ITEM 6. MANAGEMENT´S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included elsewhere herein.
Forward Looking Statements
When used in this annual report on Form 10-KSB and in our other filings with the SEC, in our press releases and in oral statements made with the approval of one of our authorized executive officers, the words or phrases "will likely result", "plans", "will continue", "is anticipated", "estimated", "expect", "project" or "outlook" or similar expressions (including confirmations by one of our authorized executive officers of any such expressions made by a third party with respect to us) are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. We caution readers not to place undue reliance on any such statements, each of which speaks only as of the date made. Such statements are subject to certain risks and uncertainties, including but not limited to our history of losses, our limited operating history, our need for additional financing, rapid technological change, and an uncertain market, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the factors described below and in the Description of Business section of this annual report. We undertake no obligation to release publicly revisions we made to any forward-looking statements to reflect events or circumstances occurring after the date of such statements. All written and oral forward-looking statements made after the date of this annual report and/or attributable to us or persons acting on our behalf are expressly qualified in their entirety by this discussion.
Significant Accounting Estimates and Policies
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates including the allowance for doubtful accounts, the saleability and recoverability of inventory, income taxes and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We must make estimates of the collectability of accounts receivable. We analyze historical write-offs, changes in our internal credit policies and customer concentrations when evaluating the adequacy of our allowance for doubtful accounts. Differences may result in the amount and timing of expenses for any period if we make different judgments or use difference estimates.
Property and equipment are evaluated for impairment whenever indicators of impairment exist. Accounting standards require that if an impairment indicator is present, the Company must assess whether the carrying amount of the asset is unrecoverable by estimating the sum of the future cash flows expected to result form the asset, undiscounted and without interest charges. If the carrying amount is less than the recoverable amount, an impairment charge must be recognized, based on the fair value of the asset. Management assumed the Company was a going concern for purposes of evaluating the possible impairment of its property and equipment. Should the Company not be able to continue as a going concern, there may be significant impairment in the value of the Company´ s property and equipment.
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes. This process involves estimating our current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent that we establish a valuation allowance or increase this allowance in a period, we must include a tax provision or reduce our tax benefit in the statements of operations. We use our judgment to determine our provision or benefit for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We believe, based on a number of factors including historical operating losses, which we will not realize the future benefits of a significant portion of our net deferred tax assets and we have accordingly provided a full valuation allowance against our deferred tax assets. However, various factors may cause those assumptions to change in the near term.
We cannot predict what future laws and regulations might be passed that could have a material effect on our results of operations. We assess the impact of significant changes in laws and regulations on a regular basis and update the assumptions and estimates used to prepare our financial statements when we deem it necessary.
We have determined the significant principles by considering accounting policies that involve the most complex or subjective decisions or assessments. Our most significant accounting policies are those related to revenue recognition and accounting for stock-based compensation.
Revenue Recognition. Our revenue recognition policies are based on the requirements of SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements.
Revenue from sales of telecommunication services is generally recognized during the period when the services are rendered. Prepaid services which have not yet been rendered are reflected in deferred income until such time as the services are rendered.
Accounting for Stock-Based Compensation. We have elected to apply the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. In accordance with the provisions of SFAS 123, we apply Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees , and will use related interpretations in accounting for stock option plans. We account for stock issued to non-employees in accordance with the provisions of SFAS 123 and the Emerging Issues Task Force consensus in 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. Generally, under APB 25, if the option exercise price for a fixed award to an employee is equal to the fair value of the common stock at the date of the grant of the stock option, no compensation expense is recorded. Under SFAS 123 and EITF 96-18, the amount of compensation expense that is recorded is based on an option pricing model which incorporates such factors as the expected volatility of future movements in the price of the underlying stock, risk-free interest rates, the term of the options and any dividends expected to be paid. As a result, under SFAS 123 and EITF 96-18, we would generally expect to record a greater amount of compensation expense than under APB 25.
Segment Reporting. We have adopted SFAS No. 131, A Disclosures About Segments of an Enterprise and Related Information. SFAS 131 requires companies to disclose certain information about reportable segments. Based on the criteria within SFAS 131, we have determined that we currently have only one reportable segment, telecommunications systems and related services.
Overview
We derive our revenues primarily from the sale of our long-distance telecommunication services. Our revenues and operating results have depended, and will continue to depend, upon the continued adoption and use of our products and services by consumers and small businesses. The rate of adoption is influenced significantly over the longer term by government laws and mandates, performance and pricing of our products/services, relationships with the public and other factors.
Our revenues also may be impacted by other factors including the length of our sales cycle, the timing of sales orders, budget cycles of our customers, competition, the timing and introduction of new versions of our products, the loss of, or difficulties affecting, key personnel and distributors, changes in market dynamics or the timing of product development or market introductions. These factors have impacted our historical results to a greater extent than has seasonality. Combinations of these factors have historically influenced our growth rate and profitability significantly in one period compared to another, and is expected to continue to influence future periods, which may compromise our ability to make accurate forecasts.
Our three most significant customers each accounted for more than 10% of our revenues during the year ended September 30, 2005. These are: Telecor 26%, VIPS 15%, Carrefour 13%. Domestic sales in Spain accounted for 100% of our revenues in each of the last two years.
Telecommunication revenues decreased by $1,237,000 in 2005, or 20% from 2004 revenues though gross profit increased in 2005 by $301,000 or 24,6%.
Cost of goods sold consists primarily of the costs associated with carriers which supply the telecom services for the Company to resell. We rely on third parties to offer the majority of the services we have in our portfolio. Accordingly, a significant portion of our cost of goods sold consists of payments to these carriers. Cost of goods sold revenues also consists of customer support costs, training and professional services expenses, and parts.
Our gross profit has been and will continue to be affected by a variety of factors, including competition, the mix and average selling prices of products, maintenance and services, new versions of products, the cost of equipment, component shortages, and the mix of distribution channels through which our products are sold. Our gross profit will be adversely affected by price declines if we are unable to reduce costs on existing products or to introduce new versions of products with higher margins.
Selling, general and administrative expenses consist primarily of salaries and related expenses for executive, finance, accounting, legal and human resources personnel, professional fees and corporate expenses. We expect general and administrative expenses to increase in absolute dollars as we employ additional personnel and incur additional costs related to the growth of our business and our operation as a public company. We include stock-based compensation as a part of general and administrative expenses.
Stock-based compensation charges are recorded when the exercise price of an option or the sales price of stock is less than the fair value of the underlying Common Stock for awards to employees. We also record stock-based compensation charges when options are granted to non-employees. Compensation charges for non-employees are based on estimates of the underlying stock fair values. In addition the Company has issued Common Stock to consultants and professionals in exchange for services to the Company.
Year Ended September 30, 2005, Compared to September 30, 2004
The following table sets forth certain operating information regarding the
Company, including its subsidiary Teleconnect Comunicaciones, S.A.
Year Ended Year Ended
September 30, 2005 September 30, 2004
Revenues $ 4,930,000 $ 6,167,000
Cost of goods sold $ 3,406,000 $ 4,944,000
Selling, general and administrative $ 3,574,000 $ 4,127,000
Depreciation $ 444,000 $ 480,000
Bad Debt Expense (Recoveries) $ -- $ (227,000)
Other Income (Expenses) $ 511,000 $ (558,000)
Net Loss $ (3,005,000) $ (3,202,000)
Comprehensive (Loss) $ (3,044,000) $ (3,645,000)
Net Loss Per Share $ (0.04) $ (0.10)
Revenues. Revenues for the year ended September 30, 2005 decreased to $4,930,000, compared to $6,167,000 or 20% from the prior year revenues.
Our revenues during the year ended September 30, 2005, were derived primarily from providing a range of integrated telephone service solutions to our clients:
* Prepaid Calling Cards
* Prepaid fixed line long distance calling
* Other
Pricing Policies The pricing for our services differs depending on the services provided, the speed of service, geographic location and capacity utilization. In the case of services directed at foreign residents in Spain for them to call long distance, pricing is oriented to provide a significant discount compared to the incumbent operator. It is not the intention of the Company to enter A price wars @ with other similar companies. The Company strives to differentiate itself with the quality of our customer care, with the quality of the service, and the accuracy of the billing. For services directed at small and medium companies, we try to position ourselves to provide a turnkey solution to their telecommunications needs, providing voice local and long distance calling, access to the internet, email, web hosting, PBX supply and maintenance, etc. With our prepaid calling card services, we have sought tourists that needed to call home but at cheaper prices than the hotel phone or local public phone.
Client Contracts. Our contracts with customers generally include an agreed-upon price schedule that details both fixed and variable prices for contracted services. The client contracts generally have a term of one to three years, however, when clients implement a number of our services, they may choose to extend the contracts for a longer period of time. Our sales representatives can easily add additional services to existing contracts, enabling clients to increase the number of locations through which they access our network, increase the speed of that access, increase the sophistication of the services they use, or extend the term for existing services.
Cost of Goods Sold: Cost of goods sold for the year ended September 30, 2005 were $3,406,000, a decrease of $1,538,000 or 31.1% from the prior year cost of sales of $4,944,000. Cost of Goods sold as a percentage of sales was 69.1% in 2005 while it was 80.2% for the same period in 2004.
Gross profits increased during fiscal 2005 to $1,524,000 or 20% from $1,223,000 in fiscal 2004. The principal reasons for the increase were management´s conscious effort to renegotiate its carrier pricing. The gross profit margins were improved 10.9% from 19.8 to 30.9% even though the Company did not have the liquidity to do any promotion or marketing of its products.
Selling, General and Administrative. Selling, general and administrative expenses for the year ended September 30, 2005 were $3,574,000, a decrease of $553,000 or 19,5% from the prior year´s operating expenses of $4,127,000. The principal reasons for the decrease were management´s effort to reduce its fixed costs which included the move of the office to a much more economical and newer industrial park. Some reduction in staff had also taken place during the year. Though the actual reduction in selling, general and administrative expenses was significant, it was partially offset by the valuation of stock issued as compensation for services to external consultants and shareholders that provided financing.
SG&A for the period ending September 30, 2005 was 70.5% of revenue compared to 66.9% for the same period in 2004. If consideration is given to the fact that stock compensation for services in included in the SG&A, then reducing SG&A in 2005 by this amount of $744,000 associated with services, SG&A in 2005 becomes 57.4% of sales, a reduction of 9.5% from 2004 ratio of 66.9%
Depreciation Expense. Depreciation expense for the year ended September 30, 2005 was $444,000, an decrease of $36,000 or 1,25% from the prior year´s depreciation expense of $480,000. This small decrease is due primarily to the fact that some equipment became fully depreciated in 2004.
Bad Debt Expense (Recoveries). Bad debt expense (recoveries) for the year ended September 30, 2005 was $0 a decrease of $227,000 from the prior year´s bad debt expense of $(227,000).
Interest Expense. Interest expense for the year ended September 30, 2005 was $474,000- as compared to $558,000 for the prior year. This decrease was due primarily to less interest incurred on loans made from affiliated parties during fiscal 2005 to finance the operations since some conversion into stock had taken place.
Income from Discontinued Operations. During the year ended September 30, 2004, the Company entered into an agreement with a third party to sell its post paid long distance business. Dialers and other equipment with a net book value of 89,000 euro were transferred to the purchasers resulting in a gain of $513,000.
Net Loss. The net loss of the Company decreased to ($3,005,000) during the fiscal year ended September 30, 2005 compared to $(3,202,000) during the fiscal year ended September 30, 2004, a decrease of approximately 14%.
Liquidity and Capital Resources. At September 30, 2005, the Company had negative working capital of approximately $(6,643,000), compared to negative working capital of $(7,970,000), at September 30, 2004. Therefore the Company experienced an improvement of $1,327,000 or 16.6%.
The ability of the Company to satisfy its obligations and to continue as a going concern will depend in part upon its ability to raise funds through the sale of additional shares of its Common Stock, increasing borrowing, and in part upon its ability to reach a profitable level of operations. The Company´s financial statement so not reflect adjustments that might result from its inability to continue as a going concern and these adjustments could be material.
The Company s capital resources have been provided primarily by capital contributions from stockholders, stockholders´ loans, the conversion of outstanding debt into Common Stock of the Company, and services rendered in exchange for Common Stock.
Contractual Obligations and Commercial Commitments. The following table is a recap of the Company s contractual obligations as of September 30, 2005.
Payments Due by Period
Less than
Total One Year 1-3 Years
Tax Agency Debt $ 307,000 $ 147,000 $ 160,000
Note payable to bank 120,000 120,000 --
Operating Leases 158,000 92,000 66,000
------------ ------------ ------------
Total Contractual Cash Obligations $ 585,000 $ 359,000 $ 226,000
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Plan of Operations.
The Company expects that new funds will be injected into the Company during the three months ending March 31, 2006.
The Company will be offering to sell its Common Stock and other securities to further capitalize the Company, and will also borrow from banks and others to the extent necessary to provide liquidity for its operations.
The Company has maintained its telecommunications activities and the associated costs consistent with its plan of operations in order to develop its telephone and other communications services and products for proposed residential and commercial use. The Company expects to continue the development of its telephone and other communications products and services to incorporate technical changes and improvements. In addition, as the Company increases its marketing activities, the Company will incur additional operating and equipments costs.
Recent Accounting Pronouncements.
In November 2004, the FASB issued SFAS No 151, "Inventory Costs - an amendment of ARB No 43, Chapter 4. Statement No 151 requires that certain abnormal costs associated with manufacturing, freight and handling costs associated with inventory be charged to current operations in the period in which they are incurred. The adoption of SFAS 151 had no impact on the Company´s financial position, results of operations, or cash flows.
In December 2004, the FASB issued a revision of No. 123 "Share-based Payment". This statement establishes standards for the accounting of transactions in which an entity exchanges its equity investments for goods and services. It also addresses transactions in which an entity incurs liabilities in exchange for goods and services which are based on fair value of the entity´s equity instruments or that may be settled by the issuance of those equity instruments. The statement does not change the accounting guidance for share-based payments with parties other than employees.
The statement requires a public entity to measure the cost of employee service received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exception). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award (usually the vesting period). A public entity will initially measure the cost of employee services received in exchange for an award of liability instrument based on its current fair value: the fair value that award will be re-measured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation over that period.
The grant-date for fair value of employee share options and similar instruments will be estimated option pricing models adjusted for the unique characteristics of those instruments.
The statement is effective for the quarter beginning January 1, 2006.
In December 2004, the FASB issued SFAS No. 153 "Exchanges of Non-monetary Asset-amendment of APB Opinion No29", Statement 153 eliminates the exception to fair value for exchanges of similar productive assets and replaces it with a general exception for exchange transactions that do not have commercial substance., defined as transactions that are not expected to result in significant changes in cash flows of the reporting entity. This statement is effective for exchanges of non-monetary assets occurring after June 15th, 2005.
In May 2005, the FASB issued SAFS No 154, Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3. Statement 154 requires retrospective application to prior period´s financial statements of changes in accounting principle, unless it is impractical to determine either the period-specific effects of the cumulative effect of the change. The statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expect this statement to have a material effect on its reporting.