Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion should be read in conjunction with the attached financial statements and notes thereto. Except for the historical information contained herein, the matters discussed below are forward-looking statements that involve certain risks and uncertainties, including, among others, the risks and uncertainties discussed below.
OVERVIEW
Management’s objective for the three and six months ended December 31, 2010 was to improve overall operations to reduce the need for external financing but also to position the Company for growth in existing markets and new areas such as mobile payments and remittances. The company continues to target suitable acquisitions to enhance the profitability from sustainable, higher margin, revenue streams. We continued our focus on growing our prepaid telecom segment that resulted in increased revenues over the period last year but a lower gross margin due to a change in product offerings for the period. We have been actively engaged in seeking additional external financing and other strategic partnerships and relationships to further enhance the scale, depth and profitability of the business.
In the three months ended December 31, 2010, we had a net loss of $2,221,663 ($0.10 per share basic and diluted), as compared to a net loss of $10,053,978 ($2.62 per share basic and diluted) in the three months ended December 31, 2009. We had a net loss of $4,311,246 ($0.26 per share basic and diluted) in the six months ended December 31, 2010, as compared to a net loss of $13,106,197 ($3.37 per share basic and diluted) in the six months ended December 31, 2009. The decrease in the losses year on year was a direct result of the ceasing of non-profitable businesses, in February 2010, that were acquired as part of the CHVC transaction in 2009 and managements focus on operational cost rationalization during 2010. Operating losses reduced by 48% in the six months ended December 31, 2010 compared to the same period last year.
Our overall cash increased by $66,892 in the six months ended December 31, 2010, compared to a decrease by $1,049,752 in the six months ended December 31, 2009.
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2010 AND 2009
REVENUES
Revenues for the three months ended December 31, 2010 increased 7% to $4,423,909 as compared to $4,134,368 for the three months ended December 31, 2009. Revenues for the six months ended December 31, 2010 increased 2% to $8,860,669 as compared to $8,675,006 for the six months ended December 31, 2009. This increase is primarily due to growth in the both the equipment and prepaid segments.
COST OF REVENUES AND GROSS MARGIN
Gross margin decreased to $183,137 (4.1%) and $432,004 (4.9%) respectively in the three and six months ended December 31, 2010 from $423,254 and $768,126 in the three and six months ended December 31, 2009. This decrease was primarily due to a changing product mix during 2010 and the loss of higher margin destinations for the prepaid segment from the previous year.
OPERATING EXPENSES
Operating expenses decreased by 28% to $1,356,329 in the three month period ended December 31, 2010 versus $1,872,192 for the same period in the last fiscal year, and decreased 51% to $2,044,145 in the six month period ended December 31, 2010 versus $4,138,606 for the same period in the last fiscal year.
Operating expenses consist of general and administrative expenses, including payroll, accounting, legal, consulting, rent and other overhead costs. This category also includes stock compensation and option expense, the costs associated with being a publicly traded company, including the costs of SEC filings, a management fee payable to Flint, Ltd., investor relations and public relations.
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The reduction in operating costs was due to management’s focus on cost rationalization throughout 2010, after an increase in operating costs of $597,312 resulting from the acquisitions of III and P2P in October 2010.
The non-cash charges for compensation consist mainly of depreciation and amortization charges for fixed and intangible assets and the grants of stock issued as part of settlements for services rendered. The common stock issued was valued at its fair market value at the date of issuance and do not represent any cash payments.
INTEREST EXPENSE
The $1,074,034 and $2,655,783 for the three and six months ended December 31, 2010, respectively, in interest expense is related to accrued interest on the convertible and promissory notes, as well as the amortization of the debt discounts related and beneficial conversion features to those notes. The other component is exchange gains and losses from currency transactions in the Euro and U.S. dollar. The amount of interest charges related to accounting for debt discounts and beneficial conversion features that did not involve the payment of cash amounted to $1,519,674.
LIQUIDITY AND CAPITAL RESOURCES
Overall cash increased by $66,892 for the six months ended December 31, 2010.
The sources and uses of cash are summarized as follows (unaudited):
Six Months Ended
December 31,
2010
2009
Net cash used in operating activities
$
(589,215
)
$
(1,678,061
)
Net cash provided by (used in) investing activities
15,063
(133,532
)
Net cash provided by financing activities
597,723
751,034
Net cash used in foreign currency activities
43,321
10,807
Net increase (decrease) in cash and cash equivalents
$
66,892
$
(1,049,752
)
During the six months ended December 31, 2010, cash used in operating activities was $589,215 resulting from a gross profit of $432,004 and operating expenses of $2,044,145 . This included non cash charges for depreciation, stock and option compensation, amortization of beneficial conversion feature and accretion of debt discount of $306,879, $631,542, $867,445 and $652,229, respectively.
Other operating activities that increased cash were a reduction in Inventory of $17,972, an increase in the cash overdraft of $29,550, an increase in accounts payable of $703,810, an increase in other accrued liabilities of $199,200 and an increase in accrued interest of $1,152,348. Operating activities that decreased cash included an increase in accounts receivable of $834,575.
Cash provided by investing activities for the six months ended December 31, 2010 consisted of cash assumed on acquisition of $15,063.
Cash provided by financing activities for the six months ended December 31, 2010 consisted of the sale of short term promissory notes, which provided $602,000 in cash. Cash used in financing activities for the six month ended December 31, 2010 consisted of payments of $4,277 to lines of credit.
$43,321 of cash was provided in foreign currency transactions related to exchange gains on convertible notes payable during the six months ended December 31, 2010 and $10,807 was used in the six months ending December 31 2009.
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As of December 31, 2010, we had cash and cash equivalents of $86,311, an increase of $66,892 from the balance at June 30, 2010, which was $19,419. Our working capital deficit increased as of December 31, 2010 to ($14,741,401) as compared to a working capital deficit of ($10,630,231) at June 30, 2010 . We have not yet generated sufficient revenues to cover the costs of continued product and service development and support, sales and marketing efforts and general and administrative expenses
We are still largely dependent on financing in order to generate cash to maintain its operations.
On November 26, 2010 we signed an Equity Line of Credit Agreement with Kodiak Capital, as amended and restated on January 21, 2011. This agreement allows us to place up to $15 million worth of our common stock to Kodiak over two years, subject certain conditions, which will become available to us when a registration statement on Form S-1 is deemed effective by the SEC. This agreement will require Kodiak to sell shares in the market and in order to be successful requires the stock to be liquid and trading at levels that will generate enough value to allow the company to draw the full amount over the period. The agreement allows us to place shares with Kodiak based on a formula. The maximum amount of each Put is equal to, at Kodiak’s election, five hundred percent (500%) of the average daily volume (U.S. market only) of the Common Stock for the five (5) trading days prior to the applicable Put notice date, multiplied by the average of the five (5) daily closing bid prices immediately preceding the Put Date, or (B) five hundred thousand dollars ($500,000). This determines the maximum amount that we can draw per Put and is directly related to the trading activity of the stock.
If this formula was applied to the trading history of our stock over the previous calendar quarter and we elected to make two puts per month then we would have been able to place shares up the following Put amounts on Kodiak :
Date
5 Day Average Volume
500% of 5 Day Average
Average Closing Bid Price
Maximum Put Amount Available
Oct 15, 2010
11,551,055
57,755,273
$
0.0068
$
393,891
Oct 29, 2010
36,956,706
184,783,530
$
0.0054
$
500,000
Nov 12, 2010
27,519,420
137,597,101
$
0.0032
$
437,559
Nov 26, 2010
33,929,362
169,646,810
$
0.0024
$
403,759
Dec 15, 2010
15,030,872
75,154,359
$
0.0016
$
123,253
Dec 30, 2010
43,849,763
219,248,816
$
0.0015
$
337,643
The above table is based on historical performance and is intended purely to illustrate the amount of funds that we could have drawn from Kodiak had the Equity Finance Agreement been available during that period. Actual amounts sold to Kodiak are based on the lowest closing bid price of the shares in the 5 days following the Put that will determine the actual amount of shares issued to Kodiak with each Put. We are under no contractual obligation to exercise a Put and market conditions at the time will determine when management would take that option. Future performance cannot be guaranteed but on the basis that the share volumes continue in future periods in line with recent history we would have the ability to avail ourselves of the full $15 million available under the agreement. As of September 30, 2010, we do not have sufficient authorized shares available to raise the full $15 million under the Kodiak financing agreement. In order to facilitate the full draw we will have to either (i) increase our number of authorized shares or (ii) effectuate a reverse stock split that does not correspondingly decrease the total number of authorized shares. A special meeting of shareholders was held on August 10, 2010, and one of the items voted on and approved by the shareholders was a reverse split that did not correspondingly decrease the authorized shares.
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As of the date of the filing of this report, we have a total of approximately $2.9 million of loan principal that is past due from a total principal balance of approximately $6.7 million, representing 11 individual parties. Under the terms of the loan agreements the $6.7 million principal is payable. In addition, approximately $2.25 million of accumulated interest, preferred share dividends and related penalties is past due on these loans. We are in active discussions with these parties about the outstanding debt and rescheduling payments in the future based on the business progress during 2010 and the ability of the Company to meet the new arrangements from the Kodiak funding. They are waiting to finalize these terms once the Registration Statement is deemed effective and a structured funding environment is in place. Of the 11 parties, four have initiated legal proceedings, the remainder, including our secured lender, have not initiated legal proceedings. Of the four that have taken legal steps, we believe, based on discussions with them, that suitable payment terms will be agreed upon over the duration of the Kodiak funding. In addition to these loans, we have approximately $1.2 million of trade payables that are past due. Two parties have received summary judgments, as reported in our Form 10-K for the year ended June 30, 2010 and in this quarterly report, and we have been served with a pending action from another. Despite receiving these judgments, we have agreed to terms to pay down one of the larger amounts over two years. Management is confident the Company will be successful in satisfying these obligations prior to foreclosure or bankruptcy. However, there is no assurance that any additional capital will be raised.
FORWARD LOOKING STATEMENTS
Certain statements contained in this report may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements that are not historical in nature and which may be identified by the use of words like “expects,” “assumes,” “projects,” “anticipates,” “estimates,” “we believe,” “could be,” and other words of similar meaning, are forward-looking statements. These statements are based on management’s expectations and assumptions and are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, risks associated with the integration of businesses following an acquisition, concentration of revenue from one source, competitors with broader product lines and greater resources, emergence into new markets, the termination of any of the Company’s significant contracts or partnerships, the Company’s inability to maintain working capital requirements to fund future operations or the Company’s inability to attract and retain highly qualified management, technical and sales personnel, changes in laws regulating telecommunications providers, changes in laws affecting the telecommunications products and services we provide. We disclaim any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.