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Form 10-Q for EPIXTAR CORP
Friday, May 20, 2005
Quarterly Report
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
OVERVIEW
The following Management's Discussion and Analysis (MD&A) is intended to help the reader understand Epixtar. MD&A is provided as a supplement to, should be read in conjunction with and is qualified in its entirety by reference to, the Company's Consolidated Financial Statements and related Notes to Consolidated Financial Statements (Notes) appearing under Item 1 in this report. In addition, reference is made to the Company's audited Consolidated Financial Statements and related Notes thereto and related MD&A included in its Annual Report on Form 10-K for Fiscal 2004. Except for the historical information contained herein, the discussions in MD&A contain forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under "Forward-Looking Statements" and "Risk Factors that May Affect Future Results."
The following are the sections of MD&A contained in this report, together with the Company's perspective on the contents of these sections of MD&A, which it hopes will make reading these pages and understanding of the Company's operations more beneficial.
Recent Events - description of acquisition of IMS, Voxx new stock options plan and options granted, and financing obtained on April 29, 2005.
Operations Review - an analysis of the Company's consolidated results of operations and of the results in each of our two operating segments, to the extent the operating segment results are material to an understanding of the Company's business as a whole, for the periods presented in its Consolidated Financial Statements.
Liquidity and Capital Resources - an analysis of cash flows, capital structure and resources, off-balance sheet arrangements, commercial commitments and contractual obligations.
Discussion of Critical Accounting Policies and New Accounting Pronouncements - a discussion of accounting policies that require critical judgments and estimates, and of accounting pronouncements that have been issued but not yet implemented by the Company and their potential impact.
Forward-Looking Statements - cautionary information about forward-looking statements.
RECENT EVENTS
On January 3, 2005, the Company completed its purchase all of the outstanding common shares of Innovative Marketing Strategies, Inc. (IMS), a privately-held Florida corporation with six years experience providing business process outsourcing and contact center services to the financial services market. IMS customers include banks, credit card companies and mortgage companies. These services are delivered from four call center facilities located in U.S. and one facility located in the Philippines. Select operational functions are conducted from its network operations center (NOC) in North Carolina.
On April 20, 2005, the board of directors of Epixtar Corp. (the "Company") granted and conveyed an aggregate of 2,000,000 shares of Voxx Corporation common stock owned by the Company (the "Restricted Shares") to certain employees and consultants of the Company, each of which grants is evidenced by a Restricted Stock Agreement between the Company and the grantee. Voxx Corporation is a subsidiary of the Company.
The Restricted Period for the Restricted Shares commenced on the date of grant and will end on the date of any initial public offering of Voxx common stock. During the Restricted Period, the grantee may not sell, assign, transfer or encumber the Restricted Shares, the right to vote the Restricted Shares or the right to receive dividends on the Restricted Shares (collectively, the "Restrictions"), provided that the grantee shall have all other rights of a stockholder of Voxx which the Company previously had with respect to the shares, including, without limitation, the right to receive dividends on and the right to vote the shares. The Restricted Shares shall vest upon any initial public offering of Voxx common stock, at which time the Restrictions shall lapse with respect to such shares. The Restricted Stock Agreement provides that all rights to the Restricted Shares shall be forfeited to the Company without consideration in the event that an initial public offering of Voxx common stock does not occur prior to July 31, 2006.
Each grantee, as a condition of the grant, is required to elect, within 30 days of the date of grant, and upon written notice delivered to the Internal Revenue Service with a copy delivered to the Company, to recognize income for federal income tax purposes equal to the Fair Market Value of the shares as of the date the shares are transferred to the grantee, regardless of the Restrictions and the vesting schedule. If the grantee timely makes this required election and otherwise complies with the provisions of the Restricted Stock Agreement relating to such election, then on December 31, 2005, the Company will pay to each grantee, as an additional incentive payment, an amount equal to $0.30 per Restricted Share granted to such grantee. At the request of the Company, Voxx or any representative of the underwriters in connection with an initial public offering of Voxx common stock, each grantee shall be subject to a lock-up period in connection with such initial public offering with respect to the shares granted under the Restricted Stock Agreement, whether vested or still restricted.
On April 20, 2005, Voxx Corporation ("Voxx"), a wholly-owned subsidiary of Epixtar Corp., adopted the Voxx Corporation 2005 Stock Incentive Plan (the "Incentive Plan") which permits the granting of awards of non-statutory stock options, incentive stock options, stock appreciation rights, restricted stock and performance shares with respect to Voxx common stock. The Incentive Plan was approved by Epixtar Corp. (the "Company") as the sole stockholder of Voxx. Awards under the Incentive Plan may be granted or awarded to employees of Voxx or its Affiliates (including the Company), persons who are hired to be employees of Voxx or its Affiliates, non-employee directors of Voxx or any of its Affiliates, and consultants and independent contractors who render key services to Voxx or its Affiliates. The maximum number of shares of common stock of Voxx that may be issued under the Incentive Plan or pursuant to awards made under the plan is 2,375,000 shares, subject to adjustment in the event of a change in corporate capitalization of Voxx. The Incentive Plan will be administered by the Board of Directors of Voxx (the "Voxx Board") unless and until the Voxx Board delegates administration to a committee of members of the Voxx Board (such committee and the Voxx Board herein collectively referred to as the "Administrator").
On April 20, 2005, the Voxx Board granted options with respect to an aggregate of 2,000,000 shares of Voxx common stock to certain employees of Voxx and its affiliates pursuant to the Incentive Plan, which options are all designated as incentive stock options to the extent permitted. The Voxx Board also granted non-qualified stock options with respect to an aggregate of 375,000 shares of Voxx common stock to certain non-employee directors pursuant to the Incentive Plan. Voxx has entered into Stock Option Agreements, pursuant to the terms of the Incentive Plan, with each optionee.
The exercise price for each option that was granted is $3.00 per share. All of the granted options are exercisable immediately and will remain exercisable for a period of ten years unless the recipient's rights under the option agreement terminate earlier in accordance with the terms of the Stock Option Agreement or the terms of the Incentive Plan.
On April 29, 2005, the Company., and its majority-owned subsidiary, Voxx Corporation, entered into a financing facility with Laurus Master Fund, Ltd and affiliates of Laidlaw & Company (UK) Ltd., pursuant to which the Company and Voxx borrowed $7,000,000 represented by Senior Secured Convertible Notes (the Notes) that mature on April 29, 2008, bear interest at the rate of prime + 2% per year, and are payable beginning on October 29, 2005 at the monthly rate of $166,667 plus accrued but unpaid interest. Payments may, in certain circumstances, be made in shares of the Company and/or Voxx common stock. The Notes may be prepaid at any time at 130% of the then outstanding principal balance due at the time of prepayment.
The Notes are secured by all of the assets of Voxx Corporation and its subsidiaries, the Company's shareholdings in Voxx Corporation and significantly all of its other subsidiaries, by a pledge of the Company and Voxx's contract revenues from certain sources and by certain other assets of the Company and its subsidiaries. The Notes significantly restrict the ability of Epixtar, Voxx and their subsidiaries from borrowing additional monies without the consent of the lenders.
The Notes are convertible into the common stock of Epixtar at $1.00 per share and/or into the common stock of Voxx in the event Voxx conducts an initial public offering of its own securities at a 15% discount to the IPO price.
As additional consideration for the making of the loan, the lenders received options to purchase 31% or 4,167,028 shares of Voxx Corporation common stock computed on a fully diluted basis at the time of closing at a price of $.001 per share, warrants to purchase 556,596 shares of Voxx common stock at a price, generally, equal to the IPO price, and payments and reimbursements to the lenders and related parties of approximately $640,000. The options and warrants both provide the holder with anti-dilution protection in the event of stock splits, stock dividends and other extraordinary corporate events.
The remaining proceeds of the loan were used by the Company to repay $1,100,000 of outstanding debt with the balance reserved to continue the build out of Voxx Corporation's Philippine-based contact center facilities and for general corporate purposes.
As a condition of the making of this loan, the Company was also required to amend the terms of its existing $5,000,000 loan facility with Laurus to reprice to $1.00 per common share approximately 3,148,144 of previously issued warrants originally issued at prices ranging from $2.15 to $4.66 per share, including 1.9 million warrants issued for the Company's common stock on February 28, 2005 in connection with the Amendment and Waiver agreement of the facility, and to further secure the facility with certain additional contract revenues from the Company's ISP business.
The Notes provide that it is an "event of default" in the event of, among other things, non-payment, a breach of a covenant or any other agreement made by the borrowers in the note purchase agreements, the appointment of a receiver, an unsatisfied money judgment against one of the borrowers or any of their subsidiaries in excess of $150,000 for more than 30 days, a change in control of the Company or Voxx (other than in connection with a Voxx IPO), the institution of a government regulatory proceeding which prevents the borrowers from utilizing a substantial portion of their assets , or the occurrence of an "event of default" in certain other agreements to which the borrowers are parties. If an "event of default" should occur and continue beyond any applicable grace period, 110% of the then outstanding principal balance of the Notes plus accrued but unpaid interest becomes immediately due and payable.
The $7,000,000 loan is convertible into the Company's common stock at $1.00 per share or Voxx common stock at a price equal to 85% of the IPO price and included the issuance of options and warrants to acquire shares of the Company's principal subsidiary, Voxx Corporation, at $0.001 per share and the IPO price, respectively. All of these securities were issued and sold pursuant to Section 4(2) of the Securities Act of 1933, as amended, as securities sold by an issuer in a transaction "not involving any public offering." The transaction was privately negotiated with representatives of accredited investors with whom the Company had pre-existing business relationships only and did not involve any general solicitation or advertising.
As a result of the transaction described above, certain rights to acquire, or to convert certain debt obligations of Epixtar Corp. and Voxx Corporation into, shares of common stock of Epixtar Corp. and/or Voxx Corporation that were outstanding at the time of such transaction will be modified by (i) increasing the number of such shares which may be acquired upon the exercise of such rights or the conversion of such obligations and (ii) reducing the price of such shares at which such acquisition or conversion is effected.
The dilutive effect of the issuance of Epixtar Corp. equity securities and the re-pricing of certain previously issued securities, as per this agreement, could, if all of the debt was converted and all of the warrants were exercised, result in an increase in the Company's issued and outstanding common stock by 9,915,726, shares or an increase of 81.6% of the number of common shares outstanding as of May 1, 2005. This dilutive effect includes the effects from re-pricing other equity securities, but it excludes the potential dilutive effect on the Company's percentage ownership of its Voxx subsidiary as a result of equity securities held by the lender to purchase Voxx common stock.
OPERATIONS REVIEW
Highlights
Operations highlights for the first quarter of fiscal 2005 include:
Revenues increased 86.2% to $9,080,074 in the first quarter of fiscal 2005, from $4,876,148 in the first quarter of fiscal 2004.
Loss from continuing operations increased $4,746,332, to $5,605,887, in the first quarter of fiscal 2005, from $859,555 in the first quarter of fiscal 2004;
BPO segment achieved revenue growth of $5,792,294. The Company's new IMS acquisition contributed $5,156,998 to the increase. Operating income declined $3,855,732, compared to the first quarter of fiscal 2004 primarily as a result of the Company's expansion of its BPO operations in 2004 and continuing in 2005.
ISP segment revenue declined $1,588,368 as a result of its declining customer base. Operating income increased $448,194, or 33.9%, compared to the first quarter of fiscal 2004 primarily due to lower direct and administrative costs as the Company has suspended its marketing efforts.
Business Segments
The Company engages in two primary lines of business: business process outsourcing concentrating on contact center activities (BPO) and internet service provider services (ISP). Through 2003, the Company's revenues were primarily derived from its ISP business, which provides Internet services, including unlimited Internet access and email, to small business subscribers. As a result of the ISP's ongoing business interaction with the contact center industry, combined with extensive analysis of the contact center industry, management made the strategic decision to focus the Company's energies and resources in developing and operating offshore contact centers. BPO services complement the ISP business and consequently, the Company continues to maintain and service its ISP business customers while concentrating the Company's efforts in growing the business process outsourcing and contact center services business.
Business Processing Outsourcing and Contact Center Business
The Company began developing its contact center business in the latter part of 2003 and continued throughout 2004 and now has approximately 1,525 operational seats in the Philippines and the United States, including approximately 500 seats added through the Company's acquisition of IMS, supporting several major clients. The Company is actively marketing its contact center services and, depending on financing, will continue to build out infrastructure and hire additional personnel. See Recent Events, above for a description of financing obtained in April 2005.
Revenues from contact center operations are derived from telemarketing, tele-verification, and customer support services provided to clients based on individual business requirements. Depending on the contract under which services are provided, the company may earn revenues on a commission basis, a performance basis, an hourly basis, or a blend of the three.
Cost of generating revenue consists of direct payroll costs, recruitment and training of personnel and communication costs. On an ongoing basis, the most significant expense of the Company's contact center business will be labor costs for agents, supervisors and administrators as well as commissions paid to brokers, as well as rental expense for leased facilities.
ISP Business
While the Company is not presently marketing its ISP business, it is continuing to service its existing customer base. The Company's ISP operations consisted essentially of the marketing of value-added internet service provider services, primarily through third party facilities. The Company does not operate its own network but uses third parties to obtain access to the Internet for its clients. Prior to 2004 when the Company suspended its marketing efforts, the customer base kept growing as a direct result of the marketing efforts. ISP revenues are derived from monthly fees charged customers for value-added internet services.
Cost of generating revenue associated with ISP operations include the costs of maintaining the Company's customer base including customer care and telecommunication costs for Internet access. Because the Company is not marketing the ISP business, cost of revenue has and should continue to decline thereby increasing gross profit margins for this business. The ISP customer base now consists of seasoned customers and based on current attrition rates the Company believes it will continue to derive revenues on a declining basis for several years.
Current Trends
The trend of the Company's revenue and income over the next several quarters depends upon several variables, some of which cannot at this time be ascertained definitively. Revenue from ISP sources will decline as a result of suspended ISP marketing activity and a declining customer base. The Company will continue to incur losses as a result of development costs associated with contact center operations. In January 2005, the Company acquired IMS to increase its contact center penetration. BPO revenues and overall revenue should increase as a result of this acquisition; however, since IMS has been incurring losses, there is no assurance we will be able to operate this new subsidiary profitably. As a result of the IMS acquisition, and depending on obtaining additional new contracts and implementing existing ones, the Company believes revenue from its contact centers will increase, offsetting declining ISP revenues in the future. Because the Company has elected to proceed with the expansion of its contact center business, it will have a need for substantial capital during the next several quarters.
Results of Operations
The Company reported a net loss of $5,605,887, or $0.48 per basic and diluted common share, for the three months ended March 31, 2005, compared with a net loss of $859,555, or $0.08 per basic and diluted common share for the comparable period in 2004. The increase in the loss for the March 2005 quarter compared with the same period in 2004 was due to the Company's expansion during 2004 and 2005 into business process outsourcing and contact center services operations (BPO), including its acquisition of IMS in January 2005, a decline of approximately 21.6% in the gross profit of its internet service provider services operations (ISP) as a result of a declining customer base, and approximately $900,000 of expense associated with the valuation of 1.9 million warrants issued by the Company to a lender during the March 2005 quarter as consideration for the release of escrowed funds and the waiver of registration rights.
On a pro forma basis, assuming the acquisition of IMS had been in January 2004, the Company would have reported a net loss of $1,721,132, or $0.16 per basic and diluted common share, for the three months ended March 31, 2004. IMS' gross profit margin for the period was approximately $1,832,000, or 40%; however, high administrative expenses resulted in a loss from operations of approximately $400,000.
Set forth below are comparisons of financial results of operations for the three months ended March 31, 2005 and 2004. These comparisons are intended to aid in the discussion that follows. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and accompanying Notes, which appear in Item 1. Financial Statements, in this Quarterly Report on Form 10-Q.
See following page.
THREE MONTHS ENDED MARCH 31, 2005 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2004
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Variance
2005 - 2004 - $ - %
Revenue: $9,080,074 - $4,876,148 - $4,203,926 - 86.2%
Cost of revenue: $4,194,181 - $1,304,354 - $2,889,827 - 221.6%
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Gross profit: $4,885,893 - $3,571,794 - $1,314,099 - 36.8%
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Operating expenses (exclusive of depreciation, and
amortization of intangibles): $7,838,039 - $3,986,291 - $3,851,748 - 96.6%
Depreciation, and amortization of intangibles: $1,157,634 - $100,994 - $1,056,640 - 1046.2%
Other non operating expenses, net: $1,496,107 - $344,064 - $1,152,043 - 334.8%
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Net loss: $(5,605,887) - $(859,555) - $(4,746,332) - (552.2)
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Net loss per share $ (0.48) - ($0.08)
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Revenue for the first quarter of 2005 increased to $9,080,074 in 2005 from $4,876,148, or 86.2%. The Company's BPO operations contributed $5,792,294 to the increase, including $5,156,998 from its new IMS acquisition, partially offset by a decline of approximately $1,588,368 in revenue from ISP operations. Since the Company is focusing its resources solely on its contact center business and the Company and is no longer marketing its ISP services, there is no growth in the ISP customer base. The Company expects a gradual continued decline of revenues from its ISP operations offset by growth in its BPO business revenue.
Cost of revenue for the first quarter of 2005 increased to $4,194,181 in 2005 from $1,304,354 in 2004, or 221.6%. The increase in the cost or revenue is due primarily to a $3,650,698 increase in costs associated with BPO operations, including $3,672,604 from IMS, offset in part by reduced ISP costs of approximately $760,870. Cost of BPO production personnel contributed approximately $3,045,484 to the increase, as a result of the Company's expansion of its BPO business. The number of BPO production employees increased by approximately 1,260, to 1,325, from 65 at March 31, 2004. IMS accounted for an increase of 650 in the number of production employees.
Gross profit for the first quarter of 2005 was $4,885,893 compared with $3,571,794 in 2004, or an increase of 36.8%. BPO gross profit increased approximately $2,141,596, of which $1,484,394 was attributable to IMS. The gross profit margin for ISP decreased approximately $827,498 as a result of lower sales and fixed direct costs associated with the operations.
Operating expenses, exclusive of depreciation, and amortization of intangibles, were $7,838,039, or a 96.6% increase for the first quarter of 2005 compared with $3,986,291 in 2004. Compensation and employees benefits increased $1,771,559, to $3,426,329, or 107.1% for the first quarter of 2005, compared with $1,654,770, for the same period in 2004. This increase was primarily the result of an increase in the number of BPO sales, marketing and administrative employees, to 360 at March 31, 2005 from 60 in 2004. Occupancy, advertising and marketing, travel and professional fees were also higher during the first quarter of 2005. The increases in these costs are reflective of the Company's expansion of its BPO operations in the Philippines and its acquisition of three call centers in the U.S.
Depreciation and amortization expense for the first quarter of 2005 was $784,384 compared to $100,994 in 2004. This increase was due to depreciation of significant acquisitions of property and equipment related to the development of call centers in the Philippines in 2004 and 2005, and the acquisition of property and equipment on the IMS purchase.
Amortization of intangibles resulting from the valuation of IMS acquired assets and liabilities was $373,250 for the first quarter of 2005.
The increase in non-operating expenses, net, was due primarily to expenses associated with the issuance of equity and debt securities during the second half of 2004 and the first quarter of 2005. Amortization of debt discounts and costs associated with borrowings amounted to approximately $396,801 in 2005. Interest expense of $220,864 was recognized during the first quarter of 2005 compared to $219,804 in 2004. On February 28, 2005, the Company entered into an Amendment and Waiver agreement with a lender. As consideration for this agreement, the Company issued to the lender warrants to purchase 1,900,000 shares of the Company's common stock at an exercise price of $2.15 per share, exercisable at any time over a seven-year period. The fair value of these warrants were estimated to be approximately $1,060,065, or $0.56 per common share. This amount, net of $193,333 of previously accrued debt fees was recognized as expense during the March 2005 quarter.
Liquidity and Capital Resources
Historical Cause of Liquidity Issues
Prior to the FTC proceeding in October 2003, the Company expected it would continue to meet its obligations arising from its existing ISP business through cash flow from operations but would require additional financing to fund its entry to the business outsourcing process and contact center business. As a result of the FTC proceeding the Company was deprived of substantial cash because of the asset freeze and escrow imposed by the FTC, and incurred substantial expenses and interruption of services to customers, and therefore of revenue. As a consequence the Company was unable to pay all of its expenses in the normal course of business. The Company was therefore compelled to take several measures including the reduction of personnel, temporary reduction of executive salaries, and postponement of most activity relating to its start-up of its BPO operations. The Company's liquidity problems have continued particularly as it determined to proceed with its contact center business. This direction required increased capital expenditures and operating expenses in excess of cash flow. In 2004 the Company received additional financing which enabled it to proceed with the implementation of its BPO operations. The Company has continued to proceed with the implementation of its call center business, in the belief that financing would be available and commitments have been made based on that belief. Since some obligations became due ahead of financing receipts the Company has experienced significant cash flow problems. . . .
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Contact Info:
Brandi Piacente
Investor Relations
The Anne McBride Company, Inc.
212-983-1702 x208
Email: bpiacente@annemcbride.com
www.annemcbride.com
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