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Form 10QSB for PHANTOM FIBER CORP
Quarterly Report
MAY 16, 2006
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
Forward-Looking Statements
Certain matters discussed in this Quarterly Report may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and as such may involve risks and uncertainties. These forward-looking statements relate to, among other things, expectations of the business environment in which the Company operates, projections of future performance, perceived opportunities in the market and statements regarding the Company's goals. The Company's actual results, performance, or achievements expressed or implied in such forward-looking statements may differ.
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Current Business and Outlook
Phantom Fiber provides wireless technology products and services that allow users to experience internet-like graphics and internet-like speed in an end-to-end highly secure solution for multiple mobile platforms. The Company's customers include cellular network carriers such as Wind (Italy), Vodophone and Telus Mobility (Canada), and several online gaming, horse racing, fixed odd game providers and sports book service providers companies including Golden Palace, Real-Time Gaming, WagerWorks, Interactive Gaming and Wagering, Digital Gaming Solutions, Kiron Interactive, Bet Options, Tribeca Tables, Wager Works, Orbis , IQ-Ludorum, CaribSports, and Parlay Entertainment. In this most recent quarter we also signed GTS to expand our product offering into the Fixed Odds and soft gaming market. Similar to other agreements, this agreement is for 5 years and includes an ongoing revenue sharing model. The Company also has clients in the financial and mobile payments vertical (such as FireOne, Citadel, and Navaho Networks), logistics and distribution software providers, and the security and remote-monitoring industries.
Phantom Fiber's gaming and sports book customers typically enter into exclusive multi-year, revenue-sharing agreements, under which they use Phantom Fiber's technology to offer games, content or other services to their subscribers and are charged a monthly user fee or percentage of the revenues or income generated from those games.
In early 2006 we successfully completed a $3.5M convertible debt financing. These funds will go directly towards increasing our geographic reach and increasing the depth of our technical and sales teams. In the quarter we also successfully completed the registration of the underlying shares of common stock from this financing.
Our goal for this year is to begin deploying the backlog of sites we have amassed through our existing contracts and to work much closer with the site operators in assisting them in the marketing of a mobile product. Each client signed usually represents several operators or sites who license our partners or clients software. Therefore, each signed partnership agreement requires Phantom Fiber to deploy a number of sites which makes up the companies backlog. As we described in previous filings, we have now incorporated a number of functions that are directed towards the gaming industry. These functions includes affiliate tracking; multi-lingual and multi-currency support; enhanced bandwidth optimization; integrated refer-a-friend; online registration; a simplified single click install wizard; enhanced client tracking and interactive technical support. Our management believes this additional functionality further separates us from the competition. It is our goal for 2006 to exploit these key technical differentiators and secure a larger market share in the gaming sector. The Company has determined that by working closer with its client operators it can significantly influence adoption by end users. The Company's marketing team has been enhanced to support the existing and growing client base to serve these needs.
Management believes that ongoing success will stem from three areas: (1) contract fulfillment through client deployments; (2) direct involvement in the marketing and user adoption strategies of the operator; and (3) ongoing product development to expand the Company's product and service offerings and increase its competitive position. The Company intends to enhance its product offering by introducing new features and products as the market demands. As part of its product development process, the Company has worked closely with its customers and its distribution channels to ensure that such market needs are met.
The recent financing closed on January 9, 2006 was another major advancement enabling the Company to increase its staff and execute on its plans. These plans include expanding to London, England, the US and Costa Rica in the second quarter of 2006, enhancing product support and accelerating deployment of new products and client sites.
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Three markets management believes will dominate the Company's efforts in 2006 will be:
· the online gaming, horse racing and sports book sectors;
· the live video streaming and interactive mobile content sectors; and
· the payment processing sector allowing a seamless transition into a mobile wallet or mobile commerce market in subsequent years.
The Company's product development program and establishment of new long-term relationships, globally, is expected to expand the distribution channels for its product and service offerings and generate meaningful revenue streams. This remains key to Phantom Fiber's objective of increasing brand awareness and market share on a basis that enhances profitability and shareholder value.
Results of operations
In the first quarter of fiscal 2006 the operating loss, before other income and expenses, increased by $353,756 to $820,359 from $466,603 in the first quarter of 2005. After the net impact of other income and expenses the net loss for the quarter ended March 31, 2006 was $1,464,559 ($0.105 per share) compared to a net loss of $868,758 ($0.003 per share) for the same period in the preceding year, an increase of $595,801.
Revenue
Total revenue increased by $61,181 from $47,428 for the quarter ended March 31, 2005 to $108,609 for the quarter ended March 31, 2006, an increase of 129%. Professional services revenue increased by $57,162 from $22,986 in the first quarter of 2005 to $80,148 in the first quarter of fiscal 2006. This increase in revenue is due to the increase in usage of the product and the increase in the number of sites deployed into production.
User fees and royalties are based on number of users and are recognized monthly. User fees and royalties increased by $4,019 from $24,442 in the first quarter of 2005 to $28,461 in the first quarter of 2006. This increase in royalties is directly attributable to the increase in the number of operators or sites distributing our products along with the number of clients using the product.
Operating expenses
Total operating expenses increased $414,937 from $514,031 for the quarter ended March 31, 2005 to $928,968 for the quarter ended March 31, 2006, an increase of 81%. Operating expenses are grouped into Research and development ("R&D"), Sales and marketing and General and administrative. The change in each of these groupings is described below:
Research and development
|
2006 |
2005 |
Change |
% |
| Salaries and benefits |
$260,973 |
$ 250,349 |
$ 10,624 |
4 |
Other expenses 3,190 4,530 (1,340) (30) Less: Investment tax credits (21,650) -- 21,650 (45)
Total $242,513 $ 254,879 $ (12,366) (5)
The total R&D costs decreased by $12,366 to $242,513 in the first quarter of 2006 from $254,879 in the same period in the prior year. R&D salaries and benefits paid to develop the product and assist in implementation increased from $250,349 in 2005 to $260,973 in 2006 an increase of $10,624 (4%). The Company had 27 people in the first quarter of 2006 compared to 18 for the same period last year. This increase reflects the need for resources to continue to extend the capability of the product and to support the increased in product development activities and customer deployments. These increases were offset by the reallocation of 70% of the CEO's salary from R&D to Administrative reflecting a change in the role from overseeing development to broader management activities. The Company is eligible for tax credits offered by federal and provincial governments in Canada for spending on R&D. In the first quarter of 2006 the Company accrued investment tax credits of $21,650. There were no accruals made in the first quarter of the prior year.
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Sales and marketing
|
2006 |
2005 |
Change |
% |
| Salaries and benefits |
$43,375 |
$ 37,649 |
5,726 |
15 |
| Advertising and promotion |
3,118 |
7,212 |
(4,094) |
(57) |
| Public relations |
95,528 |
32,534 |
62,994 |
194 |
| Travel and entertainment |
16,136 |
2,551 |
13,583 |
532 |
| Total |
$158,157 |
$ 79,946 |
$ 78,209 |
98 |
Total sales and marketing expenses increased by $78,211 to $158,157 in the first quarter of fiscal 2006 from $79,946 in the previous year. Sales and marketing salaries and benefits increased by 15% from $37,649 in 2005 to $43,375 in 2006. The Company had two people in the sales and marketing department throughout the first quarter in 2006. In the same period last year two people left the Company leaving only one person for much of the quarter. Advertising and promotion spending declined in the first quarter of 2006 by $4,094 from $7,212 in the first quarter of fiscal 2005 to $3,118 this year. The Company is currently developing its marketing strategy that will determine how much advertising and promotion spending will take place in subsequent periods. The spending on public relations increased by $62,994 in the first quarter of 2006 from $32,534 last year to $95,528 in the current year. The Company signed an agreement with a high profile firm to assist in public relations and investor relations. This company received stock compensation with a fair value of $80,300 as a signing bonus. Travel and entertainment expenses increased from $2,551 in the first quarter of 2005 to $16,136 in the first quarter of the current year. The Company incurred these costs to travel to prospective customer sites, attend trade shows and entertain prospective clients. These costs had been curtailed in prior years due to keep costs down and preserve cash.
General and administrative expenses
|
2006 |
2005 |
Change |
% |
| Salaries and benefits |
$327,968 |
$ 26,416 |
301,552 |
11415 |
| Director's compensation |
25,006 |
-- |
25,006 |
-- |
| Professional and consulting fees |
91,478 |
103,789 |
(12,311) |
(12) |
| Investor relations and filing fees |
13,018 |
16,265 |
(3,247) |
(20) |
| Occupancy costs |
24,245 |
21,842 |
2,403 |
11 |
| Telephone |
2,926 |
3,041 |
(115) |
(4) |
| Equipment leasing |
481 |
-- |
481 |
-- |
| Insurance |
37,902 |
-- |
37,902 |
-- |
| Office and general |
1,870 |
4,536 |
(2,666) |
(59) |
| Amortization |
3,404 |
3,317 |
87 |
3 |
| Total |
$ 528,928 |
$ 179,206 |
$ 349,722 |
195 |
The Company's general and administrative expenses increased to $528,928 for the quarter ended March 31, 2006 from $179,206 for the same period last year an increase of $349,722. Administrative salaries and benefits increased by $301,552, due to a stock bonus paid to the CEO of $255,000 and an allocation of approximately $50,000 of the CEO's salary that had been recorded in R&D in prior periods. The Company accrued fees of $25,006 for its directors in the first quarter of 2006 which had not been accrued in the prior year. The occupancy costs increased by $2,403 from $21,842 in 2005 to $24,245 in 2006 due to increases in monthly rent. The professional and consulting fees declined by $12,311 to $91,478 in the first quarter of 2006 from $103,789 for the same period last year. Reductions in legal consulting fees were partially offset by an increase in audit fees. The Company is focusing on further reducing professional fees in future periods. The insurance expense increased by $37,902 in the first quarter of 2006 for directors and officer coverage the company acquired. The Company had not previously had this form of coverage.
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Other income and expenses
|
2006 |
2005 |
Change |
% |
| Loss on disposal of
marketable securities |
-- |
$(373,786) |
$373,786 |
100 |
| Loss on settlement of payables and debt |
(4,163) |
(12,578) |
(8,415) |
67 |
| Amortization of deferred |
(65,332) |
-- |
(65,332) |
-- |
| financing costs |
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| Interest expense |
(16,146) |
(21,871) |
5,725 |
26 |
| Interest expense - beneficial conversion feature |
(490,000) |
-- |
(490,000) |
-- |
Interest expense - amortization of discount
on senior convertible notes |
(70,664) |
-- |
(70,664) |
-- |
| Interest revenue |
1,427 |
5,729 |
4,302 |
(75) |
| Gain (loss) on foreign exchange |
678 |
351 |
327 |
93 |
| Total |
$(644,200) |
$ (402,155) |
($250,271) |
(62) |
During the first quarter of fiscal 2005, the Company recorded a loss on disposal of marketable securities that were sold to fund operations of $373,786. The Company did not sell any marketable securities in the first quarter of the current year. In the first quarter of 2006 the Company issued shares to pay for accounts payable that had a market value in excess of the outstanding balances. The excess value has been recorded as a loss on settlement. This loss was offset by a gain recognized on the settlement of an account for cash payment. The Company recorded deferred financing costs in connection with the senior convertible notes. These are being amortized over the term of the notes. Expense in the first quarter of 2006 was $65,332. The Company settled a short term loan in the first quarter of 2005 resulting in a loss on debt settlement of $12,578. The Company repaid a number of interest bearing obligations during fiscal 2005 as a result the interest expense in the first quarter of fiscal 2006 is lower than in the same period last year. The Company recorded an interest expense of $490,000 equal to the intrinsic value of the conversion feature of the senior convertible notes. The Company also recorded interest expense of $70,664 equal to the amortization of the discount on the senior convertible notes in the first quarter of 2006. The Company received interest revenue of $5,729 in the first quarter of fiscal 2005 from the Government of Canada on its investment tax credits receivable. In the first quarter of 2006 the Company received interest of $1,427 on surplus cash balances invested in interest bearing deposits.
Financial Condition
Total assets increased $2,154,827 from $719,859 as at December 31, 2005 to $2,874,686 as at March 31, 2006:
· Cash increased by 1,722,112 due to funds raised in the issuance of senior convertible notes.
· Marketable securities increased by $446 through unrealized gains from an increase in the market price of marketable securities held for sale.
· Investment tax credits increased by $21,279 from additional investment tax credits accrued in the quarter.
· Prepaid expenses increased by $32,099 from shares issued to a service provider for a one year service contract.
· Deferred financing costs increased by $364,888 comprised of legal fees of $58,942, corporate finance fees of $241,778 and warrants issued in connection with financing with a fair value of $129,500 less amortization of $65,332.
· Property, plant and equipment increased by $7,102 from additional computer equipment leased in the quarter.
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Total liabilities increased $556,353 from $2,124,704 at December 31, 2005 to $2,681,057 as at March 31, 2006. At March 31, 2006 accounts payable and accrued liabilities decreased by $435,769 to $703,722 at March 31, 2006 from $1,139,491 at the end of the fiscal 2005. The factors impacting this change include:
· a reduction in trade accounts payable of $13,746 from December 31, 2005 to March 31, 2006,
· the payment of a common stock bonus accrued to the CEO of $255,000 in 2005,
· an accrual for director's compensation of $24,740 in the first quarter of 2006,
· accrued interest of $12,379 in the first quarter of 2006,
· a decrease in the professional fee accrual of $76,804 at the end of March 31, 2006 as fees accrued at year end are paid down,
· a writedown of accounts payable of $27,790 from a negotiated settlement in the first quarter of 2006,
· a decrease in statutory liabilities for employee tax deductions and sales tax of $96,591 from December 31, 2005, and
· an increase of $12,043 in other miscellaneous accruals at March 31, 2006 compared to the prior year.
There was a balance of $51,963 in unearned revenue at the end of fiscal 2005 for funds received on professional services projects not completed at year end. This balance was taken into income in the first quarter of 2006. Short term borrowings increased by $57,016 from $45,171 at the end of fiscal 2005 to $102,187 at the end of the first quarter of fiscal 2006. The obligation under capital leases increased by $7,805 from $30,079 at the end of fiscal 2005 to $37,884 at the end of March 2006 as the Company leased additional computer equipment. The Company issued senior convertible notes totaling $3,500,000 in the first quarter of 2006. Securities subscriptions of $858,000 received during December, 2005 were rolled into this note issue. $The senior convertible notes have a fair value of $2,418,600. These notes have been discounted by $581,336 equal to the value received by the holders of the notes in excess of proceeds received by the Company.
Stockholders' deficiency of $1,404,845 at December 31, 2005 increased to shareholders equity of $193,629 at March 31, 2006. The increase is the result of:
1. Stock based compensation of $222,900;
2. Issuance of shares totaling $646,025;
3. An unrealized holding gain on marketable securities of $466;
4. Value of the beneficial conversion feature recorded as additional paid in capital $490,000
5. Fair value of warrants associated with the senior convertible debt recorded as additional paid in capital $1,733,400
offset by:
1. a net loss of $1,464,559; and
2. cumulative translation loss of $29,758.
The consolidated financial statements of the Company are prepared in conformity with United States generally accepted accounting principles, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Some of the significant estimates required to be made by management include the realizable value of intangible assets and the fair value of common stock and common stock equivalents issued for services or in settlement of obligations. Actual results could differ from those estimates.
Liquidity and Capital Resources
The Company improved from a negative working capital of $669,152 at December 31, 2005 to positive working capital of $1,538,716 at March 31, 2006 representing an improvement of $2,207,868. The improvement was primarily the result of funds raised in an issue of senior convertible notes of $2,642,000 and accounts payable of $305,973 paid with common stock. As of March 31, 2006, the Company had cash and cash equivalents of $1,991,552 compared with cash and cash equivalents of $269,410 at the end of the prior year.
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For the quarter ended March 31, 2006, cash used in operating activities totaled $679,877, primarily as a result of operating losses. This amounts compares to $111,379 used in operations in the first quarter of 2005. These losses were funded by an increase in financing activities of $2,401,929. The Company raised funds in an issuance of senior convertible notes of $2,642,000, an increase in short term borrowings of $57,016 and the issuance of shares of $6,394. These funds raised were partially offset by financing costs of $300,720 and lease payments of $2,701 during the quarter. In the first quarter of fiscal 2005 the Company generated $324,200 from the sale of marketable securities offset by repayments on short term borrowings of $162,703 and repayments of capital lease obligations of $5,197.
During the first fiscal quarter of 2006 the company completed a private placement of senior convertible notes and warrants for gross proceeds received during 2006 of $2,642,000. Based on current cash resources and other current assets, management believes the Company has sufficient liquidity to fund operations for the next twelve months.
Off-Balance Sheet Arrangements
The Company does not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, results of operations, liquidity or capital expenditures.
Critical Accounting Policies and Estimates
The discussion and analysis of results of operations and financial condition are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Management evaluates the estimates on an on-going basis, including those related to bad debts, inventories, investments, customer accounts, intangible assets, income taxes, and contingencies and litigation. Management bases its estimates on historical experience and on various other assumptions that they believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Note 2 of the "Notes to Consolidated Financial Statements" of the Company's annual audited Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of the consolidated financial statements. The following is a brief description of the more significant accounting policies and methods the Company uses.
Investments
The Company's investment in marketable securities is classified as available for sale securities. Unrealized holding gains and losses are reported as a net amount in a separate component of shareholders' equity until realized.
Revenue recognition
The Company recognizes software licensing revenues in accordance with all applicable accounting regulations, including the American Institute of Certified Public Accountants Statement of Position ("SOP") 97-2, "Software Revenue Recognition", SOP 98-9, "Modification of SOP 97-2 with respect to Certain Transactions" and Staff Accounting Bulletin ("SAB") 104.
Following the requirements of these accounting pronouncements, the Company recognizes license revenues when all of the following conditions are met:
· there is a signed license agreement with the customer;
· the software product has been delivered to the customer;
· the amount of the fees to be paid by the customer is fixed or determinable; and
· collection of these fees is probable.
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The Company generally negotiates formal license agreements with its customers. Each of the license agreements includes provisions for receipt of an up-front license fee and royalties. Generally, service providers pay these royalty fees either in the form of a one-time payment or as an on-going monthly fee. On-going royalties are recognized monthly based on the number of subscribers at month end. One-time royalties are recognized based on the number of new subscribers at the end of each period.
The Company may also negotiate license agreements that allow for the payment of the initial license fee to be made in future installments over a period of less than a year. Revenues recognized in advance of the installments being due are recorded as unbilled revenues in the balance sheet.
Maintenance and technical support revenues are recognized rateably over the applicable service period, which is usually one year. Revenues derived from professional services are recognized upon performance of the related services. Revenues derived from license agreements containing multiple deliverables, such as product licenses, maintenance and technical support and other services, are allocated among the various deliverables based on the fair value of each deliverable. Payments received from customers prior to the completion of services are recorded as unearned revenue.
Allowance for Doubtful Accounts
The Company records an allowance for doubtful accounts based on specifically identified amounts that management believes to be uncollectible. The criteria for allowance provision are determined based on historical experience and the Company's assessment of the general financial conditions affecting its customer base. If the Company's actual collections experience changes, revisions to the allowance may be required.
Intangible Assets
Long-lived assets, including intangible assets, are reviewed when facts and circumstances indicate that the carrying value of the asset may not be recoverable. When necessary, impaired assets are written down to estimated fair value based on the best information available. Fair value is determined by estimated future cash flows and appraised value of the assets.
Recent Accounting Pronouncements
In September 2005, the Financial Accounting Standards Board ("FASB") ratified the following consensus reached in EITF Issue 05-8 ("Income Tax Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature"):
· The issuance of convertible debt with a beneficial conversion feature results in a basis difference in applying FASB Statement of Financial Accounting Standards SFAS No. 109, Accounting for Income Taxes. Recognition of such a feature effectively creates a debt instrument and a separate equity instrument for book purposes, whereas the convertible debt is treated entirely as a debt instrument for income tax purposes.
· The resulting basis difference should be deemed a temporary difference because it will result in a taxable amount when the recorded amount of the liability is recovered or settled.?
· Recognition of deferred taxes for the temporary difference should be reported as an adjustment to additional paid-in capital.
For Investor Relations, please contact:
The Investor Relations Group - Jordan Silverstein
11 Stone St., 3rd fl, New York, NY 10004
(212) 825-3210
(212) 825-3229 (FAX)
jsilverstein@investorrelationsgroup.com
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