UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
(Mark
One)
x
ANNUAL REPORT PURSUANT
TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For
the
fiscal year ended December 31, 2006
o
TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For
the
transition period ____________to____________
Commission
file number 000-28985
VOIP,
INC.
(Exact
name of registrant as specified in its charter)
Texas
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75-2785941
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(State
or other jurisdiction of incorporation or organization)
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(I.R.S.
Employer Identification No.)
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|
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151
South Wymore Road, Suite 3000
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Altamonte
Springs, Florida
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32714
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(Address
of principal executive offices)
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(ZIP
Code)
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Issuer's
telephone number, including area code: (407) 389-3232
Securities
registered pursuant to Section 12(g) of the Act: Common Stock, par value
$0.001.
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. YES oNO x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. YES o NO x
Indicate
by check mark whether the registrant (1) has 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 if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. x
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 Rule12b-2
of the Act). YES o NO x
Issuer’s
revenues for its most recent fiscal year were $14,676,948.
At
June
30, 2006, the last business day of the registrant’s most recently completed
second fiscal quarter, there were 70,509,102 shares of registrant’s common stock
outstanding, and the aggregate market value of such shares held by
non-affiliates of the registrant (based upon the closing sale price of such
shares on the Over-The-Counter Bulletin Board on June 30, 2006) was
approximately $38,722,066. Shares of the registrant’s common stock held by each
executive officer and director and by each entity or person that, to the
registrant’s knowledge, owned 5% or more of the registrant’s outstanding common
stock as of June 30, 2006, have been excluded in that such persons may be deemed
to be affiliates of the registrant. This determination of affiliate status
is
not necessarily a conclusive determination for other purposes.
At
March
28, 2007, the registrant had outstanding 98,609,701 and no shares of par value
$0.001 common stock and par value $0.001 preferred stock, respectively.
Company
Symbol-VOII
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TABLE
OF CONTENTS
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Page
No.
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PART
I
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Item
1.
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Business
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4
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Item
1A.
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Risk
Factors
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9
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Item
2.
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Properties
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18
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Item
3.
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Legal
Proceedings
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18
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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19
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PART
II
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Item
5.
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Market
for Registrant's Common Equity, Related Stockholder Matters and
Issuer
Purchases of
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Equity
Securities
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20
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Item
6.
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Selected
Financial Data
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20
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Item
7.
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Management's
Discussion and Analysis of Financial Condition and Results of
Operations
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21
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Item
7A.
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Quantitative
and Qualitative Disclosures About Market Risk
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30
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Item
8.
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Financial
Statements and Supplementary Data
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30
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Item
9.
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Changes
in and Disagreements With Accountants on Accounting and Financial
Disclosure
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31
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Item
9A.
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Controls
and Procedures
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31
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Item
9B.
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Other
Information
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33
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PART
III
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Item
10.
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Directors,
Executive Officers and Corporate Governance
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33
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Item
11.
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Executive
Compensation
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35
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Item
12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder
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Matters
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41
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Item
13.
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Certain
Relationships and Related Transactions
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44
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Item
14.
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Principal
Accounting Fees and Services
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44
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PART
IV
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Item
15.
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Exhibits
and Financial Statement Schedules
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46
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VOIP,
INC.
Item
1. Business
Caution
Regarding Forward-Looking Statements
This
annual report contains forward-looking statements relating to events anticipated
to happen in the future. These forward-looking statements are based on the
beliefs of our management, as well as assumptions made by and information
currently available to our management. Forward-looking statements also may
be
included in other written and oral statements made or released by us. You can
identify forward-looking statements by the fact that they do not relate strictly
to historical or current facts. The words "believe," "anticipate," "intend,"
"expect," "estimate," "project," “may”, “could” and similar expressions are
intended to identify forward-looking statements. Forward-looking statements
describe our expectations today of what we believe is most likely to occur
or
may be reasonably achievable in the future, but they do not predict or assure
any future occurrence and may turn out to be wrong. Forward-looking statements
are subject to both known and unknown risks and uncertainties and can be
affected by inaccurate assumptions we might make. Consequently, no
forward-looking statement can be guaranteed. Actual future results may vary
materially. We do not undertake any obligation to publicly update any
forward-looking statements to reflect new information or future events or
occurrences. These statements reflect our current views with respect to future
events and are subject to risks and uncertainties about us, including, among
other things:
· |
Our
ability to market our services successfully to new
customers;
|
· |
Our
ability to retain a high percentage of our
customers;
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· |
The
possibility of unforeseen capital expenditures and other upfront
investments required to deploy new technologies or to effect new
business
initiatives;
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· |
Our
ability to raise capital;
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· |
Network
development and operations;
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· |
Our
expansion, including consumer acceptance of new price plans and bundled
offerings;
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· |
Additions
or departures of key personnel;
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· |
Competition,
including the introduction of new products or services by our
competitors;
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· |
Existing
and future laws or regulations affecting our business and our ability
to
comply with these laws or
regulations;
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· |
Our
reliance on the systems and provisioning processes of regional Bell
operating companies;
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· |
Technological
innovations
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· |
The
outcome of legal and regulatory
proceedings;
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· |
General
economic and business conditions, both nationally and in the regions
in
which we operate; and
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· |
Other
factors described in this document, including those described in
more
detail in PART I, Item 1A. “Risk
Factors.”
|
DESCRIPTION
OF BUSINESS
General
Development
We
were
incorporated under the laws of the State of Texas on August 3, 1998, under
our
original name of Millennia Tea Masters. In February 2004 we exchanged 12,500,000
shares for the assets of two start-up telecommunication businesses,
eGlobalphone, Inc. and VoIP Solutions, Inc. We changed our name to VoIP, Inc.,
in April 2004. We consummated the acquisitions of DTNet Technologies, a hardware
supplier, and VoIP Americas, an interconnected Voice-over-Internet-Protocol
(“VoIP”) related company, in June and September, respectively, of 2004. We
decided to exit our former tea business in December 2004, and focus our efforts
and resources in the VoIP telecommunications industry. In May 2005 we completed
the acquisition of Caerus, a VoIP carrier and service provider, and in October
2005 we purchased substantially all of the VoIP related assets of WQN, Inc.
(“WQN”). In April 2006, we sold DTNet Technologies to our former Chief Operating
Officer.
We
are an
emerging global provider of wholesale long-distance and local telephone services
through our VoIP network (called the VoiceOne Network). VoIP is the real time
transmission of voice communications in the form of digitized "packets" of
information over the public Internet or our own private network, similar to
the
way in which e-mail and other data is transmitted. Our services allow customers
to communicate at significantly reduced costs compared to traditional telephony
networks, using our softswitches that connect calls over different phone lines
entirely by software run on a computer system. We are a certified Competitive
Local Exchange Carrier (“CLEC”) and InterExchange Carrier (“IXC”).
Since
2004 we have developed our business through strategic acquisitions, as noted
in
the second preceding paragraph. These acquisitions, and our subsequent
VoIP-related technological enhancements, have provided us with important
technology, intellectual capital and VoIP expertise, trade names, domain names,
VoIP enhanced service applications, key business relationships and revenues.
We
own our network and technology, and provide a portfolio of advanced
telecommunications technologies, enhanced service solutions, and broadband
products to the VoIP industry. Our current and targeted customers include CLECs,
IXCs, Internet Service Providers (“ISPs”), cable operators, and VoIP service
providers in the United States and various countries around the
world.
Our
goal
is to become the premier enabler for packet communication services for carriers
(portal and ISP), service providers and cable operators seeking to offer
value-added voice, data and enhanced services products using VoIP
technology.
Business
Segments
Our
business was previously divided into three primary segments: (1)
telecommunications, which consists of consumer and wholesale telecommunication
services provided through our propriety VoIP network and technology; (2)
wholesale sales of VoIP hardware and broadband components; and (3) the
wholesaling of prepaid calling cards. We recently sold businesses comprising
our
hardware sales and prepaid calling card segments. Accordingly, separate
financial statement information for the former segments is not
provided.
Our
Technology and Network
Our
proprietary softswitch technology was developed in-house using protocol agnostic
architecture, enabling virtually any network protocol, from legacy switches
to
the latest Multi-Protocol Label Switching (“MPLS”) standards, to communicate
with our softswitches. Prior to softswitches, existing legacy technology uses
hardware such as physical switches to route calls. Our technology approach
enables us to integrate our network directly into the public switched telephone
networks, with more limited capital expenditure costs.
Based
on
Microsoft .NET technology, we believe that integration to the enterprise desktop
will drive market acceptance and use of our advanced services. Our network
currently supports its own media gateways, softswitch controller, unified
messaging systems, voicemail, media trans-coding and many other integral parts
of a complete solution. Using our web interfaces, our customers also have the
management tools needed for provisioning and maintenance of their
services.
Our
network operations center (“NOC”) located in Orlando, Florida, is a fully
staffed, 24x7x365 operation.
From the NOC we monitor all aspects of the technical environment, from our
nationwide OC-12 backbone to network routers, SIP proxies and numerous routing
gateways, soft switches and other aspects of our VoIP infrastructure.
Fully
redundant technologies are deployed in a scalable network environment that
we
believe will enable us to compete in the demanding IP telephony marketplace.
Our
network incorporates an advanced MPLS architecture which provides services
to
carriers and other service providers. Our network features direct
interconnection facilities with multiple RBOCs, CLECs, IXCs, service providers,
cable operators, wireless carriers and resellers. We also operate a smaller
combination Time Division Multiplexing (“TDM”)/IP network located in Dallas,
Texas.
Products and
Services
Our
telecommunications products and service offerings target VoIP wholesale
customers, CLECs, IXCs, ISPs, cable operators and other providers of telephony
services in the United States and various countries around the world. We also
sell VoIP products such as EasyTalk and Rocket VoIP that are targeted at
individual consumers.
Call
Termination
We
charge
our wholesale customers minute-based fees to terminate calls on our network.
We
pay termination fees when it is necessary to route calls from our network to
other networks for termination. Our revenues and profit margins on those
revenues are a function of the number and duration of calls handled by our
network and what we charge and pay to handle this traffic.
U.S.
call
termination takes place either on our network or that of one of our network
partners to which we route traffic. Our international termination product
features direct routes and connections established to many international voice
carriers worldwide. Carriers use complex least-cost-routing algorithms that
direct traffic to the lowest cost carrier. We are attempting to establish a
competitive cost structure through the efficiencies of our network design,
the
completion and implementation of our own least-cost routing algorithms, and
through current and future partnerships with key off-net and niche providers.
Revenues generated from these services for the year ended December 31, 2006,
substantially all of which were derived from one customer, amounted to $5.7
million or 39% of our consolidated revenues during this period.
VoiceOne
Carrier Direct
We
are in
the early stages of implementing our VoiceOne Carrier Direct program which
we
believe will enable us to develop a significant facilities-based, carrier
customer base. We believe that carriers that want to offer VoIP services have
essentially three options: create their own internal VoIP capabilities, acquire
a VoIP carrier, or partner with a VoIP carrier. The first two of these options
are typically expensive and time consuming, both initially and with respect
to
ongoing system maintenance. With respect to the third option, our VoiceOne
Carrier Direct is a partner program for carriers that provide them with our
technology to IP-enable their TDM networks. With this program the carriers
receive our equipment and expertise, enabling them to rapidly enter the VoIP
services market without making significant capital expenditures. Because our
technology is protocol agnostic, by implementing the VoiceOne Carrier Direct
program we believe our customers can avoid modifications to their TDM networks
and the operability issues that can plague the interface of legacy systems
with
IP technology. We interface our customers' TDM systems to our VoIP network.
We
do not charge the carriers for equipment that includes softswitch technology,
a
media gateway, a service creation environment, a multi-protocol label switching
network and access to our products and services. In return for our equipment
and
expertise, the facilities based carrier pays us fees to terminate calls on
our
network and for other services such as Hosted IP Centrex and local inbound.
We
anticipate that this strategy will be attractive to the carriers since it
provides them with a new group of customers and revenue sources without
requiring them to modify their legacy systems or expend capital. Once the
carriers are part of our Carrier Direct Program, we can obtain revenues from
calls the carriers terminate on our network, and can terminate calls on their
network. Through December 31, 2006 we had not generated any
significant revenues from our VoiceOne Carrier Direct program.
Click-to-Call
In
November 2006 we introduced Click-to-Call, which involves initiating phone
calls
from computers without dialing. This technology is currently used as a sales
lead generator in online ads. From a web site, users type in the desired service
(flowers, pizza, etc.) along with their zip code. Once a service provider is
located and selected, the user then enters their phone number, clicks “call” on
the web site, and their phone will ring connecting them to the service provider.
We receive minute-based revenue for each call carried on our network.
Through
December 31, 2006 we had not generated significant revenues from our
Click-to-Call program.
EasyTalk
EasyTalk,
our automated number identification (“ANI”) retail product, marketed through our
website, is a long distance service with “ease of use” features for consumers.
We believe that EasyTalk is a step beyond calling cards. Our network is
programmed to automatically recognize our customers’ phone numbers and to
provide callers from these numbers immediate access to long-distance services.
No calling card or PIN number is required. Consumer features include PIN-less
dialing, fast *1 recharge of the service, speed dial, and quick query of current
balance. As of December 31, 2006 we had approximately 25,000 EasyTalk customers,
and revenues generated from this product offering amounted to approximately
$5.5
million for the year ended December 31, 2006.
Rocket
VoIP
Our
Rocket VoIP retail product allows customers to use, through a media terminal
adapter we provide, their high speed Internet connection to place local, long
distance and international calls. As of December 31, 2006 we had approximately
3,000 Rocket VoIP customers, and revenues generated for this product offering
amounted to approximately $600,000 for the year ended
December 31, 2006.
Other
Products
We
also
sell various PIN and ANI products to consumers via our website.
Prepaid
Calling Cards Segment
We
previously sold prepaid calling cards that we purchased from other carriers
to
private distributors located in Southern California. Unlike our other
communications products, the communication traffic arising from the use of
these
cards to place telephone calls was handled by carriers affiliated with vendors
we purchased the cards from, and not by our network. In October 2006, we
terminated our Marketing and Distribution Agreement with Phone House, Inc.,
effectively discontinuing this business segment, and its operations are
accounted for as discontinued.
Hardware
Sales Segment
Our
hardware sales subsidiary, doing business as DTNet Technologies, operated a
fulfillment center in Clearwater, Florida from which we sold a variety of VoIP
hardware and broadband components to broadband service providers. These products
included cable modems, DSL modems, AV power line and home plug adapters, and
multimedia terminal adapters. In April 2006, we sold DTNet Technologies to
our
former Chief Operating Officer, and its operations have since been accounted
for
as discontinued.
OUR
STRATEGY
Our
objective is to provide reliable, scalable, and competitively-priced worldwide
VoIP communication services with unmatched quality. We plan to achieve this
objective by delivering innovative technologies and services while balancing
the
needs of our customers with the needs of our business. We intend to bring high
quality voice products and services, at an affordable price, to other
communication providers, businesses and residential consumers to enhance the
ways in which these customers communicate with the rest of the world.
Recognizing that basic voice service is a commodity item that does not drive
significant profits, we plan to provide basic services to customers that will
lead into margin expansion as more advanced features are offered on our network,
including initiating phone calls from computers without dialing (click-to-call
technology), checking voicemail, faxes, and emails from a single computer in-box
(unified messaging), providing audio and video teleconferencing, and offering
VoIP services with leased lines.
Specific
strategies to accomplish this objective include:
· building
our carrier/service provider customer base through aggressive marketing of
our
VoiceOne Carrier Direct program;
· completing
the expansion of our network (currently in process);
· capitalizing
on our technological expertise to introduce new products, services and
features;
· customizing
our service offerings for the purpose of pursuing strategic partnerships with
major customers and suppliers;
· offering
the best possible service and support to our customers;
· developing
additional distribution channels;
· expanding
our market share for our retail calling services;
· increasing
our customer base by introducing cost-effective solutions to interconnect with
our network; and
· controlling
operating expenses and capital expenditures.
Competition
We
compete primarily in the market for enhanced IP communications services. This
market is highly competitive and has numerous service providers. The market
for
enhanced Internet and IP communications services is new and rapidly evolving.
We
believe that the primary competitive factors determining success in the Internet
and IP communications market are:
· quality
of service;
· breadth
and depth of service offerings;
·
ability
to custom create innovative solutions;
·
the
ability to meet and anticipate customer needs through multiple service offerings
and feature sets;
· responsive
customer care services; and
· price.
Future
competition could come from a variety of companies both in the Internet and
telecommunications industries. These industries include major companies who
have
greater resources and larger customer bases than we have, and have been in
operation for many years. We also compete in the growing market of discount
telecommunications services including "pure play" VoIP service providers,
prepaid calling cards, call-back services, dial-around or 10-10 calling and
collect calling services. In addition, some Internet service providers have
begun to aggressively enhance their real time interactive communications,
including instant messaging, PC-to-PC and PC-to-Phone services, and broadband
phone services.
Some
competitors may be able to bundle services and products that are not offered
by
us together with enhanced Internet and IP communications services, which could
place us at a significant competitive disadvantage. Many of our competitors
enjoy economies of scale that can result in lower cost structure for
transmission and related costs, which could cause significant pricing pressures
within the industry. At the same time, we see these potential competitors as
potential customers, and have organized our various reseller and service
provider products and services to meet the emergent needs of these
companies.
Our
primary competitors include:
· carriers
operating in the U.S. and abroad, including Level 3, Global Crossing, Cogent
Communications Group, Inc., XO Holdings, Inc., US LEC Corporation, Pac-West
Telecomm, Inc.; and
· subscriber
based service provider competitors, including Vonage, Packet8, DeltaThree,
SunRocket, Time Warner, Comcast and Net2phone.
Human
Resources
VoIP,
Inc. currently employs 53 persons in the following capacities: 3 officers,
26
general and administrative employees, and 24 technology personnel. We consider
our relations with our employees to be favorable. We have never had a work
stoppage, and none of our employees is represented by collective bargaining
agreements. We believe that our future success will depend in part on our
ability to attract, integrate, retain and motivate highly qualified personnel,
and upon the continued service of our senior management and key technical
personnel. Our Chief Executive Officer and Chief Operating Officer are bound
by
employment agreements through September 2009. Competition for qualified
personnel in our industry and geographical location is intense. We cannot assure
you that we will be successful in attracting, integrating, retaining and
motivating a sufficient number of qualified employees to conduct our business
in
the future.
Intellectual
Property
We
have
developed several important intellectual property features. VoiceOne has
developed and the network provides an E911 solution to comply with the FCC's
recent order imposing E911 requirements on VoIP service providers. VoiceOne's
911 service is known as Enhanced E911. A key feature of the E911 service is
that
it can route emergency calls for the customer whose location is constant as
well
as the customer who often moves the location of his VoIP device. Customers
can
update their location information in real time, so that their 911 call will
be
delivered to the appropriate PSAP in the new location. To further support the
FCC 911 mandate, we have applied for a patent for our 911 compliant VoIP
Multimedia Terminal Adaptor.
We
have
developed Pathfinder as a "cascading provisioning server" feature for deployment
of zero-touch hardware deployment and is a new development that is exclusive
to
our platform. The system allows each device to auto-provision without any
customer interaction even in situations where there are multiple levels of
resellers to distribute the product to their customers (to any number of resale
levels). This allows for installations without any customer service or technical
support time spent in configuration issues.
REGULATION
We
are
currently both a value added service provider and a provider of interconnected
Voice over Internet Protocol (“VoIP”) services as that term is defined under
federal law. The integration and softswitch portions of our business are
expected to remain unthreatened by traditional common carrier regulation in
major nations in which we expect to do business. Our telecommunications service
offerings may potentially experience regulatory pressures as the United States
makes changes in its telecommunications law to encompass interconnected VoIP
services. The imposition of government regulation on our business could
adversely affect our operations by requiring additional expense to meet
compliance requirements and subject us to additional fees and surcharges that
are currently applicable to providers of legacy telecommunications
services.
The
FCC
regulates interstate and international telecommunications services. The FCC
imposes extensive regulations on common carriers such as ILECs that have some
degree of market power. The FCC imposes less regulation on common carriers
without market power, such as the Company. The FCC permits these non-dominant
carriers to provide domestic interstate services (including long-distance and
access services) without prior authorization; but it requires carriers to
receive an authorization to construct and operate telecommunications facilities
and to provide or resell telecommunications services between the United States
and international points. Under the Telecommunications Act of 1996 (the "1996
Act"), any entity, including cable television companies and electric and gas
utilities, may enter any telecommunications market, subject to reasonable state
regulation of safety, quality and consumer protection. The 1996 Act opened
the
local services market by requiring ILECs to permit interconnection to their
networks.
The
FCC
has to date treated Internet service providers (“ISPs”) as "enhanced service
providers," exempt from federal and state regulations governing common carriers,
including the obligation to pay access charges and contribute to the universal
service fund. Nevertheless, regulations governing disclosure of confidential
communications, copyright, excise tax and other requirements may apply to the
provision of Internet access services.
FCC
Regulation of Interconnected VoIP Services
There
are
a number of regulatory proceedings underway or being considered by federal
and
state authorities, including the Federal Communications Commission, or FCC,
and
state regulatory agencies that could potentially impact providers of
interconnected VoIP services, like us. Currently, providers of interconnected
VoIP services are largely unregulated in the United States particularly when
compared to providers of traditional telecommunications services.
On March
10, 2004, the FCC adopted a Notice of Proposed Rulemaking, which will address
a
variety of issues concerning the regulatory treatment of VoIP telephony. We
cannot predict the outcome of this proceeding. Should the FCC adopt additional
regulations that would be applicable to interconnected VoIP providers like
us,
our costs of doing business would likely increase and would make our services
less competitive with traditional providers of telecommunications
services.
In
November 2004, the FCC ruled that the interconnected VoIP services of a
particular company are jurisdictionally interstate and not subject to state
certification, tariffing and most other state telecommunications regulations.
The FCC ruling was upheld on appeal. We believe that our interconnected VoIP
service is substantially similar to the one the FCC ruled on and that our
service would also be considered interstate and free from state regulation.
In
June
2006, the FCC determined that providers of interconnected VoIP services must
contribute to the federal Universal Service Fund, or USF. For a period of at
least two quarters beginning October 1, 2006, we will be required to contribute
to the USF for its subscribers’ retail revenues as well as through its
underlying carriers’ wholesale charges. The impact of this obligation is to
either increase prices for our services to our customers or to reduce our profit
margin. This could have a material adverse effect on our financial position,
results of operations and cash flows. The FCC Order applying USF contributions
to interconnected VoIP providers is currently under appeal and the FCC continues
to evaluate alternative methods for assessing USF charges, including imposing
an
assessment on telephone numbers. The outcome of these proceedings cannot be
determined at this time.
Interconnected
VoIP providers, like us,
are required to offer the 911 emergency calling capabilities similar to those
available to subscribers of traditional switched phone lines. We were also
required to distribute stickers and labels warning customers of the limitations
associated with accessing emergency services through an interconnected VoIP
service, as well as to notify and to obtain affirmative acknowledgement from
customers that customers were aware of the differences between the emergency
calling capabilities offered by interconnected VoIP providers as compared to
traditional, wireline providers of telephone service. These requirements pertain
to our Rocket VoIP customers described on page 6. The FCC’s Enforcement Bureau
released an order stating that the Enforcement Bureau will not pursue
enforcement against interconnected VoIP providers that have received affirmative
acknowledgement from at least 90% of their subscribers, which we have
received.
Like
many
interconnected VoIP providers, we cannot offer VoIP E911 services that route
emergency calls in a manner consistent with the FCC rules for all of its
customers. We are addressing this issue with our VoIP E911 solution providers.
The FCC may determine that our VoIP E911 solution for certain customers does
not
satisfy the requirements of the VoIP E911 order because, in some instances,
Volo
will not be able to connect subscribers directly to a PSAP. Volo recently
received correspondence from the FCC requesting additional information about
its
911 compliance. We understand that a number of interconnected VoIP providers
received similar correspondence. A response is due on April 11, 2007. We cannot
predict what action the FCC may take after reviewing our responses. Should
the
FCC engage in any type of enforcement action, such as disconnecting customers,
paying monetary fines, or any other type of enforcement action, such actions
could have a material adverse effect on our financial position, results of
operations and cash flows.
On
August
5, 2005, the FCC unanimously adopted an order requiring interconnected VoIP
providers, like the Company, to comply with the Communications Assistance for
Law Enforcement Act, or CALEA. CALEA requires covered providers to assist law
enforcement agencies in conducting lawfully authorized electronic surveillance.
Under the FCC Order, interconnected VoIP providers will be required to comply
with CALEA obligations by May 14, 2007 and make certain filings prior to that
date. Consistent with the relevant rules, we are working with a third-party
solution provider to devise a CALEA solution. Our failure to achieve compliance
with any future CALEA orders, rules, filings or standards, or any enforcement
action initiated by the FCC or other agency, state or task force against us
could have a material adverse effect on our financial position, results of
operations or cash flows.
The
effect of any future laws and regulations on our operations cannot be
determined.
State
Regulation
The
1996
Act is intended to increase competition in the telecommunications industry,
especially in the local exchange market. With respect to local services, ILECs
are required to allow interconnection to their networks and to provide unbundled
access to network facilities, as well as a number of other pro-competitive
measures. Because the implementation of the 1996 Act is subject to numerous
state rulemaking proceedings on these issues, it is currently difficult to
predict how quickly full competition for local services will
develop.
Local
Regulation
Our
network is subject to numerous local regulations such as building codes and
licensing. Such regulations vary on a city-by-city, county- by-county and
state-by-state basis.
Item
1A. Risk
Factors
RISKS
RELATED TO OUR COMPANY
We
are not in compliance with the terms of our secured loan agreement, and the
note
holders may accelerate the amounts due at any time.
We
are
not in compliance with certain covenants of the agreement for our secured loan
from a lending institution, now held by a group of institutional investors
(and
formerly held by Cedar Boulevard Lease Funding LLC). The loan balance currently
amounts to approximately $1.9 million,
and we
have also not made scheduled principal and interest payments. In
addition, the loan is now accruing interest at 17.5%, and is repayable through
May 2007. Because the investors have a security interest in all of our assets,
they may choose to accelerate the loan payments at any time, which would have
a
significant adverse impact on our financial condition, and could impair our
ability to continue as a going concern.
We
are not in compliance with the terms of our convertible notes issued in July
and
October 2005, in January and February of 2006, and in October 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, in January
and February 2006, and in October 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 $217,506 under the 2005 notes and have
not
made scheduled payments of $1,286,079 under the 2006 notes. Also we have not
registered all of these note shares and related warrant shares. The convertible
note holders have not declared a default under the loan agreements. However,
the
amounts due under the notes could be accelerated and immediately due and
payable, which would adversely affect our financial condition.
Because
we failed to meet our obligations to file registration statements required
under
the various subscription agreements related to certain of our 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 are
declared effective.
Pursuant
to the subscription agreements under which certain investors purchased notes,
common stock and warrants in 2005 and 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. Because we failed to comply with these
requirements, we currently owe liquidated damages of $2,200,631 plus 1,535,219
shares of common stock, and will continue to incur liquidated damages amounting
to $278,432 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. We are currently contractually obligated to register
approximately 269 million shares, warrants and options. There is no assurance
that sufficient registration statements can be filed or declared effective
by
the SEC, in which case we would continue to be unable to satisfy our contractual
obligations to register shares.
Our
substantial debt could adversely affect our financial position, operations
and
ability to grow.
As
of
December 31, 2006, our total liabilities were approximately $37.9 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
need immediate 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. To date, 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 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 further 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
September 12, 2006, we underwent a reorganization of our executive management.
Accordingly, Mr. Anthony J. Cataldo was appointed Chief Executive
Officer and Chairman, replacing Mr. Gary Post, who himself replaced a
former Chief Executive Officer on May 19, 2006. Mr. David Ahn, Vice
President Corporate Planning, also left the Company effective
September 12, 2006. On May 19, 2006, Mr. Robert V. Staats was appointed
Chief Accounting Officer, and Mr. David Sasnett resigned as Chief Financial
Officer. On July 28, 2006, Mr. Shawn M. Lewis was appointed Chief Operating
Officer in addition to Chief Technology Officer. Although the board of directors
believes that these management changes are in our best interests and that the
new management will have a positive impact, significant personnel changes may
have the effect of disrupting our day-to-day operations until such time as
the
new management is integrated and fully informed with respect to our business
and
operations.
We
may incur goodwill and intangible asset impairment
charges.
Our
balance sheet at December 31, 2006 includes approximately $21.2 million in
goodwill and approximately $11.5 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 as
a
result of 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. During the year ended December 31, 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 declines,
a material goodwill impairment charge in the future is possible.
Our
internal controls over financial reporting are not adequate, and our independent
auditors may not be able to later certify as to their adequacy, which could
have
a significant and adverse effect on our business and
reputation.
Section
404 of Sarbanes-Oxley and the rules and regulations of the Securities Exchange
Commission (the “Commission”) associated with Sarbanes-Oxley, which we refer to
as Section 404, require a reporting company to, among other things, annually
review and disclose its internal controls over financial reporting, and evaluate
and disclose changes in its internal controls over financial reporting
quarterly. Under Section 404 a reporting company is required to document and
evaluate such internal controls in order to allow its management to report
on,
and its independent auditors to attest to, these controls. We are required
to
comply with Section 404 not later than our fiscal year ending December 2007.
We
are currently evaluating our strategy to begin performing the system and process
documentation, evaluation and testing required (and any necessary remediation)
in an effort to comply with management certification and auditor attestation
requirements of Section 404. As reported in Item 9A. Controls and Procedures
beginning at page 31, we have concluded that our disclosure controls and
procedures, and our financial reporting controls, are currently ineffective.
Further, in the course of our ongoing evaluation, we may identify additional
areas of our internal controls requiring improvement, and plan to design
enhanced processes and controls to address issues that might be identified
through this review. As a result, we expect to incur additional expenses and
diversion of management's time. We cannot be certain as to the timing of
completion of our documentation, evaluation, testing and remediation actions
or
the impact of the same on our operations, and may not be able to ensure that
the
process is effective or that the internal controls are or will be effective
in a
timely manner. If we are not able to implement the requirements of Section
404
in a timely manner or with adequate compliance, our independent auditors may
not
be able to certify as to the effectiveness of our internal control over
financial reporting, and we may be subject to sanctions or investigation by
regulatory authorities, such as the Commission. As a result, there could be
an
adverse reaction in the financial markets due to a loss of confidence in the
reliability of our financial statements. In addition, we may be required to
incur costs in improving our internal control system and the hiring of
additional personnel. Any such actions could adversely affect our results of
operations, cash flows and financial condition.
We
have a history of losses and negative cash flows from operations, and we
anticipate such losses and negative cash flows will
continue.
We
have
incurred significant losses since inception, and we anticipate continuing to
incur significant losses for the foreseeable future. Our net loss for the fiscal
years ended December 31, 2006 and 2005 was approximately $41.2 million and
$28.3
million, respectively. Our net cash used for operating activities for these
same
periods was approximately $12.4 million and $20.0 million, respectively. As
of
December 31, 2006, our accumulated deficit was approximately $76.0 million.
Our
revenues may not grow or even continue at their current level. We will need
to
significantly increase our revenues and gross margins to become profitable.
In
order to increase our revenues, we need to attract and maintain customers to
increase the fees we collect for our services. If our revenues do not increase
as much as we expect, we may never be profitable. Even if our revenues increase,
if we are unable to generate sufficiently profitable margins on these revenues,
we may never be profitable. If we become profitable, we may not be able to
sustain or increase profitability.
We
have a limited operating history upon which you can evaluate
us.
We
have
only a limited operating history upon which you can evaluate our business and
prospects. We commenced operations of our current business in 2004, and the
majority of our operations are comprised of businesses we acquired in 2005.
You
should consider our prospects in light of the risks, expenses and difficulties
we may encounter as an early stage company in the new and rapidly evolving
market for Internet protocol (IP) communications services. These risks include
our ability:
· |
To
successfully integrate our recent
acquisitions;
|
· |
To
increase acceptance of our VoIP communications services, thereby
increasing the number of users of our IP telephony
services;
|
· |
To
compete effectively; and
|
· |
To
develop new products and keep pace with developing
technology.
|
In
addition, because we expect an increasing percentage of our revenues to be
derived from our IP communications services, our past operating results may
not
be indicative of our future results.
We
may not be able to expand our revenue base and achieve
profitability.
Our
business strategy is to expand our revenue sources by providing IP
communications services to several different customer groups. We can neither
assure you that we will be able to accomplish this nor that this strategy will
be profitable. Approximately 39% of our consolidated revenues for the year
ended
December 31, 2006 were derived from one customer, and our gross margins for
these revenues were negative. Currently, our revenues are generated by providing
termination services for other carriers and end users, and from the sales of
retail VoIP services to consumers. These services have not been profitable
to
date and may not be profitable in the future.
In
the
future, we intend to generate increased revenues from IP communications services
from multiple sources, many of which are unproven. We expect that our revenues
for the foreseeable future will be dependent on, among other
factors:
· |
Acceptance
and use of IP telephony;
|
· |
Growth
in the number of our customers;
|
· |
Expansion
of service offerings;
|
· |
Traffic
levels on our network;
|
· |
The
effect of competition, regulatory environment, international long
distance
rates, and access and transmission costs on our prices;
and
|
· |
Continued
improvement of our global network
quality.
|
We
cannot
assure you that a market for our services will develop. Our market is new and
rapidly evolving. Our ability to sell our services may be inhibited by, among
other factors, the reluctance of some end-users to switch from traditional
communications carriers to IP communications carriers and by concerns with
the
quality of IP telephony and the adequacy of security in the exchange of
information over the Internet, and the reluctance of our resellers and service
providers to utilize outsourced solutions providers.
End-users
in markets serviced by recently deregulated telecommunications providers are
not
familiar with obtaining services from competitors of these providers and may
be
reluctant to use new providers such as us. We will need to devote substantial
resources to educate customers and end-users about the benefits of IP
communications solutions in general and our services in particular. If
enterprises and their customers do not accept our enhanced IP communications
services as a means of sending and receiving communications, we will not be
able
to increase our number of paid users or successfully generate revenues in the
future.
Potential
fluctuations in our quarterly financial results may make it difficult for
investors to predict our future performance.
Our
quarterly operating results may fluctuate significantly in the future as a
result of a variety of factors, many of which are outside our
control.
Such
factors also may create other risks affecting our long-term success, as
discussed in the other risk factors. We believe that quarter-to-quarter
comparisons of our historical operating results may not be a good indication
of
our future performance, nor would our operating results for any particular
quarter be indicative of our future operating results.
Our
network may not be able to accommodate our capacity needs.
We
expect
the volume of traffic we carry over our network to increase significantly as
we
expand our operations and service offerings. Our network may not be able to
accommodate this additional volume. In order to ensure that we are able to
handle additional traffic, we may have to enter into long-term agreements for
leased capacity. To the extent that we overestimate our capacity needs, we
may
be obligated to pay for more transmission capacity than we actually use,
resulting in costs without corresponding revenues. Conversely, if we
underestimate our capacity needs, we may be required to obtain additional
transmission capacity from more expensive sources. If we are unable to maintain
sufficient capacity to meet the needs of our users, our reputation could be
damaged and we could lose customers and revenues.
Additionally,
our success depends on our ability to handle a large number of simultaneous
calls. We expect that the volume of simultaneous calls will increase
significantly as we expand our operations. If this occurs, additional stress
will be placed upon the network hardware and software that manages our traffic.
We cannot assure stockholders of our ability to efficiently manage a large
number of simultaneous calls. If we are not able to maintain an appropriate
level of operating performance, or if our service is disrupted, then we may
develop a negative reputation and our business, results of operations, and
financial condition could be materially adversely affected.
We
may be unsuccessful selecting the most economical call
routing.
We
rely
on vendors to terminate calls. Vendor charges for these services vary by call
route, and costs between vendors for the same routes vary. Because of the heavy
volume of calls handled by our network, automation of the call routing to the
“least-cost” vendor for each route is typically required to generate a positive
gross margin. We are currently developing such automation, but we may not be
successful in its implementation or further maintenance, which would adversely
affect our financial performance.
We
face a risk of failure of computer and communications systems used in our
business.
Our
business depends on the efficient and uninterrupted operation of our computer
and communications systems as well as those that connect to our network. We
maintain communications systems (also referred to as network access points)
in
facilities in Orlando, Atlanta, New York, Dallas, and Los Angeles.
Our
systems and those that connect to our network are subject to disruption from
natural disasters or other sources such as power loss, communications failure,
hardware or software malfunction, network failures, and other events both within
and beyond our control. Any system interruptions that cause our services to
be
unavailable, including significant or lengthy telephone network failures or
difficulties for users in communicating through our network or portal, could
damage our reputation and result in a loss of users.
Our
computer systems and operations may be vulnerable to security
breaches.
Our
computer infrastructure is potentially vulnerable to physical or electronic
computer viruses, break-ins and similar disruptive problems and security
breaches that could cause interruptions, delays or loss of services to our
users. We believe that the secure transmission of confidential information,
such
as credit card numbers, over the Internet is essential in maintaining user
confidence in our services. We rely on licensed encryption and authentication
technology to effect secure transmission of confidential information, including
credit card numbers. It is possible that advances in computer capabilities,
new
technologies or other developments could result in a compromise or breach of
the
technology we use to protect user transaction data. A party that is able to
circumvent our security systems could misappropriate proprietary information
or
cause interruptions in our operations. Security breaches also could damage
our
reputation and expose us to a risk of loss or litigation and possible liability.
Although we have experienced no security breaches to date of which we are aware,
we cannot guarantee you that our security measures will prevent security
breaches.
Online
credit card fraud can harm our business.
The
sale
of our products and services over the Internet exposes us to credit card fraud
risks. Some of our products and services can be ordered or established (in
the
case of new accounts) over the Internet using a major credit card for payment.
As is prevalent in retail telecommunications and Internet services industries,
we are exposed to the risk that some of these credit card accounts are stolen
or
otherwise fraudulently obtained. In general, we are not able to recover
fraudulent credit card charges from such accounts. In addition to the loss
of
revenue from such fraudulent credit card use, we also remain liable to third
parties whose products or services are engaged by us (such as termination fees
due telecommunications providers) in connection with the services which we
provide. In addition, depending upon the level of credit card fraud we
experience, we may become ineligible to accept the credit cards of certain
issuers. We are currently authorized to accept American Express, Visa,
MasterCard, and Discover. The loss of eligibility for acceptance of credit
cards
could significantly and adversely affect our business. We will attempt to manage
fraud risks through our internal controls and our monitoring and blocking
systems. If those efforts are not successful, fraud could cause our revenue
to
decline significantly and our business, financial condition and results of
operations to be materially and adversely affected.
We
depend on highly qualified technical and managerial
personnel.
Our
future success also depends on our continuing ability to attract, retain and
motivate highly qualified technical expertise and managerial personnel necessary
to operate our businesses. We may need to give retention bonuses and stock
incentives to certain employees to keep them, which can be costly to us. The
loss of the services of members of our management team or other key personnel
could harm our business. Our future success depends to a significant extent
on
the continued service of key management, client service, product development,
sales and technical personnel. We do not maintain key person life insurance
on
any of our executive officers and do not intend to purchase any in the future.
Although we generally enter into non-competition agreements with our key
employees, our business could be harmed if one or more of our officers or key
employees decided to join a competitor or otherwise compete with
us.
We
may be
unable to attract, assimilate or retain highly qualified technical and
managerial personnel in the future. Wages for managerial and technical employees
are increasing and are expected to continue to increase in the future. We may
have difficulty in hiring and retaining highly skilled employees with
appropriate qualifications. If we were unable to attract and retain the
technical and managerial personnel necessary to support and grow our businesses,
our businesses would likely be materially and adversely affected.
International
operations may expose us to additional and unpredictable
risks.
We
may
enter international markets such as Eastern Europe, the Middle East, Latin
America, Africa and Asia and may expand our existing operations outside the
United States. International operations are subject to inherent risks,
including:
· |
Potentially
weaker protection of intellectual property
rights;
|
· |
Political
and economic instability;
|
· |
Unexpected
changes in regulations and tariffs;
|
· |
Fluctuations
in exchange rates;
|
· |
Varying
tax consequences; and
|
· |
Uncertain
market acceptance and difficulties in marketing efforts due to language
and cultural differences.
|
Our
entry into new lines of business, as well as potential future acquisitions,
joint ventures or strategic transactions, entail numerous risks and
uncertainties that could have an adverse effect on our
business.
We
may
enter into new or different lines of business, as determined by management
and
our board of directors. Our acquisitions, as well as any future acquisitions
or
joint ventures, could result, and in some instances have resulted, in numerous
risks and uncertainties including:
· |
Potentially
dilutive issuances of equity securities, which may be issued at the
time
of the transaction or in the future if certain performance or other
criteria are met or not met, as the case may be. These securities
may be
freely tradable in the public market or subject to registration rights
which could require us to publicly register a large amount of our
common
stock, which could have a material adverse effect on our stock
price;
|
· |
Diversion
of management’s attention and resources from our existing
businesses;
|
· |
Significant
write-offs if we determine that the business acquisition does not
fit or
perform up to expectations;
|
· |
The
incurrence of debt and contingent liabilities or impairment charges
related to goodwill and other long-lived
assets;
|
· |
Difficulties
in the assimilation of operations, personnel, technologies, products
and
information systems of the acquired
companies;
|
· |
Regulatory
and tax risks relating to the new or acquired
business;
|
· |
The
risks of entering geographic and business markets in which we have
limited
(or no) prior experience;
|
· |
The
risk that the acquired business will not perform as expected;
and
|
· |
Material
decreases in short-term or long-term
liquidity.
|
RISKS
RELATED TO OUR INDUSTRY
Our
future success depends on the growth in the use of Internet Protocol as a means
of communications.
If
the
market for IP communications in general, and our services in particular, does
not grow or does not grow at the rate we anticipate, we will not be able to
increase our number of customers or generate the revenues we anticipate. To
be
successful, IP communication requires validation as an effective, quality means
of communication and as a viable alternative to traditional telephone service.
Demand and market acceptance for recently introduced services are subject to
a
high level of uncertainty. The Internet may not prove to be a viable alternative
to traditional telephone service for reasons including:
· |
Inconsistent
quality or speed of service;
|
· |
Potentially
inadequate development of the necessary
infrastructure;
|
· |
Lack
of acceptable security
technologies;
|
· |
Lack
of timely development and commercialization of performance improvements;
and
|
· |
Unavailability
of cost-effective, high-speed
access.
|
If
Internet usage grows, the Internet infrastructure may not be able to support
the
demands placed on it by such growth, or its performance or reliability may
decline. In addition, Web sites may from time to time experience interruptions
in their service as a result of outages and other delays occurring throughout
the Internet network infrastructure. If these outages or delays frequently
occur
in the future, Internet usage, as well as usage of our communications portal
and
our services, could be adversely affected.
Intense
competition could reduce our market share and harm our financial
performance.
Competition
in the market for IP communications services is becoming increasingly intense,
and such competition is expected to increase significantly in the future. The
market for Internet and IP communications is new and rapidly evolving. We expect
that competition from companies both in the Internet and telecommunications
industries will increase in the future. Our competitors include both start-up
IP
telephony service providers and established traditional communications
providers. Many of our existing competitors and potential competitors have
broader portfolios of services; greater financial, management and operational
resources; greater brand-name recognition; larger subscriber bases; and more
experience than we have. In addition, many of our IP telephony competitors
use
the public Internet instead of a private network to transmit traffic. Operating
and capital costs of these providers may be less than ours, potentially giving
them a competitive advantage over us in terms of pricing. We also compete
against discount telecommunications services including prepaid calling cards,
call-back services, dial-around or 10-10 calling and collect calling services.
In addition, some Internet service providers have begun to aggressively enhance
their real time interactive communications, focusing on instant messaging,
PC-to-PC and PC-to-phone, and/or broadband phone services.
In
addition, traditional carriers, cable companies and satellite television
providers are bundling services and products not offered by us with Internet
telephony services. While this provides us with the opportunity to offer these
companies our products and services as a way for them to offer Internet
telephony services, it also introduces the risk that they will introduce these
services on their own utilizing other options while at the same time making
it
more difficult for us to compete against them with direct-to-consumer offerings
of our own. If we are unable to provide competitive service offerings, we may
lose existing users and be unable to attract additional users. In addition,
many
of our competitors, especially traditional carriers, enjoy economies of scale
that result in a lower cost structure for transmission and related costs, which
cause significant pricing pressures within the industry. In order to remain
competitive we intend to increase our efforts to promote our services, and
we
cannot be sure that we will be successful in doing this.
In
addition to these competitive factors, recent and pending deregulation in some
of our markets may encourage new entrants. We cannot assure you that additional
competitors will not enter markets that we plan to serve or that we will be
able
to compete effectively.
Decreasing
telecommunications rates may diminish our revenues and
profitability.
International
and domestic telecommunications rates have decreased significantly over the
last
few years in most of the markets in which we operate, and we anticipate that
rates will continue to be reduced in all of the markets in which we do business
or expect to do business. Users who select our services to take advantage of
the
current pricing differential between traditional telecommunications rates and
our rates may switch to traditional telecommunications carriers as such pricing
differentials diminish or disappear, and we will be unable to use such pricing
differentials to attract new customers in the future. In addition, our ability
to market our carrier transmission services to telecommunications carriers
depends upon the existence of spreads between the rates offered by us and the
rates offered by traditional telecommunications carriers, as well as a spread
between the retail and wholesale rates charged by the carriers from which we
obtain wholesale service. Continued rate decreases will require us to lower
our
rates to remain competitive, could reduce our revenues, and reduce or possibly
eliminate our gross profit from our carrier transmission services. If
telecommunications rates continue to decline, we may lose users for our
services.
We
may not be able to keep pace with rapid technological changes in the
communications industry.
Our
industry is subject to rapid technological change. We cannot predict the effect
of technological changes on our business. In addition, widely accepted standards
have not yet developed for the technologies we use. We expect that new services
and technologies will emerge in the market in which we compete. These new
services and technologies may be superior to the services and technologies
that
we use, or these new services may render our services and technologies obsolete.
To be successful, we must adapt to our rapidly changing market by continually
improving and expanding the scope of services we offer and by developing new
services and technologies to meet customer needs. Our success will depend,
in
part, on our ability to license leading technologies and respond to
technological advances and emerging industry standards on a cost-effective
and
timely basis. We may need to spend significant amounts of capital to enhance
and
expand our services to keep pace with changing technologies.
Third
parties might infringe upon our proprietary technology, and we could be deemed
to have infringed upon others’ proprietary technology.
We
cannot
assure you that the steps we have taken to protect our intellectual property
rights will prevent misappropriation of our proprietary technology. To protect
our rights to our intellectual property, we rely on a combination of trademark
and trade secret protection, confidentiality agreements and other contractual
arrangements with our employees, affiliates, strategic partners and others.
We
may be unable to detect the unauthorized use of, or take appropriate steps
to
enforce, our intellectual property rights. Effective copyright and trade secret
protection may not be available in every country in which we offer or intend
to
offer our services. Failure to adequately protect our intellectual property
could harm our brand, devalue our proprietary content and affect our ability
to
compete effectively. Further, defending our intellectual property rights could
result in the expenditure of significant financial and managerial resources.
In
addition, given the growing level of VoIP-related patents and related patent
litigation, we could be deemed to have infringed on the patent rights of others,
which could also result in the expenditure of significant financial and
managerial resources, and which, if we are unsuccessful in defending, could
result in significant damage awards.
If
we are not able to obtain necessary licenses of third-party technology at
acceptable prices, or at all, some of our products may become
obsolete.
From
time
to time, we may be required to license technology from third parties to develop
new products or product enhancements. Third-party licenses may not be available
or continue to be available to us on commercially reasonable terms. The
inability to maintain or re-license any third-party licenses required in our
current products, or to obtain any new third-party licenses to develop new
products and product enhancements, could require us to obtain substitute
technology of lower quality or performance standards or at greater cost, and
delay or prevent us from making these products or enhancements, any of which
could seriously harm the competitiveness of our products. We currently license
third party technology for products acquired through the WQN
acquisition.
Government
regulation and legal uncertainties relating to IP telephony could harm our
business.
Historically,
voice communications services have been provided by regulated telecommunications
common carriers. We offer voice communications to the public for international
and domestic calls using IP telephony. Based on specific regulatory
classifications and recent regulatory decisions, we believe we qualify for
certain exemptions from telecommunications common carrier regulation in many
of
our markets. However, the growth of IP telephony has led to close examination
of
its regulatory treatment in many jurisdictions, making the legal status of
our
services uncertain and subject to change as a result of future regulatory
action, judicial decisions or legislation in any of the jurisdictions in which
we operate. Established regulated telecommunications carriers have sought and
may continue to seek regulatory actions to restrict the ability of companies
such as ours to provide services or to increase the cost of providing such
services. In addition, our services may be subject to regulation if regulators
distinguish phone-to-phone telephony service using IP technologies over
privately-managed networks such as our services from integrated PC-to-PC and
PC-originated voice services over the Internet. Some regulators may decide
to
treat the former as regulated common carrier services and the latter as
unregulated enhanced or information services. Application of new regulatory
restrictions or requirements to us could increase our costs of doing business
and prevent us from delivering our services through our current arrangements.
In
such event, we would consider a variety of alternative arrangements for
providing our services, including obtaining appropriate regulatory
authorizations for our local network partners or ourselves, changing our service
arrangements for a particular country or limiting our service offerings. Such
regulations could limit our service offerings, raise our costs and restrict
our
pricing flexibility, and potentially limit our ability to compete effectively.
Further, regulations and laws which affect the growth of the Internet could
hinder our ability to provide our services over the Internet.
Recent
regulatory enactments by the FCC will require us to provide enhanced Emergency
911 dialing capabilities to our subscribers as part of our standard VoIP
services and to comply with certain notification requirements with respect
to
such capabilities. These requirements will result in increased costs and risks
associated with the delivery of our VoIP services. Even assuming our full
compliance with Emergency 911 requirements, such compliance and our efforts
to
achieve such compliance will increase our cost of doing business in the VoIP
arena and may adversely affect our ability to deliver our VoIP telephony
services to new and existing customers in all geographic regions.
Our
products must comply with industry standards, FCC regulations, state,
country-specific and international regulations, and changes may require us
to
modify existing products.
In
addition to reliability and quality standards, the market acceptance of
telephony over broadband IP networks is dependent upon the adoption of industry
standards so that products from multiple manufacturers are able to communicate
with each other. There is currently a lack of agreement among industry leaders
about which standard should be used for a particular application, and about
the
definition of the standards themselves. These standards, as well as audio and
video compression standards, continue to evolve. We also must comply with
certain rules and regulations of the Federal Communications Commission (FCC)
regarding electromagnetic radiation and safety standards established by
Underwriters Laboratories, as well as similar regulations and standards
applicable in other countries. Standards are continuously being modified and
replaced. As standards evolve, we may be required to modify our existing
products or develop and support new versions of our products. The failure of
our
products to comply, or delays in compliance, with various existing and evolving
industry standards could delay or interrupt volume production of our IP
telephony products, which would have a material adverse effect on our business,
financial condition and operating results.
Terrorist
attacks, hostilities or other sustained military campaigns may adversely impact
the industry and us.
The
terrorist attacks that took place in the United States on September 11, 2001,
were unprecedented events that have created many economic and political
uncertainties, some of which may materially adversely impact us. The long-term
impact that terrorist attacks and the threat of terrorist attacks may have
on
the telecommunications industry is not known at this time. Uncertainty
surrounding future hostilities both in the United States and abroad may
adversely impact us in unpredictable ways.
RISKS
RELATED TO OUR STOCK
Because
many of our current financing agreements contain “favored nations” clauses,
future securities issuances at prices below contractual thresholds may trigger
price ratchets that could decrease the exercise price or conversion rate of
our
existing convertible debt and warrants, significantly diluting existing
shareholders.
Many
of
our existing convertible debt and warrant agreements contain “favored nations”
clauses, whereby their related conversion or exercise prices automatically
ratchet downward to match potentially more favorable terms issued to new
security holders. This has the effect of increasing the number of our common
shares issuable upon the assumed conversion or exercise of our existing
convertible debt and warrants. Existing conversion or exercise prices related
to
financing agreements with favored nations clauses have been ratcheted to as
low
as $0.18 per share. If future issuances of securities are made at conversion
or
exercise prices with terms more favorable than this, existing shareholders
could
be significantly diluted.
Our
stock price has been and may continue to be volatile.
The
market for technology stocks in general and our common stock in particular,
has
been and will likely continue to be extremely volatile. The following factors
could cause the market price of our common stock to fluctuate
significantly:
· |
The
addition or loss of any major
customer;
|
· |
Changes
in the financial condition or anticipated capital expenditure purchases
of
any existing or potential major
customer;
|
· |
Quarterly
variations in our operating
results;
|
· |
Changes
in financial estimates by securities
analysts;
|
· |
Speculation
in the press or investment
community;
|
· |
Announcements
by us or our competitors of significant contracts, new products or
acquisitions, distribution partnerships, joint ventures, or capital
commitments;
|
· |
Sales
of common stock or other securities by us or by our shareholders
in the
future;
|
· |
Securities
and other litigation;
|
· |
Announcement
of a stock split, reverse stock split, stock dividend, or similar
event;
|
· |
Economic
conditions for the telecommunications, networking, and related industries;
and
|
We
do not expect to pay dividends.
We
do not
anticipate paying any cash dividends on our common stock in the foreseeable
future. We intend to retain profits, if any, to fund growth and
expansion.
We
do not have sufficient authorized or registered shares, and future common stock
dilution is likely.
Our
authorized shares of stock consist of 400,000,000 shares of common stock. As
of
March 28, 2007, 98,609,701 common shares were issued and outstanding, and
approximately 242.1 million additional shares are currently issuable upon the
conversion of all convertible debt, and the exercise of all options and
warrants. We are also required to reserve an additional 76.6 million common
shares under our various financing agreements and stock option plans. We will
need to seek future shareholder approval of additional common shares to meet
these obligations. If such approval is not obtained, we will be unable to
satisfy all of the contractual obligations we have undertaken to issue and
reserve future shares of common stock. Also, if significant numbers of
additional common shares are issued as allowed for above or in conjunction
with
new financing, our current shareholders would experience significant dilution
of
their ownership, and our stock price per share could decline substantially.
The
following table specifies, for each listed obligation, the common shares
issuable upon the conversion of all convertible debt and the exercise of all
options and warrants, additional reservation requirements, and planned common
share issuances upon approval of our proposed increase in our authorized common
shares.
|
|
Additional
Common Stock Outstanding
|
|
Additional
Reservation
|
|
Current
|
|
Minimim
Total
|
|
|
|
Upon
Conversion/Exercise 1
|
|
Requirements
2
|
|
Obligations
|
|
Additional
|
|
|
|
Convertible
|
|
|
|
|
|
|
|
Convertible
|
|
|
|
|
|
To
Issue
|
|
Authorized
|
|
|
|
Notes
|
|
Warrants
|
|
Options
|
|
Subtotal
|
|
Notes
|
|
Options
|
|
Subotal
|
|
Shares
3
|
|
Shares
Required
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May
2005 private placement
|
|
|
-
|
|
|
2,486,970
|
|
|
-
|
|
|
2,486,970
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
1,535,219
|
|
|
4,022,189
|
|
July
and October 2005 convertible
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
notes
and warrants
|
|
|
2,714,130
|
|
|
3,713,542
|
|
|
-
|
|
|
6,427,672
|
|
|
12,730,778
|
|
|
-
|
|
|
12,730,778
|
|
|
10,016,678
|
|
|
29,175,128
|
|
January
and February 2006 convertible
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
notes
and warrants
|
|
|
46,406,121
|
|
|
9,074,104
|
|
|
-
|
|
|
55,480,225
|
|
|
10,514,238
|
|
|
-
|
|
|
10,514,238
|
|
|
6,165,068
|
|
|
72,159,531
|
|
November
2005 financing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
agreement
|
|
|
-
|
|
|
2,225,000
|
|
|
-
|
|
|
2,225,000
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
4,736,111
|
|
|
6,961,111
|
|
WQN,
Inc.
|
|
|
21,978,113
|
|
|
-
|
|
|
-
|
|
|
21,978,113
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
21,978,113
|
|
October
06 convertible notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
warrants
|
|
|
16,143,750
|
|
|
10,378,125
|
|
|
-
|
|
|
26,521,875
|
|
|
16,143,750
|
|
|
-
|
|
|
16,143,750
|
|
|
-
|
|
|
42,665,625
|
|
February 1,
2007 convertible notes
|
|
|
10,653,227
|
|
|
-
|
|
|
-
|
|
|
10,653,227
|
|
|
-
|
|
|
|
|
|
-
|
|
|
-
|
|
|
10,653,227
|
|
February 16,
2007 convertible notes
|
|
|
23,244,394
|
|
|
21,320,661
|
|
|
-
|
|
|
44,565,055
|
|
|
23,244,394
|
|
|
|
|
|
23,244,394
|
|
|
-
|
|
|
67,809,449
|
|
Nov/Dec
06 & Jan 07 bridge notes
|
|
|
-
|
|
|
2,421,894
|
|
|
-
|
|
|
2,421,894
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
4,000,000
|
|
|
6,421,894
|
|
2004
Stock Option Plan
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
4,000,000
|
|
|
4,000,000
|
|
|
-
|
|
|
4,000,000
|
|
2006
Stock Option Plan
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
10,000,000
|
|
|
10,000,000
|
|
|
-
|
|
|
10,000,000
|
|
Securities
owned by consulting and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
other
professional firms
|
|
|
-
|
|
|
4,349,327
|
|
|
305,646
|
|
|
4,654,973
|
|
|
-
|
|
|
|
|
|
-
|
|
|
2,170,000
|
|
|
6,824,973
|
|
Current
and former officer and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
employee
securities 4
|
|
|
-
|
|
|
6,225,000
|
|
|
1,562,500
|
|
|
7,787,500
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
23,435,218
|
|
|
31,222,718
|
|
Securities
owned by or owed to
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
shareholders
|
|
|
-
|
|
|
3,892,385
|
|
|
-
|
|
|
3,892,385
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
979,282
|
|
|
4,871,667
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
|
121,139,735
|
|
|
66,087,008
|
|
|
1,868,146
|
|
|
189,094,889
|
|
|
62,633,160
|
|
|
14,000,000
|
|
|
76,633,160
|
|
|
53,037,576
|
|
|
318,765,625
|
|
1
These columns represent common shares issuable upon the hypothetical conversion
of outstanding convertible debt, and the exercise of all outstanding warrants
and options.
2
These columns represent contractual requirements to reserve specified or
computed numbers of common shares from our authorized capital, in addition
to
the conversion/exercise amounts referred to in footnote 1.
3
These are common shares that are contractually owing to various individuals
or
firms, and are expected to be issued after our authorized shares are increased.
(See Note R to our December 31, 2006 consolidated financial statements
on page
71 for subsequent authorized common stock increase.)
4In
addition, our Chief Executive Officer and Chief Operating Officer may
receive
additional options sufficient to maintain their common share ownership
at 5% and
8%, respectively.
Item
2. Properties
Our
headquarters are in Altamonte Springs, Florida. We also have offices and
facilities in Dallas, Texas. Following is a description of these facilities,
all
of which are leased, as of December 31, 2006.
Location
|
|
Purpose
|
|
Approx.
Sq. Ft.
|
|
Annual
Rent
|
|
151
S. Wymore Rd, Suite 3000
|
|
|
Network
facilities and
|
|
|
11,500
|
|
$
|
208,000
|
|
Altamonte
Springs, FL 32714
|
|
|
corporate
offices
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14911
Quorum Dr., Suite 140
|
|
|
Offices
|
|
|
3,124
|
|
$
|
60,000
|
|
Dallas,
Texas 75254
|
|
|
|
|
|
|
|
|
|
|
Item
3. Legal
Proceedings
MCI
On
April
8, 2005, our subsidiary, Volo Communications, 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.
Extensive
discovery took place throughout 2006,
with multiple depositions taking place, written discovery requests being
exchanged, and extensive document productions being held.
On
December 20, 2006, the Court granted MCI WorldCom summary judgment dismissing
Caerus' claim for slander of credit. On January 7, 2007, the Court issued
a
scheduling order setting a trial date for June 18, 2007, with several interim
deadlines. On February 28, 2007, the Court denied MCI WorldCom's motion for
summary judgment of dismissal of the claims of Volo and Caerus for declaratory
relief, denied Caerus' motion for clarification or reargument of the dismissal
of the slander of credit claim and denied Volo's and Caerus' motions in the
alternative to amend their complaints.
On
January 2, 2007, an Amended Case Management and Scheduling Order was entered
which imposed a May 18, 2007 discovery cutoff; a June 5, 2007 pre-trial
conference; and a June 18, 2007 time-certain trial. On January 11, 2007,
MCI
WorldCom and Volo/Caerus participated in a Court-ordered mediation conference.
The parties engaged in further settlement discussions in February and March
2007, which ultimately led to an agreement to terms to settle the litigation
and
the signing of a mutually acceptable settlement term sheet on March 27,
2007.
The term sheet contains a due diligence provision that, upon completion
under
certain circumstances, permits MCI WorldCom to decide whether or not to
proceed
with the settlement. The parties’ contemplate finalizing and executing mutually
acceptable settlement documents reflecting the confidential settlement
term
sheet before the case is be dismissed.
In
the
event the parties withdraw from the settlement, the Company is currently
unable
to assess the likelihood of a favorable or unfavorable outcome. In that
event,
it is not clear whether or not the Court will hold the parties to the
previously-ordered June 2007 trial.
Cross
Country Capital Partners, L.P.
On
or
about September 25, 2006, Cross Country Capital Partners, L.P. (“Cross Country”)
filed suit against us in the District Court, 116th
Judicial
Circuit, Dallas County, Texas. Cross Country asserts a claim for breach of
contract in connection with a securities purchase agreement entered into with
us. Cross Country also seeks specific performance of the securities purchase
agreement at issue. Cross Country seeks unspecified damages and attorneys’ fees,
which fees are provided for in the securities purchase agreement and under
Texas
law. On or about December 14, 2006, we filed our Answer denying any wrongdoing
and asserting numerous affirmative defenses. We intend to vigorously defend
this
matter but are unable to assess the outcome of this litigation or its impact
on
our financial condition and results of operations.
Other
Litigation
We
are
currently a defendant in other lawsuits and disputes arising in the ordinary
course of business, and have accrued related litigation charges totaling
$561,305 for the year ended December
31, 2006.
We believe
that resolution of all known contingencies is uncertain, and there can be no
assurance that future costs related to such litigation would not exceed the
amounts accrued in our consolidated financial statements, which may in turn
materially adversely affect our financial position or results of operations.
Item
4. Submission
of Matters to a Vote of Security Holders
No
matters were submitted to a vote of security holders during the quarter ended
December 31, 2006.
PART
II
Item
5. Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
Dividends
We
have
no current plans to pay any future cash dividends on the common stock. Instead,
we intend to retain all earnings, other than those required to be paid to the
holders of any preferred stock we may issue in the future, to support our
operations and future growth. The payment of any future dividends on the common
stock will be determined by the board of directors based upon our earnings,
financial condition and cash requirements; possible restrictions in future
financing agreements, if any; business conditions; and such other factors deemed
relevant.
Market
Information
The
common stock is traded on the OTCBB under the symbol “VOII.” The
following quotations reflect the high and low for our common stock based on
inter-dealer prices, without retail mark-up, mark-down or commission and may
not
represent actual transactions. The high and low bid prices of our common stock
for the periods indicated below are as follows:
Quarter
Ended
|
|
High
|
|
Low
|
|
12/31/06
|
|
$
|
0.47
|
|
$
|
0.29
|
|
9/30/06
|
|
|
0.68
|
|
|
0.26
|
|
6/30/06
|
|
|
1.29
|
|
|
0.49
|
|
3/31/06
|
|
|
2.62
|
|
|
1.28
|
|
12/31/05
|
|
|
2.07
|
|
|
1.27
|
|
9/30/05
|
|
|
2.30
|
|
|
0.95
|
|
6/30/05
|
|
|
1.65
|
|
|
1.03
|
|
3/31/05
|
|
|
4.08
|
|
|
1.61
|
|
Holders
As
of March 22, 2007 there were approximately 424 shareholders of record
and an unknown number of beneficial holders holding through
brokers.
Common
Stock
We
are
authorized to issue up to 400,000,000 shares of common stock, par value $.001
per share. As of March 28, 2007, approximately 98,609,701 shares of our common
stock were issued and outstanding.
Holders
of the common stock are entitled to one vote per share on all matters to be
voted upon by the stockholders. Holders of common stock are entitled to receive
ratably such dividends, if any, as may be declared by the board of directors
out
of funds legally available therefore. Upon the liquidation, dissolution, or
winding up of our company, the holders of common stock are entitled to share
ratably in all of our assets which are legally available for distribution after
payment of all debts and other liabilities and liquidation preference of any
outstanding common stock. Holders of common stock have no preemptive,
subscription, redemption or conversion rights. The outstanding shares of common
stock are validly issued, fully paid and non-assessable.
Item
6. Selected
Financial Data
The
following table sets forth selected historical financial data as of and for
each
of the years ended December 31, 2002, 2003, 2004, 2005, and 2006. The
related financial data as of December 31, 2004, 2005, and 2006 and for the
years
then ended are derived from our consolidated financial statements which have
been audited by Berkovits, Lago & Company, LLP, independent auditors, and
their report is included elsewhere in this annual report. The selected financial
data as of December 31, 2002, and 2003 and for the years then ended are derived
from our consolidated financial statements which have been audited by Tschopp,
Whitcomb & Orr, P.A., independent auditors. The following financial
information should be read in conjunction with “Management's Discussion and
Analysis of Financial Condition and Results of Operations,” and our consolidated
financial statements and related notes appearing elsewhere in this Form
10-K.
|
|
2002(1)
|
|
2003(1)
|
|
2004(1)
|
|
2005(1)
|
|
2006(1)
|
|
Revenues
|
|
$
|
-
|
|
$
|
-
|
|
$
|
1,020,285
|
|
$
|
8,945,868
|
|
$
|
14,676,948
|
|
Gross
profit (loss)
|
|
|
-
|
|
|
-
|
|
|
265,687
|
|
|
(1,299,648
|
)
|
|
(8,062
|
)
|
Operating
expenses
|
|
|
-
|
|
|
-
|
|
|
5,573,575
|
|
|
21,063,041
|
|
|
31,015,685
|
|
Loss
from continuing operations
|
|
$
|
-
|
|
$
|
-
|
|
$
|
(5,307,888
|
)
|
$
|
(23,794,994
|
)
|
$
|
(39,216,559
|
)
|
Net
loss
|
|
$
|
(61,926
|
)
|
$
|
(352,968
|
)
|
$
|
(5,862,120
|
)
|
$
|
(28,313,333
|
)
|
|
($41,196,512
|
)
|
Net
loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$
|
-
|
|
$
|
-
|
|
$
|
(0.36
|
)
|
$
|
(0.62
|
)
|
$
|
(0.52
|
)
|
Net
loss
|
|
$
|
(0.04
|
)
|
$
|
(0.20
|
)
|
$
|
(0.40
|
)
|
$
|
(0.74
|
)
|
$
|
(0.55
|
)
|
Summary
cash flow data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash used in operating activities
|
|
$
|
-
|
|
$
|
(78,706
|
)
|
$
|
(3,330,574
|
)
|
$
|
(17,601,150
|
)
|
$
|
(12,371,474
|
)
|
Net
cash provided by (used in) investing activities
|
|
|
73,849
|
|
|
82,196
|
|
|
479,594
|
|
|
(4,909,352
|
)
|
|
(6,494
|
)
|
Net
cash provided by financing activities
|
|
|
-
|
|
|
-
|
|
|
3,988,618
|
|
|
24,598,110
|
|
|
9,239,396
|
|
Balance
Sheet Data (at period end):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
|
9
|
|
|
3,499
|
|
|
1,141,137
|
|
|
3,228,745
|
|
|
90,172
|
|
Property
and equipment
|
|
|
-
|
|
|
-
|
|
|
389,528
|
|
|
10,141,872
|
|
|
6,860,233
|
|
Goodwill
and other intangible assets
|
|
|
-
|
|
|
-
|
|
|
1,713,301
|
|
|
36,044,271
|
|
|
32,687,822
|
|
Total
assets
|
|
|
530,230
|
|
|
259,459
|
|
|
8,672,548
|
|
|
53,338,359
|
|
|
40,925,121
|
|
Long
term obligations
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
245,248
|
|
|
222,669
|
|
Total
liabilities
|
|
|
68,970
|
|
|
151,167
|
|
|
1,027,727
|
|
|
26,472,439
|
|
|
37,880,305
|
|
Total
shareholders' equity
|
|
|
461,260
|
|
|
108,292
|
|
|
7,644,821
|
|
|
26,865,920
|
|
|
3,044,816
|
|
Book
value per share
|
|
$
|
0.30
|
|
$
|
0.06
|
|
$
|
0.32
|
|
$
|
0.45
|
|
$
|
0.03
|
|
Cash
dividends per share
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
(1) |
Operations
relating to Millennia Tea Masters, DTNet Technologies and Phone House,
Inc. were discontinued in 2004, 2005 and 2006, respectively. Operating
results prior to these events were reclassified as discontinued
operations.
|
Item
7. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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-K. Certain statements contained
in this Form 10-K 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
believe 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 us, 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 this Form 10-K. 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.
Balance
Sheet Data:
|
|
December
31,
|
|
|
|
2006
|
|
2005
(1)(2)(3)
|
|
|
|
|
|
(Restated)
|
|
|
|
|
|
|
|
Goodwill
and other intangible assets
|
|
$
|
32,687,822
|
|
$
|
36,044,271
|
|
Total
assets
|
|
|
40,925,121
|
|
|
53,338,359
|
|
Notes
and loans payable, current
|
|
|
2,574,835
|
|
|
4,685,236
|
|
Total
liabilities
|
|
|
37,880,305
|
|
|
26,472,439
|
|
Shareholders'
equity
|
|
|
3,044,816
|
|
|
26,865,920
|
|
Statement
of Operations Data:
|
|
For
the Year Ended December 31,
|
|
|
|
2006
|
|
2005
(1)(2)
|
|
2004
(2)
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
14,676,948
|
|
$
|
8,945,868
|
|
$
|
1,020,285
|
|
Cost
of sales
|
|
|
14,685,010
|
|
|
10,245,516
|
|
|
754,598
|
|
Gross
profit (loss)
|
|
|
(8,062
|
)
|
|
(1,299,648
|
)
|
|
265,687
|
|
Operating
expenses
|
|
|
31,015,685
|
|
|
21,063,041
|
|
|
5,573,575
|
|
Loss
from continuing operations
|
|
|
(31,023,747
|
)
|
|
(22,362,689
|
)
|
|
(5,307,888
|
)
|
Other
expenses, net
|
|
|
8,192,812
|
|
|
1,432,305
|
|
|
-
|
|
Loss
before discontinued operations
|
|
|
(39,216,559
|
)
|
|
(23,794,994
|
)
|
|
(5,307,888
|
)
|
Loss
from discontinued operations
|
|
|
(1,979,953
|
)
|
|
(4,518,339
|
)
|
|
(554,232
|
)
|
Net
loss
|
|
$
|
(41,196,512
|
)
|
$
|
(28,313,333
|
)
|
$
|
(5,862,120
|
)
|
Per
common share:
|
|
|
|
|
|
|
|
|
|
|
Loss
before discontinued operations
|
|
$
|
(0.52
|
)
|
$
|
(0.62
|
)
|
$
|
(0.36
|
)
|
Net
loss
|
|
$
|
(0.55
|
)
|
$
|
(0.74
|
)
|
$
|
(0.40
|
)
|
(1)
|
Includes
the results of Caerus, Inc. and subsidiaries (“Caerus”) subsequent to
their acquisition in May 2005, and the results of WQN, Inc’s (“WQN”)
operations subsequent to acquiring substantially all of the assets
of
WQN’s VoIP business in October
2005.
|
(2)
|
Adjusted
to reflect discontinued operations classification pertaining to
the sale
of our DTNet Technologies subsidiary in April 2006, and the October
2006
termination of our Marketing and Distribution Agreement with Phone
House,
Inc., a wholesale prepaid telephone calling card business acquired
in our
WQN acquisition.
|
(3)
|
Our
consolidated balance sheet at December 31, 2005 was restated to
reduce
both goodwill and stockholders’ equity by $2,360,000, which represented
contingent consideration (escrowed common shares - see Note J to
our
consolidated financial statements on page 66) related to the Caerus
acquisition. According to Statement of Financial Accounting Standards
No.
141, such contingent consideration should not have been included
in the
Caerus purchase price determination. Our consolidated statements
of
operations and cash flows for the year ended December 31, 2005
were not
affected.
|
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 year ended December
31, 2005, assuming these business combinations had occurred at the beginning
of
2005.
Revenues
|
|
$
|
42,744,118
|
|
Net
loss
|
|
|
(41,217,317
|
)
|
Net
loss per share
|
|
|
(1.07
|
)
|
Revenues
|
|
|
|
|
Revenues
Our
consolidated revenues for the years ended December 31, 2006 and 2005
(reclassified to exclude revenues from discontinued operations) were $14.7
million and $8.9 million, respectively. Our consolidated loss before
discontinued operations was $39.2 million ($0.52 per share) for the year ended
December 31, 2006, as compared to a loss before discontinued operations of
$23.8
million ($0.62 per share) for the year ended December 31, 2005. The
increases in our revenues and loss from 2005 to 2006 reflect the inclusion
of
the results of Caerus and the VoIP business of WQN from the dates of their
acquisitions, coupled with increased financing activities. Revenues generated
from the combined Caerus and WQN businesses were $14.5 million and $7.3 million
in 2006 and 2005, respectively. Substantially all of the Caerus revenues for
2006 (which represents 39% of our 2006 consolidated revenues) were generated
by
one customer. Revenues other than Caerus and WQN declined by $1.4 million due
to
our decreased emphasis on non-core markets in 2006, including hardware sales.
Our results for 2006 and 2005 include losses before discontinued operations
of
$13.3 million and $8.6 million, respectively, generated by the combined Caerus
and WQN businesses.
Our
consolidated revenues for the years ended December 31, 2005 and 2004
(reclassified to exclude revenues from discontinued operations) were $8.9
million and $1.0 million, respectively. Our consolidated loss before
discontinued operations was $23.8 million ($0.62 per share) for the year ended
December 31, 2005, as compared to a loss before discontinued operations of
$5.3
million ($0.36 per share) for the year ended December 31, 2004. The increases
in
our revenues and net loss from 2004 to 2005 reflect the inclusion of the results
of Caerus and the VoIP business of WQN, Inc. from the dates of their
acquisitions. Revenues generated from the combined Caerus and WQN businesses
were $7.3 million in 2005. Substantially all of the Caerus revenues for 2005
(which represents 52% of our 2005 consolidated revenues) were generated by
one
customer. Our 2005 results include losses before discontinued operations of
$8.6
million generated by the combined Caerus and WQN businesses.
Cost
of Sales and Gross Profit (Loss)
Consolidated
cost of sales was $14.7 million and $10.2 million for the years ended December
31, 2006 and 2005 (reclassified to exclude revenues from discontinued
operations), respectively. This increase reflects the inclusion of the results
of Caerus and WQN from the dates of their acquisitions. Cost of sales from
the
combined Caerus and WQN businesses was $14.5 million and $8.7 million in 2006
and 2005, respectively. The
negative gross profit of $1.3 million (15% of revenues) in 2005 reflects costs
paid to third party vendors that exceeded the revenues we charged to terminate
the calls of our customers. We improved this negative gross margin in 2006
to a
substantial break-even by using lower cost routes and negotiating more favorable
pricing. We do not expect to generate substantial positive margins on our
network traffic until such time as we are able to (1) increase the overall
volume of traffic handled by our network by growing our customer base and (2)
continue to lower the average cost per minute we pay for call termination
through negotiation of more favorable pricing, expanding our selection of third
party vendors, and continuing to improve our routing process to ensure we are
using the lowest cost route available to us to terminate each call.
Consolidated
cost of sales was $10.2 million and $0.8 million for the years ended December
31, 2005 and 2004 (reclassified to exclude revenues from discontinued
operations), respectively. This increase reflects the inclusion of the results
of Caerus and WQN from the dates of their acquisitions. Cost of sales from
the
combined Caerus and WQN businesses was $8.7 million in 2005. The
negative gross profit of $1.3 million (15% of revenues) in 2005 reflects costs
paid to third party vendors that exceeded the revenues we charged to terminate
the calls of our customers.
Operating
Expenses
Consolidated
operating expenses were $31.0 million and $21.1 million for the years ended
December 31, 2006 and 2005 (reclassified to exclude operating expenses
from discontinued operations), respectively. Compensation and related expenses
accounted for $5.9 million of the increase from 2005. Included in 2006
compensation is $7.9 million of non-cash expenses connected to employee options
and warrants, primarily related to current and former officers, including $4.9
million of employment termination-associated expenses related to former
officers. Professional, legal and consulting expenses increased by $5.0 million,
due primarily to attorneys’ fees related to the litigation discussed in Note K
to our consolidated financial statements, and to costs associated with
maintaining our increasingly complex financing structure and SEC filings, as
well as increased investor relations activities in 2006. Depreciation and
amortization increased $2.1 million in 2006, due primarily to a full year of
amortization of intangible assets relating to the acquisition of Caerus and
WQN
assets in 2005.
We
incurred significantly greater corporate operating expenses in 2005 ($21.2
million) than in 2004 ($5.6 million) (reclassified to exclude revenues from
discontinued operations), due to the increased size and complexity of our
operations, resulting from the acquisition of Caerus and WQN assets in 2005.
Included in 2005 operating expenses are $7.3 million in compensation and
benefits, $4.8 million in commissions and fees paid to third parties primarily
in connection with our capital raising efforts, professional and legal fees
of
$1.9 million, $3.1 million of depreciation and amortization, and $4.0 million
of
general and administrative expenses.
Other
Expenses, Net
Consolidated
net other expenses were $8.2 million and $1.4 million for the years ended
December 31, 2006 and 2005 (reclassified to exclude operating expenses
from discontinued operations), respectively. Amortization of debt discounts,
the
primary component of our reported interest expense, increased by $5.9 million
in
2006, reflecting our significantly higher convertible note balances in 2006
used
to finance our operations, all which were issued at significant discounts as
part of our fund raising activities. Financing penalties and expenses amounted
to $6.4 million in 2006 (none in 2005), related primarily to our lack of
compliance with the securities registration requirements in many of our
financing agreements, as discussed in Note H to our consolidated financial
statements. Of this $6.4 million, $5.7 million was paid or is payable in our
common stock or warrants. We also incurred $1.1 million in 2006 (none in 2005)
of litigation charges related to the litigation discussed in Note K to our
consolidated financial statements.
We
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 Issue 00-19 (“EITF 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 our consolidated balance sheet. In addition, $770,314 of the
proceeds received from the May 2006 warrant repricing and exercise as discussed
on page 30 were allocated to these warrants, and recorded as a warrant liability
on our balance sheet. Also, the May 2006 warrant repricing to $0.78 per share
triggered contractual “favored nations” price ratchets on a number of our
existing convertible debt and warrant agreements, reducing their effective
conversion and exercise prices to $0.78 per share. The effect was to increase
the number of fully diluted shares of common stock to approximately 129 million,
relative to our authorized 100 million common shares. Our total warrants then
outstanding were approximately 28 million. Per EITF 00-19, we then began
classifying all remaining warrants as a liability, transferring $5,406,284
from
additional paid-in capital to fair value liability for warrants on our
consolidated balance sheet. The warrant liabilities have since been
marked-to-market, resulting in a $5,102,731 liability at December 31, 2006,
and
a corresponding $7,226,430 noncash credit to earnings for the year ended
December 31, 2006. Future changes in the market value of these warrants can
have
a material effect on our operating results.
Consolidated
net other expenses were $1.4 million and $0 for the years ended
December 31, 2005 and 2004 (reclassified to exclude operating expenses
from discontinued operations), respectively. The expenses for 2005 include
$1.6
million of interest expense reflecting the buildup of interest-bearing debt
that
began in 2005, partially offset by a $206,184 gain on the sale of fixed
assets.
In
accordance with SFAS No. 142, we are required to periodically evaluate the
carrying value of our goodwill and other intangible assets. During the years
ended December 31, 2006 and 2005, we recognized impairment expense of $839,101
and $4,173,452, respectively, related to goodwill recorded for our former
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 will 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 declines,
a
material goodwill impairment charge in the future is possible.
Discontinued
Operations
On
April
19, 2006, we sold our wholly-owned subsidiary, DTNet Technologies, to our 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 our common stock
held
by the Purchaser; and (2) the return for cancellation of 200,000 shares of
our
common stock held by the Purchaser. Because DTNet Technologies' operations
were
the primary component of our former hardware sales business segment, we recorded
an impairment charge of $839,101 in our statement of operations for the year
ended December 31, 2006. The remaining $198,000 of goodwill for this former
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.
Effective
October 12, 2006, we terminated our Marketing and Distribution Agreement with
Phone House, Inc. dated September 1, 2004 and amended February 16, 2006,
effectively discontinuing this business segment. The Agreement called for the
wholesale distribution, marketing and selling of prepaid telephone calling
cards
by Phone House, Inc., under license from us. We recognized a related impairment
loss of $936,122 for the year ended December 31, 2006, primarily related to
inventory and accounts receivable write-offs, and have filed suit in Los Angeles
County against the primary Phone House, Inc. employee to recover same.
The
following summarizes the combined operating results of DTNet Technologies and
the calling card business of Phone House, Inc. for the years ended December
31,
2006 (through the respective dates of sale or termination), 2005 and 2004,
classified as discontinued operations for all periods presented.
|
|
2006
|
|
2005
|
|
2004
|
|
Revenues
|
|
$
|
14,308,466
|
|
$
|
6,561,277
|
|
$
|
807,908
|
|
Cost
of sales
|
|
|
13,968,554
|
|
|
6,086,147
|
|
|
617,547
|
|
Gross
profit
|
|
|
339,912
|
|
|
475,130
|
|
|
190,361
|
|
Compensation
and benefits
|
|
|
358,189
|
|
|
402,110
|
|
|
-
|
|
Asset
impairment charges
|
|
|
1,775,223
|
|
|
4,173,452
|
|
|
-
|
|
Other
operating expenses
|
|
|
186,453
|
|
|
417,907
|
|
|
744,593
|
|
Net
loss
|
|
$
|
(1,979,953
|
)
|
$
|
(4,518,339
|
)
|
$
|
(554,232
|
)
|
Results
by Segment
Our
operations formerly consisted of three segments: Telecommunication Services,
Hardware Sales and Calling Card Sales. However, with our sale of DTNet
Technologies and the termination of our Marketing and Distribution Agreement
with Phone House, Inc., both referred to above, these former segments are being
accounted for as discontinued operations, and prior period financial statements
have been appropriately reclassified. Also as a result of these discontinued
operations, our operations currently consist of one segment, Telecommunication
Services. Therefore, separate segmented financial results are not
presented.
Assets
Total
assets (adjusted for discontinued operations classification) at December 31,
2006 were $40.9 million, down from $53.3 million at December 31, 2005. The
decrease is due in part to $5.2 million of depreciation and amortization of
property and equipment and intangible assets other than goodwill in 2006. Our
cash balance also declined by $3.1 million in 2006, primarily related to our
operating loss. In addition, $1.8 million of net assets from discontinued
operations at December 31, 2005 did not exist as such at December 31, 2006,
because the 2006 amount was a net liability from discontinued
operations.
Goodwill
and other intangible assets comprised 80% of our consolidated total assets
at
December 31, 2006, attributable primarily to the acquisitions of Caerus and
WQN
assets.
Liquidity
and Capital Resources
Cash
and
cash equivalents were approximately $90 thousand at December 31, 2006. Our
consolidated net cash used in operating activities for the year ended December
31, 2006, was $12.4 million, due primarily to the losses described above. We
funded our operating activities principally through financing activities that
generated net proceeds of $17.0 million ($9.2 million net of debt repayments)
during the year ended December 31, 2006. At December 31, 2006 our negative
working capital was $36.4 million.
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 our consolidated financial statements for the year ended
December 31, 2006, based on substantial doubt about our ability to continue
as a
going concern.
At
December 31, 2006, our contractual obligations for debt, leases and capital
expenditures totaled approximately $25.3 million. Included in this amount is
approximately $2.4 million due on a loan from Cedar Boulevard Lease Funding
LLC
(“Cedar”). This loan bears interest at 17.5%, and is repayable through May 2007.
The loan agreement contains customary covenants and restrictions and provides
the lender the right to a perfected, first-priority security interest in all
of
our assets. On February 1, 2007 Cedar assigned its rights under a subordinated
loan and security agreement, as amended, including the note payable with a
current principal balance of $1,917,581 and the related security interest,
to a
group of institutional investors. Also on February 1, 2007 the note's terms
were
amended to allow conversion of any unpaid principal balance into our restricted
common stock at $0.26 per share. In conjunction with our February 2007 financing
discussed below, on February 16, 2006 the note's common stock conversion rate
was reduced to $0.18 per share. We were in violation of certain
requirements of this debt facility at December 31, 2006, and have not made
scheduled principal and interest payments. However, the lenders have currently
not declared this loan in default. As a result, the full amount of the loan
at
December 31, 2006 has been classified as current.
In
July
and October 2005 we issued and sold $3,085,832 in principal amount of
convertible notes to institutional 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 an original conversion
rate
of $0.80 per share. These investors also received five-year warrants to purchase
964,322 shares of our common stock for $1.37612 per share, five-year warrants
to
purchase 964,322 shares of our common stock for $1.6503 per share, and one-year
warrants to purchase 1,928,644 shares of our common stock for $1.60 per share.
The investors also received “favored nations” rights such that for our future
securities offerings at a price per share less than the above conversion rate
or
warrant exercise prices, the investors' conversion rate and warrant exercise
price would be adjusted to the lower offering price. 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 balance of these notes was $488,543
and
$1,496,804 at December 31, 2006 and 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 the stock on the OTC Bulletin
Board (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
$2,740,120. We then issued warrants to the investors to purchase a like number
of shares for $0.80. As a result of the favored nations provision discussed
above and the Section 3(a)(10) agreement described below, the notes' conversion
rate (retroactive to the original note principal balances) and the exercise
price of outstanding warrants were effectively reduced to $0.26 per share.
As a
result of the February 2007 financing agreements described below, the notes'
conversion rate (retroactive to the original note principal balances) and the
exercise price of outstanding warrants were further reduced to $0.18 per share.
At December 31, 2006, we had not made scheduled principal payments of $118,930
on these notes. Beginning October 2005, we were in violation of the registration
requirements contained in the October 2005 subscription agreements, and
beginning July 2006 we were in violation of the registration requirements
contained in the July 2005 subscription agreements. As a result, we owed related
liquidated damages of $343,034 at December 31, 2006, and will incur additional
damages of $40,494 per month until a registration statement related to the
shares and warrants is declared effective by the SEC. While the investors have
not declared the notes currently in default, the full amount of the notes at
December 31, 2006 has been classified as current.
In
January and February 2006, we issued and sold $11,959,666 in principal amount
of
convertible notes to institutional investors at a discount, receiving net
proceeds of $9,816,662. These notes are immediately convertible at the option
of
the note holders into shares of our common stock at an original conversion
rate
of $1.318 per share. These investors also received five-year warrants to
purchase 4,537,052 shares of our common stock for $1.45889 per share, and
one-year warrants to purchase 4,537,052 shares of the our common stock for
$1.5915 per share. The investors also received “favored nations” rights such
that for our future securities offerings at a price per share less than the
above conversion rate or warrant exercise prices, the investor's conversion
rate
and warrant exercise price would be adjusted to the lower offering price. Of
the
total initial principal, $8,318,284 of the notes are secured by a subordinated
lien on our assets. The principal balance of the notes was $8,353,101 at
December 31, 2006, and all the notes bear interest at an effective rate of
approximately 20%. The unsecured portion of these notes became payable beginning
in July 2006 over two years in cash or, at our option, in registered common
stock at the lesser of $1.318 per share or 85% of the weighted average price
of
the stock on the OTCBB, but not less than $1.00 per share. As a result of a
May
2006 warrant restructure, the secured portion of these notes became payable
beginning in August 2006 over two years in cash or, at our option, 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, but not less than $0.80 per share.
As a
result of the favored nations provision discussed above and the Section 3(a)(10)
agreement described below, the notes' conversion rate (retroactive to the
original note principal balances) was effectively reduced to $0.26 per share,
and the outstanding warrants were re-priced to $0.475 per share. As a result
of
the February 2007 financing agreements described below, the notes' conversion
rate (retroactive to the original note principal balances) and the exercise
price of outstanding warrants were further reduced to $0.18 per share. At
December 31, 2006, we had not made scheduled principal payments of $1,083,782
on
these notes. Beginning April 2006, we were in violation of the registration
requirements of the secured notes, and beginning May 2006, we were in violation
of the registration requirements of the unsecured notes. In May 2006, we issued
an aggregate of 166,368 shares to the secured investors in satisfaction of
then-existing secured non-registration liquidated damages. We owed additional
liquidated damages of $694,514 at December 31, 2006, and will incur
additional damages of $129,014 per month until a registration statement related
to the shares and warrants is declared effective by the SEC. While the investors
have not declared the notes currently in default, the full amount of the notes
at December 31, 2006 has been classified as current.
On
October 17, 2006, we issued and sold
$2,905,875 in secured convertible notes to twelve institutional investors,
for a
net purchase price of $2,324,700 (after a 20% original issue discount) in a
private placement. The investors also received five-year warrants to purchase
a
total of 10,378,125 shares of our common stock at an exercise price of $0.407
per share. These convertible notes are secured by a subordinated lien on our
assets, are not interest bearing, and are due on December 31, 2007. The note
holders may at their election convert all or part of the convertible notes
into
shares of our common stock at an original conversion rate of $0.28 per share.
The investors also received “favored nations” rights such that for future
securities offerings by us at a price per share less than the above conversion
rate or warrant exercise prices, the investor's conversion rate and warrant
exercise price would be adjusted to the lower offering price. As a result of
the
favored nations provision discussed above and the February 2007 financing
agreements described below, the notes' conversion rate (retroactive to the
original note principal balances) and the exercise price of outstanding warrants
were reduced to $0.18 per share. Pursuant to the subscription agreement, we
were
to obtain shareholder approval to increase our authorized common stock to
400,000,000 shares and file an amendment to its articles of incorporation by
December 20, 2006. Failing this, the holders of the convertible notes are
entitled to liquidated damages that will accrue at the rate of two percent
of
the amount of the purchase price of the outstanding convertible notes per month
during such default. We also agreed to file registration statements covering
the
resale of 130% of the shares of common stock that may be issuable upon
conversion of the convertible notes, and 100% of the shares of common stock
issuable upon the exercise of the warrants. The first such registration
statement was to be filed on or before January 2, 2007 and declared effective
by
March 31, 2007. Because we were in violation of these authorized share and
registration requirements, liquidated damages have been accruing at the rate
of
$58,925 per month since December 20, 2006. (See Note R to our December 31,
2006
consolidated financial statements on page 71 for subsequent authorized common
stock increase.) While the investors have not declared the notes currently
in
default, the full amount of the notes at December 31, 2006 has been
classified as current.
On
February 16, 2007, we issued and sold $3,462,719 in secured convertible notes
(“Convertible Notes”) to a group of institutional investors, for a net purchase
price of $2,770,175 (after a 20% original issue discount) in a private
placement. $900,000 of the proceeds (before closing costs of $67,512) were
paid
in cash to us at closing, and $1,870,175 of the proceeds were used to repay
fourteen outstanding promissory notes (including related accrued interest and
a
10% premium on the promissory notes' total principal of $1,666,667) held by
five
of the investors in the private placement. The investors also received five-year
warrants to purchase a total of 19,237,328 shares of our common stock at an
effective exercise price of $0.18 per share. These Convertible Notes are secured
by a subordinated lien on our assets, are not interest bearing, and are due
on
February 16, 2008. The note holders may at their election convert all or part
of
the Convertible Notes into shares of our common stock at the conversion rate
of
$0.18 per share, subject to adjustment as provided in the notes. The investors
also received “favored nations” rights such that for our future securities
offerings at a price per share less than the above conversion rate or warrant
exercise price, the investors' conversion rate and warrant exercise price would
be adjusted to the lower offering price. Pursuant to the related subscription
agreement, two of the investors are to receive due diligence fees totaling
$346,272, in the form of convertible notes having the same terms and conversion
features as the Convertible Notes. Also pursuant to the subscription agreement,
we agreed to issue a total of 4,000,000 common shares to the former holders
of
the above-referenced promissory notes, in lieu of and in payment for accrued
damages associated with these promissory notes. Said common share issuance
is
required no later than April 15, 2007. Also pursuant to the subscription
agreement, we must obtain the authorization and reservation of our common stock
on behalf of the investors of not less than 200% of the common shares issuable
upon the conversion of the notes, and 100% of the common shares issuable upon
the exercise of the warrants by April 15, 2007. Failing this authorization
and
reservation, the holders of the Convertible Notes will be entitled to liquidated
damages that will accrue at the rate of two percent of the amount of the
purchase price of the outstanding Convertible Notes for each thirty days or
pro
rata portion thereof during such default.
The
subscription agreements for our convertible notes issued in July and October
2005 (“2005 Notes”), January and February 2006 (“Early 2006 Notes”), October
2006 (“Late 2006 Notes”), and February 2007 (“2007 Notes”) contain the following
provisions that could impact our future capital raising efforts and capital
structure:
· |
We
are required to file registration statements to register amounts
ranging
up to 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 these notes. Certain registration statements were filed, but
have
since become either ineffective or withdrawn. Until sufficient
registration statements are declared effective by the Securities
and
Exchange Commission (the “SEC”), we are liable for liquidated damages
totaling $1,058,858 through December 31, 2006, and will continue
to incur
additional liquidated damages of $228,432 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 (a) 60 to 365 days following the effective date of the
notes
registration statement or (b) 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.
|
· |
Since
October 2005, we have been in violation of certain requirements of
the
2005 Notes, the Early 2006 Notes, and the Late 2006 Notes. While
the
investors have not declared these notes currently in default, the
full
amount of the notes at December 31, 2006 has been classified as current.
|
In
September 2006 certain of the July and October 2005 and the January and February
2006 convertible note holders filed actions against us claiming a breach of
contract related to the notes. In settlement of these actions, the parties
entered into settlement agreements pursuant to which, among other things:
1) interest and liquidated damages due under the notes were set at $242,149
and $415,353, respectively; 2) the note holders exchanged the interest and
liquidated damages due, along with $3,899,803 in principal, and a discount
of
$881,155, for 20,917,153 shares of the our common stock through the issuance
of
freely trading securities issued pursuant to Section 3(a)(10) of the Securities
Act; 3) the conversion rate for the remaining principal balance due under
the notes was reset to $0.26; 4) the exercise price of the outstanding
warrants purchased by the note holders in connection with the January and
February 2006 notes was reduced to $0.475; and 5) certain investors agreed
to surrender their claims associated with warrants issued in May 2006 in
exchange for 2,500,000 shares of our common stock through the issuance of freely
trading securities issued pursuant to Section 3(a)(10) of the Securities
Act.
In
October 2005, we acquired
substantially all of the operating assets and liabilities of WQN, Inc. for
a total purchase price of $9.8 million. The acquisition was funded 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. The note is secured
by a subordinated lien on our consolidated assets. The principal balance of
the
note was $3,700,000 at December 31, 2006. The note, bearing a nominal
interest rate of 6%, became payable beginning February 2006 over 12 months
in cash or, at our option, in Series A preferred stock (subsequently authorized
- see Note R) at $10.00 per share or in common stock at an original $1.06 per
share. WQN received “favored nations” rights such that for future securities
offerings by us at a price per share less than this conversion price, this
common stock conversion price would be adjusted to the lower offering price.
As
a result of this favored nations provision and the February 2007 financing
agreements described in Note R to our consolidated financial statements on
page
71, the note’s common stock conversion rate was effectively reduced to $0.18 per
share. At December 31, 2006, we had not made scheduled principal payments of
$3,391,667. WQN has agreed to subordinate its repayment claim to the convertible
note holders described in the two preceding paragraphs. Also as a result of
the
October 2005 acquisition, WQN, Inc. received five-year warrants to purchase
5,000,000 shares of our common stock for $0.001 per share. WQN exercised the
warrants on January 5, 2006 for 4,996,429 shares of our common stock.
All WQN convertible shares and warrant shares have piggyback registration rights
on any registration statement we file between October 2005 and October 2007.
At
December 31, 2006, we were in violation of certain requirements of
this note. While WQN has not declared the note in default, the full amount
of
the note at December 31, 2006, has been classified as current. On
March 16, 2007, WQN notified us that it is exercising its right to convert
its
note and related accrued interest into approximately 22,008,524 shares of our
common stock.
In
connection with a private placement memorandum dated May 20, 2005, we issued
2,242,500 shares of our common stock for $0.80 per share, and warrants to
purchase 2,207,751 common shares at prices from $1.60 to $2.23 per share. At
December 31, 2006, the fair value of these outstanding warrants was $58,510,
which was recorded as a liability on our consolidated balance sheet. As required
by the subscription agreements, a portion of the shares was registered with
the
SEC in October 2005, but that registration became ineffective in July 2006.
Non-registration liquidated damages accrued until September 2006, when all
related shares and warrants became tradable under Rule 144, and, in accordance
with the terms of the subscription agreements, accrual of liquidated damages
ceased. At December 31, 2006, liquidated damages totaled 1,482,500 shares and
226,500 warrants owing, recognized as a $1,342,299 current liability on our
balance sheet.
In
connection with a subscription agreement dated August 26, 2005 and amended
on
November 16, 2005, we issued 1,375,000 shares of our common stock for $0.80
per
share, and warrants to purchase 2,225,000 common shares at prices ranging from
$1.37 to $1.60 per share. The investor also received “favored nations” rights
such that for future securities offerings by us at a price per share less than
the per share purchase price or warrant exercise prices, the investor's
effective per share purchase price and warrant exercise price would be adjusted
to the lower offering price. As a result of this favored nations provision
and
the February 2007 financing agreements described in Note R, the subscription
agreement’s per share purchase price and the warrants’ exercise prices were
effectively reduced to $0.18 per share. At December 31, 2006, the fair value
of
these outstanding warrants was $400,500, which was recorded as a liability
on
our consolidated balance sheet. We also agreed to register a total of 5,850,000
common shares and warrants related to this agreement by January 17, 2006. Until
a registration statement is declared effective by the SEC, we are liable for
liquidated damages totaling $600,000 through December 31, 2006, and will
continue to incur additional liquidated damages of $50,000 per month until
the
required shares and warrants are registered.
On
March 29, 2007, we issued an unsecured promissory note in the principal
amount of $300,000 (the “Note”) to Shawn M. Lewis, the Company’s Chief Operating
Officer. The Note and related accrued interest at 10% per annum is payable
upon
demand. The cash proceeds to the Company were $252,000 net of related closing
costs and expense reimbursements of $48,000, $30,000 of which was paid to
Mr. Lewis. In the event of a default, in addition to all sums due and owing
under the Note, we will also be required to pay the sum of $750,000 as
liquidated damages.
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 $2.4 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 common stock consisted
of 100,000,000 common shares at December 31, 2006, of which 98,609,701 common
shares were issued and outstanding, and approximately 141 million additional
shares were contingently issuable upon the exercise of stock options and
warrants, conversion of convertible securities, and increased authorized common
shares. An additional 24 million common shares were required to be reserved
under our various existing financing agreements. As of December 31, 2006 we
were
also contractually obligated to register approximately 192 million shares,
warrants and options. (See Note R for a subsequent increase in our authorized
common stock to 400,000,000 shares, and the authorization of a new class of
preferred stock.) As the result of transactions since December 31, 2006,
issuable shares and reserve requirements have increased (see Part I, Item 1A.
Risk Factors, RISKS RELATED TO OUR STOCK, on page 17). We intend to seek an
additional increase in our authorized common shares. If such proposal is not
approved, we will be unable to satisfy the contractual obligations we have
undertaken to issue future shares of common stock. There is no assurance that
sufficient registration statements can be filed or declared effective by the
SEC, or that sufficient additional common stock authorizations can be approved
by shareholders, in which case we would continue to be unable to satisfy our
contractual obligations to register shares, and would be unable to satisfy
the
contractual obligations we have undertaken to reserve shares of common
stock.
Capital
Expenditure Commitments
We
did
not have any substantial outstanding commitments to purchase capital equipment
at December 31, 2006.
Payments
Due by Period
The
following table illustrates our outstanding debt, purchase obligations, and
related payment projections as of December 31, 2006:
Contractual
Obligations
|
|
Total
|
|
Less
than
1
Year
|
|
1-3
Years
|
|
3-5
Years
|
|
Convertible
notes (principal)
|
|
$
|
15,447,520
|
|
$
|
15,447,520
|
|
$
|
-
|
|
$
|
-
|
|
Loan
payable
|
|
|
2,574,835
|
|
|
2,574,835
|
|
|
-
|
|
|
-
|
|
Unsecured
advances
|
|
|
616,667
|
|
|
616,667
|
|
|
-
|
|
|
-
|
|
Nonregistration
penalties and other stock-based payables
|
|
|
4,748,381
|
|
|
4,748,381
|
|
|
-
|
|
|
-
|
|
Other
liabilities
|
|
|
1,523,020
|
|
|
1,300,851
|
|
|
222,169
|
|
|
-
|
|
Subtotal
|
|
|
24,910,423
|
|
|
24,688,254
|
|
|
222,169
|
|
|
-
|
|
Purchase
obligations
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Operating
leases
|
|
|
410,678
|
|
|
268,557
|
|
|
142,121
|
|
|
-
|
|
Total
|
|
$
|
25,321,101
|
|
$
|
24,956,811
|
|
$
|
364,290
|
|
$
|
-
|
|
We
have
identified the policies and significant estimation processes below as critical
to our business operations and the understanding of our results of operations.
This listing is not intended to be a comprehensive list. In many cases, the
accounting treatment of a particular transaction is specifically dictated by
accounting principles generally accepted in the United States, with no need
for
management's judgment in their application. In other cases, management is
required to exercise judgment in the application of accounting principles with
respect to particular transactions. The impact and any associated risks related
to these policies on our business operations is discussed throughout
“Management's Discussion and Analysis of Financial Condition and Results of
Operations” where such policies affect reported and expected financial results.
For a detailed discussion on the application of these and other accounting
policies, see Note B in the Notes to Consolidated Financial Statements for
the
year ended December 31, 2006, included in this annual report. Our preparation
of
our consolidated financial statements requires us to make estimates and
assumptions that affect the reported amount of assets and liabilities,
disclosure of contingent assets and liabilities at the date of our consolidated
financial statements, and the reported amounts of revenue and expenses during
the reporting periods. Management bases its estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances. There can be no assurance that actual results will not differ
from those estimates and such differences could be significant.
Revenue
Recognition.
Our
revenue is primarily derived from fees charged to terminate voice services
over
our network, and from monthly recurring charges associated with Internet
services.
Variable
revenue is earned based on the number of minutes during a call and is recognized
upon completion of a call. Revenue for each customer is calculated from
information received through our network switches. We track the information
received from the switch and analyze the call detail records and apply the
respective revenue rate for each call.
Fixed
revenue is earned from monthly services provided to customers that are fixed
and
recurring in nature, and are connected for a specified period of time. Revenue
recognition commences after the provisioning, testing, and acceptance of the
service by the customer. Revenues are recognized as the services are provided
and continue until the expiration of the contract or until cancellation of
the
service by the customer.
Accounts
Receivable.
Accounts receivable are stated at the amount we expect to collect from
outstanding balances. We provide for probable uncollectible amounts based on
our
assessment of the current status of the individual receivables and after using
reasonable collection efforts. As of December 31, 2006 and 2005, the balance
of
the allowance for uncollectible accounts was $113,653 and $177,489,
respectively.
Goodwill.
In
accordance with SFAS No. 142, we are required to periodically evaluate the
carrying value of our goodwill and other intangible assets. During the years
ended December 31, 2006 and 2005, we recognized impairment expense of $839,101
and $4,173,452, respectively, related to goodwill recorded for our former
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 will 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 declines,
a
material goodwill impairment charge in the future is possible.
Convertible
Debt and Related Detachable Warrants.
Convertible
debt with beneficial conversion features is accounted for in accordance with
Emerging Issues Task Force (“EITF”) No. 98-5 "Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios" and EITF No. 00-27 "Application of EITF 98-5 to Certain
Convertible Instruments." The relative fair value of the warrants and the
beneficial conversion feature at inception have generally been recorded as
a
discount against the debt and is amortized over the term of the debt. However,
because we have insufficient authorized common shares to satisfy our warrant
obligations, the initial value of warrants issued in 2006 at their issuance
dates was recorded as a debt discount and a warrant liability on our
consolidated balance sheet, in accordance with Emerging Issues Task Force
(“EITF”) No. 00-19 "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a Company’s Own Stock.” Also per EITF No. 00-19,
since we continued to have insufficient authorized common shares to satisfy
our
warrant obligations, all warrant liabilities have been marked-to-market,
resulting in a $5,102,731 liability at December 31, 2006, and a corresponding
credit to earnings for the year ended December 31, 2006 of
$7,226,430.
Discontinued
Operations. Our operations formerly consisted of
three segments: Telecommunication Services, Hardware Sales and Calling Card
Sales. However, with our sale of DTNet Technologies and the termination of
our
Marketing and Distribution Agreement with Phone House, Inc. both referred to
above, these former segments are being accounted for as discontinued operations,
as discussed more fully in Note P to our December 31, 2006 consolidated
financial statements on page 69, and prior period financial statements have
been
appropriately reclassified. Also as a result of these discontinued operations,
our operations currently consist of one segment, Telecommunication Services.
Therefore, separate segmented financial results are not presented.
Recently
Issued Accounting Pronouncements
In
September 2006, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (“SFAS”) No. 157, “Fair
Value Measurements.”
SFAS
No. 157 defines fair value as the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market
participants at the measurement date, and also establishes a framework for
measuring fair value. The
provisions of this Statement are effective for fiscal years beginning after
November 15, 2007. At this time we cannot determine whether or not the adoption
of this Statement will have a material impact on our financial
statements.
In
February 2007, the Financial Accounting Standards Board issued SFAS
No. 159, “The
Fair
Value Option for Financial Assets and Financial Liabilities,”
which
amends SFAS No. 115, “Accounting for Certain Investments in Debt and Equity
Securities.” SFAS No. 159 permits companies to choose to measure many financial
instruments at fair value, and could apply to our potential future convertible
debt and stock warrant agreements. The
provisions of this Statement are effective for fiscal years beginning after
November 15, 2007. We do not plan to elect fair value accounting under SAFS
No.
159, therefore do not expect the adoption of this Statement to have a material
impact on our financial statements.
Item
7A. Quantitative
and Qualitative Disclosures About Market Risk
In
conjunction with our May 2006 financing, we repriced a portion of our
outstanding warrants to $0.78 per share, triggering contractual “favored
nations” price ratchets on a number of our existing convertible debt and warrant
agreements, bringing their effective conversion and exercise prices down to
$0.78 per share. The effect was to increase the number of our fully diluted
shares to approximately 129 million, relative to our authorized 100 million
shares. Our total warrants then outstanding were approximately 28 million.
EITF
No. 00-19 states that in this instance, asset or liability classification of
the
warrants is required (as opposed to permanent equity classification). From
January to May 2006, only a portion of our warrants were subject to liability
classification. However, beginning May 2006, all of our warrants were classified
as a liability on our consolidated balance sheet, and their value was
marked-to-market at December 31, 2006, resulting in a fair value warrant
liability of $5,102,731, and a $7,226,430 credit to earnings for the year ended
December 31, 2006. Until we have sufficient authorized common shares to satisfy
these warrant obligations, we will be subject to future non-cash mark-to-market
exposure to the extent that the estimated market value of these warrants changes
in the future, which value in turn is primarily dependent on our common stock
market price per share. As a hypothetical example, a $0.25 per share increase
or
decrease in the market price of our common stock at December 31, 2006, would
have increased or decreased the estimated average market value of these warrants
by $0.18 or $0.11 per warrant, respectively, resulting in hypothetical
mark-to-market adjustments that would have further increased our consolidated
net loss for the year ended December 31, 2006, by $7,168,430, or decreased
that
loss by $4,543,612 respectively.
We
are
not exposed to significant interest rate or foreign currency exchange rate
risk.
Item
8. Financial
Statements and Supplementary Data
The
financial statements required by this item begin at page
53 herein.
Selected
Quarterly Financial Data
You
should read the following tables presenting our quarterly results of operations
in conjunction with our consolidated financial statements and related notes
contained elsewhere in this Form 10-K We have prepared the unaudited information
on the same basis as our audited consolidated financial statements. You should
also keep in mind, as you read the following tables, that our operating results
for any quarter are not necessarily indicative of results for any future
quarters or for a full year.
The
following table presents our unaudited quarterly results of operations for
the
three years ended December 31, 2006. This table includes all
adjustments, consisting only of normal recurring adjustments, that we consider
necessary for fair presentation of our financial position and operating results
for the quarters presented.
|
|
Quarter
Ended (1) (3)
|
|
|
|
|
|
J
un
30,
2004
|
|
|
|
Dec
31 ,
2004
|
|
Mar
31,
2005
|
|
J
un
30,
2005
|
|
Sep
30,
2005
|
|
Dec
31,
2005
|
|
Mar
31,
2006
|
|
|
|
|
|
Dec
31 ,
2006
|
|
|
|
|
|
|
|
(2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
-
|
|
$
|
39,945
|
|
|
333,309
|
|
$
|
647,031
|
|
$
|
1,006,111
|
|
|
1,589,857
|
|
|
1,776,155
|
|
$
|
4,573,745
|
|
$
|
4,700,400
|
|
$
|
4,267,641
|
|
$
|
2,670,961
|
|
$
|
3,037,946
|
|
Gross
profit (loss)
|
|
|
-
|
|
|
11,379
|
|
|
(24,615
|
)
|
|
278,924
|
|
|
8,222
|
|
|
528,602
|
|
|
(922,381
|
)
|
|
(914,091
|
)
|
|
(719,030
|
)
|
|
142,723
|
|
|
473,292
|
|
|
94,952
|
|
Income
(loss) from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
continuing
operations
|
|
|
(22,324
|
)
|
|
(417,024
|
)
|
|
(5,499,670
|
)
|
|
631,130
|
|
|
(1,559,518
|
)
|
|
(3,482,529
|
)
|
|
(8,833,168
|
)
|
|
(9,919,778
|
)
|
|
(12,833,962
|
)
|
|
(5,160,815
|
)
|
|
(11,246,808
|
)
|
|
(9,974,974
|
)
|
Net
income (loss)
|
|
|
(22,324
|
)
|
|
(408,658
|
)
|
|
(5,647,736
|
)
|
|
216,598
|
|
|
(1,555,398
|
)
|
|
(3,536,104
|
)
|
|
(8,742,001
|
)
|
|
(14,479,830
|
)
|
|
(13,807,034
|
)
|
|
(5,191,699
|
)
|
|
(12,312,707
|
)
|
|
(9,885,072
|
)
|
Per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
continuing
operations
|
|
$
|
(0.01
|
)
|
$
|
(0.03
|
)
|
$
|
(0.28
|
)
|
$
|
(0.01
|
)
|
$
|
(0.06
|
)
|
$
|
(0.13
|
)
|
$
|
(0.21
|
)
|
$ |
(0.17 |
) |
$
|
(0.20
|
)
|
$
|
(0.08
|
)
|
$
|
(0.16
|
)
|
$
|
(0.10
|
)
|
Net
loss
|
|
$
|
(0.01
|
)
|
$
|
(0.03
|
)
|
$
|
(0.29
|
)
|
$
|
0.02
|
|
$
|
(0.06
|
)
|
$
|
(0.13
|
)
|
$
|
(0.21
|
)
|
$ |
(0.25 |
) |
$
|
(0.21
|
)
|
$
|
(0.08
|
)
|
$
|
(0.17
|
)
|
$
|
(0.10
|
)
|
(1)
|
These
quarterly results reflect the merger in May 2005 of Caerus and
the
acquisition in October 2005 of the VoIP-related assets of
WQN.
|
(2)
|
The
results for the quarter ended September 30, 2004 include expenses
of $4.9
million related to the issuance of stock warrants.
|
(3)
|
Operations
relating to Millennia Tea Masters, DTNet Technologies and Phone
House,
Inc. were discontinued in 2004, 2005 and 2006, respectively.
Operating
results
prior to these events were reclassified as discontinued
operations.
|
Item
9. Changes
in and Disagreements With Accountants on Accounting and Financial
Disclosure
None.
Item
9A. 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 December 31, 2006, 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 our 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 internal control over financial reporting and
identified four 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 a 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 December 31, 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
December 31, 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 our
assets;
|
· |
Provide
reasonable assurance that transactions are recorded as necessary
to permit
preparation of financial statements in accordance with generally
accepted
accounting principles, and that our receipts and expenditures are
being
made only in accordance with authorization of our management and
directors; 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 December 31, 2006, and concluded
that we had the following control deficiencies as of
December 31, 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 our 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)
|
On
October 31, 2006, we concluded that our consolidated financial statements
for the three and six months ended
June 30, 2006 understated other income and warrant
liabilities, and overstated net loss and additional paid-in
capital, related to the accounting for our warrants under EITF 00-19.
We therefore restated our consolidated financial statements for these
periods. Adjustments to (i) increase the fair value warrant liability;
(ii) decrease additional paid-in capital; and (iii) increase other
income
and decrease net loss aggregated $4,323,999, $5,271,659, and $947,660,
respectively, for the three and six months ended June 30,
2006.
|
(c)
|
We
do not have sufficient accounting personnel resources at corporate
headquarters. 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.
|
(d)
|
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.
|
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
December 31, 2006 based on the criteria in the Internal Control -
Integrated Framework.
Remediation
Steps to Address Control Deficiencies
We
are in
the process of addressing the identified material weakness by remediating the
control deficiencies in our 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 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
have recently completed a comprehensive debt, equity, warrant, and
option
tracking system, which includes identification of all related covenants
and requirements including interrelated contractual debt conversion
and
warrant repricing impacts.
|
c) |
We
continue to seek to improve our in-house accounting resources. 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),
and has
served as the CFO and/or controller of various companies (including
a
public registrant). In May 2006, our Chief Financial Officer resigned,
and
the Corporate Controller was promoted to Chief Accounting
Officer.
|
d) |
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 in
2007.
|
As
a
non-accelerated filer, we plan to complete our assessment of, and improvements
to, the effectiveness of our 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.
Item
9B. Other
Information
None.
PART
III
Item
10. Directors
and Executive Officers of the Registrant
Directors,
Executive Officers, Promoters and Control Persons
The
following table sets forth information concerning our executive officers and
directors as of the periods set forth below:
Name
|
|
Age
|
|
Position
with Company
|
|
Dates
|
Anthony
J. Cataldo
|
|
55
|
|
Chairman
and Chief Executive Officer and Director
|
|
September
2006 to present
|
Shawn
M. Lewis
|
|
38
|
|
Chief
Technology Officer and
|
|
May
2005 to present
|
|
|
|
|
Chief
Operating Officer
|
|
|
Robert
V. Staats
|
|
53
|
|
Chief
Accounting Officer
|
|
May
2006 to present
|
Stuart
Kosh
|
|
50
|
|
Director
|
|
January
2006 to present
|
Gary
Post
|
|
58
|
|
Director
|
|
May
2006 to present
|
Nicholas
A. Iannuzzi, Jr.
|
|
40
|
|
Director
|
|
March
2007 to present
|
Anthony
J. Cataldo
became
our Chief Executive Officer and Chairman in September 2006. During the past
five
(5) years, Mr. Cataldo has served as non-executive chairman of the board of
directors of BrandPartners Group, Inc. (OTC BB:BPTR), a provider of integrated
products and services dedicated to providing financial services and traditional
retail clients with turn-key environmental solutions from October 2003 through
August 2006. Mr. Cataldo also served as non-executive co-chairman of the board
of MultiCell Technologies, Inc. (OTC BB: MUCL), a supplier of functional,
non-tumorigenic immortalized human hepatocytes from February 2005 through July
2006. Mr. Cataldo has also served as executive chairman of Calypte Biomedical
Corporation (AMEX: HIV), a publicly traded biotechnology company, involved
in
the development and sale of urine based HIV-1 screening tests from May 2002
through November 2004. Prior to that, Mr. Cataldo served as the Chief Executive
Officer and Chairman of the Board of Directors of Miracle Entertainment, Inc.,
a
Canadian film production company, from May 1999 through May 2002 where he was
the executive producer or producer of several motion pictures. From August
1995
to December 1998, Mr. Cataldo served as President and Chairman of the Board
of
Senetek, PLC (OTC BB:SNTKY), a publicly traded biotechnology company involved
in
age-related therapies.
Shawn
M. Lewis
oversees
all of our technological and engineering activities. Mr. Lewis founded and
was
the President and CEO of Caerus, Inc. and its three subsidiaries, Volo
Communications, Inc., Caerus Networks, Inc., and Caerus Billing & Mediation,
Inc. from 2001 to 2005. We acquired Caerus, Inc. in May 2005 at which time
Mr.
Lewis became our Chief Technology Officer. Mr. Lewis also became our Chief
Operating Officer in July 2006. Prior to Caerus, Mr. Lewis co-founded XCOM
Technologies, a competitive local exchange carrier, where he served in an
executive capacity and led the development of patents for the first softswitch
and SS7 Media Gateway. XCOM Technologies was sold to Level 3 in 1998. His next
venture, set-top box vendor River Delta, was sold to Motorola. His most recent
venture, Caerus, Inc., empowers carriers and service providers to begin selling
advanced Voice over Internet Protocol related services. In 2004, Mr. Lewis
pled
guilty to a felony drug possession offense and received probation. Mr.
Lewis
was recently engaged in a Chapter 11 bankruptcy in Orlando,
Florida.
Robert
V. Staats
has been
the Director of Finance of our Caerus, Inc. unit since June 2005 and became
our
Chief Accounting Officer in May 2006. Mr. Staats brings 30 years of financial
management experience to the Company including, during the past six years,
CFO
or Controller responsibilities at three start-up telecommunications companies
(including the Company). From 1996 to 2000, Mr. Staats was the Director, Finance
with the telecommunications company Electric Lightwave, Inc. Before that at
PacifiCorp (then a $3.4 billion company) he was Director of Financial Reporting
and Accounting, responsible for consolidated financial statements and SEC
reporting. Mr. Staats also has five years' experience with KPMG Peat Marwick.
He
graduated with high honors from the University of Washington with a bachelor's
degree in Accounting and is a member of the Washington Society of Certified
Public Accountants and the American Society of Certified Public Accountants.
Mr.
Staats was recently engaged in a Chapter 13 bankruptcy in Orlando,
Florida.
Stuart
Kosh
moved to
Florida in 1978 to join his father and brother at Kosh Ophthalmic, Inc., a
wholesale optical laboratory with annual sales of $15 million, where he managed
100 employees. In 1998, the company was sold to Essilor of America, and Mr.
Kosh
maintains his position as General Manager. His leadership roles have included
involvement with the Big Brothers Big Sisters Program of Broward County as
a
mentor to needy youth. For the past 15 years, Mr. Kosh has been involved with
the National Multiple Sclerosis Society. He has served on its board and chairs
its annual golf tournament fundraiser. Presently he is serving on the Temple
Dor
Dorim Board of Directors.
Gary
Post
became
our President, Chief Executive Officer and Chairman in May 2006 and served
in
this capacity until September 2006. Mr. Post continues to serve on our board
of
directors. Since 1999, Mr. Post has been a Managing Director and investment
Principal of Ambient Advisors, LLC (“Ambient”), a venture investment and
management company. In his capacity as Managing Director at Ambient, Mr. Post
has acted as an interim Chief Executive Officer and/or a director for two
private early- to mid-stage companies in which Ambient had invested since April
2002, and at OPMI Funding, Inc., a company that acquired in July 2002 the assets
of Opticon Medical, Inc., a public medical device company. Since March 2006,
he
has also been a director of Oxis International, Inc. (OXIS:BB) and in October
2006 became Acting Chief Operating Officer of Oxis. Prior to Ambient, he served
as First Vice President at Drexel Burnham Lambert; Vice President at Kidder
Peabody; Managing Director at Houlihan, Lokey, Howard and Zukin; and Director
of
Research and Consultant at McKinsey & Company. Mr. Post holds an MBA from
the UCLA Graduate School of Management and an AB in Economics from Stanford
University.
Nicholas
A. Iannuzzi,
Jr.
is a
partner in the law firm of Rothenberg, Estner, Orsi, Arone and Grumbach, LLP
of
Wellesley, Massachusetts, where he has worked since 2002. From 1997 to 2002,
Mr.
Iannuzzi maintained his own law practice in Boston, Massachusetts. Mr. Iannuzzi
specializes in the areas of corporate and contract law, civil litigation and
real estate. He serves as general counsel to numerous corporations and has
advised his clients on various business matters and transactions, including
major acquisitions and sales of businesses. Mr. Iannuzzi is a graduate of Boston
College and received his J.D. from the Suffolk University Law
School.
Board
of Directors and Committee Meetings; Committees of the Board
During
the fiscal year ended December 31, 2004 and through October 2005, Mr. Steven
Ivester was our sole director; consequently, formal board and committee meetings
were not held during that time. One formal meeting of the board of directors
was
held in December 2005. During the fiscal year ending December 31, 2006, there
were six board meetings.
To
date
we have not had a standing compensation, nominating or audit committee. Existing
board of directors members participate in the selection of director nominees,
with the general objective of achieving a balance of experience, knowledge,
integrity and capability on the board. A nominating committee is not considered
necessary due to the small size of the company and of our board.
We
shortly plan to establish a compensation committee consisting of two or more
independent directors. The compensation committee will operate pursuant to
a
written charter. We also shortly plan to establish an audit committee consisting
of two or more independent directors, and at least one financial expert. The
audit committee will operate pursuant to a written charter.
We
do not
presently have a policy with respect to attendance by the directors at the
annual meetings of shareholders.
Section
16(a) Beneficial Ownership Reporting Compliance
Section
16(a) of the Exchange Act requires our directors, executive officers and holders
of more than 10% of our common stock to file with the SEC reports of their
ownership and changes in ownership of our securities. Officers, directors and
greater than 10% shareholders are required by SEC regulations to furnish us
with
copies of all Section 16(a) reports they file. To our knowledge, based solely
on
a review of the copies of such reports and written representations that no
other
reports were required, we believe that all filing requirements applicable to
our
officers, directors and greater than 10% shareholders were satisfied during
the
years ended December 31, 2006 and 2005, except as noted below:
Seventeen
(17) Forms 4 required under Section 16(a) were filed late by Mr. Steven
Ivester, and Mr. Ivester noted in reports filed by him that he had realized
certain “short swing profits,” all of which have been repaid to the Company. Two
Forms 4 were filed late by Mr. Bill Burbank; one Form 4 was filed late by Mr.
David Sasnett; and one Form 4 was filed late by Mr. John Todd. In addition,
Forms 3 were filed late by each of Mr. Gary Post, Mr. David Ahn, Mr.
Robert Staats, Mr. Bill Burbank, Mr. David Sasnett, and WQN,
Inc. Forms 4 for 2006 transactions were not filed, and the related Form 5
was filed late, by Mr. Shawn M. Lewis.
Code
of Ethics
We
shortly plan to adopt a Code of Business Conduct and Ethics, within the meaning
of Item 406(b) of Regulation S-K, that applies to our directors, officers
and employees, including our principal executive officer, principal financial
officer and principal accounting officer. Upon adoption, a complete copy of
the
proposed Code of Ethics will be posted at our website at
www.voipincorporated.com
under
“Investor Info.” Any amendments to, or waivers of, the Code of Ethics will be
promptly disclosed on our website.
Item
11. Executive
Compensation
Compensation
Discussion and Analysis
The
objectives of our compensation program are as follows:
· |
Reward
performance that drives substantial increases in shareholder value,
as
evidenced through both future operating profits and increased market
price
of our common shares; and
|
· |
Attract,
hire and retain well-qualified executives given our competitive industry,
start-up nature, and risk profile.
|
The
compensation level of our Chief Executive Officer (“CEO”) and our Chief
Operating Officer (“COO”) in general is higher than other Company executives,
and reflects the CEO's and COO's unique position and incentive to positively
affect our future operating performance and shareholder value. Our CEO's and
COO's compensation is heavily weighted toward equity compensation, primarily
through stock options and grants, to provide a relatively strong personal
economic incentive for these executives to increase the market price of our
common shares. Specific salary and bonus levels, as well as the amount and
timing of equity incentive grants, are determined informally and judgmentally,
on an individual-case basis, taking into consideration each executive's unique
talents and experience as they relate to our needs. Specific Company performance
measures as they may relate to the timing and amount of executive compensation
have not yet been developed. Executive compensation is primarily paid or granted
pursuant to each executive's formal compensation agreement, but relatively
small
discretionary cash compensation is awarded at times on an individual-case basis.
Compensation adjustments are made occasionally based on changes in an
executive's level of responsibility or on changed local and specific executive
employment market conditions.
Our
current employment agreements with our CEO, COO and Chief Accounting Officer
(“CAO”) contain provisions for lump sum payments in the event their employment
is involuntarily terminated without defined cause. In addition, our CEO's
employment agreement contains a provision for a lump sum payment in the event
his employment is voluntarily terminated for good cause, as defined. For our
CEO
and COO, these lump sum payments would equal any earned but unpaid salary and
bonus, unearned and unpaid bonus to the end of the contract term, plus the
greater of unearned and unpaid salary to the end on the contract term or six
months of salary. For our CAO, this lump sum payment would equal
$75,000.
While
our
executives are involved in negotiating their own employment agreements, such
agreements are approved by our board of directors.
On
September 14, 2006, we entered into employment agreements with Anthony J.
Cataldo, our Chairman and Chief Executive Officer, and Shawn Lewis, our Chief
Operating and Technology Officer. These agreements provided for, among
other things, the award of 10,000,000 stock options each to Messrs. Cataldo
and
Lewis upon sufficient underlying shares of common stock being authorized and
available. The options were to be exercisable to purchase 10,000,000 shares
of
our common stock each for Messrs. Cataldo and Lewis at an exercise price of
$0.01 per share for a period of five (5) years. The options were to contain
a
cashless exercise provision and cost free piggyback registration rights with
respect to the common stock underlying the options. Messrs. Cataldo and Lewis
were also to receive sufficient additional options under the same terms to
assure that they have the right to exercise options to maintain a minimum of
5%
and 8% beneficial ownership, respectively, of our issued and outstanding common
stock.
A
number of our current financing agreements contain “favored nations”
provisions that require convertible debt conversion prices and stock warrant
exercise prices to be repriced (reduced) in the event that, among other things,
options are granted at exercise prices less than our quoted common stock market
price at grant date. However, these favored nations repricing provisions
are not triggered upon issuing employee stock grants. Accordingly, in lieu
of
the stock options to be granted to Messrs. Cataldo and Lewis, the
board of directors on January 24, 2007 resolved to issue stock grants
for 10,000,000 common shares each, subject to sufficient increased shares of
common stock being authorized and available for issuance, which will require
shareholder approval. The stock grants are to have the same 5% and 8%
anti-dilution provisions and piggyback registration rights as the options were
to have. On March 16, 2007, our shareholders approved an authorized common
share
increase
sufficient to issue these shares.
Compensation
Committee Report
The
board
of directors has reviewed and discussed the Compensation Discussion and Analysis
with management, and based on this discussion the following board members,
representing all current board members, recommended that this Compensation
Discussion and Analysis be included in this annual report on Form
10-K:
Anthony
Cataldo;
Gary
Post;
Stuart
Kosh; and
Nicholas
A. Iannuzzi, Jr.
The
following table sets forth information with respect to the compensation for
the
year ended December 31, 2006 of our principal executive officers and principal
financial officers during 2006, and each person who served as an executive
officer of our Company as of December 31, 2006.
Name
and
|
|
|
|
|
|
|
|
Stock
|
|
Option
|
|
All
Other
|
|
|
|
Principal
Position
|
|
Year
|
|
Salary
|
|
Bonus
|
|
Awards
|
|
Awards
(1)
|
|
Compensation
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Anthony
Cataldo (2)
|
|
|
2006
|
|
$
|
83,333
|
|
$
|
23,750
|
|
$ |
- |
|
$ |
- |
|
$
|
6,000
|
|
$
|
113,083
|
|
Chairman
and Chief Executive Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Principal
Executive Officer)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shawn
M. Lewis (3)
|
|
|
2006
|
|
|
214,584
|
|
|
64,808
|
|
|
1,080,000
|
|
|
-
|
|
|
35,429
|
|
|
1,394,821
|
|
Chief
Operating Officer;
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chief
Technology Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Robert
V. Staats (4)
|
|
|
2006
|
|
|
132,597
|
|
|
5,692
|
|
|
-
|
|
|
133,000
|
|
|
-
|
|
|
271,289
|
|
Chief
Accounting Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Principal
Financial Officer)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gary
Post (5)
|
|
|
2006
|
|
|
72,668
|
|
|
-
|
|
|
300,000
|
|
|
930,000
|
|
|
241,672
|
|
|
1,544,340
|
|
Former
President, Chief Executive
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Officer
and Chairman (6)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Michael
Adler
|
|
|
2006
|
|
|
60,923
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
60,923
|
|
Former
Chairman and Chief
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Executive
Officer (7)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David
Sasnett
|
|
|
2006
|
|
|
54,375
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
54,375
|
|
Former
Chief Financial Officer (8)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Includes
awards of stock warrants where applicable. Values are computed in
accordance with Statement of Financial Accounting Standards number
123R.
|
(2)
|
Mr.
Cataldo's 2006 salary and bonus represent the contractual monthly
amounts
($20,833 and $5,000, respectively) earned since September 2006, plus
a
discretionary bonus of $3,750. All Other Compensation represents
Mr.
Cataldo's monthly vehicle allowance since September 2006. Mr. Cataldo's
employment agreement is effective through September 2009, and will
thereafter automatically renew for successive one-year periods unless
either party provides a 90-day notice of termination. See Compensation
Discussion and Analysis for a description of certain stock options
and
stock grants pertaining to Mr. Cataldo. Since those stock options
were not
granted, they are not reflected in the Summary Compensation
Table.
|
(3)
|
Mr.
Lewis' 2006 salary and bonus represent his contractual monthly amounts
earned (which have been $20,833 and $5,000, respectively, since September
2006), plus a discretionary bonus of $4,808. On November 8, 2006,
Mr.
Lewis was granted options to purchase 3,000,000 common shares at
$0.36 per
share (closing market price at the grant date). On November 9, 2006,
we
settled Mr. Lewis' claims against us for alleged breaches of his
employment agreement, and for nonregistration of our common shares
he
holds pursuant to the Caerus merger agreement dated May 31, 2005,
for
$1,080,000. Also on November 9, 2006, Mr. Lewis exercised his options
to
purchase 3,000,000 common shares, and the $1,080,000 proceeds were
credited toward the settlement of his claims. All Other Compensation
represents Mr. Lewis' $1,500 monthly vehicle allowance since July
2006,
plus discretionary expense reimbursement treated as compensation.
Mr.
Lewis' employment agreement is effective through September 2009.
See
Compensation Discussion and Analysis for a description of certain
stock
options and stock grants pertaining to Mr. Lewis. Since those stock
options were not granted, they are not reflected in the Summary
Compensation Table.
|
(4)
|
Mr.
Staats' 2006 salary ($11,667 per month at December 31, 2006, increasing
to
$12,917 in January 2007) represents his contractual monthly amounts
earned. His bonus amount was discretionary. Mr. Staats' employment
agreement also provides for the award of 100,000 options and 100,000
warrants, subject to approval by our board of directors. The options
and
warrants will each be exercisable to purchase 100,000 shares of our
common
stock at $1.02 a share until May 2011, and were valued at a combined
$133,000 in May 2006. Mr. Staats' employment agreement is effective
through May 2009, and will thereafter automatically renew for successive
one-year periods unless terminated at least 90 days prior to the
expiration of each current existing twelve-month period. Mr. Staats
may
terminate his employment agreement upon 30 days' prior
notice.
|
(5)
|
Mr.
Post's 2006 salary represents his contractual monthly amount earned
from
May to September 2006. Subject to approval by our board of directors,
Mr.
Post's employment agreement provides for the issuance of 300,000
common
shares. Mr. Post's employment agreement also provided for the award
of
options and warrants to purchase a total of 3,000,000 shares of the
Company's common stock at $1.00 a share until May 2011. On December
12,
2006 these options and warrants were converted to warrants to purchase
3,000,000 of our common shares at $0.475 per share, exercisable until
December 2016. These new warrants were valued at $930,000. Mr. Post's
employment agreement also provides for certain post-employment
compensation totaling approximately $241,672, listed under All Other
Compensation.
|
(6)
|
Mr.
Post resigned his position as President, Chief Executive Officer
and
Chairman in September, 2006.
|
|
|
(7)
|
Mr.
Adler resigned his position as Chairman and Chief Executive Officer
in
May, 2006.
|
(8)
|
Mr.
Sasnett resigned his position as Chief Financial Officer in May,
2006.
|
Outstanding
Equity Awards at Fiscal Year-End
The
following table sets forth information with respect to grants of options
to
purchase our common stock to the named executive officers as of December
31,
2006.
|
|
|
|
|
|
|
|
|
|
|
|
Option
and Warrant Awards
|
|
|
|
Number
of Securities Underlying Unexercised Options and Warrants
|
|
Option
or Warrant Exercise
|
|
Option
or Warrant
|
|
|
|
Exercisable
|
|
Unexercisable
|
|
Price
|
|
Expiration
Date
|
|
Name
and
|
|
|
|
|
|
|
|
|
|
Principal
Position
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Anthony
Cataldo (1)
|
|
|
-
|
|
|
-
|
|
$
|
-
|
|
|
|
|
Chairman
and Chief Executive Officer
|
|
|
-
|
|
|
-
|
|
$
|
-
|
|
|
|
|
(Principal
Executive Officer)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shawn
M. Lewis (2)
|
|
|
-
|
|
|
-
|
|
$
|
-
|
|
|
|
|
Chief
Operating Officer;
|
|
|
-
|
|
|
-
|
|
$
|
-
|
|
|
|
|
Chief
Technology Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Robert
V. Staats
|
|
|
190,625
|
|
|
59,375
|
|
$
|
1.02
|
|
|
5/17/11
|
|
Chief
Accounting Officer
|
|
|
62,500
|
|
|
38,500(9
|
)
|
$
|
1.12
|
|
|
6/3/10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gary
Post (3)
|
|
|
3,000,000
|
|
|
-
|
|
$
|
0.475
|
|
|
12/12/16
|
|
Former
President, Chief Executive
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Officer
and Chairman (6)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Michael
Adler (4)
|
|
|
500,000
|
|
|
-
|
|
$
|
1.56
|
|
|
10/18/10
|
|
Former
Chairman and Chief
|
|
|
500,000
|
|
|
-
|
|
$
|
1.50
|
|
|
10/18/10
|
|
Executive
Officer (7)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David
Sasnett
(5)
|
|
|
450,000
|
|
|
|
|
$
|
1.53
|
|
|
10/18/10
|
|
Former
Chief Financial Officer (8)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
See
Compensation Discussion and Analysis for a description of certain
stock
options and stock grants pertaining to Mr. Cataldo. Since those stock
options were not granted, they are not reflected in the Outstanding
Equity
Awards at Fiscal Year-End table.
|
(2)
|
See
Compensation Discussion and Analysis for a description of certain
stock
options and stock grants pertaining to Mr. Lewis. Since those stock
options were not granted, they are not reflected in the Outstanding
Equity
Awards at Fiscal Year-End table.
|
(3)
|
Mr.
Post's employment agreement provided for the award of options and
warrants
to purchase a total of 3,000,000 shares of the Company's common stock
at
$1.00 a share until May 2011. On December 12, 2006 these options
and
warrants were converted to warrants to purchase 3,000,000 of the
Company's
common shares at $0.475 per share, exercisable until December
2016.
|
(4)
|
Mr.
Adler's options and warrants were issued in 2005 in conjunction with
his
employment agreement.
|
(5)
|
Mr.
Sasnett's's warrants were issued in 2005 in conjunction with his
employment agreement.
|
(6)
|
Mr.
Post resigned his position as President, Chief Executive Officer
and
Chairman in September, 2006.
|
(7)
|
Mr.
Adler resigned his position as Chairman and Chief Executive Officer
in
May, 2006.
|
(8)
|
Mr.
Sasnett resigned his position as Chief Financial Officer in May,
2006.
|
(9)
|
Mr.
Staats' remaining 59,375 and 38,500 options vest ratably until May
2009
and June 2008, respectively.
|
Option
Exercises and Stock Vested
|
|
|
|
|
|
|
|
|
|
|
|
Option
Awards (1)
|
|
Stock
Awards
|
|
|
|
Number
of Shares Acquired on Exercise
|
|
Value
Realized on Exercise
|
|
Number
of Shares Acquired on Vesting
|
|
Value
Realized on Vesting
|
|
Name
and
|
|
|
|
|
|
|
|
|
|
Principal
Position
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Anthony
Cataldo
|
|
|
-
|
|
$
|
-
|
|
|
-
|
|
$
|
-
|
|
Chairman
and Chief Executive Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Principal
Executive Officer)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shawn
M. Lewis (2)
|
|
|
3,000,000
|
|
$
|
-
|
|
|
-
|
|
$
|
-
|
|
Chief
Operating Officer;
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chief
Technology Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Robert
V. Staats
|
|
|
-
|
|
$
|
-
|
|
|
-
|
|
$
|
-
|
|
Chief
Accounting Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gary
Post (3)
|
|
|
-
|
|
$
|
-
|
|
|
300,000
|
|
$
|
300,000
|
|
Former
President, Chief Executive
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Officer
and Chairman (4)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Michael
Adler
|
|
|
-
|
|
$
|
-
|
|
|
-
|
|
$
|
-
|
|
Former
Chairman and Chief
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Executive
Officer (5)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David
Sasnett
|
|
|
-
|
|
$
|
-
|
|
|
-
|
|
$
|
-
|
|
Former
Chief Financial Officer (6)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Includes
awards of stock warrants, where applicable. Values are computed in
accordance with Statement of Financial Accounting Standards No.
123R.
|
(2)
|
On
November 8, 2006, Mr. Lewis was granted options to purchase 3,000,000
common shares at $0.36 per share (closing market price at the grant
date).
On November 9, 2006, we settled Mr. Lewis' claims against us for
alleged
breaches of his employment agreement, and for nonregistration of
our
common shares he holds pursuant to the Caerus merger agreement dated
May
31, 2005, for $1,080,000. Also on November 9, 2006, Mr. Lewis exercised
his options to purchase 3,000,000 common shares, and the $1,080,000
proceeds were credited toward the settlement of his
claims.
|
(3)
|
Subject
to approval by our board of directors, Mr. Post's employment agreement
provides for the issuance of 300,000 common
shares.
|
(4)
|
Mr.
Post resigned his position as President, Chief Executive Officer
and
Chairman in September, 2006.
|
(5)
|
Mr.
Adler resigned his position as Chairman and Chief Executive Officer
in
May, 2006.
|
(6)
|
Mr.
Sasnett resigned his position as Chief Financial Officer in May,
2006.
|
The
following table sets forth with respect to the named director, compensation
information inclusive of equity awards and payments made in the year ended
December 31, 2006.
Name
of Director
|
|
Stock
Awards
|
|
|
|
|
|
Anthony
Cataldo
|
|
$
|
-
|
|
|
|
|
|
|
Gary
Post (1)
|
|
$
|
105,000
|
|
|
|
|
|
|
Stuart
Kosh (1)
|
|
$
|
105,000
|
|
|
|
|
|
|
Nicholas
A. Iannuzzi, Jr. (1)
|
|
$
|
-
|
|
|
|
|
|
|
(1)
|
On
December 12, 2006 non-employee directors were each awarded 300,000
of our
common shares, subject to sufficient authorized shares being approved
by
shareholders, as annual board member compensation. The fair value
of the
stock awards was based on the our closing common stock price of $0.35
per
share on the grant date. Nicholas A. Iannuzzi was elected to our
board of
directors on March 16, 2007.
|
Potential
Payments upon Termination or Change in Control
Our
current employment agreements with our CEO, COO and CAO contain provisions
for
lump sum payments in the event their employment is involuntarily terminated
without defined cause. In addition, our CEO's employment agreement contains
a
provision for a lump sum payment in the event his employment is voluntarily
terminated for good cause, as defined. For our CEO and COO, these lump sum
payments would equal any earned but unpaid salary and bonus, unearned and unpaid
bonus to the end of their contract terms (September 2009), plus the greater
of
unearned and unpaid salary to the end on their contract terms or six months
of
salary. As of December 31, 2006, this would have equated to a lump sum payment
of approximately $840,000 each for our CEO and COO, respectively. For our CAO,
this lump sum payment would equal $75,000.
In
May
2006 we entered into an employment agreement with Gary Post who became our
President, Chief Executive Officer and Chairman and served in this capacity
until September 2006. During his employment with us, Mr. Post served under
an
employment agreement. The employment agreement was for a term of three years
(unless terminated earlier pursuant to its terms) and provided for a salary
of
$16,667 per month through December 31, 2006, increasing to $18,000 per month
on
January 1, 2007. Mr.
Post's employment agreement also provides for the future payment of certain
post-employment compensation totaling approximately $241,672 as of December
31,
2006.
Compensation
Committee Interlocks and Insider Participation
To
date
we have not had a standing compensation committee. Mr. Anthony Cataldo, our
Chief Executive Officer, Mr. Shawn Lewis, our Chief Operating Officer and Chief
Technical Officer, and Mr. Gary Post, our former Chief Executive officer,
participated in deliberations with our board of directors concerning executive
officer compensation during the year ended December 31, 2006.
Item
12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Equity
Compensation Plan Information
See
Note
L to our consolidated financial statements on page 68 for a description of
our
2004 Employee Stock Option Plan (the “2004 Plan”) and our 2006 Equity Incentive
Plan (the “2006 Plan”). The following table provides information as of
December 31, 2006 regarding compensation plans under which our equity
securities are authorized for issuance.
|
|
Number
of securities to be issued upon exercise of outstanding options,
warrants
and rights
(a)
|
|
Weighted-average
exercise price of outstanding options, warrants and rights
(b)
|
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in
column
(a))
(c)
|
|
|
|
|
|
|
|
|
|
Equity
compensation plans approved by
shareholders
|
|
|
644,350
|
|
$
|
1.11
|
|
|
13,355,650
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
compensation plans not
approved
by shareholders
|
|
|
8,156,247
|
|
|
1.00
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
8,800,597
|
|
$
|
1.01
|
|
|
13,355,650
|
|
The
above
table excludes the 10,000,000 common shares that were granted to each of
Messrs.
Cataldo
and Lewis by the board of directors on January 24, 2007, as more fully
described in the Compensation Discussion and Analysis above.
Beneficial
Ownership
The
following table sets forth information as of March 15, 2007, except as otherwise
noted, with respect to the beneficial ownership of our common stock and is
based
on 98,609,701 shares of common stock issued and outstanding as of March 15,
2007:
· |
Each
person known by us to own beneficially more than five percent of
our
outstanding common stock;
|
· |
Each
of our directors and prospective
directors;
|
· |
Our
Chief Executive Officer and each person who serves as an executive
officer
of the Company; and
|
· |
All
our executive officers and directors as a
group.
|
The
number of shares beneficially owned by each shareholder is determined under
rules promulgated by the SEC. The information is not necessarily indicative
of
beneficial ownership for any other purpose. Under these rules, beneficial
ownership includes any shares as to which the individual has sole or shared
voting power or investment power and any shares as to which the individual
has
the right to acquire beneficial ownership within 60 days, except as otherwise
noted, through the exercise or conversion of any stock option, warrant,
preferred stock or other right. The inclusion in the following table of those
shares, however, does not constitute an admission that the named shareholder
is
a direct or indirect beneficial owner of those shares. Unless otherwise
indicated, to our knowledge based upon information produced by the persons
and
entities named in the table, each person or entity named in the table has sole
voting power and investment power, or shares voting and/or investment power
with
his or her spouse, with respect to all shares of capital stock listed as owned
by that person or entity.
The
address for each of our officers and directors is c/o VoIP, Inc., 151 South
Wymore Road, Suite 3000, Altamonte Springs, Florida 32714.
Name
of Beneficial Owner
|
|
Shares
of Common Stock Beneficially Owned (1)
|
|
Ownership
of Common Stock (1,2)
|
|
|
|
|
|
|
|
WQN,
Inc. (3)
|
|
|
27,816,227
|
|
|
23.1
|
%
|
14911
Quorum Drive, Suite 140
|
|
|
|
|
|
|
|
Dallas,
Texas 75240
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nicholas
A. Iannuzzi, Jr.
|
|
|
307,355
|
|
|
*
|
|
Stuart
Kosh (4)
|
|
|
2,968,750
|
|
|
3.0
|
%
|
Shawn
Lewis (5,6)
|
|
|
7,035,857
|
|
|
7.0
|
%
|
Gary
Post (7)
|
|
|
3,600,000
|
|
|
3.5
|
%
|
Robert
Staats (8)
|
|
|
253,125
|
|
|
*
|
|
Anthony
Cataldo (6)
|
|
|
0
|
|
|
*
|
|
|
|
|
|
|
|
|
|
All
directors and executive officers as a
|
|
|
14,165,087
|
|
|
13.3
|
%
|
group
(6 persons) (9)
|
|
|
|
|
|
|
|
(1)
|
We
have issued and outstanding 98,609,701 shares of common stock; and
a total
of 400,000,000 shares are authorized. Additional issuances of common
stock
resulting from the exercise of options and/or warrants and/or the
conversion of debt are subject to the authorized
limit.
|
(2)
|
Based
upon 98,609,701 shares of common stock issued and outstanding as
of March
15, 2007.
|
(3)
|
Consists
of 5,787,429 shares of common stock and 22,028,798 shares issuable
upon
conversion of a convertible promissory note. Conversion shares were
calculated by dividing (i) the sum of the note principal of $3,700,000
and
interest at 6% from 1/3/06 through 3/15/07 by (ii) effective conversion
price of $0.18 per share.
|
(4)
|
Consists
of (a) 1,962,500 shares of common stock; (b) currently exercisable
options
to purchase 156,250 shares of common stock; and (c) warrants to purchase
850,000 shares of common stock.
|
(5)
|
Consists
of 7,035,857 shares of common
stock.
|
(6)
|
As
previously disclosed, on September 14, 2006, we entered into employment
agreements with Anthony J. Cataldo, our Chairman and Chief Executive
Officer, and Shawn Lewis, our Chief Operating and Technology
Officer. These agreements provided for, among other things, the award
of
10,000,000 stock options each to Messrs. Cataldo and Lewis upon sufficient
underlying shares of common stock being authorized and available.
The
options were to be exercisable to purchase 10,000,000 shares of our
common
stock each for Messrs. Cataldo and Lewis at an exercise price of
$0.01 per
share for a period of five (5) years. The options were to contain
a
cashless exercise provision and cost free piggyback registration
rights
with respect to the common stock underlying the options. Messrs.
Cataldo
and Lewis were also to receive sufficient additional options under
the
same terms to assure that they have the right to exercise options
to
maintain a minimum of 5% and 8% beneficial ownership, respectively,
of our
issued and outstanding common stock.
A
number of our current financing agreements contain “favored nations”
provisions that require convertible debt conversion prices and stock
warrant exercise prices to be repriced (reduced) in the event that,
among
other things, options are granted at exercise prices less than our
quoted
common stock market price at grant date. However, these favored
nations repricing provisions are not triggered upon issuing employee
stock
grants. Accordingly, in lieu of the stock options to be granted to
Messrs. Cataldo and Lewis, the board of directors on January 24, 2007
resolved to issue stock grants for 10,000,000 common shares
each, subject to sufficient increased shares of common stock being
authorized and available for issuance, which will require shareholder
approval. The stock grants are to have the same 5% and 8% anti-dilution
provisions and piggyback registration rights as the options were
to
have.
Accordingly,
these shares are not included with the shares, if any, reported as
beneficially owned herein.
|
(7)
|
Consists
of 600,000 shares of common stock and warrants to purchase 3,000,000
shares of common stock.
|
(8)
|
Consists
of warrants to purchase 150,000 shares of common stock and currently
exercisable options to purchase 103,125 shares of common
stock.
|
(9)
|
Represents
the combined beneficial ownership as of March 15, 2007, of the executives
and the Company’s four directors (a total of six
persons).
|
Item
13. Certain
Relationships and Related Transactions
In
October 2005, we purchased all of the assets of WQN, Inc. (“WQN”). Mr. Adler,
our former chairman and chief executive officer, was the Chief Executive Officer
of WQN, and owned approximately 37% of WQN's outstanding common stock. In
connection with the transaction, we purchased the assets for a purchase price
consisting of (1) a note in the principal amount of $3,700,000 (the “Note”), (2)
1,250,000 shares of our restricted common stock and (3) a warrant to purchase
5,000,000 shares of our common stock at an exercise price of $ $0.001 per share
(the “Warrant”). The Note accrues interest at the rate of 6% per annum. In
addition, we issued WQN, Inc. an additional 500,000 shares of restricted common
stock relating to the difference between the amount of accounts receivable
transferred in the transaction and the accounts payable. The Note is convertible
into common stock or preferred stock (at such time that a series of preferred
stock is established). The Warrant was exercised for common stock. Pursuant
to
our asset purchase agreement with WQN, on March 16, 2007 our shareholders
approved a class of preferred stock that could have been used to satisfy the
conversion features of the Note. On March 16, 2007, WQN notified us that it
was
exercising its right to convert its note and related accrued interest into
approximately
22,008,524 shares of our common stock.
The
Company and Mr. Ivester, a
shareholder and former Chief Executive Officer of the Company,
entered
into a 3-year consulting agreement on October 18, 2005, which we terminated
in
October 2006. Pursuant to the consulting agreement, Mr. Ivester provided general
business strategy, financing and product development advice. Mr. Ivester
received $200,000 per year for his services under the consulting agreement,
as
well as a $2,500 per month vehicle allowance. Mr. Ivester was eligible to
receive bonuses and participate in our stock option plan, as determined by
the
board of directors. We also owed Mr. Ivester $305,212 as of December 31, 2006
under a demand note payable bearing interest at 3.75%. On March 16, 2007 we
agreed to settle all of Mr. Ivester’s claims under his consulting agreement and
his demand note payable, in return for cash payments totaling $75,000, and
500,000 shares of the our common stock.
On
November 8, 2006, Mr. Lewis, our Chief Operating Officer and Chief Technology
Officer, was granted options to purchase 3,000,000 common shares at $0.36 per
share (closing market price at the grant date). On November 9, 2006, we settled
Mr. Lewis' claims against us for alleged breaches of his employment
agreement, and for nonregistration of our common shares he holds pursuant to
the
Caerus merger agreement dated May 31, 2005, for $1,080,000. Also on November
9,
2006, Mr. Lewis exercised his options to purchase 3,000,000 common shares,
and
the $1,080,000 proceeds from this exercise were credited toward the settlement
of his claims.
On
March 29, 2007, we issued an unsecured promissory note in the principal
amount of $300,000 (the “Note”) to Shawn M. Lewis, the Company’s Chief Operating
Officer. The Note and related accrued interest at 10% per annum is payable
upon
demand. The cash proceeds to the Company were $252,000 net of related closing
costs and expense reimbursements of $48,000, $30,000 of which was paid to
Mr. Lewis. In the event of a default, in addition to all sums due and owing
under the Note, we will also be required to pay the sum of $750,000 as
liquidated damages.
Item
14. Principal
Accountant Fees and Services
Audit
Fees.
Berkovits, Lago & Company, LLP provided services to us during the years
ended December 31, 2006 and 2005 in the categories shown below.
|
|
Fiscal
Years Ending
|
|
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
Audit
Fees
(1)
|
|
$
|
291,914
|
|
$
|
120,234
|
|
Audit-Related
Fees (2)
|
|
|
124,398
|
|
|
-
|
|
Tax
Fees (3)
|
|
|
55,000
|
|
|
-
|
|
All
Other Fees (4)
|
|
|
-
|
|
|
-
|
|
(1)
|
Audit
fees
-
These are fees billed for professional services performed by Berkovits,
Lago & Company, LLP for the audit of our annual financial
statements and review of financial statements included in our Form
10-Q
filings, and services that are normally provided in connection with
statutory regulatory filings or
engagements.
|
(2)
|
Audit-related
fees
-
These are fees billed for assurance and related services performed
by
Berkovits, Lago & Company, LLP that are reasonably related to the
performance of the audit or review of our financial statements. These
include attestations that are not required by statute, and consulting
on
financial accounting/reporting standards.
|
|
|
(3)
|
Tax
fees
-
These are fees billed for professional services performed by Berkovits,
Lago & Company, LLP with respect to tax compliance, tax advice
and tax planning. These include preparation of original and amended
tax
returns for the Company and its consolidated subsidiaries, refund
claims,
payment planning, tax audit assistance, and tax work stemming from
“audit-related” items.
|
(4)
|
All
other fees
-
Services that do not meet the above three category descriptions are
not
permissible work performed for us by Berkovits, Lago & Company,
LLP.
|
PART
IV
Item
15. Exhibits and Financial Statement Schedules
(b)
Exhibits
(3)
|
|
2.1
|
|
Stock
Contribution Agreement dated May 25, 2004, between Registrant and
Steven
Ivester
|
|
|
|
|
|
(12)
|
|
2.2
|
|
Agreement
and Plan of Merger with Caerus, Inc. dated as of May 31,
2005
|
|
|
|
|
|
(14)
|
|
2.3
|
|
Asset
Purchase Agreement dated as of August 3, 2005, by and between VoIP,
Inc.
Acquisition Company and WQN, Inc.
|
|
|
|
|
|
(1)
|
|
3.1.1
|
|
Articles
of Incorporation
|
|
|
|
|
|
(1)
|
|
3.1.2
|
|
Bylaws
|
|
|
|
|
|
(3)
|
|
3.2
|
|
Amendment
to Articles of Incorporation dated April 13, 2004
|
|
|
|
|
|
(32)
|
|
3.3
|
|
Amended
and Restated Bylaws of VoIP, Inc.
|
|
|
|
|
|
(3)
|
|
4.1
|
|
Specimen
Stock Certificate
|
|
|
|
|
|
(28)
|
|
4.2.1
|
|
Form
of Consulting Agreement with Irawan Onggara effective November
20,
2006
|
|
|
|
|
|
(28)
|
|
4.2.2
|
|
Form
of Consulting Agreement with Piter Korompis effective November
20,
2006
|
|
|
|
|
|
(2)
|
|
10.1
|
|
Stock
Purchase Agreement dated February 27, 2004, between Registrant
and Steven
Ivester
|
|
|
|
|
|
(3)
|
|
10.2
|
|
2004
Stock Option Plan
|
|
|
|
|
|
(4)
|
|
10.3
|
|
Stock
Purchase Agreement dated June 25, 2004, among Registrant, DTNet
Technologies and Marc Moore
|
|
|
|
|
|
(5)
|
|
10.4
|
|
Stock
Purchase Agreement dated September 10, 2004, among Carlos Rivas,
Albert
Rodriguz, Registrant and Vox Consulting Group Inc.
|
|
|
|
|
|
(6)
|
|
10.5.1
|
|
Subscription
Agreement dated November 11, 2004
|
|
|
|
|
|
(6)
|
|
10.5.2
|
|
Form
of Class A Warrant
|
|
|
|
|
|
(6)
|
|
10.5.3
|
|
Form
of Class B Warrant
|
|
|
|
|
|
(8)
|
|
10.6.1
|
|
Stock
Purchase Warrant dated December 10, 2004, issued to Ivano
Angelastri
|
|
|
|
|
|
(8)
|
|
10.6.2
|
|
Stock
Purchase Warrant dated December 10, 2004, issued to Ebony
Finance
|
|
|
|
|
|
(9)
|
|
10.7.1
|
|
Form
of Incentive Stock Option Agreement
|
|
|
|
|
|
(9)
|
|
10.7.2
|
|
Form
of Non-Qualified Stock Option Agreement
|
|
|
|
|
|
(10)
|
|
10.8
|
|
Net
Exercise Agreement dated February 14, 2005, with John
Todd
|
|
|
|
|
|
(11)
|
|
10.9
|
|
Asset
Purchase Agreement dated February 23, 2005, among Creative Marketing
Associates, Registrant, and
eGlobalPhone
|
(12)
|
|
10.10
|
|
Caerus,
Inc. Merger Documents dated May 31, 2005:
|
|
|
|
|
|
(12)
|
|
10.10.1
|
|
Option
Exchange Agreement
|
|
|
|
|
|
(12)
|
|
10.10.2
|
|
Registration
Rights Agreement
|
|
|
|
|
|
(12)
|
|
10.10.3
|
|
Exchange
Agreement
|
|
|
|
|
|
(12)
|
|
10.10.4
|
|
Registration
Rights Agreement
|
|
|
|
|
|
(12)
|
|
10.10.5
|
|
Consent
and Waiver Agreement
|
|
|
|
|
|
(12)
|
|
10.10.6
|
|
Guaranty
|
|
|
|
|
|
(12)
|
|
10.10.7
|
|
Security
Agreement
|
|
|
|
|
|
(12)
|
|
10.10.8
|
|
Employment
Agreement dated May 27, 2005, between Registrant and Shawn
Lewis
|
|
|
|
|
|
(13)
|
|
10.11.1
|
|
Subscription
Agreement dated July 5, 2005
|
|
|
|
|
|
(13)
|
|
10.11.2
|
|
Form
of Class C Warrant
|
|
|
|
|
|
(13)
|
|
10.11.3
|
|
Form
of Class D Warrant
|
|
|
|
|
|
(13)
|
|
10.11.4
|
|
Form
of Convertible Note
|
|
|
|
|
|
(13)
|
|
10.11.5
|
|
Security
Agreement
|
|
|
|
|
|
(13)
|
|
10.11.6
|
|
Security
and Pledge Agreement
|
|
|
|
|
|
(13)
|
|
10.11.7
|
|
Guaranty
|
|
|
|
|
|
(14)
|
|
10.12
|
|
WQN,
Inc. Documents dated August 3, 2005:
|
|
|
|
|
|
(14)
|
|
10.12.1
|
|
Warrant
|
|
|
|
|
|
(14)
|
|
10.12.2
|
|
Security
Agreement between Registrant and WQN, Inc.
|
|
|
|
|
|
(14)
|
|
10.12.3
|
|
Consent,
Waiver and Acknowledgement by and among Cedar Boulevard Lease Funding,
Inc., Registrant, and certain Subsidiaries of
Registrant
|
|
|
|
|
|
(14)
|
|
10.12.4
|
|
Third
Amendment to Subordinated Loan and Security Agreement by and among
Cedar
Boulevard Lease Funding, Inc., Registrant, and certain Subsidiaries
of
Registrant
|
|
|
|
|
|
(14)
|
|
10.12.5
|
|
Security
Agreement between Cedar Boulevard Lease Funding, Inc. and VoIP
Acquisition
Company
|
|
|
|
|
|
(14)
|
|
10.12.6
|
|
Guaranty
between Cedar Boulevard Lease Funding, Inc. And VoIP Acquisition
Company
|
|
|
|
|
|
(15)
|
|
10.13
|
|
Consulting
Services Agreement dated October 18, 2005, between Registrant and
Steven
Ivester
|
|
|
|
|
|
(16)
|
|
10.14.1
|
|
Cross
Country Capital Partners Amendment Subscription Agreement dated
November
16, 2005
|
|
|
|
|
|
(16)
|
|
10.14.2
|
|
Cross
Country Capital Partners Class C Warrant
|
|
|
|
|
|
(16)
|
|
10.14.3
|
|
Stock
Purchase Agreement with Steven Ivester
|
|
|
|
|
|
(16)
|
|
10.14.4
|
|
Promissory
Note to Steven Ivester
|
(17)
|
|
10.15.1
|
|
Subscription
Agreement for Secured Notes dated January 6, 2006
|
|
|
|
|
|
(17)
|
|
10.15.2
|
|
Subscription
Agreement for Unsecured Notes dated January 6, 2006
|
|
|
|
|
|
(17)
|
|
10.15.3
|
|
Form
of Class A Warrant
|
|
|
|
|
|
(17)
|
|
10.15.4
|
|
Form
of Class B Warrant
|
|
|
|
|
|
(17)
|
|
10.15.5
|
|
Form
of Secured Convertible Note
|
|
|
|
|
|
(17)
|
|
10.15.6
|
|
Form
of Unsecured Convertible Note
|
|
|
|
|
|
(17)
|
|
10.15.7
|
|
Security
Agreement
|
|
|
|
|
|
(17)
|
|
10.15.8
|
|
Security
and Pledge Agreement
|
|
|
|
|
|
(17)
|
|
10.15.9
|
|
Guaranty
Agreement
|
|
|
|
|
|
(18)
|
|
10.16.1
|
|
Subscription
Agreement dated February 2, 2006
|
|
|
|
|
|
(18)
|
|
10.16.2
|
|
Form
of Class A Warrant
|
|
|
|
|
|
(18)
|
|
10.16.3
|
|
Form
of Class B Warrant
|
|
|
|
|
|
(18)
|
|
10.16.4
|
|
Form
of Secured Convertible Note
|
|
|
|
|
|
(18)
|
|
10.16.5
|
|
Security
Agreement
|
|
|
|
|
|
(18)
|
|
10.16.6
|
|
Security
and Pledge Agreement
|
|
|
|
|
|
(18)
|
|
10.16.7
|
|
Guaranty
Agreement
|
|
|
|
|
|
(19)
|
|
10.17
|
|
2006
Equity Incentive Plan
|
|
|
|
|
|
(20)
|
|
10.18
|
|
Stock
Purchase Agreement dated as of April 19, 2006, by and between Registrant,
VCG Technologies, Inc. d/b/a DTNet Technologies and William F.
Burbank
|
|
|
|
|
|
(21)
|
|
10.19.1
|
|
Employment
Agreement effective May 15, 2006, between Registrant and Mr. Gary
Post
|
|
|
|
|
|
(21)
|
|
10.19.2
|
|
Employment
Agreement effective May 17, 2006, between Registrant and Mr. Robert
Staats
|
|
|
|
|
|
(21)
|
|
10.19.3
|
|
Employment
Agreement effective May 15, 2006, between Registrant and Mr. David
Ahn
|
|
|
|
|
|
(21)
|
|
10.19.4
|
|
Modification
and Amendment Agreement dated May 22, 2006
|
|
|
|
|
|
(36)
|
|
10.20.1
|
|
Promissory
Note dated September 13, 2006, issued to Bristol Investment Fund,
Ltd., in
the Principal Amount of $166,666
|
|
|
|
|
|
(36)
|
|
10.20.2
|
|
Promissory
Note dated September 13, 2006, issued to Alpha Capital Anstalt
in the
Principal Amount of $333,334
|
|
|
|
|
|
(22)
|
|
10.21
|
|
Promissory
Note dated September 29, 2006, issued to Whalehaven Capital Fund
Limited
in the Principal Amount of $387,800
|
|
|
|
|
|
(23)
|
|
10.22.1
|
|
Subscription
Agreement dated October 17, 2006
|
|
|
|
|
|
(23)
|
|
10.22.2
|
|
Form
of Class C Warrant
|
(23)
|
|
10.22.3
|
|
Form
of Secured Convertible Note
|
|
|
|
|
|
(24)
|
|
10.23
|
|
Compensation
Agreement dated October 12, 2006, among Registrant and Marc
Ross
|
|
|
|
|
|
(26)
|
|
10.24.1
|
|
Alpha
et al 3(a)(10) Settlement dated September 15, 2006
|
|
|
|
|
|
(26)
|
|
10.24.2
|
|
Stonestreet
et al 3(a)(10) Settlement dated September 18, 2006
|
|
|
|
|
|
(26)
|
|
10.24.3
|
|
Employment
Agreement effective September 14, 2006, between Registrant and
Mr. Anthony
Cataldo
|
|
|
|
|
|
(26)
|
|
10.24.4
|
|
Second
Amendment effective September 14, 2006 to Employment Agreement
between
Registrant and Mr. Shawn Lewis
|
|
|
|
|
|
(26)
|
|
10.24.5
|
|
Non-Qualified
Stock Option Agreement dated November 8, 2006
|
|
|
|
|
|
(26)
|
|
10.24.6
|
|
Settlement
Agreement and Release of Claims among Shawn Lewis and
Registrant
|
|
|
|
|
|
(27)
|
|
10.25.1
|
|
Promissory
Note dated November 27, 2006, issued to Whalehaven Capital Fund,
Limited,
in the Principal Amount of $133,333
|
|
|
|
|
|
(27)
|
|
10.25.2
|
|
Promissory
Note dated November 27, 2006, issued to Alpha Capital Anstalt in
the
Principal Amount of $133,334
|
|
|
|
|
|
(27)
|
|
10.25.3
|
|
Promissory
Note dated November 27, 2006, issued to Ellis International Ltd.
in the
Principal Amount of $100,000
|
|
|
|
|
|
(29)
|
|
10.26.1
|
|
Form
of Stock Purchase Warrant dated December 7, 2006, with Cashless
Exercise
Provision
|
|
|
|
|
|
(29)
|
|
10.26.2
|
|
Form
of Stock Purchase Warrant dated December 7, 2006, without Cashless
Exercise Provision
|
|
|
|
|
|
(30)
|
|
10.27.1
|
|
Promissory
Note dated December 15, 2006, issued to Whalehaven Capital Fund,
Limited,
in the Principal Amount of $83,333
|
|
|
|
|
|
(30)
|
|
10.27.2
|
|
Promissory
Note dated December 15, 2006, issued to Alpha Capital Anstalt in
the
Principal Amount of $83,334
|
|
|
|
|
|
(30)
|
|
10.27.3
|
|
Promissory
Note dated December 15, 2006, issued to Ellis International Ltd.
in the
Principal Amount of $83,333
|
|
|
|
|
|
(31)
|
|
10.28.1
|
|
Promissory
Note dated January 4, 2007, issued to Whalehaven Capital Fund,
Limited, in
the Principal Amount of $83,333
|
|
|
|
|
|
(31)
|
|
10.28.2
|
|
Promissory
Note dated January 4, 2007, issued to Alpha Capital Anstalt in
the
Principal Amount of $83,332
|
|
|
|
|
|
(31)
|
|
10.28.3
|
|
Promissory
Note dated January 4, 2007, issued to Alpha Capital Anstalt in
the
Principal Amount of $83,335
|
|
|
|
|
|
(33)
|
|
10.29.1
|
|
Promissory
Note dated January 18, 2007, issued to Alpha Capital Anstalt in
the
principal amount of $100,000
|
|
|
|
|
|
(33)
|
|
10.29.2
|
|
Promissory
Note dated January 18, 2007, issued to Centurion Microcap L.P.
in the
principal amount of $100,000
|
|
|
|
|
|
(33)
|
|
10.29.3
|
|
Promissory
Note dated January 18, 2007, issued to Ellis International Ltd.
in the
principal amount of $100,000
|
(33)
|
|
10.29.4
|
|
Form
of Promissory Notes issued to Bristol Investment Fund, Ltd., in
the
principal amount of $250,000 each
|
|
|
|
|
|
(33)
|
|
10.29.5
|
|
Form
of Bridge Financing Letter Agreement with Bristol Investment Fund,
Ltd.
|
|
|
|
|
|
(34)
|
|
10.30.1
|
|
Form
of Assignment of Secured Subordinated Promissory Note dated June
1, 2004
(Assignment dated February 1, 2007)
|
|
|
|
|
|
(34)
|
|
10.30.2
|
|
Form
of Addendum to Assignment of Secured Subordinated Promissory Note
(Addendum dated February 1, 2007)
|
|
|
|
|
|
(35)
|
|
10.31.1
|
|
Form
of Subscription Agreement dated February 16, 2007
|
|
|
|
|
|
(35)
|
|
10.31.2
|
|
Form
of Convertible Note dated February 16, 2007
|
|
|
|
|
|
(35)
|
|
10.31.3
|
|
Form
of Class D Common Stock Purchase Warrant dated February 16,
2007
|
|
|
|
|
|
(35)
|
|
10.31.4
|
|
Form
of Cedar Reallocation and Assignment Agreement dated February 16,
2007
|
|
|
|
|
|
(35)
|
|
10.31.5
|
|
Form
of Reallocation and Assignment Agreement dated February 16,
2007
|
|
|
|
|
|
(36)
|
|
10.32.1
|
|
$300,000
Subordinated Demand Promissory Note dated March 29,
2007
|
|
|
|
|
|
(7)
|
|
16.1
|
|
Resignation
Letter from Tschopp, Whitcomb & Orr
|
|
|
|
|
|
(25)
|
|
21.1
|
|
Subsidiaries
of the Registrant
|
|
|
|
|
|
(36)
|
|
31.1
|
|
Certification
of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a)
and
15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of
2002
|
|
|
|
|
|
(36)
|
|
31.2
|
|
Certification
of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a)
and
15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of
2002
|
|
|
|
|
|
(36)
|
|
32.1
|
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
|
|
|
|
|
(36)
|
|
32.2
|
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350,
as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
|
|
|
|
|
(1)
|
|
|
|
Filed
as exhibit to Registrant’s Form 10-SB filed January 19,
2000
|
|
|
|
|
|
(2)
|
|
|
|
Filed
as exhibit to Form 8-K filed March 3, 2004
|
|
|
|
|
|
(3)
|
|
|
|
Filed
as exhibit to Form 8-K filed June 9, 2004
|
|
|
|
|
|
(4)
|
|
|
|
Filed
as exhibit to Form 8-K filed July 7, 2004
|
|
|
|
|
|
(5)
|
|
|
|
Filed
as exhibit to Form 8-K filed September 16, 2004
|
|
|
|
|
|
(6)
|
|
|
|
Filed
as exhibit to form 8-K filed November 17, 2004
|
|
|
|
|
|
(7)
|
|
|
|
Filed
as exhibit to form 8-K filed November 18, 2004
|
|
|
|
|
|
(8)
|
|
|
|
Filed
as exhibit to form 8-K filed December 15, 2004
|
|
|
|
|
|
(9)
|
|
|
|
Filed
as exhibit to form S-8 filed January 26, 2005
|
|
|
|
|
|
(10)
|
|
|
|
Filed
as exhibit to form 8-K filed February 16, 2005
|
|
|
|
|
|
(11)
|
|
|
|
Filed
as exhibit to form 8-K filed March 1,
2005
|
(12)
|
|
|
|
Filed
as exhibit to form 8-K filed June 6, 2005
|
|
|
|
|
|
(13)
|
|
|
|
Filed
as exhibit to Form 8-K filed July 11, 2005
|
|
|
|
|
|
(14)
|
|
|
|
Filed
as exhibit to Form 8-K filed August 9, 2005
|
|
|
|
|
|
(15)
|
|
|
|
Filed
as exhibit to Form 8-K filed October 24, 2005
|
|
|
|
|
|
(16)
|
|
|
|
Filed
as exhibit to Form 8-K filed November 22, 2005
|
|
|
|
|
|
(17)
|
|
|
|
Filed
as exhibit to Form 8-K filed January 12, 2006
|
|
|
|
|
|
(18)
|
|
|
|
Filed
as exhibit to Form 8-K filed February 8, 2006
|
|
|
|
|
|
(19)
|
|
|
|
Filed
as exhibit to Form 10-KSB filed April 17, 2006
|
|
|
|
|
|
(20)
|
|
|
|
Filed
as exhibit to Form 8-K filed April 25, 2006
|
|
|
|
|
|
(21)
|
|
|
|
Filed
as exhibit to Form 8-K filed May 25, 2006
|
|
|
|
|
|
(22)
|
|
|
|
Filed
as exhibit to Form 8-K filed October 5, 2006
|
|
|
|
|
|
(23)
|
|
|
|
Filed
as exhibit to Form 8-K filed October 20, 2006
|
|
|
|
|
|
(24)
|
|
|
|
Filed
as exhibit to Form S-8 filed October 27, 2006
|
|
|
|
|
|
(25)
|
|
|
|
Filed
as exhibit to Form 10-KSB/A filed October 27, 2006
|
|
|
|
|
|
(26)
|
|
|
|
Filed
as exhibit to Form 10-Q filed November 17, 2006
|
|
|
|
|
|
(27)
|
|
|
|
Filed
as exhibit to Form 8-K filed December 1, 2006
|
|
|
|
|
|
(28)
|
|
|
|
Filed
as exhibit to Form S-8 filed December 1, 2006
|
|
|
|
|
|
(29)
|
|
|
|
Filed
as exhibit to Form 8-K filed December 13, 2006
|
|
|
|
|
|
(30)
|
|
|
|
Filed
as exhibit to Form 8-K filed December 21, 2006
|
|
|
|
|
|
(31)
|
|
|
|
Filed
as exhibit to Form 8-K filed January 10, 2007
|
|
|
|
|
|
(32)
|
|
|
|
Filed
as exhibit to Form 8-K filed January 29, 2007
|
|
|
|
|
|
(33)
|
|
|
|
Filed
as exhibit to Form 8-K filed February 1, 2007
|
|
|
|
|
|
(34)
|
|
|
|
Filed
as exhibit to Form 8-K filed February 2, 2007
|
|
|
|
|
|
(35)
|
|
|
|
Filed
as exhibit to Form 8-K filed February 23, 2007
|
|
|
|
|
|
(36)
|
|
|
|
Filed
herewith
|
REPORT
OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors
VoIP,
Inc. and Subsidiaries
Ft.
Lauderdale, Florida
We
have
audited the accompanying consolidated balance sheets of VoIP, Inc. and
Subsidiaries (“the Company”) as of December 31, 2006 and 2005, and the related
consolidated statements of operations, shareholders’ equity, and cash flows for
the years ended December 31, 2006, 2005 and 2004. These financial statements
are
the responsibility of the Company’s management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures
that
are appropriate in the circumstances, but not for the purpose of expressing
an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures
in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of the Company as of December 31,
2006
and 2005, and the results of its operations and its cash flows
for the years ended December 31, 2006, 2005 and 2004 in
conformity with accounting principles generally accepted in the United States
of
America.
The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note C to the financial
statements, the Company’s dependence on outside financing, lack of sufficient
working capital, and recurring losses raise substantial doubt about the
Company’s ability to continue as a going concern. Management’s plans are
described in Note C to the financial statements. The financial statements do
not
include any adjustments that might result from the outcome of this
uncertainty.
As
described in Note E to the consolidated financial
statements, the accompanying consolidated balance sheet and statement of changes
in shareholders’ equity of VoIP, Inc. and Subsidiaries as of December 31, 2005
and for the year then ended have been restated to correct for misstatements
in
the December 31, 2005 financial statements previously filed.
/s/
Berkovits, Lago & Company, LLP
Fort
Lauderdale, Florida
March
23, 2007
VoIP,
Inc.
|
Consolidated
Balance Sheets
|
|
|
December
31
|
|
|
|
2006
|
|
2005
|
|
ASSETS
|
|
|
|
(Restated)
|
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
90,172
|
|
$
|
3,228,745
|
|
Accounts
receivable, net of allowance for doubtful account
|
|
|
|
|
|
|
|
of
$113,653 and $177,489, respectively
|
|
|
439,818
|
|
|
471,649
|
|
Due
from related parties
|
|
|
31,227
|
|
|
161,530
|
|
Inventory
|
|
|
-
|
|
|
238,292
|
|
Prepaid
expenses and deposits
|
|
|
716,021
|
|
|
935,320
|
|
Total
current assets
|
|
|
1,277,238
|
|
|
5,035,536
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
6,860,233
|
|
|
10,141,872
|
|
Goodwill
and other intangible assets
|
|
|
32,687,822
|
|
|
36,044,271
|
|
Net
assets of discontinued operations
|
|
|
-
|
|
|
1,767,475
|
|
Other
assets
|
|
|
99,828
|
|
|
349,205
|
|
|
|
|
|
|
|
|
|
TOTAL
ASSETS
|
|
$
|
40,925,121
|
|
$
|
53,338,359
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND SHAREHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
8,219,743
|
|
$
|
10,488,745
|
|
Accrued
expenses
|
|
|
4,853,007
|
|
|
2,149,514
|
|
Loans
payable
|
|
|
2,574,835
|
|
|
4,685,236
|
|
Convertible
notes payable
|
|
|
9,576,592
|
|
|
3,399,798
|
|
Fair
value liability for warrants
|
|
|
5,102,731
|
|
|
-
|
|
Nonregistration
penalties and other stock-based payables
|
|
|
4,748,380
|
|
|
-
|
|
Accrued
litigation charges
|
|
|
1,054,130
|
|
|
-
|
|
Notes
and advances from investors
|
|
|
616,667
|
|
|
3,000,000
|
|
Due
to related parties
|
|
|
-
|
|
|
1,572,894
|
|
Net
liabilities from discontinued operations
|
|
|
354,398
|
|
|
-
|
|
Other
current liabilities
|
|
|
557,153
|
|
|
931,004
|
|
Total
current liabilities
|
|
|
37,657,636
|
|
|
26,227,191
|
|
|
|
|
|
|
|
|
|
Other
liabilities
|
|
|
222,669
|
|
|
245,248
|
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES
|
|
|
37,880,305
|
|
|
26,472,439
|
|
|
|
|
|
|
|
|
|
Shareholders'
equity:
|
|
|
|
|
|
|
|
Common
stock - $0.001 par value;
|
|
|
|
|
|
|
|
100,000,000
shares authorized;
|
|
|
|
|
|
|
|
98,609,701
and 59,523,397 shares
|
|
|
|
|
|
|
|
issued
and outstanding, respectively
|
|
|
98,610
|
|
|
59,523
|
|
Additional
paid-in capital
|
|
|
78,942,818
|
|
|
61,606,497
|
|
Accumulated
deficit
|
|
|
(75,996,612
|
)
|
|
(34,800,100
|
)
|
Total
shareholders' equity
|
|
|
3,044,816
|
|
|
26,865,920
|
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES AND SHAREHOLDERS' EQUITY
|
|
$
|
40,925,121
|
|
$
|
53,338,359
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
|
VoIP
Inc.
|
Consolidated
Statements of Operations
|
|
|
Year
Ended December 31
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
14,676,948
|
|
$
|
8,945,868
|
|
$
|
1,020,285
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
14,685,010
|
|
|
10,245,516
|
|
|
754,598
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit (loss)
|
|
|
(8,062
|
)
|
|
(1,299,648
|
)
|
|
265,687
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
|
|
|
|
|
|
|
|
Compensation
and related expenses
|
|
|
13,184,377
|
|
|
7,328,685
|
|
|
3,800,336
|
|
Commissions
and fees to third parties
|
|
|
2,573,386
|
|
|
4,823,786
|
|
|
400,787
|
|
Professional,
legal and consulting expenses
|
|
|
6,852,584
|
|
|
1,858,088
|
|
|
430,432
|
|
Depreciation
and amortization
|
|
|
5,168,467
|
|
|
3,111,042
|
|
|
70,988
|
|
General
and administrative expenses
|
|
|
3,236,871
|
|
|
3,941,440
|
|
|
871,032
|
|
Total
operating expenses
|
|
|
31,015,685
|
|
|
21,063,041
|
|
|
5,573,575
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations before income taxes
|
|
|
(31,023,747
|
)
|
|
(22,362,689
|
)
|
|
(5,307,888
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Other
(income) expenses:
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
7,715,400
|
|
|
1,638,489
|
|
|
-
|
|
Financing
penalties and expenses
|
|
|
6,375,342
|
|
|
-
|
|
|
-
|
|
Gain
on sale of fixed assets
|
|
|
-
|
|
|
(206,184
|
)
|
|
-
|
|
Decrease
in fair value liability for warrants
|
|
|
(7,226,430
|
)
|
|
-
|
|
|
-
|
|
Litigation
charges
|
|
|
1,068,500
|
|
|
-
|
|
|
-
|
|
Other
|
|
|
260,000
|
|
|
-
|
|
|
-
|
|
Total
other expenses
|
|
|
8,192,812
|
|
|
1,432,305
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before income taxes and results of
|
|
|
|
|
|
|
|
|
|
|
discontinued
operations
|
|
|
(39,216,559
|
)
|
|
(23,794,994
|
)
|
|
(5,307,888
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss before discontinued operations
|
|
|
(39,216,559
|
)
|
|
(23,794,994
|
)
|
|
(5,307,888
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations,
|
|
|
|
|
|
|
|
|
|
|
net
of income taxes
|
|
|
(1,979,953
|
)
|
|
(4,518,339
|
)
|
|
(554,232
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(41,196,512
|
)
|
$
|
(28,313,333
|
)
|
$
|
(5,862,120
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before discontinued operations
|
|
$
|
(0.52
|
)
|
$
|
(0.62
|
)
|
$
|
(0.36
|
)
|
Loss
from discontinued operations,
|
|
|
|
|
|
|
|
|
|
|
net
of income taxes
|
|
|
(0.03
|
)
|
|
(0.12
|
)
|
|
(0.04
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss per share
|
|
$
|
(0.55
|
)
|
$
|
(0.74
|
)
|
$
|
(0.40
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares outstanding
|
|
|
75,329,007
|
|
|
38,458,871
|
|
|
14,597,312
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
|
|
VoIP,
Inc.
|
Consolidated
Statements of Cash Flows
|
|
|
Year
Ended December 31
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
Continuing
operations:
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(39,216,559
|
)
|
$
|
(23,794,994
|
)
|
$
|
(5,307,888
|
)
|
Adjustments
to reconcile net loss to net cash
|
|
|
|
|
|
|
|
|
|
|
used
in operating activities:
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
5,168,467
|
|
|
3,140,401
|
|
|
82,832
|
|
Common
shares issued for services
|
|
|
2,713,405
|
|
|
3,380,474
|
|
|
599,166
|
|
Common
shares issued for nonregistration penalty settlements
|
|
|
1,125,000
|
|
|
-
|
|
|
-
|
|
Options
and warrants issued for services and compensation
|
|
|
10,014,613
|
|
|
2,181,350
|
|
|
3,320,763
|
|
Amortization
of debt discounts
|
|
|
6,266,190
|
|
|
416,175
|
|
|
-
|
|
Decrease
in fair value liability for warrants
|
|
|
(7,226,431
|
)
|
|
-
|
|
|
-
|
|
Noncash
nonregistration penalties
|
|
|
5,130,219
|
|
|
-
|
|
|
-
|
|
Noncash
litigation charges
|
|
|
663,713
|
|
|
-
|
|
|
-
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
31,831
|
|
|
861,934
|
|
|
202,731
|
|
Due
from related parties
|
|
|
130,303
|
|
|
(161,530
|
)
|
|
-
|
|
Inventory
|
|
|
238,292
|
|
|
495,241
|
|
|
171,800
|
|
Prepaid
expenses and deposits
|
|
|
219,298
|
|
|
(583,783
|
)
|
|
54,531
|
|
Accounts
payable and accrued expenses
|
|
|
2,768,766
|
|
|
(4,474,899
|
)
|
|
(1,113,607
|
)
|
Other
current liabilities
|
|
|
(393,851
|
)
|
|
870,948
|
|
|
(378,670
|
)
|
Net
cash used in continuing operating activities
|
|
|
(12,366,745
|
)
|
|
(17,668,683
|
)
|
|
(2,368,342
|
)
|
Discontinued
operations:
|
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations
|
|
|
(1,979,953
|
)
|
|
(4,518,339
|
)
|
|
(554,232
|
)
|
Goodwill
impairment charge
|
|
|
839,101
|
|
|
4,173,452
|
|
|
-
|
|
Provision
for assets & liabilties of discontinued operations
|
|
|
1,136,122
|
|
|
412,420
|
|
|
(408,000
|
)
|
Net
cash provided by (used in) discontinued operating activities
|
|
|
(4,730
|
)
|
|
67,533
|
|
|
(962,232
|
)
|
Net
cash used in operating activities
|
|
|
(12,371,475
|
)
|
|
(17,601,150
|
)
|
|
(3,330,574
|
)
|
|
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations:
|
|
|
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(18,522
|
)
|
|
(2,582,827
|
)
|
|
(127,541
|
)
|
Acquisition
of Caerus and WQN (Note J)
|
|
|
-
|
|
|
(1,290,727
|
)
|
|
-
|
|
Cash
from acquisitions
|
|
|
-
|
|
|
-
|
|
|
104,872
|
|
(Purchase)
or disposition of other assets
|
|
|
249,377
|
|
|
267,940
|
|
|
(71,100
|
)
|
Net
cash provided by (used in) continuing investing activities
|
|
|
230,855
|
|
|
(3,605,614
|
)
|
|
(93,769
|
)
|
Discontinued
operations:
|
|
|
|
|
|
|
|
|
|
|
Net
assets - DTNet and Phone House (Note P)
|
|
|
(237,350
|
)
|
|
(1,303,738
|
)
|
|
573,363
|
|
Net
cash provided by (used in) discontinued investing activities
|
|
|
(237,350
|
)
|
|
(1,303,738
|
)
|
|
573,363
|
|
Net
cash provided by (used in) investing activities
|
|
|
(6,494
|
)
|
|
(4,909,352
|
)
|
|
479,594
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
Proceeds
from issuance of notes payable and advances
|
|
|
13,337,094
|
|
|
10,656,104
|
|
|
360,000
|
|
Proceeds
from common stock issuances
|
|
|
3,689,726
|
|
|
11,719,614
|
|
|
3,628,618
|
|
Issuance
of stock for note conversions
|
|
|
-
|
|
|
2,465,286
|
|
|
-
|
|
Repayment
of notes payable and advances
|
|
|
(7,787,424
|
)
|
|
(242,894
|
)
|
|
-
|
|
Net
cash provided by financing activities
|
|
|
9,239,396
|
|
|
24,598,110
|
|
|
3,988,618
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
increase (decrease) in cash
|
|
|
(3,138,573
|
)
|
|
2,087,608
|
|
|
1,137,638
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at beginning of year
|
|
|
3,228,745
|
|
|
1,141,137
|
|
|
3,499
|
|
Cash
and cash equivalents at end of year
|
|
$
|
90,172
|
|
$
|
3,228,745
|
|
$
|
1,141,137
|
|
The
accompanying notes are an integral part of these consolidated
financial
statements.
|
VoIP,
Inc.
|
Consolidated
S tatements of Changes in S hareholders'
Equity
|
Years
Ended December 31, 2006, 2005 and
2004
|
|
|
|
|
|
|
Additional
Paid-
in
Capital
|
|
|
|
Total
|
|
Balance
as of December 31, 2003
|
|
|
1,730,939
|
|
$
|
1,731
|
|
$
|
731,208
|
|
$
|
(624,647
|
)
|
$
|
108,292
|
|
Common
stock issued
|
|
|
12,500,000
|
|
|
12,500
|
|
|
-
|
|
|
-
|
|
|
12,500
|
|
Common
stock issued to investors for cash received
|
|
|
5,520,566
|
|
|
5,521
|
|
|
3,610,598
|
|
|
-
|
|
|
3,616,119
|
|
Common
stock issued for services
|
|
|
907,477
|
|
|
907
|
|
|
493,259
|
|
|
-
|
|
|
494,166
|
|
Common
Stock issued for acquisition of DTNet Tech.
|
|
|
2,500,000
|
|
|
2,500
|
|
|
4,747,500
|
|
|
-
|
|
|
4,750,000
|
|
Common
Stock issued for acquisition of Voip Americas
|
|
|
1,000,000
|
|
|
1,000
|
|
|
1,099,000
|
|
|
-
|
|
|
1,100,000
|
|
Warrants
issued to two comp any officers
|
|
|
-
|
|
|
-
|
|
|
3,320,763
|
|
|
-
|
|
|
3,320,763
|
|
Warrants
issued for intellectual property
|
|
|
100,000
|
|
|
100
|
|
|
105,000
|
|
|
-
|
|
|
105,100
|
|
Loss
for the y ear
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(5,862,120
|
)
|
|
(5,862,120
|
)
|
Balance
December 31, 2004
|
|
|
24,258,982
|
|
|
24,259
|
|
|
14,107,328
|
|
|
(6,486,767
|
)
|
|
7,644,820
|
|
Common
Stock issued for services
|
|
|
2,994,592
|
|
|
2,995
|
|
|
3,377,479
|
|
|
-
|
|
|
3,380,474
|
|
Common
stock issued to investors for cash received
|
|
|
6,740,038
|
|
|
6,740
|
|
|
8,022,598
|
|
|
-
|
|
|
8,029,338
|
|
Common
stock issued for cash received, pursuant to
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
exercise
of warrants
|
|
|
3,292,778
|
|
|
3,293
|
|
|
3,919,360
|
|
|
-
|
|
|
3,922,653
|
|
Common
stock issued for debt conversions
|
|
|
4,054,536
|
|
|
4,054
|
|
|
2,461,232
|
|
|
-
|
|
|
2,465,286
|
|
Common
Stock issued for acquisition of Caerus, Inc. (restated)
|
|
|
16,932,471
|
|
|
16,932
|
|
|
17,598,068
|
|
|
-
|
|
|
17,615,000
|
|
Options
issued for acquisition of Caerus, Inc.
|
|
|
-
|
|
|
-
|
|
|
355,000
|
|
|
-
|
|
|
355,000
|
|
Common
Stock issued for acquisition of WQN
|
|
|
1,250,000
|
|
|
1,250
|
|
|
1,298,250
|
|
|
-
|
|
|
1,299,500
|
|
Value
of warrants issued for acquisition of WQN
|
|
|
-
|
|
|
-
|
|
|
5,200,000
|
|
|
-
|
|
|
5,200,000
|
|
Value
of warrants and conversion features of debt issue
|
|
|
-
|
|
|
-
|
|
|
3,085,832
|
|
|
-
|
|
|
3,085,832
|
|
Stock
compensation - amortization
|
|
|
-
|
|
|
-
|
|
|
242,101
|
|
|
|
|
|
242,101
|
|
Option
and warrant compensation - amortization
|
|
|
-
|
|
|
-
|
|
|
1,939,249
|
|
|
-
|
|
|
1,939,249
|
|
Loss
for the y ear
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(28,313,333
|
)
|
|
(28,313,333
|
)
|
Balance
December 31, 2005 (restated)
|
|
|
59,523,397
|
|
|
59,523
|
|
|
61,606,497
|
|
|
(34,800,100
|
)
|
|
26,865,920
|
|
Common
Stock issued for services
|
|
|
4,658,595
|
|
|
4,659
|
|
|
3,272,337
|
|
|
|
|
|
3,276,996
|
|
Common
stock issued for cash received, pursuant to
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
exercise
of warrants
|
|
|
8,826,609
|
|
|
8,826
|
|
|
2,339,725
|
|
|
|
|
|
2,348,551
|
|
Common
stock issued for debt conversions
|
|
|
16,230,505
|
|
|
16,230
|
|
|
1,811,728
|
|
|
|
|
|
1,827,958
|
|
Common
stock issued for nonregistration and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
other
penalties, and interest
|
|
|
8,584,278
|
|
|
8,585
|
|
|
3,320,657
|
|
|
|
|
|
3,329,242
|
|
Common
stock issued for acquisition of Caerus, Inc.
|
|
|
666,667
|
|
|
667
|
|
|
259,333
|
|
|
|
|
|
260,000
|
|
Common
stock issued for cash received, pursuant to
|
|
|
319,650
|
|
|
320
|
|
|
330,753
|
|
|
|
|
|
331,073
|
|
exercise
of options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock acquired, DTNet sale
|
|
|
(200,000
|
)
|
|
(200
|
)
|
|
(383,800
|
)
|
|
|
|
|
(384,000
|
)
|
Value
of warrants and conversion features of debt issued
|
|
|
|
|
5,168,168
|
|
|
|
|
|
5,168,168
|
|
Stock
compensation - amortization
|
|
|
|
|
|
|
|
|
296,875
|
|
|
|
|
|
296,875
|
|
Option
and warrant compensation - amortization
|
|
|
|
|
|
|
|
|
6,326,829
|
|
|
|
|
|
6,326,829
|
|
Value
of warrants reclassified to liabilities
|
|
|
|
|
|
|
|
|
(5,406,284
|
)
|
|
|
|
|
(5,406,284
|
)
|
Loss
for the year
|
|
|
|
|
|
|
|
|
|
|
|
(41,196,512
|
)
|
|
(41,196,512
|
)
|
Balance
December 31, 2006
|
|
|
98,609,701
|
|
$
|
98,610
|
|
$
|
78,942,818
|
|
$
|
(75,996,612
|
)
|
$
|
3,044,816
|
|
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. In October 2006 the Company terminated its Marketing and
Distribution Agreement with Phone House, Inc., a wholesale prepaid telephone
calling card business acquired in its WQN acquisition.
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.
NOTE B
- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation
The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries, Caerus, Inc., eGlobalphone, Inc., VoIP Solutions,
Inc., and VoIP Americas, Inc. from their respective dates of acquisition. All
significant intercompany balances and transactions have been eliminated in
consolidation.
Discontinued
Operations
The
Company's operations formerly consisted of three segments: Telecommunication
Services, Hardware Sales and Calling Card Sales. However, with the Company’s
sale of DTNet Technologies and the termination of its Marketing and Distribution
Agreement with Phone House, Inc., both referred to above, these former segments
are being accounted for as discontinued operations, as discussed more fully
in
Note P, and prior period financial statements have been appropriately
reclassified. Also as a result of these discontinued operations, the Company’s
operations currently consist of one segment, Telecommunication Services.
Therefore, separate segmented financial results are not presented.
Use
of Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities; disclosure of contingent
assets and liabilities at the date of the financial statements; and the reported
amounts of revenues and expenses. Actual results could differ from those
estimates.
Cash
and Cash Equivalents
For
purposes of reporting cash flows, the Company considers all cash on hand, in
banks, including amounts in book overdraft positions, certificates of deposit
and other highly liquid debt instruments with a maturity of three months or
less
at the date of purchase, to be cash and cash equivalents. Cash overdraft
positions may occur from time to time due to the timing of making bank deposits
and releasing checks, in accordance with the Company's cash management
policies.
Accounts
Receivable
Accounts
receivable are stated at the amount management expects to collect from
outstanding balances. Management provides for probable uncollectible amounts
based on its assessment of the current status of the individual receivables
and
after using reasonable collection efforts. As of December 31, 2006 and 2005
the
balance of the allowance for uncollectible accounts amounted to $133,653 and
$177,489, respectively.
Inventory
Inventory
consists of finished goods and is valued at the lower of cost or market using
the first-in, first-out method.
Convertible
Debt
Convertible
debt with beneficial conversion features, whereby the conversion feature is
“in
the money,” are accounted for in accordance with guidance supplied by Emerging
Issues Task Force (“EITF”) No. 98-5 "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios"
and
EITF No. 00-27 "Application of Issue 98-5 to Certain Convertible Instruments."
The relative fair value of the warrants and the beneficial conversion feature
has been recorded as a discount against the debt and is amortized over the
term
of the debt.
Fair
Value Liability for Warrants
As
a
result of the Company’s 2006 financing agreements, the number of common shares
issuable upon the exercise of outstanding warrant agreements, when combined
with
existing outstanding common shares and shares issuable upon the conversion
of
applicable notes payable, exceeded the Company’s authorized common shares.
Therefore, as required Emerging Issues Task Force Issue No. 00-19 (“EITF 00-19”)
asset or liability classification of the warrants is required (as opposed to
permanent equity classification) for the excess warrant shares. From
January to May 2006, only a portion of the Company’s warrants were subject to
liability classification. However, beginning May 2006, all of the Company’s
warrants were classified as a liability on its consolidated balance sheet,
and
their values were marked-to-market at December 31, 2006. Until the Company
has
sufficient authorized common shares to satisfy these warrant obligations, it
will be subject to future noncash mark-to-market income or expense to the extent
that the estimated market value of these warrants changes in the future, which
are in turn primarily dependent upon the Company's common stock market price
per
share. See Note R for subsequent authorization of common shares, sufficient
to
satisfy these warrant obligations.
Income
Taxes
The
Company follows Statement of Financial Accounting Standards No. 109 “Accounting
for Income Taxes” (“SFAS No. 109”). Under the asset and liability method of SFAS
No. 109, deferred tax assets and liabilities are recognized for the future
tax
consequences attributed to differences between the financial statements carrying
amounts of existing assets and liabilities and their respective tax base.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Under SFAS No. 109, the
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in the results of operations in the period that includes the
enactment date. If it is more likely than not that some portion of a deferred
tax asset will not be realized, a valuation allowance is recognized
Earnings
(Loss) Per Share
Basic
earnings (loss) per share is computed by dividing the net income (loss) for
the
year by the weighted-average number of shares of common stock outstanding.
The
calculation of fully diluted earnings per share assumes the dilutive effect
of
all potential outstanding common shares attributable to outstanding options,
warrants, and convertible notes. Potential outstanding shares are not included
in the computation of fully diluted loss per share as their effect is
anti-dilutive.
Fair
Value of Financial Instruments
The
carrying amount of cash, accounts receivable, accounts payable and notes
payable, as applicable, approximates fair value due to the short term nature
of
these items and/or the current interest rates payable in relation to current
market conditions.
Revenue
Recognition
Revenues
are primarily derived from fees charged to terminate voice services over the
Company's network and from monthly recurring charges associated with Internet
and telecommunication services.
Variable
revenue is earned based on the number of minutes during a call and is recognized
upon completion of a call. Revenue for each customer is calculated from
information received through the Company's network switches. The Company tracks
the information received from the switch and analyzes the call detail records
and applies the respective revenue rate for each call. Fixed revenue is earned
from monthly recurring services provided to customers that are fixed and
recurring in nature, and are connected for a specified period of time. Revenue
recognition commences after the provisioning, testing, and acceptance of the
service by the customer. Revenues are recognized as the services are provided
and continue until the expiration of the contract or until cancellation of
the
service by the customer.
Property
and Equipment
Property
and equipment are stated at cost. Depreciation is provided over the estimated
useful lives of the related assets using the straight line method. The useful
life of assets ranges from three to five years. The leasehold improvements
are
amortized over the life of the related leases. The Company reviews the
recoverability of its property and equipment when events or changes in
circumstances occur that indicate that the carrying value of the asset group
may
not be recoverable.
Business
Combinations
The
Company accounts for business combinations in accordance with Statement of
Financial Accounting Standard No. 141, “Business Combinations” (SFAS No. 141).
SFAS No. 141 requires that the purchase method of accounting be used for all
business combinations. SFAS No. 141 requires that goodwill and intangible assets
with indefinite useful lives no longer be amortized, but instead be tested
for
impairment at least annually by comparing carrying value to the respective
fair
value in accordance with the provisions of Statement of Financial Accounting
Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS No. 142). This
pronouncement also requires that the intangible assets with estimated useful
lives be amortized over their respective estimated useful lives.
Goodwill
and Other Intangible Assets
In
accordance with Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets," the Company tests its goodwill and
intangible assets for impairment at least annually by comparing the fair values
of these assets to their carrying values, and the Company may be
required to record impairment charges for these assets if in the future their
carrying values exceed their fair values. During the years ended December 31,
2006 and 2005, the Company recognized impairment expense of $839,101 and
$4,173,452, respectively, related to goodwill recorded for its former hardware
sales business segment, and included in its reported loss from discontinued
operations. If in the future the remaining carrying value of our goodwill
exceeds its fair market value, the Company will be required to record an
additional impairment charge in its 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 declines,
a
material goodwill impairment charge in the future is possible.
Stock
Based Compensation
The
Company applies the fair value method of Statement of Financial Accounting
Standards No. 123R, "Accounting for Stock Based Compensation" ("SFAS No. 123R")
in accounting for its stock options. This standard states that compensation
cost
is measured at the grant date based on the value of the award and is recognized
over the service period, which is usually the vesting period. The fair value
for
each option granted is estimated on the date of the grant using the
Black-Scholes option pricing model. The fair value of all vested options granted
has been charged to salaries, wages, and benefits in accordance with SFAS No.
123. Common stock granted to employees, directors and consultants are charged
to
operating expenses based on the fair value of the stock at the date the stock
rights are granted.
Restatement
The
Company’s consolidated balance sheet at December 31, 2005 was restated to reduce
both goodwill and stockholders’ equity by $2,360,000, which represented
contingent consideration (escrowed common shares - see Note J) related to the
Caerus acquisition. According to Statement of Financial Accounting Standards
No.
141 (“SFAS No.
141”),
such contingent consideration should not have been included in the Caerus
purchase price determination. The Company’s consolidated statements of
operations and cash flows for the year ended December 31, 2005 were not
affected.
Reclassifications
Certain
reclassifications have been made to the 2005 and 2004 financial statements
to
conform to the 2006 presentation, including reclassifications pertaining to
discontinued operations as described in Note P.
Recent
Accounting Pronouncements
In
September 2006, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (“SFAS”) No. 157, “Fair
Value Measurements.”
SFAS
No. 157 defines fair value as the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market
participants at the measurement date, and also establishes a framework for
measuring fair value. The
provisions of this Statement are effective for fiscal years beginning after
November 15, 2007. The Company does not expect the adoption of this Statement
to
have a material impact on its financial statements.
In
February 2007, the Financial Accounting Standards Board issued SFAS
No. 159, “The
Fair
Value Option for Financial Assets and Financial Liabilities,”
which
amends SFAS No. 115, “Accounting for Certain Investments in Debt and Equity
Securities.” SFAS No. 159 permits companies to choose to measure many financial
instruments at fair value, and could apply to the Company’s potential future
convertible debt and stock warrant agreements. The
provisions of this Statement are effective for fiscal years beginning after
November 15, 2007. The Company does not plan to elect fair value accounting
under SAFS No. 159, therefore do not expect the adoption of this Statement
to
have a material impact on its financial statements.
NOTE
C - LIQUIDITY, CAPITAL RESOURCES, AND GOING CONCERN
This
Note
C should be reviewed in conjunction with Notes F, G, H, I and R to the Company's
consolidated financial statements.
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 current business in 2004, has been dependent on issuances
of
debt and equity instruments to fund its operations and capital expenditures,
and
is in violation of most of its financing covenants. 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, 2006, based
on
substantial doubt about the Company's ability to continue as a going
concern.
At
December 31, 2006, the Company's contractual obligations for debt, leases and
capital expenditures totaled approximately $25.3 million. Included in this
amount is approximately $2.4 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 this loan in
default. (See Note R, for a description of the subsequent assignment and
restructure of this debt.)
See
Notes
G and R for a description of the Company's convertible notes issued in July
and
October 2005 (“2005 Notes”), January and February 2006 (“Early 2006 Notes”),
October 2006 (“Late 2006 Notes”), and February 2007 (“2007 Notes”). As explained
below and in Notes G and R, the subscription agreements for these notes contain
provisions that could impact the Company's future capital raising efforts and
its capital structure:
· |
The
Company is required to file registration statements to register amounts
ranging up to 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 these notes. Certain registration statements were
filed,
but have since become either ineffective or withdrawn. Until sufficient
registration statements are declared effective by the Securities
and
Exchange Commission (the “SEC”), the Company is liable for liquidated
damages totaling $1,058,858 through December 31, 2006, and will continue
to incur additional liquidated damages of $228,432 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 (a) 60 to 365 days following the effective date of the
notes
registration statement or (b) 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.
|
· |
Since
October 2005, the Company has been in violation of certain requirements
of
the 2005 Notes, the Early 2006 Notes, and the Late 2006 Notes. While
the
investors have not declared these notes currently in default, the
full
amount of the notes at December 31, 2006 has been classified as current.
|
In
connection with a private placement memorandum dated May 20, 2005, the Company
issued 2,242,500 shares of its common stock for $0.80 per share, and warrants
to
purchase 2,207,751 common shares at prices from $1.60 to $2.23 per share. At
December 31, 2006, the fair value of these outstanding warrants was $58,510,
which was recorded as a liability on the Company’s consolidated balance sheet.
As required by the subscription agreements, a portion of the shares was
registered with the SEC in October 2005, but that registration became
ineffective in July 2006. Non-registration liquidated damages accrued until
September 2006, when all related shares and warrants became tradable under
Rule
144, and, in accordance with the terms of the subscription agreements, accrual
of liquidated damages ceased. At December 31, 2006, liquidated damages totaled
1,482,500 shares and 226,500 warrants owing, recognized as a $1,342,299 current
liability on the Company’s balance sheet.
In
connection with a subscription agreement dated August 26, 2005 and amended
on
November 16, 2005, the Company issued 1,375,000 shares of its common stock
for
$0.80 per share, and warrants to purchase 2,225,000 common shares at prices
ranging from $1.37 to $1.60 per share. The investor also received “favored
nations” rights such that for future securities offerings by the Company at a
price per share less than the per share purchase price or warrant exercise
prices, the investor's effective per share purchase price and warrant exercise
price would be adjusted to the lower offering price. As a result of this favored
nations provision and the February 2007 financing agreements described in Note
R, the subscription agreement’s per share purchase price and the warrants’
exercise prices were effectively reduced to $0.18 per share. At December 31,
2006, the fair value of these outstanding warrants was $400,500, which was
recorded as a liability on the Company’s consolidated balance sheet. The Company
also agreed to register a total of 5,850,000 common shares and warrants related
to this agreement by January 17, 2006. Until a registration statement is
declared effective by the SEC, the Company is liable for liquidated damages
totaling $600,000 through December 31, 2006, and will continue to incur
additional liquidated damages of $50,000 per month until the required shares
and
warrants are registered.
The
Company will need to continue to raise additional debt or equity capital to
provide the funds necessary to restructure or repay its $2.4 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.
The
Company's authorized common stock consisted of 100,000,000 common shares at
December 31, 2006, of which 98,609,701 common shares were issued and
outstanding, and approximately 141 million additional shares were
contingently issuable upon the exercise of stock options and warrants, or
conversion of convertible securities. An additional 24 million common shares
were required to be reserved under the Company’s various existing financing
agreements. As of December 31, 2006 the Company was also contractually obligated
to register approximately 192 million shares, warrants and options. (See Note
R
for a subsequent increase in the Company’s authorized common stock to
400,000,000 shares, and the authorization of a new class of preferred stock.)
There is no assurance that sufficient registration statements can be filed
or
declared effective by the SEC, or that sufficient additional common stock
authorizations can be approved by shareholders, in which case the Company would
continue to be unable to satisfy its contractual obligations to register shares,
and would be unable to satisfy the contractual obligations it has undertaken
to
reserve shares of common stock.
NOTE
D - PROPERTY AND EQUIPMENT, NET
At
December 31, 2006 and 2005, property and equipment consisted
of the
following:
|
|
|
|
|
|
|
|
|
2006
|
|
2005
|
|
Equipment
|
|
$
|
8,766,749
|
|
$
|
9,381,372
|
|
Furniture
& Fixtures
|
|
|
91,647
|
|
|
171,705
|
|
Software
|
|
|
666,842
|
|
|
1,667,864
|
|
Vehicles
|
|
|
15,269
|
|
|
15,269
|
|
Leasehold
improvements
|
|
|
105,075
|
|
|
248,952
|
|
Total
|
|
|
9,645,582
|
|
|
11,485,162
|
|
Less
accumulated depreciation
|
|
|
(2,785,349
|
)
|
|
(1,343,290
|
)
|
Total
|
|
$
|
6,860,233
|
|
$
|
10,141,872
|
|
|
|
|
|
|
|
|
|
Depreciation
expense for the years ended December 31, 2006, 2005 and 2004
amounted to
$1,844,020, $1,208,331, and $82,832,
respectively.
|
The
amount of equipment held under capital leases, included above and net of
accumulated amortization, was $244,656 and $259, 946 at December 31, 2006
and
2005, respectively.
NOTE
E - GOODWILL AND OTHER INTANGIBLE ASSETS
In
accordance with Statement of Financial Accounting Standards No. 142 (“SFAS No.
142”), the Company performs an evaluation of the fair values of its operating
segments annually, and more frequently if an event occurs or circumstances
change that may indicate that the fair value of a reporting unit is less than
its carrying amount. As described in Note P, on April 19, 2006, the Company
completed the sale of its interest in its subsidiary DTNet Technologies. DTNet
Technologies' operations were the primary component of the Company's hardware
sales business segment, and the Company recorded a goodwill impairment charge
of
$839,101 in its March 31, 2006 statement of operations to reduce the carrying
value of this subsidiary to its estimated fair value. The remaining $198,000
balance of goodwill for this segment was a component of net assets
sold.
The
Company's balance sheet at December 31, 2006 includes approximately $21.2
million in goodwill and approximately $11.5 million in other intangible assets
recorded in connection with its acquisition in October 2005 of substantially
all
of the assets relating to the VoIP business of WQN, and its acquisition in
May
2005 of Caerus and its subsidiaries.
In
accordance with SFAS 142, management tests the carrying value of its 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. During the year ended December 31, 2006, the Company
recorded an impairment charge to operating results of $839,101 as a result
of
selling the Company's 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 declines, or its future
revenue does not increase coincident with amounts previously projected and
utilized to determine the fair value of the Company's goodwill and other
intangible assets, a material goodwill impairment charge in the future is
possible.
As
of December 31, 2006 and 2005 goodwill and other intangible assets
consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
(Restated)
|
|
|
|
|
|
|
|
|
|
Goodwill |
|
|
|
|
$
|
21,228,339
|
|
$
|
20,946,341
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
1,700,000
|
|
|
1,700,000
|
|
Non-compete
agreement
|
|
|
1.0
|
|
|
500,000
|
|
|
500,000
|
|
Other
intangible assets
|
|
|
Indefinite
|
|
|
200,000
|
|
|
200,000
|
|
Subtotal
|
|
|
|
|
|
16,725,000
|
|
|
16,725,000
|
|
Accumulated
amortization
|
|
|
|
|
|
(5,265,517
|
)
|
|
(1,627,070
|
)
|
Other
intangible assets, net
|
|
|
|
|
|
11,459,483
|
|
|
15,097,930
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
goodwill and other intangible assets
|
|
|
|
|
$
|
32,687,822
|
|
$
|
36,044,271
|
|
The
December 31, 2005 goodwill amount excludes $1,037,101 related to the Company's
former hardware sales segment, which was reclassified to net assets of
discontinued operations. Amortization expense for the years ended December
31,
2006, 2005 and 2004 amounted to $3,324,447, $1,627,070 and $0, respectively.
The
December 31, 2005 goodwill amount was also restated to reflect a reduction
of
$2,360,000 which represented contingent consideration (escrowed common shares
-
see Note J) related to the Caerus acquisition. According to SFAS No. 141, such
contingent consideration should not have been included in the Caerus purchase
price determination. The Company's consolidated statements of operations and
cash flows for the year ended December 31, 2005 were not affected.
NOTE
F - LOANS PAYABLE
At
December 31, 2006 and 2005, loans payable consisted of the following:
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Note
payable to a lending institution
|
|
$
|
2,381,085
|
|
$
|
4,685,236
|
|
Other
notes payable
|
|
|
193,750
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Total
loans payable
|
|
$
|
2,574,835
|
|
$
|
4,685,236
|
|
|
|
|
|
|
|
|
|
The
note
payable to a lending institution bears interest at 17.5%, and is repayable
through May 2007. Interest expensed and paid under this debt facility during
the
years ended December 31, 2006, 2005 and 2004 was $443,805, $399,551,
and $0,
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. The Company was in violation of certain
requirements of this debt facility at December 31, 2006, and has not made
scheduled principal and interest payments. However, the lender has currently
not
declared this loan in default. As a result, the full amount of the loan at
December 31, 2006 has been classified as current. (See Note R for subsequent
reassignment and restructure of this loan.)
The
other
notes payable at December 31, 2006 was classified as common stock and additional
paid-in capital at December 31, 2005, because related notes payable were
converted to common stock in 2005. According to the terms of a November 2006
settlement agreement between the Company and the convertible note holders,
the
note holders returned the common stock to the Company, and the convertible
debt
was reclassified to loans payable.
NOTE
G - CONVERTIBLE NOTES AND WARRANTS PAYABLE
At
December 31, 2006 and 2005, convertible notes payable, and the fair value
liability for related warrants consisted of the following:
|
|
Convertible
Notes Payable
|
|
Fair
Value Liability for Warrants
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Payable
to WQN, Inc. (1)
|
|
$
|
3,700,000
|
|
$
|
3,700,000
|
|
$
|
-
|
|
$
|
-
|
|
Payable
to accredited investors:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
July
& October 2005 (2)
|
|
|
488,543
|
|
|
1,496,804
|
|
|
441,313
|
|
|
-
|
|
January
& February 2006 (3)
|
|
|
8,353,102
|
|
|
-
|
|
|
980,409
|
|
|
-
|
|
October
2006 (4)
|
|
|
2,905,875
|
|
|
-
|
|
|
1,971,844
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May
2005 private placement (5)
|
|
|
-
|
|
|
-
|
|
|
58,510
|
|
|
-
|
|
August
2005 subscription agreement (5)
|
|
|
-
|
|
|
-
|
|
|
400,500
|
|
|
-
|
|
Other
- see Note M
|
|
|
-
|
|
|
-
|
|
|
1,250,155
|
|
|
-
|
|
Subtotal
|
|
|
15,447,520
|
|
|
5,196,804
|
|
|
5,102,731
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
discounts
|
|
|
(5,870,928
|
)
|
|
(1,797,006
|
)
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
9,576,592
|
|
$
|
3,399,798
|
|
$
|
5,102,731
|
|
$
|
-
|
|
(1) |
|
In
October 2005, the Company acquired substantially all of the operating
assets and liabilities of WQN, Inc. for a total purchase price of
$9.8 million. The acquisition was funded 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. The note is secured
by a
subordinated lien on the Company's assets. The principal balance
of the
note was $3,700,000 at December 31, 2006. The note, bearing a nominal
interest rate of 6%, became payable beginning February 2006 over 12
months in cash or, at the option of the Company, in Series A preferred
stock (subsequently authorized - see Note R) at $10.00 per share
or in
common stock at an original $1.06 per share. WQN received “favored
nations” rights such that for future securities offerings by the Company
at a price per share less than this conversion price, this common
stock
conversion price would be adjusted to the lower offering price.
As a
result of this favored nations provision and the February 2007
financing
agreements described in Note R, the note’s common stock conversion rate
was effectively reduced to $0.18 per share. At December 31, 2006,
the
Company had not made scheduled principal payments of $3,391,667.
WQN has
agreed to subordinate its repayment claim to the convertible note
holders
described in paragraphs (2) through (4) below. Also as a result
of the
October 2005 acquisition, WQN, Inc. received five-year warrants to
purchase 5,000,000 shares of the Company's common stock for $0.001
per
share. WQN exercised the warrants on January 5, 2006 for
4,996,429 shares of the Company's common stock. All WQN convertible
shares
and warrant shares have piggyback registration rights on any registration
statement filed by the Company between October 2005 and October
2007. At
December 31, 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 December 31, 2006, has been
classified as current.
|
(2) |
|
In
July and October 2005 the Company issued and sold $3,085,832 in
principal
amount of convertible notes to institutional 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 an original conversion rate of $0.80 per share.
These
investors also received five-year warrants to purchase 964,322
shares of
the Company's common stock for $1.37612 per share, five-year warrants
to
purchase 964,322 shares of the Company's common stock for $1.6503
per
share, and one-year warrants to purchase 1,928,644 shares of the
Company's
common stock for $1.60 per share. The investors also received “favored
nations” rights such that for future securities offerings by the Company
at a price per share less than the above conversion rate or warrant
exercise prices, the investors' conversion rate and warrant exercise
price
would be adjusted to the lower offering price. 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 $488,543 and $1,496,804 at December 31, 2006 and 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 $2,740,120. The Company then issued
warrants to
the investors to purchase a like number of shares for $0.80. As
a result
of the favored nations provision discussed above and the Section
3(a)(10)
agreement described below, the notes' conversion rate (retroactive
to the
original note principal balances) and the exercise price of outstanding
warrants were effectively reduced to $0.26 per share. As a result
of the
February 2007 financing agreements described in Note R, the notes'
conversion rate (retroactive to the original note principal balances)
and
the exercise price of outstanding warrants were further reduced
to $0.18
per share. At December 31, 2006, the fair value of these outstanding
warrants was $441,313, which was recorded as a liability on the
Company’s
consolidated balance sheet. (See the last paragraph of this Note
G below
for additional background.) At December 31, 2006, the Company had
not made
scheduled principal payments of $118,930 on these notes. Beginning
October
2005, the Company was in violation of the registration requirements
contained in the October 2005 subscription agreements, and beginning
July
2006 the Company was in violation of the registration requirements
contained in the July 2005 subscription agreements. As a result,
the
Company owed related liquidated damages of $343,034 at December
31, 2006,
and will incur additional damages of $40,494 per month until a
registration statement related to the shares and warrants is declared
effective by the SEC. While the investors have not declared the
notes
currently in default, the full amount of the notes at
December 31, 2006 has been classified as
current.
|
(3) |
|
In
January and February 2006, the Company issued and sold $11,959,666
in
principal amount of convertible notes to institutional investors
at a
discount, receiving net proceeds of $9,816,662. These notes are
immediately convertible at the option of the note holders into
shares of
the Company's common stock at an original conversion rate of
$1.318 per
share. These investors also received five-year warrants to purchase
4,537,052 shares of the Company's common stock for $1.45889 per
share, and
one-year warrants to purchase 4,537,052 shares of the Company's
common
stock for $1.5915 per share. The investors also received “favored nations”
rights such that for future securities offerings by the Company
at a price
per share less than the above conversion rate or warrant exercise
prices,
the investor's conversion rate and warrant exercise price would
be
adjusted to the lower offering price. Of the total initial principal,
$8,318,284 of the notes are secured by a subordinated lien on
the
Company's assets. The principal balance of the notes was $8,353,101
at
December 31, 2006, and all the notes bear interest at an effective
rate of
approximately 20%. The unsecured portion of these notes became
payable
beginning in July 2006 over two years in cash or, at the option
of the
Company, in registered common stock at the lesser of $1.318 per
share or
85% of the weighted average price of the stock on the OTCBB,
but not less
than $1.00 per share. As a result of a May 2006 warrant restructure,
the
secured portion of these notes became payable beginning in
August 2006 over two years 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, but not less
than $0.80
per share. As a result of the favored nations provision discussed
above
and the Section 3(a)(10) agreement described below, the notes'
conversion
rate (retroactive to the original note principal balances) was
effectively
reduced to $0.26 per share, and the outstanding warrants were
re-priced to
$0.475 per share. As a result of the February 2007 financing
agreements
described in Note R, the notes' conversion rate (retroactive
to the
original note principal balances) and the exercise price of outstanding
warrants were further reduced to $0.18 per share. At December
31, 2006,
the fair value of these outstanding warrants was $980,409, which
was
recorded as a liability on the Company’s consolidated balance sheet. (See
the last paragraph of this Note G below for additional background.)
At
December 31, 2006, the Company had not made scheduled principal
payments
of $1,083,782 on these notes. Beginning April 2006, the Company
was in
violation of the registration requirements of the secured notes,
and
beginning May 2006, the Company was in violation of the registration
requirements of the unsecured notes. In May 2006, the Company
issued an
aggregate of 166,368 shares to the secured investors in satisfaction
of
then-existing secured non-registration liquidated damages. The
Company
owed additional liquidated damages of $694,514 at
December 31, 2006, and will incur additional damages of $129,014
per month until a registration statement related to the shares
and
warrants is declared effective by the SEC. While the investors
have not
declared the notes currently in default, the full amount of the
notes at
December 31, 2006 has been classified as
current.
|
|
|
In September 2006 certain of the July and October
2005
and the January and February 2006 convertible note holders filed
actions
against the Company claiming a breach of contract related to the
notes. In
settlement of these actions, the parties entered into settlement
agreements pursuant to which, among other things: 1) interest and
liquidated damages due under the notes were set at $242,149 and
$415,353,
respectively; 2) the note holders exchanged the interest and
liquidated damages due, along with $3,899,803 in principal, and
a discount
of $881,155, for 20,917,153 shares of the Company's common stock
through
the issuance of freely trading securities issued pursuant to Section
3(a)(10) of the Securities Act; 3) the conversion rate for the
remaining principal balance due under the notes was reset to $0.26;
4) the exercise price of the outstanding warrants purchased by the
note holders in connection with the January and February 2006 notes
was
reduced to $0.475; and 5) certain investors agreed to surrender
their claims associated with warrants issued in May 2006 in exchange
for
2,500,000 shares of the Company's common stock through the issuance
of
freely trading securities issued pursuant to Section 3(a)(10) of
the
Securities Act. |
(4) |
|
On
October 17, 2006, the Company issued and sold $2,905,875 in secured
convertible notes to twelve institutional investors, for a net
purchase
price of $2,324,700 (after a 20% original issue discount) in
a private
placement. Proceeds of approximately $1,436,900 (before closing
costs of
$308,748) were paid in cash to the Company at closing, and $887,800
of the
proceeds were used to repay three outstanding promissory notes
held by
three of the investors in the private placement. The investors
also
received five-year warrants to purchase a total of 10,378,125
shares of
the Company's common stock at an exercise price of $0.407 per
share. The
principal balance of the notes was $2,905,875 at December 31,
2006. These
convertible notes are secured by a subordinated lien on the Company's
assets, are not interest bearing, and are due on December 31,
2007. The
note holders may at their election convert all or part of the
Convertible
Notes into shares of the Company's common stock at an original
conversion
rate of $0.28 per share. The investors also received “favored nations”
rights such that for future securities offerings by the Company
at a price
per share less than the above conversion rate or warrant exercise
prices,
the investor's conversion rate and warrant exercise price would
be
adjusted to the lower offering price. As a result of the favored
nations
provision discussed above and the February 2007 financing agreements
described in Note R, the notes' conversion rate (retroactive
to the
original note principal balances) and the exercise price of outstanding
warrants were reduced to $0.18 per share. At December 31, 2006,
the fair
value of these outstanding warrants was $1,971,844, which was
recorded as
a liability on the Company’s consolidated balance sheet. (See the last
paragraph of this Note G below for additional background.) Pursuant
to the
subscription agreement, the Company was to obtain shareholder
approval to
increase its authorized shares of common stock to 400,000,000
shares and
file an amendment to its articles of incorporation by December
20, 2006.
Failing this, the holders of the convertible notes are entitled
to
liquidated damages that will accrue at the rate of two percent
of the
amount of the purchase price of the outstanding convertible notes
per
month during such default. The Company has also agreed to file
registration statements covering the resale of 130% of the shares
of
common stock that may be issuable upon conversion of the convertible
notes, and 100% of the shares of common stock issuable upon the
exercise
of the warrants. The first such registration statement was to
be filed on
or before January 2, 2007 and declared effective by March 31,
2007.
Because the Company is in violation of these authorized share
and
registration requirements, liquidated damages have been accruing
at the
rate of $58,925 per month since December 20, 2006. (See Note
R for
subsequent authorized common stock increase.) While the investors
have not
declared the notes currently in default, the full amount of the
notes at
December 31, 2006 has been classified as
current.
|
(5) |
See
Note C for a discussion of the May 2005 private placement and the
August
2005 subscription agreement.
|
No
interest was paid on any of the convertible notes described above during the
years ended December 31, 2006, 2005 and 2004, except as described in
the Section 3(a)(10) agreement above affecting the interest owed to the
July/October 2005 and January/February 2006 convertible note
holders.
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 Issue 00-19 (“EITF 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 sixth preceding paragraph above were allocated
to
these warrants, and recorded as a warrant liability on the Company's balance
sheet. Also, the May 2006 warrant repricing to $0.78 per share triggering
contractual “favored nations” price ratchets on a number of our existing
convertible debt and warrant agreements, reducing their effective conversion
and
exercise prices to $0.78 per share. The effect was to increase the number of
fully diluted shares of common stock at the time to approximately 129 million,
relative to the Company's then-authorized 100 million common shares. The
Company's total warrants then outstanding were approximately 28 million. Per
EITF 00-19, the Company classified all remaining warrants as a liability,
transferring $5,406,284 from additional paid-in capital to fair value liability
for warrants on its consolidated balance sheet. The warrant liabilities have
since been marked-to-market, resulting in a $5,102,731 liability at December
31,
2006, and a corresponding credit to earnings for the year ended December 31,
2006 of $7,226,430, respectively.
NOTE
H - NONREGISTRATION PENALTIES AND OTHER STOCK-BASED
PAYABLES
At
December 31, 2006 and 2005, nonregistration penalties and other stock-based
payables consisted of the following:
|
|
2006
|
|
2005
|
|
Nonregistration
penalties payable:
|
|
|
|
|
|
|
|
In
cash
|
|
$
|
1,658,858
|
|
$
|
-
|
|
In
common stock and warrants
|
|
|
1,342,299
|
|
|
-
|
|
Common
stock payable to officer
|
|
|
732,678
|
|
|
|
|
Common
stock payable to directors
|
|
|
210,000
|
|
|
-
|
|
Common
stock payable to investors
|
|
|
347,419
|
|
|
-
|
|
Common
stock payable for other services rendered
|
|
|
439,200
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
4,730,454
|
|
$
|
-
|
|
As
discussed in Note G - Convertible Notes and Warrants Payable, the Company is
in
violation of the registration requirements of a number of its existing financing
agreements. As such, liquidated damages payable in a combination of stock and
cash amounted to $3,001,157 as of December 31, 2006.
As
discussed in Note L, the Company’s Chief Operating Officer exercised options to
purchase 3,000,000 shares of common stock. Since the Company had insufficient
authorized common shares at December 31, 2006, only 964,782 shares were issued,
and the balance of 2,035,218 shares (valued at $732,678) will be issued upon
authorization of sufficient common shares. Common stock payable to directors,
investors and others for services rendered will be issued upon authorization
of
sufficient common shares.
(See
Note
R for subsequent shareholder approval of increased common shares.)
NOTE
I - NOTES AND ADVANCES FROM INVESTORS
Notes
and
advances from investors of $616,667 and $3,000,000 at December 31, 2006 and
2005, respectively, represent funds loaned to or deposited with the Company
in
anticipation of the issuance of future notes payable. The $616,667 at December
31, 2006 represents funds advanced to the Company in November and December
2006,
in anticipation of the issuance of convertible notes payable, which were issued
in February 2007 (see Note R). The $3,000,000 at December 31, 2005 represents
funds deposited with the Company in anticipation of the issuance of convertible
notes payable, which were issued in January 2006 (see Note G).
These
notes and advances are unsecured. The $616,667 notes at December 31, 2006 bore
interest at 18%. The $3,000,000 advance at December 31, 2005 was not interest
bearing,
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 14,400,000 of the Company's common shares
(excluding 2,000,000 escrowed common shares, 666,667 of which were issued in
November 2006).
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 $15.9 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.
|
|
|
|
(Restated)
|
|
|
|
|
|
|
|
|
|
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
|
|
|
15,418,000
|
|
|
4,120,000
|
|
Intangible
assets - other
|
|
|
13,800,000
|
|
|
2,925,000
|
|
Intangible
assets
|
|
|
29,218,000
|
|
|
7,045,000
|
|
|
|
|
|
|
|
|
|
Net
fair value assets acquired
|
|
$
|
18,329,000
|
|
$
|
9,760,000
|
|
The
goodwill amount for Caerus, Inc. was restated to reflect a reduction of
$2,360,000, which represented contingent consideration (escrowed common shares
-
see Note J) related to the Caerus acquisition.
NOTE
K - LITIGATION
MCI
On
April
8, 2005, the Company's subsidiary, Volo Communications, 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.
Extensive
discovery took place throughout 2006,
with multiple depositions taking place, written discovery requests being
exchanged, and extensive document productions being held.
On
December 20, 2006, the Court granted MCI WorldCom summary judgment dismissing
Caerus' claim for slander of credit. On January 7, 2007, the Court issued
a
scheduling order setting a trial date for June 18, 2007, with several interim
deadlines. On February 28, 2007, the Court denied MCI WorldCom's motion for
summary judgment of dismissal of the claims of Volo and Caerus for declaratory
relief, denied Caerus' motion for clarification or reargument of the dismissal
of the slander of credit claim and denied Volo's and Caerus' motions in the
alternative to amend their complaints.
On
January 2, 2007, an Amended Case Management and Scheduling Order was entered
which imposed a May 18, 2007 discovery cutoff; a June 5, 2007 pre-trial
conference; and a June 18, 2007 time-certain trial. On January 11, 2007,
MCI
WorldCom and Volo/Caerus participated in a Court-ordered mediation conference.
The parties engaged in further settlement discussions in February and March
2007, which ultimately led to an agreement to terms to settle the litigation
and
the signing of a mutually acceptable settlement term sheet on March 27,
2007.
The term sheet contains a due diligence provision that, upon completion
under
certain circumstances, permits MCI WorldCom to decide whether or not to
proceed
with the settlement. The parties’ contemplate finalizing and executing mutually
acceptable settlement documents reflecting the confidential settlement
term
sheet before the case is be dismissed.
In
the
event the parties withdraw from the settlement, the Company is currently
unable
to assess the likelihood of a favorable or unfavorable outcome. In that
event,
it is not clear whether or not the Court will hold the parties to the
previously-ordered June 2007 trial.
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 $408,343
litigation gain during the year ended December 31, 2006, primarily related
to
the excess of accounts payable over the net book value of the equipment
returned.
Cross
Country Capital Partners, L.P.
On
or
about September 25, 2006, Cross Country Capital Partners, L.P. (“Cross Country”)
filed suit against the Company in the District Court, 116th
Judicial
Circuit, Dallas County, Texas. Cross Country asserts a claim for breach of
contract in connection with a securities purchase agreement entered into with
the Company. Cross Country also seeks specific performance of the securities
purchase agreement at issue. Cross Country seeks unspecified damages and
attorneys’ fees, which fees are provided for in the securities purchase
agreement and under Texas law. On or about December 14, 2006, the Company filed
its Answer denying any wrongdoing and asserting numerous affirmative defenses.
The Company intends to vigorously defend this matter but is unable to assess
the
outcome of this litigation or its impact on the Company's financial condition
and results of operations.
Other
The
Company and Mr. Ivester, a
shareholder and former Chief Executive Officer of the Company,
entered
into a 3-year consulting agreement on October 18, 2005, which the Company
terminated in October 2006. Pursuant to the consulting agreement, Mr. Ivester
provided general business strategy, financing and product development advice.
Mr. Ivester received $200,000 per year for his services under the consulting
agreement, as well as a $2,500 per month vehicle allowance. Mr. Ivester was
eligible to receive bonuses and participate in the Company's stock option plan,
as determined by the board of directors. The Company also owed Mr. Ivester
$305,212 as of December 31, 2006 under a demand note payable bearing interest
at
3.75%. On March 16, 2007, the Company agreed to settle all of Mr. Ivester’s
claims under his consulting agreement and his demand note payable, in return
for
cash payments totaling $75,000, and the issuance of 500,000 shares of the
Company’s common stock. In conjunction with this settlement, the Company
recognized a $85,212 litigation gain during the year ended December 31, 2006,
primarily related to the excess of the demand note payable over the fair value
of the cash and stock settlement.
In
February 2006, the Company settled claims against it pertaining to the exchange
of its common shares for Caerus shares pursuant to the Caerus merger agreement
dated May 31, 2005. The settlement required a cash payment of $710,000, which
was recognized as a litigation charge during the year ended December 31,
2006.
In
March
2007, the Company settled claims against it brought by a former employee and
two
investors, requiring cash payments totaling $132,000, and the issuance of
475,000 shares of the Company’s common stock. In conjunction with this
settlement, the Company recognized a $290,750 litigation charge during the
year
ended December 31, 2006.
The
Company is currently a defendant in other lawsuits and disputes arising in
the
ordinary course of business, and has accrued related litigation charges totaling
$561,305 for the year ended December
31, 2006.
The Company believes
that resolution of all known contingencies is uncertain, and there can be no
assurance that future costs related to such litigation would not exceed the
amounts accrued in its consolidated financial statements, which may in turn
materially adversely affect the Company’s financial position or results of
operations.
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 (the “2004 Plan”). In addition, on
March 16, 2007 the Company obtained shareholder approval of 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 up to 10,000,000 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 activity in the 2004 plan (no activity in the 2006
Plan)
for the year ended December 31, 2006 is as follows:
|
|
Number
|
|
Exercise
Price
Range
|
|
|
|
Options
outstanding at December 31, 2005
|
|
|
3,746,562
|
|
|
$0.85
- $1.56
|
|
$
|
1.21
|
|
Options
returned to the plan due
|
|
|
|
|
|
|
|
|
|
|
to
employee terminations
|
|
|
(2,782,562
|
)
|
|
$0.85
- 1.56
|
|
$
|
1.29
|
|
Options
granted
|
|
|
3,000,000
|
|
|
$0.36
|
|
$
|
0.36
|
|
Options
exercised
|
|
|
(3,319,650
|
)
|
|
$0.36
- $1.56
|
|
$
|
0.43
|
|
Options
outstanding at December 31, 2006
|
|
|
644,350
|
|
|
$0.85
- $1.56
|
|
$
|
1.11
|
|
In
September 2006, the Company entered into employment agreements with its Chief
Executive Officer (“CEO”) and Chief Operating Officer (“COO”). These agreements
provided for, among other things, the award of 10,000,000 stock options each,
upon sufficient underlying shares of common stock being authorized and
available, and subject to the board of directors’ approval. The options were to
be exercisable to purchase 10,000,000 shares of the Company's common stock
each
for Messrs. Cataldo and Lewis at an exercise price of $0.01 per share for a
period of five (5) years. The options were to contain a cashless exercise
provision and cost free piggyback registration rights with respect to the common
stock underlying the options. Messrs. Cataldo and Lewis were also to receive
sufficient additional options under the same terms to assure that they have
the
right to exercise options to maintain a minimum of 5% and 8% beneficial
ownership, respectively, of the Company's issued and outstanding common stock.
In lieu of these stock options, the board of directors on January 24, 2007
resolved to issue stock grants for 10,000,000 common shares each,
subject to sufficient increased shares of common stock being authorized and
available for issuance, which in turn is subject to shareholder approval. The
stock grants are to have the same 5% and 8% anti-dilution provisions and
piggyback registration rights as the options were to have. (See Note R for
subsequent authorization of sufficient increased common stock.)
On November
8, the Company's COO was granted options to purchase 3,000,000 shares of the
Company's common stock at $0.36 per share (closing market price on November
6,
2006) under the Company's 2004 Stock Option Plan. On November 9, 2006, the
Company settled claims the COO had against the Company for alleged breaches
of
his employment agreement, and for nonregistration of the Company's common shares
he holds pursuant to the Caerus merger agreement dated May 31, 2005, for
$1,080,000. Also on November 9, 2006, the COO exercised his options to purchase
3,000,000 common shares, and the proceeds were credited toward the settlement
of
his claims. The $1,080,000 settlement expense has been recognized in the
Company's results of operations as compensation expense for the year ended
December 31, 2006.
Separate
from the CEO and COO options noted in the preceding paragraphs, at December
31,
2006 the Company had outstanding commitments to issue stock options under either
the 2004 Plan or the 2006 Plan to purchase 644,350 shares of common stock,
at
exercise prices ranging from $0.85 to $1.56 per share, and at a weighted average
exercise price of $1.11 per share.
The
Company recorded compensation expense of $7,913,904, $894,333
and $1,103,309 for
the
years ended December 31, 2006, 2005, and 2004, respectively, in connection
with
options, warrants and stock granted to employees. As of December 31, 2006,
approximately $8,361,649 in total compensation cost related options, warrants
and stock grants 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
December 31, 2006 the Company has issued to employees, institutional investors,
and financial services firms warrants to purchase the Company’s common stock.
During the years ended December 31, 2006, 2005, and 2004, the Company issued
8,826,609, 4,400,000 and 0 shares, respectively, of common stock in exchange
for
these warrants. As of December 31, 2006, the Company had outstanding 15,780,776
warrants, excluding those warrants issued in conjunction with convertible debt
and common stock issuances discussed in Notes C and G, to purchase its common
stock exercise prices ranging from $0.26 to $2.60 per share, and at a weighted
average exercise price of $1.09 per share. At December 31, 2006, the fair value
of these outstanding warrants was $1,250,155, which was recorded as a liability
on the Company’s consolidated balance sheet.
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
December 31, 2006 are as follows:
Year
ending December 31,
|
|
|
|
2007
|
|
$
|
268,556
|
|
2008
|
|
|
98,386
|
|
2009
|
|
|
43,736
|
|
2010
|
|
|
-
|
|
Total
|
|
$
|
410,678
|
|
Rent
expense for these leases for the years ended December 31, 2006, 2005, and 2004
was $233,355, $144,833
and $41,957,
respectively.
NOTE
O - RELATED PARTY TRANSACTIONS
As
of
December 31, 2006 and 2005, the amount due from related parties of $31,227
and
$161,530, respectively, consisted of an account receivable from Shawn M. Lewis,
the Company’s
Chief Operating Officer, and 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 December 31, 2006 and 2005, the outstanding
balance of these notes was $0 and $1,572,894, respectively. The December 31,
2006 amount reflects the March 2007 settlement discussed in Note K.
Interest
paid under these notes was $12,208, $50,613,
and $0
during the years ended December 31, 2006, 2005, and 2004,
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 former hardware sales business segment, the Company recorded
an
impairment charge of $839,101 in its statement of operations for the year ended
December 31, 2006. The remaining $198,000 of goodwill for this former 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.
Effective
October 12, 2006, the Company terminated its Marketing and Distribution
Agreement with Phone House, Inc. dated September 1, 2004 and amended February
16, 2006, effectively discontinuing this business segment. The Agreement called
for the wholesale distribution, marketing and selling of prepaid telephone
calling cards by Phone House, Inc., under license from the Company. The Company
recognized a related impairment loss of $936,122 for the year ended December
31,
2006, primarily related to inventory and accounts receivable write-offs, and
has
filed suit in Los Angeles County against the primary Phone House, Inc. employee
to recover same.
The
following summarizes the combined operating results of DTNet Technologies and
the calling card business of Phone House, Inc. for the years ended December
31,
2006 (through the respective dates of sale or termination), 2005 and 2004,
classified as discontinued operations for all periods presented.
|
|
2006
|
|
2005
|
|
2004
|
|
Revenues
|
|
$
|
14,308,466
|
|
$
|
6,561,277
|
|
$
|
807,908
|
|
Cost
of sales
|
|
|
13,968,554
|
|
|
6,086,147
|
|
|
617,547
|
|
Gross
profit
|
|
|
339,912
|
|
|
475,130
|
|
|
190,361
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation
and benefits
|
|
|
358,189
|
|
|
402,110
|
|
|
-
|
|
Asset
impairment charges
|
|
|
1,775,223
|
|
|
4,173,452
|
|
|
-
|
|
Other
operating expenses
|
|
|
186,453
|
|
|
417,907
|
|
|
744,593
|
|
Net
loss
|
|
$
|
(1,979,953
|
)
|
$
|
(4,518,339
|
)
|
$
|
(554,232
|
)
|
NOTE
Q - INCOME TAXES
The
components of the Company's consolidated income tax provision are
as
follows:
|
|
|
Year
ended December 31,
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
Current
benefit
|
|
$
|
6,259,445
|
|
$
|
7,025,848
|
|
$
|
2,040,000
|
|
Deferred
benefit (expense)
|
|
|
2,334,449
|
|
|
(304,845
|
)
|
|
-
|
|
Subtotal
|
|
|
8,593,894
|
|
|
6,721,003
|
|
|
2,040,000
|
|
Less
valuation allowances
|
|
|
(8,593,894
|
)
|
|
(6,721,003
|
)
|
|
(2,040,000
|
)
|
Net
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
The
reconciliation of the income tax provision at the statutory rate
to the
reported income tax expense is as follows:
|
|
|
|
|
|
|
Year
ended December 31,
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
Computed
at statutory rate
|
|
|
34
|
%
|
|
34
|
%
|
|
34
|
%
|
Options,
warrants and stock-related expenses
|
|
|
-16
|
%
|
|
-4
|
%
|
|
-
|
|
Change
in fair value liability for warrants
|
|
|
6
|
%
|
|
-
|
|
|
-
|
|
Goodwill
impairments and intangible asset amortization
|
|
|
-3
|
%
|
|
-6
|
%
|
|
-
|
|
Valuation
allowance
|
|
|
-21
|
%
|
|
-24
|
%
|
|
-34
|
%
|
Total
|
|
|
-
|
|
|
-
|
|
|
-
|
|
At
December 31, 2006, the Company's net deferred tax assets consisted
of the
following:
|
|
Net
operating loss carryforwards
|
|
$
|
14,703,783
|
|
Excess
tax over book depreciation expense
|
|
|
(634,033
|
)
|
Excess
book over tax amortization of debt discounts
|
|
|
2,130,505
|
|
Discontinued
operations impairment charge
|
|
|
318,281
|
|
Noncash
litigation charges
|
|
|
225,662
|
|
Subtotal
|
|
|
16,744,198
|
|
Less
valuation allowances
|
|
|
(16,744,198
|
)
|
Total
|
|
$
|
-
|
|
The
Company's net operating loss carryforwards for federal income tax purposes
were
approximately $43,200,000 as of December 31, 2006. These carryforwards expire
in
2018 ($4,200,000), 2019 ($20,600,000), and 2020 ($18,400,000),
respectively.
NOTE
R - SUBSEQUENT EVENTS
Cedar
Note Assignment and Restructure
The
Company as of December 31, 2006 owed the sum of $2.4 million to Cedar Boulevard
Lease Funding LLC (“Cedar”) pursuant to a subordinated loan and security
agreement (the “Loan Agreement”). As previously disclosed, the Company failed to
make a payment due
December
1, 2006 under the Loan Agreement and was declared in default by the lender
as of
December 15, 2006 and was provided until December 20, 2006 to cure the default.
Subsequently, the lender extended the time to cure the default until
January 3, 2007. The lender's default notice to the Company had demanded
the entire principal amount of the loan plus unpaid interest, approximately
$2.4
million as of that date. On January 3, 2007 the Company received a default
notice pursuant to the Loan Agreement. On January 10, 2007 Cedar agreed to
waive
the prior default based upon the Company agreeing to make accelerated payments
through May 2007, and to maintain the loan's interest rate at 17.5% per annum
for the remainder of the loan's amended term. Under the Loan Agreement,
Cedar was granted a security interest in all of the Company's
assets.
On
February 1, 2007 Cedar assigned its rights under the Loan Agreement, including
the note payable (the “Note”) with a current principal balance of $1,917,581 and
the related security interest, to a group of institutional investors
(the “Investors”). In conjunction with the assignment, the Company paid a
fee of $200,000 to Cedar. Also following the assignment, the Note's terms were
amended to allow conversion of any unpaid principal balance into the Company's
restricted common stock at $0.26 per share, subject to sufficient increased
authorized common shares being approved by the Company's shareholders. The
Company is also not required to register these shares. The Note was also amended
to include “favored nations” rights such that for future securities offerings by
the Company at a price per share less than this $0.26 per share, the Note's
conversion rate would be adjusted to the lower offering price. In conjunction
with the Company's financing discussed below, on February 16, 2006 the Note's
common stock conversion rate was reduced to $0.18 per share.
Convertible
Note and Warrant Financing
On
February 16, 2007, VoIP, Inc. (the “Company”) issued and sold $3,462,719 in
secured convertible notes (the “Convertible Notes”) to a group of institutional
investors, for a net purchase price of $2,770,175 (after a 20% original issue
discount) in a private placement. $900,000 of the proceeds (before closing
costs
of $67,512) were paid in cash to the Company at closing, and $1,870,175 of
the
proceeds were used to repay fourteen outstanding promissory notes (including
related accrued interest and a 10% premium on the promissory notes' total
principal of $1,666,667) held by five of the investors in the private placement.
The investors also received five-year warrants to purchase a total of 19,237,328
shares of the Company's common stock at an effective exercise price of $0.18
per
share.
The
Convertible Notes are secured by a subordinated lien on the Company's assets,
are not interest bearing, and are due on February 16, 2008. The note holders
may
at their election convert all or part of the Convertible Notes into shares
of
the Company's common stock at the conversion rate of $0.18 per share, subject
to
adjustment as provided in the notes. The investors also received “favored
nations” rights such that for future securities offerings by the Company at a
price per share less than the above conversion rate or warrant exercise price,
the investors' conversion rate and warrant exercise price would be adjusted
to
the lower offering price.
Pursuant
to the related subscription agreement, two of the investors are to receive
due
diligence fees totaling $346,272, in the form of convertible notes (“Due
Diligence Notes”) having the same terms and conversion features as the
Convertible Notes. Also pursuant to the Subscription Agreement, the Company
agreed to issue a total of 4,000,000 common shares to the former holders of
the
above-referenced promissory notes, in lieu of and in payment for accrued damages
associated with these promissory notes. Said common share issuance is required
no later than April 15, 2007.
Also
pursuant to the Subscription Agreement, the Company must obtain the
authorization and reservation of its common stock on behalf of the investors
of
not less than 200% of the common shares issuable upon the conversion of the
Convertible Notes and Due Diligence Notes, and 100% of the common shares
issuable upon the exercise of the warrants by April 15, 2007. Failing this
authorization and reservation, the holders of the Convertible Notes and Due
Diligence Notes will be entitled to liquidated damages that will accrue at
the
rate of two percent of the amount of the purchase price of the outstanding
Convertible Notes and Due Diligence Notes for each thirty days or pro rata
portion thereof during such default.
Shareholders
Meeting
At
the
shareholders meeting held on March 16, 2007, the following actions were
approved:
1. |
The
2006 VoIP, Inc. 2006 Equity Incentive Plan was
approved.
|
2. |
25,000,000
shares of preferred stock were
authorized.
|
3. |
The
authorized shares of the Company’s common stock were increased from
100,000,000 to 400,000,000 shares.
|
WQN,
Inc. Convertible Note
On
March
16, 2007, WQN notified the Company that it is exercising its right to convert
its note and related accrued interest into approximately
22,008,524 shares of the Company’s common stock.
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 VOIP, INC. ("VOIP" or the "Company"),
CAERUS, INC. ("CAERUS"), and WQN, Inc. (“WQN”).
On
June
1, 2005, the Company, and Caerus announced the closing of the merger of Volo
Acquisition Corp., 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,
Inc. relating to WQN’s “Voice over Internet Protocol” 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 operation for the year
ended December 31, 2005 assumes that the mergers of Caerus, WQN and the Company
were consummated at the beginning of the respective periods.
The
unaudited pro forma condensed combined statements of operations has 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.
VoIP,
Inc
|
Pro
Forma Condensed Combined Statement of Operations
(Unaudited)
|
Year
Ended December 31, 2005
|
|
|
VoIP,
Inc
|
|
Caerus,
Inc
|
|
WQN,
Inc
|
|
Adjustments
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
4,273,028
|
|
|
11,312,596
|
|
$
|
27,158,494
|
|
$
|
-
|
|
$
|
42,744,118
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
3,908,523
|
|
|
14,814,908
|
|
|
25,796,559
|
|
|
-
|
|
|
44,519,990
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
364,505
|
|
|
(3,502,312
|
)
|
|
1,361,935
|
|
|
-
|
|
|
(1,775,872
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
15,198,094
|
|
|
8,583,676
|
|
|
5,018,437
|
|
|
3,660,556
|
|
|
32,460,763
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
before
income taxes
|
|
|
(14,833,589
|
)
|
|
(12,085,988
|
)
|
|
(3,656,502
|
)
|
|
(3,660,556
|
)
|
|
(34,236,635
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain
on sale of fixed assets
|
|
|
(206,184
|
)
|
|
|
|
|
|
|
|
|
|
|
(206,184
|
)
|
Interest
expense
|
|
|
1,238,938
|
|
|
786,389
|
|
|
-
|
|
|
643,200
|
|
|
2,668,527
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before income taxes and results of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
discontinued
operations
|
|
|
(15,866,343
|
)
|
|
(12,872,377
|
)
|
|
(3,656,502
|
)
|
|
(4,303,756
|
)
|
|
(36,698,978
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss before discontinued operations
|
|
|
(15,866,343
|
)
|
|
(12,872,377
|
)
|
|
(3,656,502
|
)
|
|
(4,303,756
|
)
|
|
(36,698,978
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net
of income taxes
|
|
|
(4,518,339
|
)
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(4,518,339
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(20,384,682
|
)
|
$
|
(12,872,377
|
)
|
$
|
(3,656,502
|
)
|
$
|
(4,303,756
|
)
|
$
|
(41,217,317
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before discontinued operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(0.95
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net
of income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(0.12
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(1.07
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
38,458,871
|
|
VOIP,
INC. AND SUBSIDIARIES
NOTES
TO UNAUDITED PRO FORMA CONDENSED COMBINED
FINANCIAL
STATEMENTS
(1)
VoIP,
INC. Basis of Presentation
Historical
financial information for VoIP, Inc. for the year ended December 31, 2005 has
been derived from VoIP, Inc.'s historical statements.
(2)
Caerus, Inc. Basis of Presentation
Historical
financial information for Caerus, Inc. for the year ended December 31, 2005
has
been derived from Caerus, Inc.'s historical statements.
(3)
Historical financial information for WQN, Inc. for the year ended December
31,
2005 has been derived from WQN, Inc.’s historical financial
statements.
(4)
VoIP,
Inc. and Caerus, Inc. Merger
On
June
1, 2005, the Company and Caerus, Inc. announced the closing of the merger of
Volo Acquisition Corp., a wholly-owned subsidiary of the Company with and into
Caerus, Inc. with Caerus, Inc. 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 by the
conversion of all Caerus, Inc. capital stock into 16,434,470 shares of common
stock, par value $0.001, of the Company.
(5)
On
October 6, 2005, the Company purchased substantially all of the assets of WQN,
Inc. relating to WQN’s “Voice over Internet Protocol” business. Such assets
consist of WQN’s properties and infrastructure for its services platform for
both retail and wholesale voice over Internet business.
(6)
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.
Board
of
Directors
Caerus,
Inc.
Altamonte
Springs, Florida
We
have
audited the accompanying consolidated balance sheets of Caerus, Inc. as of
December 31, 2004 and 2003, and the related consolidated statements of
operations, changes in stockholders' equity (deficit), and cash flows for the
year ended December 31, 2004 and for period May 15, 2002 (date of inception)
through December 31, 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an
opinion on these consolidated financial statements based on our audits.
We
conducted our audits in accordance with auditing standards generally accepted
in
the United States of America. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In
our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Caerus, Inc.
as
of December 31, 2004 and 2003, and the results of its operations and cash flows
for the year ended December 31, 2004 and for the period May 15, 2002 (date
of
inception) through December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America.
The
accompanying financial statements have been prepared assuming the Company will
continue as a going concern. As discussed in Note 1 to the consolidated
financial statements, the Company has incurred significant losses and negative
cash flows from operations, has a working capital deficit, and has significant
unresolved litigation as discussed in Note 8 to the financial statements. These
matters, among other things, raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans related to these matters
are
also discussed in Note 1. These financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
|
/s/
Moore Stephens Lovelace, P.A.
Certified
Public Accountants
Orlando,
Florida
July
25, 2005
|
CAERUS,
INC.
|
CONSOLIDATED
BALANCE SHEETS
|
December
31, 2004 and 2003
|
ASSETS
|
|
|
|
2004
|
|
2003
|
|
CURRENT
ASSETS
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
19,414
|
|
$
|
25,078
|
|
Restricted
cash
|
|
|
60,224
|
|
|
196
|
|
Accounts
receivable
|
|
|
2,098,598
|
|
|
358,522
|
|
Note
receivable - related party
|
|
|
-
|
|
|
179,974
|
|
Supplies,
deposits and prepaid expenses
|
|
|
70,999
|
|
|
350,199
|
|
|
|
|
|
|
|
|
|
TOTAL
CURRENT ASSETS
|
|
|
2,249,235
|
|
|
913,969
|
|
|
|
|
|
|
|
|
|
PROPERTY
AND EQUIPMENT
|
|
|
|
|
|
|
|
Telecommunications
equipment and computers
|
|
|
6,390,973
|
|
|
732,205
|
|
Furniture
and fixtures
|
|
|
61,960
|
|
|
21,624
|
|
Leasehold
improvements
|
|
|
163,808
|
|
|
146,358
|
|
Purchased
and developed software
|
|
|
473,228
|
|
|
598,243
|
|
|
|
|
7,089,969
|
|
|
1,498,430
|
|
Less
accumulated depreciation and amortization
|
|
|
(824,580
|
)
|
|
(183,408
|
)
|
|
|
|
|
|
|
|
|
NET
PROPERTY AND EQUIPMENT
|
|
|
6,265,389
|
|
|
1,315,022
|
|
|
|
|
|
|
|
|
|
OTHER
ASSETS
|
|
|
|
|
|
|
|
Deferred
loan origination costs, net
|
|
|
285,075
|
|
|
-
|
|
Lease
deposit and other
|
|
|
28,959
|
|
|
65,000
|
|
|
|
|
|
|
|
|
|
TOTAL
ASSETS
|
|
$
|
8,828,658
|
|
$
|
2,293,991
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY (DEFICIT)
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
$
|
7,137,293
|
|
$
|
452,094
|
|
Note
payable
|
|
|
6,006,899
|
|
|
-
|
|
Convertible
notes payable - related party
|
|
|
1,830,000
|
|
|
1,050,000
|
|
Deferred
revenue and customer deposits
|
|
|
38,750
|
|
|
60,576
|
|
|
|
|
|
|
|
|
|
TOTAL
CURRENT LIABILITIES
|
|
|
15,012,942
|
|
|
1,562,670
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS’
EQUITY (DEFICIT)
|
|
|
|
|
|
|
|
Common
stock - $.01 par value; 50,000,000 shares authorized;
|
|
|
|
|
|
|
|
14,940,508
and 11,948,367 shares issued and outstanding, respectively
|
|
|
149,405
|
|
|
119,484
|
|
Preferred
stock - $.01 par value; 25,000,000 shares authorized;
|
|
|
|
|
|
|
|
-0-
shares issued and outstanding
|
|
|
-
|
|
|
-
|
|
Additional
paid-in capital
|
|
|
4,618,253
|
|
|
2,952,184
|
|
Accumulated
deficit
|
|
|
(10,951,942
|
)
|
|
(2,340,347
|
)
|
|
|
|
|
|
|
|
|
TOTAL SHAREHOLDERS’ EQUITY (DEFICIT)
|
|
|
(6,184,284
|
)
|
|
731,321
|
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
|
|
$
|
8,828,658
|
|
$
|
2,293,991
|
|
The
accompanying notes are an integral part of the consolidated financial
statements.
CAERUS,
INC.
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
For
The Year Ended December 31, 2004, and
|
The
Period May 15, 2002 (Date of Inception) Through December 31,
2003
|
|
|
2004
|
|
2002-2003
|
|
|
|
|
|
(Development
|
|
|
|
|
|
Stage)
|
|
|
|
|
|
|
|
SALES
|
|
$
|
14,379,365
|
|
$
|
1,191,287
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COST
OF SALES
|
|
|
|
|
|
|
|
Network
and termination costs
|
|
|
15,103,149
|
|
|
900,681
|
|
Testing
and sales concessions
|
|
|
662,052
|
|
|
-
|
|
|
|
|
|
|
|
|
|
TOTAL
COST OF SALES
|
|
|
15,765,201
|
|
|
900,681
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT (LOSS)
|
|
|
(1,385,836
|
)
|
|
290,606
|
|
|
|
|
|
|
|
|
|
OPERATING
EXPENSES
|
|
|
|
|
|
|
|
Equipment
and computer expenses
|
|
|
603,189
|
|
|
97,068
|
|
Office
expenses
|
|
|
228,108
|
|
|
206,215
|
|
Labor-related
expenses
|
|
|
2,973,070
|
|
|
1,214,240
|
|
Professional
fees
|
|
|
814,243
|
|
|
400,872
|
|
Marketing
|
|
|
217,835
|
|
|
16,689
|
|
Litigation
settlement
|
|
|
326,205
|
|
|
-
|
|
Rent,
utilities and security
|
|
|
246,545
|
|
|
355,481
|
|
Taxes
and licenses
|
|
|
55,527
|
|
|
25,390
|
|
Travel,
lodging and entertainment
|
|
|
163,555
|
|
|
90,928
|
|
Depreciation
and amortization
|
|
|
641,172
|
|
|
183,409
|
|
Asset
impairment charge
|
|
|
299,122
|
|
|
-
|
|
|
|
|
|
|
|
|
|
TOTAL
EXPENSES
|
|
|
6,568,571
|
|
|
2,590,292
|
|
|
|
|
|
|
|
|
|
LOSS
FROM OPERATIONS
|
|
|
(7,954,407
|
)
|
|
(2,299,686
|
)
|
|
|
|
|
|
|
|
|
OTHER
EXPENSES
|
|
|
|
|
|
|
|
Interest
expense, net
|
|
|
(657,238
|
)
|
|
(19,654
|
)
|
Other
expense, net
|
|
|
50
|
|
|
(21,007
|
)
|
|
|
|
|
|
|
|
|
NET
LOSS
|
|
$
|
(8,611,595
|
)
|
$
|
(2,340,347
|
)
|
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of the consolidated financial
statements.
CAERUS,
INC.
|
CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(DEFICIT)
|
For
The Year Ended December 31, 2004, and
|
The
Period May 15, 2002 (Date of Inception) Through December 31,
2003
|
|
|
Common
Stock
|
|
Additional
|
|
|
|
Total
|
|
|
|
$.01
Par Value
|
|
Paid-In
|
|
Accumulated
|
|
Stockholders’
|
|
|
|
Shares
|
|
Amount
|
|
Capital
|
|
Deficit
|
|
Equity
(Deficit)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE
- MAY 15, 2002
|
|
|
-
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ISSUANCE
OF FOUNDER STOCK
|
|
|
5,400,000
|
|
|
54,000
|
|
|
-
|
|
|
-
|
|
|
54,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SALE
OF COMMON STOCK
|
|
|
6,186,592
|
|
|
61,866
|
|
|
2,721,909
|
|
|
-
|
|
|
2,783,775
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ISSUANCE
OF COMMON STOCK
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FOR
SERVICES
|
|
|
150,000
|
|
|
1,500
|
|
|
81,750
|
|
|
-
|
|
|
83,250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ISSUANCE
OF COMMON STOCK
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FOR
PROPERTY AND EQUIPMENT
|
|
|
211,775
|
|
|
2,118
|
|
|
148,525
|
|
|
-
|
|
|
150,643
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
LOSS
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(2,340,347
|
)
|
|
(2,340,347
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE
- DECEMBER 31, 2003
|
|
|
11,948,367
|
|
|
119,484
|
|
|
2,952,184
|
|
|
(2,340,347
|
)
|
|
731,321
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ISSUANCE
OF COMMON STOCK
|
|
|
712,071
|
|
|
7,121
|
|
|
273,139
|
|
|
-
|
|
|
280,260
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ISSUANCE
OF COMMON STOCK
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FOR
DEBT
|
|
|
2,280,070
|
|
|
22,800
|
|
|
1,097,200
|
|
|
-
|
|
|
1,120,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ISSUANCE
OF STOCK WARRANTS IN CONNECTION WITH SECURED NOTE PAYABLE
|
|
|
-
|
|
|
-
|
|
|
218,813
|
|
|
-
|
|
|
218,813
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EMPLOYEE
STOCK OPTIONS - COMPENSATION EXPENSE RECOGNIZED
|
|
|
-
|
|
|
-
|
|
|
76,917
|
|
|
-
|
|
|
76,917
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
LOSS
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(8,611,595
|
)
|
|
(8,611,595
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE
- DECEMBER 31, 2004
|
|
|
14,940,508
|
|
$
|
149,405
|
|
$
|
4,618,253
|
|
$
|
(10,951,942
|
)
|
$
|
(6,184,284
|
)
|
The
accompanying notes are an integral part of the consolidated financial
statements.
CAERUS,
INC.
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
For
The Year Ended December 31, 2004, and
|
The
Period May 15, 2002 (Date of Inception) Through December 31,
2003
|
|
|
|
|
|
|
|
|
2004
|
|
2002-2003
|
|
|
|
|
|
(Development
|
|
|
|
|
|
Stage)
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(8,611,595
|
)
|
$
|
(2,340,347
|
)
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
Litigation
settlement
|
|
|
326,205
|
|
|
-
|
|
Depreciation
and amortization
|
|
|
641,172
|
|
|
183,408
|
|
Asset
impairment charge
|
|
|
299,122
|
|
|
-
|
|
Amortization
of deferred loan fees
|
|
|
56,613
|
|
|
-
|
|
Stock
issued to Founder
|
|
|
-
|
|
|
54,000
|
|
Stock
issued for services
|
|
|
-
|
|
|
83,250
|
|
Expense
related to employee stock options
|
|
|
76,917
|
|
|
-
|
|
Forgiveness
of related-party loan
|
|
|
415,323
|
|
|
-
|
|
Changes
in:
|
|
|
|
|
|
|
|
Restricted
cash
|
|
|
(60,028
|
)
|
|
(196
|
)
|
Accounts
receivable
|
|
|
(2,066,281
|
)
|
|
(358,522
|
)
|
Supplies,
deposits and prepaid expenses
|
|
|
279,200
|
|
|
(415,199
|
)
|
Other
assets
|
|
|
36,041
|
|
|
-
|
|
Accounts
payable and accrued expenses
|
|
|
6,685,199
|
|
|
452,094
|
|
Deferred
revenue
|
|
|
(21,826
|
)
|
|
60,576
|
|
|
|
|
|
|
|
|
|
NET
CASH USED IN OPERATING ACTIVITIES
|
|
|
(1,943,938
|
)
|
|
(2,280,936
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
Additions
to property and equipment
|
|
|
(5,890,661
|
)
|
|
(1,347,787
|
)
|
Additions
to related-party loan
|
|
|
(235,349
|
)
|
|
(179,974
|
)
|
|
|
|
|
|
|
|
|
NET
CASH USED IN INVESTING ACTIVITIES
|
|
|
(6,126,010
|
)
|
|
(1,527,761
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
Proceeds
from borrowings
|
|
|
8,900,000
|
|
|
1,050,000
|
|
Repayment
of note payable
|
|
|
(993,101
|
)
|
|
-
|
|
Proceeds
from issuance of common stock
|
|
|
280,260
|
|
|
2,783,775
|
|
Payments
for loan origination costs
|
|
|
(122,875
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
NET
CASH PROVIDED BY FINANCING ACTIVITIES
|
|
|
8,064,284
|
|
|
3,833,775
|
|
|
|
|
|
|
|
|
|
NET
CHANGE IN CASH
|
|
|
(5,664
|
)
|
|
25,078
|
|
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS - BEGINNING OF PERIOD
|
|
|
25,078
|
|
|
-
|
|
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS - END OF PERIOD
|
|
$
|
19,414
|
|
$
|
25,078
|
|
The
accompanying notes are an integral part of the consolidated financial
statements.
Caerus,
Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For
The
Year Ended December 31, 2004 and For The Period May 15, 2002 (Date of Inception)
Through December 31, 2003
Caerus,
Inc. and subsidiaries (collectively referred to as the "Company") were
incorporated on May 15, 2002 and are wholesale providers of advanced
telecommunications technologies and services to carriers and service providers,
including Inter Exchange Carriers ("IXCs"), Competitive Local Exchange Carriers
("CLECs"), Internet Service Providers, Cable Operators and Enhanced Voice and
Data Service Providers. Through its wholesale-only model, the Company has
positioned itself as a "carrier's carrier" and offers protocol-agnostic packet
switched technologies to address the gap between traditional communications
and
"next generation" platforms.
During
the period May 15, 2002 (date of inception) to December 31, 2003, the Company
was in the process of developing its resources, enhancing its proprietary
technology, building a nationwide network with five physical interconnection
points (cities), working with potential customers on testing its network, and
attracting key engineering professionals; accordingly, the Company was
considered to be a development stage enterprise. In January 2004, the Company
became fully operational and management determined that the Company was no
longer in a development stage.
The
Company offers a comprehensive suite of Internet Protocol ("IP")-based broadband
packet voice services, IP and Time Division Multiplexing ("TDM")
origination/termination services, IP PBX-hosted services, and unified messaging
services that include enhanced voice and data solutions. The suite of services
is complemented by a Service Creation Environment that enables the Company
to
develop custom applications and features "on the fly" for its customers.
The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.
The
Company has incurred significant losses and negative cash flows from operations
since its inception. Additionally, the Company has a working capital deficit
of
$12,763,707 and an accumulated deficit of $10,951,942 at December 31, 2004.
Management continues to undertake steps as part of a plan to attempt to improve
liquidity and operating results with the goal of sustaining Company operations.
These steps include seeking (a) to increase high-margin sales; and (b) to
control overhead costs and operating expenses. Management plans, in this regard,
to continue the implementation of a stabilized and fully operational network,
adding recurring-revenue customers, attracting an experienced management team
capable of building a profitable company, and securing funding to meet current
obligations.
There
can
be no assurance that the Company can successfully accomplish these steps.
Accordingly, the Company's ability to continue as a going concern is uncertain
and dependent upon continuing to achieve improved operating results and cash
flows or obtaining additional financing. These consolidated financial statements
do not include any adjustments to the amounts and classification of assets
and
liabilities that might be necessary should the Company be unable to continue
in
business.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash
and Cash Equivalents
For
financial presentation purposes, the Company considers short-term, highly liquid
investments with original maturities of three months or less to be cash
equivalents.
Restricted
Cash and Letters of Credit
Certain
cash is restricted to support standby letters of credit which, in turn, support
operating license bonds required by several states' regulatory agencies. These
standby letters of credit are generally in force for one year with automatic
one-year extensions. Maximum draws available to the beneficiary as of December
31, 2004 were $60,000. If the Company was required to obtain replacement standby
letters of credit as of December 31, 2004 for those currently outstanding,
it is
the Company's opinion that the replacement costs would not significantly vary
from the present fee structure.
Accounts
Receivable
Accounts
receivable result from the sale of the Company's services, net of estimated
allowances. The Company estimates an allowance for doubtful accounts based
on a
specific-identification basis. The Company had no allowance for doubtful
accounts as of December 31, 2004 and 2003.
Property
and Equipment
Property
and equipment are recorded at cost. Depreciation and amortization are calculated
on a straight-line basis over the assets' useful lives, which range from three
to ten years. Leasehold improvements are amortized over the estimated useful
lives of the improvements, or the term of the lease, if shorter. Maintenance
and
repairs are expensed as incurred, while renewals and betterments are
capitalized. Upon the sale or other disposition of property, the cost and
related accumulated depreciation are removed from the accounts, and any gain
or
loss is recognized in operations.
Under
the
Statement of Position ("SOP") 98-1, "Accounting for the Cost of Computer
Software Developed or Obtained for Internal Use," the Company expenses computer
software costs related to internal-use software that is incurred in the
preliminary project stage. When the capitalization criteria of SOP 98-1 have
been met, costs of developing or obtaining internal-use computer software are
capitalized. The Company capitalized approximately $772,350 of costs incurred
for internally developed software during the period from inception through
December 31, 2004. Amortization of internal-use software over a 5-year estimated
useful life commenced upon the software being placed in service beginning
January 1, 2004. Amortization of internal-use software for the periods ended
December 31, 2004 and 2003 was approximately $77,000 and $-0-, respectively.
During 2004, the Company suspended a number of software development projects
and, accordingly, recognized a related asset impairment charge of $299,122
in
2004.
Deposits
Deposits
consist primarily of an equipment deposit, a refundable office lease deposit
and
various other deposits outstanding with service providers.
Deferred
Revenue
Deferred
revenue represents fees for services that have not yet met the criteria to
be
recognized as revenue.
Revenue
Recognition
Revenue
is recognized when earned. Revenue related to long distance, carrier access
service and certain other usage-driven charges are billed monthly in arrears,
and the associated revenues are recognized during the month of service.
Income
Taxes
The
Company utilizes the asset and liability method of accounting for income taxes.
Under this method, deferred income taxes are recorded to reflect the tax
consequences in future years of differences between the tax basis of assets
and
liabilities and their financially reported amounts at each year-end, based
on
enacted laws and statutory rates applicable to the periods in which differences
are expected to affect taxable income. As of December 31, 2004, the Company
had
a deferred tax asset of approximately $3,000,000, the components of which
consisted primarily of the Company's net losses, fixed asset depreciation and
stock-based compensation. Also at December 31, 2004, the Company had a net
operating loss carryforward of approximately $11,000,000 for federal income
tax
purposes that will begin to expire in 2022, and that is subject to significant
limitations based upon the occurrence of certain changes in ownership of the
Company.
A
valuation allowance is provided against the future benefits of deferred tax
assets if it is determined that it is more likely than not that the future
tax
benefits associated with the deferred tax asset will not be realized. Due to
recurring losses since inception and the resultant uncertainty of the
realization of the tax loss carryforward, the Company has established a 100%
valuation allowance against the carryforward benefit. Accordingly, no
provision/benefit for income taxes has been included in these consolidated
financial statements.
Concentration
of Credit Risk
Financial
instruments that may subject the Company to concentrations of credit risk
consist principally of cash and cash equivalents and accounts receivable. The
Company has investment policies and procedures that are reviewed periodically
to
minimize credit risk.
One
customer represented approximately 98% and 90% of the Company's accounts
receivable as of December 31, 2004 and 2003, respectively, and approximately
91%
and 95% of the Company's revenues for the year ended December 31, 2004 and
for
the period May 15, 2002 (date of inception) through December 31, 2003,
respectively. The loss of this customer would have a significant adverse affect
on the Company's operations.
Concentration
of Supplier Risk
One
supplier represented approximately 86% of the Company's accounts payable as
of
December 31, 2004, and approximately 94% of the Company's cost of sales for
the
year ended December 31, 2004 (see Note 8).
Stock-based
Compensation
The
Company uses the fair value method of Statement of Financial Accounting
Standards No. 123R, "Accounting for Stock Based Compensation" in accounting
for
its stock options. This standard states that compensation cost is measured
at
the grant date based on the value of the award and is recognized over the
service period, which is usually the vesting period. The fair value for each
option granted is estimated on the date of the grant using the minimum value
method.
Estimates
The
preparation of these consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements. Estimates also affect
the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. Significant management estimates
affect the carrying value of, among other things, internal-use software, cost
of
goods sold (see Note 7), the estimating of the fair value of the Company's
common stock (see Note 3), and the evaluation of existing disputes and claims
(see Notes 7 and 8).
Reclassifications
Certain
reclassifications have been made to the 2003 financial statements to conform
to
the 2004 presentation.
NOTE
3 - CONVERTIBLE NOTES PAYABLE - RELATED PARTY
During
2003, the Company issued two one-year convertible notes to a stockholder of
the
Company, $1,050,000 and $70,000 of which were funded in the periods ended
December 31, 2003 and 2004, respectively. These notes accrued interest at 12%
per annum, with all interest and principal due in September and December 2004.
These notes, which had certain anti-dilution provisions and which were
collateralized by substantially all of the assets of the Company, were converted
into common stock in May 2004 (see Note 6) and the convertible notes were
cancelled and the principal amount was satisfied in full.
The
Company determined the conversion rates based upon its evaluation of the
Company's common stock on the issuance dates. The Company's evaluations were
based upon, among other things, peer company valuations, industry and market
conditions, the Company's current financial position, terms and conditions
of
funding available to the Company at the time of issuance, etc.
During
2004, the Company issued two one-year convertible notes to a stockholder of
the
Company, totaling $1,830,000. These notes accrue interest at 12% per annum,
with
monthly principal and interest payments originally scheduled through August
and
November 2004. Restrictive covenants pertaining to the note payable discussed
in
Note 4 to these financial statements precluded payment of scheduled principal
and interest on these notes; therefore, these notes are currently due. However,
the same covenants preclude payment until the note described in Note 4 to these
financial statements is paid in full. These one-year notes are collateralized
by
substantially all of the assets of the Company (see Note 8).
Interest
expense incurred with respect to these notes during the year ended December
31,
2004 and the period May 15, 2002 (date of inception) through December 31, 2003,
was $122,223 and $19,653, respectively.
Interest
payments made with respect to these notes during the year ended December 31,
2004 and the period May 15, 2002 (date of inception) through December 31, 2003,
were $42,560 and $-0-, respectively.
NOTE
4 - NOTE PAYABLE
In
June
2004, the Company secured a $15,000,000 debt facility and drew down the first
$7,000,000 traunch primarily for the purpose of funding network equipment
purchases. These borrowings are repayable over a three-year period and bear
interest at 12.5% per annum. Additional borrowings under this facility are
contingent upon, among other things, the Company raising certain levels of
additional equity financing. The loan agreement contains customary covenants
and
restrictions and provides the lender the right to a perfected first-priority,
secured interest in all of the Company's assets, as well as rights to preferred
stock warrants (see Notes 6 and 8).
Interest
paid under this debt facility during the year ended December 31, 2004, was
$484,867.
The
Company is currently in violation of several of the restrictive covenants in
this debt facility. Under its provisions, the lender has the right to call
the
related note payable due. Accordingly, the full amount of the note at December
31, 2004 has been classified as current.
NOTE
5 - NOTE RECEIVABLE - RELATED PARTY
During
the period May 15, 2002 (date of inception) through December 31, 2004, the
Company advanced $415,323 to an officer of the Company. In 2005, these advances
were characterized as compensation and were forgiven; accordingly, their
carrying value was reduced to zero at December 31, 2004. In addition, the
Company agreed to pay the related federal income tax withholding of
approximately $104,000 on behalf of the related party, which was accrued at
December 31, 2004.
NOTE
6 - STOCKHOLDERS' EQUITY
In
June
2002, the Company increased its authorized shares to 100,000 shares of $0.01
par
value common stock. In July 2002, the Company increased its authorized shares
to
3,000,000 shares of $0.01 par value common stock and approved a 2-for-1 common
stock split. In October 2002, the Company increased its authorized shares to
6,000,000 shares of $0.01 par value common stock. In July 2003, the Company
approved an additional 3-for-1 common stock split and an increase in the
authorized shares of common stock to 18,000,000. The Articles of Amendment
for
this amendment were not filed with the state of Delaware until 2004. The
accompanying consolidated financial statements and related notes present all
of
these amendments as if they were affected for all periods presented.
In
2002,
5,400,000 shares of common stock were issued to the founder of the Company.
These shares were recorded at their par value.
In
2002,
the Company issued 150,000 shares of its common stock for legal services
provided to the Company, which were recorded at their estimated fair value
of
$83,250.
During
the period May 15, 2002 (date of inception) through December 31, 2003, the
Company issued 5,965,957 shares of its common stock and received net proceeds
of
$2,783,775. Offering costs related to these sales consisted of the issuance
of
an additional 220,635 shares of the Company's common stock.
During
the period May 15, 2002 (date of inception) through December 31, 2003, the
Company issued 211,775 shares of its common stock in consideration for leasehold
improvements and equipment, of which 190,211 of the shares were issued to the
founder of the Company. These shares were recorded at their estimated fair
value
of $150,643.
In
May
2004, $1,120,000 of convertible notes payable to a shareholder were converted
into 2,280,070 shares of common stock.
In
May
and August 2004, the Company issued 500,000 and 212,071 shares of its common
stock for cash of $100,000 and $180,260, respectively.
In
May
2004, the Company authorized the issuance of up to 25,000,000 shares of $.01
par
value preferred stock, the terms of which will be decided upon by the Company's
board of directors.
In
August
2004, the Company approved increasing the authorized common stock to 50,000,000
shares. However, the related state filing has yet to be effected.
Rights
to Convert to Preferred Stock
At
December 31, 2004, related parties held 12,989,445 shares of common stock that
had the right to be converted into preferred shares; however, as of December
31,
2004, no shares of preferred stock had been issued by the Company (see Note
8).
Stock
Options
During
October 2004, the Board approved the Company's 2004 Stock Option Plan (the
"Plan"), whereby 4,000,000 shares of the Company's common stock were reserved
for issuance under the Plan to selected directors, officers, employees and
consultants of the Company. As of December 31, 2004, options to purchase
2,164,969 shares of common stock for $0.85 per share were issued and outstanding
under the Plan. These options expire ten years from the date of issuance. They
vest from 36 to 48 months of employment following the date of option issuance.
These options had an estimated fair value of $330,599 at the date of grant,
using the minimum-value method with the following assumptions:
Expected
life (in years)
|
|
|
10.0
|
|
Risk-free
interest rate
|
|
|
2.0
|
%
|
Dividend
yield
|
|
|
0.0
|
%
|
Related
2004 compensation expense was $76,917, determined by amortizing the options'
estimated fair value at grant date over their vesting period. The weighted
average remaining contractual life of the options outstanding at December 31,
2004 was 9.8 years (see Note 8). The Company had no stock options outstanding
at
December 31, 2003.
Stock
Warrants
In
2004,
the Company granted a series of warrants to purchase shares of preferred stock,
the specific terms of which had yet to be determined, at an exercise price
of
$0.85 per share, in conjunction with the long-term note payable issuance (see
Note 4). These warrants expire at the earlier of ten years from their issuance
date, or five years after a potential initial public securities offering. At
the
warrant holder's election, these warrants may be exercised on a non-cash basis
whereby the warrant holder uses the surplus of the preferred stock's then-fair
market value per share over the $0.85 exercise price as payment for the
preferred stock purchased under these warrants.
These
warrants had estimated fair values totaling $218,813 at their grant dates,
recognized as additional paid-in capital and deferred loan origination costs.
Additional information pertaining to these warrants issued and outstanding
at
December 31, 2004 is as follows:
Date
Granted
|
|
Shares
|
|
June,
2004
|
|
|
1,235,294
|
|
August,
2004
|
|
|
766,020
|
|
October,
2004
|
|
|
383,010
|
|
Total
Issued and Outstanding
|
|
|
2,384,324
|
|
Also
in
conjunction with the long-term note payable issuance (see Note 4), the Company
granted warrants to purchase up to $1.0 million of common or preferred stock
that may be issued in conjunction with any future securities offering of at
least $5.0 million, upon the same price and conditions as afforded to
third-party investors in said potential securities offering.
In
August
2004, the Company issued warrants to purchase 150,000 shares of common stock
to
a former employee whose employment was terminated in June 2004. Such warrants
are exercisable at $0.85 per share, and expire on June 26, 2006. The Company
had
no stock warrants outstanding at December 31, 2003.
Operating
Leases
In
August
2002, the Company entered into an operating lease for office space, which
expires in February 2008. Approximate minimum future lease payments due under
this operating lease, are as follows:
Year
Ending
December
31,
|
|
Amount
|
|
2005
|
|
$
|
196,000
|
|
2006
|
|
$
|
202,000
|
|
2007
|
|
$
|
208,000
|
|
2008
|
|
$
|
35,000
|
|
During
the year ended December 31, 2004 and the period May 15, 2002 (date of inception)
through December 31, 2003, $172,700 and $234,000, respectively, were charged
to
operations for rent expense related to this operating lease.
Legal
and Regulatory Proceedings
The
Company's 100%-owned subsidiary, Volo Communications, Inc., settled its breach
of contract dispute related to a 2003 "take or pay" sales contract with the
Company. In connection with this settlement, the Company wrote off its
previously recorded account receivable of $326,205 in 2004.
Vendor
Dispute
Certain
transport and termination costs incurred by the Company are recorded at vendor
invoice amount less any amounts that have been formally disputed, for which
the
Company expects to receive a credit. Disputed amounts are based upon
management's detailed review of vendor call records and contract provisions;
accordingly, the recorded transport and termination costs represent management's
estimates of what is ultimately due and payable. During the year ended December
31, 2004, and the period May 15, 2002 (date of inception) through December
31,
2003, $4,500,000 and $2,500,000, respectively, of one vendor's charges were
formally disputed. As of December 31, 2004, approximately $4,759,000 remained
in
dispute and are, therefore, not included in the accompanying financial
statements (see Note 8). Differences between the disputed amounts and final
settlements, if any, are reported in operations in the year of settlement.
Other
Telecommunications
industry revenues are subject to statutory and regulatory changes,
interpretations of contracts, etc., all of which could materially affect our
revenues. Generally, our customers have sixty days from the invoice date to
dispute any billed charges. Management reviews all billings for compliance
with
applicable rules, regulations and contract terms and believes that it is in
compliance therewith; accordingly, no allowance has been recorded in the
accompanying financial statements for potential disputed charges.
NOTE
8 - SUBSEQUENT EVENTS
Capital
Stock Transactions
In
February 2005, the Company issued 511,750 shares of Series B preferred stock
for
$818,800 cash. In May 2005, 7,289,445 shares of common stock were converted
into
5,944,669 shares of Series A preferred stock. Both Series A and Series B
preferred stock are convertible into common stock, and they carry voting rights
equal to the equivalent number of common shares into which they are convertible.
Also, both Series A and Series B preferred stock contain equal and ratable
dividend and liquidation preferences over common stock.
Litigation
On
April 8, 2005, Volo Communications, Inc. (“Volo”) (a wholly-owned
subsidiary of Caerus, Inc.) filed suit against MCI Worldcom Network Services,
Inc. d/b/a UUNET (“MCI”). Volo alleges that MCI 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 refused to negotiate
such overcharges in good faith. Volo also seeks damages arising out of MCI’s
alleged 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 declared Volo in default of its obligations under the Services
Agreement, claiming that Volo owes a past due amount of $8,365,980 through
March, 2005, and threatening to terminate all services to Volo within 5 days.
On
April 12, 2005, MCI terminated all services to Volo. By these actions, 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 is in breach
of the Services Agreement; (2) $8,365,980 billed by MCI is not “due and
payable” under that agreement; and (3) MCI’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 filed an Answer, Affirmative Defenses, Counterclaim and
Third-Party Complaint naming Caerus, Inc. as a third-party defendant. MCI
asserts a breach of contract claim against Volo, a breach of guarantee claim
against Caerus, Inc., and a claim for unjust enrichment against both parties,
seeking an amount to be determined at trial. On July 11, 2005, Volo and
Caerus, Inc. answered the counterclaim and third-party complaint, and filed
a
third-party counterclaim against MCI for declaratory judgment, fraud in the
inducement, and breach of implied duty of good faith and fair dealing. Volo
and
Caerus, Inc. seek damages in an amount to be determined at trial. MCI has filed
a motion to strike certain of Caerus’ affirmative defenses and a motion to
dismiss Caerus’ counterclaims. Discovery should commence shortly. While
management is optimistic about the outcome of this litigation, it is currently
unable to assess the ultimate likelihood of a favorable or unfavorable outcome;
accordingly, no related provision or liability has been made in the accompanying
financial statements.
Merger
On
May
31, 2005, the Company consummated an Agreement and Plan of Merger ("Merger
Agreement") with VoIP, Inc. ("VoIP") (OTCBB:VOII.OB), whereby 100% of Caerus,
Inc.'s common and preferred stock, stock options and warrants were exchanged
for
the common stock of a wholly-owned subsidiary of VoIP. The VoIP subsidiary's
name was then changed to Caerus, Inc. Also in conjunction with this merger,
the
holder of the $1,830,000 notes payable at December 31, 2004 referred to in
Note
3 agreed to exchange those notes plus accrued interest for an equivalent number
of shares of VoIP common stock valued at $1.23 per share.
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors
WQN,
Inc.
and Subsidiaries
We
have
audited the accompanying consolidated balance sheets of WQN, Inc. (a Delaware
corporation) formerly known as WorldQuest Networks, Inc. and subsidiaries (“the
Company”) as of December 31, 2004 and 2003, and the related consolidated
statements of operations, changes in stockholders’ equity, and cash flows for
the years then ended. These financial statements are the responsibility of
the
Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures
in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of WQN, Inc. and subsidiaries as
of
December 31, 2004 and 2003, and the results of its operations and its cash
flows
for the years then ended in conformity with accounting principles generally
accepted in the United States of America.
As
more
fully discussed in Note 20 to the financial statements, the Company sold
substantially all of its operating assets and liabilities to an unrelated
third-party.
/s/
Berkovits, Lago & Company, LLP
Fort
Lauderdale, Florida
October
16, 2006
WQN,
INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
|
|
December
31,
|
|
|
|
2004
|
|
2003
|
|
ASSETS
|
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
9,942,280
|
|
$
|
17,931,820
|
|
Investment
in partnership
|
|
|
2,944,243
|
|
|
-
|
|
Accounts
receivable, net of allowances of $25,000 in 2004 and 2003
|
|
|
689,885
|
|
|
553,251
|
|
Notes
receivable
|
|
|
2,408,679
|
|
|
-
|
|
Prepaid
expenses and other current assets
|
|
|
806,068
|
|
|
557,577
|
|
Total
current assets
|
|
|
16,791,155
|
|
|
19,042,648
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
597,522
|
|
|
1,039,783
|
|
Note
receivable
|
|
|
204,167
|
|
|
-
|
|
Other
assets, net
|
|
|
972,794
|
|
|
101,192
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
18,565,638
|
|
$
|
20,183,623
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
1,630,088
|
|
$
|
1,108,152
|
|
Accrued
expenses
|
|
|
457,459
|
|
|
471,746
|
|
Deferred
revenue
|
|
|
444,988
|
|
|
254,121
|
|
Promissory
note
|
|
|
300,000
|
|
|
-
|
|
Total
current liabilities
|
|
|
2,832,535
|
|
|
1,834,019
|
|
|
|
|
|
|
|
|
|
Promissory
note
|
|
|
-
|
|
|
300,000
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
Preferred
stock, par value $0.01 per share:
|
|
|
|
|
|
|
|
Authorized
shares—10,000,000; none issued and outstanding
|
|
|
-
|
|
|
-
|
|
Common
stock, par value $.01 per share:
|
|
|
|
|
|
|
|
Authorized
shares—50,000,000; issued and outstanding shares — 6,830,062 at December
31, 2004 and — 6,386,199 at December 31, 2003
|
|
|
68,301
|
|
|
63,862
|
|
Additional
capital
|
|
|
43,180,859
|
|
|
41,994,594
|
|
Accumulated
deficit
|
|
|
(27,516,057
|
)
|
|
(24,008,852
|
)
|
Total
stockholders’ equity
|
|
|
15,733,103
|
|
|
18,049,604
|
|
|
|
|
|
|
|
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
18,565,638
|
|
$
|
20,183,623
|
|
WQN,
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|
Year
ended December 31,
|
|
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
Retail
telephony revenue
|
|
$
|
9,036,354
|
|
$
|
9,152,320
|
|
Wholesale
telephony revenue and other
|
|
|
6,227,452
|
|
|
206,572
|
|
Total
revenue
|
|
|
15,263,806
|
|
|
9,358,892
|
|
|
|
|
|
|
|
|
|
Cost
of revenue
|
|
|
13,536,886
|
|
|
7,008,908
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
1,726,920
|
|
|
2,349,984
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
3,901,045
|
|
|
4,517,784
|
|
Merger
expenses
|
|
|
1,311,945
|
|
|
-
|
|
Depreciation
and amortization
|
|
|
796,426
|
|
|
921,900
|
|
Total
operating expenses
|
|
|
6,009,416
|
|
|
5,439,684
|
|
|
|
|
|
|
|
|
|
Operating
loss
|
|
|
(4,282,496
|
)
|
|
(3,089,700
|
)
|
|
|
|
|
|
|
|
|
Interest
income, net
|
|
|
287,709
|
|
|
202,187
|
|
Loss
from partnership investment
|
|
|
(55,757
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
|
(4,050,544
|
)
|
|
(2,887,513
|
)
|
|
|
|
|
|
|
|
|
Income
(loss) from discontinued operations
|
|
|
543,339
|
|
|
(457,879
|
)
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(3,507,205
|
)
|
$
|
(3,345,392
|
)
|
|
|
|
|
|
|
|
|
Income
(loss) per share - basic and diluted:
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
(0.61
|
)
|
$
|
(0.45
|
)
|
Discontinued
operations
|
|
|
0.08
|
|
|
(0.07
|
)
|
|
|
|
|
|
|
|
|
Income
(loss) per share
|
|
$
|
(0.53
|
)
|
$
|
(0.52
|
)
|
|
|
|
|
|
|
|
|
Weighted-average
common shares outstanding - basic and diluted
|
|
|
6,642,005
|
|
|
6,386,199
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
WQN,
INC. AND SUBSIDIARIES
|
|
Common
Stock
|
|
Additional
Capital
|
|
Accumulated
Deficit
|
|
|
|
|
|
Shares
|
|
Amount
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2002
|
|
|
6,386,199
|
|
$
|
63,862
|
|
$
|
41,994,594
|
|
$
|
(20,663,460
|
)
|
$
|
21,394,996
|
|
Net
loss
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(3,345,392
|
)
|
|
(3,345,392
|
)
|
Balance
at December 31, 2003
|
|
|
6,386,199
|
|
|
63,862
|
|
|
41,994,594
|
|
|
(24,008,852
|
)
|
|
18,049,604
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance
of warrants
|
|
|
-
|
|
|
-
|
|
|
76,000
|
|
|
-
|
|
|
76,000
|
|
Exercise
of stock options
|
|
|
443,863
|
|
|
4,439
|
|
|
1,110,265
|
|
|
-
|
|
|
1,114,704
|
|
Net
loss
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(3,507,205
|
)
|
|
(3,507,205
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2004
|
|
|
6,830,062
|
|
$
|
68,301
|
|
$
|
43,180,859
|
|
$
|
(27,516,057
|
)
|
$
|
15,733,103
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
WQN,
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|
Year
ended December 31,
|
|
|
|
2004
|
|
2003
|
|
Operating
Activities
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(3,507,205
|
)
|
$
|
(3,345,392
|
)
|
|
|
|
|
|
|
|
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
Gain
on sale of operations
|
|
|
(777,114
|
)
|
|
-
|
|
Depreciation
and amortization
|
|
|
796,426
|
|
|
921,900
|
|
Loss
on disposition of property and equipment, net
|
|
|
76,522
|
|
|
18,541
|
|
(Income)
loss in investment in partnership
|
|
|
55,757
|
|
|
-
|
|
Changes
in operating assets and liabilities net of effects of
acquisitions:
|
|
|
|
|
|
|
|
Accounts
receivable and notes receivable
|
|
|
(227,585
|
)
|
|
4,243
|
|
Accounts
payable and accrued expenses
|
|
|
283,649
|
|
|
237,297
|
|
Deferred
revenue
|
|
|
190,867
|
|
|
15,185
|
|
Other
assets
|
|
|
(1,122,886
|
)
|
|
(235,772
|
)
|
Net
cash used in operating activities of continuing operations
|
|
|
(4,231,569
|
)
|
|
(2,383,998
|
)
|
|
|
|
|
|
|
|
|
Investing
Activities
|
|
|
|
|
|
|
|
Additions
to property and equipment
|
|
|
(436,423
|
)
|
|
(405,389
|
)
|
Proceeds
from the sale of subsidiary net of disposed cash
|
|
|
417,915
|
|
|
-
|
|
Payments
received on note from the sale of subsidiary
|
|
|
145,833
|
|
|
-
|
|
Loan
to Ntera Holdings, Inc.
|
|
|
(2,000,000
|
)
|
|
-
|
|
Purchase
of partnership interest
|
|
|
(3,000,000
|
)
|
|
-
|
|
Net
cash used in investing activities
|
|
|
(4,872,675
|
)
|
|
(405,389
|
)
|
|
|
|
|
|
|
|
|
Financing
Activities
|
|
|
|
|
|
|
|
Proceeds
from exercise of stock options
|
|
|
1,114,704
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Decrease
in cash and cash equivalents
|
|
|
(7,989,540
|
)
|
|
(2,789,387
|
)
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at beginning of year
|
|
|
17,931,820
|
|
|
20,721,207
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at end of year
|
|
$
|
9,942,280
|
|
$
|
17,931,820
|
|
|
|
|
|
|
|
|
|
Supplemental
Disclosures of Cash Flow Information:
|
|
|
|
|
|
|
|
Interest
paid
|
|
$
|
4,538
|
|
$
|
4,692
|
|
Non-cash
note receivable from sale of subsidiary
|
|
$
|
700,000
|
|
$
|
-
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
WQN,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Years
ended December 31,
2004 and 2003
1.
Organization and Description of Business
We
are a
Voice Over Internet Protocol (“VoIP”) telephony company providing international
long distance services. VoIP enables voice communications over the Internet
by
compressing voice into data packets that can be efficiently transmitted over
data networks and then converted back into voice at the receiving end. Our
customers utilize our enhanced VoIP services platform to make and receive
calls
using their home phone, business phone, personal computer and mobile
phone.
Our
business currently includes the provision of enhanced Internet-based and
other
telephony services under various brand names to individual consumers primarily
seeking to make international calls; the provision of enhanced Internet-based
and other telephony services to resellers, corporations and service providers
under their brand names and carrier transmission services whereby we sell
our
excess capacity to other long-distance carriers. We also distribute telephony
services including prepaid long- distance and prepaid wireless through a
network
of over 90 private distributors. Through this network we estimate that our
products are sold through over 10,000 retail outlets of which more than 5,000
retail outlets are located in Southern California. We expect to begin selling
our proprietary VoIP products through this distribution channel beginning
in
2005.
As
of
December 31,
2004,
Eagle Venture Capital, LLC (“Eagle Venture”) owned approximately 2.6 million, or
38%, of our outstanding shares of common stock. Eagle Venture is primarily
owned
by B. Michael Adler, our founder and Chief Executive Officer.
In
November 2004, we changed our name to WQN, Inc. from WorldQuest Networks,
Inc. (see Note 18).
2.
Significant Accounting Policies
Use
of Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management
to
make estimates and assumptions that affect the reported amounts of assets
and
liabilities and disclosure of contingent liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Management believes the estimates used in preparing
the
financial statements are reasonable; however, actual results could differ
from
these estimates.
Principles
of Consolidation
The
consolidated financial statements include the accounts of the Company, its
subsidiaries and joint ventures in which the Company owns a controlling
interest. Investments in 20% to 50% owned partnerships and affiliates are
accounted for on the equity method. All significant intercompany balances
and
transactions have been eliminated in consolidation.
Reclassifications
Certain
reclassifications have been made to the 2003 financial statements to conform
to
the 2004 presentation.
Cash
Equivalents
Cash
equivalents include money market mutual funds and other highly liquid
investments purchased with maturities of three months or less.
Depreciation
and Amortization
Property
and equipment are recorded at cost and depreciated using the straight-line
method over the estimated useful lives of the assets. Amortization of capital
leases and leasehold improvements is provided on a straight line basis over
the
lives of the related assets or the life of the lease, whichever is shorter,
and
is included with depreciation expense. Maintenance repairs are charged to
operations as incurred. Gains and losses on the disposition of property and
equipment are recorded in the period incurred.
Depreciation
expense totaled $500,778 and $820,709 for 2004 and 2003, respectively.
Amortization expense totaled $295,648 for 2004 and $101,191 for 2003 for
continuing operations and $107,297 for 2004 and $153,863 for 2003 for
discontinued operations.
WQN,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Impairment
of Long-lived Assets
The
Company evaluates long-lived assets, including intangible assets, for impairment
whenever events or changes in circumstances indicate the carrying amount
of an
asset may not be recoverable and the undiscounted cash flows to be generated
by
these assets are less than the carrying amounts of these assets. For the
year
ended December 31,
2004
the Company determined that certain stored value equipment could no longer
be
used and recorded a non-cash impairment charge of approximately
$60,000.
Website
Development Costs
Costs
related to the planning and post implementation phases of our website
development efforts are expensed. Direct costs incurred in the development
phase
are capitalized and amortized over the product’s
estimated useful life of one to three years and are included in depreciation
expense. Costs associated with minor enhancements and maintenance for the
website are expensed. Website development costs capitalized for the years
ended
December 31,
2004
and 2003 were $243,986 and $190,000, respectively.
Income
Taxes
Income
taxes are determined using the liability method, which gives consideration
to
the future tax consequences associated with differences between the financial
accounting and tax basis of assets and liabilities. This method also gives
immediate effect to changes in income tax laws.
Revenue
Recognition
Retail
telephony revenue is recorded net of estimated returns and allowances and
is
recognized as calling services are used. Wholesale traffic revenue is recognized
as calls are processed. Revenue on the distribution of telephony products
is
included in wholesale telephony revenue, is recorded net of estimated returns
and allowances and is recognized when the products are shipped to the customer.
Distribution products are processed by other carriers therefore no future
service is provided by the Company.
Intangible
Assets
Intangible
assets consist primarily of acquired customer lists and are included in other
assets. Amortization is provided for by the straight-line method over the
assets
estimated life ranging from 2 to 4 years.
At
December 31,
2004
intangible assets totaled $972,794 net of accumulated amortization of $337,136.
The estimated aggregate amortization for each of the succeeding years is
as
follows: 2005 - $362,395, 2006 - $295,269, 2007 - $253,711, 2008 -
$61,419.
Investment
in Partnership
The
Company’s
investment in partnership is accounted for on the partnership basis of
accounting. Gains and losses are included in income (loss) from
partnership investment. The Company can receive a distribution on its partner
capital account by giving the partnership 60 days
written notice.
Notes
Receivable
Notes
receivable represent balances due from third parties related to the sale
of its
wholly-owned subsidiary buyindiaonline.com, Inc. and the merger agreement
with
Ntera Holdings. Interest earned on notes receivable are recognized over the
term
of the note and is included in interest income, net.
Advertising
Costs
The
Company expenses advertising costs as incurred. Advertising expense for the
years ended December 31,
2004
and 2003 was $467,000 and $334,000, respectively.
WQN,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Stock-Based
Compensation
The
Company has elected to follow Accounting Principles Board Opinion
No. 25,
“Accounting for Stock Issued to Employees,” in the primary financial statements
and has provided supplemental disclosures required by Statement of Financial
Accounting Standards No. 123,
“Accounting for Stock-Based Compensation” (“SFAS 123”) and by Statement of
Financial Accounting Standards No. 148,
“Accounting for Stock-Based Compensation -
Transition and Disclosure an amendment of FASB Statement No. 123.”
SFAS 123
requires the disclosure of pro forma net loss and loss per share computed
as if
the Company had accounted for its employee stock options under the fair value
method set forth in SFAS 123. The Company’s
reported and pro forma net loss for the years ending December 31, 2004 and
2003
are as follows:
|
|
Year
ended December 31,
|
|
|
|
2004
|
|
2003
|
|
Net
loss as reported
|
|
$
|
(3,507,205
|
)
|
$
|
(3,345,392
|
)
|
Pro
forma stock-based employee compensation expense
|
|
|
(202,499
|
)
|
|
(170,863
|
)
|
Pro
forma net loss
|
|
$
|
(3,376,470
|
)
|
$
|
(3,516,255
|
)
|
Net
loss per share:
|
|
|
|
|
|
|
|
As
reported - basic and diluted
|
|
$
|
(0.53
|
)
|
$
|
(0.52
|
)
|
Pro
forma - basic and diluted
|
|
$
|
(0.56
|
)
|
$
|
(0.55
|
)
|
The
fair
value of options granted was estimated at the date of grant using the
Black-Scholes option pricing model. The following weighted average assumptions
used in the December 31,
2004
calculation were as follows: risk free interest rate of 3.5%, dividend yield
of
zero, volatility factor of 1.1, and average expected life of 4 years.
The weighted average assumptions used in the December 31,
2003
calculation were as follows: risk free interest rate of 3.25%, dividend yield
of
zero, volatility of .85 and average expected life of 5 years.
The options granted during 2004 and 2003 had a weighted average fair value
of
$1.50 and $1.40 per share, respectively.
Net
Loss per Share
Basic
and
diluted net loss per share is computed using the Company’s
net
loss for each period presented divided by the average common shares outstanding
during the period. Stock options and warrants convertible into 1,267,759
and
1,790,556 shares of the Company’s
common
stock for the years ended December 31,
2004
and 2003, respectively, are excluded from the calculation of diluted earning
per
share because the Company reported losses from continuing operations in those
periods and their effect would be antidilutive.
Comprehensive
Income
Comprehensive
income is defined as the change in equity of a business enterprise during
a
period from transactions and other events and circumstances from non-owner
sources. For the years ended December 31,
2004
and 2003, the Company had no transactions other than those reported in its
statement of operations.
Fair
Value of Financial Instruments
The
Company’s
financial instruments consist primarily of cash equivalents, accounts and
notes
receivable, accounts payable and long-term debt. At December 31,
2004
and 2003, the carrying amount of the Company’s
financial instruments approximates their fair values. Management believes
the
Company’s
debt
approximates fair value due to its short maturity and its variable interest
rate.
Concentration
of Credit and Business Risks
Financial
instruments that potentially subject the Company to concentrations of credit
risk consist primarily of cash equivalents, accounts receivable and notes
receivable. Accounts receivable consist of amounts owed by credit card
processing companies relating to retail telephony sales, amounts owed by
distributors for the purchase of telephony products and money transfer services.
We bill our retail customers on a prepaid basis through credit cards. Credit
is
extended to some wholesale customers with terms that generally allow them
to pay
for our products within two weeks. All other wholesale customers pay for
our
products upfront.
WQN,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Concentration
of Credit and Business Risks (Continued)
Customers
purchase the Company’s
retail
telephony products using major credit cards, which are reimbursed by credit
card
processing companies. The Company does not routinely perform on-going credit
evaluations of its retail customers but does evaluate its credit card
processors. The Company performs credit evaluations and establishes credit
limits for its wholesale traffic and whole sale distribution customers,
including requiring deposits when applicable.
For
the
years ended December 31,
2004
and 2003, a substantial portion of our retail customers were calling from
the
United States to India. The India international telephony market continues
to
experience downward pricing pressures, which has resulted in a decrease in
our
average selling price to our retail customers. It is unlikely that this trend
will reverse in the near future.
At
December 31,
2004,
one customer accounted for 19% of total accounts receivable and no receivables
from credit card processing companies accounted for more than 10% of total
accounts receivable. At December 31,
2003,
three credit card processing companies accounted for 35%, 13%, and 10% of
total
accounts receivable. At December 31,
2004
and 2003, accounts receivable are stated net of an allowance for doubtful
accounts of $25,000. Bad debt expense for the years ended December 31,
2004
and 2003 was $189,000 and $83,000, respectively. For the year ended
December 31,
2004,
the Company purchased data communication and telecommunication services from
three suppliers, which accounted for 18%, 13% and 11% of cost of goods sold
for
telecommunication services. For the year ended December 31,
2003,
the Company purchased data communication and telecommunication services from
three suppliers, which accounted for 35%, 18%, and 11% of cost of goods sold
for
telecommunication services.
New
Accounting Pronouncements
In
December 2004,
FASB issued statement of Financial Accounting standards No. 123
(revised 2004), Share-Based Payment (SFAS 123R), which will be effective
in our
first quarter of fiscal 2006. This standard sets forth the revised rules
for the
accounting treatment of employee stock options and other share-based payments.
SFAS 123(R) requires the adoption a fair value-based method for measuring
the
compensation expense related to employee stock awards; this will lead to
additional compensation expense. We currently use the intrinsic value method
to
measure compensation expense for stock-based awards to our employees. Under
this
standard, we do not recognize any compensation related to stock option grants
we
issue under our stock option plans. Note 2 to our Consolidated Financial
Statements in this report provides our pro forma net loss and loss per share
as
if we had used a fair value-based method required under SFAS 123 to measure
the
compensation expense for employee stock awards during fiscal 2004 and 2003.
The
Company has not yet determined the full effect of implementing SFAS 123R
on the
financial statements.
3.
Discontinued Operations
In
July 2004,
the
Company sold all of the outstanding capital stock of its wholly-owned subsidiary
buyindiaonline.com, Inc. (“Cash2India”) to a private company for approximately
$1,552,000. The Cash2India business comprised the Company’s
previously reported financial services segment and is accounted for as a
discontinued operation in the accompanying condensed consolidated financial
statements. Under the terms of the transaction, the Company received $852,000
in
cash, a promissory note for $700,000, and a warrant to purchase common stock
in
the acquiring company. The cash payment included consideration for $352,000
in
working capital associated with Cash2India at the time of the sale. The
promissory note bears interest at 5% per annum, is secured by the capital
stock
of Cash2India, and is to be repaid in twenty-four consecutive monthly payments
of $29,167 plus accrued interest. The balance of the promissory note and
accrued
interest was $554,167 as of December 31,
2004.
As a result of the transaction the Company recorded a gain on the disposition
of
Cash2India of approximately $777,000 in the third quarter of 2004. The net
gain/(loss) from discontinued operations is comprised as follows:
WQN,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
3.
Discontinued Operations (Continued)
|
|
Year
ended December 31,
|
|
|
|
2004
|
|
2003
|
|
Revenue
|
|
$
|
340,027
|
|
$
|
556,462
|
|
Cost
of revenue
|
|
|
(134,969
|
)
|
|
(200,880
|
)
|
Gross
profit
|
|
|
205,058
|
|
|
(355,582
|
)
|
Operating
Expenses
|
|
|
(438,833
|
)
|
|
(813,461
|
)
|
Net
loss
|
|
|
(233,775
|
)
|
|
(457,879
|
)
|
Gain
on disposal
|
|
|
777,114
|
|
|
-
|
|
Income
(loss) from discontinued operations
|
|
$
|
543,339
|
|
$
|
(457,879
|
)
|
|
|
2004
|
|
2003
|
|
Cash
and cash equivalents
|
|
$
|
-
|
|
$
|
514,635
|
|
Accounts
receivable
|
|
|
-
|
|
|
409,717
|
|
Prepaid
expenses and other current assets
|
|
|
-
|
|
|
71,988
|
|
Property
and equipment, net
|
|
|
-
|
|
|
236,308
|
|
Accounts
payable and accrued expenses
|
|
|
-
|
|
|
(210,658
|
)
|
|
|
$ |
- |
|
$
|
1,021,990
|
|
4.
Merger Agreement with Ntera Holdings
On
March 16,
2004,
the Company entered into an Agreement and Plan of Merger (the “Agreement”) with
Ntera Holdings, Inc., a Delaware corporation (“Ntera”), providing for a
transaction that would have resulted in a change of control of WQN. In
connection with the Agreement, WQN extended to Ntera a bridge loan in the
principal amount of $2 million
bearing interest of 7% per annum, which is secured by the assets of Ntera.
On
September 2,
2004,
the Company terminated the Agreement with Ntera. Under the terms of the loan
agreement, the full amount of the loan and accrued interest are due and payable
within six months of the termination of the Agreement. The Company and Ntera
have amended the repayment provisions of the loan agreement whereby Ntera
will
make installment payments to repay the loan and accrued interest by
March 31,
2005.
The balance of the note and accrued interest at December 31,
2004
was $2,058,679, which is net of a payment of approximately $56,000 received
during 2004 in the form of telecommunication services. During the first quarter
of 2005, the Company received debt payments from Ntera totaling $1,650,000.
The
unpaid principal and interest as of March 1,
2005
from Ntera was $408,679 and is expected to be collected on its due date.
The
loan is secured by the assets of Ntera.
5.
Value Communications Transaction
In
April 2004,
the
Company purchased from Value Communications Corporation (“ValuCom”), a wholly
owned subsidiary of Rediff.com India Limited, certain assets consisting
primarily of ValuCom’s
customer list, brand, trademarks, web sites, internally built software, and
certain hardware for $500,000 in order to increase its customer base. The
Company paid $200,000 of the total consideration at closing with the remaining
$300,000 to be paid in twelve monthly installments of $25,000 commencing
May 2004.
In
addition, the Company entered into an advertising agreement with Rediff.com,
Inc. (“Rediff”) entitling WQN to marketing services including exclusive rights
to prominent online advertising space on the Rediff.com U.S. website, the
premier online destination for Indians in North America. Under the terms
of the
advertising agreement, the Company will pay Rediff $50,000 for twelve
consecutive months commencing in May 2004 for the advertising services. The
Company provided both ValuCom and Rediff irrevocable letters of credit for
the
Company’s
remaining obligation under the agreements. The letters of credit are secured
by
deposits in money market funds and the amount of the letters of credit and
the
deposits are reduced as the monthly installments are paid. At
December 31,
2004,
the Company’s
obligation under both the agreements totaled $300,000. Substantially all
of the
ValuCom purchase consideration was allocated to customer lists, which is
included in other assets and is being amortized over four years.
WQN,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
6.
Distribution and Marketing Agreement
In
September 2004,
we
entered into a distribution and marketing agreement with a privately held
company. As a result of the agreement, the Company’s
products will be sold in more than 5,000 retail outlets in the Southern
California market. We sell telephony and other products to a network of
distributors who then re-sell the product to the retail outlets. The revenues
generated through this agreement are included in wholesale telephony revenues.
In connection with the agreement, we paid the private company $50,000 and
issued
a warrant to purchase 40,000 shares of our common stock for a total
consideration of approximately $126,000 as valued with the Black-Scholes
pricing
model which is included in other assets and is being amortized over the three
year term of the agreement. The warrants exercise price is $0.01.
7.
Investment in Partnership
In
November 2004,
the
Company invested $3 million
in a partnership managed by an affiliate of a director of the Company. The
majority of the partnership assets are to be invested in private investments
in
public entities. The partnership investments will take the form of common
equity, preferred equity, convertible debt and/or equity or debt securities.
Although the partnership will endeavor to engage in hedging transactions
in
order to mitigate downside risk, there can be no assurance that the
partnership’s
investments will be successful and, as a result, the Company may lose all
or
some of its investment. The partnership agreement contains certain restrictions,
including limits on the Company’s
ability
to withdraw capital from the partnership and limits on the transferability
of
the Company’s
interests in the partnership. The Company can receive a distribution on its
partner capital account by giving the partnership 60 days
written notice. The Company records its proportionate share of earnings and
losses from the partnership based on its share of the partnership and for
the
year ended December 31,
2004
recorded a loss from its partnership investment of $55,757.
8.
Notes Receivable
Components
of notes receivable are as follows:
|
|
2004
|
|
2003
|
|
Loan
to Ntera Holdings, Inc.
|
|
$
|
2,058,679
|
|
$
|
-
|
|
Note
from sale of Cash2India subsidiary
|
|
|
554,167
|
|
|
-
|
|
Less
amounts classified as current
|
|
|
(2,408,679
|
)
|
|
-
|
|
Long-term
portion
|
|
$
|
204,167
|
|
$
|
-
|
|
During
2004, in connection with the Agreement and plan of merger with Ntera Holding
Inc., WQN extended to Ntera a bridge loan in the principal amount of
$2 million
bearing interest of 7% per annum (see Note 4). The balance of the note and
accrued interest at December 31,
2004
was $2,058,679. The full amount of the loan and accrued interest are to be
repaid in installments by March 31,
2005.
During the first quarter of 2005 the Company has received debt payments from
Ntera totaling $1,650,000. The unpaid principal and interest as of
March 1,
2005
from Ntera was $408,679. The loan is secured by the assets of
Ntera.
In
July 2004,
the
Company sold all of the outstanding capital stock of its wholly-owned subsidiary
Cash2India and received as a component of the purchase price a promissory
note
for $700,000 (See Note 3). The promissory note bears interest at 5% per annum,
is secured by the capital stock of Cash2India, and is to be repaid in
twenty-four consecutive monthly payments of $29,167 plus interest. During
2004,
the Company received principal and interest payments of $159,290 and the
balance
of the promissory note and accrued interest was $554,167 as of December 31,
2004.
WQN,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
9.
Prepaid Expenses and Other Current Assets
Prepaid
expenses and other current assets consist of the following as of
December 31:
|
|
2004
|
|
2003
|
|
Prepaid
telecommunication services
|
|
$
|
534,181
|
|
$
|
33,222
|
|
Deposits
|
|
|
151,781
|
|
|
316,936
|
|
Prepaid
expenses
|
|
|
120,106
|
|
|
207,419
|
|
|
|
$
|
806,068
|
|
$
|
557,577
|
|
10.
Property and Equipment
Property
and equipment consists of the following as of December 31:
|
|
Estimated
Useful Life (Years)
|
|
2004
|
|
2003
|
|
Leasehold
improvements
|
|
|
2
to 5
|
|
$
|
78,134
|
|
$
|
78,134
|
|
Computers
and network equipment
|
|
|
2
to 5
|
|
|
3,871,060
|
|
|
3,797,148
|
|
Furniture
and fixtures
|
|
|
5
|
|
|
86,308
|
|
|
87,196
|
|
Purchased
software and website development costs
|
|
|
1
to 5
|
|
|
865,755
|
|
|
1,315,622
|
|
Total
|
|
|
|
|
|
4,901,257
|
|
|
5,278,100
|
|
Less:
accumulated depreciation and amortization
|
|
|
|
|
|
(4,303,735
|
)
|
|
(4,238,317
|
)
|
Net
property and equipment
|
|
|
|
|
$
|
597,522
|
|
$
|
1,039,783
|
|
Property
and equipment balances at December 31,
2003
are inclusive of assets of our discontinued operation, Cash2India (see note
3
for a detail of the components of net assets of discontinued operations).
For
the years ended December 31,
2004
and 2003 the Company recorded losses of $16,522 and $18,541, respectively
on the
disposal of certain fixed assets.
11.
Accrued Expenses
Accrued
expenses consist of the following as of December 31:
|
|
2004
|
|
2003
|
|
Accrued
franchise, property and sales taxes
|
|
$
|
44,471
|
|
$
|
130,608
|
|
Accrued
payroll expenses
|
|
|
67,467
|
|
|
62,115
|
|
ValuCom
payable
|
|
|
300,000
|
|
|
-
|
|
Other
accrued expenses
|
|
|
45,521
|
|
|
279,023
|
|
|
|
$
|
457,459
|
|
$
|
471,746
|
|
12.
Debt
Long-term
debt consists of the following as of December 31:
|
|
2004
|
|
2003
|
|
Promissory
note
|
|
$
|
300,000
|
|
$
|
300,000
|
|
Less
current portion
|
|
|
(300,000
|
)
|
|
-
|
|
Long
term debt net of current portion
|
|
$
|
-
|
|
$
|
300,000
|
|
WQN,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
12.
Debt (Continued)
In
2001,
the Company borrowed $300,000 from a financial institution under a term
promissory note agreement (the “Note”). The Note bears interest at the financial
institution’s
prime
rate as adjusted from time to time (5.25% at December 31,
2004)
less 2.25% per annum. The Note, originally due in October 2003
was
extended and is now due in October 2005.
The
Note is collateralized by a $300,000 certificate of deposit bearing interest
of
1.47 % per annum.
13.
Related Party Transactions
The
Company’s
founder, Chief Executive Officer and President holds a controlling interest
in
Eagle Venture Capital, which owns approximately 2.6 million
outstanding shares of the common stock of the Company as of December 31,
2004
and 2003.
A
consulting company managed by one of the Company’s
directors holds warrants to acquire 100,000 shares of the Company’s
common
stock. The warrants have an exercise price of $6.00 per share and expire
in
2005.
In
November 2004,
the
Company invested $3 million
in a partnership managed by an affiliate of a director of the Company (see
Note 7). Certain other company directors and officers have also invested
separately in the partnership.
14.
Income Taxes
Deferred
income taxes reflect the net tax effects of temporary differences between
the
carrying amounts of assets and liabilities for financial reporting purposes
and
the amounts used for income tax purposes. Significant components of deferred
tax
assets and liabilities are as follows as of December 31:
|
|
2004
|
|
2003
|
|
Deferred
tax assets/(liability):
|
|
|
|
|
|
|
|
Property
and equipment
|
|
$
|
21,265
|
|
$
|
(35,341
|
)
|
Capital
loss carry forward
|
|
|
195,941
|
|
|
195,941
|
|
Other
|
|
|
66,162
|
|
|
29,075
|
|
Net
operating loss carry forwards
|
|
|
9,281,128
|
|
|
9,292,073
|
|
Total
deferred tax assets
|
|
|
9,564,496
|
|
|
9,481,748
|
|
Valuation
allowance
|
|
|
(9,564,496
|
)
|
|
(9,481,748
|
)
|
Net
deferred tax assets
|
|
$
|
-
|
|
$
|
-
|
|
The
Company has U.S. net
operating loss carry forwards of approximately $25,104,000 as of
December 31, 2004. The Company has not recognized a deferred tax asset in
the accompanying balance sheets due to the uncertainty of future realization.
Accordingly, no tax benefit has been recognized in the accompanying consolidated
statements of operations. Net operating loss carry forwards associated with
the
sale of our Cash2India subsidiary of approximately $2,900,000 have not been
included in the deferred tax assets at December 31, 2004. No other
significant reconciling items exist between the actual effective tax rate
and
the expected effective tax rate. During 2004 and 2003, the valuation allowance
increased by approximately $83,000 and $1,232,000, respectively. If unused,
accumulated net operating losses expire as follows: 2011 - $214,000; 2012
-
$1,531,000; 2018 - $1,447,000; 2019 - $1,999,000; 2020 - $4,628,000; 2021
-
$8,210,000; 2022 - $3,828,000; 2023 - $3,247,000.
15.
Stockholders’ Equity
Common
and Preferred Stock
The
Company’s
authorized share capital consists of 50,000,000 shares of common stock with
par
value of $0.01 per share, and 10,000,000 shares of preferred stock with par
value of $0.01 per share.
WQN,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Warrants
At
December 31,
2004
and 2003, the Company had outstanding warrants to purchase 414,775 and 720,775
shares of its common stock, respectively. These warrants expire
March 2005
through July 2006 and have a weighted average exercise price of $16.98 per
share. At December 31,
2004,
all of the warrants were exercisable. The warrants outstanding include warrants
granted to a consulting company managed by one of the Company’s
directors to acquire 100,000 shares of common stock (see Note 13); warrants
granted to representatives of the Company’s
underwriters in connection with the Company’s
initial
public offering to acquire 275,000 shares of common stock; and warrants granted
to various service providers and others to acquire 39,775 shares of common
stock. In 2004, we issued warrants to purchase 40,000 shares of our common
stock
to a privately held company in connection with a distribution and marketing
agreement (see Note 6).
Stock
Options
The
Company has stock option plans (the “Plans”) under which the Company may grant
Directors and key employees options to purchase up to 1,750,000 shares of
the
Company’s
common
stock at an amount at least equal to the fair value of the Company’s
common
stock on the date of grant. The exercise and vesting period of each option
is
determined by the Company’s
board
of directors, but no option shall have a term longer than 10 years.
Options granted under the Plans are non-qualified stock options. The following
table summarizes the employee stock option transactions for the years ended
December 31,
2004
and 2003 under the Plans:
|
|
Number
of Shares
|
|
Weighted
Average Exercise Price
|
|
Outstanding
at December 31, 2002
|
|
|
886,080
|
|
$
|
4.05
|
|
Granted
|
|
|
55,000
|
|
|
2.04
|
|
Exercised
|
|
|
—
|
|
|
0.00
|
|
Cancelled
|
|
|
(39,166
|
)
|
|
3.82
|
|
Outstanding
at December 31, 2003
|
|
|
901,914
|
|
$
|
3.93
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
265,500
|
|
|
2.65
|
|
Exercised
|
|
|
(275,996
|
)
|
|
2.51
|
|
Cancelled
|
|
|
(38,434
|
)
|
|
2.10
|
|
Outstanding
at December 31, 2004
|
|
|
852,984
|
|
$
|
4.11
|
|
|
|
|
|
|
|
|
|
Options
exercisable:
|
|
|
|
|
|
|
|
December
31, 2003
|
|
|
794,258
|
|
|
4.18
|
|
December
31, 2004
|
|
|
662,486
|
|
$
|
4.57
|
|
A
summary
of stock options under the Plans outstanding as of December 31,
2004
are as follows:
|
|
Options
Outstanding
|
|
Options
Exercisable
|
|
Range
of Exercise Prices
|
|
Shares
|
|
Weighted-Average
Remaining Life (Years)
|
|
Weighted-Average
Exercise Price
|
|
Shares
|
|
Weighted
Average Exercise Price
|
|
$1.00
- 1.99
|
|
|
145,000
|
|
|
6.59
|
|
$
|
1.31
|
|
|
95,000
|
|
$
|
0.99
|
|
$2.00
- 2.99
|
|
|
426,984
|
|
|
5.02
|
|
|
2.25
|
|
|
341,486
|
|
|
2.19
|
|
$3.00
- 3.99
|
|
|
155,500
|
|
|
3.46
|
|
|
3.16
|
|
|
100,500
|
|
|
3.21
|
|
$5.00
- 11.00
|
|
|
25,000
|
|
|
2.6
|
|
|
5.75
|
|
|
25,000
|
|
|
5.75
|
|
$13.00
- 14.00
|
|
|
35,000
|
|
|
1.9
|
|
|
13.00
|
|
|
35,000
|
|
|
13.00
|
|
$19.00
- 20.00
|
|
|
60,000
|
|
|
2.24
|
|
|
19.13
|
|
|
60,000
|
|
|
19.13
|
|
$21.00
- 22.00
|
|
|
5,500
|
|
|
2.22
|
|
|
21.63
|
|
|
5,500
|
|
|
21.63
|
|
Total
|
|
|
852,984
|
|
|
4.59
|
|
|
4.11
|
|
|
662,486
|
|
|
4.57
|
|
WQN,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Stock
Options (Continued)
In
December 1998,
the
Company issued options outside of the option plans to purchase 167,867 shares
of
its common stock to a former officer of the Company at an exercise price
of
$3.33 with a seven-year term. During 2004 all of these options were
exercised.
16.
Benefit Plan
The
Company has a 401(k) benefit plan. The plan provides for voluntary employee
contributions and the Company matches 15% of the first 8% of payroll contributed
by the employee. Employees become 100% vested in employment contributions
after
2 years
of
service accruing 50% per year of service. For the years ended
December 31,
2004
and 2003, the Company’s
plan
contributions were $3,400 and $5,400, respectively.
17.
Commitments
The
Company has operating leases relating principally to office facilities, which
expire in 2006 and have future minimum lease commitments under operating
leases
with remaining non-cancelable lease terms in excess of one year at
December 31,
2004:
2005 - $112,500; 2006 - $75,000. Rental expense under operating leases was
approximately $113,000 and $138,000 for the years ended December 31, 2004
and
2003, respectively.
In
September 2004,
the
Company settled a dispute with a vendor from which it had previously purchased
telecommunication services. Under the terms of the settlement, the Company
agreed to purchase from the vendor a total of $960,000 in telecommunication
services at rates less than the Company is paying for similar services over
a
fourteen month period. The Company must purchase a minimum of $80,000 per
month
in services beginning four months after the settlement date.
18.
Contingencies
In
December 1996, the Company applied to the United States Patent and
Trademark Office to register the trademarks: “WorldQuest” and “WorldQuest
Networks.” We received a registration for the trademark “WorldQuest” from the
U.S. Patent and Trademark Office on November 23,
1999.
In October 1997,
the
Patent and Trademark Office issued a notice of publication regarding our
application to register “WorldQuest Networks” as a trademark. In response to
that notice, Qwest Communications filed a notice of opposition in
September 1998.
Qwest Communications instituted a cancellation proceeding in the Patent and
Trademark Office for the registered trademark “WorldQuest.” In
December 2001,
a
judgment was made in the Company’s
favor
whereby Qwest’s
motion
to cancel our “WorldQuest” trademark was dismissed, however, Qwest filed a
motion appealing the judgment. In December 2002,
Qwest filed a separate complaint stating that the Company’s
prepaid
cash card product infringes on the Qwest trademark. In February 2003,
the
companies settled all outstanding claims whereby WorldQuest received a cash
payment and telecommunication services (primarily long distance termination)
from Qwest and Qwest retained all rights to the trademarks in question. Pursuant
to the term of a settlement agreement with Qwest Communications arising out
of a
trademark dispute, on November 9,
2004
the Company changed its name to WQN, Inc. from WorldQuest Networks,
Inc.
The
Company is a defendant from time to time in lawsuits and disputes arising
in the
ordinary course of business. The Company believes
that resolution of all known contingencies is uncertain, and there can be
no
assurance that future costs related to such litigation would not be material
to
the Company’s financial position or results of operations.
19.
Interest Income, Net
Interest
income for the years ended December 31,
2004
and 2003 was $293,000 and $207,000, respectively. Interest income includes
$114,778 interest on the Ntera loan and $13,457 interest on the loan received
in
connection with the sale of the Company’s
financial service subsidiary. Interest expense for the years ended
December 31,
2004
and 2003 was $5,000 and $5,000, respectively.
20.
Subsequent Events
On
October 5, 2005, the Company sold substantially all of its operating assets
and
liabilities to VoIP, Inc. Proceeds from the sale consisted of a $3.7 million
note payable which is convertible into VoIP, Inc. common stock, 1,300,000
shares
of VoIP, Inc.'s common stock, and 5,000,000 warrants to purchase VoIP, Inc's
common stock at $0.001 per share which were exercised in January
2006.
WQN,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
20.
Subsequent Events (Continued)
On
July
3, 2006, the Company's securities were delisted from The Nasdaq National
Market
("Nasdaq") Listing Qualifications Panel (the “Panel”). This action was a result
of the Panel determining that the Company had not met the requirement that
it be
current in its required reporting obligations under Nasdaq Rule 430(c)(14),
principally because of the Company's failure to file its Form 10-QSB for
the
quarter ended March 31, 2006 and because Nasdaq determined that the Company
is a
"public shell," which, in Nasdaq's determination, could be detrimental to
the
interests of the investing public under Nasdaq Rule 4300.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of
1934, the registrant has duly caused this report to be signed on its behalf
by
the undersigned, thereunto duly authorized, in the City of Altamonte Springs,
State of Florida, on April 2, 2007.
|
|
|
|
VOIP,
INC. |
|
|
|
|
By: |
/s/
Anthony J. Cataldo |
|
Anthony
J. Cataldo |
|
Chief
Executive Officer |
Date:
|
April 2,
2007 |
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the registrant and in
the
capacities and on the dates indicated.
|
|
|
|
By: |
/s/
Anthony J. Cataldo |
|
Anthony
J. Cataldo |
|
Chief
Executive Officer |
|
|
Date:
|
April 2,
2007 |
|
|
|
|
By: |
/s/
Shawn Lewis |
|
Shawn
M. Lewis |
|
Chief
Operating Officer |
|
|
Date:
|
April 2,
2007 |
|
|
|
|
By: |
/s/
Robert Staats |
|
Robert
V. Staats |
|
Chief
Accounting Officer |
|
|
Date:
|
April 2,
2007 |
|
|
|
|
By: |
/s/
Gary Post |
|
Gary
Post |
|
Director |
|
|
Date:
|
April 2,
2007 |
|
|
|
|
By: |
/s/
Stuart Kosh |
|
Stuart
Kosh |
|
Director |
|
|
Date:
|
April 2,
2007 |
|
|
|
|
By: |
/s/
Nicholas A. Iannuzzi, Jr. |
|
Nicholas
A. Iannuzzi, Jr. |
|
Director |
|
|
Date:
|
April 2,
2007 |