Form 10QSB for REALITY WIRELESS NETWORKS INC
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24-May-2004
Quarterly Report
Item 2. Management's Discussion and Analysis of Financial Condition
Forward-looking Statements
Certain statements in this Quarterly Report on Form 10-QSB, as well asstatements made by Reality Wireless Networks, Inc. ("Reality" or "the Company")in periodic press releases, oral statements made by the company's officials toanalysts and shareholders in the course of presentations about the company,constitute "forward-looking statements" within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Such forward-looking statementsinvolve known and unknown risks, uncertainties, and other factors that may causethe actual results, performance or achievements of the company to be materiallydifferent from any future results, performance or achievements expressed orimplied by the forward looking statements. Such factors include, among otherthings, (1) general economic and business conditions; (2) interest rate changes;(3) the relative stability of the debt and equity markets; (4) competition; (5)demographic changes; (6) government regulations; (7) required accountingchanges; and (8) other factors over which Reality has little or no control.
GENERAL OVERVIEW
Reality was incorporated in the state of Nevada on March 17, 1999. On March 5,2002 the Company entered into an asset purchase agreement with Reality Networks,Inc. a Delaware corporation. The Company is a service provider of fixed,wireless, high-speed, broadband Internet access to principally residential homesand small businesses. The Company provides this service as an alternative todigital subscriber line ("DSL") or cable Internet access service. The Instituteof Electrical and Electronics Engineers ("IEEE") "802.11a" and "802.11b" radiofrequencies, on which no license is required for a broadcaster, such as theCompany, to broadcast, is the medium by which the Company provides its service.The Company provides its service primarily in geographical areas of northernCalifornia where DSL and cable services are not available and intends to expandits service to geographical areas outside of northern California.
Company focus and strategy to raise needed financing has shifted away fromacquiring additional capital from investors for a proposed investment throughprivate placement in the equity and equity related securities of the Companystarted on August 26, 2002. The Company is now actively pursuing a growthstrategy targeting acquisitions possessing assets to compliment current businessmodel, with a solid revenue or customer base. This strategy will be financedthrough additional shares issued by the Company. As of March 31, 2004, $350,000had been raised through convertible debentures and all but $95,000 had beenconverted into 18,337,932 shares of common stock. On May 13, 2004, the $200,000traunch was received, increasing cash, net of $27,700 in fee, increasingconvertible debenture liability and debt issuance cost prepaid for the amount offees. $9,066 of this was immediately converted into 9,066,248 common stockshares.
On February 1, 2004 the Company and IElement (privately held nationalcommunications service provider) began exchanging services among their clientsand began to provide their joint venture services to current and new businessand household customers. Besides leveraging infrastructure assets, RealityWireless began to leverage IElement's management and billing resources.
IElement is a subsidiary of Integrated Communications Consulants Internet("ICCI") with whom Reality Wireless entered into a non-binding letter of intentto merge announced the beginning of August 2003. ICCI and IElement are usedthroughout 10QSB interchangeably; ICCI is the parent company with whom LOI issigned and promissory note referred to in LOI (see Note 3 to the financials) isexecuted with IElement. Until the completion of their merger, the Company willmarket IElement's products and services, and IElement will market and deployReality Wireless' fixed wireless solution to its customers. IElement will alsouse its resources to strengthen the services offered existing and new RealityWireless Networks' customers with an eye toward expanding into new territoriesin the next 18 months. As of March 31, 2004 the Company is in default per thebinding clause of the letter of intent for Reality to provide to IElement$500,000 on or before August 15, 2003. IElement as of March 31, 2004 hadreceived $247,500 of the $500,000.
RESULTS OF OPERATIONS
Retail sales for the three months ended March 31, 2004 and 2003 were $20,385 and$30,924, respectively. Retail sales for the six months ended March 31, 2004 and2003 were $44,216 and $59,751, respectively. The majority of the difference inrevenue from prior year to current year is in the monthly service fee, as therehas been a decline in the number of customers from prior year. IElement iscurrently providing not only billing services and network maintenance, butconsulting on improving and stabilizing network to prepare for attracting newcustomers. The Company was open in two markets at the end of the quarter. Bothmarkets were in Northern California. The Company plans to expand outside ofNorthern California upon funding.
The Company's cost of sales for the three months ended March 31, 2004 and 2003were $20,727 and $31,896, respectively and for the six months ended March 31,2004 and 2003 were $42,932 and $55,910. All cost of sales in this fiscal yearhave been invoiced to Reality by Wavepipe and now, IElement for the same amountas monthly customer billing revenue received. Beginning August 2003, the Companyretained Wavepipe Networks, LLC, a related party, to manage customers andnetwork operations. Wavepipe established new relationships with vendors and paysall invoices for running network out of fees they receive from the Company.Wavepipe is owned by a former board member and director of Reality Wireless. OnFebruary 1, 2004 Wavepipe turned over day to day operations, includingaccounting and customer support to IElement. The cost of sales charged does notcover actual expenses incurred by IElement, however, IElement has agreed toperform services at a loss to them for 12 months.
Gross margin for the three months ended March 31, 2004 and 2003 was ($341) and($972), respectively and for the six months ended March 31, 2004 and 2003 was$1,284 and $3,841. Until the merger with IElement is executed, gross margin willbe close to $0, as cost of sales is being billed to the Company by 3rd partyservice provider, IElement, for the same amount as IElement collects on monthlyrevenue billed, as they are 3rd party billing provider as well.
Engineering and development costs for the three months ended March 31, 2004 and2003 were $787 and $19,623, respectively and for the six months ended March 31,2004 and 2003 were $1,574 and $35,782, respectively. 2004 costs were exclusivelydepreciation of node head end and bandwidth software. 2003 expenses included ITsalaries and approximately $10,000 more of depreciation, as assets were impairedand written down in the quarter ending June 30, 2003.
There were no sales and marketing costs for the three and six months ended March31, 2004 and 2003, as the Company preserved cash necessary to service currentcustomer base.
General and administrative expenses for the three months ended March 31, 2004and 2003 were $2,111,042 and $522,149, respectively. 98,588,000 shares valued at$2,733,030, fair market value on grant date of $.02-$.03/share, were issued inthe three months ended March 31, 2004 of which as of March 31, 2004 $1,192,712has been expensed and the remaining $1,540,318 will be expensed over life ofcontracts and is recorded on balance sheet as a contra-equity. In addition, anexpense of $843,460 was recorded on stock issued in prior quarters and earned incurrent quarter. The prior year consulting expenses recorded on issuance ofstock totaled $343,200.
General and administrative expenses for the six months ended March 31, 2004 and2003 were $3,162,984 and $628,311. Consulting, legal and employment expense fromcontracts paid with common stock was $3,146,853 for the six months ended March31, 2004 and $343,200 for the six months ended March 31, 2003.
Interest expense for the three months ended March 31, 2004 and 2003 was $211,708and $25,480, respectively. Current year expense included $177,796 for beneficialconversion recognition on the $200,000 and $150,000 convertible debenturesissued in November 2003 and January 2004, respectively. It also included $9,594accrual for interest on outstanding payroll taxes. The remaining $24,318 wasaccrual of interest on outstanding notes payable. For the three months endedMarch 31, 2003 the majority was accrued interest on outstanding notes payable.
Interest expense for the six months ended March 31, 2004 and 2003 was $237,154and $50,260. The difference was the items listed above in explanation of threemonth interest expense at March 31, 2004 and 2003.
Settlement loss for the three (and six months) ended March 31, 2004 and 2003 was$31,785 and $0, respectively. $31,785 was recorded in February 2004 as fouroutstanding notes payable were settled in full for the issuance of 5,933,333common stock shares valued at $.02/share. The difference between the outstandingnote plus accrued interest and fair market value of shares at date of grant wasposted to Other Expense account, "Settlement Expense."
Net loss for the three months ended March 31, 2004 and 2003 was $2,351,714 and$568,223, respectively. Net loss for the six months ended March 31, 2004 and2003 was $3,424,275 and $710,511.
Liquidity and Capital Resources
At March 31, 2004, the Company had negative working capital of $2.4 million.$1.16 million of this is attributable to bridge financing short-term notes, ofwhich the Company hopes the majority will convert into equity upon funding.
Net cash used in investing activities was $247,500 and $2,195 for the six monthsended March 31, 2004 and 2003, respectively. The $247,500 represents a notereceivable and deposit from IElement, a privately held corporation, inconjunction with potential merger. Upon completion of the merger between RealityWireless and IElement, Reality Wireless will receive a percentage of commonstock in IElement equivalent to the principal plus interest owed to date dividedby value of IElement as defined by the definitive merger documents, as announcedAugust 1, 2003.
Net cash provided by financing activities was $272,800 and $254,592 for the sixmonths ended March 31, 2004 and 2003, respectively. The Company has been fundingbusiness operations through bridge financing. Management is actively pursuingsignificant funding to allow for execution of business plan. The Company hopesthe majority of bridge loans will convert to equity at time of funding.
Critical Accounting Policies
Revenue Recognition
The Company follows the guidance of the Securities and Exchange Commission'sStaff Accounting Bulletin 104 for revenue recognition. In general, the Companyrecords revenue when persuasive evidence of an arrangement exists, services havebeen rendered or product delivery has occurred, the sales price to the customeris fixed or determinable, and collectability is reasonably assured. Thefollowing policies reflect specific criteria for the revenues stream of theCompany: Revenues are recognized pro-rata over the service period. A customer'scredit card is charged at the first of the month and revenue is earned by theend of the month. Therefore, no deferred revenue is recorded as of month end.
Impairment
The Company records impairment losses on long-lived assets used in operationswhen indicators of impairment are present and the undiscounted cash flowsestimated to be generated by those assets are less than the assets' carryingamount.
Accounting for Stock-Based Compensation
We account for stock-based compensation based on the provisions of AccountingPrinciples Board Opinion No. 25, "Accounting for Stock Issued to Employees," asamended by the Financial Accounting Standards Board Interpretation No. 44,"Accounting for Certain Transactions Involving Stock Compensation." AccountingPrinciples Board Opinion No. 25 and Financial Accounting Standards BoardInterpretation No. 44 state that no compensation expense is recorded for stockoptions or other stock-based awards to employees that are granted with anexercise price equal to or above the estimated fair value per share of thecompany's common stock on the grant date. We adopted the disclosure requirementsof Statement of Financial Accounting Standards No. 123, "Accounting forStock-Based Compensation," which requires compensation expense to be disclosedbased on the fair value of the options granted at the date of the grant.
In December 2002, the Financial Accounting Standards Board issued its StatementNo. 148, "Accounting for Stock-Based CompensationTransition and Disclosurean amendment of Financial Accounting Standards Board Statement No. 123." This
Statement amends Statement of Financial Accounting Standards No. 123, to providealternative methods of transition for an entity that voluntarily changes to thefair value based method of accounting for stock-based employee compensation. Italso amends the disclosure provisions of Statement of Financial AccountingStandards No. 123 to require prominent disclosure about the effects on reportednet income of an entity's accounting policy decisions with respect tostock-based employee compensation. The transition and annual disclosureprovisions of Statement of Financial Accounting Standards No. 148 are effectivefor fiscal years ending after December 15, 2002, and the interim disclosureprovisions were effective for the first interim period beginning after December15, 2002. We did not voluntarily change to the fair value based method ofaccounting for stock-based employee compensation, therefore, the adoption ofStatement of Financial Accounting Standards No. 148 did not have a materialimpact on our operations and/or financial position.
Factors That May Affect Future Results
Competition: The broadband internet access industry is highly competitive andrequires constant investment in research and development expenditures in orderto keep pace with technology and competitors' products. The success of theCompany depends upon its ability to go into markets and establish a base levelof customers that will cover costs of opening and maintaining a market. If theCompany is unable to compete effectively or acquire additional financing to fundfuture research and development and deployment expenditures, it would have amaterially adverse effect on the company's business operations and the Companywould not be unable to continue marketing and developing products
Dependence Upon External Financing: The Company has been building its businessthrough revenues generated from operations supplemented by the sale of itscommon stock. The ability of the Company to continue its growth and expand itsbusiness is dependent upon the ability of the Company to raise additionalfinancing either through the issuance of additional stock or the incurrence ofdebt.
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