10QSB/A 1 bestnet10qsba113005.txt PERIOD ENDED 11-30-05 ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB/A (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended November 30, 2005. [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from to . -------------- -------------- Commission File Number 0-15482 BESTNET COMMUNICATIONS CORP. --------------------------------------------------------- (Name of Small Business Issuer as Specified in Its Charter) Nevada 86-1006416 ------------------------------ ----------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2850 Thornhills Ave. SE, Suite 104, Grand Rapids, Michigan 49546 -------------------------------------- (Address of principal executive offices) (616) 977-9933 ------------------------- (Issuer's telephone number) Check whether the issuer (1) filed all report required to be filed by Section 13 or 15(d) of the Exchange Act during the past twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of December 30, 2005 there were 46,050,054 shares of common stock, par value $.001 per share, outstanding. Transitional Small Business Disclosure Format (Check One): Yes [ ] No [X] ================================================================================ 1 Explanatory Note. This amendment is being filed to correct typographical errors in the Balance sheet only. No other changes or corrections were made to this filing. We refiled the entire 10-QSB in order to provide more convenient access to the corrected information in context. BESTNET COMMUNICATIONS CORP. TABLE OF CONTENTS PAGE PART I. FINANCIAL INFORMATION ---- ITEM 1. Financial Statements Condensed Consolidated Balance Sheets as of November 30, 2005 (unaudited) and August 31, 2005 3 Unaudited Condensed Consolidated Statements of Operations for the three months ended November 30, 2005 and 2004 4 Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended November 30, 2005 and 2004 5 Notes to Unaudited Condensed Consolidated Financial Statements 6 ITEM 2. Management's Discussion and Analysis or Plan of Operation 11 ITEM 3. Controls and Procedures 14 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 15 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 15 ITEM 3. Defaults Upon Senior Securities 15 ITEM 4. Submission of Matters to a Vote of Security Holders 15 ITEM 5. Other Information 15 ITEM 6. Exhibits and Reports on Form 8-K 15 2
PART I: FINANCIAL INFORMATION ITEM 1. Financial Statements BESTNET COMMUNICATIONS CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS November 30, August 31, ASSETS 2005 2005 ------ ---- ---- (UNAUDITED) Current Assets: Cash and cash equivalents $ 165,263 $ 86,651 Accounts receivable, net of allowance of $16,711 and $15,434 60,898 62,743 Prepaid expenses and other current assets 67,566 21,077 ------------ ------------ Total current assets 293,727 170,471 Property and equipment, net of accumulated depreciation of $3,645,044 and $3,611,813 181,261 208,299 Deposits and other assets 78,247 80,197 ------------ ------------ Total assets $ 553,235 $ 458,967 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ LIABILITIES Current Liabilities: Capital lease obligations, current portion $ 1,380 $ 2,721 Accounts payable and accrued expenses 128,022 99,681 Note payable 39,540 464 Convertible note payable - related parties 80,450 80,450 Deferred revenue 11,088 15,863 ------------ ------------ Total current liabilities 260,480 199,179 ------------ ------------ STOCKHOLDERS EQUITY Preferred stock, par value $.001 per share; 10,000,000 shares authorized; 443,162 shares issued and outstanding at November 30, 2005 and August 31, 2005 443 443 Common stock, par value $.001 per share; 100,000,000 shares authorized; 47,950,054 shares issued and 46,050,054 shares outstanding at November 30, 2005; 47,019,654 shares issued and 45,119,654 shares outstanding at August 31, 2005 47,950 47,020 Additional paid-in capital 37,504,362 37,300,605 Accumulated deficit (36,348,000) (36,176,280) ------------ ------------ 1,204,755 1,171,788 Less treasury stock, 1,900,000 common shares, at cost (912,000) (912,000) ------------ ------------ Total stockholders' equity 292,755 259,788 ------------ ------------ Total liabilities and stockholders' equity $ 553,235 $ 458,967 ============ ============ See accompanying notes to condensed consolidated financial statements. 3
BESTNET COMMUNICATIONS CORP. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004 2005 2004 ---- ---- Revenues $ 342,453 $ 398,271 ------------ ------------ Expenses: Cost of revenues (exclusive of depreciation and amortization shown separately below) 213,008 243,023 General and administrative expenses 264,092 384,635 Depreciation and amortization 33,231 43,733 ------------ ------------ Total expenses 510,331 671,391 ------------ ------------ Loss from operations (167,878) (273,120) ------------ ------------ Other income (expense): Interest income 323 636 Interest and finance charges (2,417) (23,440) Other expense (1,748) (4,377) ------------ ------------ Total other expense (3,842) (27,181) ------------ ------------ Net loss attributable to common shareholders $ (171,720) $ (300,301) ============ ============ Loss per common share, basic and diluted $ (.00) $ (.01) ------------ ------------ Weighted average number of common shares outstanding, basic and diluted 45,600,190 40,674,424 ============ ============ See accompanying notes to condensed consolidated financial statements. 4
BESTNET COMMUNICATIONS CORP. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004 2005 2004 ---- ---- Operating activities: Net loss $(171,720) $(300,301) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 33,231 43,733 Non-cash stock based compensation -- 54,555 Amortization of discounts on notes payable -- 18,919 Other non-cash transactions -- 18,000 Changes in assets and liabilities: Accounts receivable 1,845 2,904 Prepaid expenses and other current assets (2,175) 13,718 Deposits and other assets 1,950 (974) Accounts payable and accrued expenses 28,341 (46,070) Deferred revenue (4,775) 690 --------- --------- Net cash used in operating activities (113,303) (194,826) --------- --------- Investing activities: Purchase of property and equipment (6,193) (23,253) --------- --------- Net cash used in investing activities (6,193) (23,253) --------- --------- Financing activities: Proceeds from exercise of warrants 204,687 -- Repayment of notes payable (5,238) (49,265) Principal payments on capital lease obligation (1,341) (1,200) --------- --------- Net cash provided by financing activities 198,108 (50,465) --------- --------- Net increase (decrease) in cash and cash equivalents 78,612 (268,544) Cash and cash equivalents, beginning of period 86,651 405,299 --------- --------- Cash and cash equivalents, end of period $ 165,263 $ 136,755 ========= ========= See accompanying notes to condensed consolidated financial statements. 5
BESTNET COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- BASIS OF PRESENTATION The condensed consolidated financial statements include the accounts of BestNet Communications Corp. and its wholly owned subsidiaries, Interpretel, Inc., and Telplex International Communications, Inc. (collectively the "Company", "BestNet", "we", "us", or "our"). All material intercompany balances and transactions have been eliminated. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-QSB. Accordingly, certain information and footnote disclosures normally included in financial statements have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the unaudited condensed consolidated financial statements for the periods presented include all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation. The balance sheet at August 31, 2005, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. For further information, refer to the Company's financial statements, and footnotes thereto, for the fiscal year ended August 31, 2005, included in our Form 10-KSB for such fiscal year. Operating results for the three-month period ended November 30, 2005, are not necessarily indicative of the results that may be expected for the fiscal year ending August 31, 2006. Bestnetcall and ClicktoPhone are registered trademarks of BestNet Communications Corp. All other trademarks, service marks and trade names referred to in this report are the property of their respective owners. Certain reclassifications have been made to conform fiscal 2005 information to the presentation of fiscal 2006 information. The reclassifications have no effect on net income. NOTE 2 -- PER SHARE DATA Basic earnings (loss) per share is calculated by dividing income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is calculated based on the weighted average number of common shares outstanding during the period plus the dilutive effect of common stock purchase warrants and stock options using the treasury stock method and the dilutive effects of convertible notes payable and convertible preferred stock using the if-converted method. Due to the net losses for the three-month periods ending November 30, 2005 and 2004, basic and diluted loss per share were the same, as the effect of potentially dilutive securities would have been anti-dilutive. Potentially dilutive securities not included in the diluted loss per share calculation, due to net losses, are as follows: November 30, November 30, 2005 2004 Underlying Underlying Description Common Shares Common Shares ----------- -------------- --------------- Convertible preferred stock 886,324 3,190,258 Convertible notes payable 670,417 -- Options 3,728,634 4,776,968 Warrants 3,165,738 6,213,494 -------------- --------------- Total potentially dilutive securities 8,451,113 14,180,720 ============== ============== 6 NOTE 3 -- STOCKHOLDERS EQUITY UNITS: On March 30, 2003, the Company completed the private placement of Units pursuant to the terms of a Unit Purchase Agreement (the "Units") with accredited investors. Each Unit consists of the following underlying securities: (a) three shares of the Company's common stock; (b) one share of Series A Convertible Preferred Stock, par value $.001 per share; and (c) one three-year warrant to purchase one share of common stock at a per share price of $0.30. Each share of Series A Convertible Preferred Stock is convertible into two shares of the Company's common stock in exchange for $0.10 per common share ($.20 for each Series A Convertible Preferred share converted). The securities underlying the Units are not to be separately tradable or transferable apart from the Units until such time as determined by the Company's Board of Directors. Our Company's Board of Directors authorized the splitting of the Units twice, once in July 2004 and then again in February 2005. As of November 30, 2005, there were 443,162 Units outstanding which have not been split. These units are presented as their underlying securities on our balance sheet and consist of 443,162 shares of Series A Preferred Stock, 443,162 warrants and 1,329,486 shares of common stock. On March 12, 2004, we received approximately $60,000 from the completed sale of an aggregate 200,000 Units at a per Unit purchase price of $0.30 to an accredited investor, Katsinam Partners, LP, which is an affiliate of one of our directors, Messrs Anthony Silverman. In August 2004, these Units were separated into their underlying securities. WARRANTS: On September 26, 2005, the Company's Executive Committee temporarily reduced the exercise price on its trading warrants. The original exercise price of these warrants was $0.30. For the period from September 26, 2005 through October 14, 2005, the exercise price on these warrants was reduced to $0.22. As of October 14, 2005, 930,400 warrants were exercised and 930,400 shares of common stock were issued as a result of these warrants being exercised. This resulted in gross proceeds to the Company of approximately $204,600. No other warrants were granted or exercised during the three-month period ended November 30, 2005. NOTE 4 -- NOTES PAYABLE Convertible Note Payable: On March 23, 2005, the Company issued to Anthony Silverman, a member of our Board of Directors, a Convertible Promissory Note in the principal amount of $110,000, convertible at the option of the holder into 916,667 shares of the Company's common stock at a conversion price of $0.12 per share, due on March 31, 2006 and bearing interest at the rate of 10% per annum, payable monthly. If the note is converted, the holder may participate in any registration of securities (with certain exceptions) effected by the Company under the Securities Act of 1933 (so-called "piggy-back" rights). On June 30, 2005, Mr. Silverman exercised warrants for the purchase of 197,000 shares of common stock at an aggregate exercise price of $29,550. Mr. Silverman agreed to reduce the principal balance of the above Convertible Promissory Note to $80,450. As of November 30, 2005, the note is convertible into 670,417 shares of the Company's common stock. Note Payable: On October 1, 2005, the Company entered into a note payable agreement to finance $44,314 of directors and officer's insurance premiums. The note bears interest at a rate of 9.25% per annum and is due in nine monthly installments of $5,115, including principal and interest, beginning on November 1, 2005. As of November 30, 2005, the principal balance outstanding was $39,540. NOTE 5 -- STOCK BASED COMPENSATION In December 2002, the Financial Accounting Standards Board ("FASB") issued Statements of Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS 7
No. 123, "Accounting for Stock-Based Compensation" in that it requires additional disclosures about our stock-based compensation plans. SFAS No. 148 is effective for periods beginning after December 15, 2002. We account for our stock-based compensation plans using the intrinsic value method of recognition and measurement principles under APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. We have adopted the disclosure-only provisions of SFAS No. 123. Assuming that we had accounted for our stock-based compensation programs using the fair value method promulgated by SFAS no. 123, pro forma net income (loss) and net income (loss) per share would have been as follows: Three Months Ended ------------------ November 30, ------------ 2005 2004 --------- --------- Net loss available to common stockholders, as reported $(171,720) $(300,301) Add: Compensation expense for equity awards recorded at fair value in the determination of net loss as reported -- 54,555 Less: Compensation expense for equity awards determined by the fair value based method (3,556) (126,867) --------- --------- Pro forma net loss available to common stockholders $(175,276) $(372,613) ========= ========= Loss per share, as reported $ (.00) $ (.01) ========= ========= Pro forma loss per share available to common stockholders $ (.00) $ (.01) ========= ========= NOTE 6 -- COMMITMENTS AND CONTINGENCIES On November 1, 2005, we entered into a new lease for our corporate headquarters. Our corporate headquarters are located on leased office space at 2850 Thornhills Ave. SE, Suite 104, Grand Rapids, Michigan 49546, at a monthly rent of $1,465 under a lease that is due to expire in October, 2007. On or about November 22, 2004, we were notified that Softalk had renewed its demand to arbitrate the issues and terminate the Softalk License, but we believe, based on the advice of our outside counsel, that the matter is now dormant. If the matter becomes active, we intend to contest Softalk's claims vigorously and to assert counterclaims against Softalk for, among other things, breaching its agreement not to compete with us for commercial customers through the use of the technology that is subject to the Softalk License. The outcome of any litigation cannot be predicted with any certainty and we are unable as of the date of this filing to estimate the costs of arbitration proceedings, if any. For further information, refer to the Company's financial statements, and footnotes thereto, for the fiscal year ended August 31, 2005, included in our Form 10-KSB for such fiscal year. NOTE 7 -- SUBSEQUENT EVENTS On December 5, 2005, members of our Board of Directors were each granted stock options to purchase 10,000 shares of our common stock at an exercise price of $0.24. These options were granted as part of our annual grant program as defined in our 2000 Incentive Stock Plan On December 19, 2005, BestNet entered into a one-year consulting agreement with Steven Kurtzman, MD whereunder, Dr. Kurtzman is expected to apply his medical expertise to advising BestNet's Board of Directors on various business opportunities in the medical or biotech fields. As full compensation for his services, Dr. Kurtzman has been granted stock options to purchase up to 200,000 shares of BestNet common stock at a price of $0.19 per share. The option will vest after one year and is exercisable during the four-year period after vesting. It has been issued under BestNet's existing Stock Plan for employees, directors and advisors. 8
NOTE 8 -- GOING CONCERN The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company has incurred losses from operations over the years and anticipates additional losses in fiscal year 2006. Management has been successful in obtaining financing from members of our Board of Directors, and additional financing was raised from the exercise of our outstanding stock purchase warrants. The Company requires and continues to pursue additional capital for revenue growth and strategic plan implementation. NOTE 9 -- RECENT AND PENDING ACCOUNTING PRONOUNCEMENTS In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"). SFAS No. 123R is a revision of FASB Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and its related implementation guidance. As permitted under SFAS No. 123, we currently account for stock options under APB Opinion No. 25 whereby (i) stock options are granted at market price and (ii) no compensation expense is recognized for stock options issued to employees since the exercise price equals the stock price on the grant date, and we disclose the pro forma effect on net earnings assuming that compensation cost had been recognized under the requirements of SFAS No. 123. SFAS No. 123R requires companies to measure and recognize compensation expense for all stock-based payments at fair value. Stock-based payments include stock option grants. We grant options to purchase common stock to some of our employees and directors at prices equal to the market value of the stock on the dates the options were granted. SFAS No. 123R becomes effective for us beginning March 1, 2006. SFAS No. 123R permits public companies to adopt its requirements using one of two methods: (i) a "modified prospective" method in which the requirements of SFAS No. 123R apply for all share-based payments granted or modified after the effective date, and to any unvested awards as service is rendered on or after the effective date or (ii) a "modified retrospective" method which includes the requirements of the modified prospective method described above, but also permits companies to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either for all periods presented or prior interim periods of the year of adoption. We have not yet determined either the method of adoption or the impact that the new standard is expected to have on our financial statements. Note 1 -- Stock Options illustrates the pro forma effects on net income and earnings per share as if we had adopted SFAS No. 123 using the Black-Scholes option-pricing model. However, the impact on future periods will depend on, among other things, the number of share-based awards granted and variables such as the volatility of our stock and when employees exercise stock options. In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151 "Inventory Costs -- an amendment of ARB No. 43, Chapter 4" ("SFAS No. 151") effective for fiscal years beginning after June 15, 2005. SFAS No. 151 will become effective for us on September 1, 2005, the beginning of our next fiscal year. This Statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). This Statement requires that those items be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. We believe that the adoption of SFAS No. 151 will not have a material effect on our financial position or results of operations. In November 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary Assets - An Amendment of APB No. 29" ("SFAS No. 153"). The provisions of this statement are effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. This statement eliminates the exception to fair value for exchanges of similar productive assets and replaces it with a general exception for exchange transactions that do not have commercial substance - that is, transactions that are not expected to result in significant changes in the cash flows of the reporting entity. We believe that the adoption of SFAS No. 153 will not have a material effect on our financial position or results of operations. In June 2005, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 154, "Accounting Changes and Error Corrections" ("SFAS No. 154"), a replacement of APB Opinion No. 20, "Accounting Changes" and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements." SFAS No. 154 applies to all voluntary changes in accounting principle and changes the requirements for accounting for and reporting a change in accounting principle. SFAS No. 154 requires the retrospective application to prior periods' financial statements of the direct 9 effect of a voluntary change in accounting principle unless it is impracticable. APB No. 20 required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. The FASB stated that SFAS No. 154 improves financial reporting because its requirements enhance the consistency of financial information between periods. Unless early adoption is elected, SFAS No. 154 is effective for fiscal years beginning after December 15, 2005. Early adoption is permitted for fiscal years beginning after June 1, 2005. SFAS No. 154 does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this statement. We will adopt SFAS No. 154 on September 1, 2005, the beginning of our next fiscal year. We expect that the adoption of SFAS No. 154 will not have a material impact on our financial position or results of operations. 10 ITEM 2. Management's Discussion And Analysis Or Plan Of Operation THIS QUARTERLY REPORT ON FORM 10-QSB CONTAINS CERTAIN STATEMENTS WHICH ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE SAFE HARBOR PROVISIONS OF SECTION 27A OF THE SECURITIES ACT OF 1993, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE STATEMENTS RELATE TO FUTURE EVENTS, INCLUDING THE FUTURE FINANCIAL PERFORMANCE OF BESTNET. IN SOME CASES, YOU CAN IDENTIFY FORWARD-LOOKING STATEMENTS BY TERMINOLOGY SUCH AS "MAY," "WILL," "SHOULD," "EXPECTS," "PLANS," "ANTICIPATES," "BELIEVES," "ESTIMATES," "PREDICTS," "POTENTIAL," OR "CONTINUE" OR THE NEGATIVE OF SUCH TERMS AND OTHER COMPARABLE TERMINOLOGY. THESE STATEMENTS ONLY REFLECT MANAGEMENT'S EXPECTATIONS AND ESTIMATES AS OF THE DATE OF THIS REPORT. ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY FROM THESE EXPECTATIONS. IN EVALUATING THOSE STATEMENTS, YOU SHOULD SPECIFICALLY CONSIDER VARIOUS FACTORS, INCLUDING THE RISKS INCLUDED IN THE REPORTS FILED BY BESTNET WITH THE SEC. THESE FACTORS MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANY FORWARD-LOOKING STATEMENTS. BESTNET IS NOT UNDERTAKING ANY OBLIGATION TO UPDATE ANY FORWARD-LOOKING STATEMENTS CONTAINED IN THIS REPORT. All references to "we," "our," "us," or "BestNet refer to BestNet Communications Corp. and its subsidiaries. This report should be read in conjunction with our Annual report on Form 10-KSB for the fiscal year ended August 31, 2005. OVERVIEW BestNet is a long distance phone carrier providing domestic and international long distance, international dialing, teleconferencing services, ClicktoPhone and custom Internet-based communications services based on proprietary technology. Our services are accessed via web browsers, text messaging, standard phones, mobile phones, wireless devices, e-mail and soft-phones. Services are delivered using standard phone lines and equipment. Our suite of communications products can potentially allow customers to save up to 70% on their existing long distance costs, with no contracts. RESULTS OF OPERATIONS COMPARISON OF THE THREE MONTH PERIOD ENDED NOVEMBER 30, 2005, TO THE THREE MONTH PERIOD ENDED NOVEMBER 30, 2004. Revenues Revenues decreased to $342,453 during the three-month period ended November 30, 2005, compared to $398,271, a decrease of 14% or $55,818 from the comparable period in fiscal 2005. The Caribbean hurricanes in September 2004 disrupted telephone communications and caused our revenue to decline beginning during the second week of September 2004. To date, this revenue has not fully returned and we do not expect it to return to the levels prior to these hurricanes. Call volume and call duration decreased by approximately 12% during the three-month period ended November 30, 2005 from the comparable period in fiscal 2005. Average revenue per minute decreased by 3% during the same comparable periods. Current period revenues were derived from customer usage of Bestnetcall service including international long distance, conference calling as well as the Company's new product, ClicktoPhone. Cost of Revenues Cost of revenues decreased to $213,008 during the three-month period ended November 30, 2005, from $243,023, a decrease of 13% or $30,015 from the comparable period in fiscal 2005. The decrease was directly related to the decrease in minutes used by customers on our network, primarily resulting from the Caribbean hurricanes in September 2004. Cost of revenues primarily include carrier expenses and charges for connectivity to our carriers. 11 General and Administrative Expenses General and administrative expenses decreased to $264,092 during the three-month period ended November 30, 2005, from $384,634, a decrease of 31% or $120,542 from the comparable period in fiscal 2005. Payroll and related expenses decreased to $68,419 during the three-month period ended November 30, 2005, from $91,005 during the comparable period in fiscal 2005. This decrease was in direct relation to a decrease in salary payments to the Company's officers. Marketing and consulting expenses decreased to $230 during the three-month period ended November 20, 2005, from $147,512 during the comparable period in fiscal 2005. The Company ended consulting contracts with two of its board members, which primarily accounted for this decrease. Insurance expense decreased to $17,078 during the three-month period ended November 30, 2005, from $23,158 during the comparable period in fiscal 2005 due to a lower premium from the renewal of the Company's Directors and Officers insurance policy. Contractors expenses increased to $35,283 during the three-month period ended November 30, 2005, from $20,458 during the comparable period in fiscal 2005. This was a direct result of capitalizing more software which met our capitalization criteria during fiscal 2005. Accounting expense increased to $54,870 during the three-month ended November 30, 2005, from $22,499 during the comparable period in fiscal 2005 due primarily to the timing of accounting services rendered. Legal expenses increased to $10,518 during the three-month period ended November 30, 2005, from $4,594 during the comparable period in fiscal 2005 due primarily to the timing of legal services rendered. Excise and commodity taxes increased to $4,216 during the three-month period ended November 30, 2005, from $2,738 during the comparable period in fiscal 2005. This increase was due primarily to the Company having to pay excise tax as a result of an excise tax audit. Depreciation and Amortization Expenses Depreciation and amortization expenses decreased to $33,231 for the three-month period ended November 30, 2005, from $43,733 for the comparable period in fiscal 2005. The decrease was primarily due to assets becoming fully depreciated. Interest Income Interest income was not significant during the periods present. Interest and Finance Charges Interest and finance charges decreased to $2,417 for the three-month period ended November 30, 2005, from $23,440 for the comparable period in fiscal 2005. The interest and finance charges are primarily attributable to the Company's issuance and conversion of convertible notes in connection with its financing transactions. The majority of these convertible notes were converted into the Company's equity securities prior to the end of fiscal 2004. LIQUIDITY AND CAPITAL RESOURCES We have never achieved a positive cash flow or profitability in our present business because we have not yet generated a volume of business sufficient to cover our overhead costs. During the second quarter of fiscal 2005, we implemented further cost cutting measures. See general and administrative expenses under "RESULTS OF OPERATIONS" within this document. Success in these efforts and plans, and even our ability to remain in business, will depend on our ability to obtain funding, as our cash flow is insufficient to cover our operating expenses or to acquire additional equipment or other assets that may be required. Our auditors have qualified their opinion on our financial statements reflecting uncertainty as to our ability to continue as a going concern. At November 30, 2005, we had cash of $165,263, which is expected to finance operations for approximately 4 months. The Company does not generate income sufficient to offset the costs of its operations. As a result, we have historically relied upon the issuance of debt or equity in order to finance our operations. Our operating losses to date have been covered by equity and debt financing obtained from private investors, including certain present members of our Board of Directors. 12 Unless we achieve profitable operations in future periods, obtain additional capital through asset sales, securing a revolving credit facility, debt or equity offerings, or a combination of the foregoing, we will encounter liquidity difficulties and be unable to continue in business. No assurance can be given that the Company will be able to raise additional capital when needed, or at all, or that such capital, if available, will be on terms acceptable to the Company. CRITICAL ACCOUNTING POLICIES "Managements Discussion and Analysis or Plan of Operation" discusses our condensed consolidated unaudited financial statements that have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements, the 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. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition, valuation allowances for accounts receivable and impairment of long-lived assets. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. The result of these estimates and judgments form the basis for making conclusions about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. The SEC suggests that all registrants list their most "critical accounting policies" in Management's Discussion and Analysis. A critical accounting policy is one which is both important to the portrayal of the Company's financial condition and results and requires management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Management believes the following critical accounting policies affect its more significant judgments and estimates in the preparation of its consolidated financial statements. The carrying value of long-lived assets and reserves related to accounts receivable, deferred income taxes and pending or threatening litigation. 13 INFLATION AND OTHER FACTORS The Company's operations are influenced by general economic trends and technology advances in the telecommunications industry. Our industry is generally subject to federal, state, provincial and local regulation. In the United States, the Federal Communications Commission ("FCC") exercises jurisdiction over all facilities and services of telecommunications common carriers to the extent those facilities are used to provide, originate, or terminate interstate or international communications. Internationally and within the United States, we operate under a Section 214 License issued to us by the FCC. We operate in Canada under a Class "A" Operating License issued to us by the Canadian Radio-television and Telecommunications Commission ("CRTC"). Currently we believe these licenses are sufficient for the services we provide. We continue to monitor changes in regulations and plan to fully comply in areas we operate around the world. ITEM 3. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, including our chief executive officer and principal accounting officer, have carried out an evaluation of the effectiveness of our disclosure controls and procedures as of November 30, 2005, pursuant to Exchange Act Rules 13a - 15(e) and 15(d) - 15 (e). Based upon that evaluation, our chief executive officer and principal accounting officer have concluded that as of such date, our disclosure controls and procedures in place are adequate to ensure material information and other information requiring disclosure is identified and communicated on a timely basis. Changes in Internal Control Over Financial Reporting During the period covered by this Report, there have been no significant changes in our internal control over financial reporting that have materially affected or are reasonably likely to have a material affect on our internal control over financial reporting. 14 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings Our involvement in legal proceedings is described in our Annual Report on Form 10-KSB filed with the SEC as of August 31, 2005. There have been no changes since this filing. ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds None. ITEM 3. Defaults Upon Senior Securities None. ITEM 4. Submission of Matters to a Vote of Security Holders None. ITEM 5. Other Information None. ITEM 6. Exhibits and Reports on Form 8-K a) Exhibits. Description 31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. b) Reports on Form 8-K Filed during the The Period Covered by This Report are as Follows: September 27, 2005 BestNet Communications Announces Temporary Reduction of Exercise Price on its Warrants October 4, 2005 BestNet Communications Announces New Facility Lease December 22, 2005 BestNet Communications Announces Medical Advisor 15 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: January 13, 2006 BESTNET COMMUNICATIONS CORP. By: /s/ Stanley L. Schloz -------------------------------- Stanley L. Schloz, President By: /s/ Michael A. Kramarz -------------------------------- Michael A. Kramarz, Chief Financial Officer