ITEM 1. BUSINESS
GENERAL
The consolidated financial statements as of December 31, 2003 and for the year ended December 31, 2003 and related notes to the consolidated financial statements are unaudited. The Company's external auditors are expected to complete the annual audit of Telesource by the end of April 2004 and the Company will file an amendment as soon as practical to update the 10-K to reflect the external audit report.
Telesource International, Inc. was formed in 1994 to facilitate various intra-corporate activities and, until July 1999, was a wholly owned subsidiary of Sayed Hamid Behbehani & Sons Co. W.L.L. ("SHBC"), a Kuwait-based civil, electrical and mechanical construction company. Telesource International is an international engineering and construction company, constructing single family homes, airports, radio towers and engaged in the construction and operation of energy conversion power plants. In Tinian, an island in the Commonwealth of the Northern Mariana Islands, a U.S. Territory, Telesource operates a diesel fired electric power generation plant for the sale of electricity to the local power grid. Telesource International's facility in Lombard, Illinois, handles the procurement, export and shipping of U.S. fabricated products for use by its subsidiaries or for resale to customers in the southwest Pacific.
Telesource International conducts its operations through three subsidiaries: (i) Telesource CNMI, handles construction and management of the energy conversion facilities in the Commonwealth of the Northern Mariana Islands and operates a branch office in Guam; (ii) Commsource International, which is an international export company that facilitates the purchase of equipment in the U.S. (during 2001, the business activities of Commsource were transferred to Telesource); and (iii) Telesource Fiji, Limited, that handles the power generation activities in Fiji. Telesource's Palau operations are carried out by Telesource International.
Telesource has three main operating segments: construction services, brokerage of goods and services and power generation and construction of power plants. The power generation activities commenced in March 1999.
Construction Services - ---------------------
Telesource International's Micronesian construction services are primarily carried out through Telesource International's Mariana subsidiary, Telesource CNMI. In late 1996, Telesource CNMI was subcontracted by Telesource International's then-parent corporation to build a radio relay station in the Commonwealth of the Northern Mariana Islands for the United States Information Agency.
In 1999, through a competitive bidding process, Telesource International was awarded a contract to build 45 housing units for the Northern Mariana Housing Agency, a government agency. These are government-subsidized, low-income housing units. This project was completed as of December 31, 2002. Management believes that there may be additional contracts or phases to this project in the future, though there can be no assurances that additional phases will be
contracted or whether Telesource International would be successful in being awarded the contract.
In 2000, through a competitive bidding process, Telesource was awarded a contract to expand two existing power generation stations in Fiji. The project covered the expansion of the building housing the power plant and the addition of two power generation engines at each of the two sites. The total power production capacity to be added for both sites is approximately 16 Mwh. This project was completed as of December 31, 2002.
In 2000, through a competitive bidding process, Telesource International was awarded a contract to construct a 7,800 linear foot airport runway on the Island of Tinian. This contract is valued at $19.0 million and was complete at December 31, 2003.
In August 2001, through a competitive bidding process, Telesource International was awarded a contract to construct a radio broadcast station in Lebanon. This contract is valued at $1.5 million and was completed as of December 31, 2002.
In December 2001, through a competitive bidding process, Telesource was awarded a contract to install an overhead transmission line on the island of Tinian. This contract is valued at $1.0 million and was 100.0% complete as of December 31, 2002.
In February 2002, through a competitive bidding process, Telesource was awarded a contract to construct a 334-bed prison in accordance with the requirements specified by the U.S. Department of Justice. The notice to proceed on the construction of this project was issued in March 2002. This contract is valued at $17.8 million and was 66.0% complete as of December 31, 2003. The prison project is expected to be completed in late 2004.
In May 2002, Telesource received a contract to originally design and construct a 10-year landfill in the Republic of Palau. In December 2002, this contract scope was modified to design and permit a 50-year landfill and construct a road to the landfill. The contract is valued at $1.6 million and was in the early stages of completion at December 31, 2002. The landfill project is expected to be completed in mid 2004.
In July 2002, Telesource received a Notice of Award for a contract to construct the New Belau National Museum project in the Republic of Palau. Funding for the project has come through a grant from the Government of Taiwan. The project consists of the renovation of the small original Museum building and the design and construction of a museum building totaling approximately 15,500 square feet. The project also includes the development of an outdoor amphitheater and terraced seating into the natural grade of the project site. The design phase of the project began in late July with physical construction starting in March 2003. The contract is valued at $2.2 million and was 75.5% complete at December 31, 2003. The museum project is expected to be completed in mid 2004.
In January 2003, Telesource received a Notice of Award for a $5.9 million contract for construction services on the second phase of the Palau National Capitol Relocation Project. Funding for the project has come through a grant from the Government of Taiwan. The project is for the supply and installation of claddings and ornamental trims to the President's Building, the
Executive Building, the Legislative Building, and the Judiciary Building. The project also includes the construction of a mechanical and electrical yard, a drainage system with wastewater handling and a pumping station. The contract is valued at $5.9 million and was 14.6% complete at December 31, 2003. This project is expected to be completed by mid 2004.
In January 2003, Telesource agreed to deliver heavy equipment to Guam for use by the Federal Emergency Management Agency and the Guam Power Authority to assist in typhoon recovery efforts underway on Guam. The Guam Power Authority issued a purchase order to lease equipment to be used in the cleanup efforts in connection with super typhoon Pongsona, which severely damaged the electrical distribution network on Guam. Telesource airlifted boom trucks owned by Telesource from the U.S. mainland to Guam. The trucks are being used to replace overhead electrical lines damaged during the super typhoon. The contract value for this assistance was $918,933 and was completed during the second quarter of 2003.
In March 2003, Telesource received a Notice of Award for a $5.7 million contract to expand an existing radio relay broadcast station located in the Commonwealth of Northern Mariana Islands for an agency of the U.S. Government Department of State; the Broadcasting Board of Governors International Broadcasting Bureau. The existing station was constructed by Telesource and began operations in 2000. The expansion of this radio relay station is for the addition of two short wave antennas. This contract was 53.5% completed at December 31, 2003 and is expected to be completed by mid 2004.
In March 2003, Telesource was awarded a 20-year, multi-million dollar, energy conversion agreement with the Fiji Electric Authority for the operation and maintenance of three diesel power plants with generation capacity of 78 MW. The three power plants are located in Kinoya, Vuda and Labasa, Fiji. Telesource and the Fiji Electric Authority have completed and executed the Energy Conversion Agreement, which covers the take-over and operation of the two of the facilities with the third facility to be taken over during 2004.
Specialized Construction Processes - ----------------------------------
Building an airport or a broadcasting facility is not like the construction of a more conventional building. Because of the high levels of radio frequency emissions or the generation of electrical currents, every part of the structure is integrated into the overall design and plays a role in making the overall facility safer and more efficient.
The building of these specialized structures requires additional engineering skills, the knowledge of specialized construction techniques and relationships with specialized subcontractors. The situation is made more difficult when building offshore, where distance from raw materials and subcontractors becomes a risk factor.
Past and Present Power Generation Construction Projects - -------------------------------------------------------
Telesource International's power generation business involves:
* Building the power plants
* Operating the power plants for a contracted period of time
* Selling wholesale power to the client to be distributed on their power grid
* The transfer of the ownership of the properties to the clients at the end of the contract.
In 1997, a governmental agency located in the Commonwealth of the Northern Mariana Islands, awarded Telesource CNMI a contract to design, build and operate a 10-30 megawatt power plant.
The initial 10 megawatts are now on-line, completed within budget and on time and the plant has been operational since March 1999. The second phase of the project was completed in March 2000, also within budget and on time. The third phase will be constructed at Telesource CNMI's discretion as the demand for power increases. Accordingly, if power demand fails to meet Telesource International's projections, this phase may never be constructed.
In 2000, Telesource International was contracted to expand two existing power stations in Fiji and to add additional power generators with a combined production capacity of 32 Mwh for a fixed price of approximately $12.1 million. This project was completed in late 2001 at a cost of $11.1 million. Performance for this contract was divided between Telesource International and Telesource Fiji, Ltd., a subsidiary of Telesource International, based on the location and type of service to be performed. The construction services were recognized under Telesource Fiji, Ltd. while the purchasing of the power generation engines was recognized on a net basis under Telesource International. The contract with the customer reflects this arrangement. This contract was a performance pay contract (i.e., as specified milestones are reached, Telesource bills the customer and receives payments within 30 days).
Power Plant Operation and Maintenance - -------------------------------------
Our agreement with the governmental agency in the Commonwealth of the Northern Mariana Islands is an example of a power plant operation and maintenance project. Under the terms of this agreement, Telesource International designed, financed and built the power plant. Telesource International obtained financing for the project through a $25,000,000 line of credit from the Commercial Bank of Kuwait, New York branch. For the construction of the first phase of this power plant Telesource International is paid $180,000 per month for ten years by the governmental agency. Each monthly payment is secured by a promissory note in the amount of $180,000 issued by the Commonwealth Utilities Corporation.
Telesource International has a 20-year lease on the land on which the power plant is built, plus title to the entire plant and a two-month escrow account of no less than $360,000 on which Telesource International has a first lien. In the event of the governmental agency is unable to meet its obligations either to make payments of monthly maintenance fees or on the promissory notes, Telesource International may sell, lease, assign or transfer the power plant or any of the plant equipment.
In the first phase of the project, the governmental agency also pays Telesource a production fee of $.02 per kilowatt-hour for each kilowatt-hour produced on its behalf for the first 5,140,000-
kilowatt hours per month. In the second phase, which added 10-megawatts of capacity, the governmental agency has agreed to pay Telesource International an additional production fee of $.065 per kilowatt-hour produced over the initial 5,140,000-kilowatt hours per month.
In addition, the governmental agency pays Telesource a service fee of $50,000 per month for operating and maintaining the power plant.
In May 2001, the governmental agency and Telesource executed Change Order No. 3 to the Tinian Power Plant Contract. Change Order No. 3 provides a suspension in the Escalator on the variable payments from January 1, 2001 to December 31, 2005. This Change Order extends the term of the contract from an expiration of 10 years following commissioning of the last constructed phase (currently Phase II was commissioned in March 2000 and therefore the contract was to have expired in March 2010) to an new expiration date of March 31, 2020. Change Order No. 3 does not include an expansion of the power generation capacity of the power plant. The power plant will continue to operate at its current maximum generation capacity of 20 Mwh. Effectively, the contract has been extended for an additional 10 years. Power rates agreed to under the original contract and Change Order No. 1 remain unchanged. Change Order No. 3 does provide the customer with an early termination option of the extended agreement beginning on March 31, 2010 and available annually thereafter; however, the customer is required to give a six-month notice and pay an early termination fee of $6,000,000. Change Order No. 3 prohibits the customer from purchasing power from any source other than Telesource for the first 30 MW. The expanded agreement executed under Change Order No. 3 only extends the power generation contract term and does not require additional performance by Telesource, with respect to construction activities.
Potential Future Power Plant Construction and Power Supply - ----------------------------------------------------------
Based on previous experience, management believes there will be a growing demand for power around the world; however competition and deregulation could eliminate the financial feasibility of these projects and thereby prevent Telesource International from taking advantage of the expected growth in demand. In the U.S., two-thirds of the country's installed plants are 25 or more years old and need to be replaced and repowered, principally with new gas combustion turbines. The world's use of electricity is projected to increase by two-thirds over the forecast horizon, from 13 trillion kilowatt hours in 1999 to 22 trillion kilowatt-hours in 2020. The strongest growth rates in electricity consumption are projected for the developing world. The most rapid expansion in electricity use in the reference case is expected for developing Asia and Central and South America, with average annual growth rates exceeding 3.5 percent between 1999 and 2020. In the industrialized world, electricity consumption is expected to grow at a more modest pace. Slower population and economic growth, along with the market saturation of certain electronic appliances (such as washers and dryers) and efficiency gains from electrical appliances help to explain the expected slower growth of electricity use in the industrialized nations, although growing computer usage and the introduction of new electronic devices could modulate that trend in the future. Telesource International also believes that those situations where the local governments lack the up-front funding to build the additional power plants will represent an opportunity for Telesource International to find alternative solutions up to and including having Telesource International locate the needed project financing. Without the additional energy, Telesource International believes that many of the infrastructure upgrades
envisioned by local governments will be unable to occur. In Telesource International's experience, in return for securing project financing in a manner similar to that obtained for the project in the Commonwealth of the Northern Mariana Islands, local governments will be willing to enter into contracts which guarantee Telesource International a minimum amount of power consumption, coupled with long-term operations and maintenance contracts.
Telesource International anticipates that these contracts will generally be secured by governmental guarantees, promissory notes, liens and collateral on the land and in the physical power plants.
Sales and Marketing Strategies - ------------------------------
Most of Telesource International's construction projects are obtained through a public bid process, and clients are either governments or governmental agencies. In obtaining contracts:
* Telesource International performs significant market research. Telesource International analyzes potential markets, looking for future building plans or plans to expand the capital infrastructure. Telesource International's research also includes analyzing numerous government documents and reviewing previous and current requests for bids.
* Telesource International is actively involved in public relations with the governments and agencies that might contract for Telesource International's services. Much of this effort is informational, learning the specific needs of each governmental agency while at the same time explaining what services Telesource International has to offer.
* Telesource International has created and provides to potential clients a survey to help governmental agencies evaluate whether Telesource International's resources and services might be more efficient and cost-effective than their current system.
Telesource International maintains three full-time salaried marketing executives to help sales and marketing efforts; one in the Illinois headquarters and two offshore.
Competition - -----------
The independent power industry has grown rapidly over the past twenty years. There are a large number of suppliers in the wholesale market and a surplus of capacity, which has led to intense competition in this market. The principal sources of competition in this market include traditional regulated utilities that have excess capacity, unregulated subsidiaries of regulated utilities, energy brokers and traders, energy service companies in the development and operation of energy-producing projects and the marketing of electric energy, equipment suppliers and other non-utility generators like Telesource International. Competition in this industry is substantially based on price with competitors discovering lower cost alternatives for providing electricity. The electric industry is also characterized by rapid changes in regulations, which Telesource International expects could continue to increase competition. Telesource International does not believe the Tinian power plant would be significantly impacted by competition in the wholesale energy market since its revenues are subject to contracted rates which are substantially fixed for several years.
Telesource International also competes in the market to develop power generation facilities. The primary bases of competition in this market are the quality of development plans, the ability of the developer to finance and complete the project and the price. In some cases, competitive bidding for a development opportunity is required. Competition for attractive development opportunities is expected to be intense as there are a number of competitors in the industry interested in the limited number of opportunities. Many of the companies competing in this market have substantially greater resources. Telesource International believes its project development experience and its experience in creating strategic alignments with other development firms with greater financial and technical resources could enable Telesource to continue to compete effectively in the development market if and when opportunities arise. Presently, Telesource International believes there are a number of opportunities for additional project development worldwide for projects similar to those previously developed by Telesource. However, Telesource International is currently evaluating whether it should seek development opportunities in other areas outside of the south pacific to diversify its activities.
Presently, there is significant merger and consolidation activity occurring in the electric industry. From time to time, Telesource International may consider merger and acquisition proposals when they appear to present an opportunity to enhance stockholder value. Telesource International is not involved in any of these discussions or negotiations at this time.
Energy Regulation - -----------------
Telesource International's projects are subject to regulation under federal and local energy laws and regulations. Telesource International is subject to the requirements established by its permitting authorities, i.e. the Department of Environmental Quality ("DEQ") and the Environmental Protection Agency ("EPA").
Presently, neither the Customer Choice Act nor proposed legislation dealing with U.S. energy policy directly impacts Telesource International because the legislation and restructuring plan pertain to the retail market or new contracts in the wholesale market. However, as discussed above, Telesource International could be impacted in the future by, among other things, increases in competition as a result of deregulation. Telesource International is actively monitoring these developments in energy proceedings in order to evaluate the impact on existing projects and also to evaluate new business opportunities created by the restructuring of the electric industry.
Environmental Regulation - ------------------------
Telesource International's projects are subject to regulation under federal, foreign and local environmental laws and regulations and must also comply with the applicable laws pertaining to the protection of the environment, primarily in the areas of water and air pollution. These laws and regulations in many cases require a lengthy and complex process of obtaining and maintaining licenses, permits and approvals from federal and local agencies. As regulations are enacted or adopted in any of these jurisdictions, Telesource International cannot predict the effect of compliance therewith on its business. Telesource International's failure to comply with all applicable requirements could result in delays in proceeding with any projects under development or require modifications to operating facilities. During periods of non-compliance,
Telesource International's operating facilities may be forced to shutdown until the instances of non-compliance are corrected. Telesource International is responsible for ensuring compliance of its facilities with applicable requirements and, accordingly, attempts to minimize these risks by dealing with reputable contractors and using appropriate technology to measure compliance with the applicable standards.
Insurance and Bonding - ---------------------
Telesource International maintains general and excess liability, construction equipment, and workers' compensation insurance; all in amounts consistent with industry practices. Telesource International believes its insurance programs are adequate.
Telesource International was required to provide bonding for the airport runway project on the island of Tinian. This project has partial funding from the U.S. Government (the FAA) and consequently, U.S. Treasury Listed Bonding was required. During 2002, Telesource was required to provide bonding for the prison project on the island of Saipan. This project has partial funding from the U.S. Government and therefore, U.S. Treasury Listed Bonding was required. In order to secure the required bonding, Telesource's largest shareholder, SHBC provided a letter of credit to the surety equal to 100% of the contract value of $17 million. Telesource International's ability to obtain additional surety bonding depends upon its capitalization, working capital, past performance, management expertise and other factors, which may change from time to time. Currently Telesource is required to provide collateral equal to 100% of the surety bond by Telesource International's surety company.
Employees - ---------
Telesource International presently employs 198 people, consisting of 17 employees in management, 27 engineers and technical staff members, 15 support staff members and 139 hourly employees. All of Telesource International's employees are nonunion workers, although Telesource International may employ union subcontractors from time to time.
Ninety percent of Telesource International's project teams include engineers and technical staff, due to the technical nature of its construction contracts. Working on a power plant, broadcasting facility or other technical construction site requires a higher level of expertise and a greater attention to safety issues.
Telesource International's non-engineering level employees are hourly workers, while its engineering and supervisory staffs are on monthly salaries.
ITEM 2.
ITEM 2. PROPERTIES
Properties - ----------
Telesource International maintains leased office space and leases land for storage of construction equipment. Telesource International's Mariana subsidiary's head office in the Commonwealth of the Northern Mariana Islands is leased for an additional year. In Fiji, Telesource has an office
leased on a month-to-month basis. Telesource has leased office space in the Republic of Palau on a month-to-month basis. Telesource International's corporate offices in Illinois are leased on a month-to-month basis. Additionally, Telesource has approximately three leased vehicles in its fleet.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Telesource is involved in legal proceedings and claims asserted by and against Telesource, which have arisen in the ordinary course of business. Telesource believes it has a number of valid defenses to these actions, and Telesource intends to vigorously defend or assert these claims and does not believe that a material liability will result.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 4(a). EXECUTIVE OFFICERS OF THE REGISTRANT
The names, ages and backgrounds of Telesource International's executive officers are as follows:
Name and Age; Years Principal Occupation for Past Served as Director Five Years; Other Directorships - -------------------------------- ---------------------------------------- Khajadour Semikian Khajadour Semikian, President, joined Age 50 Telesource International in September Director Since 1995 1996. From January 1986 to December 1996, Mr. Semikian was Assistant General Manager with Sayed Hamid Behbehani & Sons. Mr. Semikian has also served as a director for Computhink Incorporated since 1994, Telebond Insurance Corporation and Retsa Development Incorporated since 1998, and as President of Telebond Insurance Corporation since 1998.
Nidal Zayed Nidal Zayed, Executive Vice President, Age 43 joined Telesource International in Director Since 1998 January 1996. He is also engaged in the practice of law. He received a law degree from Loyola University School of Law in 1985 and a B.A. in Accounting from Loyola University of Chicago in 1982. He serves as Chairman for Computhink Incorporated and has been a director for Computhink since 1994.
Bud Curley Mr. Curley joined Telesource Age 40 International as its Chief Financial Officer in September 1999. Prior to September 1999, Mr. Curley served as the Chief Financial Officer, Secretary and Executive Vice President for Surety Capital Corporation and Surety Bank, N.A. from 1996 to 1999. From 1993 to 1996, Mr. Curley served as Surety Capital Corporation and Surety Bank, N.A.'s Controller and Senior Vice President. In 1989, Mr. Curley received a B.A. in Business Administration from the University of Texas. He has also served as a director for Surety Capital Corporation and Surety Bank, N.A. from 1998 to 1999.
Jeff Karandjeff Mr. Karandjeff joined Telesource Age 36 International as Secretary in 1997. From October 1996 to February 1997, Mr. Karandjeff was an Associate with Schoenberg, Fisher, Newman & Rosenberg, LTD. He received a law degree from Loyola University School of Law in 1993 and a Bachelors Degree from Massachusetts Institute of Technology in 1988.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION. On November 1, 2001, Telesource's common stock began trading on the Over-the-Counter Bulletin Board under the symbol "TSCI". Prior to that time, Telesource's common stock was not listed for trading.
The following table sets forth high and low sales prices for the common stock for the periods indicated as reported by the Over-the-Counter Bulletin Board since November 1, 2001:
HIGH LOW -------- -------- ---- Fourth Quarter............................ $1.95 $0.51
---- First Quarter............................. 2.45 1.50 Second Quarter............................ 1.75 0.82 Third Quarter............................. 1.62 1.30 Fourth Quarter............................ 1.40 1.35
---- First Quarter............................. 1.70 1.25 Second Quarter............................ 1.50 1.45 Third Quarter............................. 1.50 1.10 Fourth Quarter............................ 1.10 0.55
As of April 8, 2004, the latest stock quote for Telesource was $1.15 per share.
HOLDERS. As of March 31, 2004, there were 192 shareholders of record.
DIVIDENDS. Telesource did not pay dividends on its common stock during 2003 or 2002, and it does not anticipate that it will pay dividends on its common stock in the foreseeable future. Telesource's working capital credit facility limits the payment of dividends on its common stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
The following selected financial data as of and for the years ended December 31, 2003, 2002, 2001, 2000, and 1999, has been derived from the audited consolidated financial statements of Telesource International, Inc. and subsidiaries. The consolidated financial statements as of December 31, 2003 and 2002, and for each of the years in the three-year period ended December 31, 2002, are included elsewhere in this Form 10-K. This selected financial data should be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Form 10-K:
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
HIGHLIGHTS
Revenues for the year ended December 31, 2003 were $19.5 million, compared to $20.3 million and $18.3 million for the years ended December 31, 2002 and 2001, respectively. Net loss was $7.3 million for 2003, an increase of $2.4 million, or 49.7 %, from the loss of $4.9 million for 2002. For 2001, net loss was $7.2 million. Basic and diluted net loss per share was $0.49 per share for 2003, compared to $0.33 per share for 2002 and $0.52 per share for 2001.
Liquidity and Going Concern
As of December 31, 2003, the Company's current liabilities exceeded its current assets by $5.9 million. The Company relies heavily on bank financing to support is operations and its ability to refinance its existing bank debt is critical to provide funding to satisfy the Company's obligations as they mature. As of December 31, 2003 the Company had total outstanding debt of $29,552,417 of which $9,422,915 is due in 2004. As of December 31, 2003 the Company had an accumulated deficit of $36,747,674 and total stockholders' deficit of $14,096,928.
The Company incurred operating losses of $5,112,748, $3,118,300 and $4,903,676 for the years ended December 31, 2003, 2002 and 2001, respectively. The Company incurred net losses of $7,315,693, $4,886,397 and $7,245,774 for the years ended December 31, 2003, 2002 and 2001, respectively.
Cash used in operating activities was $6,805,337, $2,031,793 and $4,382,413 for the years ended December 31, 2003, 2002 and 2001, respectively. Funds provided by net borrowings and stock sales amounted to $8,552,417, $2,200,000 and $3,351,882 for the years ended December 31, 2003, 2002 and 2001, respectively.
The Company's net working capital deficiency, total stockholders' deficit, recurring losses and negative cash flows from operations raise substantial doubt about the Company's ability to continue as a going concern. Management has made significant achievements during 2003 to address the going concern issue and will continue to work to address these uncertainties by continuing its efforts to increase revenues and control costs with the goal of achieving profitability. Management has raised $14.7 million in preferred stock during 2003 and also was able to raise $2.0 million thru the sale of common stock during 2003. As of the April 14, 2004, management sold an additional $3.0 million in common stock and expects to sell an additional $2.5 million worth of stock during the second quarter of 2004. The additional equity raised during 2004 will be used to pay down debt which will significantly reduce the amount of debt burden. Most of the debt obligations coming due during 2004 are project financing based and will generate cash collections through the collection of project receivables and billings. These collections on the projects along with the expected additional equity are believed by management to be sufficient to cover Telesource's 2004 obligations. Management expects the increase in revenues to be achieved by securing additional substantial projects during 2004 and through increasing revenues from existing long term power plant operation and maintenance agreements as a result of continued expansion on the island of Tinian and within Fiji. However, no assurance
can be given that such increased revenues will be achieved. Although management believes that the Company will be cash flow positive in 2004 including debt payments, the Company has and expects to continue to seek support from its principal stockholder, SHBC, for its operations, for working capital needs, debt repayment, and business expansion as may be required. SHBC has continued its support of the Company. SHBC has agreed to guarantee or provide letters of credit covering $27,214,000 of the Company's total debt of $29,552,417.
OPERATING SEGMENTS
Telesource's business consists of the following operating segments: power generation and construction of power plants, trading, and construction services. Power generation activities did not commence until March 1999. Revenue of the power generation and construction of power plants segment includes sales-type lease revenues. The power generation activities occurred in the Commonwealth of Northern Mariana Islands, a U.S. territory, ("CNMI") and construction of power plants occurred in Fiji. Construction services occurred in the CNMI and the Republic of Palau while trading activities occurred in the United States and the CNMI.
CRITICAL ACCOUNTING POLICIES
Telesource believes its most critical accounting policy is revenue recognition from long-term contracts for which Telesource uses the percentage-of-completion method of accounting. Percentage of completion accounting is the preferred method of accounting for long-term contracts under accounting principles generally accepted in the United States of America, and accordingly, is the method used for revenue recognition within Telesource's industry. Percentage-of-completion is measured principally by the ratio of costs incurred to date for each contract to the estimated total costs for each contract at completion. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined.
Application of percentage-of-completion accounting results in the recognition of costs and estimated earnings in excess of billings on uncompleted contracts within the consolidated balance sheets. Costs and estimated earnings in excess of billings on uncompleted contracts reflected on the consolidated balance sheets arise when revenues have been recognized but the amounts cannot be billed under the terms of the contracts. Such amounts are recoverable from customers upon achievement of various measures of performance, including achievement of certain milestones, completion of specified units or completion of the contract. Costs and estimated earnings in excess of billings on uncompleted contracts also includes amounts Telesource seeks to collect from customers or others for errors or changes in contract specifications or design, contract change orders once approved as to both scope and price, or other customer-related causes of unanticipated additional contract costs. Such amounts are recorded at estimated net realizable value when the scope and price have been agreed to by the client and Telesource.
Due to uncertainties inherent within estimates employed to apply percentage-of-completion accounting, it is possible that estimates will be revised as project work progresses. Application of percentage of completion accounting requires that the impact of those revised estimates be reported in the consolidated financial statements prospectively.
Impairment of Long-Lived Assets
When we undergo changes in our business, including the closure or relocation of facilities, we may have equipment and other assets that are no longer needed in our business. When this occurs, we estimate how much we believe we are likely to receive upon disposal of the assets and we record an impairment charge if this amount is less than the net carrying value. If actual market conditions for these assets are less favorable than those projected by management, additional impairment charges may be required. Telesource did not incur any impairment of long-lived assets for equipment or other assets during 2003, 2002 or 2001.
The investment in sales-type lease along with our property, plant and equipment are considered to be a long-lived assets. Based on the anticipated cash flows for the assets along with the current revenues and expenses and an evaluation of future changes in the market and economic outlook as well as the length of the contractual commitment, Telesource does not believe any impairment was indicated at December 31, 2003.
RESULTS OF OPERATIONS
REVENUES
Overview
Telesource International is an international engineering and construction company, which has among its operations power generation and specialty construction services in the Commonwealth of the Northern Mariana Islands and the Republic of Palau. Telesource International operates a diesel fired electric power generation plant for the sale of electricity to the local power grid in CNMI. Telesource has signed an agreement to take over the operation and maintenance of three diesel fired electric power generation plants in Fiji beginning in 2003 for 20 years. Telesource International's facility in Lombard, Illinois handles the procurement, export and shipping of U.S. fabricated products for use by Telesource International's subsidiaries or for resale to customers outside of the mainland.
Telesource International was formed in 1994 to facilitate various intra-corporate activities and, until July 1999, was a wholly owned subsidiary of SHBC, a Kuwait-based civil, electrical and mechanical construction company. Operations are conducted primarily through subsidiaries. Telesource International currently has three subsidiaries. Telesource CNMI, Inc. handles construction and management for the power facilities in the Commonwealth of the Northern Mariana Islands. Telesource CNMI, Inc. has branch offices in Guam, Telesource Pacifica and Pacifica Power Resources. Commsource International located in Chicago, Illinois, is an international export company that facilitates the purchase of equipment fabricated in the U.S. The business activities of Commsource have been transferred to Telesource. Telesource Fiji, Ltd. was established to oversee Telesource International, Inc.'s power plant construction activities within Fiji, which currently involves the installation of additional power generators for existing power plants in Fiji. Construction activities in the Republic of Palau are carried out by Telesource International.
Telesource International has three main operating segments: construction services, trading activities, and power generation and construction of power plants.
Revenue from construction and construction of power plants is recognized using the percentage-of-completion method of accounting based upon costs incurred and projected costs. Construction revenue includes revenues recognized by Telesource International, Inc.'s power plant construction segment and from other projects ranging from housing development to the construction of airports and prisons. The construction of power generation plants is considered by management to be a part of Telesource International, Inc.'s power generation and construction of power plants segment. Cost of revenue consists of direct costs on contracts; including labor and materials, amounts payable to subcontractors, direct overhead costs, equipment expense (primarily depreciation, maintenance and repairs), interest associated with construction projects and insurance costs. Depreciation is provided using straight-line methods for construction equipment. Contracts frequently extend over a period of more than one year and revisions in cost and profit estimates during construction are reflected in the accounting period in which the facts that require the revision become known. Losses on contracts, if any, are provided when determined, regardless of the degree of project completion. Claims for additional contract revenue are recognized in the period when it is probable that the claim will result in additional revenue and the amount can be reliably estimated. The foregoing as well as the stage of completion, and mix of contracts at different margins may cause fluctuations in gross profit between periods.
Construction revenues on power plants are recognized using the percentage-of-completion method of accounting, based upon costs incurred and projected costs. This revenue is separated on the face of the consolidated financial statements due to its origin within Telesource International's power generation and construction of power plants segment. Cost of revenue consists of direct costs on contracts; including labor and materials, amounts payable to subcontractors, direct overhead costs, equipment expense (primarily depreciation, maintenance and repairs), interest associated with construction projects and insurance costs. Depreciation is provided using straight-line methods for construction equipment. Contracts frequently extend over a period of more than one year and revisions in cost and profit estimates during construction are reflected in the accounting period in which the facts that require the revision become known. Losses on contracts, if any, are provided in total when determined, regardless of the degree of project completion. Claims for additional contract revenue are recognized in the period when it is probable that the claim will result in additional revenue and the amount can be reliably estimated. The foregoing as well as the stage of completion, and mix of contracts at different margins may cause fluctuations in gross profit between periods.
Telesource accounts for its leasing activities in accordance with the requirements of Statement of Financial Accounting Standards No. 13, Accounting for Leases. Revenue associated with the sale of the Tinian power plant constructed and sold under a sales-type lease, measured as the present value of non-cancelable rents, was recognized in connection with recording the loss on sale in 1997 and 1998. Telesource recognizes finance lease revenue on the resulting sales-type lease receivable at a constant rate using the interest method. Service revenues received from operating and maintaining the Tinian power plant for the duration of the lease are recognized as earned based on actual kilowatt hours of electricity produced and delivered to the lessee's customers. To the extent that variable payments based on kilowatt-hours of production exceed the fair value of
operation and maintenance services provided, Telesource recognizes such contingent payments as additional finance lease revenue as they are earned.
Sales revenues are derived from brokering of U.S. fabricated goods and management of various projects outside of Telesource International's construction and power generation segments. Sales of goods exported are recognized at the time of shipment. When an order is received, the customer's product specifications are sent to the manufacturer and upon completion the goods are shipped from the manufacturer directly to the customer. In most cases, the risk of loss during shipping is either borne by the manufacturer or the customer. Telesource International is responsible for payment to the manufacturer; however, Telesource normally collects payment from the customer before the manufacturer is paid. The sales revenues are recognized net of cost of goods sold. In 1999, Telesource entered into an agreement with its primary customer, SHBC, to charge a flat fee of 7.5% of the invoice amount for all orders executed by Telesource on behalf of SHBC.
Service revenues are recognized in the period in which the work is performed. Service revenues consist of amounts billed to SHBC for project management of the radio relay station and for other types of services provided to local customers for small projects. The cost of services provided was not recorded separately, and therefore was included in the general and administrative expenses.
Rental income consists of fees collected on rental of equipment to SHBC for use in construction of the radio relay station as well as to local customers. The rental fees are billed on a monthly basis for equipment used during the billing period. Telesource recognizes rental revenue on the accrual basis pursuant to contractual arrangements between Telesource and its customers.
Finance lease revenues are recognized on the amortization of the minimum lease payments for the power plant located on the Island of Tinian that were discounted upon execution of the contract in June of 1997 at an interest rate of 6.74%. The amortization of the minimum lease payments began in March 1999 at an effective interest rate of 9.40% and will fully amortize in March 2010.
Construction costs are comprised of both variable and semi-variable expenses, including labor and materials, amounts payable to subcontractors, direct overhead costs, equipment expense (primarily depreciation, maintenance and repairs), interest associated with construction projects and insurance costs. Depreciation is provided using straight-line methods for construction equipment.
Construction costs on power plants are comprised of both variable and semi-variable expenses, including labor and materials, amounts payable to subcontractors, direct overhead costs, equipment expense (primarily depreciation, maintenance and repairs), interest associated with construction projects and insurance costs. Depreciation is provided using straight-line methods for construction equipment. These costs are disclosed separately from construction costs due to their origin within the power generation segment.
Operations and maintenance costs - power generation plant consist of labor, direct overhead costs, equipment expense (primarily maintenance and repairs), and insurance costs. These costs are recognized as incurred.
Salaries and employee benefits consist of all wages and benefits for management and staff wages and benefits that are not directly associated with a particular project, that is, idle costs for employees are charged to general and administrative expense. Telesource's principal market, the Commonwealth of the Northern Mariana Islands, allows employers to import guest employees. The local labor laws require employers importing guest employees, principally from the Philippines, to execute a one-year employment contract with the guest employee. Since Telesource has a few large contracts, this can lead to short periods of inactivity for some employees. As Telesource continues to grow, this issue is expected to be minimized; however, it can have a significant impact on Telesource's operating results.
Occupancy and equipment expense consist of rent, utilities and office equipment for Telesource International's offices in Illinois, CNMI, Guam and Fiji.
General and administrative expenses consist primarily of depreciation, telephone expense, insurance, travel, financial and legal expenses and a gross revenue tax incurred on Telesource International's operations in the Commonwealth of the Northern Mariana Islands.
Telesource International, Inc., Commsource International, Inc., Telesource CNMI, Inc. and Telesource Fiji, Ltd. file separate corporate income tax returns. Telesource International, Inc. and Commsource International, Inc. are U.S. corporations that file separate U.S. corporate tax returns. Telesource CNMI, Inc. is a Commonwealth of the Northern Mariana Island corporation and files a corporation tax return for this commonwealth. Telesource Fiji, Ltd. is a Fijian corporation and files a Fijian corporation tax return.
Deferred income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
TINIAN POWER PLANT
Phase I
In June 1997, Telesource International entered into a contract to construct and operate a power plant on the island of Tinian. The June 1997 agreement (hereafter referred to as Phase I) called for Telesource International to construct a 10Mwh power generation plant with the capacity to add an additional 20Mwh of power at later dates, and to operate the power plant for a period of 10 years from the date of commissioning. Phase I was commissioned in March 1999. The terms for Phase I call for fixed payments of $180,000 per month plus a production fee of $0.02 per Kwh produced for the first 5,140,000 Kwh produced each month (hereafter referred to as the Base Load). The agreement also provides that Telesource International will receive a monthly service fee of $50,000 for a period of 10 years from the date of commissioning. Following the conclusion of that 10-year period, the only payments Telesource International will receive for the Base Load is a production fee of $0.03 per Kwh produced, as adjusted for inflation per the agreement.
Phase II
In November 1998, Telesource International received a change order instructing Telesource to add an additional 10Mwh of power generation capacity (hereafter referred to as Phase II). This change order provided for Telesource International to receive only variable payments in the form of a production fee of $0.065 per Kwh produced in excess of the Base Load (hereafter referred to as the Expansion Rate) and for these payments to occur over a ten-year period commencing upon the commissioning of Phase II. After the completion of the ten-year period, the production fee changes from $0.065 per Kwh to $0.03 per Kwh for all power produced. Phase II was commissioned in March 2000 and increased the power plant's total generation capacity to its maximum current level of 20Mwh.
Expanded Agreement
In May 2001, Telesource International received a third change order extending the term of the agreement for an additional ten years or to March 31, 2020 (hereafter referred to as the Expanded Agreement). The Expanded Agreement leaves the option to expand the power plant by adding an additional 10Mwh of generation capacity unchanged. The power generation plant currently has 20Mwh of production capacity, which can be increased to 30Mwh by installing the appropriate power generators. The production rates for the Base Load and the Expansion Rate do not change from the amounts originally agreed upon. In summary, Telesource will receive $0.03 (adjusted for inflation) per Kwh produced after March 31, 2010 for all power produced.
Accounting for the Construction of the Power Plant
Telesource accounts for its leasing activities in accordance with the requirements of Statement of Financial Accounting Standards No. 13, Accounting for Leases. Revenue associated with the sale of the Tinian power plant constructed and sold under a sales-type lease, measured as the present value of non-cancelable rents, was recognized in connection with recording the loss on sale in 1997 and 1998. Telesource recognizes finance lease revenue on the resulting sales-type lease receivable at a constant rate using the interest method. Service revenues received from operating and maintaining the Tinian power plant for the duration of the lease are recognized as earned based on actual kilowatt hours of electricity produced and delivered to the lessee's customers. To the extent that variable payments based on kilowatt-hours of production exceed the fair value of operation and maintenance services provided, Telesource recognizes such contingent payments as additional finance lease revenue as they are earned.
The original net investment in sales-type lease was recognized in June 1997, the date the contract was executed. The components of the net investment in sales-type lease are as follows:
When Telesource recognized the net investment in sales-type lease at the inception of the agreement in June 1997, Telesource also recognized a loss on the sale of Phase I in the amount of $1,748,713. In 1998, Telesource recognized a loss on the sale of Phase II in the amount of $12,521,457 (equal to the entire amount of the construction costs for Phase II, as there were no additional minimum lease payments related to this phase). The loss recognized on the sale of Phase II was recognized when the contract for Phase II was executed in November 1998.
Phase I of the power plant was commissioned in March of 1999. Phase II was commissioned in March of 2000. Telesource recognized power generation revenues from billings at the rate of $0.02 per Kwh produced of $1,130,172, $858,336, $692,160 and $304,920 for the years ended December 31, 2002, 2001, 2000 and 1999, respectively. No power generation income was recognized during 1998.
Revenues for this contract consist of the present value of the total contractual minimum lease payments, which were recognized at lease inception. The minimum lease payments were discounted using an interest rate of 6.74% and the minimum lease payments are comprised of a guaranteed monthly payment along with an operation and maintenance fee. Interest earned on the minimum lease payments, which is recognized over the lease term so as to yield a constant percentage return on the net investment in the lease beginning in March 1999, is included in finance lease revenues in the consolidated statements of operations.
Telesource also receives variable monthly payments as compensation for its production of power. The variable payments are recognized based upon power produced and billed to the customer as earned during each accounting period.
The total construction costs for the power plant were $32,120,170. A substantial portion (approximately $14,270,000) of the repayment to Telesource International for these construction costs is expected to come from the variable production fees that will be recognized as revenue when power is produced and billed to the customer. Due to the fact that the agreement does not provide for any minimum production fees, there is no guarantee that Telesource International will recover all of the construction costs incurred to construct the power plant; however, the agreement does require the customer to purchase 100% of its power from Telesource International until the maximum power generation capacity has been reached each month. The future minimum lease payments to be collected by Telesource are $2,760,000 each year through March 2009.
Future revenue related to the construction and operation of the power plant will be recorded as service fees until the amount exceeds the estimated fair value of the services performed. Amounts in excess of the fair value of the services performed will be accounted for as additional finance lease revenue.
Results of Operations
The following table sets forth results of operations expressed as a percentage of total revenues:
Backlog
The following schedule shows a reconciliation of backlog representing the amount of revenue Telesource International expects to realize from work to be performed on uncompleted contracts accounted for using the percentage-of-completion method of accounting in progress at December 31, 2003:
Comparison of the twelve months ended December 31, 2003 and 2002
Construction Revenues. Construction revenues, including related party, decreased 17.4% to $14.4 million in 2003 from $17.4 million in 2002. The decreased in construction revenues is attributed to the completion of the airport expansion project and the lower revenues from the prison project. The backlog was $15.1 million at December 31, 2003 and was $17.5 million at December 31, 2002.
Service Fees - Power Generation Plant. Service fees - power generation plant increased 178% to $3.1 million in 2003 from $1.1 million in 2002. The big increase in service fees - power generation plant is attributed to the $2.0 million revenues from the operation and maintenance of two diesel power plants in Fiji which was awarded to the Company by Fiji Electric Authority during 2003 for 20 years. The energy conversion agreement covered the take-over and operation of the two facilities in Kinoya, and Vuda, Fiji.
Sales Revenues, Net. Sales revenues decreased 74% to $103,486 in 2003 from $397,376 in 2002. Sales to SHBC decreased to $30,992 in 2003 from $89,998 in 2002. Sales to SHBC are not expected to increase in future periods.
Rental Income. Rental income increased to $247,026 in 2003 from $68,209 in 2002. The increase in rental income was a result of short term lease agreement signed in 2003 with the Guam Power Authority to assist the local utility in clean up efforts from a super typhoon, Pongsona, which struck Guam in December 2002.
Service Fees. Service fees increased to $511,926 in 2003 from $34,640 in 2002. The increase is a result of Telesource providing project management services to third parties.
Finance Lease Revenues. Finance lease revenues decreased 11% to $1.1 million in 2003 from $1.3 million in 2002. Finance lease revenue for the Tinian power plant will decrease each year until the investment in sales type lease is fully amortized in March 2010.
Expenses
Construction Costs. Total construction costs (includes related party and third party) were flat at $15.9 million for 2003 and 2002.
Operation and Maintenance Costs - Power Generation Plant. Operation and maintenance costs - power generation plant increased 113% to $2,612,363 in 2003 from $1,224,202 in 2002. The increase in operation and maintenance costs was due to $1.4 million from Fiji's operation and maintenance of two power plants added during 2003.
Salaries and Employee Benefits. Salaries and employee benefits decreased 3% to $1.7 million in 2003 from $1.7 million in 2002. The decrease in salaries and employee benefits is attributed to management's continuing efforts to reduce costs during 2003.
Occupancy and Equipment. Occupancy and equipment expenses increased 12% to $383,812 in 2003 from $342,189 in 2002. The increase in occupancy and equipment expense is attributed to
additional occupancy expense incurred in Palau in the amount of $82,813 and $37,328 in Fiji during 2003.
General and Administrative Expenses. General and administrative expenses decreased 4% to $4.1 million in 2003 from $4.3 million in 2002. The decrease is attributed to lower bank service charges and taxes and licenses.
Other Expense, Net. Other expense increased 20% to $2.1 million in 2003 from $1.8 million in 2002. The increase is a result of increased borrowing costs due to the additional preferred stock issued during 2003.
Income Tax Expense. There was no income tax expense for 2003. Telesource had net operating loss carryforward at December 31, 2003 of approximately $34,340,000; however, Telesource International's subsidiary in Fiji had taxable income of $144,921 resulting in a tax expense of $74,947 in 2003 and none in 2002.
Comparison of the twelve months ended December 31, 2002 and 2001
Revenues
Construction Revenues. Construction revenues, including related party, increased 47.2% to $17.4 million in 2002 from $11.8 million in 2001. The growth in construction revenues is attributed to the $19.0 million airport expansion project during 2002 along with the progress on the $17.6 million prison project. The airport expansion project is expected to be completed during the second quarter of 2003 and the prison project is expected to be completed in early 2004. The growth in construction revenues is expected to continue in future periods but not at the pace experienced in 2002. The backlog was $17.5 million at December 31, 2002 and was $9.7 million at December 31, 2001. The backlog at December 31, 2002 does not include two contracts awarded to Telesource during the first quarter of 2003 with a total contract value for both contracts of $11.6 million.
Construction Revenues on Power Plants. There was no construction revenues on power plants for 2002 as compared to $4.1 million in 2001. These revenues in 2001 were recognized on a contract Telesource International had to expand two existing power stations in Fiji by expanding the facilities and installing additional power generators with a combined output of 32 Mwh. This contract was accounted for under the percentage-of-completion method of accounting and was completed during 2001. Construction revenues on power plants are not expected in the immediate future until Telesource is successful in being awarded additional contracts.
Service Fees - Power Generation Plant. Service fees - power generation plant increased 31.7% to $1.1 million in 2002 from $858,336 in 2001. The growth in service fees - power generation plant is attributed to an increase in power demand by the radio relay broadcast station in Tinian during 2002 as well as completion of an expansion to the local power distribution network which connected additional customers during 2002.
Sales Revenues, Net. Sales revenues increased 203.5% to $397,376 in 2002 from $130,930 in 2001. The growth in sales during 2002 is attributed to an increase in sales to third party customers in Guam. Sales to SHBC increased to $89,998 in 2002 from $256 in 2001. Sales to SHBC are not expected to increase in future periods.
Rental Income. Rental income increased to $68,209 in 2002 from none in 2001. The increase in rental income is a result of leasing equipment not in use by Telesource to third party customers in the CNMI. Telesource expects a significant growth in rental income to third parties during 2003 due to a short term lease agreement signed in 2003 with the Guam Power Authority to assist the local utility in clean up efforts from a super typhoon, Pongsona, which struck Guam in December 2002.
Service Fees. Service fees increased to $34,640 from none. The increase is a result of Telesource providing project management services to third parties. Service fees are not expected to generate a significant source of revenues in future periods.
Finance Lease Revenues. Finance lease revenues decreased 9.3% to $1.3 million in 2002 from $1.4 million in 2001. Finance lease revenue for the Tinian power plant will decrease each year until the investment in sales type lease is fully amortized in March 2010.
Expenses
Construction Costs. Total construction costs (includes related party and third party) increased 28.5% to $15.9 million from $12.4 million for 2002 and 2001, respectively. The growth in construction costs is a direct result of an increase in construction activities, primarily due to the airport expansion project, the prison project and the museum project. Construction costs as a percentage of construction revenues were 91.4% and 104.7% for 2002 and 2001, respectively. The effective gross margin of 8.6% on construction activities during 2002 is attributed primarily to the airport project. Telesource recognized a gross margin for construction activities on the airport project of 1.5% on revenues of $9.0 million, which was 51.4% of Telesource's construction revenues for 2002. The airport's gross margin was affected by costs incurred on certain tasks at the airport project which are outside of the scope of the contract for an estimated cost of approximately $700,000. Management expects a change order to be executed in early 2003 which will cover these costs. In addition to these costs, Telesource incurred significant weather delays during the fourth quarter of 2002. Out of a total of 92 work days for the fourth quarter there were 84 days of work stoppage. The negative gross margin in 2001 on construction revenues is primarily attributed to a cost over run on the Kobblerville housing project due to delays encountered as a result of inclement weather. Additionally, there were delays in the processing of Telesource International's invoices by the Federal Housing Authority, which resulted in a delay in the collection of payments for the Kobblerville project. This ultimately led to an increase in interest expense incurred directly on this project, as well as increased costs for supplies. The weather delays and the delay in the processing of Telesource's invoices occurred during the first quarter of 2001 and were identified in connection with management's quarterly project review process. The costs estimates for the Kobblerville project were revised to $6,153,417 during 2001 from an estimated total costs of $4,830,000. The estimated profit for the Kobblerville project was reduced from $1,480,000 to $136,583. The change in estimate decreased profit on third party construction revenues by $1,343,417 and was reflected in 2001 operating results. This increase in estimated costs was recognized during 2001 and is attributed to the delays encountered in completing the project. The Kobblerville project was completed in December 2001.
Construction Costs on Power Plants. Construction costs on power plants were $0 in 2002 and $3.5 million in 2001. The decrease in construction costs on power generation plants is a result of
Telesource completing a power plant construction contract for Fiji. The net margin realized in 2001 on the construction of power generation plants was 13.5%.
Operation and Maintenance Costs - Power Generation Plant. Operation and maintenance costs - power generation plant increased 5.6% to $1,224,202 in 2002 from $1,159,132 in 2001. The increase in operation and maintenance costs for the Tinian power plant is attributed to growth in power production during 2002. During 2002, Telesource's realized increased revenue on power produced of 32.7%, which resulted in additional operation and maintenance cost of 5.6% for servicing costs. Telesource recognized a loss on power generation activities of $94,030 and $300,796 for the twelve months ended December 31, 2002 and 2001, respectively, and is attributed to management and staffing costs associated with the power plant exceeding the power production revenues. Telesource expects the Tinian power plant to become profitable in 2003.
Salaries and Employee Benefits. Salaries and employee benefits decreased 7.9% to $1.7 million in 2002 from $1.9 million in 2001. The decrease in salaries and employee benefits is attributed to management's efforts to reduce costs during 2002 by reducing staffing levels.
Occupancy and Equipment. Occupancy and equipment expenses decreased 39.0% to $342,189 in 2002 from $560,476 in 2001. The decrease in occupancy and equipment expense is attributed to cost cutting efforts of management which were achieved by closing the office on Tinian and reducing the amount of cost incurred to store equipment.
General and Administrative Expenses. General and administrative expenses increased 14.0% to $4.3 million in 2002 from $3.7 million in 2001. The increase is attributed to increased professional fees, telephone expense, bank service charges, insurance, travel and entertainment and gross revenue taxes associated with the growth and development of the business.
Other Expense, Net. Other expense decreased 23.9% to $1.8 million in 2002 from $2.3 million in 2001. The decrease is a result of reduced borrowing costs due to declining interest rates for obtained for debt by Telesource.
Income Tax Expense. There was no income tax expense for 2002 as compared to income tax expense in 2001 of $19,440. Telesource had net operating loss carryforward at December 31, 2002 of approximately $27,024,000; however, Telesource International's subsidiary in Fiji had taxable income during 2001 and incurred an estimated tax liability of $19,440.
Liquidity and Capital
Since 1994, Telesource International's primary sources of operating funds have been bank borrowings, contributions of equity capital and profits realized on projects completed. On December 31, 2003, 17,000,000 shares of Telesource International's common stock were issued and outstanding. Telesource had 15,000,000 shares issued and outstanding on December 31, 2002 until on December 29, 2003, when Telesource International sold 2 million shares of common stock at $1.00 per share to Al Amal Investments.
Cash used in operating activities during the twelve months ended December 31, 2003 and 2002 was $6.8 million and $2.0 million, respectively. The cash used in operating activities was
principally due to the increase in costs and estimated earnings in excess of billings during 2003 of $2.5 million. Significant payments on accounts payable were made in 2003.
Cash used in investing activities was $504,523 for the twelve months ended December 31, 2003 as compared to net cash provided by investing activities of $128,236 for the twelve months ended December 31, 2002. The cash used in investing activities during 2003 is attributed to capital purchases during 2003 of $639,523 which was due to the purchase of seven bucket trucks used on the super typhoon cleanup efforts on Guam during 2003.
Cash provided by financing activities generated $8.6 million for the twelve months ended December 31, 2003 as compared to $2.2 million for the same period in 2002. The cash generated by financing and from the proceeds from the sale of $11.7 million worth of preferred stock during 2003 along with $2 million of common stock.
Telesource International had a working capital deficit of $6 million at December 31, 2003 and $20.4 million at December 31, 2002. The decrease in the deficit is a result of all loans of $20.5 million, except for $7 million owed on the Commercial Bank of Kuwait credit line, becoming long term as of December 31, 2003. During 2003, the Company refinanced the balance of $13,000,000 loan from the Commercial Bank of Kuwait into monthly payments of $180,000 per month plus interest and a $2.2 million balloon payment due at maturity on March 4, 2009. The first payment of $180,000 started on February 4, 2004 and the final monthly payment to occur on March 4, 2009.
Telesource is substantially dependent upon SHBC to provide resources for operating, working capital, and business expansion. To address the working capital deficit and reduce its dependence on debt financing obtained with the support of SHBC, Telesource plans on making some reductions on existing lines and renewing the credit lines. The amount of the reductions is dependent upon the amounts of capital raised by Telesource International within the next twelve months.
Telesource International currently expects that its existing cash balances along with credit lines established in 2003 together with funds available through SHBC will be sufficient to meet anticipated cash requirements for at least the next 12 months. Telesource International obtained a $5 million credit line committed from Al-Ahli Bank for the radio relay station expansion project and the Palau Capitol Relocation projects at March 31, 2003.
Telesource has forecasted cash inflows for the next twelve months from projects of $26 million, $4.0 million from the sale of common stock in the first quarter of 2004, and $2.0 million in additional borrowings. Telesource's forecasted cash outflows consist of $9.1 million in principal and interest payments on credit lines and $24.2 million for project costs and general and administrative expenses. Telesource had cash on hand balance at December 31, 2003 of $1.5 million and forecasted cash on hand after these collections and payments of $600,000 in December of 2004.
There can be no assurance that Telesource International's present capital and financing will be sufficient to finance future operations. Telesource International may seek to raise additional capital in 2004 through the sale of equity to reduce the existing credit line borrowings as well as
to provide capital needed for growth. There can no assurance that Telesource will be successful in such efforts. If Telesource International sells additional shares of common stock to raise funds, the terms and conditions of the issuances and any dilutive effect may have an adverse impact on the existing stockholders. If additional financing beyond current levels becomes necessary, there can be no assurance that the financing can be obtained on satisfactory terms, if at all. In this event, Telesource International could be required to restrict its operations.
NEW ACCOUNTING PRONOUNCEMENTS
In August 2001, FASB issued Statement of Financial Accounting Standards No. 143 ("SFAS 143"), "Accounting for Asset Retirement Obligations," which is effective for our fiscal year beginning January 1, 2003. SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 requires, among other things, that the retirement obligations be recognized when they are incurred and displayed as liabilities on the balance sheet. In addition, the asset's retirement costs are to be capitalized as part of the asset's carrying amount and subsequently allocated to expense over the asset's useful life. We do not believe the adoption of SFAS 143 will have a material effect on our financial position, results of operations, or cash flows.
In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 establishes a single accounting model, based on the framework established in Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121"), for long-lived assets to be disposed of by sale, and resolves significant implementation issues related to SFAS 121. This statement also supercedes the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," ("APB 30") for the disposal of a segment of a business. The provisions of SFAS No. 144 are effective for the fiscal years beginning after December 15, 2001. The adoption of SFAS 144 did not have a material impact on its results of operations, financial position or cash flows.
In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal Activities." SFAS 146 requires recording costs associated with exit or disposal activities at their fair values when a liability has been incurred and is effective January 1, 2003. Under previous guidance, certain exit costs were accrued upon management's commitment to an exit by the company. We do not believe the adoption of SFAS 146 will have a material effect on our financial position, results of operations, or cash flows.
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 requires certain disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. FIN 45 supercedes FASB Interpretation No. 34, "Disclosure of Indirect Guarantees of Indebtedness of Others". The disclosure provisions of FIN 45 are effective for financial statements of both interim and annual periods that end after December 15, 2002 and the initial recognition and measurement provisions are effective on a prospective basis to guarantees issued or modified after December 31, 2002. We do not believe the adoption of FIN 45 will have a material effect on our financial position, results of operations, or cash flows.
In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148 ("SFAS 148"), "Accounting for Stock-Based Compensation -- Transition and Disclosure -- an amendment of FASB Statement No. 123." SFAS 148 amends SFAS 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities -- an Interpretation of ARB No. 51." FIN 46 addresses consolidation accounting for certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. We do not believe the adoption of FIN 46 will have a material effect on our financial position, results of operations, or cash flows.
QUARTERLY RESULTS
The following table sets forth selected unaudited financial information for the eight quarters in the period ended December 31, 2003. This information has been prepared on the same basis as the audited financial statements and, in the opinion of management, contains all adjustments necessary for a fair presentation thereof.
QUARTERLY FINANCIAL DATA (UNAUDITED -- IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
Net income per share calculations are based on the weighted average common shares outstanding for each period presented. Accordingly, the sum of the quarterly net income per share amounts may not equal the per share amount reported for the year.
Telesource's stock began trading on November 2, 2001.
ITEM 7.A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Telesource is exposed to market risk for changes in interest rates for borrowings under some of its credit facilities. These credit facilities that bear interest at variable rates, and the fair value of the borrowings are not significantly affected by changes in market interest rates.
Amounts invested in Telesource's foreign operations (Telesource Fiji, Ltd.) are translated into U. S. dollars at the exchange rates in effect at year-end. The resulting translation adjustments are recorded as accumulated other comprehensive loss, a component of stockholders' equity, in the consolidated balance sheets.
An increase in interest rates of 1.0% at December 31, 2003 would increase Telesource's interest expense on adjustable loans by approximately $175,000 per year. A decrease in interest rates of approximately the same amount, $175,000.
THIS ANNUAL REPORT ON FORM 10-K CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, PARTICULARLY STATEMENTS REGARDING MARKET OPPORTUNITIES, MARKET SHARE GROWTH, COMPETITIVE GROWTH, GROSS PROFIT, AND SELLING, GENERAL AND ADMINISTRATIVE EXPENSES AND THE INVESTMENT CONSIDERATIONS LISTED BELOW. THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN ANY SUCH FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE, BUT ARE NOT LIMITED TO ADVERSE CHANGES IN GENERAL ECONOMIC CONDITIONS, INCLUDING CHANGES IN THE SPECIFIC MARKETS FOR TELESOURCE'S SERVICES, ADVERSE BUSINESS CONDITIONS, DECREASED OR LACK OF GROWTH IN THE MECHANICAL AND ELECTRICAL CONSTRUCTION AND FACILITIES SERVICES INDUSTRIES, INCREASED COMPETITION, PRICING
PRESSURES AND RISK ASSOCIATED WITH FOREIGN OPERATIONS AND OTHER FACTORS.
Investment Considerations
Telesource International - Risks related to construction activities - --------------------------------------------------------------------
Telesource International will likely experience significant fluctuation in quarterly results, which makes it difficult for investors to make reliable period-to-period comparisons of its business.
Telesource International's quarterly operating results will depend on revenues from contracts for major projects. Telesource International can only undertake a specific number of projects at any one time. If Telesource International finishes one large project and does not have another large project to start on, revenues and results of operations within the quarter and possibly subsequent periods could suffer. Customers may also cancel or defer existing contracts resulting in reduced revenues for the quarter. Though management intends to take steps to adjust spending in a timely manner to compensate for any unexpected revenue shortfalls, it may not be successful. For example staffing reductions cannot be implemented quickly due to local labor and employment laws in the Commonwealth of Northern Mariana Islands, which limit our ability to release employees at will, and losses could result. Accordingly, any such revenue shortfalls could result in continued operating losses.
Telesource International's revenues are derived mainly from fixed-price contracts that may lead to variations in profits due to a failure to control costs.
All of Telesource International's construction revenues are derived from fixed-price contracts. Because Telesource International assumes the risk of performing such contracts at the stipulated price, any change in the estimate of ultimate costs to be incurred under the contract or to control costs during contract performance could result in losses or reduced profits for particular fixed-price contracts, which, in turn, could result in periods of operating losses.
Telesource International's principal market is highly competitive, and if Telesource International is unable to compete successfully in this market, it may be unable to increase its operations or become profitable.
The market for construction services is highly competitive and rapidly changing. Telesource International competes directly with other firms that focus on providing general construction services as well as services for more sophisticated structures, including power plants and broadcasting facilities. Many of Telesource International's competitors have well-established reputations for building residential and technical structures and have longer operating histories and significantly greater financial, technical, marketing, personnel and other resources than Telesource International has. Telesource International is subject to competition that is expected to increase in the future. If Telesource International does not successfully compete in its market, its growth opportunities will be limited and its business will not grow and its revenues may be reduced.
Telesource International relies on third parties for important raw materials and technical expertise. Telesource International's ability to enter into new engagements or to engage the business in a profitable manner will be harmed if its access to these important resources is limited or becomes too costly.
Telesource International relies on third-party suppliers for raw materials like wood, steel and concrete; for fabrication of technical equipment subsystems including diesel generations, antennas, towers and transmitters, and for providing technical expertise. Telesource International's ability to obtain raw materials, fabrication services and technical assistance is subject to a number of external factors which are outside of its control, including:
o Third parties may increase the price of the raw materials, fabrication services or technical assistance they provide.
o Third-party raw material suppliers, fabricators or technical expertise providers may decide not to provide Telesource International with materials or services.
o Telesource International has no long-term contracts with third-party suppliers of raw materials, fabrication services or technical expertise providers.
o Telesource International's third-party contracts are usually short term in duration and are cancelable by such third party.
If Telesource International fails to obtain what it needs from these providers, it may not be able to successfully compete for new business or to complete existing engagements profitably.
Telesource International is subject to substantial claims for warranty coverage which, if such claims arise, could harm its financial condition.
Telesource International offers warranties on its construction services and power generating plants. Telesource International does not maintain any material warranty reserves because these warranties are usually backed by warranties from its vendors. Should Telesource International be required to cover the cost of repairs not covered by the warranties of Telesource International's vendors or should one of Telesource International's major vendors be unable to cover future warranty claims, Telesource International could be required to outlay substantial funds, which could harm its financial condition.
Telesource International - Risks related to power generation activities - ------------------------------------------------------------------------
Telesource International's power-generating facility could be shut down unexpectedly, making it difficult to sustain revenues and cash flow.
Telesource International owns a diesel fired electric generating facility with a maximum power generation capacity of 20 mega-watts (Mw) located on the island of Tinian, in the Commonwealth of the Northern Mariana Islands, a U.S. possession. This facility from time to time may experience both scheduled and unscheduled shutdowns. Periodically, the facility will
incur scheduled shutdowns in order to perform maintenance procedures to equipment that cannot be performed while the equipment is operating. The facility may also incur unscheduled shutdowns or may be required to operate at reduced capacity levels following the detection of equipment malfunctions, or following minimum generation orders received by the utility. During periods when the facility is shutdown or operating at reduced capacity levels, Telesource International may incur losses due to the loss of its operating revenues and/or due to additional costs which may be required to complete any maintenance procedures. It is not possible for it to predict the frequency of future unscheduled shutdowns or to predict the extent of maintenance that may be required during shutdowns related to equipment maintenance.
Telesource International depends on a single customer at its power-generation facility. The loss of this single customer could cause Telesource International's revenues to decline.
Since March 1999, Telesource International began deriving a portion of its revenues from the sale of electric power. Under Telesource International's agreement with a governmental agency, the electrical power generated at Telesource International's power generation facility is owned by the governmental agency. Telesource International is paid a fee to produce the electric power. The governmental agency in turn sells the electric power to the various users throughout the Island of Tinian. If the end-user customer defaults or increases in power use do not materialize as anticipated, Telesource International's revenues base may not grow to support other operations.
Telesource International's insurance or reserves may be insufficient to cover future claims on Telesource International's power generation activities.
Telesource International's power generation activities involve significant risks of environmental damage, equipment damage and failures, personal injury and fines and costs imposed by regulatory agencies. Though management believes its insurance programs are adequate, if a liability claim is made against it, or if there is an extended outage or equipment failure or damage at Telesource International's power plant for which it is inadequately insured or subject to a coverage exclusion, and Telesource International is unable to defend against these claims successfully or obtain indemnification or warranty recoveries, Telesource International may be required to pay substantial amounts, which could have a materially adverse effect on its financial condition.
Telesource International - Other risks - --------------------------------------
Telesource International is subject to several inherent risks of conducting business internationally.
Telesource International's international operations are subject to the inherent risks of doing business abroad. The loss of any or all of Telesource International's international suppliers and customers could harm Telesource International's ability to deliver Telesource International's construction services and power services on time and cause Telesource International's sales to decline. Telesource International's financial performance could be harmed by many events and circumstances relating to international operations, including:
* Shipping delays and cancellations; * Increases in import duties and tariffs; * Foreign exchange rate fluctuations; * Changes in foreign laws and regulations; and * Political and economic instability.
Telesource International is subject to government regulation. Both the costs of compliance and the penalties imposed for a failure to comply could be substantial.
Although management does not believe that compliance with applicable regulatory requirements has harmed Telesource International's operations in the past relative to its competitors, government regulations can change, which could increase Telesource International's costs of compliance with these requirements. In addition, Telesource International's aggregate materials operations require operating permits granted by governmental agencies. Telesource International believes that tighter regulations for the protection of the environment and other factors will make it increasingly difficult to obtain new permits and renewal of existing permits may be subject to more restrictive conditions than currently exist. Failure to comply with these laws and regulations could result in fines, additional licensing requirements or the revocation of Telesource International's licenses in the particular jurisdiction. The costs of compliance could affect adversely operating results. If a substantial fine or other penalty is imposed, Telesource International's business and financial condition could be harmed.
If Telesource International does not manage its growth effectively, its future business prospects could be harmed.
Telesource International will need to expand in anticipation of a growing user base and larger demand for Telesource International's services. The focus on development of new business could cause disruptions of existing operations adversely affecting Telesource International's business. Expansion will require Telesource International to make significant up front expenditures for increasing Telesource International's sales and marketing efforts and to hire and train additional project managers, engineers and facilities operators as well as incur costs in connection with constructing power plants to be owned by Telesource. Telesource may not be successful in expanding its operations or maintaining adequate management, financial and operating systems and controls of its larger business base.
Telesource International's largest stockholder and its affiliates own approximately 66.7% of the common stock, and their interest may not be the same as the minority stockholders who will have little or no influence over Telesource International's activities.
The largest stockholder, SHBC, is able to control the outcome of all matters submitted to a vote of the holders of common stock, including the election of directors, amendments to Telesource's certificate of incorporation and approval of significant corporate transactions. SHBC owns beneficially approximately of 66.7% of the common stock.
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2003 (unaudited) and 2002
See accompanying notes to consolidated financial statements.
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 2003, 2002, and 2001
See accompanying notes to consolidated financial statements.
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Deficit and Comprehensive Income (Loss)
Years ended December 31, 2003 (unaudited), 2002, and 2001
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2003 (unaudited), 2002, and 2001
See accompanying notes to consolidated financial statements.
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
The preceding consolidated financial statements as of December 31, 2003 and for the year ended December 31, 2003 and related notes to the consolidated financial statements are unaudited. The Company's external auditors are expected to complete the annual audit of Telesource by the end of April 2004 and the Company will file an amendment as soon as practical to update the 10-K to reflect the external audit report.
(1) Background
Telesource International, Inc. (Telesource or the Company) was incorporated in Delaware in 1994. Telesource was formed in 1994 to facilitate various intra-corporate activities and, until July 1999, was a wholly owned subsidiary of Sayed Hamid Behbehani & Sons Co. W.L.L. (SHBC), a Kuwait-based civil, electrical, and mechanical engineering and construction company. Telesource is an international engineering and construction company, engaged in constructing single family homes, airports, and radio towers, and in the construction and operation of energy conversion power plants. In Tinian, an island in the Commonwealth of the Northern Mariana Islands (U.S. Territory), the Company operates a diesel fired electric power generation plant for the sale of electricity to the local power grid. In Fiji, the Company operates two diesel fired electric power generation plants for the sale of electricity to the local power grid. The Company's facility in Lombard, Illinois, handles the procurement, export, and shipping of U.S. fabricated products for use by the Company's subsidiaries or for resale to customers outside of the mainland.
The Company conducts its operations through three subsidiaries. The Company's Mariana subsidiary, Telesource CNMI, Inc., handles construction and management of the Company's energy conversion facilities in the Commonwealth of the Northern Mariana Islands and operates a branch office in Guam. The Company's second subsidiary, Commsource International, Inc., is an international export company that facilitates the purchase of equipment in the U.S. The Company's third subsidiary, Telesource Fiji, Ltd., handles the Company's power generation activities in Fiji. The Company's Palau operations are handled directly by the Company.
Telesource has three main operating segments: construction services, brokerage of goods and services, and power generation and construction of power plants. The power generation activities commenced in March 1999.
During 1999, Telesource entered into an agreement for a merger with Sixth Business Service Group, a registered company with the Securities and Exchange Commission (SEC) located in Tampa, Florida. Telesource completed the merger with and into Sixth Business Service Group on September 7, 2001, pursuant to which the stockholders of Telesource received shares of Sixth Business Service Group in exchange for their shares of Telesource stock. Sixth Business Service Group is the surviving corporation, and after the merger was completed, Sixth Business Service Group changed its name to Telesource International, Inc. Upon completion of the merger, Telesource made application for listing its common stock with the NASD and Telesource was approved for listing on the NASD Over The Counter Bulletin Board in October 2001.
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TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(2) Summary of Significant Accounting Policies
(a) Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: Telesource CNMI Inc., Commsource International, Inc., and Telesource Fiji, Ltd. All significant intercompany transactions and accounts have been eliminated.
(b) Liquidity and Going Concern
As of December 31, 2003, the Company's current liabilities exceeded its current assets by $5,868,256. The Company relies heavily on bank financing to support is operations and its ability to refinance its existing bank debt is critical to provide funding to satisfy the Company's obligations as they mature. As of December 31, 2003 the Company had total outstanding debt of $29,552,417 of which $9,422,195 is due in 2004. As of December 31, 2003 the Company had an accumulated deficit of $36,747,674 and total stockholders' deficit of $14,096,928.
The Company incurred operating losses of $5,112,748, $3,118,300, and $4,903,676 for the years ended December 31, 2003, 2002, and 2001, respectively. The Company incurred net losses of $7,315,693, $4,886,397, and $7,245,774 for the years ended December 31, 2003, 2002, and 2001, respectively.
Cash used in operating activities was $6,805,337, $2,031,793, and $4,382,413 for the years ended December 31, 2003, 2002, and 2001, respectively. Funds provided by net borrowings and stock sales amounted to $8,552,417, $2,200,000, and $3,351,882 for the years ended December 31, 2003, 2002, and 2001, respectively.
The Company's net working capital deficiency, total stockholders' deficit, recurring losses, and negative cash flows from operations raise substantial doubt about the Company's ability to continue as a going concern. Management intends to work to address these uncertainties by continuing its efforts to increase revenues and control costs with the goal of achieving profitability. Management expects the increase in revenues to be achieved by securing additional substantial projects during 2004 and through increasing revenues from existing long term power plant operation and maintenance agreements as a result of continued expansion on the island of Tinian and in the country of Fiji. However, no assurance can be given that such increased revenues will be achieved. Although management believes that the Company will be cash flow positive in 2004 including debt payments, the Company has and expects to continue to seek support from its principal stockholder, SHBC, for its operations, for working capital needs, debt repayment, and business expansion as may be required. SHBC has continued its support of the Company. SHBC has agreed to guarantee or provide letters of credit covering $27,214,000 of the Company's total debt of $29,552,417.
(c) Cash Equivalents
Telesource records as cash equivalents all highly liquid short-term investments with original maturities of three months or less.
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(d) Foreign Currency
All assets and liabilities denominated in foreign currencies are translated at the exchange rate on the balance sheet date. Revenues, costs, and expenses are translated at average rates of exchange prevailing during the period. Translation adjustments are deferred as a separate component of stockholders' equity. Gains and losses resulting from foreign currency transactions are included in the consolidated statements of earnings.
(e) Deposits in Excess of Federal Deposit Insurance Corporation Insurance
The Company maintains cash in accounts in excess of the Federal Deposit Insurance Corporation's insured limit of $100,000.
(f) Revenue Recognition
Revenue from construction contracts and construction revenues on power plants, with the exception of the power plant constructed on Tinian which is accounted for using the sales-type lease method of accounting as discussed below, is recognized using the percentage-of-completion method of accounting, based upon costs incurred and projected costs. Cost of revenue consists of direct costs on contracts, including labor and materials, amounts payable to subcontractors, direct overhead costs, equipment expense (primarily depreciation, maintenance, and repairs), interest associated with construction projects, and insurance costs. Contracts frequently extend over a period of more than one year and revisions in cost and profit estimates during construction are recognized in the accounting period in which the facts that require the revision become known. Losses on contracts, if any, are provided in total when determined, regardless of the degree of project completion. Claims for additional contract revenue are recognized in the period when it is probable that the claim will result in additional revenue and the amount can be reasonably estimated.
The Company accounts for its leasing activities in accordance with the requirements of Statement of Financial Accounting Standards No. 13, Accounting for Leases. Revenue associated with the sale of the Tinian power plant constructed and sold under a sales-type lease, measured as the present value of noncancelable rents, was recognized in connection with recording the loss on sale in 1997 and 1998. The Company recognizes finance lease revenue on the resulting sales-type lease receivable at a constant rate using the interest method. Service revenues received from operating and maintaining the Tinian power plant for the duration of the lease are recognized as earned based on actual kilowatt hours of electricity produced and delivered to the lessee's customers. To the extent that variable payments based on kilowatt-hours of production exceed the fair value of operation and maintenance services provided, the Company recognizes such contingent payments as additional finance lease revenue as they are earned.
The Company also receives variable monthly payments as compensation for its production of power. The variable payments are recognized based upon power produced and billed to the customer as earned during each accounting period.
Revenue from the Company's brokering of U.S. fabricated goods is recognized at the time of shipment. The sales revenues for U.S. fabricated goods are recognized net of costs of goods sold due to title transferring from the manufacturer directly to the Company's customer, with the risk of loss
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
borne by the customer at the time of transfer. The Company recognizes management fees and energy sales revenue in the period in which the commodity is delivered or at the time the work is performed. Telesource recognizes rental revenue on the accrual basis pursuant to contractual arrangements between the Company and its customers.
(g) Property, Plant, and Equipment
Property, plant, and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method at rates sufficient to depreciate the cost over the estimated economic lives of the assets. Depreciable lives used for financial reporting purposes are as follows:
Estimated Asset description useful life ----------------------------------------------- ------------------- Leasehold improvements Lesser of lease term or 7 years Automobiles 5 years Construction machinery and equipment 10 years Office furniture and fixtures 5 years Computer and communication equipment 5 years
Cost and accumulated depreciation are eliminated from the accounts when assets are sold or retired and any resulting gain or loss is reflected in operations in the year of disposition.
(h) Impairment of Long-lived Assets
The Company accounts for long-lived assets in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment of Long-Lived Assets. This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
(i) Income Taxes
Telesource International, Inc., Commsource International, Inc., Telesource CNMI, Inc., and Telesource Fiji, Ltd. file separate corporation income tax returns. Telesource International, Inc. and Commsource International, Inc. are U.S. corporations that file separate U.S. corporate income tax returns. Telesource CNMI, Inc. is a Commonwealth of Northern Mariana Islands corporation and files a corporation tax return for this commonwealth. Telesource Fiji, Ltd. is a Fijian corporation and files a Fijian corporation tax return. There is no corporate income tax in Palau.
Deferred income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company's subsidiary, Telesource CNMI, Inc., in the Commonwealth of the Northern Mariana Islands (CNMI) prepares its corporate income tax returns based on the local tax code. The tax code used is outlined in the "Covenant to Establish a Commonwealth of the Northern Mariana Islands in Political Union with the United States," which adopted the Internal Revenue Code as the local territorial income tax. Beginning January 1, 1985, 95% of any income tax due on the CNMI source income is rebated to the extent that it exceeds local business gross receipts taxes (GRT). In 1995, the rebate percent was decreased and currently ranges from 90% decreasing to 50% depending upon the amount of taxable income. The amounts paid for the gross receipts tax amounted to $400,509, $1,037,861, and $567,301 in 2003, 2002, and 2001, respectively, and are included in general and administrative expenses on the accompanying consolidated statements of operations.
(j) Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires 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. Actual results could differ from those estimates.
(k) Fair Value of Financial Instruments
The Company's financial instruments include cash and cash equivalents, certificate of deposit, receivables, short-term debt, accounts payable, and long-term debt. The gross carrying amount of the notes receivable related to the sales-type lease approximates fair value as the notes have been discounted at a rate approximating the Company's borrowing rate. The carrying amount of the long-term debt approximates fair value due to the variable interest rates. The carrying amounts of other assets and liabilities approximate fair value because of the short maturities of those instruments.
(l) Stock Based Compensation
The Company uses the intrinsic value method of accounting for its stock based compensation programs.
Statement of Financial Accounting Standards 123, Accounting for Stock-Based Compensation (SFAS 123), encourages, but does not require, companies to record compensation cost for employee stock-based compensation plans at fair value as determined by generally recognized option pricing models such as the Black-Scholes or the Binomial model. The Company has adopted the disclosure-only provisions of SFAS 123, and applies Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees, which does not require compensation costs to be recorded on options which have exercise prices at least equal to the market value of the stock on
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
the date of grant. Accordingly, the Company has not recognized compensation cost for its stock-based plans. If the Company had accounted for its stock-based compensation plans using the fair value recognition provision of SFAS 123, net loss and diluted earnings per share would have been increased to the pro forma amounts as follows:
(3) Customer and Credit Concentrations
The Company has a concentration with three major customers. The Company was contracted by the Commonwealth Utilities Corporation (CUC) to construct and operate a power generation facility. In March 1999, the power generation plant became operational. Power revenues from this plant began in March 1999 and are earned under the terms of a long-term power energy conversion agreement with this customer. Revenues from the CUC were $2.3 million, $2.4 million, and $2.3 million for 2003, 2002, and 2001, respectively. Another major customer, SHBC, is the Company's parent corporation and principal stockholder. SHBC is a major customer of the Company's subsidiary, Commsource International, which is involved in the trading of U.S. fabricated products. Revenues from SHBC were 0.2%, 4.6%, and 0% of the Company's total revenues for 2003, 2002, and 2001, respectively. Receivables from SHBC were $0 and $0 at December 31, 2003 and 2002, respectively. The third major customer is the Commonwealth Ports Authority (CPA). In 2001, the Company was contracted to construct an airport expansion project on the island of Tinian by the CPA. The Company recognized revenues of $1.8 million, $10.8 million, and $7.9 million from the CPA for 2003, 2002, and 2001, respectively. The forth major customer is the Department of Public Work (DPW) in the Commonwealth of Northern Mariana Islands. In 2002, the Company was contracted to construct a prison for the DPW on the island of Saipan. The Company recognized revenues of $6.5 million and $5.3 million for 2003 and 2002 from the DPW. The fifth major customer is the Fiji Electric Authority (FEA). The Company signed a 20 year operations and maintenance agreement with the FEA in April 2003 and recognized revenues from the FEA of $2.0 million in 2003.
Upon commissioning of the Company's power plant on the island of Tinian for Phase I in March 1999, the Company received 120 promissory notes each in the amount of $180,000 representing the guaranteed payment due from the customer over the term of the agreement. The par value balance of promissory notes outstanding was $11.2 million and $13.3 million as of December 31, 2003 and 2002, respectively. The discounted value of the promissory notes was $8.8 million and $10.1 million at December 31, 2003 and
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
2002, respectively. The discounted value of the operation and maintenance fee was $2.5 million and $2.8 million at December 31, 2003 and 2002, respectively. The promissory notes have been included in the original net investment in sales-type lease as discussed in note 7. Revenues from the Tinian power plant were 11.3% and 10.9% of the Company's revenues for 2003 and 2002, respectively. Gross receivables for the investment in sales-type lease were $14,260,000 and $17,020,000 at December 31, 2003 and 2002, respectively.
(4) Accounts Receivable
Accounts receivable consist of the following at December 31, 2003 and 2002:
Retainages are all due within the next 12 months. Provisions taken as an allowance for doubtful accounts during 2003 and 2002 were $38,972 and $0, respectively.
(5) Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts
Long-term construction contracts in progress accounted for using the percentage-of-completion method consisted of:
See note 3 for a description of customer concentrations.
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(6) Property, Plant, and Equipment
Total depreciation expense was $533,578, $501,554 and $411,425 in 2003, 2002, and 2001, respectively. Depreciation for construction machinery and equipment is recognized as a project expense when appropriate.
(7) Investment in Sales-type Lease
The Company's contract with one customer (Commonwealth Utilities Corporation (CUC)) for the construction and operation of a power plant on the island of Tinian is accounted for as a sales-type lease. The minimum lease payments due under the agreement began upon commissioning of the first phase of the power plant and are comprised of a guaranteed monthly payment of $180,000 for one hundred and twenty (120) months, and an operation and maintenance fee of $50,000 due monthly for one hundred and twenty (120) months. These minimum lease payments were discounted at an interest rate of 6.74%, which was the ten-year U.S. Treasury note rate in June 1997, the time of contract execution. Amortization of the minimum lease payments began in March 1999 when the plant was commissioned and the Company began collecting payments on the promissory notes and service fees for operating the plant. The Company also receives variable monthly payments as a part of its production fee of $0.02 per Kwh produced for the first 5,140,000 Kwh produced each month (Base Load) plus $0.065 per Kwh for any amount produced beyond the Base Load of 5,140,000 each month. The variable payments are recognized based upon power produced and delivered to the customer as earned during each accounting period. Service fees earned in 2003 and 2002 were not in excess of the estimated fair value of the services performed.
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
The original net investment in sales-type lease was recognized in June 1997, the date the contract was executed. The components of the net investment in sales-type lease are as follows:
The future minimum lease payments to be collected by the Company are $2,760,000 each year through 2009.
When the Company recognized the net investment in sales-type lease at the inception of the agreement in June 1997, the Company also recognized a loss on the sale of Phase I in the amount of $1,748,713. The Company recognized a loss on the sale of Phase II for the entire amount of the construction costs for Phase II, as there were no additional minimum lease payments related to this phase. The loss recognized on the sale of Phase II occurred when the contract for Phase II was executed in November 1998, and amounted to $12,521,457.
Phase I of the power plant was commissioned in March of 1999. Phase II was commissioned in March of 2000. The Company recognized power generation revenues from billings on the Tinian power plant at the rate of $0.02 per Kwh produced of $1,131,144, $1,130,172, and $858,336 for the years ended December 31, 2003, 2002, and 2001, respectively.
(8) Long-term Debt and Credit Arrangements
Long-term debt consists of the following at December 31, 2003 and 2002:
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
The Company's debt agreements contain various covenants. The Company was in compliance with these covenants or obtained waivers for the year ended December 31, 2003.
Scheduled maturities of debt outstanding as of December 31, 2003 are as follows:
Year ending December 31: 2004 $ 9,422,195 2005 20,130,222 -------------- $ 29,552,417 ==============
(9) Preferred Stock
On December 9, 2002, the Company entered into a Preferred Stock Subscription Agreement with Al Soor Consulting for Financial Management Co., W.L.L. (Al Soor), whereby Al Soor agreed to purchase 4,000,000 shares of newly designated series A convertible preferred stock, at a purchase price of $1.50 per share of series A convertible preferred stock or a total amount of $6,000,000. The sale of the 4,000,000 shares of series A preferred stock occurred in two tranches of 2,000,000 shares each on December 16, 2002 and on March 3, 2003. The Company received the proceeds of $3,000,000 from the first tranche on December 16, 2002 and issued 2,000,000 shares of Series A Preferred Stock to Al Soor. The Company has agreed to provide two promissory notes for a total value of $360,000 to the holder as collateral for dividends.
On March 31, 2003, the Company and Al Soor agreed to restructure the Certificate of Designation underlying the preferred stock sold to Al Soor in December of 2002. The restructuring involves the elimination of the collateral provided to Al Soor, elimination of the redemption feature (the preferred stock
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
was to have been redeemed by payment of $6.0 million to Al Soor by the Company at maturity in March 2008 provided that Al Soor had not converted the preferred stock prior to maturity), added a provision to allow the Company to force a conversion of the preferred stock to common stock from January 1, 2008 to March 31, 2008, and increased the coupon rate for dividends from 6.0% to 6.5%.
(10) Stockholder's Equity
On March 6, 2003, Telesource received the second tranche of funds due from Al Soor for the purchase of the preferred stock sold under a subscription agreement executed by Telesource and Al-Soor on December 9, 2002, whereby Al Soor agreed to purchase 4,000,000 shares of newly designated series A convertible preferred stock, at a purchase price of $1.50 per share of series A convertible preferred stock or a total amount of $6,000,000. Al-Soor purchased and paid for 2,000,000 shares of preferred stock in December 2002 and has now purchased the total amount of subscribed preferred stock.
On March 31, 2003, Telesource and Al Soor agreed to restructure the Certificate of Designation underlying the preferred stock sold to Al Soor in December of 2002. The restructure provided for the elimination of the collateral provided to Al Soor, elimination of the redemption feature, added a provision to allow the Company to force a conversion of the preferred stock to common stock from January 1, 2008 to March 31, 2008, and increased the coupon rate for dividends from 6.0% to 6.5%. The restructure resulted in the reclassification of the preferred stock to equity.
On March 20, 2003, the Company completed a $1,000,000 offering of 666,666 shares of Series A, 6% convertible preferred stock. On July 18, 2003, the Company completed a $700,000 offering of 466,666 shares of Series A, 6% convertible preferred stock. On August 15, 2003, the Company completed a $2,500,000 offering of 1,666,667 shares of Series A, 6% convertible preferred stock which matures in five years. On August 29, 2003, the Company completed a $500,000 offering of 333,333 shares of Series A, 6% convertible preferred stock. The preferred stock sold has been to three unrelated third parties. The Company has the option to force a conversion of all issued preferred stock into common stock at maturity. On December 15, 2003, the Company completed a $4,000,000 offering of 2,666,667 shares of Series A, 6% convertible preferred stock. The preferred stock sold has been to four unrelated third parties. The Company has the option to force a conversion of all issued preferred stock into common stock at maturity. As of December 31, 2003, the total number of shares of preferred stock issued and outstanding was 9,799,999 shares.
In January 2002, Telesource agreed to issue warrants to SHBC to purchase 1,000,000 shares of Telesource's common stock at an exercise price of $3.00 per share in connection with SHBC's agreement to provide a standby letter of credit to Telesource to be used to secure financing with The Hongkong Shanghai Banking Corporation Limited. These warrants expired unused on December 31, 2003.
In 2003, Telesource agreed to issue warrants to the purchasers of the preferred stock sold for the purchase of 2,499,999 shares of Telesource's common stock at an exercise price of $1.50 per share. The warrants issued in 2003 will expire on dates ranging from July 18, 2008 to December 15, 2008.
On December 31, 2003, 17,000,000 shares of the Company's common stock were issued and outstanding. The Company sold 2,000,000 shares of common stock to an investor, Al Amal Investments, on December 29, 2003 at $1 per share. Proceeds from the sale were received by the Company on December 29, 2003.
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
On December 31, 2002, 15,000,000 shares of the Company's common stock were issued and outstanding.
In January 2001, 2,000,000 warrants were issued to SHBC in connection with an agreement whereby SHBC granted a $10,000,000 letter of credit to the Company. Each warrant allowed SHBC to receive one share of the Company's common stock at an exercise price of $1 per share. The warrants were exercised on June 29, 2001 resulting in an additional 2,000,000 shares of the Company's common stock being issued.
On December 31, 2000, 13,000,000 shares of the Company's common stock were issued and outstanding. The Company had 10,000,000 shares issued and outstanding for most of 2000 until the Company issued an additional 3,000,000 shares to its principal stockholder, SHBC, to settle $3.0 million in trade payables due to the same stockholder. The Company had no remaining debt owed to SHBC at December 31, 2000. During the year ended December 31, 1999, the Company had 10,000,000 shares of common stock issued and outstanding.
(11) Earnings Per Share
In accordance with the disclosure requirements of Statement of Financial Accounting Standards No. 128, Earnings Per Share (SFAS 128), a reconciliation of the numerator and denominator of basic and diluted earnings per share is provided as follows:
For 2003, options to purchase 225,000 shares of common stock at a price of $1.25 and 9,799,999 shares of preferred stock were outstanding but not included in the computation of diluted earnings per share.
For 2002, options to purchase 225,000 shares of common stock at a price of $1.25 and 3,000,000 shares of preferred stock were outstanding but not included in the computation of diluted earnings per share as the effect of the options would be anti-dilutive. For 2001, options to purchase 225,000 shares of common stock at a price of $1.25 were outstanding but not included in the computation of diluted earnings per share as the effect of the options would be anti-dilutive.
(12) Stock Option Plans
The Company has adopted the disclosure-only provisions of SFAS 123, Accounting for Stock-Based Compensation. Had compensation cost for the Company's stock option plans been determined using the fair value method of accounting described in SFAS 123, the Company's net income would have been changed to the pro forma amounts indicated in note 2 of the notes to consolidated financial statements.
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
For purposes of calculating the compensation cost consistent with SFAS 123, the fair value of each option grant is estimated on the date of grant using the binomial option-pricing model with the following weighted average assumptions used for grants in 2003, 2002, and 2001:
2003 2002 2001 ----------- ----------- ----------- Risk free interest rate 4% 4% 5% Expected volatility 30% 30% 30% Expected lives (in years) 8% 8% 9% Expected dividend yield -- --
2001 Non-Employee Director's Stock Option Plan
In January 2001, the Company's board of directors adopted the 2001 Non-Employee Director's Stock Option Plan that provides for the issuance of nonqualified stock options to outside directors. Under the terms of this plan, under which 285,000 shares of common stock were reserved for issuance, options to purchase common stock are granted at not less than fair market value, become exercisable over a 3 year period from the date of grant (vesting occurs annually on the grant date at 33.3% of the grant), and expire 10 years from the date of grant.
Changes in options outstanding are summarized as follows:
2001 Incentive Stock Option Plan
In January 2001, the Company's board of directors adopted the 2001 Incentive Stock Option Plan that provides for the issuance of qualified stock options to employees. Under the terms of this plan, under which 888,000 shares of common stock were reserved for issuance, options to purchase common stock are granted at not less than fair market value, become exercisable over a 3 year period from the date of grant (vesting occurs annually on the grant date at 33.3% of the grant), and expire 10 years from the date of grant.
2001 Non-Qualified Stock Option Plan
In January 2001, the Company's board of directors adopted the 2001 Non-Qualified Stock Option Plan that provides for the issuance of nonqualified stock options to employees. Under the terms of this plan, under which 27,000 shares of common stock were reserved for issuance, options to purchase common stock are
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
granted at less than fair market value, become exercisable immediately on the date of grant, and expire 10 years from the date of grant.
All Stock Option Plans
As of December 31, 2003, the Company has issued only 225,000 options with an exercise price of for all 225,000 options of $1.25 per share. These 225,000 options were issued on January 1, 2001, vest 33.3% on each anniversary date, and are exercisable for 10 years from date of grant. The remaining contractual life for these options is six and one half years.
(13) Financial Instruments With Off-balance Sheet Risk and Concentrations of Credit Risk
Derivative financial instruments - Historically the Company has not engaged in hedging activities and currently does not hold any hedging instruments to minimize exchange rate risk.
Fair value disclosures - The carrying amounts of cash and cash equivalents, trade receivables, other current assets, accounts payable, amounts included in investments and accruals meeting the definition of financial instruments and short-term debt approximate fair value.
Standby letters of credit and financial guarantees - In the ordinary course of business with customers, vendors, and others, the Company is contingently liable for performance under letters of credit and other financial guarantees totaling approximately $22.5 million at December 31, 2003. The Company's management does not believe it is practicable to estimate the fair values of these financial instruments and does not expect any losses from their resolution.
(14) Related-party Transactions
Certain of the Company's executive officers, directors, and major stockholders are also owners, officers, and/or directors of SHBC located in Kuwait. SHBC is a civil, electrical, and mechanical engineering firm and construction contractor with 750 employees and over 30 years of experience. SHBC and its affiliates were the sole stockholder of Telesource International prior to July 1999 and now own approximately 66.7% of the common stock outstanding. SHBC and Telesource International bid and compete within the same industries; however, SHBC has agreed in writing to not bid projects within the United States and its possessions. Additionally, SHBC and SHBC's majority stockholders, Fouad Behbehani and Nasrallah Behbehani, have signed as guarantors on Telesource CNMI's promissory note with the Commercial Bank of Kuwait, New York Branch, and as guarantors on a $1,000,000 credit facility for Telesource CNMI with Kuwait Real Estate Bank. SHBC and SHBC's majority stockholders have also signed as guarantors on a $2,000,000 letter of credit issued to the Bank of Hawaii to secure a $1,900,000 credit facility. These credit facilities were used to finance the construction activities on the power plant, the West Tinian Airport expansion project, and to provide financing for other projects. Also see note 8.
Additionally, from time to time the Company may hire, on a part time or temporary basis, individuals employed by SHBC to provide assistance to Telesource on certain projects in the Northern Mariana Islands. The rates paid do not exceed the fair market value of similar services provided by unrelated third parties.
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
In 1996, the Company was subcontracted by SHBC to build a radio relay station in the Commonwealth of Northern Mariana Islands for the United States Information Agency. The agreement between SHBC and the Company included payment to the Company on a monthly basis for all time and material plus a fee of 7.5% on local purchases and procurements. The radio relay station project was completed in early 1999, however, an addition to the radio relay station was approved and the Company was hired by SHBC to perform additional construction services on the radio relay station under the same terms as the original agreement. This project concluded in 2000.
The following table provides a summary of financial information related to all services provided to SHBC by the Company:
The following table summarizes all balances related to transactions with SHBC as of the end of each period:
The Company held an investment in Telebond Insurance Corporation at December 31, 2003, in the amount of $77,695. The Company purchased insurance from Telebond and paid premiums of $45,863, $59,760, and $23,566 during the years ended December 31, 2003, 2002, and 2001, respectively. Telebond provides employment bonds along with bid, performance, and payment bonds for the Company's projects. Telebond is not a U.S. Treasury listed bonding company. Most bid, performance, and payment bonds for the Company are secured from third party vendors. The Company's President and CEO, K.J. Semikian, serves on Telebond Insurance Corporation's board of directors and as President of Telebond, and owns 10% of the stock of Telebond.
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(15) Income Taxes
Income tax expense consists of:
The foreign tax was incurred in connection with the Company's operations in Fiji and is based upon earnings within Fiji. The average tax rate for Fiji was 31%. In 2003, 2002, and 2001, the Company recorded a loss for financial reporting purposes as well as a loss for income tax reporting purposes and therefore, no current U.S. income tax expense has been reflected in the accompanying consolidated statements of operations.
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2003 and 2002 are presented below:
The valuation allowance for deferred tax assets as of December 31, 2003 and 2002 was $12,677,983 and $9,814,562, respectively. The net change in the total valuation allowance for the years ended December 31, 2003 and 2002 was an increase of $2,863,421 and an increase of $2,104,619, respectively. The net deferred tax asset at December 31, 2003 and 2002 was also fully reserved. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management believes that the valuation allowance reduces the recognition of deferred tax assets to a level that reflects the amount that is more likely than not to be realized, considering the tax planning strategies available to the Company.
At December 31, 2003, the Company has net operating loss carryforwards of approximately $34,340,000. The net operating loss carryforwards expire in the years 2017 through 2023. The 2001 deferred tax assets for the net operating loss carryforwards have been adjusted to actual amounts.
(16) Commitments and Contingencies
Minimum rental commitments under all noncancelable-operating leases, primarily related to property, vehicles, and construction equipment, in effect at December 31, 2003 are:
Year ending December 31: 2004 $ 149,804 2005 115,978 2006 30,746 2007 12,938 ----------- $ 265,782 ===========
Lease expense was $250,169, $181,043, and $452,045 for the years ended December 31, 2003, 2002, and 2001, respectively.
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
Telesource entered into an employment agreement with Khajadour Semikian in June 1999, Nidal Zayed in August 1999, and Bud Curley in April 2001. The term of the agreement with Mr. Semikian is from July 1, 1999 to July 1, 2002, which has been extended to July 3, 2004. Under the terms of the agreement, Mr. Semikian is required to devote his full time to the Company's business. The Company has agreed to pay him an annualized base salary of $220,000 during 1999, increased to $270,000 during 2000 and remaining at $270,000 per year until July 3, 2003. The payment of cash bonuses to Mr. Semikian will be at the Board's discretion. The Company has agreed to provide Mr. Semikian with health insurance for him and his family.
The term of the agreement with Mr. Zayed is from September 1, 1999 to September 1, 2002, which has been extended to July 3, 2004. Under the terms of the agreement, Mr. Zayed's responsibilities comprise serving as the number two operating officer accountable for the full range of operations. The Company has agreed to pay him an annualized base salary of $125,000 per year for the term of the agreement. The payment of cash bonuses to Mr. Zayed will be at the Board's discretion. The Company has also agreed to provide Mr. Zayed with health insurance for him and his family along with a company car. The term of the original agreement with Mr. Curley is from April 1, 2001 to October 1, 2003, which has been renewed to October 1, 2005. Under the terms of the agreement, Mr. Curley is required to devote his full time to the Company's business. The Company has agreed to pay him an annualized base salary of $165,000 during the period from April 1, 2001 to October 31, 2001, and $175,000 from November 1, 2001 to October 1, 2004. The payment of cash bonuses to Mr. Curley will be at the Board's discretion. The Company has agreed to provide Mr. Curley with health insurance for him and his family. The Company has agreed to provide Mr. Curley with a $10,000 per year car allowance for the term of this agreement.
The Company is involved in various litigation proceedings arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations, or liquidity.
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(17) Business Segment Information
The Company adopted SFAS No. 131, Disclosure About Segments of an Enterprise and Related Information, in 1998. Segments were determined based on products and services provided by each segment. Telesource has three operating segments: power generation and construction of power plants, trading, and construction services. Power generation activities did not commence until March 1999. The power generation and construction of power plants segment includes sales-type lease revenues recognized. There were no material amounts of transfers between segments. Any inter segment revenues have been eliminated. The following table sets forth certain segment information for the periods indicated:
(Continued)
TELESOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
The basis used to attribute revenues to individual countries is based upon where the services are provided.
The power generation segment includes revenues from the Company's power station on Tinian, Commonwealth of the Northern Mariana Islands in the amount of $2,273,304, $2,416,943, and $2,276,792, for 2003, 2002, and 2001, respectively. The construction revenues recognized for the expansion of two power plants in Fiji are included under the power generation segment and were $2,011,511, $0, and $4,052,600 for 2003, 2002, and 2001, respectively.
Revenues from the Company's related party, SHBC, were $30,992, $89,998, and $256 for 2003, 2002, and 2001, respectively. All other revenues recognized within the construction segment for all periods presented were earned in the Commonwealth of Mariana Islands.
Trading revenues generated by the Company's Guam office were $72,494, $307,378, and $130,205 for 2003, 2002, and 2001, respectively. All other revenues recognized within the trading segment for all periods presented were earned in the United States.
Long-lived assets located in the Commonwealth of the Northern Mariana Islands were $11.4, $13.7 million, and $15.7 million as of December 31, 2003, 2002, and 2001, respectively. Long-lived assets located in Fiji were $148,694, $12,206, and $0 as of December 31, 2003, 2002, and 2001, respectively. Long-lived assets located in Palau were $38,207, $0 and $0 as of December 31, 2003, 2002 and 2001, respectively.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The sections entitled "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" are incorporated by reference from the definitive proxy statement to be filed with the Securities and Exchange Commission in connection with the Company's 2003 annual meeting of stockholders. Information about the Company's executive officers is set forth in Item 4(a) in Part I of this Report.
ITEM 11. EXECUTIVE COMPENSATION
The section entitled "Executive Compensation" excluding the Board Compensation Committee Report and the stock price performance graph is incorporated by reference from the definitive proxy statement to be filed with the Securities and Exchange Commission in connection with the Company's 2004 annual meeting of stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Ownership of Securities" is incorporated by reference from the definitive proxy statement to be filed with the Securities and Exchange Commission in connection with the Company's 2004 annual meeting of stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section entitled "Certain Transactions" is incorporated by reference from the definitive proxy statement to be filed with the Securities and Exchange Commission in connection with the Company's 2004 annual meeting of stockholders.
PART IV
ITEM 14. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, within 90 days of the filing date of this report (the "Evaluation Date"). To maintain a cost-effective controls structure, management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can only provide reasonable assurance that our management's control objectives are met. In addition, the design of any system of control is based upon certain assumptions about the likelihood of future events, and there can no assurance that any design will succeed in achieving its stated goals under all future events, no matter how remote.
Based on this evaluation, our chief executive officer and chief financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective in timely alerting them to material information relating to the company required to be included in our periodic SEC reports. In addition, there were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the Evaluation Date. We have not identified any significant deficiencies or material weaknesses in our internal controls, and therefore there were no corrective actions taken.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The following consolidated financial statements of Telesource International, Inc. and Subsidiaries are included in Part II, Item 8: