U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-KSB/A
(Amendment
No. 3)
(Mark
one)
x
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
fiscal year ended September 30, 2003
o
TRANSITION
REPORT UNDER SECTION 13 OR 15 (d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
Transition period from ________ to ____________
Commission
File Number: 0-24217
YP
CORP.
(Name
of
Small Business Issuer in its Charter)
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NEVADA
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85-0206668
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(State
or other jurisdiction of incorporation or organization)
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(IRS
Employer Identification No.)
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4840
EAST JASMINE STREET, SUITE 105, MESA, ARIZONA
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85205
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(Address
of principal executive offices)
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(Zip
Code)
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(480)
654-9646
(Issuer’s
telephone number)
Securities
registered under Section 12(b) of the Exchange Act: NONE
Securities
registered under Section 12(g) of the Exchange Act:
COMMON
STOCK, $.001 PAR VALUE
(Title
of
Class)
YP.NET,
INC.
(Former
Name)
Check
whether the issuer (1) filed all reports required to be filed by Section 13
or
15(d) of the Exchange Act during the past 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes x
No
o.
Check
if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB o.
Registrant’s
revenues for its most recent fiscal year were $30,767,444.
The
aggregate market value of the common stock held by non-affiliates computed
based
on the closing price of such stock on December 26, 2003 was approximately
$29,600,000.
The
number of shares outstanding of the registrant’s classes of common stock, as of
December 26, 2003 was 48,560,802.
Transitional
Small Business Disclosure Format: Yes o
No
x
DOCUMENTS
INCORPORATED BY REFERENCE: None.
EXPLANATORY
NOTE
This
Amendment on Form 10-KSB/A (this “Amendment”) amends the Annual Report on Form
10-KSB for the year ended September 30, 2003, as originally filed by YP Corp.
on
December 31, 2003 (the “Original Filing”), and as amended by Amendment No. 1 on
Form 10-KSB/A filed on January 30, 2004, and further amended by Amendment No.
2
on Form 10-KSB/A filed on September 23, 2004, solely for the purpose of revising
Part II, Items 6, 7 and 8A to amend and restate the disclosure with
respect to our accounting for shares issued to, and subsequently recovered
from,
certain non-performing consultants during 1999 and 2000. The historical
financial statements generated by predecessor management reflected an expense
upon issuance of the shares and a reversal of this expense when it was deemed
(through a settlement agreement or judgment) that these shares would be
returned. However, after further analysis and consultation with the Securities
and Exchange Commission, it was determined to be inappropriate to recognize
the
initial expense and its subsequent reversal as no services were rendered by
these consultants. Instead, the issuance of these shares will be reflected
as
temporary equity, together with a related receivable, until the shares were
returned. The net decrease to cumulative after-tax income of approximately
$510,000 relates to shares issued in 1999 that were expected to be returned
but,
for various reasons, cannot be obtained. Such amounts will continue to be
reflected as expense in the year granted and our revised statements will no
longer reflect the reversal of this expense.
In
addition, in connection with the filing of this Amendment and pursuant to the
rules of the Securities and Exchange Commission, we are including with this
Amendment a currently dated consent of our independent public accountants and
certain currently dated certifications.
Except
as
described above, no other changes have been made to the Original Filing. This
Amendment continues to speak as of the date of the Original Filing, and, except
a specifically stated herein, we have not updated the disclosures contained
in
this Amendment to reflect any events that occurred at a date subsequent to
the
filing of the Original Filing. The filing of this Form 10-KSB/A is not a
representation that any statements contained in items of the Original Filing
other than that information being amended are true or complete as of any date
subsequent to the date of the Original Filing. The filing of this Form 10-KSB/A
shall not be deemed an admission that the Original Filing or the amendments
made
thereto, when made, included any untrue statement of a material fact or omitted
to state a material fact necessary to make a statement not
misleading.
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ITEM
6. MANAGEMENT’S DISCUSSION AND ANALYSIS
For
a
description of our significant accounting policies and an understanding of
the
significant factors that influenced our performance during the fiscal year
ended
September 30, 2003, this “Management’s Discussion and Analysis” should be read
in conjunction with the Consolidated Financial Statements, including the related
notes, appearing in Item 7 of this Annual Report.
Forward-Looking
Statements
This
portion of this Annual Report on Form 10-KSB, includes statements that
constitute “forward-looking statements.” These forward-looking statements are
often characterized by the terms “may,” “believes,” “projects,” “expects,” or
“anticipates,” and do not reflect historical facts. Specific forward-looking
statements contained in this portion of the Annual Report include, but are
not
limited to: (i) our expectation that legal costs relating to the litigation
involving our CEO will not be significant after December 31, 2003; (ii) our
projection that capital expenditures will not increase at the same rate in
the
future; (iii) our anticipation of the cessation of advances to affiliates and
the beginning to pay a cash dividend on our common stock in fiscal 2004; (iv)
our belief that our direct mail marketing costs in fiscal 2004 will be
consistent with our expenditures in fiscal 2003; and (v) our expectation that
initial costs incurred in our branding initiative will not immediately result
in
financial benefit to the Company.
Forward-looking
statements involve risks, uncertainties and other factors, which may cause
our
actual results, performance or achievements to be materially different from
those expressed or implied by such forward-looking statements. Factors and
risks
that could affect our results and achievements and cause them to materially
differ from those contained in the forward-looking statements include those
identified in the section below titled “Certain Risk Factors Affecting Our
Business,” as well as other factors that we are currently unable to identify or
quantify, but may exist in the future.
In
addition, the foregoing factors may affect generally our business, results
of
operations and financial position. Forward-looking statements speak only as
of
the date the statement was made. We do not undertake and specifically decline
any obligation to update any forward-looking statements.
Executive
Overview
Business
Summary
We
use a
business model similar to print Yellow Page publishers. We publish basic
directory listings, free of charge, exclusively on the Internet. Like Yellow
Page publishers, we generate virtually all of our revenues from those
advertisers that desire increased exposure for their businesses by purchasing
our Internet Advertising Package’,
or IAP.
Our basic listings contain the business name, address and phone number for
almost 18 million U.S. businesses. We strive to maintain a listing for almost
every business in America in this format.
To
generate revenues, certain advertisers pay us a monthly fee for our IAP in
the
same manner that advertisers pay additional fees to traditional print Yellow
Page providers for enhanced advertisement font, location or display. The IAP
includes a Mini-Webpage’,
map
directions, a toll-free calling feature, a link to the advertiser’s own webpage
and, at no additional charge, a priority or preferred placement on our website.
The users of our website(s) are prospective customers for our
advertisers.
We
also
offer other ancillary services and products that currently account for less
than
5% of our revenue. These ancillary services and products include website design
and hosting, and dial-up Internet access.
Sales
and Marketing
We
employ
a direct mail marketing program to solicit our IAP advertisers. Currently,
our
direct mail marketing program includes a promotional incentive in the form
of a
$3.25 activation check that a solicited business simply deposits with its bank
to activate the service and become an IAP advertiser on a monthly basis. As
a
method of third-party verification, the potential IAP advertiser’s bank verifies
that the depositing party is in fact the solicited business. Upon notice of
activation by the IAP advertiser’s bank, we contact the business to confirm the
order. Within 30 days of activation, we also send a confirmation card to the
business. We offer a cancellation period of 120 days with a full refund. Our
direct mail marketing program complies with and, in many instances, exceeds
the
United States Federal Trade Commission, or “FTC,” requirements as established by
an agreement between our company and the FTC.
IAP
advertisers
In
September 2003, we revised the method by which we count our IAP advertisers.
We
now differentiate between “paying IAP advertisers” and “activated IAP
advertisers.” Paying IAP advertisers, as the name implies, are those advertisers
that are actually currently paying for the IAP service. The terms activated
IAP
advertisers or activated advertisers are broader and more inclusive terms.
They
include those advertisers that currently are paying for the IAP service, as
well
as those advertisers that either have signed-up for the IAP service but have
not
yet been billed or have been billed but have not yet remitted to us their fees.
We
believe that the new methodology is more accurate and can be more consistently
applied to each period. We also believe that tracking and disclosing the numbers
of our activated IAP advertisers, in addition to our paying IAP advertisers,
provides greater clarity into our business by providing an indication or
forecast of how many activated IAP advertisers may eventually become paying
IAP
advertisers. Our average retention rate for paying IAP advertisers is
approximately 29 months, which, in turn, approaches the average operating life
expectancy of 36 months for a small business in the U.S., according to the
U.S.
Small Business Administration.
Methods
of Billing
We
bill
most of our IAP advertisers on their local telephone bill through their Local
Exchange Carrier, or “LEC.” We are one of only a few independent Internet
advertisers that are permitted to utilize this unique and cost-efficient method
of billing. By billing our IAP advertisers on their local telephone bill, we
believe we are able to realize a greater average rate of collection than direct
invoice-billing. The amount and frequency of collections on invoice-billed
IAP
advertisers historically has been significantly lower than for IAP advertisers
billed on their monthly telephone bill. Accordingly, our revenues can be
negatively impacted if the billing method used to bill a IAP advertiser converts
from monthly telephone bill invoicing to direct invoicing.
We
are
not permitted to bill our IAP advertisers through Competitive Local Exchange
Carriers, or CLECs. Recently, the CLEC’s have been participating in providing
local telephone services to IAP advertisers at an increasing rate. We have
begun
to address this problem and we are implementing data filters to reduce the
effects of the CLEC’s. We have also sought other billing methods to reduce the
adverse effects of the CLEC billings, including Automated Clearing House, or
ACH, which is direct debit from the IAP advertiser’s bank account and credit
cards. ACH billing now accounts for approximately 12% of our total billings
and
has reduced our dependency on LEC billing. We expect this trend to continue
and
escalate.
Accounting
Policies and Procedures
We
bill
our services monthly and recognize revenue for services billed in that month.
We
utilize outside billing companies, or billing aggregators, to transmit billing
data, much of which is forwarded to the LECs for inclusion on the IAP
advertiser’s monthly local telephone bill. Because we have a 120-day
cancellation policy on new advertiser sign-ups, we accrue for such refunds
as a
liability and net such anticipated refunds against revenue to report a net
revenue number in our financial statements.
The
billing aggregators and, subsequently, the LECs filter all billings that we
submit to them. We
recognize as revenue and accounts receivable the net billings accepted by the
LECs. The
billing aggregators remit payments to us on the basis of cash that the billing
aggregators ultimately receive from the LECs. The billing aggregators and LECs
charge fees for their services, which generally are 3% to 7% each on a monthly
basis. These fees, in turn, are netted against the gross accounts receivable
balance. The billing aggregators and LECs also apply holdbacks to the
remittances for potentially uncollectible accounts. These holdbacks and fees
result in significant dilution to our gross billings and, therefore, may
significantly affect our cash flow.
Due
to
the periods of time for which adjustments may be reported by the LECs and the
billing aggregators, we estimate and accrue for dilution and fees reported
subsequent to year-end for initial billings related to services provided for
periods within the fiscal year. Dilution
amounts will vary due to numerous factors. Accordingly, we may not be certain
as
to the actual amounts of dilution on any specific billing submittal until
several months after that submittal. We estimate the amount of these fees and
holdbacks based on historical experience and subsequent information received
from the billing aggregators. We also estimate uncollectible account balances
and provide an allowance for such estimates.
We
process our billings through two primary billing aggregators—PaymentOne, Inc.
and ACI Communications, Inc. PaymentOne provides the majority of our billings,
collections, and related services.
With
respect to our alternative billing methods, we recognize revenue for ACH
billings when they are accepted. We recognize revenue for direct-invoice
billings based on estimated future collections on such billings. We continuously
review these estimates for reasonableness based on our collection
experience.
Subscription
receivables that result from direct-invoice billing are valued and reported
at
the estimated future collection amount. Determining the expected collections
requires an estimation of both uncollectible accounts and refunds.
Our
cost
of services is comprised, primarily, of variable costs and expenses, including
the following, which are reported in both cost of services and sales and
marketing expenses:
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allowances
for bad debt, which are based upon historical experience and reevaluated
monthly;
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billing
fees, such as the fees charged by our billing aggregators and the
Local
Exchange Carriers;
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billing
aggregator inquiry fees, which generally are 1% on a monthly basis;
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dilution
resulting from fees and holdbacks due to items such as wrong telephone
numbers and other indications of
uncollectibility;
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Internet
expenses, such as dial-up expenses;
and
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direct
mailer marketing costs and the amortization of such
costs.
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Our
general and administrative expenses are comprised, primarily, of fixed costs,
including compensation expenses, which generally equate to 5% to 10% of net
revenue, as well as other expenses, such as lease payments, telephone,
professional fees, and office supplies. We recognize revenue for direct-invoice
billings based on estimated future collections on such billings. We continuously
review these estimates for reasonableness based on our collection experience.
Critical
Accounting Estimates and Assumptions
The
preparation of our financial statements in conformity with accounting principles
generally accepted in the United States of America requires our management
to
make certain estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities
at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. As such, in accordance with the use of
accounting principles generally accepted in the United States of America, our
actual realized results may differ from management’s initial estimates as
reported. A summary of our significant accounting policies are detailed in
the
notes to the financial statements which are an integral component of this
filing.
The
following summarizes critical estimates made by management in the preparation
of
the financial statements:
Our
revenue is generated by customer subscriptions for directory and advertising
services. Our billing and collection procedures include significant involvement
of outside parties. We obtain customers through direct mail advertising. When
a
customer subscribes to our service we create an electronic customer file, which
is the basis for the billing. We submit gross billings electronically to third
party billing aggregators. These billing aggregators compile and format the
information submitted to us and forward the billing records to appropriate
LECs.
The billing for our service flows through to monthly bills of the individual
LEC
customers. The LECs collect our billing and remit amounts to the billing
aggregators who in turn remit funds to us. Within this process, there are
numerous adjustments, charges and holdbacks implemented by the billing
aggregators and LEC’s.
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Customer
refunds.
We have a customer refund policy that allows the customer to request
a
refund if they are not satisfied with the service within the first
120
days of the subscription. We accrue for refunds based on historical
experience of refunds as a percentage of new billings in that 120-day
period. Estimated refunds are reserved and charged to net
revenue.
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Additionally,
there are customers who may not pay the fee for our services even though we
believe they are valid subscribers. We review the trend of non-paying customers
and include a reserve as a charge to revenue for estimated non-paying
customers.
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Unbillable
records.
We recognize revenue during the month for which the service is provided
based on net billings accepted by the billing aggregators. The billing
aggregators may reject and return billing records to us if there
is no
immediate match in their database as a valid “Billing Telephone Number”
(“BTN”). We analyze the trend of accepted vs. rejected billing records.
Only accepted records are recognized as revenue. We then analyze
the
reasons for a record being rejected and then attempt to correct the
record
for resubmittal. Because there may be a period of 30-60 days to obtain
information from the billing aggregators that identify BTNs, we estimate
that amount when billed and those billings are excluded from
revenue.
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Direct
bill customers.
We bill many subscribers directly. Our collection rate on these billings
is significantly lower than those processed through the LECs. We
track
collections on direct billed customers and recognize revenue from
those
customers based on the historical collection rates. Our recent collection
experience on these billings is approximately 10% to
12%.
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Dilution
and Related Reserves.
We reserve for future fees, chargebacks and holdbacks charged by
the LECs
and third party billing aggregators that are related. Because there
may be
a period of time from when the billings are initiated and fees and
holdbacks are adjusted and processed by the billing aggregators,
we
estimate those fees based on contractual agreements with the billing
aggregators and historical experience. Fees and expenses charged
by the
LECs and billing aggregators are charged to cost of services and
netted
against gross accounts receivable. Total dilution has approximated
25% to
30% of gross billings.
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Allowance
for Doubtful
Accounts:
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Cash
is
received through the process discussed above. We have contractual advance rates
with our third party billing aggregators. The billing aggregators report to
us
their holdbacks. These holdbacks include those submitted by the LECs. Some
of
these holdbacks may take 12-18 months to collect and “true-up” with the billing
aggregators. We estimate an allowance for doubtful accounts on the basis of
information provided by the billing aggregators. This information is an
indicator of timely payments made by our subscribers. At September 30, 2003,
the
allowance for doubtful accounts was approximately 30% of gross accounts
receivable.
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Carrying
Value of Intellectual
Property:
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The
carrying value of our intellectual property at September 30, 2003, relates
primarily to the purchase of the Yellow-Page.Net Universal Resource Locator
(“URL”) from Telco Billing. The URL is recorded at its $5,000,000 purchase price
less accumulated amortization of $1,820,517. We have estimated the useful life
of this asset to be 20 years.
We
believe that based on our current income and cash flow, the carrying value
of
the URL is not impaired at September 30, 2003. We believe our customers use
this
URL for maintaining their subscriptions to the Company’s service. The Company
has had an unaffiliated, independent third party appraiser perform a valuation
of the URL. That valuation also supports the conclusion that the value is not
impaired at September 30, 2003.
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Capitalization
of Direct Response Advertising Costs and Amortization
Thereof:
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The
Company purchases mailing lists and sends advertising materials to prospective
subscribers from those mailing lists. Customers subscribe to the services by
positively responding to those advertising materials, which serve as the
contract for the subscription. The Company capitalizes and amortizes the costs
of direct-response advertising on a straight-line basis over eighteen months,
the estimated average period of retention for new customers. We believe that
when a customer is retained through the 120-day refund period, long term
retention is longer than be 18 month amortization period. However, due to
attrition in the first months of a new subscription, the amortization period
has
been determined to the 18 months. The carrying value of $3,243,241 includes
the
gross cost of approximately $6,157,017 less amortization of
$2,913,776.
Management
evaluates the probability of the utilization of the deferred income tax assets.
The Company has estimated a $1,641,000 deferred income tax asset at September
30, 2003. Of that amount, $979,000 related to net operating loss carryforwards
at September 30, 2003. Management determined that because the Company has been
generating taxable income it was appropriate to recognize the deferred income
tax asset related to the net operating loss carryforward. Management is required
to make judgments and estimates related to the timing and utilization of net
operating loss carryforwards, utilization of other deferred income tax assets,
applicable tax rates and feasible tax planning strategies.
Future
Outlook
We
expect
to make progress on a number of initiatives over the next six to twelve months,
including the following:
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attempt
to get listed on a national exchange or quotation
system;
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add
additional independent directors to our Board of
Directors;
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establish
an audit committee that fully complies with the requirements of
Sarbanes-Oxley and the exchanges;
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engage
a national auditing firm;
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obtain
broader, more sophisticated and more reliable research coverage;
and
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roll
out our national branding campaign through various mediums of
advertisement, including, Internet, billboard, radio and cable television
in select markets to be determined. We have recently engaged a marketing
firm. We expect to use approximately $2,000,000 on this campaign
over the
next 18 months. This may have a negative impact on our margins. However,
to mitigate any adverse impact, management intends to attempt to
incur
these expenses gradually to be commensurate with anticipated increases
in
revenues resulting from the branding campaign.
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Recent
Developments
Litigation
by others against our Chairman and CEO
By
order
of the Board of Directors, we have been funding the litigation defense of our
Chairman and CEO, Angelo Tullo, as it related to claims made by New Horizon
Capital, LLC (“New Horizon”), the successor in interest to American Business
Funding Corp. These claims were not adverse to the Company. However, the Board
of Directors determined that clearing Mr. Tullo’s name was important to our
future success because of the results he has achieved on behalf of our
investors.
In
December 2003, New Horizon agreed to have the litigation against Mr. Tullo
dismissed. New Horizon was ordered by the judge to pay, and has paid, $10,000
to
Mr. Tullo’s lawyers as compensation for certain expert witness fees that were to
be paid by Mr. Tullo.
We
will
finish paying for the expenses relative to this case in the second quarter
of
fiscal 2004 and no further significant expenses are expected to be incurred
after December 31, 2003.
Termination
of the Revolving Loan Agreements With Our Major Shareholders—Mathew and Markson
and Morris & Miller, LTD (“M&M’s”)
As
part
of the original acquisition of our subsidiary, Telco Billing, from the M&Ms,
we provided them with the right to “put” back to us their shares of Company
common stock under certain circumstances. We subsequently entered into a new
arrangement with the M&Ms, whereby their “put” rights were terminated in
exchange for the establishment of revolving lines of credit. Under these lines
of credit, we agreed to lend up to $10 million to each of the M&Ms, subject
to certain limitations.
In
December 2003, we entered into an agreement with the M&M’s to terminate the
revolving lines of credit previously provided to them. Under this termination
agreement, which is effective as of April 9, 2004, we are to make final
advancements to the M&Ms of approximately $1,300,000. The aggregate of all
advances made by the Company to these shareholders is to be repaid to the
Company at the end of three years, along with accrued interest.
The
schedule of final advances that we are to make to the M&Ms under the
termination agreement are as follows:
Morris
& Miller, Ltd.
$275,000
on January 30, 2004
$300,000
on February 27, 2004
$500,000
on March 31, 2004
Sufficient
funds to pay 3 years interest on April 9, 2004
Mathew
and Markson, Ltd.
$50,000
on January 30, 2004
$100,000
on February 27, 2004
$75,000
on March 31, 2004
Sufficient
funds to pay 3 years interest on April 9, 2004
Within
ten days after April 9, 2004, the M&M’s will prepay all of the interest on
their loans for the next 36 months. We will continue to retain pledged stock
as
collateral for the repayment of all such loans, which, by agreement, mature
December 2006.
As
part
of this new agreement, we have also agreed to pay a quarterly dividend of not
less than $.01 per share beginning April 30, 2004 for the period ended March
31,
2004. We believe this is in the best interests of all of our
shareholders.
Termination
of Our Relationship with Simple.Net.
On
December 29, 2003, we entered into a separation agreement with Simple.Net,
a
company beneficially owned by our Director and Corporate Secretary DeVal
Johnson, which becomes effective January 31, 2004.
Prior
to
this agreement, we purchased Internet Dial Up access from Simple.net and
performed various services for Simple.Net for a fee. These services included
Customer Service support for Simple.Net’s customers and Technology Support and
Billing assistance. At the time the contract(s) were entered into, this was
beneficial to us because we did not have sufficient dial-up customers to avoid
a
minimum fee to the backbone providers, which are companies that own the cable
and copper wire cables necessary to provide the service. As our customer base
has grown, we are now able to economically enter into our own wholesale contract
and in fact have with GlobalPOPs.
In
addition, at this time, our revenues from the customer support and technology
assistance was essentially the same as that currently paid to Simple.Net to
provide the dial up service. We will not be affected by the loss in revenue
from
Simple.Net as the new contract from GlobalPOPs, which now has no minimum
guarantees, is low enough to offset the difference.
Results
of Operations
Fiscal
Year End September 30, 2003 Compared to Fiscal Year End September
30,
2002.
Net
revenue for the year ended September 30, 2003 (“Fiscal 2003”) was $30,767,444
compared to $12,618,126 for the year ended September 30, 2002 (“Fiscal 2002”)
representing an increase of approximately 144%. This increase in net revenue
is
the result of three factors: an increase in the number of our IAP Advertisers,
the conversion of certain Advertisers from direct bill invoice to monthly
telephone billing and an increase in our monthly pricing. These three factors
are discussed further below.
Our
IAP
Advertiser count increased to 255,376 at September 30, 2003 compared to 113,565
at September 30, 2002, an increase of approximately 125%. Relating to the
conversion of certain Advertisers to monthly telephone billing, in August,
2003,
we analyzed our database of IAP Advertisers that were being billed via direct
monthly invoice to determine which of these Advertisers were eligible to be
billed on their monthly telephone bill. As a result of this analysis, we
determined that 46,717 Advertisers were eligible for monthly telephone billing.
As previously described under “Billing”
and in
the Financial Statement footnotes, our revenue recognition and collections
are
significantly higher when Advertisers are billed on their monthly telephone
bills rather than through direct invoice. Relating to our price increase, we
now
charge $21.95 monthly versus $17.95 previously for new IAP Advertisers. In
addition, the monthly charge to existing IAP Advertisers was increased to $24.95
monthly upon the first anniversary of their listing. This price increase was
instituted on March 20, 2003.
We
recently revised the method by which we count our customers. We believe that
the
new methodology is more accurate and can be more consistently applied to each
period. We believe that the disclosure of customer counts including total
Activated customers and paying customers provides the most insight into our
business.
Activated
customers include those Advertisers that are currently paying for the IAP
service, as well as those Advertisers that have signed-up for the IAP service
but have not necessarily been billed and begun their payment for the service.
Based upon these revisions, we had 255,376 Activated IAP customers at September
30, 2003, 235,162 Activated IAP customers at June 30, 2003, 222,092, Activated
IAP customers at March 31, 2003 and 168,980 Activated IAP customers at December
31, 2002.
Regarding
Paying customers, the Company had 221,537 Paying customers at September 31,
2003, 167,000 Paying customers at June 30, 2003, 151,173 paying customers at
March 31, 2003 and 137,346 Paying customers at December 31, 2002.
Cost
of
services for Fiscal 2003 was $8,473,768 compared to $3,497,678, an increase
of
142%. The increase in cost of services is due to the increased IAP customer
count, as well as the increase in our direct mail solicitation effort whereby
we
are currently mailing, on average, approximately 1 million mailers to businesses
each month. Cost of services as a percent of net revenue was approximately
27%
for Fiscal 2003 compared to 28% for Fiscal 2002. Gross margins improved to
73%
in Fiscal 2003 compared to 72% in Fiscal 2002. The improvement in gross margin
results from the leveraging of certain fixed costs, included in cost of
services, over a larger customer base.
General
and administrative expenses for Fiscal 2003 were $8,657,690 compared to
$4,754,665 for Fiscal 2002, an increase of approximately 82%. General and
administrative expenses increased due to an increase in costs and employees
relating to our previously-described growth in IAP Advertisers, the
establishment in Fiscal 2003 of our Quality Assurance and Outbound departments
as well as an increase in certain officers’ compensation relating to employment
contracts with such officers. In addition, during Fiscal 2003, the Company
paid
$410,054 for the costs of defending a civil action filed against its CEO and
Chairman pursuant to a Board of Directors resolution. The action involved a
business in which the CEO was formerly involved. The Board believed that it
was
important and in our best interests and in the best interests of our
shareholders to resolve this matter as soon as possible. As described under
“Recent Developments,” this matter has now been resolved and we no longer expect
to incur significant legal costs after December 31, 2003 relating to this
matter. Excluding the previously described legal costs, general and
administrative expenses increased approximately 67% in Fiscal 2003 over Fiscal
2003. As a percent of net revenue, general and administrative expenses were
approximately 28% in Fiscal 2003 compared to approximately 38 % in Fiscal 2002.
Excluding the previously-described legal costs, general and administrative
expenses as a percent of net revenue was approximately 26% in Fiscal 2003
compared to 38% in Fiscal 2002.
Sales
and
marketing expenses for Fiscal 2003 were $3,868,643 compared to $963,868 for
Fiscal 2002, an increase of approximately 300%. The increase was principally
the
result of our re-instituting our marketing efforts in the latter part of Fiscal
2002 with the full annual cost of such effort in Fiscal 2003. The marketing
expenses are attributed to our direct response marketing, which is our primary
source of attracting new Advertisers. As a percent of net revenue, sales and
marketing expense was approximately 13% in Fiscal 2003 versus approximately
8%
in Fiscal 2002.
Depreciation
and amortization was $660,475 in Fiscal 2003 compared to $581,290 in Fiscal
2002, an increase of approximately 14%. This increase was primarily the result
of a substantial upgrade of our information technology systems as well as
hardware purchased relating to the establishment of our Quality Assurance and
Outbound marketing departments. These efforts involved capital expenditures
of
$736,955 in Fiscal 2003 compared to 77,632 in Fiscal 2002. We do not anticipate
capital expenditures to grow at this same rate in the future. In addition,
amortization increased in Fiscal 2003 as a result of our agreement with OnRamp
Access, Inc. to license the YP.Com Uniform Resource Locator
(“URL”).
The
cost
of the Yellow-Page.Net URL was capitalized at its cost of
$5,000,000.
The
URL
is amortized on an accelerated basis over the twenty-year term of the licensing
agreement. Amortization expense on the URL was $351,933 for the year ended
September 30, 2003. Annual amortization expense in future years related to
this
URL is anticipated to be approximately $350,000-450,000.
Operating
income in Fiscal 2003 was $9,106,890 compared to $2,820,625 in fiscal 2002
representing an increase of approximately 223%. As a percent of net revenue,
operating income was approximately 30 % in Fiscal 2003 versus approximately
22%
in Fiscal 2002. The increase in operating income resulted from the previously
mentioned increases in net revenue as well as the leveraging of part of our
fixed costs, included in cost of services and general and administrative
expenses, over a larger customer base
Interest
expense for Fiscal 2003 was $19,728 compared to $92,341 for Fiscal 2002. The
decrease in interest expense was a result of decreased debt due to the repayment
of approximately $800,000 of debt in Fiscal 2002.
Interest
income was $108,995 in Fiscal 2003 compared to $17,682 in Fiscal 2002 resulting
from our increased profitability and cash.
Other
expense (income) was a net of $291,002 in income in Fiscal 2003 versus $436,848
of income in Fiscal 2002. The primary components of other income are technical
and service income from Simple.net ($618,612 and $300,900, in Fiscal 2003 and
2002, respectively), offset by legal expenses incurred relating to stock
settlements of $240,935 in Fiscal 2003.
Income
before income taxes was $9,487,159 in Fiscal 2003 and $3,182,814 in Fiscal
2002,
representing an increase of approximately 198%. As a percent of net revenue,
income before income taxes was 31% in Fiscal 2003 compared to 25% in Fiscal
2002.
The
income tax provision was $1,871,293 in Fiscal 2003 compared to an income tax
benefit of $342,082 in Fiscal 2002. The increase in the income tax provision
is
the result of our increased profitability in Fiscal 2003 offset by the use
of
our net operating loss carryforwards. During Fiscal 2003 and 2002, our
structured certain transactions related to its merger with Telco that allowed
the Company to utilize net operating losses that were previously believed to
be
unavailable or limited under the change of control rules of Internal Revenue
Code 382.
Net
income for Fiscal 2003 was $7,615,866, or $0.17 per share, compared to
$2,840,732 or $0.06 per share for Fiscal 2002, an increase in net profit of
approximately 114% despite a much higher tax provision in Fiscal 2003. The
increase in net income resulted from the increased IAP Advertiser count and
associated revenue cited above with a less than corresponding increase in
expenses cited above offset by the greater tax provision in Fiscal 2003. Net
profit as a percent of revenue increased to approximately 25% in Fiscal 2003
from 23%% in Fiscal 2002.
Liquidity
and Capital Resources
Our
cash
balance increased to $2,378,848 for Fiscal 2003 from $767,108 for Fiscal 2002.
We funded working capital requirements primarily from cash generated from
operating activities and utilized cash in investing activities and financing
activities.
Operating
Activities.
Cash
provided by operating activities was $4,762,238 for Fiscal 2003 compared to
$1,158,015 for Fiscal 2002. The principal source of our operations revenue
is
from sales of Internet Yellow Page advertising. The increase in cash provided
from operations resulted from an increase in net profit offset by an increase
in
our accounts receivable, deferred income taxes and customer acquisition costs
which also increased as a result of our increased profitability and the
continuation of our direct mail marketing solicitation effort.
Investing
Activities.
Cash
used by investing activities was $2,798,500 for Fiscal 2003 compared to $244,077
for Fiscal 2002. Advances to affiliates increased to $1,893,131 in Fiscal 2003
compared to $116,757 in Fiscal 2002. As described under “Recent Developments,”
advances to affiliates are expected to cease in Fiscal 2004. We intend to
institute a quarterly $0.01 per share dividend on our common stock at that
time.
In Fiscal 2003, we purchased $736,955 of equipment compared to $77,632 in Fiscal
2002. Increased computer purchases in Fiscal 2003 resulted from the previously
described upgrade to our information technology systems as well as the
establishment of our Quality Assurance and Outbound efforts. We do expect
capital expenditures to increase at this same growth rate in the future.
Expenditures for intellectual property increased to $261,545 in Fiscal 2003
compared to $49,688 in Fiscal 2002. This increase primarily resulted from the
licensing of the YP.Com URL from OnRamp Access, Inc.
Financing
Activities.
Cash
flows used from financing activities were $351,998 for Fiscal 2003 compared
to
$830,677 for Fiscal 2002. Regarding debt proceeds, we borrowed $378,169 in
Fiscal 2003 from two credit facilities. These credit facilities are maintained
primarily for safety and security back-up purposes as our cash flow is generally
more than sufficient to maintain and grow the business. In Fiscal 2003, we
established a Trade Acceptance Draft program with Actrade Financial Technologies
(“Actrade”), which enables us to borrow up to $150,000. A trade acceptance draft
(“TAD”) is a draft signed by us and made payable to the order of a vendor
providing us services. AcTrade provides payment to the vendor and collects
from
us the amount advanced to the vendor (plus interest) under extended payment
terms, generally 30, 60 or 90 days. When used, we pay a rate of one percent
per
month of the amount of the TAD. There is no term to the agreement with Actrade
and either party may terminate the agreement at any time.
We
understand that AcTrade is currently in Chapter 11 bankruptcy. Therefore, the
availability of this facility is uncertain. During Fiscal 2003, we signed an
unsecured credit facility of $250,000 with Bank of the Southwest. The facility
is for one year and interest on borrowings, if any, will be an interest rate
of
0.5% above the Prime Rate, as defined. During recent discussions with the Bank
of the Southwest, it was indicated to us that this credit facility will not
be
renewed as a result of their desire to focus on relationships with private
rather than public companies. In Fiscal 2004, we expect to pursue other credit
facilities to replace the aforementioned credit facilities.
We
incurred debt in the acquisition of the license right to the Yellow-Page.Net
URL. A total of $4,000,000 was borrowed, $2,000,000 from Joseph and Helen Van
Sickle, $1,000,000 from our shareholders and $2,000,000 as a Note from Mathew
& Markson Ltd. We had dedicated payments in the amount of $100,000 per month
for the payment of the Van Sickle note, which was paid in full in early Fiscal
2003. The original note has been paid in full while a balance of $115,866
remains on another note to Mathew & Markson.
We
had
cash outflow of $685,167 in Fiscal 2003 relating to the repayment of borrowing
on our credit facilities and the payment of $160,000 on the remaining Van Sickle
note and cash outflow of $830,677 in Fiscal 2002 resulting from the repayment
of
our credit facility relating to Mathew & Markson Ltd.
As
previously described, collections on accounts receivables are received primarily
through the billing service aggregators under contract to administer this
billing and collection process. The billing service aggregators generally do
not
remit funds until they are collected. The billing companies maintain holdbacks
for refunds and other uncertainties. Generally, cash is collected and remitted
to us over a 90 to 120 day period subsequent to the billing dates. In August
2002, we entered into a new agreement with its primary billing service provider,
PaymentOne, whereby cash is remitted to us on a sixty day timetable beginning
November 2002.
We
market
our products primarily through the use of direct mailers to businesses
throughout the United States. We generally pay for these marketing costs when
incurred and amortize the costs of direct-response advertising on a
straight-line basis over eighteen months. The amortization lives are based
on
estimated attrition rates. During Fiscal 2003, we paid $4,738,790 in advertising
and marketing compared to $1,941,037 in Fiscal 2002. We anticipate the outlays
for direct-response advertising to remain consistent over the next
year.
We
have
an agreement with two of our largest shareholders, Morris & miller, Ltd. and
Mathew and Markson, Ltd., which is memorialized in a third Amendment to the
original Stock Purchase Agreement. This agreement cancels the prior revolving
lines of credit with these parties effective April 9, 2004 upon the payment
of
the following final specific advances to each of them:
Morris
& Miller, Ltd.
$275,000
on January 30, 2004
$300,000
on February 27, 2004
$500,000
on March 31, 2004
Sufficient
funds to pay 3 years interest on April 9, 2004
Mathew
and Markson, Ltd.
$50,000
on January 30, 2004
$100,000
on February 27, 2004
$75,000
on March 31, 2004
Sufficient
funds to pay 3 years interest on April 9, 2004
Prior
to
December 31, 2003, our Board of Directors created YP Charities, an Internal
Revenue Code 501(c)(3) corporation, established to make charitable contributions
to worthy causes on our behalf and to encourage other companies that are good
corporate citizens to do the same. YP Charities is not a subsidiary of the
Company. It is a non-member, non-profit entity controlled and run exclusively
by
the board of directors of YP Charities, which is currently comprised of certain
officers and directors of the Company. As of this filing, we have not remitted
any amounts to YP Charities but plan to contribute $100,000 during fiscal 2004.
Certain
Risk Factors Affecting Our Business
Our
business is subject to numerous risks, including those discussed below. If
any
of the events described in these risks occurs, our business, financial condition
and results of operations could be seriously harmed.
Risks
Related to Our Business
We
have a relatively limited operating history upon which investors can evaluate
the likelihood of our success.
We
have
been engaged in the Internet-based Yellow Pages industry through our subsidiary,
Telco Billing, since 1997. As a result, an investor in our securities must
consider the uncertainties, expenses, and difficulties frequently encountered
by
companies such as ours that are in the early stages of development. Investors
should consider the likelihood of our future success to be highly speculative
in
light of our relatively limited operating history, as well as the challenges,
limited resources, expenses, risks, and complications frequently encountered
by
similarly situated companies in the early stages of development, particularly
companies in new and rapidly evolving markets such as Internet Yellow Pages.
To
address these risks and to sustain profitability, we must, among other
things:
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·
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maintain
and increase our base of
advertisers;
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increase
the number of users who visit our web sites for online directory
services;
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implement
and successfully execute our business and marketing
strategy;
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continue
to develop and upgrade our
technology;
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continually
update and improve our service offerings and
features;
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provide
superior IAP advertiser service;
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respond
to industry and competitive developments;
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successfully
manage our growth while controlling expenses;
and
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attract,
retain, and motivate qualified
personnel.
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We
may
not be successful in addressing these risks. If we are unable to do so, our
business, prospects, financial condition, and results of operations would be
materially and adversely affected.
Our
success depends upon our ability to establish and maintain relationships with
our advertisers.
Our
ability to generate revenue depends upon our ability to maintain relationships
with our existing advertisers, to attract new advertisers to sign up for
revenue-generating services, and to generate traffic to our advertisers’
websites. We primarily use direct marketing efforts to attract new advertisers.
These direct marketing efforts may not produce satisfactory results in the
future. We attempt to maintain relationships with our advertisers through IAP
advertiser service and delivery of traffic to their businesses. An inability
to
either attract additional advertisers to use our service or to maintain
relationships with our advertisers could have a material adverse effect on
our
business, prospects, financial condition, and results of
operations.
If
we do not introduce new or enhanced offerings to our advertisers and users,
we
may be unable to attract and retain those advertisers and users, which would
significantly impede our ability to generate revenue.
We
will
need to introduce new or enhanced products and services in order to attract
and
retain advertisers and users and remain competitive. Our industry has been
characterized by rapid technological change, changes in advertiser and user
requirements and preferences, and frequent new product and service introductions
embodying new technologies. These changes could render our technology, systems,
and website obsolete. We may experience difficulties that could delay or prevent
us from introducing new products and services. If we do not periodically enhance
our existing products and services, develop new technologies that address our
advertisers’ and users’ needs and preferences, or respond to emerging
technological advances and industry standards and practices on a timely and
cost-effective basis, our products and services may not be attractive to
advertisers and users, which would significantly impede our revenue growth.
In
addition, our reputation and our brand could be damaged if any new product
or
service introduction is not favorably received.
Our
revenue may decline over time.
We
have
experienced a decrease in revenue from the Local Exchange Carriers (LEC) from
the effects of the Competitive Local Exchange Carriers (CLEC) that are
participating in providing local telephone services to IAP advertisers. We
have
begun to address this problem and we are implementing data filters to reduce
the
effects of the CLECs. We have also sought other billing methods to reduce the
adverse effects of the CLEC billings. These other billing methods may be cheaper
or more expensive than our current LEC billing and we have not yet determined
if
they will be less or more effective. We cannot provide any assurances that
our
efforts will be successful and may experience future decreases in revenue.
Our
quarterly results of operations could fluctuate due to factors outside of our
control, which may cause corresponding fluctuations in the price of our
securities.
Our
net
sales may grow at a slower rate on a quarter-to-quarter basis than we have
experienced in recent periods. Factors that could cause our results of
operations to fluctuate in the future include the following:
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fluctuating
demand for our services, which may depend on a number of factors
including:
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changes
in economic conditions and our IAP advertisers’
profitability,
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varying
IAP advertiser response rates to our direct marketing
efforts,
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our
ability to complete direct mailing solicitations on a timely basis
each
month,
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changes
in our direct marketing efforts,
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IAP
advertiser refunds or cancellations,
and
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our
ability to continue to bill IAP advertisers on their monthly telephone
bills, ACH or credit card rather than through direct
invoicing;
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timing
of new service or product introductions and market acceptance of
new or
enhanced versions of our services or products;
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our
ability to develop and implement new services and technologies in
a timely
fashion to meet market demand;
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price
competition or pricing changes by us or our
competitors;
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new
product offerings or other actions by our
competitors;
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month-to-month
variations in the billing and receipt of amounts from Local Exchange
Carriers (LEC), such that billing and revenues may fall into the
subsequent fiscal quarter;
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the
ability of our check processing service providers to continue to
process
and provide billing information regarding our solicitation
checks;
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the
amount and timing of expenditures for expansion of our operations,
including the hiring of new employees, capital expenditures, and
related
costs;
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technical
difficulties or failures affecting our systems or the Internet in
general;
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a
decline in Internet traffic at our
website;
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the
cost of acquiring, and the availability of, information for our database
of potential advertisers; and
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the
fact that our expenses are only partially based on our expectations
regarding future revenue and are largely fixed in nature, particularly
in
the short term.
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The
fluctuation of our quarterly operating results, as well as other factors, could
cause the market price of our securities to fluctuate significantly in the
future. Some of these factors include:
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the
announcement of new IAP advertisers or strategic alliances or the
loss of
significant IAP advertisers or strategic
alliances;
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announcements
by our competitors;
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sales
or purchases of our securities by officers, directors and
insiders;
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announcements
regarding restructuring, borrowing arrangements, technological
innovations, departures of key officers, directors or employees,
or the
introduction of new products;
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political
or economic events and governmental actions affecting Internet operations
or businesses; and
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general
market conditions and other factors, including factors unrelated
to our
operating performance or that of our
competitors.
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Investors
in our securities should be willing to incur the risk of such price
fluctuations.
Our
ability to efficiently process new advertiser sign-ups and to bill our
advertisers monthly depends upon our check processing service providers and
billing aggregators, respectively.
We
currently use three check processing companies to provide us with advertiser
information at the point of sign-up for our Internet Advertising Package. One
of
these processors has indicated that it will be outsourcing this function in
the
future. Therefore, we have refrained from sending new business to this check
processor. Our ability to gather information to bill our advertisers at the
point of sign-up could be adversely affected if one or more of these providers
experiences a disruption in its operations or ceases to do business with
us.
We
also
depend upon our billing aggregators to efficiently bill and collect monies
from
the Local Exchange Carriers (LEC) relating to the LEC’s billing and collection
of our monthly charges from advertisers. We currently have agreements with
two
billing aggregators. Any disruption in our billing aggregators’ ability to
perform these functions could adversely affect our financial condition and
results of operations.
The
loss of our ability to bill IAP advertisers through Local Exchange Carriers
on
the IAP advertisers’ telephone bills would adversely impact our results of
operations.
Our
business model depends heavily upon our ability to bill advertisers on their
telephone bills through their respective Local Exchange Carriers (LEC). The
existence of the LECs is the result of Federal legislation. In the same manner,
Congress could pass future legislation that obviates the existence of or the
need for the LECs. Additionally, regulatory agencies could limit or prevent
our
ability to use the LECs to bill our advertisers. Finally, the introduction
of
and advancement of new technologies, such as WiFi technology or other
wireless-related technologies, could render unnecessary the existence of fixed
telecommunication lines, which, accordingly, would again obviate the need for
and access to the LECs. Our inability to use the LECs to bill our advertisers
through their monthly telephone bills would have a material adverse impact
on
our results of operations.
We
depend upon third parties to provide certain services and software, and our
business may suffer if the relationships upon which we depend fail to produce
the expected benefits or are terminated.
We
currently outsource to third parties certain of the services that we provide,
including the work of producing usable templates for and hosting of the
QuickSites, website templates known as Ezsites, and wholesale Internet access.
These relationships may not provide us benefits that outweigh the costs of
the
relationships. If any strategic supplier demands a greater portion of revenue
derived from the services it provides or increases charges for its services,
we
may decide to terminate or refuse to renew that relationship, even if it
previously had been profitable or otherwise beneficial. If we lose a significant
strategic supplier, we may be unable to replace that relationship with other
strategic relationships with comparable revenue potential. The loss or
termination of any strategic relationship with one of these third-party
suppliers could significantly impair our ability to provide services to our
advertisers and users.
We
depend
upon third-party software to operate certain of our services. The failure of
this software to perform as expected would have a material adverse effect on
our
business. Additionally, although we believe that several alternative sources
for
this software are available, any failure to obtain and maintain the rights
to
use such software would have a material adverse effect on our business,
prospects, financial condition and results of operations. We also depend upon
third parties to provide services that allow us to connect to the Internet
with
sufficient capacity and bandwidth so that our business can function properly
and
our websites can handle current and anticipated traffic. Any restrictions or
interruption in our connection to the Internet would have a material adverse
effect on our business, prospects, financial condition, and results of
operations.
The
market for our services is uncertain and is still evolving.
Internet
Yellow Pages services are evolving rapidly and are characterized by an
increasing number of market entrants. Our future revenues and profits will
depend substantially upon the widespread acceptance and the use of the Internet
and other online services as an effective medium of commerce by merchants and
consumers. Rapid growth in the use of and interest in the Internet may not
continue on a lasting basis, which may negatively impact Internet-based
businesses such as ours. In addition, advertisers and users may not adopt or
continue to use Internet-base Yellow Pages services and other online services
that we may offer in the future. The demand and market acceptance for recently
introduced services generally is subject to a high level of uncertainty.
Most
potential advertisers have only limited, if any, experience advertising on
the
Internet and have not devoted a significant portion of their advertising
expenditures to Internet advertising. Advertisers may find Internet Yellow
Pages
advertising to be less effective for meeting their business needs than
traditional methods of Yellow Pages or other advertising and marketing. Our
business, prospects, financial condition or results of operations will be
materially and adversely affected if potential advertisers do not adopt Internet
Yellow Pages as an important component of their advertising
expenditures.
We
may not be able to secure additional capital to expand our operations.
Although
we currently have no material long-term needs for capital expenditures, we
will
likely be required to make increased capital expenditures to fund our
anticipated growth of operations, infrastructure, and personnel. We currently
anticipate that our cash on hand, together with cash flows from operations,
will
be sufficient to meet our anticipated liquidity needs for working capital and
capital expenditures over the next 12 months. In the future, however, we may
seek additional capital through the issuance of debt or equity depending upon
our results of operations, market conditions or unforeseen needs or
opportunities. Our future liquidity and capital requirements will depend on
numerous factors, including the following:
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the
pace of expansion of our
operations;
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our
need to respond to competitive pressures;
and
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future
acquisitions of complementary products, technologies or
businesses.
|
Our
forecast of the period of time through which our financial resources will be
adequate to support our operations is a forward-looking statement that involves
risks and uncertainties and actual results could vary materially as a result
of
the factors described above. As we require additional capital resources, we
may
seek to sell additional equity or debt securities or draw on our existing bank
line of credit. Debt financing must be repaid at maturity, regardless of whether
or not we have sufficient cash resources available at that time to repay the
debt. The sale of additional equity or convertible debt securities could result
in additional dilution to existing stockholders. We cannot provide assurance
that any financing arrangements will be available in amounts or on terms
acceptable to us, if at all.
We
must manage our growth and maintain procedures and controls on our business.
We
have
rapidly and significantly expanded our operations and we anticipate further
significant expansion to accommodate the expected growth in our IAP advertiser
base and market opportunities. We have increased the number of our personnel
from the inception of our operations to the present. This expansion has placed,
and is expected to continue to place, a significant strain on our management
and
operational resources. As a result, we may not be able to effectively manage
our
resources, coordinate our efforts, supervise our personnel or otherwise
successfully manage our resources. We have recently added a number of key
managerial, technical, and operations personnel and we expect to add additional
key personnel in the future. We also plan to continue to increase our personnel
base. These additional personnel may further strain our management
resources.
The
rapid
growth of our business could in the future strain our ability to meet IAP
advertiser demands and manage our IAP advertiser relationships. This could
result in the loss of IAP advertisers and harm our business
reputation.
In
order
to manage the expected growth of our operations and personnel, we must continue
maintaining and improving or replacing existing operational, accounting, and
information systems, procedures, and controls. Further, we must manage
effectively our relationships with our IAP advertisers, as well as other third
parties necessary to our business. Our business could be adversely affected
if
we are unable to manage growth effectively.
We
depend upon our executive officers and key personnel.
Our
performance depends substantially on the performance of our executive officers
and other key personnel. The success of our business in the future will depend
on our ability to attract, train, retain and motivate high quality personnel,
especially highly qualified technical and managerial personnel. The loss of
services of any executive officers or key personnel could have a material
adverse effect on our business, results of operations or financial condition.
We
do not maintain key person life insurance on the lives of any of our executive
officers or key personnel.
Competition
for talented personnel is intense, and there is no assurance that we will be
able to continue to attract, train, retain or motivate other highly qualified
technical and managerial personnel in the future. In addition, market conditions
may require us to pay higher compensation to qualified management and technical
personnel than we currently anticipate. Any inability to attract and retain
qualified management and technical personnel in the future could have a material
adverse effect on our business, prospects, financial condition, and results
of
operations.
Our
business is subject to a strict regulatory environment.
Existing
laws and regulations and any future regulation may have a material adverse
effect on our business. For example, we believe that our direct marketing
programs meet or exceed existing requirements of the United States Federal
Trade
Commission (FTC). Any changes to FTC requirements or changes in our direct
or
other marketing practices, however, could result in our marketing practices
failing to comply with FTC regulations. As a result, we could be subject to
substantial liability in the future, including fines and criminal penalties,
preclusion from offering certain products or services, and the prevention or
limitation of certain marketing practices.
We
face intense competition, including from companies with greater resources,
which
could adversely affect our growth and could lead to decreased revenues.
Several
companies, including Verizon, Yahoo and Microsoft, currently market Internet
Yellow Pages services that directly compete with our services and products.
We
may not compete effectively with existing and potential competitors for several
reasons, including the following:
|
·
|
some
competitors have longer operating histories and greater financial
and
other resources than we have and are in better financial condition
than we
are;
|
|
·
|
some
competitors have better name recognition, as well as larger, more
established, and more extensive marketing, IAP advertiser service,
and IAP
advertiser support capabilities than we
have;
|
|
·
|
some
competitors may supply a broader range of services, enabling them
to serve
more or all of their IAP advertisers’ needs. This could limit our sales
and strengthen our competitors’ existing relationships with their IAP
advertisers, including our current and potential IAP
advertisers;
|
|
·
|
some
competitors may be able to better adapt to changing market conditions
and
IAP advertiser demand; and
|
|
·
|
barriers
to entry are not significant. As a result, other companies that are
not
currently involved in the Internet-based Yellow Pages advertising
business
may enter the market or develop technology that reduces the need
for our
services.
|
Increased
competitive pressure could lead to reduced market share, as well as lower prices
and reduced margins for our services. If we experience reductions in our revenue
for any reason, our margins may continue to decline, which would adversely
affect our results of operations. We cannot assure you that we will be able
to
compete successfully in the future.
We
may face risks as we expand our business into international
markets.
We
currently are exploring opportunities to offer our services in other
English-speaking countries. We have limited experience in developing and
marketing our services internationally, and we may not be able to successfully
execute our business model in markets outside the United States. We will face
a
number of risks inherent in doing business in international markets, including
the following:
|
·
|
international
markets typically experience lower levels of Internet usage and Internet
advertising than the United States, which could result in
lower-than-expected demand for our
services;
|
|
·
|
unexpected
changes in regulatory requirements;
|
|
·
|
potentially
adverse tax consequences;
|
|
·
|
difficulties
in staffing and managing foreign
operations;
|
|
·
|
changing
economic conditions;
|
|
·
|
exposures
to different legal standards, particularly with respect to intellectual
property and distribution of information over the
Internet;
|
|
·
|
burdens
of complying with a variety of foreign laws;
and
|
|
·
|
fluctuations
in currency exchange rates.
|
To
the
extent that international operations represent a significant portion of our
business in the future, our business could suffer if any of these risks
occur.
We
may be unable to promote and maintain our brands.
We
believe that establishing and maintaining the brand identities of our Internet
Yellow Pages services is a critical aspect of attracting and expanding a base
of
advertisers and users. Promotion and enhancement of our brands will depend
largely on our success in continuing to provide high quality service. If
advertisers and users do not perceive our existing services to be of high
quality, or if we introduce new services or enter into new business ventures
that are not favorably received by advertisers and users, we will risk diluting
our brand identities and decreasing their attractiveness to existing and
potential IAP advertisers.
We
may not be able to adequately protect our intellectual property
rights.
Our
success depends both on our internally developed technology and our third party
technology. We rely on a variety of trademarks, service marks, and designs
to
promote our brand names and identity. We also rely on a combination of
contractual provisions, confidentiality procedures, and trademark, copyright,
trade secrecy, unfair competition, and other intellectual property laws to
protect the proprietary aspects of our products and services. Legal standards
relating to the validity, enforceability, and scope of the protection of certain
intellectual property rights in Internet-related industries are uncertain and
still evolving. The steps we take to protect our intellectual property rights
may not be adequate to protect our intellectual property and may not prevent
our
competitors from gaining access to our intellectual property and proprietary
information. In addition, we cannot provide assurance that courts will always
uphold our intellectual property rights or enforce the contractual arrangements
that we have entered into to protect our proprietary technology.
Third
parties may infringe or misappropriate our copyrights, trademarks, service
marks, trade dress, and other proprietary rights. Any such infringement or
misappropriation could have a material adverse effect on our business,
prospects, financial condition, and results of operations. In addition, the
relationship between regulations governing domain names and laws protecting
trademarks and similar proprietary rights is unclear. We may be unable to
prevent third parties from acquiring domain names that are similar to, infringe
upon or otherwise decrease the value of our trademarks and other proprietary
rights, which may result in the dilution of the brand identity of our services.
We
may
decide to initiate litigation in order to enforce our intellectual property
rights, to protect our trade secrets, or to determine the validity and scope
of
our proprietary rights. Any such litigation could result in substantial expense,
may reduce our profits, and may not adequately protect our intellectual property
rights. In addition, we may be exposed to future litigation by third parties
based on claims that our products or services infringe their intellectual
property rights. Any such claim or litigation against us, whether or not
successful, could result in substantial costs and harm our reputation. In
addition, such claims or litigation could force us to do one or more of the
following:
|
·
|
cease
selling or using any of our products that incorporate the challenged
intellectual property, which would adversely affect our
revenue;
|
|
·
|
obtain
a license from the holder of the intellectual property right alleged
to
have been infringed, which license may not be available on reasonable
terms, if at all; and
|
|
·
|
redesign
or, in the case of trademark claims, rename our products or services
to
avoid infringing the intellectual property rights of third parties,
which
may not be possible and in any event could be costly and
time-consuming.
|
Even
if
we were to prevail, such claims or litigation could be time-consuming and
expensive to prosecute or defend, and could result in the diversion of our
management’s time and attention. These expenses and diversion of managerial
resources could have a material adverse effect on our business, prospects,
financial condition, and results of operations.
Current
capacity constraints may require us to expand our infrastructure and IAP
advertiser support capabilities.
Our
ability to provide high-quality Internet Yellow Pages services largely depends
upon the efficient and uninterrupted operation of our computer and
communications systems. We may be required to expand our technology,
infrastructure, and IAP advertiser support capabilities in order to accommodate
any significant increases in the numbers of advertisers and users of our web
sites. We may not be able to project accurately the rate or timing of increases,
if any, in the use of our services or expand and upgrade our systems and
infrastructure to accommodate these increases in a timely manner. If we do
not
expand and upgrade our infrastructure in a timely manner, we could experience
temporary capacity constraints that may cause unanticipated system disruptions,
slower response times, and lower levels of IAP advertiser service. Our inability
to upgrade and expand our infrastructure and IAP advertiser support capabilities
as required could impair the reputation of our brand and our services, reduce
the volume of users able to access our website, and diminish the attractiveness
of our service offerings to our advertisers.
Any
expansion of our infrastructure may require us to make significant upfront
expenditures for servers, routers, computer equipment, and additional Internet
and intranet equipment, as well as to increase bandwidth for Internet
connectivity. Any such expansion or enhancement will need to be completed and
integrated without system disruptions. An inability to expand our infrastructure
or IAP advertiser service capabilities either internally or through third
parties, if and when necessary, would materially adversely affect our business,
prospects, financial condition, and results of operations.
Risks
Related to the Internet
We
may not be able to adapt as the Internet, Internet Yellow Pages services, and
IAP advertiser demands continue to evolve.
Our
failure to respond in a timely manner to changing market conditions or client
requirements could have a material adverse effect on our business, prospects,
financial condition, and results of operations. The Internet, e-commerce, and
the Internet Yellow Pages industry are characterized by:
|
·
|
rapid
technological change;
|
|
·
|
changes
in advertiser and user requirements and
preferences;
|
|
·
|
frequent
new product and service introductions embodying new technologies;
and
|
|
·
|
the
emergence of new industry standards and practices that could render
our
existing service offerings, technology, and hardware and software
infrastructure obsolete.
|
In
order
to compete successfully in the future, we must
|
·
|
enhance
our existing services and develop new services and technology that
address
the increasingly sophisticated and varied needs of our prospective
or
current IAP advertisers;
|
|
·
|
license,
develop or acquire technologies useful in our business on a timely
basis;
and
|
|
·
|
respond
to technological advances and emerging industry standards and practices
on
a cost-effective and timely basis.
|
Our
future success will depend on continued growth in the use of the
Internet.
Because
Internet Yellow Pages is a new and rapidly evolving industry, the ultimate
demand and market acceptance for our services will be subject to a high level
of
uncertainty. Significant issues concerning the commercial use of the Internet
and online service technologies, including security, reliability, cost, ease
of
use, and quality of service, remain unresolved and may inhibit the growth of
Internet business solutions that use these technologies. In addition, the
Internet or other online services could lose their viability due to delays
in
the development or adoption of new standards and protocols required to handle
increased levels of Internet activity, or due to increased governmental
regulation. Our business, prospects, financial condition, and results of
operations would be materially and adversely affected if the use of Internet
Yellow Pages and other online services does not continue to grow or grows more
slowly than we expect.
We
will be required to keep pace with rapid technological change in the Internet
industry.
In
order
to remain competitive, we will be required continually to enhance and improve
the functionality and features of our existing services, which could require
us
to invest significant capital. If our competitors introduce new products and
services embodying new technologies, or if new industry standards and practices
emerge, our existing services, technologies, and systems may become obsolete.
We
may not have the funds or technical know-how to upgrade our services,
technology, and systems. If we face material delays in introducing new services,
products, and enhancements, our advertisers and users, may forego the use of
our
services and select those of our competitors, in which event our business,
prospects, financial condition and results of operations could be materially
and
adversely affected.
Regulation
of the Internet may adversely affect our business.
Due
to
the increasing popularity and use of the Internet and online services such
as
online Yellow Pages, federal, state, local, and foreign governments may adopt
laws and regulations, or amend existing laws and regulations, with respect
to
the Internet and other online services. These laws and regulations may affect
issues such as user privacy, pricing, content, taxation, copyrights,
distribution, and quality of products and services. The laws governing the
Internet remain largely unsettled, even in areas where legislation has been
enacted. It may take years to determine whether and how existing laws, such
as
those governing intellectual property, privacy, libel, and taxation, apply
to
the Internet and Internet advertising and directory services. In addition,
the
growth and development of the market for electronic commerce may prompt calls
for more stringent consumer protection laws, both in the United States and
abroad, that may impose additional burdens on companies conducting business
over
the Internet. Any new legislation could hinder the growth in use of the Internet
generally or in our industry and could impose additional burdens on companies
conducting business online, which could, in turn, decrease the demand for our
services, increase our cost of doing business, or otherwise have a material
adverse effect on our business, prospects, financial condition, and results
of
operations.
We
may not be able to obtain Internet domain names that we would like to
have.
We
believe that our existing Internet domain names are an extremely important
part
of our business. We may desire, or it may be necessary in the future, to use
these or other domain names in the United States and abroad. Various Internet
regulatory bodies regulate the acquisition and maintenance of domain names
in
the United States and other countries. These regulations are subject to change.
Governing bodies may establish additional top-level domains, appoint additional
domain name registrars or modify the requirements for holding domain names.
As a
result, we may be unable to acquire or maintain relevant domain names in all
countries in which we plan to conduct business in the future.
The
extent to which laws protecting trademarks and similar proprietary rights will
be extended to protect domain names currently is not clear. We therefore may
be
unable to prevent competitors from acquiring domain names that are similar
to,
infringe upon or otherwise decrease the value of our domain names, trademarks,
trade names, and other proprietary rights. We cannot provide assurance that
potential users and advertisers will not confuse our domain names, trademarks,
and trade names with other similar names and marks. If that confusion occurs,
we
may lose business to a competitor and some advertisers and users may have
negative experiences with other companies that those advertisers and users
erroneously associate with us. The inability to acquire and maintain domain
names that we desire to use in our business, and the use of confusingly similar
domain names by our competitors, could have a material adverse affect on our
business, prospects, financial conditions, and results of operations in the
future.
Our
business could be negatively impacted if the security of the Internet becomes
compromised.
To
the
extent that our activities involve the storage and transmission of proprietary
information about our advertisers or users, security breaches could damage
our
reputation and expose us to a risk of loss or litigation and possible liability.
We may be required to expend significant capital and other resources to protect
against security breaches or to minimize problems caused by security breaches.
Our security measures may not prevent security breaches. Our failure to prevent
these security breaches or a misappropriation of proprietary information may
have a material adverse effect on our business, prospects, financial condition,
and results of operations.
Our
technical systems could be vulnerable to online security risks, service
interruptions or damage to our systems.
Our
systems and operations may be vulnerable to damage or interruption from fire,
floods, power loss, telecommunications failures, break-ins, sabotage, computer
viruses, penetration of our network by unauthorized computer users and
“hackers,” natural disaster, and similar events. Preventing, alleviating, or
eliminating computer viruses and other service-related or security problems
may
require interruptions, delays or cessation of service. We may need to expend
significant resources protecting against the threat of security breaches or
alleviating potential or actual service interruptions. The occurrence of such
unanticipated problems or security breaches could cause material interruptions
or delays in our business, loss of data, or misappropriation of proprietary
or
IAP advertiser-related information or could render us unable to provide services
to our IAP advertisers for an indeterminate length of time. The occurrence
of
any or all of these events could materially and adversely affect our business,
prospects, financial condition, and results of operations.
If
we are sued for content distributed through, or linked to by, our website or
those of our advertisers, we may be required to spend substantial resources
to
defend ourselves and could be required to pay monetary damages.
We
aggregate and distribute third-party data and other content over the Internet.
In addition, third-party websites are accessible through our website or those
of
our advertisers. As a result, we could be subject to legal claims for
defamation, negligence, intellectual property infringement, and product or
service liability. Other claims may be based on errors or false or misleading
information provided on or through our website or websites of our directory
licensees. Other claims may be based on links to sexually explicit websites
and
sexually explicit advertisements. We may need to expend substantial resources
to
investigate and defend these claims, regardless of whether we successfully
defend against them. While we carry general business insurance, the amount
of
coverage we maintain may not be adequate. In addition, implementing measures
to
reduce our exposure to this liability may require us to spend substantial
resources and limit the attractiveness of our content to users.
Risks
Related to Our Securities
Stock
prices of technology companies have declined precipitously at times in the
past
and the trading price of our common stock is likely to be volatile, which could
result in substantial losses to investors.
The
trading price of our common stock has risen significantly over the past twelve
months and could continue to be volatile in response to factors including the
following, many of which are beyond our control:
|
·
|
decreased
demand in the Internet services
sector;
|
|
·
|
variations
in our operating results;
|
|
·
|
announcements
of technological innovations or new services by us or our
competitors;
|
|
·
|
changes
in expectations of our future financial performance, including financial
estimates by securities analysts and
investors;
|
|
·
|
our
failure to meet analysts’
expectations;
|
|
·
|
changes
in operating and stock price performance of other technology companies
similar to us;
|
|
·
|
conditions
or trends in the technology
industry;
|
|
·
|
additions
or departures of key personnel; and
|
|
·
|
future
sales of our common stock.
|
Domestic
and international stock markets often experience significant price and volume
fluctuations that are unrelated to the operating performance of companies with
securities trading in those markets. These fluctuations, as well as political
events, terrorist attacks, threatened or actual war, and general economic
conditions unrelated to our performance, may adversely affect the price of
our
common stock. In the past, securities holders of other companies often have
initiated securities class action litigation against those companies following
periods of volatility in the market price of those companies’ securities. If the
market price of our stock fluctuates and our stockholders initiate this type
of
litigation, we could incur substantial costs and experience a diversion of
our
management’s attention and resources, regardless of the outcome. This could
materially and adversely affect our business, prospects, financial condition,
and results of operations.
Certain
provisions of Nevada law and in our charter may prevent or delay a change of
control of our company.
We
are
subject to the Nevada anti-takeover laws regulating corporate takeovers. These
anti-takeover laws prevent Nevada corporations from engaging in a merger,
consolidation, sales of its stock or assets, and certain other transactions
with
any stockholder, including all affiliates and associates of the stockholder,
who
owns 10% or more of the corporation’s outstanding voting stock, for three years
following the date that the stockholder acquired 10% or more of the
corporation’s voting stock except in certain situations. In addition, our
amended and restated articles of incorporation and bylaws include a number
of
provisions that may deter or impede hostile takeovers or changes of control
or
management. These provisions include the following:
|
·
|
our
board is classified into three classes of directors as nearly equal
in
size as possible, with staggered three
year-terms;
|
|
·
|
the
authority of our board to issue up to 5,000,000 shares of serial
preferred stock and to determine the price, rights, preferences,
and
privileges of these shares, without stockholder
approval;
|
|
·
|
all
stockholder actions must be effected at a duly called meeting of
stockholders and not by written consent unless such action or proposal
is
first approved by our board of
directors;
|
|
·
|
special
meetings of the stockholders may be called only by the Chairman of
the
Board, the Chief Executive Officer, or the President of our company;
and
|
|
·
|
cumulative
voting is not allowed in the election of our
directors.
|
These
provisions of Nevada law and our articles and bylaws could prohibit or delay
mergers or other takeover or change of control of our company and may discourage
attempts by other companies to acquire us, even if such a transaction would
be
beneficial to our stockholders.
Our
common stock may be subject to the “penny stock” rules as promulgated under the
Exchange Act.
In
the
event that no exclusion from the definition of “penny stock” under the Exchange
Act is available, then any broker engaging in a transaction in our common stock
will be required to provide its IAP advertisers with a risk disclosure document,
disclosure of market quotations, if any, disclosure of the compensation of
the
broker-dealer and its sales person in the transaction, and monthly account
statements showing the market values of our securities held in the IAP
advertiser’s accounts. The bid and offer quotation and compensation information
must be provided prior to effecting the transaction and must be contained on
the
IAP advertiser’s confirmation of sale. Certain brokers are less willing to
engage in transactions involving “penny stocks” as a result of the additional
disclosure requirements described above, which may make it more difficult for
holders of our common stock to dispose of their shares.
ITEM
7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TABLE
OF CONTENTS
|
Page
|
|
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
|
26
|
|
|
CONSOLIDATED
FINANCIAL STATEMENTS:
|
|
|
|
Consolidated
Balance Sheet at September 30, 2003
|
27
|
|
|
Consolidated
Statements of Operations for the years ended September 30, 2003 and
September 30, 2002
|
28
|
|
|
Consolidated
Statements of Stockholders’ Equity for the years ended September 30, 2003
and September 30, 2002
|
29
|
|
|
Consolidated
Statements of Cash Flows for the years
ended September 30, 2003 and September 30, 2002
|
31
|
|
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
|
33
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
To
the
Stockholders and Board
of
Directors of YP Corp.:
We
have
audited the accompanying consolidated balance sheet of YP Corp. and subsidiaries
as of September 30, 2003 and the related statements of operations, stockholders’
equity and cash flows for the each of the two years in the period 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 audit in accordance with the auditing standards generally accepted
in the United States. 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 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 YP Corp. and
subsidiaries as of September 30, 2003, and the consolidated results of its
operations and cash flows for each of the two years in the period ended
September 30, 2003, in conformity with accounting principles generally accepted
in the United States of America.
As
described in Note 1, the Company restated its financial statements for
the years ended September 30, 2003 and 2002.
/s/
Epstein, Weber & Conover, PLC
|
Scottsdale,
Arizona
|
December
5, 2003
|
(except
for the restatement of financial statements
|
described
in Note 1, for which the date is November 18,
2005)
|
CONSOLIDATED
BALANCE SHEET
ASSETS:
|
|
|
|
CURRENT
ASSETS
|
|
|
|
Cash
and cash equivalents
|
|
$
|
2,378,848
|
|
Accounts
receivable, net
|
|
|
7,328,624
|
|
Prepaid
expenses and other current assets
|
|
|
154,276
|
|
Deferred
tax asset
|
|
|
1,400,637
|
|
Total
current assets
|
|
|
11,262,385
|
|
|
|
|
|
|
ACCOUNTS
RECEIVABLE - long term portion
|
|
|
1,123,505
|
|
CUSTOMER
ACQUISITION COSTS, net of accumulated amortization of
$2,913,776
|
|
|
3,243,241
|
|
PROPERTY
AND EQUIPMENT, net
|
|
|
731,142
|
|
DEPOSITS
AND OTHER ASSETS
|
|
|
148,310
|
|
INTELLECTUAL
PROPERTY- URL, net of accumulated amortization of
$1,868,283
|
|
|
3,512,952
|
|
ADVANCES
TO AFFILIATES
|
|
|
2,126,204
|
|
DEFERRED
INCOME TAXES
|
|
|
239,952
|
|
TOTAL
ASSETS
|
|
$
|
22,387,691
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY:
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
Accounts
payable
|
|
$
|
428,423
|
|
Accrued
liabilities
|
|
|
1,413,245
|
|
Notes
payable - current portion
|
|
|
115,868
|
|
Income
taxes payable
|
|
|
2,689,312
|
|
Total
current liabilities
|
|
|
4,646,848
|
|
Total
liabilities
|
|
|
4,646,848
|
|
|
|
|
|
|
STOCKHOLDERS'
EQUITY:
|
|
|
|
|
Series
E convertible preferred stock, $.001 par value, 200,000 shares
authorized,
131,840 issued and outstanding, liquidation preference
$39,552
|
|
|
11,206
|
|
Common
stock, $.001 par value, 100,000,000 shares authorized, 55,265,136
issued,
49,348,287 outstanding
|
|
|
49,348
|
|
Paid
in capital
|
|
|
9,359,866
|
|
Deferred
stock compensation
|
|
|
(3,840,843
|
)
|
Treasury
stock at cost
|
|
|
(216,422
|
)
|
Retained
earnings
|
|
|
12,377,688
|
|
Total
stockholders' equity
|
|
|
17,740,843
|
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$
|
22,387,691
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
CONSOLIDATED
STATEMENTS OF
OPERATIONS
FOR
THE YEARS ENDED SEPTEMBER 30, 2003 AND SEPTEMBER 30, 2002
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
NET
REVENUES
|
|
$
|
30,767,444
|
|
$
|
12,618,126
|
|
|
|
|
|
|
|
|
|
OPERATING
EXPENSES:
|
|
|
|
|
|
|
|
Cost
of services
|
|
|
8,473,746
|
|
|
3,497,678
|
|
General
and administrative expenses
|
|
|
8,657,690
|
|
|
4,754,665
|
|
Sales
and marketing expenses
|
|
|
3,868,643
|
|
|
963,868
|
|
Depreciation
and amortization
|
|
|
660,475
|
|
|
581,290
|
|
Total
operating expenses
|
|
|
21,660,554
|
|
|
9,797,501
|
|
|
|
|
|
|
|
|
|
OPERATING
INCOME
|
|
|
9,106,890
|
|
|
2,820,625
|
|
|
|
|
|
|
|
|
|
OTHER
(INCOME) AND EXPENSES
|
|
|
|
|
|
|
|
Interest
expense and other financing costs
|
|
|
19,728
|
|
|
92,341
|
|
Interest
income
|
|
|
(108,995
|
)
|
|
(17,682
|
)
|
Other
expense/(income)
|
|
|
(291,002
|
)
|
|
(436,848
|
)
|
|
|
|
|
|
|
|
|
Total
other income
|
|
|
(380,269
|
)
|
|
(362,189
|
)
|
|
|
|
|
|
|
|
|
INCOME
BEFORE INCOME TAXES
|
|
|
9,487,159
|
|
|
3,182,814
|
|
|
|
|
|
|
|
|
|
INCOME
TAX PROVISION (BENEFIT)
|
|
|
1,871,293
|
|
|
342,082
|
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
$
|
7,615,866
|
|
$
|
2,840,732
|
|
|
|
|
|
|
|
|
|
NET
INCOME PER SHARE:
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.17
|
|
$
|
0.06
|
|
Diluted
|
|
$
|
0.17
|
|
$
|
0.06
|
|
|
|
|
|
|
|
|
|
WEIGHTED
AVERAGE COMMON SHARES OUTSTANDING:
|
|
|
|
|
|
|
|
Basic
|
|
|
45,591,590
|
|
|
41,753,464
|
|
Diluted
|
|
|
45,591,590
|
|
|
41,753,464
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY FOR
THE
YEARS
ENDED SEPTEMBER 30, 2003 AND SEPTEMBER 30, 2002
|
|
Common
Stock
|
|
Preferred
E
|
|
|
|
Treasury
|
|
Paid-in
|
|
Retained
|
|
|
|
|
|
Shares
|
|
Amount
|
|
Shares
|
|
Amount
|
|
Stock
|
|
Capital
|
|
Earnings
|
|
Total
|
|
|
|
|
|
|
|
___________ |
|
|
|
|
|
|
|
|
|
|
|
BALANCE
OCTOBER 1, 2001
|
|
|
40,801,449
|
|
$
|
40,802
|
|
|
-
|
|
$
|
-
|
|
$
|
(171,422
|
)
|
$
|
4,595,609
|
|
$
|
1,923,562
|
|
$
|
6,388,551
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock issued for services
|
|
|
100,000
|
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
8,900
|
|
|
|
|
|
9,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series
E preferred stock issued in exchange for common
shares
|
|
|
(131,840
|
)
|
|
(132
|
)
|
|
131,840
|
|
|
11,206
|
|
|
|
|
|
(11,074
|
)
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series
E preferred stock dividends
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(494
|
)
|
|
(494
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,840,732
|
|
|
2,840,732
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE
SEPTEMBER 30, 2002
|
|
|
40,769,609
|
|
$
|
40,770
|
|
|
131,840
|
|
$
|
11,206
|
|
$
|
(171,422
|
)
|
$
|
4,593,435
|
|
$
|
4,763,800
|
|
$
|
9,237,789
|
|
(CONTINUED)
The
accompanying notes are an integral part of these consolidated financial
statements
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE
YEARS
ENDED SEPTEMBER 30, 2003 AND SEPTEMBER 30,
2002
(continued)
|
|
Common
Stock
|
|
Preferred
E
|
|
|
|
Treasury
|
|
Paid-in
|
|
Deferred
|
|
Retained
|
|
|
|
|
|
Shares
|
|
Amount
|
|
Shares
|
|
Amount
|
|
Stock
|
|
Capital
|
|
Compensation
|
|
Earnings
|
|
Total
|
|
|
|
|
|
|
|
___________ |
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE
OCTOBER 1, 2002
|
|
|
40,769,609
|
|
$
|
40,770
|
|
|
131,840
|
|
$
|
11,206
|
|
$
|
(171,422
|
)
|
$
|
4,593,435
|
|
$
|
-
|
|
$
|
4,763,800
|
|
$
|
9,237,789
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock issued for services
|
|
|
7,005,678
|
|
|
7,006
|
|
|
|
|
|
|
|
|
|
|
|
712,678
|
|
|
|
|
|
|
|
|
719,684
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock issued for URL
|
|
|
100,000
|
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
59,900
|
|
|
|
|
|
|
|
|
60,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase
of treasury stock
|
|
|
(500,000
|
)
|
|
(500
|
)
|
|
|
|
|
|
|
|
(45,000
|
)
|
|
500
|
|
|
|
|
|
|
|
|
(45,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series
E preferred stock dividends
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,978
|
)
|
|
(1,978
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock issued in restricted stock plan
|
|
|
1,973,000
|
|
|
1,973
|
|
|
|
|
|
|
|
|
|
|
|
3,993,352
|
|
|
(3,995,325
|
)
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization
of deferred stock compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
154,482
|
|
|
|
|
|
154,482
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7,615,866
|
|
|
7,615,866
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE
SEPTEMBER 30, 2003
|
|
|
49,348,287
|
|
$
|
49,349
|
|
|
131,840
|
|
$
|
11,206
|
|
$
|
(216,422
|
)
|
$
|
9,359,865
|
|
$
|
(3,840,843
|
)
|
$
|
12,377,688
|
|
$
|
17,740,843
|
|
(CONTINUED)
The
accompanying notes are an integral part of these consolidated financial
statements
CONSOLIDATED
STATEMENTS OF CASH FLOWS FOR
THE
YEARS
ENDED SEPTEMBER 30, 2003 AND SEPTEMBER 30, 2002
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
7,615,866
|
|
$
|
2,840,732
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
660,475
|
|
|
581,290
|
|
Amortization
of deferred stock compensation
|
|
|
154,482
|
|
|
|
|
Issuance
of common stock as compensation for services
|
|
|
719,684
|
|
|
9,000
|
|
Gain
on settlement of debt
|
|
|
(45,362
|
)
|
|
-
|
|
Deferred
income taxes
|
|
|
(1,631,774
|
)
|
|
1,078,157
|
|
Loss
on disposal of equipment
|
|
|
6,932
|
|
|
|
|
Provision
for uncollectible accounts
|
|
|
1,688,058
|
|
|
1,375,226
|
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(6,064,894
|
)
|
|
(2,580,410
|
)
|
Customer
acquisition costs
|
|
|
(1,825,014
|
)
|
|
(1,224,983
|
)
|
Prepaid
and other current assets
|
|
|
(183,196
|
)
|
|
(44,042
|
)
|
Deposits
and other assets
|
|
|
2,415
|
|
|
(127,438
|
)
|
Accounts
payable
|
|
|
233,027
|
|
|
(119,511
|
)
|
Accrued
liabilities
|
|
|
1,228,470
|
|
|
106,069
|
|
Income
taxes payable
|
|
|
2,203,069
|
|
|
(736,075
|
)
|
Net
cash provided by operating activities
|
|
|
4,762,238
|
|
|
1,158,015
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
Advances
made to affiliate
|
|
|
(1,800,000
|
)
|
|
(116,757
|
)
|
Expenditures
for intellectual property
|
|
|
(261,545
|
)
|
|
(49,688
|
)
|
Purchases
of equipment
|
|
|
(736,955
|
)
|
|
(77,632
|
)
|
Net
cash used for investing activities
|
|
|
(2,798,500
|
)
|
|
(244,077
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Proceeds
from debt
|
|
|
378,169
|
|
|
-
|
|
Principal
repayments on notes payable
|
|
|
(685,167
|
)
|
|
(830,677
|
)
|
Purchase
of treasury stock
|
|
|
(45,000
|
)
|
|
-
|
|
Net
cash used for financing activities
|
|
|
(351,998
|
)
|
|
(830,677
|
)
|
|
|
|
|
|
|
|
|
INCREASE
IN CASH AND CASH EQUIVALENTS
|
|
|
1,611,740
|
|
|
83,261
|
|
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS, beginning of year
|
|
|
767,108
|
|
|
683,847
|
|
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS, end of year
|
|
$
|
2,378,848
|
|
$
|
767,108
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
YP.NET,
INC.
CONSOLIDATED
STATEMENT OF CASH FLOWS, (continued)
FOR
THE YEARS ENDED SEPTEMBER 30, 2003 and 2001
SUPPLEMENTAL
CASH FLOW INFORMATION:
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
Interest
Paid
|
|
$
|
11,258
|
|
$
|
99,541
|
|
|
|
|
|
|
|
|
|
Income
taxes paid
|
|
$
|
1,300,000
|
|
$
|
-0-
|
|
SUPPLEMENTAL
SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
Common
stock issued for services
|
|
$
|
719,684
|
|
$
|
9,000
|
|
|
|
|
|
|
|
|
|
Common
stock issued to purchase intellectual property
|
|
$
|
60,000
|
|
$
|
-0-
|
|
|
|
|
|
|
|
|
|
Common
stock exchanged for Series E Convertible Preferred Stock
|
|
$
|
-
0 -
|
|
$
|
11,206
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE YEARS ENDED SEPTEMBER 30, 2003 AND 2002
1. |
ORGANIZATION
AND BASIS OF PRESENTATION
|
YP.Net,
Inc. (the “Company”), formally RIGL Corporation, had previously attempted to
develop software solutions for medical practice billing and administration.
The
Company had made acquisitions of companies performing medical practice billing
services as test sites for its software and as business opportunities. The
Company was not successful in implementing its medical practice billing and
administration software products and looked to other business opportunities.
The
Company acquired Telco Billing Inc. (“Telco”) in June 1999, through the issuance
of 17,000,000 shares of the Company’s common stock. Prior to its acquisition of
Telco, RIGL had not generated significant or sufficient revenue from planned
operations.
Telco
was
formed in April 1998, to provide advertising and directory listings for
businesses on its Internet website in a “Yellow
Page”
format.
Telco provides those services to its subscribers for a monthly fee. These
services are provided primarily to businesses throughout the United States.
Telco became a wholly owned subsidiary of YP.Net, Inc. after the June 16, 1999
acquisition.
At
the
time that the transaction was agreed to, the Company had 12,567,770 common
shares issued and outstanding. As a result of the merger transaction with Telco,
there were 29,567,770 common shares outstanding, and the former Telco
stockholders held approximately 57% of the Company’s voting stock. For financial
accounting purposes, the acquisition was a reverse acquisition of the Company
by
Telco, under the purchase method of accounting, and was treated as a
recapitalization with Telco as the acquirer. Consistent with reverse acquisition
accounting: (i) all of Telco’s assets, liabilities, and accumulated deficit were
reflected at their combined historical cost (as the accounting acquirer) and
(ii) the preexisting outstanding shares of the Company (the accounting acquiree)
were reflected at their net asset value as if issued on June 16, 1999.
The
accompanying financial statements represent the consolidated financial position
and results of operations of the Company and include the accounts and results
of
operations of the Company and Telco, its wholly owned subsidiary, for the years
ended September 30, 2003 and September 30, 2002. Certain reclassifications
have
been made to the September 30, 2002 balances to conform to the 2003
presentation. These reclassifications to the 2002 financial statements
include:
|
·
|
Customer
refunds of $313,716 in 2002 have been reclassified by moving them
from
cost of services to netting them in revenue. As a result of better
reporting by the third party billing aggregator, these refunds were
specifically identified when they were previously included as a general
charge back by the billing
aggregator.
|
|
·
|
It
was determined that $300,901 of revenue generated by providing services
to
an affiliate, Simple.net, which encompassed loaning personnel to
the
affiliate on a contract basis, did not represent customer revenue
in the
Company’s product line and that those related billings should therefore be
excluded from customer revenue. The Company reduced revenue as previously
reported by $300,901 and reclassified that amount in other
income.
|
|
·
|
It
was discovered in the year ended September 30, 2003, that 3,081,500
shares
of issued common stock had been improperly included in the outstanding
shares. These shares were actually treasury shares and therefore
should be
excluded from the number of shares outstanding. The Company corrected
the
error by reclassifying the par value of those shares of $3,082 from
the
common stock account to the paid in capital account. The incorrect
number
of treasury shares also had the effect of incorrectly reporting the
weighted average shares outstanding for purposes of the earnings
per share
calculation. The weighted average shares outstanding was previously
reported as 44,024,329 and has been corrected to 41,753,464. The
effect of
the corrected weighted average shares outstanding on the basic and
diluted
earnings per share for the year ended September 30, 2002 was an increase
from $0.06 to $0.07.
|
Restatement
of Financial Statements
Subsequent
to the issuance of the Company’s financial statements as of September 30, 2003,
and the year then ended, the Company determined that the accounting for its
common stock issued to, and subsequently recovered from, certain non-performing
consultants during 1999 and 2000 should not have been expensed when originally
issued as had been previously reported. The subsequent recovery of these
shares
was recorded as an item in other income at the same value at which they were
originally issued. It has been determined to be inappropriate to recognize
the
initial expense and its subsequent reversal as no services were rendered
by
these consultants. Instead, the issuance of these shares will be reflected
as
temporary equity, together with a related receivable, until the shares were
returned. The change in accounting for the recovery of the shares has the
effect
in the year ended September 30, 2003 of a decrease in net income of $308,025
from $7,923,891 to $7,615,866 and a decrease in the net income per share
from
per share from $0.18 to $0.17.
2. |
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
|
Cash
and Cash Equivalents:
This
includes all short-term highly liquid investments that are readily convertible
to known amounts of cash and have original maturities of three months or less.
At times cash deposits may exceed government insured limits. At September 30,
2003, cash deposits exceeded those insured limits by $2,255,000.
Principles
of Consolidation:
The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiary, Telco Billing, Inc. All significant intercompany
accounts and transactions are eliminated.
Customer
Acquisition Costs:
These
costs represent the direct response marketing costs that are incurred as the
primary method by which customers subscribe to the Company’s services. The
Company purchases mailing lists and sends advertising materials to prospective
subscribers from those lists. Customers subscribe to the services by positively
responding to those advertising materials, which serve as the contract for
the
subscription. The Company capitalizes and amortizes the costs of direct-response
advertising on a straight-line basis over eighteen months, the estimated average
period of retention for new customers. The Company capitalized costs of
$4,739,000 and $1,941,000 during the years ended September 30, 2003 and 2002
respectively. The Company amortized $2,914,000 and $719,000, respectively,
of
these capitalized costs during the years ended September 30, 2003 and 2002.
The
Company also analyzes these capitalized costs for impairment and believes that
there was no impairment of the carrying cost at September 30, 2003 on the basis
of customer retention and revenue generated per customer.
The
Company also incurs advertising costs that are not considered direct-response
advertising. These other advertising costs are expensed when incurred. These
advertising expenses were $955,000 and $248,000 for the years ended September
30, 2003 and 2002 respectively.
Property
and Equipment:
Property
and equipment is stated at cost less accumulated depreciation. Depreciation
is
recorded on a straight-line basis over the estimated useful lives of the assets
ranging from 3 to 5 years. Depreciation expense was $273,340 and $178,058 for
the years ended September 30, 2003 and 2002 respectively.
Revenue
Recognition:
The
Company’s revenue is generated by customer subscriptions of directory and
advertising services. Revenue is billed and recognized monthly for services
subscribed in that specific month. The Company utilizes outside billing
companies to transmit billing data, much of which is forwarded to Local Exchange
Carriers (“LEC’s”) that provide local telephone service. Monthly subscription
fees are generally included on the telephone bills of the customers. The Company
recognizes revenue based on net billings accepted by the LEC’s. Due to the
periods of time for which adjustments may be reported by the LEC’s and the
billing companies, the Company estimates and accrues for dilution and fees
reported subsequent to year-end for initial billings related to services
provided for periods within the fiscal year. Customer refunds are recorded
as an
offset to gross revenue.
Revenue
for billings to certain customers whom are billed directly by the Company and
not through the LEC’s, is recognized based on estimated future collections. The
Company continuously reviews this estimate for reasonableness based on its
collection experience.
Income
Taxes:
The
Company provides for income taxes based on the provisions of Statement of
Financial Accounting Standards No. 109,
Accounting for Income Taxes, which,
among other things, requires that recognition of deferred income taxes be
measured by the provisions of enacted tax laws in effect at the date of
financial statements.
Net
Income Per Share:
Net
income per share is calculated using the weighted average number of shares
of
common stock outstanding during the year. The Company has adopted the provisions
of SFAS No. 128, Earnings
Per Share.
Financial
Instruments:
Financial instruments consist primarily of cash, accounts receivable, advances
to affiliates and obligations under accounts payable, accrued expenses and
notes
payable. The carrying amounts of cash, accounts receivable, accounts payable,
accrued expenses and notes payable approximate fair value because of the short
maturity of those instruments. The carrying amount of the advances to affiliates
approximates fair value because the Company charges what it believes are market
rate interest rates for comparable credit risk instruments. The Company has
applied certain assumptions in estimating these fair values. The use of
different assumptions or methodologies may have a material effect on the
estimates of fair values.
Use
of
Estimates:
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Significant
estimates made in connection with the accompanying financial statements include
the estimate of dilution and fees associated with LEC billings and the estimated
reserve for doubtful accounts receivable.
Stock-Based
Compensation:
Statements of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation,
(“SFAS
123”) established accounting and disclosure requirements using a fair-value
based method of accounting for stock-based employee compensation. In accordance
with SFAS 123, the Company has elected to continue accounting for stock based
compensation using the intrinsic value method prescribed by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
From
time
to time, the Company issues stock options to executives, key employees and
members of the Board of Directors. Generally, when the Company grants stock
options to employees, there is no intrinsic value of those options on the date
of grant. Accordingly, no compensation cost has been recognized for stock
options granted to employees. There were no options granted in the years ended
September 30, 2003 and 2002 nor was there any additional vesting of options
previously granted. Because no options were granted during the years ended
September 30, 2003 and 2002, there is no presentation of pro forma information
regarding net income.
The
Company accounts for stock awards issued to nonemployees in accordance with
the
provisions of SFAS 123 and Emerging Issues Task Force (“EITF”) Issue No. 96-18
Accounting
for Equity Instruments that are Issued to Other Than Employees for Acquiring,
or
in Conjunction with Selling Goods or Services.
Under
SFAS 123 and EITF 96-18, stock awards to nonemployees are accounted for at
their
fair value as determined under Black-Scholes option pricing model.
Temporary
Equity: During
fiscal 1999 and 2000, the Company issued 925,000 shares and 600,000 shares,
respectively, to consultants and other third parties whereupon it was
subsequently determined that the consultants did not perform under the terms
of
the related agreements. The Company has pursued legal action against the
consultants and third parties and ultimately such shares were retrieved. The
value of such shares, totaling $1,689,239, was not recorded as expense but
rather was reflected as temporary equity, together with a related receivable
until such times that the shares were retrieved. No such shares were outstanding
at September 30, 2003.
Impairment
of Long-lived Assets:
The
Company assesses long-lived assets for impairment in accordance with the
provisions of SFAS 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of. SFAS
121
requires that the Company assess the value of a long-lived asset whenever there
is an indication that its carrying amount may not be recoverable. Recoverability
of the asset is determined by comparing the forecasted undiscounted cash flows
generated by said asset to its carrying value. The amount of impairment loss,
if
any, is measured as the difference between the net book value of the asset
and
its estimated fair value.
Recently
Issued Accounting Pronouncements:
In July
2002, the FASB issued SFAS No. 146, "Accounting
for Costs Associated With Exit or Disposal Activities".
This
Standard requires costs associated with exit or disposal activities to be
recognized when they are incurred. The Company estimates the impact of adopting
these new rules will not be material.
In
October 2002, the FASB issued SFAS No. 147, "Acquisitions
of Certain Financial Institutions."
SFAS No.
147 is effective October 1, 2002. The adoption of SFAS No. 147 did not have
a
material effect on the Company’s financial statements.
In
April
2003, the FASB issued SFAS No. 149, "Amendment
of Statement 133 on Derivative Instruments and Hedging
Activities,"
effective for contracts entered into or modified after June 30, 2003. This
amendment clarifies when a contract meets the characteristics of a derivative,
clarifies when a derivate contains a financing component and amends certain
other existing pronouncements. The Company believes the adoption of SFAS No.
149
will not have a material effect on the Company’s financial
statements.
In
May
2003, the FASB issued SFAS No. 150, "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities
and
Equity."
SFAS No.
150 is effective for financial instruments entered into or modified after May
31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. SFAS No. 150 requires the classification
as a liability of any financial instruments with a mandatory redemption feature,
an obligation to repurchase equity shares, or a conditional obligation based
on
the issuance of a variable number of its equity shares. The Company does not
have any financial instruments with a mandatory redemption feature. The Company
believes the adoption of SFAS No. 150 will not have a material effect on the
Company’s financial statements.
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 clarifies the requirements for a guarantor’s accounting for and
disclosure of certain guarantees issued and outstanding. The initial recognition
and initial measurement provisions of FIN 45 are applicable to guarantees issued
or modified after December 31, 2002. The disclosure requirements of FIN 45
are
effective for financial statements for periods ending after December 15, 2002.
The adoption of FIN 45 did not have a significant impact on the Company’s
financial statements. See Note 10.
In
January 2003, the FASB issued FIN No. 46, "Consolidation
of Variable Interest Entities"
(FIN
46). FIN No. 46 states that companies that have exposure to the economic risks
and potential rewards from another entity’s assets and activities have a
controlling financial interest in a variable interest entity and should
consolidate the entity, despite the absence of clear control through a voting
equity interest. The consolidation requirements apply to all variable interest
entities created after January 31, 2003. For variable interest entities that
existed prior to February 1, 2003, the consolidation requirements are effective
for annual or interim periods beginning after June 15, 2003. Disclosure of
significant variable interest entities is required in all financial statements
issued after January 31, 2003, regardless of when the variable interest was
created. The Company is presently reviewing arrangements to determine if any
variable interest entities exist but does not anticipate the adoption of FIN
46
will have a significant impact on the Company’s financial
statements.
The
Company provides billing information to third party billing companies for the
majority of its monthly billings. Billings submitted are “filtered” by these
billing companies and the LEC’s. Net accepted billings are recognized as revenue
and accounts receivable. The billing companies remit payments to the Company
on
the basis of cash ultimately received from the LEC’s by those billing companies.
The billing companies and LEC’s charge fees for their services, which are netted
against the gross accounts receivable balance. The billing companies also apply
holdbacks to the remittances for potentially uncollectible accounts. These
dilution amounts will vary due to numerous factors and the Company may not
be
certain as to the actual amounts of dilution on any specific billing submittal
until several months after that submittal. The Company estimates the amount
of
these charges and holdbacks based on historical experience and subsequent
information received from the billing companies. The Company also estimates
uncollectible account balances and provides an allowance for such estimates.
The
billing companies retain certain holdbacks that may not be collected by the
Company for a period extending beyond one year. These balances have been
classified as long-term assets in the accompanying balance sheet.
The
Company experiences significant dilution of its gross billings by the billing
companies. The Company negotiates collections with the billing companies on
the
basis of the contracted terms and historical experience. The Company’s cash flow
may be affected by holdbacks, fees, and other matters, which are determined
by
the LEC’s and the billing companies. The Company processes its billings through
two primary billing companies.
EBillit,
Inc. (“EBI”) provides the majority of the Company’s billings, collections, and
related services. The net receivable due from EBillit at September 30, 2003
was
$6,457,998, net of an
allowance for doubtful accounts of $2,269,027. The net receivable from EBI
at
September 30, 2003, represents approximately 76% of the Company’s total net
accounts receivable at September 30, 2003.
Subscription
receivables that are directly billed by the Company are valued and reported
at
the estimated future collection amount. Determining the expected collections
requires an estimation of both uncollectible accounts and refunds. The net
subscriptions receivable at September 30, 2003 was $214,994.
Accounts
receivable at September 30, 2003 is summarized as follows:
|
|
Current
|
|
Long-Term
|
|
Total
|
|
Gross
accounts receivable
|
|
$
|
10,317,029
|
|
$
|
1,518,251
|
|
$
|
11,835,280
|
|
Allowance
for doubtful accounts
|
|
|
(2,988,405
|
)
|
|
(394,746
|
)
|
|
(3,383,151
|
)
|
Net
|
|
$
|
7,328,624
|
|
$
|
1,123,505
|
|
$
|
8,452,129
|
|
Certain
receivables have been classified as long-term because issues arise whereby
the
billing companies change holdback terms and collection experience is such that
collection can extend beyond one year.
The
allowance for doubtful accounts is attributable to the following categories
at
September 30, 2003:
Holdback
reserves of Local Exchange Carriers
|
|
$
|
2,221,441
|
|
|
|
|
|
|
Reserves
held by active third party billing aggregators
|
|
|
757,673
|
|
|
|
|
|
|
Reserves
held by inactive third party billing aggregator
|
|
|
154,037
|
|
|
|
|
|
|
Reserve
for refunds
|
|
|
250,000
|
|
|
|
$
|
3,383,151
|
|
In
connection with the Company’s acquisition of Telco, the Company was required to
provide accelerated payment of license fees for the use of the Internet domain
name or Universal
Resource
Locator
(URL) Yellow-page.
net.
Telco
had previously entered into a 20-year license agreement for the use of the
URL
with one of its two 50% stockholders. The original license agreement required
annual payments of $400,000. However, the agreement stated that upon a change
in
control of Telco, a $5,000,000 accelerated payment is required to maintain
the
rights under the licensing agreement. The URL holder agreed to discount the
accelerated payments from $8,000,000 to $5,000,000 at the time of the
acquisition. The Company agreed to make that payment upon effecting the
acquisition of Telco.
The
Company made a $3,000,000 cash payment and issued a note payable for $2,000,000
to acquire the licensing rights of the URL. The Company also issued 2,000,000
shares of its common stock to be held as collateral on the note. The note
payable was originally due on July 15, 1999. The Company failed to make the
$2,000,000 payment when due. The repayment terms were renegotiated to extend
the
due date to January 15, 2000. The Company was required to pay an extension
fee
of $200,000 at that time. The Company again renegotiated the repayment terms
on
April 26, 2000, to a demand note, with monthly installments of $100,000, subject
to all operating requirements, which, management believes, have subsequently
been met by the Company.
In
the
year ended September 30, 2002, the former URL holder claimed that it was due
additional amounts for the prior loan extensions. The Company reached a
settlement with the former URL holder that required the Company to issue to
the
former URL holder, 4,000,000 shares of the Company’s common stock, warrants to
purchase 500,000 shares of the Company’s common stock and a note payable for
$550,000. The Company recorded an expense of approximately $917,000 related
to
the settlement representing the principal amount of the note payable, $360,000
as the fair value of the 4,000,000 common shares and $7,176 as the fair value
of
the warrants. The value of the common stock was determined on the basis of
the
quoted trading price of the shares on the date of the agreement. The fair value
of the warrants was determined on the using the Black-Scholes option pricing
model.
The
URL
is recorded at its cost net of accumulated amortization. Management believes
that the Company’s business is dependent on its ability to utilize this URL
given the recognition of the Yellow
page
term.
Also, its current customer base relies on the recognition of this term and
URL
as a basis for maintaining the subscriptions to the Company’s service.
Management believes that the current revenue and cash flow generated through
use
of Yellow-page.net
supports
the carrying of the asset. The Company periodically analyzes the carrying value
of this asset to determine if impairment has occurred. No such impairments
were
identified during the year ended September 30, 2003. The URL is amortized on
an
accelerated basis over the twenty-year term of the licensing agreement.
Amortization expense on the URL was $387,135 and $403,232 for the years ended
September 30, 2003 and 2002 respectively.
During
the year ended September 30, 2003, the Company acquired a three year license
for
the domain name, “YP.com” for $250,000 cash and 100,000 shares of the Company’s
common stock valued at $60,000.
The
following summarizes the estimated future amortization expense related to
intangible assets:
Years
ended September 30,
|
|
|
|
2004
|
|
$
|
431,022
|
|
2005
|
|
|
398,528
|
|
2006
|
|
|
343,986
|
|
2007
|
|
|
236,212
|
|
2008
|
|
|
213,035
|
|
Thereafter
|
|
|
1,890,169
|
|
|
|
|
|
|
Total
|
|
$
|
3,512,952
|
|
5.
|
PROPERTY
AND EQUIPMENT
|
Property
and equipment consisted of the following at September 30, 2003:
Leasehold
improvements
|
|
$
|
376,287
|
|
Furnishings
and fixtures
|
|
|
167,706
|
|
Office
and computer equipment
|
|
|
857,869
|
|
Total
|
|
|
1,401,862
|
|
Less
accumulated depreciation
|
|
|
(670,720
|
)
|
|
|
|
|
|
Property
and equipment, net
|
|
$
|
731,142
|
|
6. |
NOTES
PAYABLE AND LINE OF CREDIT
|
Notes
payable at September 30, 2003 are comprised of the following:
Note
payable to former Telco stockholders, original balance of $550,000,
interest at 10.5% per annum. Repayment terms require monthly installments
of principal and interest of $19,045 beginning December 15, 2002.
Stated
maturity September 25, 2004. Collateralized by all assets of the
Company.
|
|
$115,868
|
The
note
payable to the former Telco stockholders totaled $550,000 at the beginning
of
the fiscal year ending September 30, 2002. In accordance with instructions
that
the Company received from said stockholders, the Company has made payments
to
third parties on behalf of the stockholders and applied those payments as
reductions to the note payable. Said stockholders are not a part of management
or on the Board of Directors of the Company. Payments on the note were
accelerated at the option of the Company. Although the note calls for monthly
payments of $19,045, the Company would not be required to make another payment
until February 2004 under the original repayment provisions of the note. The
full remaining balance of $115,866 is due in the year ended September 30,
2004.
7.
|
PROVISION
FOR INCOME TAXES
|
Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes
and
the amounts used for income tax purposes.
During
the years ended September 30, 2003 and 2002, the Company structured certain
transactions related to its merger with Telco that allowed the Company to
utilize net operating losses that were previously believed to be unavailable
or
limited under the change of control rules of Internal Revenue Code 382. The
deferred income tax asset of approximately $1,463,000 related to these net
operating losses recorded at September 30, 2001, was partially offset by a
valuation allowance of approximately $773,000. The Company also amended prior
year tax returns reflecting a higher net operating loss carryforward that had
initially been estimated. The additional net operating loss carryforwards
previously not recognized resulted in an income tax benefit of $979,000 that
was
utilized to offset some of the income tax provision for the year ended September
30, 2003. Additionally, as a result of these changes and the elimination of
the
valuation allowance an income tax benefit of approximately $917,000 was
recognized during the year ended September 30, 2002. At September 30, 2003
the
Company had a federal net operating loss carryforward of $2,880,000 and no
state
net operating losses. Those operating loss carryforwards expire in 2019 and
2020.
Income
taxes for years ended September 30, is summarized as follows:
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
Current
Provision
|
|
$
|
3,337,208
|
|
$
|
376,582
|
|
Deferred
(Benefit) Provision
|
|
|
(1,465,915
|
)
|
|
77,836
|
|
|
|
|
|
|
|
|
|
Net
income tax provision
|
|
$
|
1,871,293
|
|
$
|
454,418
|
|
A
reconciliation of the differences between the effective and statutory income
tax
rates for years ended September 30, is as follows:
|
|
2003
|
|
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
statutory rates
|
|
$
|
3,226,019
|
|
|
34
|
%
|
$
|
1,082,228
|
|
|
34
|
%
|
State
income taxes
|
|
|
114,807
|
|
|
1
|
%
|
|
222,811
|
|
|
7
|
%
|
Utilization
of valuation allowance
|
|
|
-
|
|
|
-
|
|
|
(661,088
|
)
|
|
(43
|
)%
|
Change
in estimate of NOL due to changes in structuring and state income
tax
rates used
|
|
|
(1,465,381
|
)
|
|
(15
|
)%
|
|
(143,575
|
)
|
|
(4
|
)%
|
Other
|
|
|
(4,153
|
)
|
|
-
|
|
|
(45,958
|
)
|
|
(1
|
)%
|
Effective
rate
|
|
$
|
1,871,293
|
|
|
20
|
%
|
$
|
(454,418
|
)
|
|
(7
|
)%
|
At
September 30, 2003, deferred income tax assets and liabilities were comprised
of:
Deferred
Income Tax Assets:
|
|
|
|
Book/tax
differences in accounts receivable
|
|
$
|
1,184,103
|
|
Deferred
and stock-based compensation
|
|
|
640,347
|
|
Book/tax
differences in intangible assets
|
|
|
72,140
|
|
Net
operating loss carryforward
|
|
|
979,138
|
|
Total
deferred income tax asset
|
|
|
2,875,728
|
|
|
|
|
|
|
Deferred
Income Tax Liabilities:
|
|
|
|
|
Book/tax
differences in depreciation
|
|
|
100,006
|
|
Book/tax
differences in customer acquisition costs
|
|
|
1,135,134
|
|
Total
deferred income tax liability
|
|
|
1,235,140
|
|
|
|
|
|
|
Net
income tax asset
|
|
$
|
1,640,588
|
|
During
the year ended September 30, 2003, the Company moved certain operations and
revenue generating assets to a state without corporate income taxes thereby
reducing the statutory rate used for state income taxes.
During
the year ended September 30, 2002, the valuation allowance was reduced by
approximately $773,000.
The
Company leases its office space and certain equipment under long-term operating
leases expiring through fiscal year 2006. Rent expense under these leases was
$222,418 and $145,052 for the years ended September 30, 2003 and 2002,
respectively.
Future
minimum annual lease payments under operating lease agreements for years ended
September 30 are as follows:
2004
|
|
$
|
427,597
|
|
2005
|
|
|
383,679
|
|
2006
|
|
|
292,125
|
|
|
|
|
|
|
Total
|
|
$
|
1,103,401
|
|
Common
Stock Issued for Services
The
Company has historically granted shares of its common stock to officers,
directors and consultants as payment for services rendered. The value of those
shares was determined based on the trading value of the stock at the dates
on
which the agreements were made for the services. During the year ended September
30, 2003, the Company issued 6,300,000 shares of common stock to officers and
directors, or entities controlled by those individuals, valued at $478,750.
Additionally, shares were granted under the Company’s Restricted Stock Plan (see
Note 14).
During
the year ended September 30, 2002, the Company issued 100,000 shares of common
stock to officers, directors and consultants valued at $9,000
Common
Stock Issued for URL
During
the year ended September 30, 2003, the Company acquired a three year license
for
the domain name, “YP.com” for $250,000 cash and 100,000 shares of the Company’s
common stock valued at $60,000.
Series
E Convertible Preferred Stock
During
the year ended September 30, 2002, the Company created a new series of capital
stock, the Series E Convertible Preferred Stock. The Company authorized 200,000,
$0.001 par value shares. The shares carry a $0.30 per share liquidation
preference and accrue dividends at the rate of 5% per annum on the liquidation
preference per share, payable quarterly from legally available funds. If such
funds are not available, dividends shall continue to accumulate until they
can
be paid from legally available funds. Holders of the preferred shares shall
be
entitled, after two years from issuance, to convert them into common shares
on a
one-to-one basis together with payment of $0.45 per converted share.
During
the year ended September 30, 2002, pursuant to an existing tender offer, holders
of 131,840 shares of the Company’s common stock exchanged said shares for an
equal number of the Series E Convertible Preferred shares, at the then $0.085
market value of the common stock. As of September 30, 2003, the liquidation
preference value of the outstanding Series E Convertible Preferred Stock was
$39,552, and dividends totaling $2,472 had been accrued associated with said
shares.
Treasury
Stock
During
the year ended September 30, 2003, the Company acquired 500,000 shares of its
common stock from a former consultant to the Company for $45,000, which was
the
approximate trading value of those shares at the time the settlement was
reached.
10.
|
COMMITMENTS
AND CONTINGENCIES
|
Telco
Billing
The
acquisition of Telco by the Company called for the issuance of 17,000,000 new
shares of stock in exchange of the existing shares of Telco. As part of that
agreement, the Company gave the former shareholders the right to “Put” back to
the Company certain shares of stock at a minimum stock price of 80% of the
current trading price with a minimum strike price of $1.00. The net effect
of
which was that the former Telco shareholders could require the Company to
repurchase shares of stock of the Company at a minimum cost of $10,000,000.
The
agreement required the Company to attain certain market share
levels.
The
“Put”
feature has renegotiated and retired. As part of the renegotiated settlement,
the Company provided a credit facility of up to $20,000,000 to the former Telco
shareholders, collateralized by the stock held by these shareholders, with
interest at least 0.25 points higher than the Company’s average cost of
borrowing. Additional covenants warrant that no more that $1,000,000 can be
advanced at any point in time and no advances can be made in excess with out
allowing at least 30 days operating cash reserves or if the Company is in an
uncured default with any of its lenders. At September 30, 2003, the Company
had
advanced $2,126,204 under this agreement. The former Telco shareholders have
been making interest payments on the advances but, as allowed under the
agreement, have not made any principal repayments.
Subsequent
to September 30, 2003, the Company and the former Telco shareholders agreed
to
amend the arrangement whereby the Company will be required to advance only
an
additional $1,300,000 through April 2004 and the ability to draw on that
facility will cease at that time. However, the Company made a commitment in
connection with that amendment to begin paying dividends to all of its common
stockholders in the fiscal year ended September 30, 2004.
Billing
Service Agreements
The
Company has entered into a customer billing service agreement with EBillit,
Inc.
(EBI). EBI provides billing and collection and related services associated
to
the telecommunications industry. The agreement term is for two years,
automatically renewable in two-year increments unless appropriate notice to
terminate is given by either party. The agreement will automatically renew
on
September 1, 2005, unless either party gives notice of termination 90 days
prior
to that renewal date. Under the agreement, EBI bills, collects and remits the
proceeds to Telco net of reserves for bad debts, billing adjustments, telephone
company fees and EBI fees. If either the Company’s transaction volume decreases
by 25% from the preceding month, less than 75% of the traffic is billable to
major telephone companies, EBI may at its own discretion increase the reserves
and holdbacks under this agreement. EBI handles all billing information and
collection of receivables. The Company’s cash receipts on trade accounts
receivable are dependent upon estimates pertaining to holdbacks and other
factors as determined by EBI. EBI may at its own discretion increase the
reserves and holdbacks under this agreement.
The
Company has also entered into an agreement with ACI Communications, Inc. ACI
provides billing and collection and related services associated to the
telecommunications industry.
These
agreements with the billing companies provide significant control to the billing
companies over cash receipts and ultimate remittances to the Company. The
Company estimates the net realizable value of its accounts receivable on
historical experience and information provided by the billing companies
reflecting holdbacks and reserves taken by the billing companies and
LEC’s.
Line
of Credit Facilities
The
Company has a line of credit arrangement with a financial institution for a
total of $250,000. Interest on borrowings is at the prime rate plus 0.5% The
facility expires in May 2004. There were no outstanding borrowings under this
arrangement at September 30, 2003.
The
Company also has a facility to borrow from a financial institution that allows
borrowings based on qualifying trade accounts receivable. The advances made
under the arrangement are made on a basis of individually negotiated
transactions. The advances are generally short-term, being repaid within 30
to
60 days. Advances are limited to $150,000 and accrued interest at an effective
rate of 1% per month. There is no specified expiration date on the facility.
There were no outstanding borrowings under this arrangement at September 30,
2003.
Other
The
Company’s Board of Directors has committed the Company to pay for the costs of
defending a civil action filed against its CEO and Chairman. The action involves
a business that the CEO was formerly involved in. The Company and at least
one
officer have received subpoenas in connection with this matter and the Board
believes that it is important to help resolve this matter as soon as possible.
The Board action includes the payment of legal and other fees for any other
officers and directors that may become involved in this civil action. Through
September 30, 2003, the Company has paid $732,500 on behalf of its CEO relative
to this matter. This amount is presented as compensation expense within general
and administrative expenses in the accompanying statement of operations for
the
year ended September 30, 2003. The Company believes that all civil actions
against the CEO related to this matter have been dismissed subsequent to
September 30, 2003. However, additional legal costs will be incurred to address
all matters in finalizing this issue and, at this time, the Company cannot
estimate what additional costs may be incurred to continue covering the costs
related to this matter, but all such costs shall be deemed to be additional
compensation to the CEO. There can be no assurance that the Company may not
be
named a defendant in this action in the future.
The
Company has entered into “Executive Consulting Agreements” with four entities
controlled by four of the Company’s officers individually. These agreements call
for fees to be paid for the services provided by these individuals as officers
of the Company as well as their respective staffs. These agreements are not
personal service contracts of these officers individually. The agreements extend
through 2007 and require annual performance bonuses that aggregate up to
approximately $320,000 depending upon available cash and meeting of certain
performance criteria.
The
Company is named as a defendant in proceedings that including alleged wrongful
discharge of certain former employees and a purported class action proceeding
related to the Company’s mailings of marketing materials. The Company intends to
defend these actions and does not believe that these claims have merit nor
will
the resolution of such have a material adverse effect on the Company’s financial
condition and results of operations.
The
Company has entered into several agreements with third parties to distribute
and
enhance the services its provides to its customers. These agreements have terms
for up to three years and call for payments of approximately $110,000 per month.
Generally these agreements are cancelable within 30 to 60 days upon written
notice from either party.
Net
income per share is calculated using the weighted average number of shares
of
common stock outstanding during the year. Preferred stock dividends are
subtracted from the net income to determine the amount available to common
shareholders. There were $1,978 and $494 preferred stock dividends in the years
ended September 30, 2003 and 2002, respectively. Warrants to purchase 500,000
shares of common stock were excluded from the calculation for the year ended
September 30, 2002. The exercise price of those warrants was greater than the
average trading value of the common stock and therefore inclusion of such would
be anti-dilutive. Also excluded from the calculation were 131,840 shares of
Series E Convertible Preferred Stock issued during the year ended September
30,
2002, which are considered anti-dilutive due to the cash payment required by
the
holders of the securities at the time of conversion.
The
following presents the computation of basic and diluted loss per share from
continuing operations:
|
|
2003
|
|
2002
|
|
|
|
Income
|
|
Shares
|
|
Per
Share
|
|
Income
|
|
Shares
|
|
Per
share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
$
|
7,615,866
|
|
|
|
|
|
|
|
$
|
2,840,731
|
|
|
|
|
|
|
|
Preferred
stock dividends
|
|
|
(1,978
|
)
|
|
|
|
|
|
|
|
(494
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
available to common Stockholders
|
|
$
|
7,613,888
|
|
|
|
|
|
|
|
$
|
2,840,237
|
|
|
|
|
|
|
|
Basic
Earnings Per Share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
available to common stockholders
|
|
$
|
7,613,888
|
|
|
45,591,590
|
|
$
|
0.17
|
|
$
|
2,840,237
|
|
|
41,753,464
|
|
$
|
0.07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of dilutive securities
|
|
|
N/A
|
|
|
|
|
|
|
|
|
N/A
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
Earnings Per Share
|
|
$
|
7,613,888
|
|
|
45,591,590
|
|
$
|
0.17
|
|
$
|
2,840,237
|
|
|
41,753,464
|
|
$
|
0.07
|
|
12.
|
RELATED
PARTY TRANSACTIONS
|
During
the years ended September 30, 2003 and 2002, the Company entered into the
related party transactions with Board members, officers and affiliated entities
as described below:
Directors
& Officers
Board
of
Director fees for the years ended September 30, 2003 and 2002 were $160,000
and
$101,120 respectively. These amounts are in addition to the amounts discussed
below. At September 30, 2002, $40,000 of the 2002 amount was accrued but unpaid.
The Company also granted 50,000 shares of common stock to a director as part
of
their Board of Director fees for the year ended September 30, 2002.
During
the year ended September 30, 2002, the Company had made loans to its Chief
Executive Officer and its former Chief Financial Officer. The Board of Directors
approved the loans as part of the officers’ respective compensation packages.
The loans carried an 8% interest rate and were collateralized by shares of
Company common stock owned by the officers’ valued at the greater of $1.00 per
share or the current market price of the shares. The loans to the CEO and former
CFO totaled approximately $200,000 and $17,000 respectively. At September 30,
2002, the loan to the CEO was repaid. In May 2002, the former CFO resigned.
The
CEO,
Executive Vice President of Marketing, Corporate Secretary/Vice President of
Corporate Image and CFO are paid for their services and those of their
respective staffs through separate entities controlled by these individuals
which pre-date their association with the Company. The following describes
the
compensation paid to these entities.
Sunbelt
Financial Concepts, Inc.
Sunbelt
Financial Concepts, Inc. (“Sunbelt”) provides the services of the Chairman and
CEO and his staff to the Company.
Sunbelt
provides the strategic and overall planning as well as the operations management
to the Company. Sunbelt’s team is experienced in all areas of management and
administration.
During
the year ended September 30, 2003, the Company paid a total of approximately
$1,933,000 to Sunbelt. That amount includes $410,054 as reimbursement of legal
fees incurred by Sunbelt related to the personal legal matters discussed in
Note
10. Also included in that amount is $597,000 in fees for services rendered
by
Sunbelt. Additionally, the CEO and Sunbelt were awarded grants of the Company’s
common stock valued at approximately $603,000. Approximately $443,322 (including
the taxes on these amounts) of the total remains accrued at September 30,
2003.
Advertising
Management Specialists, Inc.
Advertising
Management Specialists, Inc. (“AMS”) provides the services of the Executive Vice
President of Marketing, a Director of the Company, and his staff to the Company.
AMS is a marketing and advertising company experienced in designing Direct
Marketing Pieces, insuring compliance with regulatory authorities for those
pieces and designing new products that can be mass marketed through the mail.
AMS’ president is a director of the Company.
The
Company outsources the design and testing of its many direct mail pieces to
AMS
for a fee. AMS is also solely responsible for the new products that have been
added to the Company’s website and is working on new mass-market products to
offer the Company’s customers.
Total
amount paid and accrued to this director and AMS during the year ended September
30, 2003 was $957,000. Of that amount, $477,000 was compensation for services
and a stock award valued at $480,000. Of the total, $125,816 is accrued at
September 30, 2003.
Advanced
Internet Marketing, Inc.
Advanced
Internet Marketing, Inc. (“AIM”) provides the services of the Vice President of
Corporate Image, a Director of the Company, and his staff to the Company. The
Company outsources the design and marketing of it’s website on the World Wide
Web to AIM. AIM’s team of designers are experienced in all areas of web design
and has created all of the Company’s logos and images for branding.
The
total
amount paid and accrued to AIM during the year ended September 30, 2003 was
$754,750. Of that amount, $74,750 was compensation for services and a stock
award valued at $480,000. Of the total, $98,294 is accrued at September 30,
2003.
MAR
& Associates
The
services of the Company’s Chief Financial Officer and his staff are paid to MAR
& Associates (“MAR”). The total amount paid and accrued to MAR during the
year ended September 30, 2003 was $851,000. Of that amount, $215,000 was
compensation for services and a stock award valued at $636,000. Of the total,
$46,198 is accrued at September 30, 2003.
Other
The
Company made additional advances to former Telco shareholders of $1,800,000
during the year ended September 30, 2003. Interest earned on these advances
was
$92,245 for the year ended September 30, 2003. Advances to affiliates are
summarized as follows at September 30, 2003:
Morris
& Miller
|
|
$
|
1,089,485
|
|
Mathew
& Markson
|
|
|
1,036,719
|
|
Total
|
|
$
|
2,126,204
|
|
On
December 22, 2003, the Company entered into an agreement with the former Telco
shareholders that terminates the line of credit agreement effective April 9,
2004.
Simple.Net,
Inc. (“SN”)
The
Company has contracted with Simple.Net, Inc. (“SN”), an internet service
provider owned by a director of the Company, to provide internet dial-up and
other services to its customers. SN has sold said services to the Company at
below market rate prices from time to time. During the years ended September
30,
2003 and 2002, the Company paid SN approximately $419,000 and $55,000,
respectively for said services. At September 30, 2003, $80,000 due SN was
accrued in accounts payable.
In
addition, SN pays a monthly fee to the Company for technical support and
customer service provided to SN’s customers by the Company’s employees. The
Company charges SN for these services according to a per customer pricing
formula:
Customer
Service & Management Agreement fees are calculated by number of customer
records of SN multiplied by a base cost of $1.02.
Technical
Support fees are calculated by number of customer records of SN multiplied
by a
base cost of 60 cents.
For
the
years ended September 30, 2003 and 2002, the Company recorded revenues of
approximately $618,611 and $300,901, respectively, from SN for these
services.
Prior
to
July 2002, the Company provided accounting functions to SN for a $2,500 monthly
fee. This arrangement was canceled in July 2002.
13.
|
CONCENTRATION
OF CREDIT RISK
|
The
Company maintains cash balances at banks in Arizona. Accounts are insured by
the
Federal Deposit Insurance Corporation up to $100,000. At September 30, 2003,
the
Company had bank balances exceeding those insured limits of
$2,255,000.
Financial
instruments that potentially subject the Company to concentrations of credit
risk are primarily trade accounts receivable. The trade accounts receivable
are
due primarily from business customers over widespread geographical locations
within the LEC billing areas across the United States. The Company historically
has experienced significant dilution and customer credits due to billing
difficulties and uncollectible trade accounts receivable. The Company estimates
and provides an allowance for uncollectible accounts receivable. The handling
and processing of cash receipts pertaining to trade accounts receivable is
maintained primarily by two third party billing companies. The Company is
dependent upon these billing companies for collection of its accounts
receivable. As discussed in Note 3, the net receivable due from a single billing
services provider at September 30, 2003 was $6,457,998, net of an
allowance for doubtful accounts of $2,269,027. The net receivable from that
billing services provider at September 30, 2003, represents approximately 76%
of
the Company’s total net accounts receivable at September 30, 2003.
14.
|
STOCK
BASED COMPENSATION
|
During
the year ended September 30, 2002, the Company’s shareholders approved the 2002
Employees, Officers & Directors Stock Option Plan (the 2002 Plan). Under the
2002 Plan, the total number of shares of common stock that may be granted is
3,000,000. The Plan provides that shares granted come from the Corporation’s
authorized but unissued common stock. The price of the options granted under
this plan shall not be less than 100% of the fair market value, or in the case
of a grant to a principal shareholder, not less than 110% of the fair market
value of such common shares at the date of grant. The options expire 10 years
from the date of grant. At September 30, 2002, no stock options had been granted
under the 2002 Plan.
During
the year ended September 30, 2003, the Company’s Board of Directors and a
majority of it shareholders voted to terminate the 2002 Plan and approved the
Company’s 2003 Stock Plan ("2003 Plan"). The 3,000,000 shares of Company common
stock previously allocated to the 2002 Plan were re-allocated to the 2003 Plan.
Substantially all Company employees are eligible to participate in the plan.
On
August 12, 2003, 2,048,000 shares authorized under the 2003 Plan were granted
in
the form of Restricted Stock. These shares of Restricted Stock were granted
to
the Company’s service providers as well as the Company’s executives. Of the
2,048,000 shares of Restricted Stock granted, 1,049,000 shares vest at the
end
of three years, an additional 599,000 shares vest either at the end of ten
years
or upon the Company’s common stock attaining an average bid and ask price of $10
per share for three consecutive trading days and an additional 400,000 shares
vest upon the common stock attaining various average bid and ask prices with
80,000 shares vesting for each $1 price increase at prices beginning from $5
per
share up to $9 per share. The vesting of all shares of Restricted Stock
accelerates upon a Change of Control, as defined in the 2003 Plan. The value
of
the shares granted was $2.02 per share, the trading value of the shares on
the
grant date. The Company deferred the expense and is recognizing the expense
over
the vesting periods. During the year ended September 30, 2003, the Company
expensed $154,482 under the 2003 Plan. Of the 2,048,000 granted in August 2003,
75,000 of those shares were forfeited unvested as of September 30, 2003.
Under
the
Employee Incentive Stock Option Plan approved by the stockholders in 1998,
the
total number of shares of common stock that may be granted is 1,500,000. The
plan provides that shares granted come from the Corporation’s authorized but
unissued common stock. The price of the options granted pursuant to this plan
shall not be less than 100 percent of the fair market value of the shares on
the
date of grant. The options expire from five to ten years from date of grant.
At
September 30, 2002, the Company had granted an aggregate of 1,212,000 options
under this plan, all of which had expired as of September 30, 2001.
In
addition to the Employee Incentive Stock Option Plan, the Company will
occasionally grant options to consultants and members of the board of directors
under specific stock option agreements. There were no such options granted
in
the years ended September 30, 2003 and 2002.
At
September 30, 2003, there were no options exercisable or outstanding. No options
were granted in the years ended September 30, 2003 and 2002.
The
Company has issued warrants in connection with certain debt and equity
transactions. Warrants outstanding are summarized as follows:
|
|
2003
|
|
2002
|
|
|
|
|
|
Weighted
Average Exercise
Price
|
|
|
|
Weighted
Average Exercise
Price
|
|
|
|
|
|
|
|
|
|
|
|
Warrants
outstanding at beginning of year
|
|
|
500,000
|
|
$
|
2.12
|
|
|
500,000
|
|
$
|
2.12
|
|
Granted
|
|
|
-0-
|
|
|
|
|
|
-0-
|
|
|
|
|
Expired
|
|
|
-0-
|
|
|
|
|
|
-0-
|
|
|
|
|
Exercised
|
|
|
-0-
|
|
|
|
|
|
-0-
|
|
|
|
|
Outstanding
at September 30,
|
|
|
500,000
|
|
$
|
2.12
|
|
|
500,000
|
|
$
|
2.12
|
|
The
warrants granted in the year ended September 30, 2001 were issued in connection
with the settlement with the former URL holder (NOTE 4). The exercise prices
of
the warrants range from $1.00 to $3.00. The fair values of these warrants were
estimated at the date of grant using the Black-Scholes option-pricing model
with
the following assumptions:
Dividend
yield
|
None
|
Volatility
|
0.491
|
Risk
free interest rate
|
4.18%
|
Expected
asset life
|
2.5
years
|
The
500,000 warrants outstanding at September 30, 2003, expire in September
2006.
15.
|
EMPLOYEE
BENEFIT PLAN
|
The
Company maintains a 401(k) profit sharing plan for its employees. Employees
are
eligible to participate in the plan upon reaching age 21 and completion of
three
months of service. The Company made contributions of $5,427 and $3,400 to the
plan for the years ended September 30, 2003 and 2002, respectively.
Other
income for the year ended September 30, 2003 includes $618,000 of income earned
from an affiliate for technical services provided to that affiliate. The total
income is reduced by expenses incurred in other legal settlements. Also, in
the
year ended September 30, 2002, is a gain of $130,000, net of legal costs,
resulting from the settlement of a dispute with one of the Company’s former
billing companies.
17.
|
QUARTERLY
FINANCIAL DATA (UNAUDITED)
|
Subsequent
to filing the interim financial statements included on Form 10-QSB for the
periods ending December 31, 2001, March 31, 2002, June 30, 2002, December 31,
2002, March 31, 2003, and June 30, 2003, the Company has changed its accounting
treatment of shares issued to non-performing consultants. The previously filed
interim statements reflected an expense upon issuance of the shares and a
reversal of this expense when it was deemed (through a settlement agreement
or
judgment) that these shares would be returned. However, after further analysis
and consultation with the Securities and Exchange Commission, it was determined
to be inappropriate to recognize the initial expense and its subsequent reversal
as no services were rendered by these consultants. Instead, the issuance of
these shares will be reflected as temporary equity, together with a related
receivable, until the shares were returned. Such treatment is described in
Note
2.
The
following table sets forth the impact of this change on the following three
month periods:
|
|
Quarter
Ended
|
|
|
|
December
31,
2002
|
|
March
30,
2003
|
|
June
30,
2003
|
|
September
30,
2003
|
|
|
|
|
|
|
|
|
|
|
|
Quarterly
Data Per 10-Q Filings
|
|
|
|
|
|
|
|
|
|
Net
revenues
|
|
$
|
5,741,455
|
|
$
|
6,849,044
|
|
$
|
8,013,845
|
|
|
na
|
|
Gross
profit
|
|
|
3,919,305
|
|
|
5,000,078
|
|
|
5,952,616
|
|
|
na
|
|
Net
income
|
|
|
1,092,892
|
|
|
1,504,921
|
|
|
1,676,830
|
|
|
na
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.02
|
|
$
|
0.03
|
|
$
|
0.04
|
|
|
na
|
|
Diluted
|
|
$
|
0.02
|
|
$
|
0.03
|
|
$
|
0.04
|
|
|
na
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revised
Quarterly Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
revenues
|
|
$
|
5,741,455
|
|
$
|
6,849,044
|
|
$
|
8,013,845
|
|
$
|
10,163,100
|
|
Gross
profit
|
|
|
3,803,327
|
|
|
5,000,078
|
|
|
5,952,616
|
|
|
7,537,677
|
|
Net
income
|
|
|
1,017,506
|
|
|
1,504,921
|
|
|
1,676,830
|
|
|
3,416,609
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.02
|
|
$
|
0.03
|
|
$
|
0.04
|
|
$
|
0.07
|
|
Diluted
|
|
$
|
0.02
|
|
$
|
0.03
|
|
$
|
0.04
|
|
$
|
0.07
|
|
|
|
Quarter
Ended
|
|
|
|
December
31,
2001
|
|
March
30,
2002
|
|
June
30,
2002
|
|
September
30,
2002
|
|
|
|
|
|
|
|
|
|
|
|
Quarterly
Data Per 10-Q Filings
|
|
|
|
|
|
|
|
|
|
Net
revenues
|
|
$
|
2,992,993
|
|
$
|
2,839,438
|
|
$
|
3,416,953
|
|
|
na
|
|
Gross
profit
|
|
|
1,808,716
|
|
|
2,106,037
|
|
|
2,248,557
|
|
|
na
|
|
Net
income
|
|
|
306,349
|
|
|
620,288
|
|
|
798,742
|
|
|
na
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.01
|
|
$
|
0.01
|
|
$
|
0.02
|
|
|
na
|
|
Diluted
|
|
$
|
0.01
|
|
$
|
0.01
|
|
$
|
0.02
|
|
|
na
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revised
Quarterly Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
revenues
|
|
$
|
2,992,993
|
|
$
|
2,839,438
|
|
$
|
3,416,953
|
|
$
|
3,368,742
|
|
Gross
profit
|
|
|
1,808,716
|
|
|
2,106,036
|
|
|
2,248,557
|
|
|
2,957,139
|
|
Net
income
|
|
|
306,349
|
|
|
620,286
|
|
|
640,728
|
|
|
1,273,369
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.01
|
|
$
|
0.01
|
|
$
|
0.01
|
|
$
|
0.03
|
|
Diluted
|
|
$
|
0.01
|
|
$
|
0.01
|
|
$
|
0.01
|
|
$
|
0.03
|
|
ITEM
8A. CONTROLS AND
PROCEDURES
Disclosure
controls are procedures that are designed with an objective of ensuring that
information required to be disclosed in our periodic reports filed with the
Securities and Exchange Commission, such as this Annual Report on Form 10-KSB,
is recorded, processed, summarized and reported within the time periods
specified by the Securities and Exchange Commission. Disclosure controls are
also designed with an objective of ensuring that such information is accumulated
and communicated to our management, including our chief executive officer and
chief financial officer, in order to allow timely consideration regarding
required disclosures.
The
evaluation of our disclosure controls by our principal executive officer and
principal financial officer included a review of the controls’ objectives and
design, the operation of the controls, and the effect of the controls on the
information presented in this Annual Report. Our management, including our
chief
executive officer and chief financial officer, does not expect that disclosure
controls can or will prevent or detect all errors and all fraud, if any. A
control system, no matter how well designed and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Also, projections of any evaluation of the disclosure controls and
procedures to future periods are subject to the risk that the disclosure
controls and procedures may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.
Based
on
their review and evaluation as of a date within 90 days of the filing of this
Form 10-KSB, and subject to the inherent limitations all as described above,
our
principal executive officer and principal financial officer have concluded
that
our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934) are effective. They are
not
aware of any significant changes in our disclosure controls or in other factors
that could significantly affect these controls subsequent to the date of their
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Subsequent
Review of Disclosure Controls
Subsequent
to the foregoing conclusions, we concluded that shares granted to consultants
in
1999 and 2000, most of which were subsequently recovered for nonperformance
of
services from 2001 to 2003, required different accounting treatment than was
previously applied. This discovery has lead us to amend and restate our
previously issued financial statements and other financial information for
the
fiscal year and quarter to date periods for the fiscal years ended September
30,
1999 through September 30, 2004.
At
the
time of filing the Original Filing, which was filed on December 31, 2003, our
management was not aware of the internal control weaknesses relating to the
accounting for shares issued to non-performing consultants. Subsequent to the
filing of the Original Filing and after considering these internal control
weaknesses, our chief executive officer and chief financial officer reevaluated
the effectiveness of our disclosure controls and procedures as of September
30,
2003 for this Form 10-KSB/A. Based upon this reevaluation, our chief executive
officer and chief financial officer concluded that our disclosure controls
and
procedures were not effective as of September 30, 2003.
The
historical financial statements generated by predecessor management reflected
an
expense upon issuance of the non-performing consultant shares and a reversal
of
this expense when it was deemed (through a settlement agreement or judgment)
that these shares would be returned. However, after further analysis, it was
determined to be inappropriate to recognize the initial expense and its
subsequent reversal as no services were rendered by these consultants. Instead,
the issuance of these shares will be reflected as temporary equity, together
with a related receivable, until the shares were returned. Such amounts will
continue to be reflected as expense in the year granted and our revised
statements will no longer reflect the reversal of this expense.
The
following exhibits are either attached hereto.
Exhibit
Number
|
|
Description
|
|
|
|
|
|
Consent
of Epstein, Weber and Conover P.L.C
|
|
|
|
|
|
Certification
pursuant to SEC Release No. 33-8238, as adopted pursuant to Section
302 of
the Sarbanes-Oxley Act of 2002
|
|
|
|
|
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002
|
In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Dated:
November 30, 2005
|
|
/s/
Peter J. Bergmann
|
|
|
|
Peter
J. Bergmann, Chief Executive Officer
|
|
53