SECURITIES
AND EXCHANGE COMMISSION
Washington,
DC 20549
FORM
10-Q
(Mark
one)
x
QUARTERLY REPORT UNDER
SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE
ACT OF 1934
For
the
quarterly period ended June 30, 2006
or
TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
OF
1934
For
the
transition period from _________ to ________
Commission
File Number: 000-28985
(Exact
name of issuer as specified in its charter)
Texas
|
75-2785941
|
(State
or other jurisdiction of incorporation or organization)
|
(I.R.S.
Employer Identification No.)
|
151
So. Wymore Rd, Suite 3000, Altamonte Springs, FL 32714
(Address
of principal executive offices)
(407)
398-3232
(Issuer's
telephone number)
Indicate
by check whether the registrant (1) filed all reports required to be filed
by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 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
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer o Accelerated
filer o Non-accelerated
filer x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
126-2 of the Exchange Act).
YES o
NO x
State
the
number of shares outstanding of each of the issuer's classes of common equity
as
of the latest practicable date: August 8, 2006: 72,509,102.
VoIP,
Inc.
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Form
10-Q for the Quarter Ended June 30, 2006
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Table
of Contents
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Page
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Part
I - Financial Information
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Item
1
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Financial
Statements
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3
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Item
2
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Management's
Discussion and Analysis of Financial Condition and Results of
Operations
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20
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Item
3
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Qualitative
and Quantitative Disclosures About Market Risk
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27
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Item
4
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Controls
and Procedures
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27
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Part
II - Other Information
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Item
1
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Legal
Proceedings
|
30
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Item
1.A
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Risk
Factors
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30
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Item
2
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Unregistered
Sales of Equity Securities and Use of Proceeds
|
32
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Item
3
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Defaults
upon Senior Securities
|
32
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Item
4
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Submission
of Matters to a Vote of Security Holders
|
32
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Item
5
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Other
Information
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32
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Item
6
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Exhibits
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32
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Signatures
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33
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PART
I - FINANCIAL INFORMATION
ITEM
1. FINANCIAL
STATEMENTS
VoIP,
Inc.
|
Consolidated
Balance Sheets
|
|
|
June
30, 2006
|
|
December
31, 2005
|
|
|
|
(Unaudited)
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|
ASSETS
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
2,805,003
|
|
$
|
3,228,745
|
|
Accounts
receivable, net of allowance of
|
|
|
|
|
|
|
|
$78,116
and $177,489 respectively
|
|
|
1,126,786
|
|
|
1,116,867
|
|
Due
from related parties
|
|
|
41,903
|
|
|
161,530
|
|
Inventory
|
|
|
472,559
|
|
|
652,231
|
|
Other
current assets
|
|
|
904,444
|
|
|
935,320
|
|
Total
current assets
|
|
|
5,350,695
|
|
|
6,094,693
|
|
|
|
|
|
|
|
|
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Property
and equipment, net
|
|
|
7,541,786
|
|
|
10,141,872
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|
Goodwill
and other intangible assets
|
|
|
36,683,014
|
|
|
38,404,271
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|
Net
assets of discontinued operations
|
|
|
-
|
|
|
1,254,120
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|
Other
assets
|
|
|
184,733
|
|
|
349,205
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|
|
|
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|
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TOTAL
ASSETS
|
|
$
|
49,760,228
|
|
$
|
56,244,161
|
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LIABILITIES
AND SHAREHOLDERS' EQUITY
|
|
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|
Current
liabilities:
|
|
|
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
$
|
11,166,062
|
|
$
|
13,184,061
|
|
Loan
payable
|
|
|
3,396,011
|
|
|
4,685,236
|
|
Convertible
notes payable
|
|
|
8,124,475
|
|
|
3,399,798
|
|
Fair
value liability for warrants
|
|
|
1,871,889
|
|
|
-
|
|
Advances
from investors
|
|
|
386,675
|
|
|
3,000,000
|
|
Due
to related party
|
|
|
303,666
|
|
|
1,572,894
|
|
Other
current liabilities
|
|
|
1,941,996
|
|
|
931,004
|
|
Total
current liabilities
|
|
|
27,190,774
|
|
|
26,772,993
|
|
|
|
|
|
|
|
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Other
liabilities
|
|
|
253,812
|
|
|
245,248
|
|
|
|
|
|
|
|
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Total
liabilities
|
|
|
27,444,586
|
|
|
27,018,241
|
|
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Shareholders'
equity:
|
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Common
stock - $0.001 par value;
|
|
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100,000,000
shares authorized;
|
|
|
|
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72,509,102
and 61,523,397 shares
|
|
|
|
|
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|
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issued
and outstanding, respectively
|
|
|
72,509
|
|
|
61,523
|
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Additional
paid-in capital
|
|
|
76,989,626
|
|
|
63,964,497
|
|
Accumulated
deficit
|
|
|
(54,746,493
|
)
|
|
(34,800,100
|
)
|
Total
shareholders' equity
|
|
|
22,315,642
|
|
|
29,225,920
|
|
|
|
|
|
|
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|
TOTAL
LIABILITIES AND SHAREHOLDERS' EQUITY
|
|
$
|
49,760,228
|
|
$
|
56,244,161
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
|
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|
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|
VoIP,
Inc.
|
Consolidated
Statements of Operations (Unaudited)
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Six
Months Ended June 30
|
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Three
Months Ended June 30
|
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2006
|
|
2005
|
|
2006
|
|
2005
|
|
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Revenues
|
|
$
|
18,998,290
|
|
$
|
2,445,796
|
|
$
|
9,003,742
|
|
$
|
1,439,685
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
19,387,178
|
|
|
1,933,103
|
|
|
8,773,597
|
|
|
935,214
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit (loss)
|
|
|
(388,888
|
)
|
|
512,693
|
|
|
230,145
|
|
|
504,471
|
|
|
|
|
|
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|
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Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation
and related expenses
|
|
|
6,958,592
|
|
|
1,548,172
|
|
|
4,000,121
|
|
|
688,758
|
|
Commissions
and fees paid to third parties
|
|
|
1,336,770
|
|
|
1,173,137
|
|
|
264,545
|
|
|
1,119,812
|
|
Professional,
legal and consulting expenses
|
|
|
3,273,125
|
|
|
670,955
|
|
|
904,737
|
|
|
361,659
|
|
Depreciation
and amortization
|
|
|
3,001,680
|
|
|
540,400
|
|
|
1,475,666
|
|
|
492,420
|
|
General
and administrative expenses
|
|
|
1,549,717
|
|
|
1,463,412
|
|
|
361,628
|
|
|
1,188,205
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
before
income taxes
|
|
|
(16,508,772
|
)
|
|
(4,883,383
|
)
|
|
(6,776,552
|
)
|
|
(3,346,383
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
(income) expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
3,531,241
|
|
|
82,103
|
|
|
2,026,793
|
|
|
67,825
|
|
Financing
expenses
|
|
|
1,362,621
|
|
|
-
|
|
|
1,020,012
|
|
|
-
|
|
Change
in fair value liability for warrants
|
|
|
(2,424,502
|
)
|
|
-
|
|
|
(3,705,780
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before income taxes and results of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
discontinued
operations
|
|
|
(18,978,132
|
)
|
|
(4,965,486
|
)
|
|
(6,117,577
|
)
|
|
(3,414,208
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss before discontinued operations
|
|
|
(18,978,132
|
)
|
|
(4,965,486
|
)
|
|
(6,117,577
|
)
|
|
(3,414,208
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net
of income taxes
|
|
|
(968,261
|
)
|
|
(126,016
|
)
|
|
(21,782
|
)
|
|
(121,896
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(19,946,393
|
)
|
$
|
(5,091,502
|
)
|
$
|
(6,139,359
|
)
|
$
|
(3,536,104
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before discontinued operations
|
|
$
|
(0.28
|
)
|
$
|
(0.18
|
)
|
$
|
(0.09
|
)
|
$
|
(0.11
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net
of income taxes
|
|
|
(0.01
|
)
|
|
(0.01
|
)
|
|
-
|
|
|
(0.01
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss per share
|
|
$
|
(0.29
|
)
|
$
|
(0.19
|
)
|
$
|
(0.09
|
)
|
$
|
(0.12
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares outstanding
|
|
|
69,018,680
|
|
|
26,940,458
|
|
|
70,418,605
|
|
|
30,012,632
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
|
VoIP,
Inc.
|
Consolidated
Statements of Cash Flows (Unaudited)
|
|
|
Six
Months Ended June 30
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
Continuing
operations:
|
|
|
|
|
|
|
|
Net
loss before discontinued operations
|
|
$
|
(18,978,132
|
)
|
$
|
(4,965,486
|
)
|
Adjustments
to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
3,001,680
|
|
|
540,400
|
|
Provision
for bad debt
|
|
|
27,017
|
|
|
99,047
|
|
Common
shares issued for services
|
|
|
1,942,779
|
|
|
748,325
|
|
Amortization
of debt discounts
|
|
|
2,590,024
|
|
|
-
|
|
Options
and warrants issued for services and compensation
|
|
|
4,392,478
|
|
|
366,738
|
|
Provision
for warrants liability
|
|
|
(2,424,502
|
)
|
|
-
|
|
Noncash
litigation settlement gain
|
|
|
(397,821
|
)
|
|
-
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(36,936
|
)
|
|
(560,850
|
)
|
Due
from related parties
|
|
|
119,627
|
|
|
(158,844
|
)
|
Inventory
|
|
|
179,672
|
|
|
(186,813
|
)
|
Other
assets
|
|
|
195,348
|
|
|
296,836
|
|
Accounts
payable and accrued expenses
|
|
|
(122,659
|
)
|
|
228,795
|
|
Other
current liabilities
|
|
|
1,198,986
|
|
|
(798,398
|
)
|
Net
cash used in continuing operating activities
|
|
|
(8,312,439
|
)
|
|
(4,390,250
|
)
|
|
|
|
|
|
|
|
|
Discontinued
operations:
|
|
|
|
|
|
|
|
Loss
from discontinued operations
|
|
|
(968,261
|
)
|
|
(126,016
|
)
|
Provision
for assets of discontinued operations
|
|
|
-
|
|
|
200,000
|
|
Goodwill
impairment
|
|
|
839,101
|
|
|
-
|
|
Net
cash provided by (used in) discontinued operating activities
|
|
|
(129,160
|
)
|
|
73,984
|
|
|
|
|
|
|
|
|
|
Net
cash used in operating activities
|
|
|
(8,441,599
|
)
|
|
(4,316,266
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
Continuing
operations:
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(177,856
|
)
|
|
(37,780
|
)
|
Net
cash used in continuing investing activities
|
|
|
(177,856
|
)
|
|
(37,780
|
)
|
|
|
|
|
|
|
|
|
Discontinued
operations - net assets
|
|
|
31,019
|
|
|
(467,313
|
)
|
|
|
|
|
|
|
|
|
Net
cash used in investing activities
|
|
|
(146,837
|
)
|
|
(505,093
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
Proceeds
from issuance of notes payable
|
|
|
7,220,919
|
|
|
2,615,339
|
|
Repayment
of notes payable
|
|
|
(1,280,661
|
)
|
|
(569,228
|
)
|
Repayment
of amounts due to related party
|
|
|
(1,269,228
|
)
|
|
-
|
|
Proceeds
from warrant repricing
|
|
|
770,314
|
|
|
-
|
|
Proceeds
from sales of common stock
|
|
|
2,723,350
|
|
|
2,702,625
|
|
Net
cash provided by financing activities
|
|
|
8,164,694
|
|
|
4,748,736
|
|
|
|
|
|
|
|
|
|
Net
decrease in cash and cash equivalents
|
|
|
(423,742
|
)
|
|
(72,623
|
)
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of period
|
|
|
3,228,745
|
|
|
1,141,137
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
2,805,003
|
|
$
|
1,068,514
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
|
Notes
to Consolidated Financial Statements
NOTE
A - ORGANIZATION AND DESCRIPTION OF BUSINESS
VoIP,
Inc. (the "Company") was incorporated on August 3, 1998 under its original
name
of Millennia Tea Masters under the laws of the State of Texas. In February
2004,
the Company exchanged 12,500,000 shares for the common stock of two start-up
telecommunication businesses, eGlobalphone, Inc. and VoIP Solutions, Inc. The
Company changed its name to VoIP, Inc. in April 2004 and acquired VCG
Technologies, Inc. d/b/a DTNet Technologies (“DTNet Technologies”), a hardware
supplier, and VoIP Americas, Inc. (“VoIP Americas”), in June and September,
respectively, of 2004. The Company decided to exit its former tea business
in
December 2004 and focus its efforts and resources in the Voice over Internet
Protocol (“VoIP”) telecommunications industry. In May 2005 the Company acquired
Caerus, Inc. (“Caerus”), a VoIP carrier and service provider. In October 2005
the Company purchased substantially all of the VoIP assets of WQN Inc.'s (“WQN”)
business. In April 2006 the Company sold DTNet Technologies to a former officer
of the Company.
The
Company is an emerging global provider of advanced communications services
utilizing VoIP technology. VoIP telephony is the real time transmission of
voice
communications in the form of digitized "packets" of information over the
Internet or a private network, similar to the way in which e-mail and other
data
is transmitted. VoIP services are expected to allow consumers and businesses
to
communicate in the future at dramatically reduced costs compared to traditional
telephony networks.
The
Company owns its network and its technology and offers the ability to provide
complete product and service solutions, including wholesale carrier services
for
call routing and termination, outsourced customer service and hardware
fulfillment. The Company is a certified Competitive Local Exchange Carrier
(“CLEC”) and Interexchange Carrier (“IXC”). The Company offers a portfolio of
advanced telecommunications technologies, enhanced service solutions, and
broadband products. Current and targeted customers include regional bell
operating companies (“RBOCs”), CLECs, IXCs, wireless carriers, resellers,
internet service providers, cable multiple system operators and other providers
of telephony services.
The
Company's operations consist of three segments: Telecommunication Services,
Hardware Sales and Calling Card Sales.
The
financial information presented herein should be read in conjunction with the
consolidated financial statements for the year ended December 31, 2005. The
accompanying consolidated financial statements for the three and six months
ended June 30, 2006 and 2005 are unaudited but, in the opinion of management,
include all adjustments (which are of normal and recurring in nature) necessary
for a fair presentation of the financial position, results of operations and
cash flows for the interim periods presented. Interim results are not
necessarily indicative of results for a full year. Therefore, the results of
operations for the three and six months ended June 30, 2006 are not necessarily
indicative of operating results to be expected for the full year or future
interim periods.
Significant
accounting policies are detailed in the Company's annual report on Form 10-KSB
for the year ended December 31, 2005. All
intercompany accounts and transactions have been eliminated in consolidation.
Certain reclassifications have been made to the 2005 financial statements to
conform to the 2006 presentation.
NOTE
B - BUSINESS SEGMENT INFORMATION
The
Company has three reportable segments: telecommunication services, hardware
sales, and calling card sales. The telecommunication services segment terminates
wholesale and retail, local and long distance calls. Such termination is either
on the Company’s network or through other telecommunication service providers.
This segment is also in the early stages of implementing wholesale VoIP
services. The hardware sales segment supplies broadband components and VoIP
hardware to broadband service providers, although to a much smaller degree
now
that the Company’s DTNet Technologies subsidiary was sold. The calling card
segment sells prepaid telephone calling cards purchased from other carriers
through a network of private distributors located primarily in southern
California.
The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies as detailed in the Company's annual
report on Form 10-KSB for the year ended December 31, 2005. Information follows
about operations by business segment, as of and for the three and six months
ended June 30, 2006 and 2005. Note that the balance sheet amounts are as of
June
30, 2006 and December 31, 2005.
Six
Months Ended June 30,
|
|
|
|
|
|
|
|
Corporate
|
|
|
|
|
|
Telecommunication
|
|
Hardware
|
|
Calling
|
|
and
|
|
|
|
|
|
Services
|
|
Sales
|
|
Cards
|
|
Eliminations
|
|
Consolidated
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
8,776,545
|
|
$
|
191,496
|
|
$
|
10,030,249
|
|
$
|
-
|
|
$
|
18,998,290
|
|
Interest
expense
|
|
|
608,931
|
|
|
-
|
|
|
-
|
|
|
2,922,310
|
|
|
3,531,241
|
|
Depreciation
and amortization
|
|
|
2,954,468
|
|
|
2,124
|
|
|
-
|
|
|
45,088
|
|
|
3,001,680
|
|
Net
income (loss)
|
|
|
(7,224,232
|
)
|
|
52,143
|
|
|
(35,695
|
)
|
|
(12,738,609
|
)
|
|
(19,946,393
|
)
|
Capital
expenditures
|
|
|
177,856
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
177,856
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
1,542,112
|
|
$
|
903,684
|
|
$
|
-
|
|
$
|
-
|
|
$
|
2,445,796
|
|
Interest
expense
|
|
|
53,446
|
|
|
-
|
|
|
-
|
|
|
28,657
|
|
|
82,103
|
|
Depreciation
and amortization
|
|
|
517,595
|
|
|
2,689
|
|
|
-
|
|
|
20,116
|
|
|
540,400
|
|
Net
income (loss)
|
|
|
(2,415,330
|
)
|
|
502,081
|
|
|
-
|
|
|
(3,178,253
|
)
|
|
(5,091,502
|
)
|
Capital
expenditures
|
|
|
15,104
|
|
|
917
|
|
|
-
|
|
|
21,759
|
|
|
37,780
|
|
Three
Months Ended June 30,
|
|
|
|
|
|
|
|
Corporate
|
|
|
|
|
|
Telecommunication
|
|
Hardware
|
|
Calling
|
|
and
|
|
|
|
|
|
Services
|
|
Sales
|
|
Cards
|
|
Eliminations
|
|
Consolidated
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
4,143,998
|
|
$
|
123,643
|
|
$
|
4,736,101
|
|
$
|
-
|
|
$
|
9,003,742
|
|
Interest
expense
|
|
|
283,571
|
|
|
-
|
|
|
-
|
|
|
1,743,222
|
|
|
2,026,793
|
|
Depreciation
and amortization
|
|
|
1,455,503
|
|
|
762
|
|
|
-
|
|
|
19,401
|
|
|
1,475,666
|
|
Net
income (loss)
|
|
|
(2,777,544
|
)
|
|
52,707
|
|
|
(9,102
|
)
|
|
(3,405,420
|
)
|
|
(6,139,359
|
)
|
Capital
expenditures
|
|
|
67,535
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
67,535
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
698,177
|
|
$
|
741,508
|
|
$
|
-
|
|
$
|
-
|
|
$
|
1,439,685
|
|
Interest
expense
|
|
|
53,446
|
|
|
-
|
|
|
-
|
|
|
14,379
|
|
|
67,825
|
|
Depreciation
and amortization
|
|
|
487,595
|
|
|
1,377
|
|
|
-
|
|
|
3,448
|
|
|
492,420
|
|
Net
income (loss)
|
|
|
(1,782,609
|
)
|
|
495,430
|
|
|
-
|
|
|
(2,248,925
|
)
|
|
(3,536,104
|
)
|
Capital
expenditures
|
|
|
5,411
|
|
|
-
|
|
|
-
|
|
|
(5,411
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
|
|
|
|
Telecommunication
|
|
Hardware
|
|
Calling
|
|
and
|
|
|
|
|
|
Services
|
|
Sales
|
|
Cards
|
|
Eliminations
|
|
Consolidated
|
|
As
of June 30, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Identifiable
assets
|
|
$
|
9,123,606
|
|
$
|
98,292
|
|
$
|
1,627,066
|
|
$
|
2,528,254
|
|
$
|
13,377,218
|
|
Goodwill
|
|
|
23,351,473
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
23,351,473
|
|
Other
intangible assets, net
|
|
|
13,026,541
|
|
|
-
|
|
|
-
|
|
|
305,000
|
|
|
13,331,541
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Identifiable
assets
|
|
$
|
11,979,115
|
|
$
|
199,703
|
|
$
|
1,448,236
|
|
$
|
2,797,186
|
|
$
|
16,424,240
|
|
Goodwill
|
|
|
23,306,341
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
23,306,341
|
|
Other
intangible assets, net
|
|
|
14,792,930
|
|
|
-
|
|
|
-
|
|
|
305,000
|
|
|
15,097,930
|
|
NOTE
C - LIQUIDITY AND CAPITAL RESOURCES
The
accompanying consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of America,
which contemplates continuation of the Company as a going concern. The Company
has incurred operating losses and negative cash flows from operations since
inception of its business in 2004 and has been dependent on issuances of debt
and equity instruments to fund its operations and capital expenditures. The
Company’s independent auditors have added an explanatory paragraph to their
opinion on the Company’s consolidated financial statements for the year ended
December 31, 2005, based on substantial doubt about the Company’s ability to
continue as a going concern.
At
June
30, 2006, the Company's contractual obligations for debt, leases and capital
expenditures totaled approximately $21.3 million. Included in this amount is
approximately $3.4 million due on a loan from a lending institution. The Company
was not in compliance with certain covenants under the loan agreement for this
debt. However, the lender has not declared a default.
See
NOTE
H for a description of the Company’s convertible notes issued in January and
February 2006. As explained below, the subscription agreements for these notes
contain provisions that could impact the Company’s future capital raising
efforts and its capital structure:
· |
As
required by the subscription agreements, in February 2006, the Company
filed a registration statement (the “Notes Registration Statement”) to
register 200% of the shares issuable upon conversion of these notes
and
all of the shares issuable upon exercise of the warrants issued in
connection with the notes. Until the Notes Registration Statement
is
declared effective by the Securities and Exchange Commission (the
“SEC”),
the Company is liable for liquidated damages totaling $181,870 through
June 30, 2006, and will continue to incur additional liquidated damages
of
$168,215 per month until the required shares and warrants are registered.
|
· |
Unless
consent is obtained from the note holders, the Company may not file
any
new registration statements or amend any existing registrations until
the
sooner of (i) 60 days following the effective date of the Notes
Registration Statement or (ii) all the notes have been converted
into
shares of the Company’s common stock and such shares of common stock and
the shares of common stock issuable upon exercise of the warrants
have
been sold by the note holders.
|
· |
Until
the Notes Registration Statement has been effective for 365 days,
the note
holders must be given the right of first refusal with respect to
any
proposed sale of the Company’s common stock or debt
obligations.
|
· |
Unless
consent is obtained from the note holders, for so long as 20% or
more of
the principal amount of the notes, the warrants or the common stock
issued
or issuable for the notes remains outstanding, the Company may not
issue
any new shares of common stock, convertible securities or warrants
at a
price per share, conversion price per share or exercise price per
share
that is lower than those prices in effect for the notes and warrants
without issuing the note holders sufficient additional shares or
warrants
at prices such that their warrant exercise price or per share price
on
average is equal to that for the proposed securities to be
issued.
|
· |
Since
April 2006, the Company has been in violation of certain requirements
of
these debt facilities. One of the note holders, owed approximately
$1.1
million, has declared its notes in default. As such, the full amount
of
the notes at June 30, 2006 has been classified as current.
|
The
Company will need to continue to raise additional debt or equity capital to
provide the funds necessary to restructure or repay its $3.4 million loan,
meet
its other contractual commitments, and continue its operations. The Company
is
actively seeking to raise this additional capital but may not be successful
in
obtaining the imminently-required debt or equity financing. The accompanying
financial statements do not include any adjustments relating to the
recoverability and classification of asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
In
connection with a private placement memorandum dated May 20, 2005, the Company
issued 2,430,500 shares of its common stock for $0.80 per share, and warrants
to
purchase the same number of common shares for $1.60 per share. As required
by
the subscription agreements, a portion of these shares were registered with
the
SEC in October 2005, and the remaining portion was included in the Company’s
February 2006 registration statement, which is not yet effective. Until this
registration statement is declared effective by the SEC, the Company is liable
for liquidated damages, requiring the issuance of new common shares at the
rate
of 1.5% of the unregistered shares per month. At June 30, 2006 this equated
to
560,750 shares owing, recognized as a $650,148 current liability on the
Company’s balance sheet. Future liquidated damages equate to 135,438 common
shares per month until this registration statement is declared effective by
the
SEC.
The
Company’s authorized shares of stock consist of 100,000,000 shares of common
stock. As of June 30, 2006, 72,509,102 common shares were issued and
outstanding, and approximately 53,000,000 additional shares are contingently
issuable upon the exercise of stock options and warrants, or conversion of
convertible securities. A proxy statement will be filed in connection with
the
Company’s annual meeting of shareholders, at which a proposal will be submitted
to increase the authorized shares of common stock to 250,000,000 shares. If
such
proposal is not approved, the Company may be unable to satisfy the contractual
obligations it has undertaken to issue future shares of common stock.
NOTE
D - PROPERTY AND EQUIPMENT, NET
Property
and equipment consisted of the
following:
|
|
|
June
30,
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
Equipment
|
|
$
|
8,726,907
|
|
$
|
9,367,737
|
|
Furniture
& Fixtures
|
|
|
89,212
|
|
|
216,402
|
|
Software
|
|
|
700,907
|
|
|
1,667,864
|
|
Vehicles
|
|
|
19,831
|
|
|
15,269
|
|
Leasehold
improvements
|
|
|
105,511
|
|
|
248,952
|
|
Total
|
|
|
9,642,368
|
|
|
11,516,224
|
|
Less
accumulated depreciation
|
|
|
(2,100,582
|
)
|
|
(1,374,352
|
)
|
Total
|
|
$
|
7,541,786
|
|
$
|
10,141,872
|
|
Depreciation
expense for the six months ended June 30, 2006 and 2005 amounted
to
$1,235,291 and $281,141,
respectively.
|
NOTE
E - GOODWILL AND OTHER INTANGIBLE ASSETS
The
Company's balance sheet at June 30, 2006 includes approximately $23.4
million in goodwill and approximately $13.3 million in other intangible assets
recorded in connection with the acquisitions. The Company recorded
significant additional amounts of goodwill and intangible assets as a result
of
the acquisition in October 2005 of substantially all of the assets relating
to
the VoIP business of WQN, and the acquisition in May 2005 of Caerus and its
subsidiaries.
In
accordance with SFAS 142, management tests the carrying value of goodwill
and
other intangible assets for impairment at least annually by comparing the
fair
values of these assets to their carrying values. During the year ended December
31, 2005 the Company recorded an impairment charge to its operating results
of
approximately $4.2 million relating to goodwill previously recorded for an
acquisition. In the six months ended June 30, 2006, we recorded an impairment
charge to operating results of $839,101 as a result of selling the interest
in
its subsidiary, DTNet Technologies in April 2006. These charges reduced the
carrying value of the subsidiary to its estimated fair value. The Company
may be
required to record additional impairment charges for these assets in the
future,
which could materially adversely affect its financial condition and results
of
operations. If the traded market price of the Company's common stock continues
to decline, or the Company's future revenue does not increase coincident
with amounts previously projected and utilized to determine the fair value
of
our goodwill and other intangible assets, a material goodwill impairment
charge in the third quarter of 2006 is likely.
As
of June 30, 2006 and December 31, 2005, goodwill and other intangible
assets consisted of the
following:
|
|
|
|
|
2006
|
|
2005
|
|
Goodwill,
by business segment:
|
|
|
|
|
|
|
|
|
|
|
Telecommunication
services
|
|
|
|
|
$
|
23,351,473
|
|
$
|
23,306,341
|
|
Hardware
sales
|
|
|
|
|
|
-
|
|
|
-
|
|
Calling
cards
|
|
|
|
|
|
-
|
|
|
-
|
|
Corporate
and other
|
|
|
|
|
|
-
|
|
|
-
|
|
Subtotal
|
|
|
|
|
|
23,351,473
|
|
|
23,306,341
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Useful
Life Years)
|
|
|
|
|
|
|
|
Technology
|
|
|
4.0
|
|
$
|
6,000,000
|
|
$
|
6,000,000
|
|
Customer
relationships
|
|
|
5.0
- 6.0
|
|
|
8,325,000
|
|
|
8,325,000
|
|
Trade
names
|
|
|
9.0
|
|
|
1,300,000
|
|
|
1,300,000
|
|
Non-compete
agreement
|
|
|
1.0
|
|
|
500,000
|
|
|
500,000
|
|
Other
intangible assets
|
|
|
Indefinite
|
|
|
914,000
|
|
|
914,000
|
|
Subtotal
|
|
|
|
|
|
17,039,000
|
|
|
17,039,000
|
|
Accumulated
amortization
|
|
|
|
|
|
(3,707,459
|
)
|
|
(1,941,070
|
)
|
Other
intangible assets, net
|
|
|
|
|
|
13,331,541
|
|
|
15,097,930
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
goodwill and other intangible assets
|
|
|
|
|
$
|
36,683,014
|
|
$
|
38,404,271
|
|
The
December 31, 2005 goodwill amount excludes $1,037,101 related to the Company’s
hardware sales segment, which was reclassified to net assets of discontinued
operations.
Amortization
expense for the six months ended June 30, 2006 and 2005 amounted
to
$1,766,389 and $259,259
respectively.
|
NOTE
F - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
As
of
June 30, 2006 and December 31, 2005, accounts payable and accrued expenses
consisted of the following:
|
|
2006
|
|
2005
|
|
Accounts
payable-trade
|
|
$
|
8,571,490
|
|
$
|
11,034,547
|
|
Accrued
expenses
|
|
|
2,594,572
|
|
|
2,149,514
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
11,166,062
|
|
$
|
13,184,061
|
|
NOTE
G - LOAN PAYABLE
The
loan
payable of $3,396,011 and $4,685,236 at June 30, 2006 and December 31, 2005,
respectively, is owed to a lending institution. This loan bears interest at
12.5%, and is repayable through June 2007 if the loan’s repayment schedule is
not accelerated or modified. Additional borrowings under this facility are
contingent upon, among other things, the Company raising certain levels of
additional equity financing. Interest expensed and paid under this debt facility
during the six months ended June 30, 2006, and 2005 was $258,954 and $53,446,
respectively.
The
loan
agreement contains customary covenants and restrictions and provides the lender
the right to a perfected, first-priority security interest in all of the
Company’s assets, as well as rights to preferred stock warrants. The Company was
in violation of certain requirements of this debt facility at June 30, 2006.
As
a result, the full amount of the loan at June 30, 2006 has been classified
as
current. To date, the lender has not declared this loan in default.
NOTE
H - CONVERTIBLE NOTES AND WARRANTS PAYABLE
At
June
30, 2006 and December 31, 2005 convertible notes payable consisted of the
following:
|
|
2006
|
|
2005
|
|
Payable
to WQN, Inc.
|
|
$
|
3,700,000
|
|
$
|
3,700,000
|
|
Payable
to accredited investors
|
|
|
12,138,023
|
|
|
1,496,804
|
|
Subtotal
|
|
|
15,838,023
|
|
|
5,196,804
|
|
|
|
|
|
|
|
|
|
Less
discounts
|
|
|
(7,713,548
|
)
|
|
(1,797,006
|
)
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
8,124,475
|
|
$
|
3,399,798
|
|
In
July
and October 2005, the Company issued and sold $3,085,832 in principal amount
of
convertible notes to accredited investors at a discount, receiving net proceeds
of $2,520,320. These notes are immediately convertible at the option of the
note
holders into shares of the Company’s common stock at $0.80 per share. These note
holders also received five-year warrants to purchase 3,569,792 shares of the
Company’s common stock for prices ranging from $1.37 to $1.65 per share. These
notes are secured by a subordinated lien on the Company’s assets, and the notes
bear interest at an effective rate of approximately 20%. The principal balance
of these notes was $923,702 and $1,496,804 at June 30, 2006 and December 31,
2005, respectively. Half of these notes became payable beginning in October
2005, and the other half beginning in January 2006 (three months following
their
respective issuances), over two years in cash or, at the option of the Company,
in registered common stock at the lesser of $0.80 per share or 85% of the
weighted average price of the stock on the OTC Bulletin Board (the “OTCBB”). In
May 2006, the Company repriced these warrants to $0.78 per share, at which
time
these warrants were exercised, resulting in net proceeds to the Company of
$2,720,120. The Company then agreed to issue warrants to purchase a like number
of shares to the investors, entitling them to purchase such shares for $0.80
for
five years. At June 30, 2006, the Company had not made scheduled payments of
$142,520 on these notes. In July 2006, the Company was also in violation of
the
registration requirements contained in the related subscription agreements.
The
Company will incur related liquidated damages of $13,856 per month until a
registration statement related to the shares and warrants is declared effective
by the SEC. One of the note holders, owed approximately $1.1 million, has
declared its notes in default. As such, the full amount of the notes at June
30,
2006 has been classified as current.
In
January and February 2006, the Company issued and sold $11,959,666 principal
amount of convertible notes to accredited investors at a discount, receiving
net
proceeds of $9,879,400. These notes were immediately convertible at the option
of the note holders into shares of the Company’s common stock at $1.40 per
share. These note holders also received five-year warrants to purchase 4,254,297
shares of the Company’s common stock for $1.46 per share, and one-year warrants
to purchase 4,254,297 shares for $1.59 per share. In May 2006, the note
conversion rate and warrant exercise prices were repriced to $1.00 per share.
Approximately $7.6 million of these notes are secured by a subordinated lien
on
the Company’s assets. The principal balance of these notes was $11,214,321 at
June 30, 2006. All these notes bear interest at an effective rate of
approximately 20%, and are payable (as amended in May 2006) over two years
beginning either July 6, 2006 or August 15, 2006 in cash or, at the option
of
the Company, in registered common stock at the lesser of $1.00 per share or
85%
of the weighted average price of the stock on the OTCBB. Since April 2006,
the
Company has been in violation of the registration requirements contained in
the
related subscription agreements. As related liquidated damages, in May 2006,
the
Company issued 166,366 shares to certain of the investors, has incurred an
additional $181,870 through June 30, 2006, and will continue to incur additional
liquidated damages of $168,215 per month until the required amount of shares
and
warrants are registered. At August 15, 2006, the Company had also not made
scheduled payments of $21,008 for these notes. One of the note holders, owed
approximately $1.1 million, has declared its notes in default. As such, the
full
amount of the notes at June 30, 2006 has been classified as current.
In
October 2005, the Company acquired substantially all of the operating assets
and
liabilities of WQN, for a total purchase price of $9.8 million. The acquisition
was financed in part with the issuance of a convertible note in the principal
amount of $3.7 million. A debt discount was established to reflect an effective
interest rate of 20%, bringing the original net note payable value to
$3,216,000. This note is convertible at the option of WQN into shares of the
Company’s common stock at a price of $0.78 per share. This note is payable over
12 months beginning February 2006, and bears nominal interest at 6%. However,
the scheduled payments have not been made, and WQN has agreed to subordinate
its
repayment claim to the convertible note holders described in the two preceding
paragraphs. At June 30, 2006 the Company was in violation of certain
requirements of this note. While WQN has not declared the note in default,
the
full amount of the note at June 30, 2006 has been classified as
current.
No
interest was paid on any of the convertible notes described above during the
six
months ended June 30, 2006.
The
Company had insufficient authorized common shares to satisfy the warrant
obligations associated with the convertible notes issued in January and February
2006 on the dates the warrants were issued. Therefore, in accordance with
Emerging Issues Task Force Issues 00-27 and 00-19, the $3,526,077 initial value
of these warrants at their issuance dates was recorded as a debt discount and
a
warrant liability on the Company’s consolidated balance sheet. In addition,
$770,314 of the proceeds received from the May 2006 warrant repricing and
exercise discussed in the fourth preceding paragraph above were allocated to
these warrants, and recorded as a warrant liability on the Company’s balance
sheet. The liability has since been marked-to-market, resulting in a $2,424,502
decrease in the liability at June 30, 2006, and a corresponding credit to
earnings for the six months ended June 30, 2006.
NOTE
I - ADVANCES FROM INVESTORS
Advances
from investors of $386,675 at June 30, 2006 represent funds deposited with
the
Company in anticipation of the issuance of future notes payable. The unsecured
advances from investors of $3,000,000 at December 31, 2005 represent funds
deposited with the Company in anticipation of the issuance of convertible notes
payable, which were issued in January 2006 (see NOTE H).
These
advances are not interest bearing, and are unsecured.
NOTE
J - ACQUISITIONS
On
May
31, 2005, the Company acquired 100% of Caerus and its wholly owned subsidiaries
Volo Communications, Inc. (“Volo”), Caerus Networks, Inc., and Caerus Billing,
Inc. in exchange for approximately 16,900,000 of the Company's common shares
(plus 2,000,000 million escrowed shares).
The
goodwill, intangible assets and property recorded for the acquisition of Caerus
represent the fair market value of liabilities as of the date of acquisition,
plus approximately $18.3 million, which represents the value of the Company's
common stock and options issued pursuant to the acquisition.
On
October 5, 2005, the Company acquired substantially all of the operating assets
and liabilities of WQN, for a total purchase price of $9.8 million. The
acquisition was financed with the issuance of $3.7 million of convertible debt
($3.2 million net of discount), 1,250,000 shares of the Company’s common stock,
and 5,000,000 warrants to purchase the Company’s common stock at $0.001 per
share.
Condensed
balance sheets of the Caerus and WQN acquisitions, reflecting the net fair
value
amounts assigned to each major asset and liability, as of their respective
acquisition dates are as follows:
|
|
Caerus,
Inc.
|
|
WQN,
Inc.
|
|
|
|
|
|
|
|
Current
assets
|
|
$
|
617,000
|
|
$
|
3,775,000
|
|
Property
and equipment, net
|
|
|
7,869,000
|
|
|
508,000
|
|
Other
assets
|
|
|
131,000
|
|
|
463,000
|
|
Accounts
payable and other current liabilities
|
|
|
(14,674,000
|
)
|
|
(2,031,000
|
)
|
Note
payable
|
|
|
(4,832,000
|
)
|
|
-
|
|
Net
liabilities assumed
|
|
|
(10,889,000
|
)
|
|
2,715,000
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
|
17,778,000
|
|
|
4,120,000
|
|
Intangible
assets - other
|
|
|
13,800,000
|
|
|
2,925,000
|
|
Intangible
assets
|
|
|
31,578,000
|
|
|
7,045,000
|
|
|
|
|
|
|
|
|
|
Net
fair value assets acquired
|
|
$
|
20,689,000
|
|
$
|
9,760,000
|
|
NOTE
K - LITIGATION
MCI
On
April
8, 2005, The Company’s subsidiary Volo filed suit against MCI WorldCom Network
Services, Inc. d/b/a UUNET ("MCI WorldCom"). Volo alleges that MCI WorldCom
engaged in a pattern and practice of over-billing Volo for the
telecommunications services it provided pursuant to the parties' Services
Agreement, and that MCI WorldCom refused to negotiate such overcharges in good
faith. Volo also seeks damages arising out of MCI WorldCom's fraudulent practice
of submitting false bills by, among other things, re-routing long distance
calls
over local trunks to avoid access charges, and then billing Volo for access
charges that were never incurred.
On
April
4, 2005, MCI WorldCom declared Volo in default of its obligations under the
Services Agreement, claiming that Volo owes a past due amount of $8,365,980,
and
threatening to terminate all services to Volo within five days. By this action
Volo alleges claims for (1) breach of contract; (2) fraud in the inducement;
(3)
primary estoppel; and (4) deceptive and unfair trade practices. Volo also seeks
a declaratory judgment that (1) MCI WorldCom is in breach of the Services
Agreement; (2) $8,365,980 billed by MCI WorldCom is not "due and payable" under
that agreement; and (3) MCI WorldCom's default letter to Volo is in violation
of
the Services Agreement. Volo seeks direct, indirect and punitive damages in
an
amount to be determined at trial.
On
May
26, 2005, MCI WorldCom filed an Answer, Affirmative Defenses, Counterclaim
and
Third-Party Complaint naming Caerus as a third-party defendant. MCI WorldCom
asserts a breach of contract claim against Volo, a breach of guarantee claim
against Caerus, and a claim for unjust enrichment against both parties, seeking
an amount to be determined at trial. On July 11, 2005, Volo and Caerus answered
the counterclaim and third-party complaint, and filed a third-party counterclaim
against MCI WorldCom for declaratory judgment, fraud in the inducement, and
breach of implied duty of good faith and fair dealing. Volo and Caerus seek
direct, indirect and punitive damages in an amount to be determined at trial.
On
August
1, 2005, MCI WorldCom moved to strike most of Volo's and Caerus' affirmative
defenses and demand for attorney's fees, and to dismiss Caerus' counterclaims.
On October 6, 2005, the Court denied the motions in part, granted them in part
with leave to amend, and deferred ruling on the motions in part. On October
13,
2005, Volo and Caerus filed amended affirmative defenses, and Caerus filed
amended counterclaims.
Discovery
is in progress. MCI WorldCom has served requests for documents and for
admissions and interrogatories on Volo and Caerus, to which Volo and Caerus
have
responded. Volo has served document requests and interrogatories on MCI
WorldCom. Volo has also initiated third party discovery. The Court on March
9,
2006 granted in part and denied in part motions to compel disclosures brought
by
Volo and MCI WorldCom and directed the appointment of an independent expert
to
review and report to the Court on certain matters relevant to the parties'
claims and defenses. The Court on April 12, 2006 granted in part and denied
in
part motions brought by Volo for a protective order and by MCI WorldCom to
compel disclosures, and MCI WorldCom's motion for clarification of the March
9,
2006 Order. On
May 4,
2006, the Court entered an order directing the appointment of an independent
expert to review and report to the Court and the parties upon the routing and
termination of calls received by MCI WorldCom from Volo. Volo has contended
that
such routing and termination is relevant, inter
alia,
to its
allegations that MCI WorldCom engaged in a fraudulent and systematic re-routing
of traffic through local trunks in order to avoid paying access fees to
terminate such calls. On
May 4,
2006, the Court issued a Case Management and Scheduling Order directing the
parties to mediate by February 1, 2007 and setting a target trial date of
February/March 2007.
The
Company is currently unable to assess the outcome of this litigation or its
impact on the Company’s financial condition and results of
operations.
Netrake
Corporation
The
Company and its subsidiaries Caerus and Volo were involved in disputes with
Netrake Corporation ("Netrake") arising from an equipment purchase contract
under which Volo agreed to purchase approximately $2.0 million of Netrake’s
telephonic equipment and software. Through mediation, these disputes were
settled July 27, 2006, primarily requiring Volo to return equipment purchased
in
connection with the contract and to make an immaterial monetary payment to
Netrake. In conjunction with this settlement, the Company recognized a $397,821
gain during the three months ended June 30, 2006, primarily related to the
excess of accounts payable over the net book value of the equipment to be
returned.
NOTE
L - STOCK BASED COMPENSATION
A
total
of 4,000,000 shares of common stock have been reserved for issuance under the
Company's 2004 Employee Stock Option Plan. In addition, on December 7, 2005,
the
Company’s Board of Directors approved, subject to shareholder approval, the
Company’s 2006 Equity Incentive Plan (the “2006 Plan”). The 2006 Plan provides
that key employees, consultants and non-employee directors of the Company or
an
affiliate may be granted: (1) options to acquire shares of the Company’s common
stock; (2) shares of restricted common stock; (3) stock appreciation rights;
(4)
performance-based awards; (5) “Dividend Equivalents”; and (6) other stock-based
awards. The Company is seeking shareholder approval at its 2006 annual meeting
of shareholders for the future issuance of options under the 2006 Plan to allow
its participants to acquire up to 10,000,000 shares of the Company’s common
stock. The activity in these plans, subject to shareholder approval of the
2006
Plan, for the six months ended June 30, 2006 is as follows:
|
|
Number
|
|
Exercise
Price Range
|
|
Weighted
Average
Exercise
Price
|
|
|
|
|
|
|
|
|
|
Options
outstanding at December 31, 2005
|
|
|
3,746,562
|
|
$
|
0.85
- $1.56
|
|
$
|
1.21
|
|
Options
returned to the plan due
|
|
|
|
|
|
|
|
|
|
|
to
employee terminations
|
|
|
(2,113,812
|
)
|
$
|
0.85
- $1.56
|
|
$
|
1.29
|
|
Options
exercised
|
|
|
(319,650
|
)
|
$
|
0.85
- $1.56
|
|
$
|
1.04
|
|
Options
granted
|
|
|
3,500,000
|
|
$
|
1.00
- $1.56
|
|
$
|
1.21
|
|
Options
outstanding at June 30, 2006
|
|
|
4,813,100
|
|
$
|
0.85
- $1.56
|
|
$
|
1.19
|
|
The
Company recorded compensation expense of $4,392,478 and $366,738 for the six
months ended June 30, 2006 and 2005, respectively, in connection with options,
warrants and stock granted to employees. As of June 30, 2006, approximately
$1,219,000 in total compensation cost related to non-vested options remains
to
be expensed in future periods.
The
value
of options and warrants was estimated using the Black-Scholes pricing model.
The
Black-Scholes pricing calculations were made using volatilities at either
one-year or three-year, monthly or weekly, trailing measures, as appropriate,
and risk-free rates as determined by the nearest maturity Treasury yield as
of
respective valuation dates.
NOTE
M - WARRANTS
Through
June 30, 2006 the Company has issued to employees and financial services firms
warrants to purchase the Company’s common stock. During the six months ended
June 30, 2006 and 2005, the Company issued 3,776,042 and 750,000 shares,
respectively, of common stock in exchange for these warrants. As of June 30,
2006 and December 31, 2005, the Company had outstanding 13,621,438 warrants,
excluding warrants issued in conjunction with convertible debt issuances
referred to in NOTE H, to purchase its common stock at a weighted average
exercise price of $1.79 per share.
NOTE
N - COMMITMENTS
The
Company is obligated under non-cancelable operating leases for its office
facilities, and apartments used for business purposes by its employees. Future
minimum lease payments under the Company's non-cancelable operating leases
as of
June 30, 2006 are as follows:
Year
ending December 31
|
|
|
|
|
2006
(six months)
|
|
$
|
202,312
|
|
2007
|
|
|
268,556
|
|
2008
|
|
|
98,388
|
|
2009
|
|
|
43,736
|
|
|
|
|
|
|
Total
|
|
$
|
612,992
|
|
NOTE
O - RELATED PARTY TRANSACTIONS
As
of
June 30, 2006 and 2005 the amount due from related parties consisted of an
account receivable from WQN, a shareholder of the Company.
In
December 2004 the Company issued a $560,000 note payable to a shareholder,
bearing interest at 3.75%, with an original maturity date of December 2005.
In
January 2005 the Company issued another note payable for $1,040,000 to the
same
shareholder under similar terms. At June 30, 2006 and December 31, 2005, the
outstanding balance of these notes was $303,666 and $1,572,894, respectively.
The notes are currently due on demand.
Interest
paid under these notes was $9,469 and $0 during the six months ended June 30,
2006 and 2005, respectively.
NOTE
P - DISCONTINUED OPERATIONS
On
April
19, 2006, the Company sold its wholly-owned subsidiary, DTNet Technologies,
to
the Company’s former Chief Operating Officer (the “Purchaser”), pursuant to a
stock purchase agreement. The consideration for the sale consisted primarily
of
(1) the return for cancellation of warrants to purchase 200,000 shares of the
Company’s common stock held by the Purchaser; and (2) the return for
cancellation of 200,000 shares of the Company’s common stock held by the
Purchaser. Because DTNet Technologies’ operations were the primary component of
the Company’s hardware sales business segment, the Company recorded an
impairment charge of $839,101 in its statement of operations for the three
months ended March 31, 2006. The remaining $198,000 of goodwill for this segment
approximated the excess of the sales proceeds received over DTNet Technologies’
carrying value (excluding goodwill) and was written off in conjunction with
the
sale of DTNet Technologies.
The
following summarizes the results of DTNet Technologies’ operations for the six
and three months ended June 30, 2006 (through the April 19, 2006 date of sale)
and 2005, classified as discontinued operations for all periods
presented.
|
|
Six
Months Ended June 30
|
|
Three
Months Ended June 30
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Revenues
|
|
$
|
421,722
|
|
$
|
866,446
|
|
$
|
54,724
|
|
$
|
470,088
|
|
Cost
of Sales
|
|
|
326,127
|
|
|
671,903
|
|
|
43,391
|
|
|
368,697
|
|
Gross
Profit
|
|
|
95,595
|
|
|
194,543
|
|
|
11,333
|
|
|
101,391
|
|
Compensation
and benefits
|
|
|
116,985
|
|
|
186,578
|
|
|
27,958
|
|
|
101,971
|
|
Other
operating expenses*
|
|
|
946,871
|
|
|
133,981
|
|
|
5,157
|
|
|
121,316
|
|
Net
loss
|
|
$
|
(968,261
|
)
|
$
|
(126,016
|
)
|
$
|
(21,782
|
)
|
$
|
(121,896
|
)
|
*Includes
$839,101 impairment of goodwill recorded in March,
2006.
|
NOTE
Q - INCOME TAXES
The
components of the Company's consolidated income tax provision are as follows:
|
|
Six
Months ended June 30,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Current
benefit
|
|
$
|
5,695,083
|
|
$
|
479,158
|
|
Deferred
benefit (expense)
|
|
|
417,579
|
|
|
(75,014
|
)
|
Subtotal
|
|
|
6,112,662
|
|
|
404,144
|
|
Less
valuation allowances
|
|
|
(6,112,662
|
)
|
|
(404,144
|
)
|
Net
|
|
$
|
-
|
|
$
|
-
|
|
The
reconciliation of the income tax provision at the statutory rate to the reported
income tax expense is as follows:
|
|
Six
Months ended June 30,
|
|
|
|
2006
|
|
2005
|
|
Computed
at statutory rate
|
|
|
34%
|
|
|
34%
|
|
Options
and warrants expense
|
|
|
(3%
|
)
|
|
(8%
|
)
|
Valuation
allowance
|
|
|
(31%
|
)
|
|
(26%
|
)
|
Total
|
|
|
-
|
|
|
-
|
|
At
June
30, 2006 the Company’s net deferred tax assets consisted of the
following:
Net
operating loss carryforwards
|
|
$
|
14,592,781
|
|
Excess
of goodwill impairment charge over
|
|
|
|
|
tax
basis amortization
|
|
|
734,694
|
|
Excess
book over tax amortization of intangible assets
|
|
|
733,280
|
|
Subtotal
|
|
|
16,060,755
|
|
Less
valuation allowances
|
|
|
(16,060,755
|
)
|
Total
|
|
$
|
-
|
|
The
Company’s net operating loss carryforwards for
federal income tax purposes were approximately $42,900,000 as of June 30, 2006.
These carryforwards expire in 2018 ($4,200,000), 2019 ($22,000,000), and 2020
($16,700,000), respectively.
VoIP,
INC. AND SUBSIDIARIES
UNAUDITED
PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The
following unaudited pro forma condensed combined financial statements are
derived from and should be read in conjunction with the historical consolidated
financial statements and related notes of the Company, Caerus, and WQN.
On
June
1, 2005, the Company and Caerus announced the closing of the merger of Volo,
a
wholly-owned subsidiary of the Company with and into Caerus, with Caerus as
the
surviving corporation (the "Merger"). The Merger was completed pursuant to
an
Agreement and Plan of Merger (the "Merger Agreement'), executed on May 31,
2005.
On
October 6, 2005, the Company purchased substantially all of the assets of WQN’s
VoIP business. Such assets consist of WQN’s properties and infrastructure for
its services platform for both retail and wholesale voice over internet
business.
The
unaudited pro forma condensed combined statements of operations for the three
and six months ended June 30, 2005 assume that the mergers of Caerus, WQN and
the Company were consummated at January 1, 2005.
The
unaudited pro forma condensed combined statements of operations have been
prepared based on currently available information and assumptions that are
deemed appropriate by the Company's management. The pro forma information is
for
informational purposes only and is not intended to be indicative of the actual
consolidated results that would have been reported had the transactions occurred
on the dates indicated, nor does the information represent a forecast of the
consolidated financial position at any future date or the combined financial
results of the Company, Caerus and WQN for any future period.
Pro
Forma Condensed Combined Statement of Operations
(Unaudited)
Six
Months Ended June 30, 2005
|
|
VoIP,
Inc
|
|
Caerus,
Inc
|
|
WQN,
Inc
|
|
Adjustments
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
2,445,796
|
|
|
6,639,756
|
|
$
|
15,583,367
|
|
$
|
-
|
|
$
|
24,668,919
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
1,933,103
|
|
|
8,477,915
|
|
|
14,931,037
|
|
|
-
|
|
|
25,342,055
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
512,693
|
|
|
(1,838,159
|
)
|
|
652,330
|
|
|
-
|
|
|
(673,136
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
5,396,076
|
|
|
2,718,729
|
|
|
2,769,889
|
|
|
1,695,599
|
|
|
12,580,293
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
before
income taxes
|
|
|
(4,883,383
|
)
|
|
(4,556,888
|
)
|
|
(2,117,559
|
)
|
|
(1,695,599
|
)
|
|
(13,253,429
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
82,103
|
|
|
386,838
|
|
|
|
|
|
321,600
|
|
|
790,541
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before income taxes and results of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
discontinued
operations
|
|
|
(4,965,486
|
)
|
|
(4,943,726
|
)
|
|
(2,117,559
|
)
|
|
(2,017,199
|
)
|
|
(14,043,970
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss before discontinued operations
|
|
|
(4,965,486
|
)
|
|
(4,943,726
|
)
|
|
(2,117,559
|
)
|
|
(2,017,199
|
)
|
|
(14,043,970
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net
of income taxes
|
|
|
(126,016
|
)
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(126,016
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(5,091,502
|
)
|
$
|
(4,943,726
|
)
|
$
|
(2,117,559
|
)
|
$
|
(2,017,199
|
)
|
$
|
(14,169,986
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before discontinued operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(0.52
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net
of income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(0.01
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(0.53
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
26,940,458
|
|
The
accompanying notes are an integral part of this pro forma condensed combined
statement of operations.
VoIP,
Inc
Pro
Forma Condensed Combined Statement of Operations
(Unaudited)
Three
Months Ended June 30, 2005
|
|
VoIP,
Inc
|
|
Caerus,
Inc
|
|
WQN,
Inc
|
|
Adjustments
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
1,439,685
|
|
|
1,642,363
|
|
$
|
7,975,629
|
|
$
|
-
|
|
$
|
11,057,677
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
935,214
|
|
|
2,120,198
|
|
|
7,605,626
|
|
|
-
|
|
|
10,661,038
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
504,471
|
|
|
(477,835
|
)
|
|
370,003
|
|
|
-
|
|
|
396,639
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
3,850,854
|
|
|
1,103,606
|
|
|
1,543,488
|
|
|
703,489
|
|
|
7,201,437
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
before
income taxes
|
|
|
(3,346,383
|
)
|
|
(1,581,441
|
)
|
|
(1,173,485
|
)
|
|
(703,489
|
)
|
|
(6,804,798
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
67,825
|
|
|
146,756
|
|
|
|
|
|
160,800
|
|
|
375,381
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before income taxes and results of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
discontinued
operations
|
|
|
(3,414,208
|
)
|
|
(1,728,197
|
)
|
|
(1,173,485
|
)
|
|
(864,289
|
)
|
|
(7,180,179
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss before discontinued operations
|
|
|
(3,414,208
|
)
|
|
(1,728,197
|
)
|
|
(1,173,485
|
)
|
|
(864,289
|
)
|
|
(7,180,179
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net
of income taxes
|
|
|
(121,896
|
)
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(121,896
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(3,536,104
|
)
|
$
|
(1,728,197
|
)
|
$
|
(1,173,485
|
)
|
$
|
(864,289
|
)
|
$
|
(7,302,075
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before discontinued operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(0.24
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net
of income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(0.24
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30,012,632
|
|
The
accompanying notes are an integral part of this pro forma condensed combined
statement of operations.
VoIP,
INC. AND SUBSIDIARIES
NOTES
TO UNAUDITED PRO FORMA CONDENSED COMBINED
FINANCIAL
STATEMENTS
(1)
Basis
of Presentation
The
historical financial information for the Company, Caerus and WQN for the three
and six months ended June 30, 2005 has been derived from each company’s
respective historical consolidated financial statements.
(2)
VoIP,
Inc. and Caerus, Inc. Merger
(3)
On
October 6, 2005, the Company purchased substantially all of the assets of WQN’s
VoIP business. Such assets consist of WQN’s properties and infrastructure for
its services platform for both retail and wholesale voice over internet
business.
(4)
Pro
Forma Statements of Operations Adjustments
Adjustments
to the pro forma Statements of Operations represent amortization of intangible
assets and interest expense related to convertible debt recorded in connection
with the acquisitions.
General
The
following discussion should be read in conjunction with the unaudited
consolidated financial statements and the notes thereto and the other financial
information appearing elsewhere in this Form 10-Q. Certain statements contained
in this Form 10-Q and other written material and oral statements made from
time
to time by us do not relate strictly to historical or current facts. As such,
they are considered "forward-looking statements" that provide current
expectations or forecasts of future events. Such statements are typically
characterized by terminology such as "believe," "anticipate," "should,"
"intend," "plan," "will," "expect," "estimate," "project," "strategy," and
“may,” and similar expressions. Our forward-looking statements generally relate
to the prospects for future sales of our products, the success of our marketing
activities, and the success of our strategic corporate relationships. These
statements are based upon assumptions and assessments made by our management
in
light of its experience and its perception of historical trends, current
conditions, expected future developments and other factors our management
believes to be appropriate. These forward-looking statements are subject to
a
number of risks and uncertainties, including the following: our ability to
achieve profitable operations and to maintain sufficient cash to operate our
business and meet our liquidity requirements; our ability to obtain financing,
if required, on terms acceptable to it, if at all; the success of our research
and development activities; competitive developments affecting our current
products; our ability to successfully attract strategic partners and to market
both new and existing products; exposure to lawsuits and regulatory proceedings;
our ability to protect our intellectual property; governmental laws and
regulations affecting operations; our ability to identify and complete
diversification opportunities; and the impact of acquisitions, divestitures,
restructurings, product withdrawals and other unusual items. A further list
and
description of these risks, uncertainties and other matters can be found
elsewhere in our Form 10-KSB for the year ended December 31, 2005. Except as
required by applicable law, we undertake no obligation to update any
forward-looking statements, whether as a result of new information, future
events or otherwise.
Financial
Summary
Balance
Sheet Data:
|
|
June
30, 2006
|
|
December
31, 2005
|
|
|
|
|
|
|
|
Goodwill
and other intangible assets
|
|
$
|
36,683,014
|
|
$
|
38,404,271
|
|
Total
assets
|
|
|
49,760,228
|
|
|
56,244,161
|
|
Notes
and loans payable, current
|
|
|
11,907,161
|
|
|
11,085,034
|
|
Total
liabilities
|
|
|
27,444,586
|
|
|
27,018,241
|
|
Shareholders'
equity
|
|
|
22,315,642
|
|
|
29,225,920
|
|
|
|
Six
Months Ended June 30
|
|
Three
Months Ended June 30
|
|
Statement
of Operations Data:
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
18,998,290
|
|
$
|
2,445,796
|
|
$
|
9,003,742
|
|
$
|
1,439,685
|
|
Operating
expenses
|
|
|
16,119,884
|
|
|
5,396,076
|
|
|
7,006,697
|
|
|
3,850,854
|
|
Loss
from continuing operations
|
|
|
(16,508,772
|
)
|
|
(4,883,383
|
)
|
|
(6,776,552
|
)
|
|
(3,346,383
|
)
|
Loss
from discontinued operations
|
|
|
(968,261
|
)
|
|
(126,016
|
)
|
|
(21,782
|
)
|
|
(121,896
|
)
|
Net
loss
|
|
|
(19,946,393
|
)
|
|
(5,091,502
|
)
|
|
(6,139,359
|
)
|
|
(3,536,104
|
)
|
Net
loss per share
|
|
|
(0.29
|
)
|
|
(0.19
|
)
|
|
(0.09
|
)
|
|
(0.12
|
)
|
Comparability
of Results
The
comparability of our results of operations is greatly impacted by the
acquisition in May 2005 of Caerus and by the purchase in October 2005 of
substantially all of the VoIP-related assets and business of WQN. The following
table presents our pro forma results of operations for the six and three months
ended June 30, 2005, assuming these business combinations had occurred at the
beginning of 2005.
|
|
Six
Months Ended
|
|
Three
Months Ended
|
|
|
|
June
30, 2005
|
|
June
30, 2005
|
|
Revenues
|
|
$
|
24,668,919
|
|
$
|
11,057,677
|
|
Cost
of sales
|
|
|
25,342,055
|
|
|
10,661,038
|
|
Operating
expenses
|
|
|
12,580,293
|
|
|
7,201,437
|
|
Net
loss
|
|
|
(14,169,986
|
)
|
|
(7,302,075
|
)
|
Net
loss per share
|
|
|
(0.53
|
)
|
|
(0.24
|
)
|
Revenues
Our
consolidated revenues for the six months ended June 30, 2006 and 2005 were
$19.0
million and $2.4 million, respectively. Our consolidated net loss was $19.9
million ($0.29 per share) for the six months ended June 30, 2006 as compared
to
a net loss of $5.1 million ($0.19 per share) for the six months ended June
30,
2005. The increases in our revenues and net loss from the 2005 to 2006 period
reflect the inclusion of the results of Caerus and the VoIP business of WQN
from
the dates of their acquisitions. Revenues for the six months ended June 30,
2006
include approximately $4.0 million and $14.8 million in revenues generated
by
the acquired Caerus and WQN businesses, respectively. Substantially all of
the
Caerus revenues for this 2006 period (which represent 21% of our consolidated
revenues for this period) were generated by one customer. Our results for this
2006 period include operating losses of $6.7 million generated by Caerus’
operations and $452,807 attributable to the business formerly owned by
WQN.
Our
consolidated revenues for the three months ended June 30, 2006 and 2005 were
$9.0 million and $1.4 million, respectively. Our consolidated net loss was
$6.1
million ($0.09 per share) for the three months ended June 30, 2006 as compared
to a net loss of $3.5 million ($0.12 per share) for the three months ended
June
30, 2005. The increases in our revenues and net loss from the 2005 to 2006
period reflect the inclusion of the results of Caerus and the VoIP business
of
WQN from the dates of their acquisitions. Revenues for the three months ended
June 30, 2006 include approximately $1.9 million and $7.0 million in revenues
generated by the acquired Caerus and WQN businesses, respectively. Substantially
all of the Caerus revenues for this 2006 period (which represent 21% of our
consolidated revenues for this period) were generated by one customer. Our
2006
results include operating losses of $2.6 million generated by Caerus’ operations
and $159,385 attributable to the business formerly owned by WQN.
Expenses
Consolidated
operating expenses were $16.1 million and $ 5.4 million for the six months
ended
June 30, 2006 and 2005, respectively. Compensation and related expenses
accounted for $5.4 million of the increase from 2005. Professional legal and
consulting expenses increased by $2.6 million, due primarily to the litigation
discussed in NOTE K to our consolidated financial statements. Depreciation
and
amortization increased $2.5 million, due primarily to amortization of intangible
assets relating to the acquisition of Caerus and WQN assets. Interest expense
also increased from $82,103 to $3.5 million, due to our increased level of
debt
used to finance our operations and the purchase of Caerus and WQN assets.
Financing expenses were $1.4 million for the six months ended June 30, 2006
due
to capital raising efforts.
Consolidated
operating expenses were $7.0 million and $3.9 million for the three months
ended
June 30, 2006 and 2005, respectively. Compensation and related expenses
accounted for $3.3 million of the increase from 2005. Professional legal and
consulting expenses increased by approximately $543,000, due primarily to the
litigation discussed in note K to our consolidated financial statements.
Depreciation and amortization increased $1.0 million, due primarily to
amortization of intangible assets relating to the acquisition of Caerus and
WQN
assets. Commissions and fees paid to third parties decreased by approximately
$855,000, because the comparable period of 2005 included expenses related to
the
Caerus acquisition. General and administrative expenses decreased by
approximately $827,000, due primarily to a $397,821 noncash gain related to
a
litigation settlement discussed in NOTE K to our consolidated financial
statements. Interest expense increased from $67,825 to $2.0 million, due to
our
increased level of debt used to finance our operations, and for the purchase
of
Caerus and WQN assets. Financing expenses were $1.0 million for the three months
ended June 30, 2006, due to our capital raising efforts.
In
accordance with SFAS No. 142, we are required to periodically evaluate the
carrying value of our goodwill and other intangible assets. During the six
months ended June 30, 2006, we recognized impairment expense of $839,101 related
to goodwill recorded for our hardware sales business segment, and included
in
our reported loss from discontinued operations. If in the future the remaining
carrying value of our goodwill exceeds its fair market value, we may be required
to record an additional impairment charge in our statement of operations. Such
an impairment charge could have a significant adverse impact on both our
operating results and financial condition. If
the
traded market price of our common stock continues to decline, or our future
revenue does not increase coincident
with amounts previously projected and utilized to determine the fair value
of
our goodwill and other intangible assets, a material goodwill impairment
charge in the third quarter of 2006 is likely.
We
did
not have sufficient authorized and unissued common shares to satisfy the related
warrant obligations associated with convertible notes issued in January and
February 2006 on the dates the warrants were issued. Therefore, in accordance
with Emerging Issues Task Force Issues 00-27 and 00-19, the value of these
warrants at their issuance dates was recorded as a debt discount and a liability
on our consolidated balance sheet. The liability was marked to market at March
31, 2006, resulting in a $1,281,278 increase in the liability and a
corresponding charge to earnings for the three months ended March 31, 2006.
At
June 30, 2006 the mark-to- market adjustment resulted in a credit to operations
of $3,705,780 for the three months ended June 30, 2006. Future changes in the
market value of these warrants may have a material effect on our operating
results.
Discontinued
Operations
On
April
19, 2006, the Company sold its wholly-owned subsidiary DTNet Technologies to
the
Company’s former Chief Operating Officer (the “Purchaser”), pursuant to a stock
purchase agreement. The consideration for the sale consisted primarily of (1)
the return for cancellation of warrants to purchase 200,000 shares of the
Company’s common stock held by the Purchaser; and (2) the return for
cancellation of 200,000 shares of the Company’s common stock held by the
Purchaser. Because DTNet Technologies’ operations were the primary component of
the Company’s hardware sales business segment, the Company recorded an
impairment charge of $839,101 in its statement of operations for the three
months ended June 30, 2006. The remaining $198,000 of goodwill for this segment
approximated the excess of the sales proceeds received over DTNet Technologies’
carrying value (excluding goodwill) and was written off in conjunction with
the
sale of DTNet Technologies.
The
following summarizes the results of DTNet Technologies’ operations for the six
and three months ended June 30, 2006 (through the April 19, 2006 date of sale)
and 2005, classified as discontinued operations for all periods
presented.
|
|
Six
Months Ended June 30
|
|
Three
Months Ended June 30
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Revenues
|
|
$
|
421,722
|
|
$
|
866,446
|
|
$
|
54,724
|
|
$
|
470,088
|
|
Cost
of sales
|
|
|
326,127
|
|
|
671,903
|
|
|
43,391
|
|
|
368,697
|
|
Gross
profit
|
|
|
95,595
|
|
|
194,543
|
|
|
11,333
|
|
|
101,391
|
|
Compensation
and benefits
|
|
|
116,985
|
|
|
186,578
|
|
|
27,958
|
|
|
101,971
|
|
Other
operating expenses*
|
|
|
946,871
|
|
|
133,981
|
|
|
5,157
|
|
|
121,316
|
|
Net
loss
|
|
$
|
(968,261
|
)
|
$
|
(126,016
|
)
|
$
|
(21,782
|
)
|
$
|
(121,896
|
)
|
*Includes
$839,101 impairment of goodwill recorded in March, 2006.
Assets
Total
assets at June 30, 2006 were $49.8 million, down from $56.2 million at December
31, 2005. This decrease in assets is due primarily to increased depreciation,
amortization and impairment related to the tangible and intangible assets.
Goodwill and other intangible assets comprised 74% of our consolidated total
assets at June 30, 2006, attributable primarily to the acquisitions of Caerus
and WQN assets.
Results
by Segment
Comparison
of Six Months Ended June 30, 2006 and 2005
Our
results by business segment for the six months ended June 30, 2006 and 2005
are
as follows:
|
|
Telecommunication
|
|
Hardware
|
|
|
|
|
|
|
|
|
|
Services
|
|
Sales
|
|
Calling
Cards
|
|
Corporate
|
|
Consolidated
|
|
2006:
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
8,776,545
|
|
$
|
191,496
|
|
$
|
10,030,249
|
|
$
|
-
|
|
$
|
18,998,290
|
|
Gross
profit (loss)
|
|
|
(640,546
|
)
|
|
64,239
|
|
|
187,419
|
|
|
-
|
|
|
(388,888
|
)
|
Operating
expenses
|
|
|
5,974,755
|
|
|
12,096
|
|
|
223,114
|
|
|
9,909,919
|
|
|
16,119,884
|
|
Profit
(loss) from continuing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operations
|
|
|
(6,615,301
|
)
|
|
52,143
|
|
|
(35,695
|
)
|
|
(9,909,919
|
)
|
|
(16,508,772
|
)
|
Other
expense
|
|
|
608,931
|
|
|
-
|
|
|
-
|
|
|
1,860,429
|
|
|
2,469,360
|
|
Loss
from discontinued operations
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(968,261
|
)
|
|
(968,261
|
)
|
Net
income (loss)
|
|
$
|
(7,224,232
|
)
|
$
|
52,143
|
|
$
|
(35,695
|
)
|
$
|
(12,738,609
|
)
|
$
|
(19,946,393
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
1,542,112
|
|
$
|
903,684
|
|
$
|
-
|
|
$
|
-
|
|
$
|
2,445,796
|
|
Gross
profit (loss)
|
|
|
(31,933
|
)
|
|
544,626
|
|
|
-
|
|
|
-
|
|
|
512,693
|
|
Operating
expenses
|
|
|
2,329,951
|
|
|
42,545
|
|
|
-
|
|
|
3,023,580
|
|
|
5,396,076
|
|
Profit
(loss) from continuing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operations
|
|
|
(2,361,884
|
)
|
|
502,081
|
|
|
-
|
|
|
(3,023,580
|
)
|
|
(4,883,383
|
)
|
Other
expense
|
|
|
53,446
|
|
|
-
|
|
|
-
|
|
|
28,657
|
|
|
82,103
|
|
Loss
from discontinued operations
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(126,016
|
)
|
|
(126,016
|
)
|
Net
income (loss)
|
|
$
|
(2,415,330
|
)
|
$
|
502,081
|
|
$
|
-
|
|
$
|
(3,178,253
|
)
|
$
|
(5,091,502
|
)
|
Telecommunication
Services Segment:
Telecommunication
services revenues increased from $1.5 million for the six months ended June
30,
2005 to $8.8 million for the six months ended June 30, 2006. The net loss from
this segment also increased from $2.4 million to $7.2 million. These increases
are attributable almost entirely to the Caerus and WQN acquisitions.
The
negative gross profit for this segment of $640,546 in the first six months
of
2006 reflects variable costs paid to third party vendors that exceeded the
revenues we charged to terminate the calls of our customers. Positive margins
on
our network traffic will require us to increase the overall volume of traffic
handled by our network by growing our customer base, and lower the average
cost
per minute we pay for call termination through: (a) negotiating more favorable
pricing; (b) expanding our selection of third party vendors; and (c) improving
our routing process and technology to ensure we are using the lowest cost route
available to us to terminate each call.
Operating
expenses in the first six months of 2006 for this segment rose to $6.0 million,
and include compensation and benefits expenses of $1.3 million, and depreciation
and amortization aggregating $2.5 million. Other expense, consisting primarily
of interest expense, increased due to debt assumed with the Caerus
acquisition.
Hardware
Sales Segment:
Hardware
sales revenues decreased from $903,684 in the six months ended June 30, 2005
to
$191,496 in the comparable period of 2006. The decrease is attributed to the
sale of DTNet Technologies in April 2006, whose revenues for both periods have
been included in our reported loss from discontinued operations.
On
April
19, 2006, the Company sold its wholly-owned subsidiary, DTNet Technologies.
However, because DTNet Technologies’ operations were the primary component of
the Company’s hardware sales business segment, the Company recorded an
impairment charge of $839,101 in its statement of operations for the three
months ended June 30, 2006, which was included in our reported loss from
discontinued operations.
Calling
Card Sales Segment:
Calling
cards revenues are all related to the WQN asset acquisition, which occurred
in
the fourth quarter of 2005. Revenues from this segment amounted to $10.0 million
for the first six months of 2006. Given the wholesale nature of this business
segment, its gross margin is inherently small, typically averaging 2%, more
or
less. This segment had a net loss of $35,695 for the six months ended June
30,
2006.
Comparison
of Three Months Ended June 30, 2006 and 2005
Our
results by business segment for the three months ended June 30, 2006 and 2005
are as follows:
|
|
Telecommunication
|
|
Hardware
|
|
|
|
|
|
|
|
|
|
Services
|
|
Sales
|
|
Calling
Cards
|
|
Corporate
|
|
Consolidated
|
|
2006:
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
4,143,998
|
|
$
|
123,643
|
|
$
|
4,736,101
|
|
$
|
-
|
|
$
|
9,003,742
|
|
Gross
profit (loss)
|
|
|
87,642
|
|
|
55,081
|
|
|
87,422
|
|
|
-
|
|
|
230,145
|
|
Operating
expenses
|
|
|
2,581,615
|
|
|
2,374
|
|
|
96,524
|
|
|
4,326,184
|
|
|
7,006,697
|
|
Profit
(loss) from continuing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operations
|
|
|
(2,493,973
|
)
|
|
52,707
|
|
|
(9,102
|
)
|
|
(4,326,184
|
)
|
|
(6,776,552
|
)
|
Other
expense
|
|
|
283,571
|
|
|
-
|
|
|
-
|
|
|
(942,546
|
)
|
|
(658,975
|
)
|
Loss
from discontinued operations
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(21,782
|
)
|
|
(21,782
|
)
|
Net
income (loss)
|
|
$
|
(2,777,544
|
)
|
$
|
52,707
|
|
$
|
(9,102
|
)
|
$
|
(3,405,420
|
)
|
$
|
(6,139,359
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
698,177
|
|
$
|
741,508
|
|
$
|
-
|
|
$
|
-
|
|
$
|
1,439,685
|
|
Gross
profit (loss)
|
|
|
(9,389
|
)
|
|
513,860
|
|
|
-
|
|
|
-
|
|
|
504,471
|
|
Operating
expenses
|
|
|
1,719,774
|
|
|
18,430
|
|
|
-
|
|
|
2,112,650
|
|
|
3,850,854
|
|
Profit
(loss) from continuing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operations
|
|
|
(1,729,163
|
)
|
|
495,430
|
|
|
-
|
|
|
(2,112,650
|
)
|
|
(3,346,383
|
)
|
Other
expense
|
|
|
53,446
|
|
|
-
|
|
|
-
|
|
|
32,777
|
|
|
86,223
|
|
Loss
from discontinued operations
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(121,896
|
)
|
|
(121,896
|
)
|
Net
income (loss)
|
|
$
|
(1,782,609
|
)
|
$
|
495,430
|
|
$
|
-
|
|
$
|
(2,267,323
|
)
|
$
|
(3,554,502
|
)
|
Telecommunication
Services Segment:
The
net
loss from our telecommunication services segment grew from $1.8 million in
the
three months ended June 30, 2005 to $2.8 million in the corresponding 2006
period. Revenue for this segment grew by $3.4 million in the first three months
of 2006 to $4.1 million. These increases are attributable almost entirely to
the
Caerus and WQN acquisitions.
The
gross
profit for this segment of $87,642 in the three months ended June 30, 2006
reflects the excess of revenues over variable costs paid to third party vendors
to terminate the calls of our customers. This is a slight improvement over
the
comparable 2005 period, and reflects an $815,830 improvement over the negative
gross margin of $728,188 from this segment reported in the first three months
of
2006.
Operating
expense increased to $2.6 million for the three months ended June 30, 2006
from
$1.7 million for the comparable period of 2005, largely attributable to the
Caerus and WQN acquisitions. Interest expense increased from $53,446 for the
three months ended June 30, 2005 to $283,571 for the comparable period in 2006,
reflecting debt assumed with the Caerus and WQN acquisitions.
Hardware
Sales Segment:
Hardware
sales revenues decreased from $741,508 in the three months ended June 30, 2005
to $123,643 in the comparable period of 2006. The decrease is attributed to
the
sale of DTNet Technologies in April 2006, whose revenues for both periods have
been included in our reported loss from discontinued operations.
Calling
Card Sales Segment:
Calling
card revenues were $4.7 million in the three months ended June 30, 2006,
reflecting the acquisition of this segment in October 2005, as a part of the
WQN
acquisition. Given the wholesale nature of this business segment, its gross
margin is inherently small, typically averaging 2%, more or less. This segment’s
loss from operations for the three months ended June 30, 2006 was
$9,102.
Liquidity
and Capital Resources
Cash
and
cash equivalents were approximately $2.8 million at June 30, 2006. Our
consolidated net cash used in operating activities for the six and three months
ended June 30, 2006 was $8.4 million and $2.6 million, respectively, due
primarily to the losses described above. We funded our operating activities
principally through financing activities that generated net proceeds of $8.2
million during the six months ended June 30, 2006.
Since
inception of business in 2004 we have never been profitable. We have experienced
negative cash flows from operations, and have been dependent on the issuances
of
debt and common stock in private transactions to fund our operations and capital
expenditures. Our independent auditors have added an explanatory paragraph
to
their opinion on the Company’s consolidated financial statements for the year
ended December 31, 2005, based on substantial doubt about the Company’s ability
to continue as a going concern.
At
June
30, 2006, our contractual obligations for debt, leases and capital expenditures
totaled approximately $21.3 million. Included in this amount is approximately
$3.4 million due on a loan from a lending institution. We are not in compliance
with certain covenants under the loan agreement for this debt. However, the
lender has not declared a default under this loan agreement.
At
June
30, 2006 our negative working capital was $21.8 million.
In
July
and October 2005, we issued and sold $3,085,832 in principal amount of
convertible notes to accredited investors at a discount, receiving net proceeds
of $2,520,320. These notes are immediately convertible at the option of the
note
holders into shares of our common stock at $0.80 per share. These note holders
also received five-year warrants to purchase 3,569,792 shares of our common
stock for prices ranging from $1.37 to $1.65 per share. These notes are secured
by a subordinated lien on our assets, and the notes bear interest at an
effective rate of approximately 20%. The principal amount of these notes was
$923,703 and $1,496,804 at June 30, 2006 and December 31, 2005, respectively.
Half of these notes became payable beginning in October 2005, and the other
half
beginning in January 2006 (three months following their respective issuances),
over two years in cash or, at our option, in registered common stock at the
lesser of $0.80 per share or 85% of the weighted average price of our stock
on
the OTCBB. In May 2006, we repriced these warrants to $0.78 per share, at which
time these warrants were exercised, resulting in net proceeds to us of
$2,720,120. We then agreed to issue warrants to purchase a like number of shares
to the investors, entitling them to purchase such shares for $0.80 for five
years. At June 30, 2006, we had not made scheduled payments of $142,520 on
these
notes. In July 2006, we became in violation of the registration requirements
contained in the related subscription agreements. We are incurring liquidated
damages of $13,856 per month until a registration statement related to the
shares and warrants is declared effective by the SEC. One of the note holders,
owed approximately $1.1 million, has declared its notes in default. As such,
the
full amount of the notes at June 30, 2006 has been classified as current.
In
January and February 2006, we issued and sold $11,959,666 principal amount
of
convertible notes to accredited investors at a discount, receiving net proceeds
of $9,879,400 (including advance funds received in December 2005). These notes
are immediately convertible at the option of the note holders into shares of
our
common stock at the conversion rate of $1.00 per share. These note holders
also
received five-year warrants to purchase 4,537,053 shares of our stock for $1.00
per share, and one-year warrants to purchase 4,537,053 shares for $1.00 per
share. Approximately $7.6 million of these notes are secured by a subordinated
lien on our assets. All these notes bear interest at an effective rate of
approximately 20%, and are payable over two years beginning 90 to 180 days
after
closing in cash or, at the option of the Company, in registered common stock
at
the lesser of $1.00 per share or 85% of the weighted average price of the stock
on the OTCBB.
The
subscription agreements for the January and February 2006 convertible notes
contain provisions that could impact our future capital raising efforts and
our
capital structure:
· |
As
required by the subscription agreements, in February 2006, we filed
a
registration statement (the “Notes Registration Statement”) to register
200% of the shares issuable upon conversion of these notes and all
of the
shares issuable upon exercise of the warrants issued in connection
with
the notes. Until the Notes Registration Statement is declared effective
by
the SEC, we are liable for liquidated damages totaling $181,870 through
June 30, 2006, and we will continue to incur additional liquidated
damages
of $168,215 per month until the required shares and warrants are
registered.
|
· |
Unless
consent is obtained from the note holders, we may not file any new
registration statements or amend any existing registrations until
the
sooner of (i) 60 days following the effective date of the Notes
Registration Statement or (ii) all the notes have been converted
into
shares of our common stock and such shares of common stock and the
shares
of common stock issuable upon exercise of the warrants have been
sold by
the note holders.
|
· |
Until
the Notes Registration Statement has been effective for 365 days,
the note
holders must be given the right of first refusal with respect to
any
proposed sale of our common stock or debt
obligations.
|
· |
Unless
consent is obtained from the note holders, for so long as 20% or
more of
the principal amount of the notes, the warrants or the common stock
issued
or issuable for the notes remains outstanding, we may not issue any
new
shares of common stock, convertible securities or warrants at a price
per
share, conversion price per share or exercise price per share that
is
lower than those prices in effect for the notes and warrants without
issuing the note holders sufficient additional shares or warrants
at
prices such that their warrant exercise price or per share price
on
average is equal to that for the proposed securities to be
issued.
|
· |
Since
April 2006, we have been in violation of certain requirements of
these
debt facilities. One of the note holders, owed approximately $1.1
million,
has declared its notes in default. As such, the full amount of the
notes
at June 30, 2006 has been classified as current.
|
Our
acquisition of WQN’s VoIP assets was funded in part with the issuance of a
convertible note with a principal amount of $3.7 million. This note is
convertible at the option of WQN into shares of the Company’s common stock at
$0.78 per share. It is also convertible by the Company into shares of preferred
stock once our articles of incorporation are amended to authorize preferred
stock issuances. This note is payable over 12 months beginning February 2006,
and bears nominal interest at 6%. However, scheduled payments have not been
made, and WQN has agreed to subordinate its repayment claim to the convertible
note holders described above.
We
anticipate that we will continue to report net losses and experience negative
cash flows from operations. We will need to raise additional debt or equity
capital to provide the funds necessary to repay or restructure our $3.4 million
loan, meet our other current contractual obligations and continue our
operations. We are actively seeking to raise this additional capital. However,
we may not be successful in obtaining imminently-required equity or debt
financing for our business.
Our
authorized shares of stock consist of 100,000,000 shares of common stock. As
of
June 30, 2006, 72,509,102 common shares were issued and outstanding, and
approximately 53,000,000 additional shares are contingently issuable upon the
exercise of stock options and warrants, or conversion of convertible securities.
A proxy statement will be filed in connection with our annual meeting of
shareholders, at which a proposal will be submitted to increase the authorized
shares of capital stock to 250,000,000 shares of common stock and 25,000,000
shares of preferred stock. If such proposal is not approved, the Company may
be
unable to satisfy the contractual obligations it has undertaken to issue future
shares of common stock.
Capital
Expenditure Commitments
We
have
outstanding commitments to purchase capital equipment of approximately $427,000
at June 30, 2006. We anticipate financing these purchases with leasing
facilities or other financing.
Payments
Due by Period
The
following table illustrates our outstanding debt, purchase obligations, and
related payment projections as of June 30, 2006:
|
|
|
|
Less
than
|
|
|
|
|
|
Contractual
Obligations
|
|
Total
|
|
1
Year
|
|
1-3
Years
|
|
3-5
Years
|
|
|
|
|
|
|
|
|
|
|
|
Convertible
notes (principal)
|
|
$
|
15,838,023
|
|
$
|
15,838,023
|
|
$
|
-
|
|
$
|
-
|
|
Loan
payable
|
|
|
3,396,011
|
|
|
3,396,011
|
|
|
-
|
|
|
-
|
|
Unsecured
advances
|
|
|
386,675
|
|
|
386,675
|
|
|
|
|
|
|
|
Due
to related parties
|
|
|
303,666
|
|
|
303,666
|
|
|
|
|
|
|
|
Other
liabilities
|
|
|
316,508
|
|
|
62,696
|
|
|
160,804
|
|
|
93,008
|
|
Subtotal
|
|
|
20,240,883
|
|
|
19,987,071
|
|
|
160,804
|
|
|
93,008
|
|
Purchase
obligaitons
|
|
|
426,750
|
|
|
426,750
|
|
|
-
|
|
|
-
|
|
Operating
leases
|
|
|
612,992
|
|
|
202,312
|
|
|
366,944
|
|
|
43,736
|
|
Total
|
|
$
|
21,280,625
|
|
$
|
20,616,133
|
|
$
|
527,748
|
|
$
|
136,744
|
|
In
conjunction with the January and February, 2006 convertible note issuances
discussed in NOTE H to our consolidated financial statements, we had
insufficient authorized common shares to satisfy the related warrants to
purchase 8,508,594 million shares of the Company’s common stock. Therefore,
under Emerging Issues Task Force Issue 00-19, the $3,526,077 value of these
warrants at their issuance dates, plus $770,314 of the proceeds received from
the May 2006 warrant repricing and exercise also discussed in Note H, was
classified as a liability on our consolidated balance sheet, and their value
was
marked-to-market at June 30, 2006, resulting in a $2,424,502 decrease in the
liability, and a corresponding credit to earnings for the six months ended
June
30, 2006. Until we have sufficient authorized common shares to satisfy these
warrant obligations, we will be subject to future noncash mark-to-market
exposure to the extent that the estimated market value of these warrants changes
in the future, which are in turn primarily dependent on the Company’s common
stock market price per share. As a hypothetical example, a $0.50 per share
increase or decrease in the market price of the Company’s common stock at June
30, 2006 would have increased or decreased the estimated average market value
of
these warrants by $0.38 or $0.19 per warrant, respectively, resulting in
hypothetical mark-to-market adjustments that would have further increased the
Company’s consolidated net loss for the six months ended June 30, 2006 by
$3,190,725, or decreased that loss by $1,616,631, respectively.
We
are
not exposed to significant interest rate or foreign currency exchange rate
risk.
ITEM
4. CONTROLS AND PROCEDURES
Evaluation
of Controls and Procedures
As
required by Rule 13a-15(b) under the Securities Exchange Act, as amended
(the “Exchange Act”), as of the end of the period covered by this Quarterly
Report, our management conducted an evaluation with the participation of our
Chief Executive Officer and Chief Accounting Officer (collectively, the
“Certifying Officers”) regarding the effectiveness of the design and operation
of the Company’s disclosure controls and procedures (as defined in
Rules13a-15(e) and 15d-15(e) under the Exchange Act). Our management, with
the
participation of the Certifying Officers, also conducted an evaluation of our
Company’s internal control over financial reporting and identified five
significant control deficiencies, which in combination resulted in a material
weakness.
A
significant deficiency is a control deficiency, or combination of control
deficiencies, that adversely affects the company’s ability to initiate,
authorize, record, process or report external financial data reliably in
accordance with generally accepted accounting principles, such that there is
more than a remote likelihood that a misstatement of our annual or interim
financial statements that is more than inconsequential will not be prevented
or
detected. A material weakness is a significant deficiency, or combination of
significant deficiencies, that results in more than a remote likelihood that
a
material misstatement of a company’s annual or interim financial statements will
not be prevented or detected, as of June 30, 2006. The control deficiencies
identified by our management and the Certifying Officers, which in combination
resulted in a material weakness, were (a) misstatements in amounts
reported for a consolidated subsidiary; (b) insufficient personnel
resources with appropriate accounting expertise; and (c) a lack of independent
verification of amounts billed to certain customers.
Based
on this evaluation and in accordance with the requirements of Auditing Standard
No. 2 of the Public Company Accounting Oversight Board, our Certifying
Officers concluded that our disclosure controls and procedures were ineffective
as of June 30, 2006.
Our
management, including the Certifying Officers, does not expect that our
disclosure controls and procedures will prevent all errors and all improper
conduct. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, a design of a control system must reflect
the
fact that there are resource constraints, and the benefits of controls must
be
considered relative to their costs. Because of the inherent limitations in
all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of improper conduct, if any, have been
detected. These inherent limitations include the realities that judgments and
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more persons, or by management
override of the control. Further, the design of any system of controls is also
based in part upon assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions. Over time, controls may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations and a
cost-effective control system, misstatements due to error or fraud may occur
and
may not be detected.
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Rule 13a-15(f)
under the Exchange Act. Our internal control over financial reporting is a
process designed to provide reasonable assurance regarding the reliability
of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles, and
includes those policies and procedures that:
· |
pertain
to the maintenance of records that, in reasonable detail accurately
and
fairly reflect the transactions and dispositions of the assets of
the
Company;
|
· |
provide
reasonable assurance that transactions are recorded as necessary
to permit
preparation of financial statements in accordance with generally
accepted
accounting principles, and that receipts and expenditures of the
Company
are being made only in accordance with authorization of management
and
directors of the Company; and
|
· |
provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets that could
have
a material effect on the financial
statements.
|
Our
management, including the Certifying Officers, assessed the effectiveness of
our
internal control over financial reporting as of June 30, 2006, and have
concluded that we had the following control deficiencies as of June 30, 2006
that, when combined, resulted in a material weakness:
(a) |
In
March 2006, during their review and analysis of 2005 results and
financial
condition in connection with the preparation of the 2005 financial
statements and the 2005 Annual Report on Form 10-KSB, our senior
financial
management discovered certain overstatements of the revenues, expenses
and
receivables reported, and understatement of net loss, for our consolidated
subsidiary DTNet Technologies. Based upon an assessment of the impact
of
the adjustments to our financial results arising from this matter,
we
restated the financial information presented in the Company’s Form 10-KSB
for the year ended December 31, 2004. Adjustments to reduce the
overstatements of revenues and receivables and the understatement
of net
loss aggregated $791,200, $651,832, and $462,618, respectively, for
the
year ended December 31, 2004.
|
(b) |
We
do not have sufficient personnel resources at corporate headquarters
with
appropriate accounting expertise or experience in financial reporting
for
public companies. Our management with the participation of the Certifying
Officers determined that the potential magnitude of a misstatement
arising
from this deficiency is more than inconsequential to the annual and/or
interim financial statements.
|
(c) |
The
amounts invoiced to our wholesale telecommunications customers are
calculated by our engineering department. This billing process is
overseen solely by the head of that department, our Chief Technology
Officer. We do not presently employ a separate revenue assurance
process whereby these bills would be recalculated and independently
verified by a department other than engineering. Our management with
the participation of the Certifying Officers determined that the
potential
magnitude of a misstatement arising due to this deficiency is more
than
inconsequential to the annual and/or interim financial
statements.
|
(d) |
Certain
of our subsidiaries need to improve the handling of cash receipts.
Our
management with the participation of the Certifying Officers determined
that the potential magnitude of a misstatement arising due to this
deficiency is more than inconsequential to the annual and/or interim
financial statements.
|
(e) |
We
do not have a formal method of ensuring that timely and complete
monthly
reconciliations and closing procedures take place. Our management
with the
participation of the Certifying Officers determined that the potential
magnitude of a misstatement arising from this deficiency is more
than
inconsequential to the annual and/or interim financial statements.
|
Management
has concluded that the above deficiencies when combined have resulted in a
material weakness in its internal control of financial reporting because the
quantitative effect of any errors resulting from these deficiencies when taken
together could result in a material misstatement of our interim and annual
financial reports. Based on this evaluation and in accordance with the
requirements of Auditing Standard No. 2 of the Public Company Accounting
Oversight Board, the Certifying Officers concluded that we did not maintain
effective internal control over financial reporting as of June 30, 2006 based
on
the criteria in the Internal Control - Integrated Framework.
Remediation
Steps to Address Control Deficiencies
The
Company is in the process of addressing the identified material weakness by
remediating the control deficiencies in the Company’s internal control over
financial reporting which comprise this material weakness as follows:
(a) |
In
March 2006, our Board of Directors (the “Board”) retained counsel to
conduct a thorough investigation of the accounting misstatements
of our
DTNet Technologies subsidiary. Such counsel, in turn, retained an
independent forensic accounting firm to assist its investigation.
Based on
this investigation our board of directors and management have concluded
that these intentional overstatements of revenues, expenses and
receivables were limited to the unauthorized actions of two individuals.
One of these individuals was employed at corporate headquarters and
the
other was employed at DTNet Technologies’ headquarters. The individual
employed at corporate headquarters resigned shortly after the initiation
of the investigation, and we terminated the employment of the other
individual immediately following the receipt of the preliminary findings
of the investigation in early April 2006. We changed the individual
responsible for the day-to-day management of DTNet Technologies,
relocated
its accounting to our corporate offices and increased our analysis
of this
subsidiary’s transactions. In April 2006, we sold this subsidiary to our
former Chief Operating Officer.
|
(b) |
We
continue to seek to improve our in-house accounting resources. During
the
fourth quarter of 2005 we hired a new Chief Financial Officer with
significant accounting and public company experience. During the
first and
second quarters of 2006 we did not hire any new accounting personnel.
However, we significantly supplemented our internal accounting resources
during these six months by using independent accounting and financial
consulting firms. We expect to continue to use such third parties
until
such time as we are able to hire sufficient in-house accounting expertise.
In April 2006 we promoted the former Finance Director of one of our
recently acquired subsidiaries to the position of Corporate Controller.
This individual has significant financial experience (including five
years
with the audit department of the accounting firm of KPMG Peat Marwick),
has served as the CFO and/or controller of various companies (including
a
public registrant), and is a Certified Public Accountant. In May
2006, our
Chief Financial Officer resigned, and the Corporate Controller was
promoted to Chief Accounting
Officer.
|
(c) |
We
are in the process of designing a revenue assurance process for the
billing of our wholesale telecommunications customers to provide
independent recalculation and verification of amounts billed. We
anticipate implementing this methodology by the end of
2006.
|
(d) |
We
have made recent improvements to our cash handling procedures, and
expect
to complete improvements as resources permit, targeting the end of
the
third quarter of 2006.
|
(e) |
We
anticipate implementing a formal method of ensuring timely and complete
monthly reconciliations and closing procedures by the end of the
fourth
quarter of 2006.
|
As
a
non-accelerated filer, we plan to complete our assessment of the effectiveness
of, and improvements to, the Company’s internal control over financial reporting
pursuant to Sarbanes-Oxley Section 404 in 2007.
Changes
in Control Over Financial Reporting
There
were no changes in our internal control over financial reporting identified
in
connection with the evaluation of such internal control that occurred during
our
last fiscal quarter that have materially affected, or are reasonably likely
to
materially affect, our internal control over financial reporting.
PART
II - OTHER INFORMATION
ITEM
1. LEGAL
PROCEEDINGS
The
Company is involved from time to time in legal proceedings and litigation
incidental to the conduct of its business. See NOTE K to the Company’s
consolidated financial statements for a discussion of litigation between Volo
(a
wholly-owned subsidiary of Caerus) and MCI WorldCom.
Item
1.A RISK
FACTORS
In
addition to the risk factors set forth in our Annual Report on Form 10-KSB
for
the year ended December 31, 2005, we are subject to the risks described below.
If
any of
the following risks and uncertainties develops into actual events, our business,
financial condition or results of operations could be materially and adversely
affected. The risk factors below contain forward-looking statements regarding
our company. Actual results could differ materially from those set forth in
the
forward-looking statements.
Because
we are not
in compliance with the terms of our loan agreement, our
payment obligations may be accelerated.
We
are
not in compliance with certain covenants of the agreement for our loan from
a
lending institution (which amounted to approximately $3.4 million at June 30,
2006). Our lender has not declared a default under the loan agreement. We
presently are current with the principal and interest payments on this loan
but
we will need to raise additional debt or equity capital to repay or restructure
this loan. Although the lender has not yet done so, the lender could elect,
among other things, to accelerate our indebtedness under the credit facility,
or
to take possession of, sell, lease, or otherwise dispose of any of the assets
of
the Company. In the event that the lender declares the amounts borrowed under
the credit facility immediately due and payable or seeks to foreclose on any
of
our assets, it would likely have a material adverse affect on our financial
position and our results of operations. If we experience delays in raising
capital or are unable to raise a sufficient amount of capital, we could be
required to seek modifications to the terms of the loan agreement or another
source of financing to continue operations.
We
are in default under the notes issued in July and October 2005 and in January
and February of 2006 and the note holders may accelerate the amounts due at
any
time.
The
provisions of the convertible notes issued in July and October 2005 and in
January and February 2006 provide that the failure to pay principal and interest
timely and the failure to register the securities underlying the notes within
the required time limit are events of default under the notes. We have not
made
scheduled payments of $142,520 under the 2005 notes and have not made scheduled
payments of $21,008 under the 2006 notes. One of the note holders, owed
approximately $1.1 million, has declared its notes in default but has not yet
taken any other action. As such, the amounts due under the notes could be
accelerated and immediately due and payable, which could adversely affect our
ability to meet all of our financial obligations.
Because
we failed to meet our obligations to file the registration statements required
under the various subscription agreements related to our 2005 and 2006 note,
warrant and common stock financings timely, we are accruing liquidated damages
for breach of contract until such time as the registration statements are filed
and go effective.
Pursuant
to the subscription agreements under which certain investors purchased notes
and
warrants in July and October 2005 and in January and February 2006, we agreed
to
register the securities purchased for resale by those investors under the
Securities Act of 1933, as amended, within a specified time. We agreed to file
a
registration statement covering the securities sold in 2005 no later than August
5, 2005, and to use our best efforts to cause that registration statement to
become effective in certain events but no later than 75 days
after the filing date. We were to file a registration statement covering the
notes and warrants issued in January 2006 no later than February 6, 2006 (to
be
effective no later than 105 days after the issuance of the notes and the
warrants) and file a registration statement covering the notes and warrants
issued in February 2006 no later than February 13, 2006 (to be effective no
later than April 21, 2006). Because we failed to comply with the requirement
to
have effective registration statements covering the notes and warrants within
the applicable time limits, we have incurred liquidated damages in an aggregate
of $454,977 and will continue to incur liquidated damages amounting to $182,071
per month until there are effective registration statements covering the notes
and warrants. Because we are incurring substantial liquidated damages on a
monthly basis, our failure to comply with the terms of the notes and warrants
could continue to have an adverse effect on our financial position and our
results of operations.
In
connection with a private placement memorandum dated
May 20, 2005, we issued 2,430,500 shares of common stock for $0.80 per share,
and warrants to purchase the same number of common shares for $1.60 per share.
As required by the subscription agreements, a portion of these shares were
registered with the SEC in October 2005, and the remaining portion was included
in the Company’s February 2006 registration statement, which is not yet
effective. Until this registration statement is declared effective by the SEC,
we are liable for liquidated damages, requiring the issuance of new common
shares at the rate of 1.5% of the unregistered shares per month. At June 30,
2006 this equated to 560,750 shares owing, recognized as a $650,148 current
liability on the Company’s balance sheet. Future liquidated damages equate to
135,438 common shares per month until this registration statement is declared
effective by the SEC.
Our
substantial debt could adversely affect our financial position, operations
and
ability to grow.
As
of
June 30, 2006, our total liabilities were approximately $27.4 million, most
of
which are classified as current. Our substantial indebtedness could have adverse
consequences in the future. For example, it could:
· require
us to dedicate a substantial portion of our cash flow from operations to
payments on our debt, which would reduce amounts available for working capital,
capital expenditures, research and development and other general corporate
purposes;
· limit
our
flexibility in planning for, or reacting to, changes in our business and the
industries in which we operate;
· increase
our vulnerability to general adverse economic and industry
conditions;
· place
us
at a disadvantage compared to our competitors that may have less debt than
we
do;
· make
it
more difficult for us to obtain additional financing that may be necessary
in
connection with our business;
· make
it
more difficult for us to implement our business and growth strategies;
and
· cause
us
to have to pay higher interest rates on future borrowings.
We
expect to need additional capital to continue our
operations.
Our
operations currently require significant amounts of cash. We intend to continue
to enhance and expand our network in order to maintain our competitive position
and meet the increasing demands for service quality, capacity and competitive
pricing. Also, our pursuit of new customers and the introduction of new products
and/or services will require significant marketing and promotional expenses
that
we often incur before we begin to receive the related revenue. Our operations
have consumed, rather than generated, cash. Our working capital and capital
expenditure requirements have been met by sales of debt and equity securities.
We will need to raise additional capital to continue our operations. We may
not
be able to raise additional capital. If we are able to raise additional capital
through the issuance of additional equity or debt, our current investors could
experience dilution. We
need
to raise additional debt or equity capital imminently to provide the funds
necessary to repay or restructure our debt and continue operations. If
unsuccessful, or if the note holders declare the Company’s notes in default, we
may not be able to continue operations.
We
have experienced significant changes in our top
management.
On May
19, 2006 the Company underwent a reorganization of its executive management.
In connection with the restructuring, Mr. Gary Post was appointed
President, Chief Executive Officer and Chairman, replacing Mr. B. Michael Adler
as Chief Executive Officer and Chairman and Mr. Hal Bibee as President.
Mr. Robert V. Staats was appointed as Chief Accounting Officer, and Mr. David
Sasnett resigned as Chief Financial Officer. Mr. David Ahn was appointed the
new
Vice President - Corporate Planning. Although the board of directors
believes the management changes are in the best interests of the Company and
that the new management will have a positive impact on the Company, significant
personnel changes may have the effect of disrupting the day to day operations
of
the Company until such time as the new management is integrated and fully
informed with respect to the business and operations of the
Company.
We
may incur goodwill and intangible asset impairment
charges.
Our
balance sheet at June 30, 2006 includes approximately $23.4 million in goodwill
and approximately $13.3 million in other intangible assets recorded in
connection with our acquisitions. We recorded significant additional amounts
of
goodwill and intangible assets as a result of our acquisition in October 2005
of
substantially all of the assets relating to the VoIP business of WQN, and our
acquisition in May 2005 of Caerus and its subsidiaries.
In
accordance with SFAS 142, we test the carrying value
of our goodwill and our other intangible assets for impairment at least annually
by comparing the fair values of these assets to their carrying values. During
the year ended December 31, 2005 we recorded an impairment charge to our
operating results of approximately $4.2 million relating to goodwill previously
recorded for an acquisition. In the six months ended June 30, 2006, we recorded
an impairment charge to operating results of $839,101 as a result of selling
our
interest in our subsidiary, DTNet Technologies, in April 2006. These charges
reduced the carrying value of the subsidiary to its estimated fair value. We
may
be required to record additional impairment charges for these assets in the
future, which could materially adversely affect our financial condition and
results of operations. If the traded market price of our common stock continues
to decline, or our future revenue does not increase coincident
with amounts previously projected and utilized to determine the fair value
of
our goodwill and other intangible assets, a material goodwill impairment
charge in the third quarter of 2006 is likely.
ITEM
2. UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On
May
22, 2006, the Company entered into a Modification and Amendment Agreement with
its principal lenders to modify certain provisions of the notes issued in
January and February 2006 in the aggregate principal amount of $8,318,284.
Such
changes, among other things, extended the first repayment date to August 15,
2006, amended the minimum price for payment of the outstanding notes in shares
of common stock from $1.00 to $0.80, amend the conversion price of the notes
from $1.318 to $1.00, and permitted the payment of liquidated damages of
$166,366 for failing to have the resale registration statement declared
effective by the required date to be made in shares of common stock at $1.00
per
share. The investors agreed to exercise warrants to purchase 3,569,792 shares
of
common stock for an amended warrant exercise price of $0.78, resulting in the
receipt by the Company of approximately $2.8 million. We then agreed to issue
warrants to purchase a like number of shares to the investors, entitling them
to
purchase such shares for $0.80 per share for five years.
ITEM
3. DEFAULTS
UPON SENIOR SECURITIES
ITEM
4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
We
have
held no regularly scheduled, called or special meetings of shareholders during
the reporting period.
ITEM
5. OTHER
INFORMATION
None
(a)
Exhibits
No. Description
31.1
Certification
by Chief Executive Officer under SEC Rule 13a-14, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification
by Chief Accounting Officer under SEC Rule 13a-14, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification
by Chief Executive Officer pursuant to 18 USC Section 1350 as adopted by Section
906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification
by Chief Accounting Officer pursuant to 18 USC Section 1350 as adopted by
Section 906 of the Sarbanes-Oxley Act of 2002.
SIGNATURES
In
accordance with the requirements of the Exchange Act, the registrant caused
this
Quarterly Report on Form 10-Q for the period ended June 30, 2006 to be signed
on
its behalf by the undersigned, thereunto duly authorized.
|
|
VoIP,
INC. |
|
|
|
Date: August 16, 2006 |
|
/s/
Robert V. Staats |
|
Robert
V. Staats |
|
Chief
Accounting Officer |