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FULLNET COMMUNICATIONS INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.
(Edgar Glimpses Via Acquire Media NewsEdge)
The following discussion should be read in conjunction with our Consolidated
Financial Statements and notes thereto included in Part II, Item 8 of this
Report. The results shown herein are not necessarily indicative of the results
to be expected in any future periods. This discussion contains forward-looking
statements based on current expectations that involve risks and uncertainties.
Actual results and the timing of events could differ materially from the
forward-looking statements as a result of a number of factors. For a discussion
of the factors that could cause actual results to differ materially from the
forward-looking statements, see "Item 1A. Risk Factors" and our other periodic
reports and documents filed with the Securities and Exchange Commission.
Overview
We are an integrated communications provider offering integrated communications
and Internet connectivity to individuals, businesses, organizations, educational
institutions and government agencies. Through our subsidiaries, we provide high
quality, reliable and scalable Internet access, Web hosting, equipment
co-location, and traditional telephone service.
Our overall strategy is to become a successful integrated communications
provider for residents and small to medium-sized businesses in Oklahoma. We
believe that the rural areas of Oklahoma are underserved by Internet service
providers, and that significant profitable growth can be achieved in serving
these markets by providing reliable Internet connectivity and value-added
services at a reasonable cost to the residents and businesses located in these
areas. We believe we can obtain a significant Internet service provider and
business-to-business market share in Oklahoma. Our wholly-owned subsidiary,
FullTel, is a licensed competitive local exchange carrier or CLEC and provides
local telephone numbers for Internet access.
The market for Internet connectivity and related services is extremely
competitive. We anticipate that competition will continue to intensify. The
tremendous growth and potential market size of the Internet access market has
attracted many new start-ups as well as existing businesses from a variety of
industries. We believe that a reliable network, knowledgeable sales people and
the quality of technical support currently are the primary competitive factors
in our targeted market and that price is usually secondary to these factors.
As a provider of telecommunications, we are affected by regulatory proceedings
in the ordinary course of our business at the state and federal levels. These
include proceedings before both the Federal Communications Commission and the
Oklahoma Corporation Commission ("OCC"). In addition, in our operations we rely
on obtaining many of our underlying telecommunications services and/or
facilities from incumbent local exchange carriers or other carriers pursuant to
interconnection or other agreements or arrangements. In January 2007, we
concluded a regulatory proceeding pursuant to the Federal Telecommunications Act
of 1996 before the OCC relating to the terms of our interconnection agreement
with Southwestern Bell Telephone, L.P. d/b/a AT&T, which succeeds a prior
interconnection agreement. The OCC approved this agreement in May 2007. This
agreement may be affected by regulatory proceedings at the federal and state
levels, with possible adverse impacts on us. We are unable to accurately
predict the outcomes of these regulatory proceedings at this time, but an
unfavorable outcome could have a material adverse effect on our business,
financial condition or results of operations.
Results of Operations
The following table sets forth certain statement of operations data as a
percentage of revenues for the years ended December 31, 2011 and 2010:
For the Years Ended December 31,
2011 2010
Percentage Percentage
Amount of revenues Amount of revenues
Revenues:
Access service revenues $ 233,895 12.5 % $ 287,773 17.0 %
Co-location and other revenues 1,639,979 87.5 1,400,172 83.0
Total revenues 1,873,874 100.0 1,687,945 100.0
Operating costs and expenses:
Cost of access service revenues 172,938 9.2 183,435 10.9
Cost of co-location and other
revenues 365,926 19.5 389,576 23.1
Selling, general and administrative
expenses 1,228,533 65.6 1,381,572 81.8
Depreciation and amortization 54,267 2.9 62,317 3.7
Total operating costs and expenses 1,821,664 97.2 2,016,900 119.5
Income (loss) from operations 52,210 2.8 (328,955 ) (19.5 )
Other income 37,268 2.0 1,198,510 71.0
Interest expense (24,148 ) (1.3 ) (81,675 ) (4.8 )
Income before income taxes 65,330 3.5 787,880 46.7
Income tax expense - - - -
Net income $ 65,330 3.5 % $ 787,880 46.7 %
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Revenues
Access service revenues decreased $53,878 or 18.7% to $233,895 for the year 2011
from $287,773 for the year 2010 primarily due to a decline in the number of
customers.
Co-location and other revenues increased $239,807 or 17.1% to $1,639,979 for the
year 2011 from $1,400,172 for the year 2010. This increase was primarily
attributable to the net addition of new customers and the sale of additional
services to existing customers.
Operating Costs and Expenses
Cost of access service revenues decreased $10,497 or 5.7% to $172,938 for the
year 2011 from $183,435 for the year 2010. This decrease was primarily due to
reductions in recurring costs associated with our network. Cost of access
service revenues as a percentage of access service revenues increased to 73.9%
for the year 2011 from 63.7% for the year 2010.
Cost of co-location and other revenues decreased $23,650 or 6.1% to $365,926 for
the year 2011 from $389,576 for the year This decrease was primarily related to
a non-recurring cost in the 2010 Period of $14,011 in addition to reductions in
equipment maintenance costs of $20,699 and costs of servicing our traditional
phone service customers of $3,024 due to a reduction in the number of customers
utilizing that service. These decreases were primarily offset by an increase in
recurring rental costs of $13,885 and an increase in usage of long distance by
our traditional phone service customers of $7,027. Cost of co-location and
other revenues as a percentage of co-location and other revenues decreased to
22.3% for the year 2011 from 27.8% for the year 2010.
Selling, general and administrative expenses decreased $153,039 or 11.1% to
$1,228,533 for the year 2011 from $1,381,572 for the year 2010. This decrease
was primarily related to a voluntary reduction in compensation and the
associated payroll tax expense for the top five executive officers in the amount
of approximately $16,787 per month, effective January 1, 2011 resulting in a
reduction of $201,444 for the 2011 Period compared to the 2010 Period. There
were also decreases in professional services, supplies and agent commission
expenses of $14,948, $3,857 and $2,542, respectively. These decreases were
offset primarily by increases in rent, employee costs, advertising, repair and
maintenance, miscellaneous, taxes, bad debt and utilities expenses of $10,003,
$36,085, $10,461, $2,842, $3,159, $2,982, $2,018, and $2,005, respectively. The
increase in employee costs of $36,085 was primarily related to the hiring of an
additional employee in 2011. Selling, general and administrative expenses as a
percentage of total revenues decreased to 65.6% for the year 2011 from 81.8% for
the year 2010.
Depreciation and amortization expense decreased $8,050 or 12.9% to $54,267 for
the year 2011 from $62,317 for the year 2010 primarily related to several assets
reaching full depreciation.
Other Income
The year 2011 includes $37,268, representing certain excess telecommunication
taxes and fees for which we have filed refund requests with the appropriate
state agencies.
During the fourth quarter of 2010, management reviewed all of our outstanding
liabilities to determine their enforceability and collectability in light of the
applicable statute of limitations. Based upon this review, management concluded
that by operation of law $1,198,510 of our outstanding liabilities were no
longer collectable and should be written-off. These uncollectable liabilities
consisting of $455,636 notes payable, $520,581 accrued interest, $164,697
accounts payable and $57,596 common stock issuable were written-off during the
fourth quarter to other income.
Interest Expense
Interest expense decreased $57,527 or 70.4% to $24,148 for the year 2011 from
$81,675 for the year 2010 primarily related to a decrease in notes payable.
Liquidity and Capital Resources
As of December 31, 2011, we had $10,987 in cash and $1,906,132 in current
liabilities, including $173,954 of deferred revenues that will not require
settlement in cash.
At December 31, 2011, we had a working capital deficit of $1,801,314, while at
December 31, 2010 we had a deficit working capital of $1,616,442. We do not have
a line of credit or credit facility to serve as an additional source of
liquidity. Historically we have relied on shareholder loans as an additional
source of funds.
At December 31, 2011, of the $138,758 we owed to our trade creditors $36,090 was
past due. We have no formal agreements regarding payment of these amounts. At
December 31, 2011, $256,443 payable under a matured lease obligation was
outstanding. The lessor has not made any formal demands for payment or
instituted collection action; however we are in discussions with the lessor to
restructure this liability. At December 31, 2011, we had outstanding principal
and interest owed on a matured convertible promissory note totaling $56,733. We
have been making quarterly interest payments on this note and the lender has not
made any demands for payment of the principal amount of this note. At December
30, 2011 a secured promissory note matured. We have been making monthly
principal and interest payments on this note and the lender has not made any
demands for payment of the outstanding principal balance of this note. At
December 31, 2011 the outstanding principal and interest owed on this secured
promissory note was $273,796.
In addition, during the years ended December 31, 2011 and 2010, we had one
customer that comprised approximately 17% and 14% of total revenues,
respectively.
During the fourth quarter of 2010, management reviewed all of our outstanding
liabilities to determine their enforceability and collectability in light of the
applicable statute of limitations. Based upon this review, management concluded
that by operation of law $1,198,510 of our outstanding liabilities were no
longer collectable and should be written-off. These uncollectable liabilities
consisting of $455,636 notes payable, $520,581 accrued interest, $164,697
accounts payable and $57,596 common stock issuable were written-off during the
fourth quarter to other income.
Cash flow for the years ending December 31, 2011 and 2010 consist of the
following:
For the Years Ended December 31,
2011 2010Net cash flows provided by operations $ 61,751 $
25,429
Net cash flows used in investing activities (46,967 ) (26,478 )
Net cash flows used in financing activities (14,653 ) -
Cash used for the purchases of equipment was $36,911 and $26,478, respectively,
for the years ended December 31, 2011 and 2010. Cash used for the acquisition
of a business was $10,056 for the year ended December 31, 2011.
Cash used for principal payments on notes payable was $23,109 for the year ended
December 31, 2011. Cash provided by the exercise of stock options was $8,456
for the year ended December 31, 2011.
The planned expansion of our business will require significant capital to fund
capital expenditures, working capital needs, and debt service. Our principal
capital expenditure requirements will include:
· mergers and acquisitions and
· further development of operations support systems and other automated back
office systems.
Because our cost of developing new networks and services, funding other
strategic initiatives, and operating our business depend on a variety of factors
(including, among other things, the number of subscribers and the service for
which they subscribe, the nature and penetration of services that may be offered
by us, regulatory changes, and actions taken by competitors in response to our
strategic initiatives), it is almost certain that actual costs and revenues will
materially vary from expected amounts and these variations are likely to
increase our future capital requirements. Our current cash balances will not be
sufficient to fund our current business operations beyond a few months. As a
consequence, we are currently focusing on revenue enhancement and cost cutting
opportunities as well as working to sell non-core assets and to extend vendor
payment terms. We continue to seek additional convertible debt or equity
financing as well as the placement of a credit facility to fund our liquidity
needs. There is no assurance that we will be able to obtain additional capital
on satisfactory terms or at all or on terms that will not dilute our
shareholders' interests.
Until we obtain sufficient additional capital, the further development of our
network will be delayed or we will be required to take other actions. Our
inability to obtain additional capital resources has had and will continue to
have a material adverse effect on our business, operating results and financial
condition.
Our ability to fund the capital expenditures and other costs contemplated by our
business plan and to make scheduled payments with respect to borrowings will
depend upon, among other things, our ability to seek and obtain additional
financing in the near term. Capital will be needed in order to implement our
business plan, deploy our network, expand our operations and obtain and retain a
significant number of customers in our target markets. Each of these factors is,
to a large extent, subject to economic, financial, competitive, political,
regulatory, and other factors, many of which are beyond our control.
There is no assurance that we will be successful in developing and maintaining a
level of cash flows from operations sufficient to permit payment of our
outstanding indebtedness. If we are unable to generate sufficient cash flows
from operations to service our indebtedness, we will be required to modify or
abandon our growth plans, limit our capital expenditures, restructure or
refinance our indebtedness or seek additional capital or liquidate our assets.
There is no assurance that (i) any of these strategies could be effectuated on
satisfactory terms, if at all, or on a timely basis or (ii) any of these
strategies will yield sufficient proceeds to service our debt or otherwise
adequately fund operations.
As of December 31, 2011, our material contractual obligations and commitments
were:
Payments Due By Period
Less than 1 1 - 3 3 - 5 More than 5
Total Year Years Years YearsLong-term debt (a) $ 328,078 $ 328,078 $ - $ - $ -
Interest on fixed rate
debt (a) 2,451 2,451 - - -
Operating leases 587,070 189,167 397,903 - -
Other agreements (b) 256,443 256,443 - - -
Total contractual cash
obligations $ 1,174,042 $ 776,139 $ 397,903 $ - $ -
-----------
(a) Included in this item is payment under a $273,078 secured promissory note
payable that matured on December 30, 2011. Also included is payment under a
convertible promissory note of $55,000 that was matured at December 31,
2011. These notes are included in the Less than One Year total. We continue
to make monthly principal and interest payments on the secured promissory
note. The lender has not made any demands for payment of the outstanding
principal balance of this note. We have been making quarterly interest
payments on the convertible promissory note. We have not negotiated an
extension of the convertible promissory note and the lender has not made any
demands for payment of the principal amount of this note.
(b) This item represents a matured lease obligation. The lessor has not made any
formal demands for payment or instituted collection action; however we are in
discussions with the lessor to restructure this liability.
Critical Accounting Policies and Estimates
The preparation of our financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect certain reported amounts and
disclosures. In applying these accounting principles, we must often make
individual estimates and assumptions regarding expected outcomes or
uncertainties. As might be expected, the actual results or outcomes are
generally different than the estimated or assumed amounts. These differences are
usually minor and are included in our consolidated financial statements as soon
as they are known. Our estimates, judgments and assumptions are continually
evaluated based on available information and experience. Because of the use of
estimates inherent in the financial reporting process, actual results could
differ from those estimates.
We periodically review the carrying value of our intangible assets when events
and circumstances warrant such a review. One of the methods used for this review
is performed using estimates of future cash flows. If the carrying value of our
intangible assets is considered impaired, an impairment charge is recorded for
the amount by which the carrying value of the intangible assets exceeds its fair
value. We believe that the estimates of future cash flows and fair value are
reasonable. Changes in estimates of these cash flows and fair value, however,
could affect the calculation and result in additional impairment charges in
future periods.
We periodically review the carrying value of our property and equipment whenever
business conditions or events indicate that those assets may be impaired. If the
estimated future undiscounted cash flows to be generated by the property and
equipment are less than the carrying value of the assets, the assets are written
down to fair market value and a charge is recorded to current
operations. Significant and unanticipated changes in circumstances, including
significant adverse changes in business climate, adverse actions by regulators,
unanticipated competition, loss of key customers and/or changes in technology or
markets, could require a provision for impairment in a future period.
We review loss contingencies and evaluate the events and circumstances related
to these contingencies. We disclose material loss contingencies that are
possible or probable, but cannot be estimated. For loss contingencies that are
both estimable and probable the loss contingency is accrued and expense is
recognized in the financial statements.
Access service revenues are recognized on a monthly basis over the life of each
contract as services are provided. Contract periods range from monthly to
yearly. Carrier-neutral telecommunications co-location revenues and traditional
telephone services are recognized on a monthly basis over the life of the
contract as services are provided. Revenue that is received in advance of the
services provided is deferred until the services are provided by us. Revenue
related to set up charges is also deferred and amortized over the life of the
contract. We classify certain taxes and fees billed to customers and remitted to
governmental authorities on a net basis in revenue.
We began billing AT&T (formerly SBC) reciprocal compensation (fees for
terminating AT&T customer's local calls onto our network) during 2004, and have
billed for the periods of March 2003 through June 2006. AT&T failed to pay and
is disputing approximately $183,700. We are pursuing AT&T for all balances due,
however there is significant uncertainty as to whether or not we will be
successful. Upon the ultimate resolution of AT&T's challenge, we will recognize
the associated revenue, if any. We do not expect reciprocal compensation to be a
significant or a long-term revenue source.
Certain Accounting Matters
Fair Value Measurements
In May 2011, the Financial Accounting Standards Board ("FASB") issued Accounting
Standards Update ("ASU") No. 2011-04, "Amendments to Achieve Common Fair Value
Measurement and Disclosure Requirements in U.S. GAAP and International Financial
Reporting Standards ("IFRS")." This pronouncement was issued to provide a
consistent definition of fair value and ensure that the fair value measurement
and disclosure requirements are similar between U.S. GAAP and IFRS. ASU 2011-04
changes certain fair value measurement principles and enhances the disclosure
requirements particularly for Level 3 fair value measurements. This
pronouncement is effective for reporting periods beginning on or after
December 15, 2011, with early adoption prohibited. The new guidance will require
prospective application. The adoption of this updated authoritative guidance is
not expected to have a significant impact on our Consolidated Financial
Statements.
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