Balance sheet information is as follows:
| |
|
December
31, 2004 |
|
| |
|
Current |
|
Long-Term |
|
Total |
|
|
Gross
accounts receivable |
|
$ |
8,239,000 |
|
$ |
2,158,000 |
|
$ |
10,397,000 |
|
|
Allowance
for doubtful accounts |
|
|
(1,866,000 |
) |
|
(168,000 |
) |
|
(2,034,000 |
) |
|
Net |
|
$ |
6,373,000 |
|
$ |
1,990,000 |
|
$ |
8,363,000 |
|
| |
|
September
30, 2004 |
|
| |
|
Current |
|
Long-Term |
|
Total |
|
|
Gross
accounts receivable |
|
$ |
11,763,000 |
|
$ |
2,345,000 |
|
$ |
14,108,000 |
|
|
Allowance
for doubtful accounts |
|
|
(3,401,000 |
) |
|
(270,000 |
) |
|
(3,671,000 |
) |
|
Net |
|
$ |
8,362,000 |
|
$ |
2,075,000 |
|
$ |
10,437,000 |
|
|
Components
of allowance for doubtful accounts are as follows: |
|
| |
|
|
|
|
|
|
|
| |
|
December
31, 2004 |
|
|
|
September
30, 2004 |
|
|
Allowance
for dilution and fees on amounts due from billing
aggregators |
|
$ |
1,726,000 |
|
|
|
|
$ |
2,978,000 |
|
|
Allowance
for customer refunds |
|
|
308,000
|
|
|
|
|
|
638,000
|
|
|
Other
allowances |
|
|
-
|
|
|
|
|
|
55,000
|
|
| |
|
$ |
2,034,000 |
|
|
|
|
$ |
3,671,000 |
|
|
Property
and equipment consists of the following: |
|
|
|
|
|
| |
|
|
|
|
|
|
|
| |
|
December
31, 2004 |
|
|
|
September
30, 2004 |
|
|
Leasehold
improvements |
|
$ |
439,000 |
|
|
|
|
$ |
439,000 |
|
|
Furnishings
and fixtures |
|
|
298,000
|
|
|
|
|
|
298,000
|
|
|
Office
and computer equipment |
|
|
1,002,000
|
|
|
|
|
|
993,000
|
|
|
Total |
|
|
1,739,000
|
|
|
|
|
|
1,730,000
|
|
|
Less
accumulated depreciation |
|
|
(1,100,000 |
) |
|
|
|
|
(1,004,000 |
) |
|
Property
and equipment, net |
|
$ |
639,000 |
|
|
|
|
$ |
726,000 |
|
|
4. |
COMMITMENTS
AND CONTINGENCIES |
At
December 31, 2004, future minimum annual lease payments under operating lease
agreements for fiscal years ended September 30 are as follows:
YP
CORP. AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - Continued
|
Remainder
of Fiscal 2005 |
|
$ |
284,000 |
|
|
Fiscal
2006 |
|
|
326,000
|
|
|
Fiscal
2007 |
|
|
19,000
|
|
|
Fiscal
2008 |
|
|
-
|
|
|
Fiscal
2009 |
|
|
-
|
|
|
Thereafter |
|
|
-
|
|
|
Total |
|
$ |
629,000 |
|
Commitments
to Investment Banking Firm
On
October 8, 2004, pursuant to the terms of a Letter Agreement with Jefferies
& Company, Inc. the Company issued a total of 925,000 shares of common stock
to Jefferies. These shares were issued in lieu of cash fees for Jefferies’
investment banking services. These shares were not issued under the Company’s
2003 Stock Plan. Of the total shares issued to Jefferies, 100,000 shares were
issued without restrictions on transfer other than those imposed by Rule 144
under the Securities Act of 1933, as amended. The remaining 825,000 shares were
issued pursuant to a Restricted Stock Agreement. Accordingly, these shares
remain subject to restrictions on transfer and sale, which lapse in accordance
with a vesting schedule depending on the achievement of certain performance
goals.
In
accordance with the provisions of EITF Topic D-90, Grantor
Balance Sheet Presentation of Unvested, Forfeitable Equity Instruments Granted
to a Nonemployee, because
the Company has a right to receive future services in exchange for unvested,
forfeitable equity instruments, the 825,000 shares are treated as unissued for
accounting purposes until such time that the performance goals are achieved.
However, they are entitled to voting rights and payment of dividends when
declared and paid.
Commitments
to Stockholders
As part
of the December 2003 agreement between the Company and two of its largest
stockholders, Morris & Miller, Ltd. and Mathew & Markson, Ltd., the
Company terminated all prior obligations to make advances to these stockholders.
Accrued interest on outstanding balances are reflected in the Due from
Affiliates line item of the accompanying balance sheet.
As part
of this agreement, the Company agreed to pay recurring quarterly dividends of
not less than $0.01 per share to all of our common stockholders, subject to
applicable law and certain restrictions with respect to the Company’s liquidity.
The
quarterly dividend associated with the first quarter
of
fiscal 2005 was
declared and paid in January 2005 and, therefore, was not accounted for in the
three months ended December 31, 2004.
Termination
Agreements with Related Parties
Prior to
fiscal 2004, the
Company entered into Executive Consulting Agreements with four entities, each of
which was controlled by one of the Company’s four executive officers.
During
the fiscal year ended September 30, 2004, the Company terminated the Executive
Consulting Agreements with the entities controlled by its former CEO, former
Executive Vice President of Marketing, and former CFO. In the case of the former
CEO, the Company will pay Sunbelt Financial Concepts, Inc. $960,000 over two
years in lieu of the amounts due under the original contract, which called for
approximately $2.6 million in payments over three years. In the case of the
former Executive Vice President of Marketing, the Company will pay Advertising
Management & Consulting Services, Inc. $697,000 over two years in lieu of
the amounts due under the original contract, which called for approximately $1.9
million in payments over three years. In the case of the former CFO, the Company
will pay MAR & Associates, Inc. $120,000 over six months in lieu of the
amounts due under the original contract, which called for approximately $750,000
in payments over three years. With respect to these agreements, approximately
$1,360,000 of the settlement payments described above will be allocated to
non-compete agreements, as paid, based on values determined by an independent
third party valuation firm. The non-compete agreements extend for six years. The
balance of the payments will be expensed as incurred as two of the agreements
call for ongoing services to be provided over a two-year period. See Note
6.
YP
CORP. AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - Continued
During
the three months ended December 31, 2004, the Company terminated the remaining
Executive Consulting Agreement with Advance Internet Marketing, an entity
controlled by DeVal Johnson, a director and former Executive Vice President.
Under the terms of this termination agreement, the Company will pay $368,000
over an 18-month period of time. Approximately $281,000 of this amount will be
allocated to non-compete agreements, as paid. See Note 6.
|
5. |
NET
INCOME
(LOSS) PER SHARE |
Net
income (loss) 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 stockholders. As the Company incurred a
net loss before cumulative effect of accounting change for the three months
ended December 31, 2004, all dilutive securities have been excluded from the
calculation of net income per share as the effects are anti-dilutive. Warrants
to purchase 500,000 shares of common stock and 1,563,000 shares of restricted
stock were excluded from the calculation of net income per share
for the three months ended December 31, 2003 as the impact of those instruments
were anti-dilutive.
YP
CORP. AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -
Continued
The
following table
presents
the computation of basic and diluted income per share :
| |
|
Three
Months Ended December 31, |
|
| |
|
2004 |
|
2003 |
|
| |
|
|
|
|
|
|
Income
(loss) before cumulative effect of accounting change |
|
$ |
(51,000 |
) |
$ |
3,285,000 |
|
|
Less:
preferred stock dividends |
|
|
-
|
|
|
-
|
|
|
Income
(loss) applicable to common stock before cumulative effect of accounting
change |
|
|
(51,000 |
) |
|
3,285,000
|
|
|
Cumulative
effect of accounting change |
|
|
100,000
|
|
|
-
|
|
|
Net
income applicable to common stock |
|
$ |
49,000 |
|
$ |
3,285,000 |
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
Basic
weighted average common shares outstanding |
|
|
46,572,106
|
|
|
46,595,302
|
|
|
Add
incremental shares for: |
|
|
|
|
|
|
|
|
Unvested
restricted stock |
|
|
-
|
|
|
335
|
|
|
Series
E convertible preferred stock |
|
|
-
|
|
|
99,242
|
|
| |
|
|
|
|
|
|
|
|
Diluted
weighted average common shares outstanding |
|
|
46,572,106
|
|
|
46,694,879
|
|
| |
|
|
|
|
|
|
|
|
Net
income per share: |
|
|
|
|
|
|
|
|
Basic: |
|
|
|
|
|
|
|
|
Income
(loss) applicable to common stock before cumulative effect of accounting
change |
|
$ |
(0.00 |
) |
$ |
0.07 |
|
|
Cumulative
effect of accounting change |
|
$ |
0.00 |
|
$ |
- |
|
|
Net
income applicable to common stock |
|
$ |
0.00 |
|
$ |
0.07 |
|
| |
|
|
|
|
|
|
|
|
Diluted: |
|
|
|
|
|
|
|
|
Income
(loss) applicable to common stock before cumulative effect of accounting
change |
|
$ |
(0.00 |
) |
$ |
0.07 |
|
|
Cumulative
effect of accounting change |
|
$ |
0.00 |
|
$ |
- |
|
|
Net
income applicable to common stock |
|
$ |
0.00 |
|
$ |
0.07 |
|
| 6. |
RELATED
PARTY TRANSACTIONS |
During
the three months ended December 31, 2004, the Company entered into the related
party transactions with current and former board members, officers and
affiliated entities as described below.
Directors
& Officers
Cash paid
to directors as fees for service for the three months ended December 31, 2004
was $40,000. These amounts are included in the amounts discussed
below.
As
described in Note 4, the former
CEO, CFO, Executive Vice President and Corporate Secretary provided their
services and those of their respective staffs through separate entities
controlled by these individuals. All of
these contracts were terminated prior to December 31, 2004. The
following describes the compensation paid to these entities during
the three months ended December 31, 2004.
YP
CORP. AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - Continued
Sunbelt
Financial Concepts, Inc.
Sunbelt
Financial Concepts, Inc. provided the services of the Chairman and CEO and his
staff to the Company, as well as the strategic and overall planning and
operations management and administration for the Company. Sunbelt’s president
was the Company’s CEO and Chairman until May 28, 2004.
During
the three months ended December 31, 2004, the Company paid a total of
approximately $173,000 to Sunbelt. At December 31, 2004, approximately $603,000
remains payable under the termination agreement with Sunbelt.
Advertising
Management & Consulting Services, Inc.
Advertising
Management & Consulting Services, Inc., or AMCS, provided the Company with
the services of Executive Vice President and Director through its officers and
employees. AMCS’ president was Executive Vice President of Marketing and a
director of the Company until June 9, 2004.
During
the three months ended December 31, 2004, the Company paid a total of
approximately $142,000 to AMCS. At December 31, 2004, approximately $403,000
remains payable under the termination agreement with AMCS.
Advanced
Internet Marketing, Inc.
Advanced
Internet Marketing, Inc., or AIM, provided the Company with the services of a
subsidiary officer, Corporate Secretary and a Director through its officers and
employees. The Company outsourced the design and marketing of its website on the
World Wide Web to AIM.
During
the three months ended December 31, 2004, the Company paid a total of
approximately $67,000 to AIM. At December 31, 2004, approximately $303,000
remains payable under the termination agreement with AIM.
MAR
& Associates
The
compensation for services of the Company’s Chief Financial Officer was paid to
MAR & Associates (“MAR”). MAR’s president was our CFO until June 21, 2004.
During
the three months ended December 31, 2004, the Company paid a total of
approximately $61,000 to MAR. At December 31, 2004, approximately $20,000
remains payable under the termination agreement with MAR.
YP
CORP. AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - Continued
| 7. |
CONCENTRATION
OF CREDIT RISK |
The
Company maintains cash balances at banks in Arizona and Nevada. Accounts are
insured by the Federal Deposit Insurance Corporation up to $100,000. At December
31, 2004, the Company had bank balances exceeding those insured limits of
$5,938,000
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 net receivable
due from a single billing services provider at December 31, 2004 was $7,141,000,
net of an
allowance for doubtful accounts of $783,000. The net receivable from that
billing services provider at December 31, 2004, represents approximately 85% of
the Company’s total net accounts receivable at December 31, 2004.
|
8. |
RECENT
ACCOUNTING PRONOUNCEMENTS |
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123R, “Share-Based Payment” (“SFAS 123R”). Under this new standard, companies
will no longer be able to account for share-based compensation transactions
using the intrinsic method in accordance with APB 25. Instead, companies will be
required to account for such transactions using a fair-value method and to
recognize the expense over the service period. This new standard also changes
the way in which companies account for forfeitures of share-based compensation
instruments. SFAS 123R will be effective for periods beginning after June 15,
2005 and allows for several alternative transition methods. In light of this
upcoming change, the Company decided
to change its method of accounting for forfeitures of restricted
stock, under
current GAAP rules
effective October 1, 2004. See Note
2. The Company expects to adopt the provisions of SFAS 123R in the fourth
quarter of
fiscal 2005 on a
prospective basis and does not expect this to have a material effect on its
financial condition or results of operations.
|
ITEM
2. |
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS |
For a
description of our significant accounting policies and an understanding of the
significant factors that influenced our performance during the three months
ended December 31, 2004, this “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” should be read in conjunction with the
Consolidated Financial Statements, including the related notes, appearing in
Item 1 of this Quarterly Report, as well
as the Company’s Annual Report on Form 10-KSB for the year ended September 30,
2004.
Forward-Looking
Statements
This
portion of this Quarterly Report on Form 10-Q, 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 Quarterly Report include, but are
not limited to the Company’s (i)
assertion that there is an expectation of tremendous growth in online
advertising; (ii)
expectation that its adoption of the provisions of SFAS 123R in the fourth
quarter of fiscal 2005 on a prospective basis will not have a material effect on
its financial condition or results of operations; (iii) expectation that the
negative effects of the LEC policy changes will decline during the second half
of fiscal 2005; (iv) expectation that its net paying customer count will
increase; (v) expectation that its new direct mail campaigns will attract
additional paying customers in the second quarter of fiscal 2005; (vi)
expectation that its revenues and profitability will improve in the second
quarter of fiscal 2005 as compared to the first quarter of fiscal 2005; (vii)
expectation that near-term revenues may continue to decline; (viii) expectation
that cost of services will continue to decrease as the Company converts
additional customers from LEC billing to alternative means such as ACH billing;
(ix) expectation that the trend of decreased dilution will continue; (x)
expectation that sales and marketing costs will continue to increase as the
Company’s marketing efforts increase and as it continues to roll out its
branding campaign; and (xi) general anticipation that its current marketing and
billing efforts will result in an increase in paying customers during the second
quarter of fiscal 2005.
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 titled “Risk Factors,” as well as other factors that
we are currently unable to identify or quantify, but that 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
This
section presents summary information regarding our industry and operating trends
only. For further information regarding the events summarized herein, you should
read “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” in its entirety.
Industry
Overview
The
Kelsey Group has published the following market information regarding the growth
of the online and print Yellow Pages advertising revenue market. While print
advertising is expected to be largely flat in the next five years, the Kelsey
Group expects online advertising to experience tremendous growth, as evidenced
by an estimated 29% annual growth rate from 2003 to 2008.
|
Advertising
Revenue
(in
Billions) |
| |
2003 |
Market
Share |
2008 |
%
Growth Per Year |
Market
Share |
|
Print |
$15.0
|
97.0% |
$15.3 |
0.4% |
90.0% |
Online |
$
0.45 |
3.0% |
$
1.6 |
29.0% |
10.0% |
|
Total |
$15.45 |
100.0% |
$16.9 |
1.2% |
100.0% |
Source:
Kelsey Group, September 2004
Business
and Company Overview
We use a
business model similar to print Yellow Pages publishers. We publish basic
directory listings on the Internet free of charge. Our basic listings contain
the business name, address and telephone number for over 17 million U.S.
businesses. We strive to maintain a listing for almost every business in America
in this format.
We
generate revenues from advertisers that desire increased exposure for their
businesses. As described below, advertisers pay us monthly fees in the same
manner that advertisers pay additional fees to traditional print Yellow Pages
providers for enhanced advertisement font, location or display. The users of our
website are prospective customers for our advertisers, as well as the other
businesses for which we publish basic listings.
Our
primary product is our Internet Advertising Package™, or IAP. Under this
package, advertisers pay for additional exposure by purchasing a Mini-WebPage™.
In order to provide search traffic to our advertiser’s Mini-WebPage, we elevate
the advertiser to a preferred listing status, at no additional charge. We also
provide our IAP advertisers with enhanced presentation and additional unique
products, such as larger font, bolded business name, map directions, ease of
communication between our advertisers and users of our website, a link to the
advertiser’s webpage, as well as other benefits.
Recent
Developments
Historically,
we have been highly dependent on our ability to bill our IAP advertisers
directly through their monthly telephone bill. We refer to this method as LEC
billing. During
the fourth quarter of fiscal 2004, changes in LEC billing practices and an
increasing presence of Competitive Local Exchange Carriers, or CLECs, reduced
the effectiveness of the Local Exchange Carriers, or LECs, as an efficient and
cost-effective means of billing our customers.
Several
LECs changed their internal policies regarding the use of activation checks as
an acceptable letter of authorization that allows us to bill our products and
services directly on our advertisers’ local telephone bill. These LECs have
required additional confirmation procedures to allow new customers to be billed
and are requiring us to reconfirm our existing customer base before allowing
such customers to be billed. Additionally, CLECs have
been participating in providing local telephone services to IAP advertisers at
an increasing rate. We are not permitted to bill our IAP advertisers through
CLECs at the present time although we are exploring billing channels that would
provide for CLEC billing. If an advertiser changes their telephone carrier from
a LEC to a CLEC, we must change the advertiser’s billing
method to an alternative billing method.
To
address the LEC internal policy changes and the billing problems posed by CLECs,
we began accelerating our conversion of a substantial amount of our customers to
automated
clearing house, or ACH, billing
in the fourth quarter of fiscal 2004, and we continue to transition customers to
ACH billing. ACH billing is less expensive, has a faster collection time than
LEC billing and presents minimal dilution. However, it is time-consuming and
labor-intensive to convert customers from one billing channel to another and can
result in missed billings or customer cancellations. In situations where we
cannot bill a customer via LEC billing or ACH billing, or in instances where the
customer requests that we bill them directly, we utilize direct invoices. Direct
billing has a higher percentage of uncollectible accounts than other billing
methods and, therefore, is our least attractive billing option.
The
following represents the breakdown of net billings by channel during the first
quarter of fiscal 2005:
| |
Q1
2005 |
Q4
2004 |
|
LEC
billing |
49% |
67% |
|
ACH
billing |
42% |
30% |
|
Direct
billing |
9% |
3% |
Because
the announcement of the change in LEC billing practices came suddenly and
unexpectedly in the fourth quarter of 2004, we were not able to transition all
impacted customers to ACH billing in a timely fashion. Accordingly, we have not
been able to bill all of our customers for services performed during the fourth
quarter of fiscal 2004 and the first quarter of fiscal 2005. With respect to
certain customers, it is unlikely that this revenue will ever be effectively
billed and collected. We currently are in the process of determining an
effective means of billing these customers for future service and expect that
the negative effects of this change on future revenues will decline during the
second half of fiscal 2005.
As
further discussed in Results of Operations below, our paying customer base has
declined by 51.6% in the past quarter. While some of this decline is
attributable to permanent customer loss, a larger portion is attributable
to:
| |
· |
customers
that are not currently being billed due to the changes previously
described; |
| |
· |
customers
that are billed via direct bill methods but are not counted in our paying
customer base as they have not demonstrated a sufficient payment history
to be considered a paying customer. |
Looking
forward to the second quarter of fiscal 2005, although we continue to experience
some customer cancellations, we expect our net paying customer count to increase
as a result of the following:
| |
· |
We
have finalized agreements with an ACH billing service provider that
allowed us to bill approximately 32,000 customers effective January 2005
that are not included in our paying customer base at December 31, 2004;
|
| |
· |
Continued
collections on our direct bill activity will increase our paying customer
count; and |
| |
· |
We
have initiated new direct mail campaigns for which we expect to attract
additional paying customers in the second quarter of fiscal 2005.
|
For these
reasons, we expect our revenues and profitability to improve in the second
quarter of fiscal 2005 as compared to the first quarter of fiscal
2005.
Results
of Operations
Net
revenue decreased 55.3%, or $7,649,812, to $6,190,155 for the first quarter of
fiscal 2005 from $13,839,967 for the first fiscal quarter of 2004. The decrease
in revenues for the first quarter was due, largely, to declines in our paying
subscriber base, which is described in more detail below.
"We had
approximately 95,000 paying customers at December 31, 2004. This is down from
approximately 196K at September 30, 2004 and approximately 253,000 at December
31, 2003." Paying customers at September 30, 2003. This reduction in our
paying customer base is due primarily to the effects of CLECs and changes in
billing practices as previously described above in Recent Developments. Although
we experienced a decline in paying customers, we have over 100,000 additional
active customers that are excluded from our paying customer count. These
customers are excluded from our paying customer count primarily because they are
either (i) customers that are not currently being billed due to the changes
previously described or (ii) customers that are billed via direct bill methods
but are not counted in our paying customer base as they have not demonstrated a
sufficient payment history to be considered a paying customer. We anticipate
that current marketing and billing efforts will result in an increase in our
paying customer count during the second quarter of fiscal 2005.
Within
the last two years, the prices for our IAP product have fluctuated between
$17.95 and $29.95 per month. Currently, the majority of our customers are
charged $29.95 per month, though recently we dropped our price to $27.50 per
month.
We
continue to take active measures to reconfirm our existing subscriber base and
to convert customers from LEC billing to ACH billing. This is a time-consuming
project and has resulted in an increase in customer cancellations. However, we
believe we have appropriately addressed the problem and we expect to begin
seeing increased paying customer counts during our second fiscal quarter
..
Cost of
services decreased 76.8%, or $3,747,818, to $1,134,584 for the first quarter of
fiscal 2005 from $4,882,402 for the first quarter of fiscal 2004. As a
percentage of net revenue, our cost of services decreased to 18.3% in the first
quarter of fiscal 2005 from 35.3% in the first quarter of fiscal 2004. The
decrease in our cost of services is directly attributable to a decrease in our
dilution expense as a result of our decreasing usage of LEC billing. Billings
through LEC channels, which drives a substantial majority of our dilution
expense, decreased to 49% of total billings in the first quarter of fiscal 2005
from over 95% of total billings in the first quarter of fiscal 2004. A
significant portion of these customers were converted to ACH billing, which has
minimal dilution. We expect cost of services to continue to decrease as we
convert additional customers from LEC billing to alternative means such as ACH
billing.
Gross
profits decreased 43.6%, or $3,901,994, to $5,055,571 for the first quarter of
fiscal 2005 from $8,957,565 for the first quarter of fiscal 2004. The decrease
in our gross profits was due to decreased revenues resulting from the previously
mentioned decrease in paying IAP
advertisers, offset by decreased dilution discussed above. Gross margins
increased to 81.7% of net revenues in the first quarter of fiscal 2005 compared
to 64.7% of net revenues in the first quarter of fiscal 2004 due to decreased
dilution in fiscal 2005. As previously discussed, we expect that this
trend of
decreased dilution
will continue.
Our
general and administrative expense increased 22.5%, or $621,108, to $3,384,851
for the first quarter of fiscal 2005 from $2,763,743 for the first quarter of
fiscal 2004. General and administrative expenses increased due to an increase in
compensation expense of approximately $200,000, increased mailing and
customer-related expenses of approximately $250,000 and other miscellaneous
expense increases. Compensation expense increased due to an increase in
officers’ compensation relating to employment contracts with such officers and
termination agreements with former officers. Mailing and customer related
expenses increased as we incurred costs for ACH notices, paper invoices and
other customer mailings associated with the conversion of many of our customers
from LEC billing to alternate billing methods.
Our
general and administrative expenses consist primarily of fixed expenses such as
compensation, rent, utilities, etc.
Therefore, revenue declines caused our general and administrative expenses to
increase as a percentage of revenues to 54.7% for the first quarter of fiscal
2005 compared to 20.0% for the first quarter of fiscal 2004.
Sales and
marketing expenses increased 24.8%, or $320,313, to $1,610,493 for the first
quarter of fiscal 2005 from $1,290,180 for the first quarter of fiscal 2004. The
main reasons for the increase in sales and marketing expenses are due to the
increased effort in our marketing solicitation program, the implementation of
new market strategies, and modifications to our direct mail marketing pieces. We
expect these sales and marketing costs to continue to increase as our marketing
efforts increase and as we continue to implement our branding campaign. We
capitalize certain direct marketing expenses and amortize those costs over an
18-month period based on the estimated
IAP advertiser attrition rates. A substantial portion of the current period
expense relates to the amortization of costs previously incurred, thereby
creating a significant fixed component of this expense. Accordingly, revenue
declines caused our sales and marketing expenses to increase as a percentage of
revenues to 26.0% for the first quarter of fiscal 2005 compared to 9.3% for the
first quarter of fiscal 2004.
Depreciation
and amortization, consisting of depreciation of property and equipment and
amortization of intangible assets, increased 50.7%, or $99,494, to $295,687 for
the first quarter of fiscal 2005 from $196,193 for the first quarter of fiscal
2004. This increase is attributable to (i)
increased
depreciation due to additional purchases of equipment related to our upgrade in
infrastructure in the information technology department and hardware purchased
relating to our Quality Assurance and Outbound Marketing initiatives
and
(ii)
increased amortization of intangible assets associated with website development
costs that were capitalized during 2004. Amortization relating to the
capitalization of our direct mail marketing costs is included in marketing
expenses, as discussed previously.
We
recorded an operating loss
of $235,460
for the first quarter of fiscal 2005 compared
to operating income of
$4,707,449 for the first quarter of fiscal 2004. Operating margins decreased to
(3.8%) of net revenue in the first quarter of fiscal 2005 from 34.0% in the
first quarter of fiscal 2004. The decrease in operating income is the result of
the decreased revenue discussed above. Operating margins decreased due primarily
to the decrease in revenues and changes in expenses previously described.
Other
income decreased $188,393 to $86,365 for the first quarter of fiscal 2005 from
$274,758 for the first quarter of fiscal 2004 due to the termination of a
service agreement with Simple.Net, an entity owned by a former director of the
Company. Prior to the termination of this agreement on March 2, 2004, we
provided technical and customer service support to Simple.Net.
We
recorded a net loss
before taxes and cumulative effect of accounting change of $68,146
for the first quarter of 2005 as
compared with net income before taxes and cumulative effect of accounting change
of
$5,053,360 for the first quarter of fiscal 2004.
The
income tax benefit was $17,370 for the first quarter of fiscal 2005 compared to
an income tax provision of $1,768,675 in the first quarter of fiscal 2004,
resulting from our decrease in profitability.
During
the first fiscal quarter of 2005, we changed our method of accounting for
forfeitures of restricted stock awards to employees, officers and directors.
Prior to October 1, 2004, we recognized forfeitures as they occurred.
Upon
occurrence, we reversed the previously recognized expense associated with such
grant. Effective October 1,
2004 we
changed to an expense recognition method that is based on an estimate of the
number of shares for which the expected service is expected to be rendered. We
believe that this is a preferable method as it provides less volatility in
expense recognition. Additionally, while both methods of accounting for
forfeitures are acceptable under current guidance, the implementation of FAS
123R
(effective during the fourth
quarter of
fiscal 2005) will no
longer permit us to recognize forfeitures as they occur. This
change resulted in an increase to net income of $99,848, net of income taxes of
$53,764 during the first quarter of fiscal 2005.
Net
income decreased to $49,072, or $0.00 per diluted share, for the
first fiscal quarter of 2005, down from net
income of $3,284,685
or $0.07 per diluted share, for the
first fiscal quarter of 2004. Net income as a percentage of net revenues was
0.8% and 23.7% for the first fiscal quarters of 2005 and 2004,
respectively.
Liquidity
and Capital Resources
Net cash
provided by operating activities increased $1,721,360, or 199%, to $2,588,368
for the first quarter of fiscal 2005 compared to $867,008 for the first quarter
of fiscal 2004. The increase in cash generated from operations is primarily due
to a conversion of many of our customers from LEC billing to alternate billing
channels that have a shorter collection time and the fact we did not actively
market for new customer acquisition during the quarter as we worked to resolve
the previously discussed billing issues.
Our
primary source of cash inflows is net remittances from our billing channels,
including LEC billings and ACH billings. For LEC billings, we receive
collections on accounts receivable through the billing service aggregators under
contracts to administer this billing and collection process. The billing service
aggregators generally do not remit funds until they are collected. Generally,
cash is collected and remitted to us (net of dilution and other fees and
expenses) over a 60 to 120 day period subsequent to the billing dates.
Additionally, for each monthly billing cycle, the billing aggregators and LECs
withhold certain amounts, or “holdback reserves,” to cover potential future
dilution and bad debt expense. These holdback reserves lengthen our cash
conversion cycle as they are remitted to us over a 12 to 18-month period of
time. We classify these holdback reserves as current or long-term receivables on
our balance sheet, depending on when they are scheduled to be remitted to us.
For ACH billings, we generally receive the net proceeds through our billing
service processors within 15 days of submission.
Our most
significant cash outflows include payments for marketing expenses and general
operating expenses. Cash outflows for direct response advertising, our primary
marketing strategy, typically occur in advance of expense recognition as these
costs are capitalized and amortized over 18 months, the average estimated
retention period for new customers. General operating cash outflows consist of
payroll costs, income taxes, and general and administrative expenses that
typically occur within close proximity of expense recognition.
Net cash
used for investing activities totaled $8,732 for the first quarter of fiscal
2005 and consisted of minor purchases of equipment. During the first quarter of
fiscal 2004, cash used for investing activities was $2,089,698, of which the
primary component was advances to affiliates of $2,000,000.
The only
net cash flows from financing activities were payments of preferred stock
dividends of $481 and $0 for the first quarter of fiscal 2005 and 2004,
respectively.
We had
working capital of $13,523,308 as of December 31, 2004, compared to $12,484,833
as of September 30, 2004. Despite our near breakeven performance during the
first fiscal quarter of 2005, our operating expenses consist of a substantial
amount of noncash expenses, such as amortization of customer acquisition costs
and deferred stock compensation, which allows us to continue to grow our cash
and working capital.
In April
2004, we established a $1,000,000 credit facility with Merrill Lynch Business
Financial Services, Inc. This facility is for one year and is renewable. The
applicable interest rate on borrowings, if any, will be a variable rate of the
one-month LIBOR rate (as published in the Wall
Street Journal), plus
3%. The facility requires an annual line fee of $10,000 payable whether or not
we have drawn any funds on the line. Outstanding advances are secured by all of
our existing and acquired tangible and intangible assets located in the United
States. There was no balance outstanding at December 31, 2004.
The
credit facility requires us to maintain a "Leverage Ratio" (total liabilities to
tangible net worth) that does not exceed 1.5-to-1 and a "Fixed Charge Ratio"
(earnings before interest, taxes, depreciation, amortization and other non-cash
charges minus any internally financed capital expenditures divided by the sum of
debt service, rent under capital leases, income taxes and dividends) that is not
less that 1.5-to-1 as determined quarterly on a 12-month trailing basis. The
credit facility includes additional covenants governing permitted indebtedness,
liens, and protection of collateral. As of the period ended 12/31/04, we were in
compliance with the covenants and are able to fully draw on the credit
facility.
We owe
$115,868 to Mathew & Markson Ltd. on a note related to the original
acquisition of the “Yellow Page.net” URL. This note is technically past due. We
have not repaid the balance, however, as we have amounts owed to us from Mathew
& Markson in excess of the amount due. As we have no legal right of offset,
we have not netted this amount due with the amounts owed to us in our
consolidated balance sheet filed as part of this Quarterly Report. We currently
are negotiating the settlement of this balance.
In
connection with our termination of the loan obligations, we began paying a $0.01
per share dividend each quarter, subject to compliance with applicable laws, to
all common stockholders, including those who hold unvested restricted stock. The
quarterly dividend associated with the first fiscal quarter of 2005 was declared
and paid in January 2005 and, therefore, was not accounted for in the three
months ended December 31, 2004.
Although
our revenues have recently declined and we generated an operating loss for the
first quarter of fiscal 2005, we believe that our existing cash on hand will
provide us with sufficient liquidity to meet our operating needs for the next
twelve months.
Risk
Factors
An
investment in our common stock involves a substantial degree of risk. Before
making an investment decision, you should give careful consideration to the
following risk factors in addition to the other information contained in this
report. The following risk factors, however, may not reflect all of the risks
associated with our business or an investment in our common stock. Accordingly,
you should only consider investing in our common stock if you can afford to lose
your entire investment.
Risks
Related to Our Business
The
loss of our ability to bill IAP advertisers through Local Exchange Carriers on
the IAP advertisers’ telephone bills will adversely impact our results of
operations.
Our
business model historically has depended heavily upon our ability to bill
advertisers on their telephone bills through their respective Local Exchange
Carriers, or LECs. We have recently faced challenges and impediments to our
ability to bill certain advertisers in this manner. This has forced us to
convert these advertisers to alternative methods of billing, which has resulted
in dilution and decreased revenues. We continue, however, to rely on our ability
to use the LEC billing method for our other advertisers.
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. 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 also could obviate the need for and access to the
LECs. Finally, if the recent trend of certain LECs to change their policies
concerning an ability to use an incentive check as a letter of authorization and
to adopt more onerous reconfirmation requirements becomes more widespread, our
ability to use the LECs to bill our advertisers could be jeopardized altogether.
Our inability to use the LECs to bill our advertisers through their monthly
telephone bills would result in increased dilution and decreased revenues and
would have a material adverse impact on our financial condition and results of
operations.
We
may experience increased dilution and our revenue may decline over time due to
the involvement of the CLECs.
We have
experienced a decrease in revenue from the LECs from the effects of the
Competitive Local Exchange Carriers, or CLECs, that are providing local
telephone services to IAP advertisers. With the competition in the telephony
industry, many business customers are finding alternative telephony suppliers,
such as CLECs, that offer less expensive alternatives to the LECs. When the LECs
effectuate a price increase this causes a rush of LEC customers looking for an
alternative telephone company, which may be a CLEC. When our advertising
customers switch service providers from the LECs to a CLEC, we are precluded
from billing these customers on their monthly telephone bill and must instead
convert them to alternative billing methods such as ACH billing or direct
invoicing. This conversion process can be disruptive to our operations and
result in lost revenue. 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. We may experience future increases in dilution of
our customer base that we are able to bill on their monthly telephone bills,
which, in turn, may result in decreases in our revenue.
Failure
to achieve and maintain effective internal controls in accordance with Section
404 of the Sarbanes-Oxley Act could have a material adverse effect on our
business and stock price.
Pursuant
to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with our Annual
Report on Form 10-K for the fiscal year ending September 30, 2005, we will be
required to furnish a report by our management on our internal control over
financial reporting. The internal control report must contain (i) a statement of
management's responsibility for establishing and maintaining adequate internal
control over financial reporting, (ii) a statement identifying the framework
used by management to conduct the required evaluation of the effectiveness of
our internal control over financial reporting, (iii) management's assessment of
the effectiveness of our internal control over financial reporting as of the end
of our most recent fiscal year, including a statement as to whether or not
internal control over financial reporting is effective, and (iv) a statement
that the Company's independent auditors have issued an attestation report on
management's assessment of internal control over financial reporting.
In order
to achieve compliance with Section 404 of the Act within the prescribed period,
beginning in our next fiscal year, we will need to engage in a process to
document and evaluate our internal control over financial reporting, which will
be both costly and challenging. In this regard, management will need to dedicate
internal resources, engage outside consultants and adopt a detailed work plan to
(i) assess and document the adequacy of internal control over financial
reporting, (ii) take steps to improve control processes where appropriate, (iii)
validate through testing that controls are functioning as documented and (iv)
implement a continuous reporting and improvement process for internal control
over financial reporting. We can provide no assurance as to our, or our
independent auditors’, conclusions at September 30, 2005 with respect to the
effectiveness of our internal control over financial reporting under Section 404
of the Act. There is a risk that neither we nor our independent auditors will be
able to conclude at September 30, 2005 that our internal controls over financial
reporting are effective as required by Section 404 of the Act.
During
the course of our testing we may identify deficiencies which we may not be able
to remediate in time to meet the deadline imposed by the Sarbanes-Oxley Act for
compliance with the requirements of Section 404. In addition, if we fail to
achieve and maintain the adequacy of our internal controls, as such standards
are modified, supplemented or amended from time to time, we may not be able to
ensure that we can conclude on an ongoing basis that we have effective internal
controls over financial reporting in accordance with Section 404 of the
Sarbanes-Oxley Act. Moreover, effective internal controls, particularly those
related to revenue recognition, are necessary for us to produce reliable
financial reports and are important to helping prevent financial fraud. If we
cannot provide reliable financial reports or prevent fraud, our business and
operating results could be harmed, investors could lose confidence in our
reported financial information, and the trading price of our stock could drop
significantly.
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.
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 to 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
quarterly results of operations could fluctuate due to factors outside of our
control.
Our net
revenues 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:
| |
· |
fluctuating
demand for our services, which may depend on a number of factors
including |
| |
o |
changes
in economic conditions and our IAP advertisers’
profitability, |
| |
o |
varying
IAP advertiser response rates to our direct marketing
efforts, |
| |
o |
our
ability to complete direct mailing solicitations on a timely basis each
month, |
| |
o |
changes
in our direct marketing efforts, |
| |
o |
IAP
advertiser refunds or cancellations, and |
| |
o |
our
ability to continue to bill IAP advertisers on their monthly telephone
bills, ACH or credit card rather than through direct
invoicing; |
| |
· |
timing
of new service or product introductions and market acceptance of new or
enhanced versions of our services or products;
|
| |
· |
our
ability to develop and implement new services and technologies in a timely
fashion in order to meet market demand; |
| |
· |
price
competition or pricing changes by us or our
competitors; |
| |
· |
new
product offerings or other actions by our
competitors; |
| |
· |
month-to-month
variations in the billing and receipt of amounts from LECs, such that
billing and revenues may fall into the subsequent fiscal quarter;
|
| |
· |
the
ability of our check processing service providers to continue to process
and provide billing information regarding our solicitation
checks; |
| |
· |
the
amount and timing of expenditures for expansion of our operations,
including the hiring of new employees, capital expenditures, and related
costs; |
| |
· |
technical
difficulties or failures affecting our systems or the Internet in
general; |
| |
· |
a
decline in Internet traffic at our website; |
| |
· |
the
cost of acquiring, and the availability of, information for our database
of potential advertisers; and |
| |
· |
our
expenses are only partially based on our expectations regarding future
revenue and are largely fixed in nature, particularly in the short
term. |
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 check processing companies to provide us with advertiser
information at the point of sign-up for our Internet Advertising Package. 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 LECs relating to the LECs’ billing and collection of our monthly charges
from advertisers, as well as collecting from those advertisers on ACH billing.
We currently have agreements with two billing aggregators and two ACH service
providers. Any disruption in our billing aggregators’ ability to perform these
functions could adversely affect our financial condition and 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 with 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 its 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 as of September 30, 2004, 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:
| |
· |
the
pace of expansion of our operations; |
| |
· |
our
need to respond to competitive pressures;
and |
| |
· |
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 added a number of key managerial,
technical, and operations personnel and we may add additional key personnel in
the future. 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 our 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. 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. Our increasing dependence on ACH billing has
exposed us to greater scrutiny by the National Automated Clearing House
Association, or NACHA. 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
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; |
| |
· |
exposure
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
websites. 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 and 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 may 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
may 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 and fallen 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, as well as our Shareholder Rights
Plan, 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. |
We also
recently adopted a Shareholder Rights Plan, commonly referred to as a poison
pill. This Plan serves as a strong deterrent to any unsolicited or hostile
takeover attempts and, effectively, requires an interested acquirer to negotiate
with our board of directors.
These
provisions of Nevada law and our articles and bylaws, as well as our poison
pill, 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 customers 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 customer’s
accounts. The bid and offer quotation and compensation information must be
provided prior to effecting the transaction and must be contained on the
customer’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
3. |
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK |
As of
December 31, 2004, we did not participate in any market risk-sensitive commodity
instruments for which fair value disclosure would be required under Statement of
Financial Accounting Standards No. 107. We believe that we are not subject in
any material way to other forms of market risk, such as foreign currency
exchange risk or foreign customer purchases (of which there were none in the
first three months of fiscal 2005 or in any of 2004) or commodity price
risk.
|
ITEM
4. |
CONTROLS
AND PROCEDURES |
Disclosure
controls and procedures 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 Quarterly Report on Form
10-QSB, 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 Quarterly 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 the end of the period covered by this Form
10-QSB, 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 as of the end
of the period covered by this report. 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. During the period covered by this Form 10-QSB, there have not been
any changes in our internal control over financial reporting that have
materially affected, or that are reasonably likely to materially affect, our
internal control over financial reporting.
PART
II - OTHER INFORMATION
|
ITEM
1. |
LEGAL
PROCEEDINGS |
From time
to time, we are party to certain legal proceedings incidental to the conduct of
our business. We believe that the outcome of pending legal proceedings will not,
either individually or in the aggregate, have a material adverse effect on our
business, financial position, results of operations, cash flows or
liquidity.
|
ITEM
6. |
EXHIBITS
AND REPORTS ON FORM 8-K UPDATE |
| (a) |
The
following exhibits are either attached hereto or incorporated herein by
reference as indicated: |
|
Exhibit
Number |
|
Description |
| |
|
|
|
10.1 |
|
Termination
Agreement between the Registrant and Advanced Internet Marketing, Inc.
dated November 4, 2004 |
| |
|
|
|
10.2 |
|
Employment
Agreement between the Registrant and Penny Spaeth dated November 1,
2004 |
| |
|
|
|
10.3 |
|
Employment
Agreement between the Registrant and John Raven dated September 21,
2004 |
| |
|
|
|
18 |
|
Auditors’
Letter Regarding Change in Accounting Principles |
| |
|
|
|
31 |
|
Certifications
pursuant to SEC Release No. 33-8238, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 |
| |
|
|
|
32 |
|
Certifications
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 |
(b) The
Registrant filed the following Current Reports on Form 8-K during the
three-month period covered by this Quarterly Report:
| |
- |
On
November 9, 2004, the Company filed a Current Report on Form 8-K in
connection with the execution of a Termination Agreement with Advanced
Internet Marketing, Inc. and the termination of an Executive Consulting
Agreement with the same entity. |
| |
- |
On
November 12, 2004, the Company filed a Current Report on Form 8-K in
connection with the execution of an Employment Agreement with Penny Spaeth
for services as the Company’s Chief Operating
Officer. |
| |
- |
On
December 30, 2004, the Company filed a Current Report on Form 8-K
attaching a press release and reporting its results of operations for the
Company’s fiscal year ended September 30,
2004. |
SIGNATURES
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.
YP.CORP.
|
Dated:
February 10, 2005 |
/s/
W. Chris Broquist |
|
| |
W.
Chris Broquist |
|
| |
Chief
Financial Officer |
|
EXHIBIT
INDEX
Exhibit
Number |
|
Description |
| |
|
|
|
10.1 |
|
Termination
Agreement between the Registrant and Advanced Internet Marketing, Inc.
dated November 4, 2004 |
| |
|
|
|
10.2 |
|
Employment
Agreement between the Registrant and Penny Spaeth dated November 1,
2004 |
| |
|
|
|
10.3 |
|
Employment
Agreement between the Registrant and John Raven dated September 21,
2004 |
| |
|
|
|
18 |
|
Auditors’
Letter Regarding Change in Accounting Principles |
| |
|
|
|
31 |
|
Certifications
pursuant to SEC Release No. 33-8238, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 |
| |
|
|
|
32 |
|
Certifications
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 |