EARNINGS (LOSS) $ (5,969,805) $ 655,974 $(3,444,426)
============ ============ ===========
Earnings (loss) per common share
Basic and diluted $(0.25) $0.03 $(0.16)
===== ==== =====
Weighted-average shares
Basic and diluted 23,932,912 24,500,881 20,902,060
============ ============ ===========
The accompanying notes are an integral part of these statements.
F-6
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
Years ended December 31, 2002, 2001 and 2000
Convertible preferred
stock Common stock Additional
---------------------- ------------------------ paid-in Accumulated
Shares Amount Shares Amount capital deficit Total
------- -------- --------- --------- ---------- ------------- --------
Balance January 1, 2000 1,500 $1,500,000 19,659,629 $19,659 $2,361,382 $ (3,360,565) $ 520,476
Conversion of preferred stock to
common stock (995) (995,000) 873,340 873 994,127
Issuance of common stock through
private placement 529,000 529 997,471 998,000
Issuance of common stock to officer
in exchange for advances payable 250,000 250 499,750 500,000
Issuance of common stock for
services rendered 855,000 855 929,186 930,041
Issuance of common stock upon
acquisition of Reliable Networks,
Inc. 1,000,000 1,000 1,961,336 1,962,336
Net loss (3,444,426) (3,444,426)
------- ---------- ---------- ------- ---------- ------------- -----------
Balance at December 31, 2000 505 505,000 23,166,969 23,166 7,743,252 (6,804,991) 1,466,427
Conversion of preferred stock to
common stock (505) (505,000) 776,013 777 504,223
Repurchase and retirement of
common stock (1,010,070) (1,010) 983 (27)
Net income 655,974 655,974
------- ---------- ---------- ------- ---------- ------------- -----------
Balance at December 31, 2001 - - 22,932,912 22,933 8,248,458 (6,149,017) 2,122,374
Issuance of common stock in connection
with acquisition of Reliable Networks,
Inc. 1,000,000 1,000 (1,000)
Net loss (5,969,805) (5,969,805)
------- ---------- ---------- ------- ---------- ------------- -----------
BALANCE AT DECEMBER 31, 2002 - $ - 23,932,912 $23,933 $8,247,458 $(12,118,822) $(3,847,431)
======= ========== ========== ======= ========== ============= ============
The accompanying notes are an integral part of these statements.
F-7
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
2002 2001 2000
----------- ----------- -----------
Cash flows from operating activities
Net income (loss) $(5,969,805) $ 655,974 $(3,444,426)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities, net of
assets acquired and liabilities assumed
Depreciation and amortization 392,612 511,175 186,524
Provision for doubtful accounts 790,403 885,282 598,474
Issuance of common stock for services rendered - - 930,041
Unrealized loss on investments - - 58,473
Loss on sale of equipment - - 555,447
Changes in assets and liabilities, net of
acquisitions
Restricted cash 30,406 (1,051,215) -
Accounts receivable (2,443,546) (8,015,461) (2,773,661)
Accounts receivable - related party (3,648,497) (250,868) (849,143)
Inventories (4,832,365) (9,319,292) (2,279,869)
Prepaid expenses and other current assets 116,421 (149,044) 30,749
Other assets (393,624) (18,149) (46,366)
Accounts payable and accrued expenses 22,919,795 20,110,295 11,560,750
Accounts payable - related party (277,198) 91,006 227,944
Income taxes payable (45,105) 34,995 22,255
----------- ----------- -----------
Net cash provided by operating activities 6,639,497 3,484,698 4,777,192
----------- ----------- -----------
Cash flows from investing activities
Acquisition of property and equipment (877,547) (878,969) (491,942)
Note receivable, Strategic Partner (1,530,975)
Acquisition of businesses (388,351) (207,742) (1,000,000)
Disposition of marketable securities - 20,962
----------- ----------- -----------
Net cash used in investing activities (2,796,873) (1,065,749) (1,491,942)
----------- ----------- -----------
Cash flows from financing activities
Notes and advances payable, shareholder, net (570,100) (2,334,836) (128,585)
Principal payments on capital lease obligations (45,538) (38,771) (66,206)
Proceeds from convertible notes payable - 203,000 -
Principal payments on convertible notes payable (35,824) (27,030) -
Repurchase and retirement of common stock - (27) -
Issuance of common stock - - 998,000
----------- ----------- -----------
Net cash provided by (used in) financing activities (651,462) (2,197,664) 803,209
----------- ----------- -----------
NET INCREASE IN CASH
AND CASH EQUIVALENTS 3,191,162 221,285 4,088,459
Cash and cash equivalents, beginning of year 4,335,936 4,114,651 26,192
----------- ----------- -----------
Cash and cash equivalents, end of year $ 7,527,098 $ 4,335,936 $ 4,114,651
=========== =========== ===========
F-8
9278 Communications, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year ended December 31,
2002 2001 2000
-------- -------- --------
Supplemental disclosures of cash flow information:
Cash paid during the year for
Interest $ 55,694 $ 122,742 $ 175,994
Income taxes (24,949) 30,405 10,565
Noncash investing and financing activities:
Equipment acquired under capital leases $ 19,200 $ 75,000
Conversion of notes and advances payable, shareholder for
common stock 500,000
Conversion of preferred stock to common stock 505,000 995,000
Notes issued for accrued dividends
Issuance of common stock for net noncash assets received
in merger
Additional paid-in capital arising from contribution
of treasury shares
Acquisition of Reliable Networks, Inc.
Net assets acquired $ 38,687
Goodwill 3,901,313
-----------
3,940,000
-----------
Less
Common stock issued 970,000
Contingent consideration - common stock 970,000
Promissory notes payable 1,000,000
-----------
2,940,000
-----------
Cash paid $ 1,000,000
===========
The accompanying notes are an integral part of these statements.
F-9
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company distributes prepaid telephone calling cards to distributors and
retail establishments through its various sales locations throughout the
United States.
In addition, the Company markets certain prepaid calling cards directly to
consumers via its internet website, 9278.Com. Sales via the internet were
$19,327,000, $6,649,000 and $0 for the years ended December 31, 2002, 2001
and 2000 respectively.
9278 Communications, Inc. is the successor-consolidated entity formed by
the merger, on December 10, 1999, of 9278 Distributor Inc. (the "Company")
and iLink Telecom, Inc. ("iLink"). iLink was originally incorporated in
Colorado on December 10, 1997 and was reincorporated in Nevada on July 14,
1998. Concurrent with the merger, iLink, a publicly held company and the
legally surviving parent company, changed its name to 9278 Communications,
Inc. This event has been given retroactive treatment in these financial
statements. The Company was incorporated in New York on April 17, 1997 and
reincorporated in Delaware on April 3, 2000. This reincorporation had no
impact on the Company's authorized stock.
The accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America,
which contemplate continuation of the Company as a going concern. The
Company sustained substantial losses from operations and its current
liabilities exceeded its current assets by approximately $11,364,000 as of
December 31, 2002. The company is largely dependent upon the extension of
credit from its vendors, in particular on credit granted by a significant
supplier. These factors raise substantial doubt about the Company's ability
to continue as a going concern.
In the event sufficient vendor credit is no longer available, the Company
would be required to seek other financing, however there can be no
assurance that the Company will be able to obtain such financing on
commercially reasonable terms, or otherwise or that the Company would be
able to satisfy short-term cash flow needs. The Company is continuously
renegotiating credit terms with its suppliers and, to date, has received
favorable terms. The Company believes its relationships with its vendors
are satisfactory; however, the Company's creditors currently have the right
to modify credit terms.
A summary of the significant accounting policies consistently applied in
the preparation of the accompanying consolidated financial statements
follows:
1. Principles of Consolidation
The accompanying consolidated financial statements include the
accounts of 9278 Communications, Inc. and its wholly-owned
subsidiaries, 9278 Distributors, Inc., 9278 Dot Com, Inc., E-Store
Solution, Inc., Reliable Acquisition Corp., 9278 Wireless Inc., 9278
Distributors Maryland Inc., 9278 Distributors Illinois Inc., NTSE
Communications, Inc., 9278 Distributors Florida Inc., 9278
Distributors North Carolina Inc. and 9278 Distributors New Jersey Inc.
(hereinafter, the
F-10
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
"Company"). All significant intercompany transactions and balances
have been eliminated in consolidation.
2. Cash and Cash Equivalents
Cash and cash equivalents include all cash and highly liquid
investments with an original maturity of three months or less.
3. Inventories
Inventories, which consist of prepaid telephone cards, are stated at
the lower of cost (first-in, first-out) or market.
4. Property and Equipment
Property and equipment are stated at cost. Depreciation and
amortization are provided for, using straight-line and accelerated
methods, in amounts sufficient to relate the cost of depreciable assets
to operations over their estimated service lives. Leased property under
capital leases is amortized over the shorter of the service lives of
the assets or the term of the lease. Repairs and maintenance are
charged to operations as incurred.
5. Goodwill
Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill
and Other Intangible Assets. In accordance with the guidelines of this
accounting principle, goodwill and indefinite-lived intangible assets
are no longer amortized but will be assessed for impairment on at least
an annual basis. SFAS No. 142 also requires that intangible assets with
estimable useful lives be amortized over their respective estimated
useful lives to their estimated residual values, and reviewed for
impairment.
F-11
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table presents a reconciliation of net income and
earnings-per-share amounts, as reported in the financial statements,
to those amounts adjusted for goodwill and intangible asset
amortization determined in accordance with the provisions of SFAS 142.
2002 2001 2000
---- ---- ----
Reported net income (loss) $(5,969,805) $655,974 $(3,444,426)
Add back: goodwill amortization - 260,000 17,000
Adjusted net income (loss) $(5,969,805) $915,974 $(3,427,426)
----------- -------- -----------
EARNINGS (LOSS) PER SHARE (BASIC AND
DILUTED):
Reported net income (loss) $ (0.25) $ 0.03 $ (0.16)
Goodwill amortization - 0.01 -
----------- -------- -----------
Adjusted net income (loss) $ (0.25) $ 0.04 $ (0.16)
----------- -------- -----------
Goodwill amortization, which was $260,000 and $17,000 for the years
ended December 31, 2001 and 2000, respectively, ceased effective
January 1, 2002. In the first quarter of 2002, pursuant to SFAS No.
142, the Company completed its reassessment of previously recognized
intangible assets, and ceased amortization of indefinite-lived
intangible assets.
SFAS No. 142 requires that goodwill be tested for impairment upon
adoption and at least annually thereafter, utilizing a two-step
methodology. The initial step requires the Company to determine the
fair value of the business acquired and compare it to the carrying
value, including goodwill, of such business. If the fair value exceeds
the carrying value, no impairment loss would be recognized. However,
if the carrying value of the reporting unit exceeds its fair value,
the goodwill of the unit may be impaired. The amount, if any, of the
impairment is then measured in the second step.
The Company completed the initial step of impairment testing during
the first quarter which indicated that no goodwill impairment existed
as of January 1, 2002. The Company determined the fair value of
business acquired for purposes of this test primarily by using a
discounted cash flow valuation technique. Significant estimates used
in the valuation include estimates of future cash flows, both future
short-term and long-term growth rates, and estimated cost of capital
for purposes of arriving at a discount factor. Based on that analysis,
no impairment was recognized.
F-12
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company performed its annual impairment test as of the beginning
of the fourth quarter of 2002. The Company determined the fair value
of the business acquired for purposes of this test primarily by using
a discounted cash flow valuation technique. Significant estimates used
in the valuation include estimates of future cash flows, both future
short-term and long-term growth rates, and estimated cost of capital
for purposes of arriving at a discount factor. Based on comparing this
discounted cash flow model to the carrying value of the reporting
units, no impairment was recognized in the consolidated statement of
operations for the year ended December 31, 2002. On an ongoing basis,
the Company expects to perform its annual impairment test during the
fourth quarter absent any impairment indicators.
6. Long-lived Assets
Long-lived assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset
or group of assets may not be fully recoverable. If an impairment
indicator is present, the Company evaluates recoverability by a
comparison of the carrying amount of the assets to future undiscounted
net cash flows that the Company expects to generate from these assets.
If the assets are impaired, the Company recognizes an impairment
charge equal to the amount by which the carrying amount exceeds the
fair value of the assets. Assets to be disposed of are reported at the
lower of carrying values or fair values, less estimated costs of
disposal.
In June 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 143 ("SFAS No. 143"),
"Accounting for Asset Retirement Obligations," which is effective for
years beginning after June 15, 2002. SFAS No. 143 addresses legal
obligations associated with the retirement of tangible long-lived
assets that result from the acquisition, construction, development or
normal operation of a long-lived asset. The standard requires that the
fair value of a liability for an asset retirement obligation be
recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. Any associated asset retirement
costs are to be capitalized as part of the carrying amount of the
long-lived asset and expensed over the life of the asset. The Company
has elected to adopt SFAS No. 143 for the year beginning January 1,
2002.
In August 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 144 ("SFAS No. 144"),
"Accounting for the Impairment or Disposal of Long-Lived Assets,"
which is effective for fiscal years beginning after December 15, 2001.
SFAS No. 144 clarifies accounting and reporting for assets held for
sale, scheduled for abandonment or other disposal, and recognition of
impairment loss related to the carrying value of long-lived assets.
The Company has elected to adopt SFAS No. 144 for the year beginning
January 1, 2002.
F-13
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
7. Income Taxes
Income taxes are accounted for in accordance with Statement of
Financial Accounting Standards No. 109 ("SFAS No. 109"), "Accounting
of Income Taxes." Under SFAS No. 109, deferred tax assets and
liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax
basis. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled.
Under SFAS No. 109, the effect on deferred tax assets and liabilities
of a change in tax rates is recognized in income in the period that
includes the enactment date.
8. Earnings (Loss) Per Share
Basic earnings (loss) per share are determined by dividing the
Company's net earnings (loss) by the weighted-average shares
outstanding. Diluted earnings per share include the dilutive effects
of outstanding stock option and warrants. Excluded from the
calculation of diluted earnings per share are 210,000, 235,000 and
23,000 options and warrants to purchase the Company's common stock in
2001, 2000 and 1999, respectively, as their inclusion would have been
antidilutive.
9. Stock-Based Compensation Plans
The Company maintains two stock option plans, as more fully described
in Note J to the consolidated financial statements, which are
accounted for using the "intrinsic value" method pursuant to the
provisions of Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations, and,
accordingly, recognizes no compensation expense. Therefore, the
Company has elected the disclosure provisions only of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation."
Pro Forma earnings (loss) and earnings (loss) per share are not
presented as the pro forma information is not materially different
from the Company's reported results.
10. Revenue Recognition
Revenue is recognized from sales when products are shipped and title
passes to the customer. Sales incentives in the form of free products
given to the Company's distributors are classified as a reduction of
revenues.
F-14
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
11. Advertising
Advertising costs are expensed as incurred and totaled $3,517,000,
$817,000 and $159,000 in 2002, 2001 and 2000, respectively.
12. Shipping and Handling Fees and Costs
The Company includes fees billed to a customer relating to shipping
and handling costs in net sales. All shipping and handling expenses
incurred by the Company are included in cost of sales.
13. Uses of Estimates and Fair Value of Financial Instruments
In preparing financial statements in conformity with accounting
principles generally accepted in the United States of America,
management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial
statements and revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Management of the Company believes that the fair value of financial
instruments, consisting of cash, accounts receivable and debt,
approximates carrying value due to the immediate or short-term
maturity associated with its cash and accounts receivable and the
interest rates associated with its debt.
14. Accounts Receivable
Accounts receivable are due within contractual payment terms and are
stated at amounts due from customers net of an allowance for doubtful
accounts. Credit is extended based on evaluation of a customer's
financial condition. Accounts outstanding longer than the contractual
payment terms are considered past due. The Company determines its
allowance by considering a number of factors, including the length of
time trade accounts receivable are past due, the Company's previous
loss history, the customer's current ability to pay its obligation to
the Company, and the condition of the general economy and the industry
as a whole. The Company writes off accounts receivable when they
become uncollectible, and payment subsequently received on such
receivables are credited to the allowance for doubtful debts.
15. Reclassifications
Certain reclassifications have been made to the prior year financial
statements to conform to the current year presentation.
F-15
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
16. Recently Issued accounting pronouncements.
In June 2002, the FASB issued SFAS No.146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No.146 nullifies
Emerging Issues Task Force Issue No. 94-3 and requires that a
liability for a cost associated with and exit or disposal activity be
recognized when the liability is incurred. This statement also
establishes that fair value is the objective for initial measurement
of the liability. SFAS No.146 is effective for exit or disposal
activities that are initiated after December 31, 2002. The impact of
the adoption of SFAS No. 146 is not expected to have a material impact
on the Company's financial position or results of operations.
In December 2002, the FASB issued SFAS No.148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of
FASB Statement No.123." SFAS No.148 amends SFAS No.123,"Accounting for
Stock-Based Compensation," to provide alternative methods of
transition for an entity that voluntarily changes to the fair
value-based method of accounting for stock-based employee
compensation. It also amends the disclosure provisions of that
Statement to require prominent disclosure about the effects on
reported net income of an entity's accounting policy decisions with
respect to stock-based employee compensation. The Company has chosen
to continue to account for stock-based compensation using the
intrinsic value method prescribed in APB Opinion No.25 and related
interpretations as provided for under SFAS No.148. Accordingly,
compensation expense is only recognized when the market value of the
Company's stock at the date of the grant exceeds the amount an
employee must pay to acquire the stock. 2003. The adoption of SFAS
No.148 did not have material impact on the Company's financial
position or results of operations.
F-16
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In November 2002, the FASB issued FASB Interpretation No.45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." FIN No.45
requires that upon issuance of a guarantee, a guarantor must recognize
a liability for the fair value of an obligation assumed under a
guarantee. FIN No. 45 also requires additional disclosures by a
guarantor in its interim and annual financial statements about the
obligations associated with guarantees issued. The recognition
provisions of FIN No.45 are effective for any guarantees issued or
modified after December 31, 2002. The disclosure requirements are
effective for financial statements of interim or annual period ending
December 15, 2002. The adoption of the disclosure requirements of FIN
No. 45 did not have a material impact on the Company's financial
position or results of operations. The Company is currently evaluating
the effects of the recognition provision of FIN No. 45, but does not
expect the adoption to have a material impact on the Company's
financial position or results of operations.
In January 2003, the FASB issued FASB Interpretation No.46
"Consolidation of Variable Interest Entities." In general, a variable
interest entity is a corporation, partnership, trust, or any other
legal structure used for business purposes that either (a) does not
have equity investors with voting rights or (b) has equity investors
that do not provide sufficient financial resources for the entity to
support its activities. A variable interest entity often holds
financial assets, including loans or receivables real estate or other
property. A variable interest entity may be essentially passive or it
may engage in activities on behalf of another company. Until now, a
company generally has included another entity in its consolidated
financial statements only if it controlled the entity through voting
interests. FIN No.46 changes that by requiring a variable interest
entity to be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual
returns or both. FIN No. 46's consolidation requirements apply
immediately to variable interest entities created or acquired after
January 31, 2003. The consolidation requirements apply to older
entities in the first fiscal year on interim period beginning after
June 15, 2003. Certain of the disclosure requirements apply to all
financial statements issued after January 31, 2003, regardless of when
the variable interest entity was established. The Company has not
adopted FIN No.46 for the year ended December 31, 2002, however the
Company has provided for the required disclosures required by FIN No.
46 (see Note F). The Company has not completed its analysis of the
effects of adopting FIN No. 46.
F-17
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE B - ACQUISITIONS
On August 31, 2002, the Company acquired certain assets of one of its
distributors in an asset purchase transaction, wherein it acquired
inventories and customer lists of the distributor. The Company paid
$149,000 in excess of the tangible assets, which has been allocated to
the estimated value of acquired customer lists. The assets acquired
were recorded at estimated fair market value. The consolidated
statements of operations include the results of this acquisition
beginning September 1, 2002.
A summary of the transactions is as follows:
Assets purchased
Inventory purchased 239,351
Customer lists 149,000
----------
Net assets acquired $ 388,351
==========
Cash paid $ 388,351
==========
Pro forma results of operations are not presented, as they are not material
to the historical results presented herein.
On January 23, 2001, the Company acquired certain assets of two of its
distributors in an asset purchase transaction, wherein it acquired accounts
receivable, inventories, fixed assets and customer lists of the
distributors, net of accounts payable. The Company paid $100,000 in excess
of its net assets for the customer lists. The assets acquired and
liabilities assumed were recorded at estimated fair values. The
consolidated statements of operations include the results of this
acquisition beginning January 23, 2001. A summary of the transactions is as
follows:
Assets purchased
Accounts receivable $ 147,904
Inventories 68,015
Other assets 5,500
Customer lists 100,000
---------
321,419
Liabilities assumed
Accounts payable (113,677)
---------
Net assets acquired $ 207,742
=========
Cash paid $ 207,742
=========
Pro forma results of operations are not presented, as they are not material
to the historical results presented herein.
F-18
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE C- INVESTMENTS AND OTHER TRANSACTIONS
On September 1, 2000, the Company entered into an agreement with Rapid
Release Research, LLC ("Rapid Release"), a company that is in the business
of providing services for management consulting, business advisory,
shareholder information and public relations (the "Consulting Agreement").
Rapid Release was to be used to inform the public of the potential
investment merit of the Company and its securities, thereby increasing
investor recognition and market liquidity and improving shareholder value,
and to assist the Company in acquisitions, mergers and other financial
transactions. This agreement was for a period of four years. The Company
issued Rapid Release 800,000 shares of its common stock and has recognized
the expense from this agreement based on the market value of the stock of
the Company at the date of issue, which was $875,040, in the year ended
December 31, 2000.
On January 29, 2001, the Company acquired, for a nominal amount, a 27%
equity interest in DMS Acquisition Corp., (a Delaware corporation) as an
inducement to enter into a long-term distribution agreement with DMS
Acquisition Corp. DMS Acquisition Corp. is a facility-based carrier of
long-distance telephone service. On February 8, 2001, DMS Acquisition Corp.
was a party to a triangular merger with Capital One Ventures Corp. (an OTC
publicly traded company) with Capital One Ventures Corp. as the surviving
entity. DMS Acquisition Corp. became a wholly-owned subsidiary of Capital
One Ventures Corp. Simultaneous with the merger, Capital One Ventures Corp.
changed the corporate name to Cirus Telecom, Inc. ("Cirus"). As a result of
the merger, the Company's equity interest of 10,800,000 shares of Cirus was
diluted to 18%. The Company's investment in Cirus was restricted and
subject to other conditions pursuant to the distribution agreement. The
investment in Cirus is accounted for at cost and is not material to the
Company's financial position. On September 26, 2001, under the terms of the
Consulting Agreement between Rapid Release and the Company, Rapid Release
returned to the Company 800,000 shares of the Company's common stock in
exchange for 600,000 shares of Cirus stock held by the Company. As
additional consideration, the two parties mutually agreed to declare the
Consulting Agreement as null and void. The Company also delivered 60,000
shares of Cirus stock to a consulting firm, for its services in negotiating
this settlement agreement. The Company has recorded no gain or loss from
this transaction.
On September 26, 2001, the Company transferred the balance of 10,140,000
shares of Cirus stock back to Cirus in exchange for (i) Cirus' consent to
the September 26, 2001 transaction between the Company and Rapid Release;
(ii) 210,070 shares of the Company's common stock held by certain
shareholders of Cirus; and (iii) an unconditional release from the
Distribution Agreement dated February 6, 2001, signed between Cirus and the
Company, from the day of its inception.
On September 30, 2001, the Company retired 1,010,070 shares of its common
stock it received from the above settlements.
F-19
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE D- PREFERRED STOCK
During the year ended December 31, 2001, the Company converted 505 shares
of Class B, $.001 par value convertible preferred stock into 776,013 shares
of common stock.
NOTE E- RESTRICTED CASH
Restricted cash consists of the following:
DECEMBER 31, DECEMBER 31,
2002 2001
----------- ------------
Amounts invested in certificate of deposit, which is
pledged as collateral for a letter of credit issued by
the bank $1,020,809 $1,000,000
Amounts invested in certificate of deposit, held by bank as
collateral fee deposited funds returned for insufficient
funds by customer bank - $51,215
---------- ----------
$1,020,809 $1,051,215
---------- ----------
NOTE F - NOTE RECEIVABLE - STRATEGIC PARTNER
On December 1, 2002, the Company entered into an agreement with a newly
established telecommunications carrier ("Telecom") whereby the Company
agreed to advance up to $3 million to establish a switching platform (the
"platform") to provide telecommunication services in exchange for certain
preferential rights to the said services. Such advances are evidenced by a
promissory note which bears interest at 10% and is collateralized by all
current and future assets of Telecom. The Company further agreed to utilize
a minimum of $10 million of these services during the year ended December
31, 2003.
In the event that Telecom is not successful in establishing the platform or
does not provide the aforementioned services to the Company in terms of the
agreement, they will be required to repay all monies previously advanced to
them and all equipment and infrastructure purchased with the said funds
will revert to the Company.
Presently, the Company is Telecom's sole source of funds and sole customer.
As a result, the operations of Telecom may be required to be consolidated
with those of the Company in terms of FASB Interpretation No.46,
"Consolidation of Variable Interest Entities". As of April 11, 2003, the
Company had advanced approximately $3.9 million to Telecom. In addition, as
of April 11, 2003, the Company had outstanding billings from Telecom for
services aggregating approximately $3.9 million.
F-20
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE G- PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31:
Estimated
useful life
(years) 2002 2001
------------ ---------- ----------
Furniture and equipment 5 - 7 $ 698,345 $ 483,164
Automobiles 5 - 7 270,064 224,566
Computer equipment 5 1,269,182 731,685
Leasehold improvements 3 - 8 325,100 245,729
---------- ----------
2,562,691 l,685,144
Less accumulated depreciation
and amortization 760,893 378,260
---------- ----------
$1,801,798 $1,306,884
========== ==========
Depreciation and amortization expense for property and equipment for the
years ended December 31, 2002, 2001 and 2000 was approximately $383,000,
$242,000 and $115,000, respectively.
Property and equipment under capital leases totaled approximately $215,440
and $215,440 and accumulated amortization on such property and equipment
aggregated approximately $92,149 and $61,185 at December 31, 2002 and 2001,
respectively.
NOTE H - NOTES PAYABLE - SHAREHOLDER
On December 10, 1999, the Company declared $3,000,000 in dividends, of
which $1,000,000 was paid. On December 13, 1999, the Company executed a
promissory note for $2,000,000 for the declared but unpaid dividends,
payable to the Company's chief executive officer, who is also a
shareholder. A principal payment of $1,000,000 was originally due on June
13, 2000, and the second payment originally payable on December 13, 2001.
On March 22, 2001, the Company amended the terms of these promissory notes
to defer both payments to March 31, 2002 and December 31, 2002,
respectively. The final payment is accelerated if the Company's gross
revenue exceeds $10 million in each of any six consecutive calendar months
or exceeds $60 million in any six-month period. During the year-ended
December 31, 2002, the Company paid the remaining principal payments
aggregating $570,000. Interest was payable at a rate of 8%. Interest
expense on this note was $12,017 and $90,100 for the years ended December
31, 2002 and 2001, respectively.
F-21
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE I- INCOME TAXES
The provision (benefit) for income taxes is summarized as follows:
2002 2001 2000
--------- -------- -------
Current
Federal $ - $31,400 $ -
State (24,949) 34,000 25,404
--------- -------- -------
(24,949) 65,400 25,404
Deferred - - -
--------- -------- -------
$(24,949) $ 65,400 $25,404
========= ======== =======
The actual income tax expense (benefit) differs from the Federal statutory
rate as follows:
2002 2001 2000
---------------------- --------------------- ----------------------
Amount % Amount % Amount %
------------ ------- ---------- ------ ------------ -------
Federal statutory rate $(2,038,000) (34.0)% $ 245,000 34.0% $(1,171,000) (34.0)%
State income taxes, net of
Federal income tax benefit (24,949) 0.4 22,044 2.0 25,404 0.1
Utilization of net operating
loss carry forwards - (201,644) (31.0)
Valuation allowance 2,038,000 34.0 1,171,000 34.0
------------ ------- ---------- ------ ------------ -------
$ (24,949) 0.0% $ 65,400 5.0% $ 25,404 0.1%
============ ======= ========== ====== ============ =======
F-22
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE I - INCOME TAXES (CONTINUED)
The tax effects of temporary differences which give rise to deferred tax
assets at December 31, 2002 and 2001 are summarized as follows:
2002 2001
----------- -----------
Deferred tax assets
Allowance for doubtful accounts $ 342,000 $ 342,000
Accrued compensation 160,000 213,750
Net operating loss carry forwards 3,475,000 576,000
Federal AMT credit - 14,400
----------- -----------
Gross deferred tax assets 3,997,000 1,146,150
Valuation allowance (3,997,000) (1,146,150)
----------- -----------
Net deferred tax asset $ - $ -
=========== ===========
At December 31, 2002, the Company has net operating loss carry forwards for
Federal income tax purposes aggregating approximately $7,722,000 expiring
through 2022.
The tax loss carry forwards of the Company and its subsidiaries may be
subject to limitation by Section 382 of the Internal Revenue Code with
respect to the amount utilizable each year. This limitation reduces the
Company's ability to utilize net operating loss carry forwards included
above each year. The amount of the limitation has not been quantified by
the Company.
NOTE J - STOCK OPTION PLANS AND WARRANTS
The Company established a nonqualified stock option plan pursuant to which
options to acquire a maximum of 500,000 shares of the Company's common
stock were exercisable (the "1993 Plan"). Under the terms of the Plan, the
options, which expire ten years after grant, are exercisable at prices
equal to the fair market value of the common stock at the date of the grant
and become exercisable in accordance with terms established at the time of
the grant. At December 31, 2002, there were 477,000 shares available for
grant under the 1993 Plan.
In March 2001, the Company adopted, subject to shareholder approval, its
2001 Stock Option Plan (the "2001 Plan") and reserved 5,000,000 shares of
common stock there under. Options are nonqualified and are granted at a
price equal to the fair market value of the Company's common stock at the
date of grant. At December 31, 2002, all 5,000,000 shares were available
for grant under the 2001 Plan.
On June 13, 2000, in consideration for an officer's agreement to amend the
repayment terms of a $2,000,000 promissory note, the Company issued a
ten-year nonqualified warrant to purchase 200,000
F-23
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE J - STOCK OPTION PLANS AND WARRANTS (CONTINUED)
shares of the Company's common stock at an exercise price of $1.625 per
share (which represented the fair market value of the underlying common
stock at the time of grant). The warrant, which vested immediately, is
exercisable through June 2010 (Note H).
On June 1, 2000, pursuant to an employment agreement between the Company
and an officer, the Company issued nonqualified options to purchase 10,000
shares of common stock, at an exercise price of $4.00 per share. The
options vested 100% upon grant and are exercisable for three years from the
date of grant.
On March 15, 2000, the Company issued ten-year nonqualified options to
purchase 25,000 shares of common stock, at an exercise price of $4.00 per
share to a director of the Company. The options vested as to 50% of the
underlying shares on September 15, 2000 and the balance vested on March 15,
2001.
The following is a summary of activity with respect to stock options and
warrants:
Weighted-average
Shares Price per share price per share
------ ----------------- ----------------
Outstanding at January 1, 2000 23,000 $5.25 $5.25
Granted 235,000 1.63 to 4.00 1.98
Expired (23,000) 5.25 5.25
-------
Outstanding at December 31, 2000 235,000 1.63 to 4.00 1.98
Forfeited (25,000) 4.00 4.00
-------
Outstanding at December 31, 2001 210,000 1.63 to 4.00 1.16
=======
Balance exercisable at December 31, 2002 210,000 1.63 to 4.00 1.16
=======
The following table summarizes significant ranges of outstanding and
exercisable options and warrants at December 31, 2002:
Options and warrants outstanding Options and warrants exercisable
--------------------------------------------- --------------------------------
Weighted- Weighted- Weighted-
average average average
Ranges of remaining exercise exercise
exercise prices Shares life in years price Shares price
--------------- -------- ------------- --------- -------- ---------
$1.63 200,000 7.45 $1.63 200,000 $1.63
$4.00 10,000 0.42 4.00 10,000 4.00
F-24
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE J - STOCK OPTION PLANS AND WARRANTS (CONTINUED)
The weighted-average fair value on the grant date was $1.96 for options and
warrants issued during the year ended December 31, 2000. No options or
warrants were granted during the year ended December 31, 2002 and 2001.
NOTE K - RELATED PARTY TRANSACTIONS
Sales of inventory to a customer who is related to an officer of the
Company were approximately $29,032,000 and $21,125,000 and $4,390,000 for
the years ended December 31, 2002, 2001 and 2000, respectively. The Company
also purchased inventory from this customer in the amount of $4,058,000,
$11,151,000 and $6,323,000 during the years ended December 31, 2002, 2001
and 2000, respectively. Sales to this related party represented 12%, 11%
and 12% of total sales during the years ended December 31, 2002, 2001 and
2000, respectively. No other single customer represented greater than 10%
of total sales during each of the three years in the period ended December
31, 2002.
NOTE L - CONCENTRATIONS
The Company made purchases from one prepaid telephone calling card supplier
which aggregated approximately 61%, 43% and 16% of total purchases during
the years ended December 31, 2002, 2001 and 2000, respectively.
Additionally, liabilities to this supplier aggregated approximately 70%,
59% and 31% of total accounts payable and accrued expenses at December 31,
2002, 2001 and 2000.
The Company made purchases from two separate prepaid telephone card
suppliers which aggregated approximately 13% and 15% of total purchases
during the years ended December 31, 2001 and 2000, respectively.
NOTE M - COMMITMENTS AND CONTINGENCIES
Litigation
For the year ended December 31, 1999, purchases from one telephone card
supplier were approximately 55% of total purchases. In November 1999, the
Company commenced an action against this supplier to recover damages
resulting from cancellation of the telephone card purchases by the Company.
The supplier subsequently countersued. In the Company's opinion, with which
its legal counsel concurs, no material liability will result from the
countersuit. The Company incurred a loss of $553,547, which was reflected
in the fourth quarter of 1999. The Company subsequently mitigated, in
substantial part, its reliance on this supplier by increasing its purchases
from other vendors. On September 30, 2001, in
F-25
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE M - COMMITMENTS AND CONTINGENCIES (CONTINUED)
order to avoid protracted litigation and mounting legal fees, the Company
decided to settle the case, wherein it agreed to pay $250,000 to the
supplier over a period of four years beginning in August 2001, pursuant to
a nonnegotiable, convertible promissory note (the "Convertible Note"). This
amount is payable in four monthly installments of $7,500 and 44 subsequent
monthly installments of $5,000, each exclusive of interest. The Company has
recorded a $203,000 charge representing the net present value of the
settlement amount. The Convertible Note contains conditions, whereby, upon
occurrence of an event of default, as defined, the supplier shall have the
right to convert 100% of the unpaid principal balance, plus an additional
$200,000 (the "Default Amount") into fully paid nonassessable shares of the
Company's common stock at a conversion price equal to the greater of the
fair market value of the common stock on the date of default ($0.04 at
December 31, 2002) or $1.00 per share.
Aggregate annual maturities of the Convertible Note are summarized as
follows:
Year ending December 31,
------------------------
2003 $ 50,020
2004 55,258
2005 34,868
--------
$140,146
--------
The Company from time to time is subject to other certain legal proceedings
and claims which have arisen in the ordinary course of its business. These
actions when ultimately concluded will not, in the opinion of management,
have a material adverse effect upon the financial position, results of
operations or liquidity of the Company.
Employment Agreements
On December 10, 1999, the Company entered into a three-year employment
agreement with its chief executive officer. Base salary for each of the
three years will be $200,000, $225,000 and $250,000, respectively. At the
end of the three-year period, the employment agreement will automatically
be extended for an additional year without any action by the Company or the
chief executive officer, unless there is a submitted written notice four
months prior to expiration of the agreement by either party. In addition to
the base salary, the Company will compensate the chief executive officer
with cash bonuses and stock option grants based on the Company's economic
performance.
F-26
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE M COMMITMENTS AND CONTINGENCIES (CONTINUED)
Employment Agreements (continued)
On March 22, 2001, in consideration for this officer's agreement to further
amend the repayment terms of a $2,000,000 promissory note (Note H), the
Company amended the officer's employment agreement whereby the officer
shall receive an additional bonus equal to 5% of the gross profit of the
Company, as defined. Such bonus shall be paid in cash, or, at the
discretion of the officer, in shares of the Company's common stock, based
upon a per share price equal to 75% of fair market value of the common
stock. Approximately $356,000 is payable to the officer and is included in
accounts payable and accrued expenses on the consolidated balance sheet at
December 31, 2002.
Lease Commitments
The Company leases its main office and sales office facilities and certain
equipment pursuant to noncancellable operating and capital leases expiring
through November 2008. The minimum rental commitments under these
noncancellable leases, at December 31, 2001, are summarized as follows:
Operating Capitalized
leases leases
------------ -----------
Year ending December 31,
2003 $ 440,178 $53,268
2004 389,754 41,449
2005 322,412 2,075
2006 309,624
2007 322,703
Thereafter 381,227
---------- -------
2,165,898 96,792
Less amount representing interest - 10,807
---------- -------
Total minimum lease payments $2,165,898 85,985
==========
Less current maturities 44,934
-------
Long-term capitalized lease obligations $41,051
=======
Rent expense for all operating leases was $559,569, $234,080 and $128,067
in 2002, 2001 and 2000, respectively.
F-27
9278 Communications, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2002, 2001 and 2000
NOTE N - SUBSEQUENT EVENTS
On January 31, 2003, the Company announced the execution of a Merger
Agreement with NTSE Holding Corp., a corporation wholly owned by the
Chairman, Chief Executive Officer and the principal stockholder, which
will result in 9278 Communications becoming a privately held corporation,
owned by the Company's Chairman. Pursuant to this agreement, all of the
outstanding shares of 9278 Communications will be cancelled and our
existing stockholders will receive a cash payment of $0.10 per share. The
transaction is subject to numerous conditions, including the approval by
our public stockholders. It is expected that a stockholder's meeting to
approve the transaction will be held in May, and that the closing of the
transaction, if approved, will occur immediately thereafter.
F-28
9278 Communications, Inc. and Subsidiaries
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2002, 2001 and 2000
Column A Column B Column C Column D Column E
-------- -------- ------------------------------ -------- --------
Additions
------------------------------
(1) (2)
Charged to
Balance at Charged to other Balance
beginning costs and accounts - Deductions - at end of
Description of period expenses describe describe period
----------- ------------- ----------- --------------- ---------- ----------
Allowance for doubtful accounts
Year ended December 31, 2002 $ 760,000 $ 790,402 $ - $ 790,402(a) $ 760,000
============= =========== =============== ========== ==========
Year ended December 31, 2001 $ 675,000 $ 885,282 $ $ 800,282(a) $ 760,000
============= =========== =============== ========== ==========
Year ended December 31, 2000 $ 125,000 $ 598,474 $ - $ 48,474(a) $ 675,000
============= =========== =============== ========== ==========
Valuation allowance-Deferred tax
asset
YEAR ENDED DECEMBER 31, 2002 $ 1,146,150 $ 2,850,850 $ - $ - $3,997,000
============= =========== =============== ========== ==========
YEAR ENDED DECEMBER 31, 2001 $ 1,512,180 $ - $ - $ 366,030(b) $1,146,150
============= =========== =============== ========== ==========
Year ended December 31, 2000 $ - $ 1,512,180 $ - $ - $1,512,180
============= =========== =============== ========== ==========
(a) Accounts receivable written off
(b) Tax benefit recognized and adjustment of net operating loss carry
forward
F-29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
21
PART III
ITEM 10. Directors and Executive Officers of The Registrant.
The following persons are our executive officers and directors as of
the date hereof:
NAME AGE OFFICES HELD
---------- --- ------------
Sajid Kapadia 29 Chairman, Chief Executive Officer and Director
Haris Syed 28 President, Secretary and Director
Hanif Bhagat 29 Director
SAJID KAPADIA. Mr. Kapadia has been our Chairman, Chief Executive
Officer and a director of ours since December 1999. In April 1997, Mr. Kapadia
founded 9278 Distributor Inc. and served as its President from inception through
its merger with iLink Telecom, Inc., our predecessor. Prior to this, Mr. Kapadia
was involved in several short-term telemarketing positions. Mr. Kapadia has a
degree in mechanical engineering from Gandhi Engineering College in Gujarat,
India.
HARIS SYED. Mr. Syed has been our President since March 2001 and has
been our Secretary and a director of ours since December 1999. Prior to being
named President, he served as our Chief Operating Officer beginning June 2000.
Before being appointed as our Chief Operating Officer, he was a Vice President
of ours, beginning December 1999. Prior to this, from November 1996 through
December 1999, he was the Vice President of TCI Telecom of NY, a telecom
switching and voice over Internet protocol integrator.
HANIF BHAGAT. Mr. Bhagat has been a director of ours since March 2001.
He has provided consulting services to us since January 2001. Prior to this he
was a student at Dawson College in Montreal, Quebec, where he received a
Bachelor of Arts degree in communications.
Board of Directors
All of our directors hold office until the next annual meeting of
stockholders and the election and qualification of their successors. Our
executive officers are elected annually by the Board of Directors to hold office
until the first meeting of the Board following the next annual meeting of
stockholders and until their successors are chosen and qualified.
22
Directors' Compensation
We reimburse our directors for expenses incurred in connection with
attending Board meetings but we do not pay director's fees or other cash
compensation for services rendered as a director.
Item 11. Executive Compensation.
Summary Compensation
Set forth below is the aggregate compensation for services rendered in
all capacities to us during our fiscal years ended December 31, 2002, 2001 and
2000 by our Chief Executive Officer and each other executive officer of ours who
received compensation in excess of $100,000 during such fiscal years.
SUMMARY COMPENSATION TABLE
--------------------------------------------------------------------------------
ANNUAL COMPENSATION LONG-TERM COMPENSATION
--------------------------------------------------------------------------------
ANNUAL
NAME AND PRINCIPAL SALARY BONUS
POSITION YEAR ($) ($)
--------------------------------------------------------------------------------
Sajid Kapadia, 2002 $250,000 $675,000
Chairman and Chief 2001 $200,000 $475,000
Executive Officer 2000 $200,000 --
--------------------------------------------------------------------------------
Haris Syed, President 2002 $150,000 --
2001 $150,000 --
--------------------------------------------------------------------------------
We did not grant any stock options to the named executive officers.
EMPLOYMENT AGREEMENTS
Contract with Sajid Kapadia
On December 10, 1999, we entered into an Employment Agreement with
Sajid Kapadia. Under the terms of this agreement, Mr. Kapadia will serve as our
Chairman of the Board and Chief Executive Officer for an initial term of three
years, which term will be automatically extended for additional one
23
year periods unless either party submits a notice of non-extension to the other
not less than four months prior to the end of the existing term.
Pursuant to the agreement, Mr. Kapadia receives a base salary of
$200,000, $225,000 and $250,000 during his first, second and third years of
employment, respectively. In addition, during each year of employment Mr.
Kapadia shall receive cash bonuses and stock option grants in amounts to be
determined by our Board of Directors. We also lease an automobile for Mr.
Kapadia's exclusive use. Mr. Kapadia is also entitled to participate in all
plans adopted for the general benefit of our employees and executive employees.
In March 2001, in consideration for his agreement to extend the payment terms of
a promissory note which we made to him and other consideration, we amended Mr.
Kapadia's employment agreement to provide that he will receive additional bonus
compensation equal to five (5%) percent of our gross profit. This bonus
compensation may be paid in cash, or with restricted shares of our common stock
based upon a price per share 75% of the fair market value of the shares, at Mr.
Kapadia's sole discretion.
The agreement with Mr. Kapadia automatically terminates upon his death.
In addition, we can terminate the agreement based on Mr. Kapadia's continued
disability, for due cause or without due cause. Mr. Kapadia can terminate his
employment for good reason. If the agreement is terminated for death,
disability, or due cause, we will pay Mr. Kapadia any unpaid base salary and
bonus through the date of termination. If we terminate Mr. Kapadia's employment
for any other reason, or if he terminates it for good reason, we will pay him
his base salary for the remaining term of the agreement, but in no event less
than 24, nor more than 35 months.
Mr. Kapadia's agreement contains standard provisions regarding
confidentiality and non-competition during the term of his employment.
Compensation Plans
iLink Telecom, Inc. Non-Qualified Stock Option Plan
Effective June 1, 1999, iLink Telecom, Inc., our predecessor, adopted
the iLink Telecom, Inc. Non-Qualified Stock Option Plan (the "iLink Plan").
Options granted under the iLink Plan are not intended to be incentive stock
options as defined in Section 422 of the Internal Revenue Code of 1954, as
amended. Our employees, directors, officers, consultants and advisors are
eligible to be granted options pursuant to the iLink Plan. The exercise price of
the options is determined by our Board of Directors.
Options granted pursuant to the iLink Plan terminate on the date
established by the Board of Directors when the options are granted.
The iLink Plan is administered by our Board of Directors. The Board of
Directors has the authority to interpret the provisions of the iLink Plan and
supervise the administration of the iLink Plan. In addition, our Board of
Directors is empowered to select those persons to whom options are to be
granted, to determine the number of shares subject to each grant of an option
and to determine when, and upon what conditions or options granted under the
iLink Plan will vest or otherwise be subject to forfeiture and cancellation.
24
In the discretion of our Board of Directors, any option granted
pursuant to the iLink Plan may include installment exercise terms so that the
option becomes fully exercisable in a series of cumulating portions. The Board
of Directors may also accelerate the date upon which any options, or any part of
any options, are first exercisable. In the discretion of the Board of Directors
payment for shares of common stock underlying options may be paid through the
delivery of shares of our common stock having an aggregate fair market value
equal to the option price, provided that such shares have been owned by the
option holder for at least one year prior to the exercise. A combination of cash
and shares of common stock may also be permitted at the discretion of the Board
of Directors. Options are generally non-transferable except upon death of the
option holder.
Our Board of Directors may at any time, and from time to time, amend,
terminate, or suspend the iLink Plan in any manner it deems appropriate,
provided that the amendment, termination or suspension cannot adversely affect
rights or obligations with respect to shares or options previously granted.
The iLink Plan is not qualified under Section 401(a) of the Internal
Revenue Code, and is not subject to any provisions of the Employee Retirement
Income Security Act of 1974.
The maximum number of shares of our common stock for which options may
be granted under the iLink Plan is 500,000. If any option expires or is canceled
without having been fully exercised we may regrant that option. Options are not
exercisable after ten years after the date we grant them. Options we grant under
the iLink Plan generally are not transferable and terminate upon severance of
employment.
As of the date hereof, no options were outstanding under the iLink
Plan.
2001 Stock Option Plan
In March 2001, we adopted our 2001 Stock Option Plan (the "2001 Plan").
The purpose of the 2001 Plan is to further our growth, development and financial
success by providing additional incentives and personal interest in our company
by those responsible for securing our continued growth and success.
The 2001 Plan is administered by our Board of Directors, and provides
for the grant to our employees of both incentive options, intended to qualify
under Section 422 of the Internal Revenue Code, and non-qualified options to
purchase our common stock. The compensation committee, or Board of Directors if
there is no compensation committee, will grant options subject to a vesting
schedule, conditions, restrictions and other provisions.
The price of the shares subject to each option will be equal to the
fair market value of the shares on the date we grant them. However, if we grant
incentive stock options to an individual owning more than 10% of the total
combined voting power of all classes of our stock, the exercise price of the
options will not be less than 110% of the fair market value of the underlying
shares on the date of grant, as required by Section 162(m) of the Internal
Revenue Code. If the aggregate fair market value of our shares with respect to
which incentive stock options are exercisable by any person for the first time
during any calendar year exceeds $100,000, the options will be treated as
non-qualified options.
25
A holder of options to purchase our common stock under the 2001 Plan
may exercise the options by delivery to us of cash equal to the exercise price,
or with approval of the board of directors, shares of our common stock equal to
the exercise price, a promissory note equal to the exercise price, or a
combination of these forms of payment.
If the outstanding shares of our common stock are changed into or
exchanged for a different number or kind of shares or other securities by reason
of reorganization, merger, consolidation, reclassification or combination of
shares, we will make adjustments in the number and kind of shares for the
purchase of which options may be granted.
The holders of options under our 2001 Plan will not be considered
shareholders of ours unless and until certificates representing shares of our
common stock have been issued by us to such holders.
The maximum number of shares of our common stock for which options may
be granted under the 2001 Plan is 5,000,000. If any option expires or is
canceled without having been fully exercised we may regrant that option. Options
are not exercisable after ten years after the date we grant them. Options we
grant under the 2001 Plan generally are not transferable and terminate upon
severance of employment.
As of the date hereof, no options are outstanding under the 2001 Plan.
Compensation Committee Interlocks and Insider Participation
Each member of our Board of Directors participates in the determination
of the level of compensation of our executive officers. Two of such directors,
Sajid Kapadia and Haris Syed, are officers of ours. Hanif Bhagat, the third
director is the brother-in-law of Sajid Kapadia and an employee of ours.
Limitation of Liability and Indemnification Matters
Article nine of our certificate of incorporation provides that the
personal liability of our directors will be eliminated to the fullest extent
permitted by the provisions of paragraph (7) of subsection (b) of ss.102 of the
General Corporation Law of the State of Delaware, as the same may be amended and
supplemented.
Article ten of our certificate of incorporation provides that we will,
to the fullest extent permitted by the provisions of the General Corporation Law
of the State of Delaware, as now or hereafter in effect, indemnify all persons
whom we may indemnify under such provisions. The indemnification provided by
this section shall not limit or exclude any rights, indemnities or limitations
of liability to which any person may be entitled, whether as a matter of law,
under our bylaws, by agreement, vote of our stockholders or disinterested
directors, or otherwise. Except as specifically required by the General
Corporation Law of the State of Delaware, as the same exists or may be amended;
none of our directors of will be liable to us or our stockholders for monetary
damages for breach of his or her fiduciary duty as a director. No amendment to
or repeal of this provision of our certificate of incorporation will apply to or
have any effect on the liability or alleged liability of any director for or
with respect to any acts or omissions of that director occurring prior to the
amendment or repeal.
26
Under Section 145 of the Delaware General Corporation Law, we have the
power, under certain circumstances, to indemnify any person who was or is a
party or is threatened to be made a party to any threatened, pending or
contemplated action, suit or proceeding, whether civil, criminal, administrative
or investigative, by reason of the fact that he is or was a director, officer,
employee or agent of ours, or is or was serving at our request as a director,
officer, employee or agent of another corporation, partnership, joint venture,
trust or other enterprise against expenses, including attorneys' fees, and
judgments against, fines and amounts paid in settlement actually and reasonably
incurred by him in connection with the action, suit or proceeding.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers, or persons controlling us
pursuant to the foregoing provisions, we have been informed that, in the opinion
of the SEC, that type of indemnification is against public policy as expressed
in the Act and is therefore unenforceable.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The following table sets forth information as of the date hereof, based
on information obtained from the persons named below, with respect to the
beneficial ownership of shares of our common stock by (i) each of our directors,
(ii) our named executive officer, (iii) each person known by us to be the owner
of more than 5% of our outstanding shares of common stock and (iv) all executive
officers and directors as a group.
Unless otherwise indicated, we believe that all persons named in the
table have sole voting and investment power with respect to all shares of common
stock beneficially owned by them. A person is deemed to be the beneficial owner
or securities that can be acquired by such person within 60 days from the date
of this prospectus upon exercise of options, warrants or convertible securities.
Each beneficial owner's percentage ownership is determined by assuming that all
options, warrants or convertible securities that are held by that person, but
not those held by any other person, and which are exercisable within 60 days of
the date of this prospectus have been exercised and converted. This table
assumes a base of 23,593,173 shares of common stock outstanding as of the date
hereof, before any consideration is given to outstanding options, warrants or
convertible securities.
Unless otherwise noted, the address for each of the persons listed
below is: c/o 9278 Communications, Inc., 1942 Williamsbridge Road, Bronx, New
York 10461.
27
NAME OF NUMBER OF SHARES PERCENTAGE
BENEFICIAL OWNER BENEFICIALLY OWNED OF CLASS
---------------- ------------------ --------
Sajid Kapadia 12,465,215(1) 52.1%
Haris Syed 256,000(2) 1.0%
Hanif Bhagat 0 *
Honest Holdings Inc. 2,000,000 8.4%
9229 Queens Blvd 17H
Rego Park, NY 11374
All executive officers 12,721,215(1)(2) 53.2%
and directors as a Group
(4 persons)
(1) Represents shares held by NTSE. Does not includes warrants to purchase
200,000 shares of our Common Stock currently held by Mr. Kapadia, which
expire on June 13, 2010.
(2) Represents shares of common stock held by KAPH Groups, Inc., a company
100% owned by Mr. Syed.
* Equals a percentage less than 1% of the outstanding shares of the
Company's Stock.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
In March 2001, Sajid Kapadia, an officer and director of ours, agreed
to amend the repayment terms of a $2.0 million promissory note made to him by us
at the time of the merger between iLink Telecom, Inc., our predecessor, and 9278
Distributor Inc., in December 1999. As amended, the terms provide for principal
repayments by us of (i) $1.0 million on March 31, 2002, and (ii) $1.0 million on
December 31, 2002. In consideration for his agreement to extend the payment
terms of the note and other consideration, we amended Mr. Kapadia's employment
agreement to provide that he will receive an annual bonus equal to five (5%)
percent of our gross profit. This bonus compensation may be paid in cash, or
with restricted shares of our common stock based upon a price per share 75% of
the fair market value of the shares, at Mr. Kapadia's sole discretion. Mr.
Kapadia had previously extended the payment terms of this promissory note, in
June 2000. At that time, in consideration for his agreement to extend the
repayment terms of the note, we issued him a warrant to purchase 200,000 shares
of our common stock at an exercise price of $1.625 per share. The warrant vested
immediately as to 100% of the shares of common stock underlying the warrant and
is exercisable for ten years from the date of the grant.
In December 1999, iLink Telecom, Inc., our predecessor, agreed to
purchase 9278 Distributor Inc., a company controlled by Sajid Kapadia, an
officer and director of ours. Mr. Kapadia was not an officer or director of
iLink. In connection with that merger, the shareholders of 9278 Distributor were
issued an aggregate of 14,900,000 shares of our common stock, as well as a
dividend of $3.0 million, of which $1.0 million was paid in December 1999 and
the balance of $2.0 million was in the form of a two-year promissory note. Of
these shares, 13,205,125 were issued to Mr. Kapadia. In addition to such
28
shares, Mr. Kapadia was granted proxies to vote an aggregate of 2,150,000
additional shares of our common stock.
In December 1999, we entered into a sublease agreement with Sajid
Kapadia, an officer and director of ours, pursuant to which we sublease the
entire premises at 1942 Williamsbridge Road, Bronx, New York as our corporate
offices, at an annual rent of $63,000. The rental terms of the sublease
agreement are substantially the same as the terms under which Mr. Kapadia leases
the space.
ITEM 14. CONTROLS AND PROCEDURES.
Based on their evaluation of the Company's disclosure controls and
procedures as of a date within 90 days of the filing of this Annual Report on
Form 10-K, the Chief Executive Officer and the Principal Accounting Officer have
concluded that such controls and procedures are effective. There were no
significant changes in the Company's internal controls or in other factors that
could significantly affect such controls subsequent to the date of their
evaluation.
29
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
(1) Financial Statements. See Index to Consolidated Financial
Statements in Item 8 hereof.
(2) Financial Statement Schedules.
None
(3) Exhibits.
Exhibit Number Description of Exhibit
-------------- ----------------------
2.1 Agreement and Plan of Merger, dated December 17, 1999, among
iLink Telecom, Inc., 9278 Distributors Acquisition Corp. and
9278 Distributor Inc. (3)
2.2 Agreement and Plan of Merger, dated April 24, 2000, between
the Company and 9278 Communications, Inc., a Nevada
corporation (5)
2.3 Agreement and Plan of Merger, dated December 8, 2000, among
Reliable Networks, Inc., Nasir Ghesani, Reliable Acquisition
Corp. and the Company (6)
3.1 Certificate of Incorporation of the Company (5)
3.2 Bylaws of the Company (5)
4.1 Specimen Common Stock Certificate of the Company (2)
4.2 Non-Qualified Stock Option Plan of the Company (4)
4.3 2001 Stock Option Plan of the Company (7)
4.4 Amended and Restated Promissory Note, in the Amount of $2.0
million, made by the Company to Sajid Kapadia, dated December
10, 1999 (7)
30
4.5 Promissory Note, in the amount of $400,000, made by the
Company to Nasir Ghesani, dated December 8, 2000 (6)
4.6 Promissory Note, in the amount of $100,000, made by the
Company to Nasir Ghesani, dated December 8, 2000 (6)
4.7 Promissory Note, in the amount of $500,000, made by the
Company to Nasir Ghesani, dated December 8, 2000 (6)
10.1 Employment Agreement, dated December 10, 1999, between the
Company and Sajid Kapadia (4)
10.2 Employment Agreement, dated December 8, 2000, between the
Company, Reliable Acquisition Corp. and Nasir Ghesani (6)
10.3 Amendment, dated March 22, 2000, to Employment Agreement
between the Company and Sajid Kapadia (7)
21.1 Subsidiaries of the Company (1)
99.1 Certificate of 9278 Communications, Inc. CEO pursuant to
Sec 906 of the Sarbanes-Oxley Act of 2002
99.2 Certificate of 9278 Communications, Inc., CEO and Principal
Accounting Officer pursuant to Sec 906 of the Sarbanes-Oxley
Act of 2002.
(1) Filed herewith
(2) Incorporated by reference from the Company's registration
statement on Form SB-2 (Registration No. 333-84845)
(3) Incorporated by reference from the Company's report on Form
8-K, dated December 10, 1999
(4) Incorporated by reference from the Company's report on Form
10-KSB for the year ended December 31, 1999
(5) Incorporated by reference from the Company's report on Form
10-QSB for the three-month period ended March 31, 2000
(6) Incorporated by reference from the Company's report on Form
8-K, dated December 8, 2000
(7) Incorporated by reference from the Company's report on Form
10KSB for the year ended December 31, 2000
(b) Reports on Form 8-K. We filed the following Current Reports on Form 8-K
during the fiscal year ended December 31, 2002:
None
31
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this Annual
Report on Form 10-K to be signed on its behalf by the undersigned, thereunto
duly authorized.
9278 COMMUNICATIONS, INC.
Date: May 1, 2003 By: /s/ Sajid Kapadia
------------------------------
Sajid Kapadia, Chairman,
Chief Operating Officer
and Director
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report on Form 10-K has been signed below by the following persons in the
capacities and on the dates indicated:
Signature Title Date
--------------------------------------------------------------------------------
/s/ Sajid Kapadia Chairman, Chief Executive Officer, May 1, 2003
-------------------- (Principal Executive Officer and Director)
Sajid Kapadia
/s/ Haris Syed President and Director May 1, 2003
--------------------
Haris Syed
CERTIFICATION
I, Sajid B. Kapadia, certify that:
1. I have reviewed this annual report on Form 10-K of 9278 Communications,
Inc. (the "registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report.
4. I am responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the a registrant, including its
consolidated subsidiaries, is made known to me by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. I have disclosed, based on my most recent evaluation, to the registrant's
auditors and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect a the registrant's ability to
record, process, summarize, and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. I have indicated in this annual report whether there were significant
changes in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of my most recent
evaluations, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 1, 2003
/s/ SAJID B. KAPADIA
-----------------------
SAJID B. KAPADIA
CHIEF EXECUTIVE OFFICER
I, Sajid B. Kapadia, certify that:
1. I have reviewed this annual report on Form 10-K of 9278 Communications,
Inc. (the "registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report.
4. I am responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the a registrant, including its
consolidated subsidiaries, is made known to me by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. I have disclosed, based on our most recent evaluation, to the registrant's
auditors and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect a the registrant's ability to
record, process, summarize, and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. I have indicated in this annual report whether there were significant
changes in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluations, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 1, 2003
/s/ SAJID B. KAPADIA
-----------------------
SAJID B. KAPADIA
CHIEF EXECUTIVE OFFICER AND PRINCIPAL
ACCOUNTING OFFICER