UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
DC 20549
FORM
10-Q
(Mark
one)
x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE
ACT OF 1934
For
the
quarterly period ended March 31, 2007
or
TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
OF
1934
For
the
transition period from _________ to ________
Commission
File Number: 000-28985
VoIP,
Inc.
(Exact
name of issuer as specified in its charter)
Texas
|
75-2785941
|
(State
or other jurisdiction of incorporation or organization)
|
(I.R.S.
Employer Identification No.)
|
151
So. Wymore Rd, Suite 3000, Altamonte Springs, FL 32714
(Address
of principal executive offices)
(407)
398-3232
(Issuer's
telephone number)
Indicate
by check whether the registrant (1) filed all reports required to be filed
by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the
past
90 days. YES x
NO
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer
o
Accelerated filer
o
Non-accelerated filer
x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
126-2 of the Exchange Act). YES o
NO
x
State
the
number of shares outstanding of each of the issuer's classes of common equity
as
of the latest practicable date: May 14, 2007: 143,757,172.
VoIP,
Inc.
Form
10-Q for the Quarter Ended March 31, 2007
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Page
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Part
I - Financial Information
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Item
1
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Financial
Statements
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3
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Item
2
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Management's
Discussion and Analysis of Financial Condition and Results of
Operations
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20
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Item
3
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Qualitative
and Quantitative Disclosures About Market Risk
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29
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Item
4
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Controls
and Procedures
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29
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Part
II - Other Information
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Item
1
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Legal
Proceedings
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32
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Item
1. A
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Risk
Factors
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Item
2
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Unregistered
Sales of Equity Securities and Use of Proceeds
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Item
3
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Defaults
upon Senior Securities
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Item
4
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Submission
of Matters to a Vote of Security Holders
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Item
5
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Other
Information
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Item
6
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Exhibits
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Signatures
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PART
I - FINANCIAL INFORMATION
ITEM
1. FINANCIAL STATEMENTS
VoIP,
Inc.
Consolidated
Balance Sheets
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March
31,
2007
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December
31,
2006
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(Unaudited)
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ASSETS
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Current
assets:
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Cash
and cash equivalents
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$
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70,276
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$
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90,172
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Accounts
receivable, net of allowance for doubtful accounts
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of
$190,933 and $113,653, respectively
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497,136
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439,818
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Due
from related parties
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42,789
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31,227
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Prepaid
expenses and deposits
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777,677
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716,021
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Assets
from discontinued operations
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110,823
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-
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Total
current assets
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1,498,701
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1,277,238
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Property
and equipment, net
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6,451,645
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6,860,233
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Goodwill
and other intangible assets
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31,908,793
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32,687,822
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Other
assets
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45,386
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99,828
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TOTAL
ASSETS
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$
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39,904,525
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$
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40,925,121
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LIABILITIES
AND SHAREHOLDERS' EQUITY
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Current
liabilities:
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Accounts
payable
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$
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8,896,960
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$
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8,219,743
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Accrued
expenses
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5,083,975
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4,853,007
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Loans
payable
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193,750
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2,574,835
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Convertible
notes payable
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13,480,185
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9,576,592
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Fair
value liability for warrants
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-
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5,102,731
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Nonregistration
penalties and other stock-based payables
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7,113,382
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4,748,380
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Accrued
litigation charges
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2,012,350
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1,054,130
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Notes
and advances from investors
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300,000
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616,667
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Note
payable - related party
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300,000
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-
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Net
liabilities from discontinued operations
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-
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354,398
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Other
current liabilities
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491,738
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557,153
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Total
current liabilities
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37,872,340
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37,657,636
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Other
liabilities
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199,597
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222,669
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TOTAL
LIABILITIES
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38,071,937
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37,880,305
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Shareholders'
equity:
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Common
stock - $0.001 par value;
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400,000,000
shares authorized; 98,609,701 shares
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issued
and outstanding, both periods
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98,610
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98,610
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Preferred
stock - $0.001 par value; 25,000,000 shares
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authorized
at March 31, 2007; none issued or outstanding
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-
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-
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Additional
paid-in capital
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91,220,894
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78,942,818
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Accumulated
deficit
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(89,486,916
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)
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(75,996,612
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)
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Total
shareholders' equity
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1,832,588
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3,044,816
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TOTAL
LIABILITIES AND SHAREHOLDERS' EQUITY
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$
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39,904,525
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$
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40,925,121
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The
accompanying notes are an integral part of these consolidated financial
statements.
VoIP
Inc.
Consolidated
Statements of Operations (Unaudited)
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Three
Months Ended March 31
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2007
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2006
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Revenues
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$
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3,189,543
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$
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4,700,400
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Cost
of sales
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3,054,571
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5,419,430
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Gross
profit (loss)
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134,972
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(719,030
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)
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Operating
expenses
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Compensation
and related expenses
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1,668,531
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2,950,007
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Commissions
and fees to third parties
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130,500
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1,072,225
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Professional,
legal and consulting expenses
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1,507,345
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1,584,947
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Depreciation
and amortization
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1,223,432
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1,526,014
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General
and administrative expenses
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371,040
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1,143,404
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Total
operating expenses
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4,900,848
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8,276,597
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Loss
from continuing operations before income taxes
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(4,765,876
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)
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(8,995,627
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)
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Other
expenses:
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Interest
expense
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2,520,582
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1,504,448
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Financing
penalties and expenses
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2,274,896
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342,609
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Increase
in fair value liability for warrants
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3,550,551
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1,281,278
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Litigation
charges
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1,043,620
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710,000
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Total
other expenses
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9,389,649
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3,838,335
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Loss
before income taxes and results of
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discontinued
operations
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(14,155,525
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)
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(12,833,962
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)
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Provision
for income taxes
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-
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-
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Net
loss before discontinued operations
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(14,155,525
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)
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(12,833,962
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)
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Gain
(loss) from discontinued operations,
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net
of income taxes
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665,221
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(973,072
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)
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Net
loss
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|
$
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(13,490,304
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)
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$
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(13,807,034
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)
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Basic
and diluted loss per share:
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Loss
before discontinued operations
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$
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(0.15
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)
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$
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(0.20
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)
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Gain
(loss) from discontinued operations,
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|
|
|
|
|
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net
of income taxes
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|
0.01
|
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|
(0.01
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)
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Net
loss per share
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|
$
|
(0.14
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)
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$
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(0.21
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)
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Weighted
average number of shares outstanding
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98,609,701
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65,587,424
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The
accompanying notes are an integral part of these consolidated financial
statements.
VoIP,
Inc.
Consolidated
Statements of Cash Flows (Unaudited)
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Three
Months Ended March 31
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2007
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2006
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CASH
FLOWS FROM OPERATING ACTIVITIES
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Continuing
operations:
|
|
|
|
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Net
loss
|
|
$
|
(14,155,525
|
)
|
$
|
(12,833,962
|
)
|
Adjustments
to reconcile net loss to net cash used
in operating activities:
|
|
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|
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Depreciation
and amortization
|
|
|
1,223,432
|
|
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1,530,088
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Common
shares issued for services
|
|
|
327,000
|
|
|
1,844,234
|
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Options
and warrants issued for services and compensation
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|
|
952,212
|
|
|
1,819,056
|
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Amortization
of debt discounts
|
|
|
2,099,699
|
|
|
1,177,051
|
|
Increase
in fair value liability for warrants
|
|
|
3,550,551
|
|
|
1,281,278
|
|
Noncash
nonregistration penalties
|
|
|
1,392,737
|
|
|
-
|
|
Noncash
litigation charges
|
|
|
1,043,620
|
|
|
-
|
|
Noncash
financing and interest expense
|
|
|
297,563
|
|
|
-
|
|
Provision
for bad debt
|
|
|
18,581
|
|
|
16,684
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(75,899
|
)
|
|
1,046,096
|
|
Due
from related parties
|
|
|
(11,562
|
)
|
|
152,083
|
|
Inventory
|
|
|
-
|
|
|
545,349
|
|
Prepaid
expenses and deposits
|
|
|
(61,656
|
)
|
|
(43,602
|
)
|
Accounts
payable and accrued expenses
|
|
|
647,091
|
|
|
(1,228,648
|
)
|
Nonregistration
penalties and other stock-based payables
|
|
|
645,265
|
|
|
-
|
|
Accrued
litigation charges
|
|
|
(69,400
|
)
|
|
-
|
|
Other
current liabilities
|
|
|
(88,488
|
)
|
|
(361,685
|
)
|
Net
cash used in continuing operating activities
|
|
|
(2,264,779
|
)
|
|
(5,055,978
|
)
|
Discontinued
operations:
|
|
|
|
|
|
|
|
Gain
(loss) from discontinued operations
|
|
|
665,221
|
|
|
(973,072
|
)
|
Provision
for discontinued operations
|
|
|
(465,221
|
)
|
|
-
|
|
Goodwill
impairment charge
|
|
|
-
|
|
|
839,101
|
|
Net
cash provided by (used in) discontinued operating activities
|
|
|
200,000
|
|
|
(133,971
|
)
|
Net
cash used in operating activities
|
|
|
(2,064,779
|
)
|
|
(5,189,949
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
Continuing
operations:
|
|
|
|
|
|
|
|
Purchase
of property and equipment and other assets
|
|
|
(10,947
|
)
|
|
(100,760
|
)
|
Sale
of other assets
|
|
|
-
|
|
|
134,890
|
|
Net
cash used in continuing investing activities
|
|
|
(10,947
|
)
|
|
34,130
|
|
Discontinued
operations:
|
|
|
|
|
|
|
|
Net
assets - DTNet and Phone House
|
|
|
-
|
|
|
(624,067
|
)
|
Net
cash used in discontinued investing activities
|
|
|
-
|
|
|
(624,067
|
)
|
Net
cash used in investing activities
|
|
|
(10,947
|
)
|
|
(589,937
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
Proceeds
from issuance of notes payable and advances
|
|
|
2,519,334
|
|
|
7,249,482
|
|
Proceeds
from common stock issuances
|
|
|
-
|
|
|
740,178
|
|
Repayment
of amounts due to related parties
|
|
|
-
|
|
|
(1,223,257
|
)
|
Repayment
of notes payable and advances
|
|
|
(463,504
|
)
|
|
(681,178
|
)
|
Net
cash provided by financing activities
|
|
|
2,055,830
|
|
|
6,085,225
|
|
|
|
|
|
|
|
|
|
Net
increase (decrease) in cash
|
|
|
(19,896
|
)
|
|
305,339
|
|
Cash
and cash equivalents at beginning of period
|
|
|
90,172
|
|
|
3,228,745
|
|
Cash
and cash equivalents at end of period
|
|
$
|
70,276
|
|
$
|
3,534,084
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
VoIP,
Inc.
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.
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 L, 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.
The
financial information presented herein should be read in conjunction with
the
consolidated financial statements for the year ended December 31, 2006.
The
accompanying consolidated financial statements for the three months ended
March
31, 2007 and 2006 are unaudited but, in the opinion of management, include
all
adjustments (which are normal and recurring in nature) necessary for a
fair
presentation of the financial position, results of operations and cash
flows for
the interim periods presented. Interim results are not necessarily indicative
of
results for a full year. Therefore, the results of operations for the three
months ended March 31, 2007 are not necessarily indicative of operating
results
to be expected for the full year or future interim periods.
NOTE B
- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Significant
accounting policies are detailed in the Company's annual report on Form
10-K for
the year ended December 31, 2006. All intercompany accounts and transactions
have been eliminated in consolidation. Certain reclassifications have been
made
to the 2006 financial statements to conform to the 2007
presentation.
Accounting
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 by Emerging Issues Task Force Issue No. 00-19 (“EITF
00-19”), asset or liability classification of the warrants was 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 and their values accordingly marked-to-market,
including a related charge of $1,281,278 million to earnings for the three
months ended March 31, 2006. In May 2006, the Company repriced certain
of its
warrants to $0.78 per share in conjunction with a financing transaction,
which
in turn triggered contractual “favored nations” price ratchets on a number of
its 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. As required by EITF 00-19, the Company classified all remaining
warrants at that time as a liability, transferring $5,406,284 from additional
paid-in capital to fair value liability for warrants on its consolidated
balance
sheet. This warrant liability, along with the original earlier 2006 warrant
liability discussed above, was subsequently marked-to-market, resulting
in a
$5,102,731 fair value warrant liability at December 31, 2006, and a
corresponding credit to earnings for the year ended December 31, 2006 of
$7,226,430.
On
March
16, 2007, the Company obtained shareholder approval to increase its authorized
common stock to 400 million shares, sufficient to satisfy all of its outstanding
warrant obligations. The warrant liability was then marked-to-market, resulting
in a debit to earnings of $3,550,551 for the three months ended March 31,
2007.
The fair value of these warrants at that date was $10,209,324, and this
amount
was transferred from the fair value liability for warrants to additional
paid-in
capital on the Company’s consolidated balance sheet as required by EITF 00-19,
and the related mark-to-market accounting then ceased. However, should
the
Company in the future have insufficient common shares to satisfy all of
its
warrant and convertible debt obligations, it will be subject to noncash
mark-to-market income or expense to the extent that the fair value of these
warrants changes, which is in turn primarily dependent upon the Company's
common
stock market price per share.
NOTE
C - LIQUIDITY, CAPITAL RESOURCES, AND GOING CONCERN
This
Note
C should be reviewed in conjunction with Notes F, G, H, J and Q 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
March
31, 2007, the Company's contractual obligations for debt, leases and capital
expenditures totaled approximately $33,587,055 million. See
Note
G 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 Note G, 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 $1,704,123 through March 31, 2007, and will
continue to
incur additional liquidated damages of $226,455 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, the Late 2006 Notes, and
the 2007
Notes. While the investors have not declared these notes currently
in
default, the full amount of the notes at March 31, 2007 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.
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 substantially tradable under Rule 144
and, in
accordance with the terms of the subscription agreements, accrual of liquidated
damages ceased. Based on subsequent agreements with the investors, in April
2007
the Company issued 350,000 common shares, and expects to issue an additional
1,270,219 common shares and warrants to purchase 364,219 common shares
at $0.18
per share, and to reprice 2,051,501 of the above-referenced originally
issued
warrants to $0.18 per share, in full settlement of the related liquidated
damages owed. At March 31, 2007, this liquidated damage obligation was
recognized as a $1,465,035 current liability on the Company's consolidated
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
G, the subscription agreement's per share purchase price and the warrants'
exercise prices were effectively reduced to $0.18 per share. 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 contractually liable for liquidated
damages
totaling $750,000 through March 31, 2007, and will continue to incur additional
liquidated damages of $50,000 per month until the required shares and warrants
are registered. As the result of ongoing settlement negotiations, the Company
has recognized an additional $1,430,500 liability for non-registration
related
damages.
The
Company needs to continue to raise additional debt or equity capital to
provide
the funds necessary to restructure or repay its debt obligations, 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 400,000,000 common shares at
March 31, 2007, of which 98,609,701 common shares were then issued and
outstanding, and approximately 249 million additional shares were
contingently issuable upon the exercise of stock options and warrants,
and
conversion of convertible securities. As of March 31, 2007 the Company
was also
contractually obligated to register approximately 266 million shares, warrants
and options. An additional 61 million common shares were required to be
reserved
under our various existing financing agreements. 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
March
31, 2007 and December 31, 2006, property and equipment consisted of the
following:
|
|
March
31,
|
|
December
31,
|
|
|
|
2007
|
|
2006
|
|
Equipment
|
|
$
|
8,802,564
|
|
$
|
8,766,749
|
|
Furniture
& Fixtures
|
|
|
91,647
|
|
|
91,647
|
|
Software
|
|
|
666,842
|
|
|
666,842
|
|
Vehicles
|
|
|
15,269
|
|
|
15,269
|
|
Leasehold
improvements
|
|
|
105,075
|
|
|
105,075
|
|
Total
|
|
|
9,681,397
|
|
|
9,645,582
|
|
Less
accumulated depreciation
|
|
|
(3,229,752
|
)
|
|
(2,785,349
|
)
|
Total
|
|
$
|
6,451,645
|
|
$
|
6,860,233
|
|
Depreciation
expense for the three months ended March 31, 2007 and 2006 amounted to
$444,403
and $621,984, respectively.
The
amount of equipment held under capital leases, included above and net of
accumulated amortization, was $218,291 and $244,656 at March 31, 2007 and
December 31, 2006, respectively.
NOTE
E - GOODWILL AND OTHER INTANGIBLE ASSETS
The
Company's balance sheet at March 31, 2007 includes approximately $21.2
million
in goodwill and approximately $10.7 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 three months ended March 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, a material
goodwill
impairment charge in the future is possible.
As
of
March 31, 2007 and December 31, 2006, goodwill and other intangible assets
consisted of the following:
|
|
|
|
March
31,
|
|
December
31,
|
|
|
|
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
|
|
|
$
|
21,228,339
|
|
$
|
21,228,339
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
|
|
|
(6,044,546
|
)
|
|
(5,265,517
|
)
|
Other
intangible assets, net
|
|
|
|
|
|
10,680,454
|
|
|
11,459,483
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
goodwill and other intangible assets
|
|
|
|
|
$
|
31,908,793
|
|
$
|
32,687,822
|
|
Amortization
expense for the three months ended March 31, 2007 and 2006 amounted to
$779,029
and $904,030, respectively.
NOTE
F - LOANS PAYABLE
At
December 31, 2006 and 2005, loans payable consisted of the
following:
|
|
March
31,
|
|
December
31,
|
|
|
|
2007
|
|
2006
|
|
Note
payable to a lending institution
|
|
$
|
-
|
|
$
|
2,381,085
|
|
Other
notes payable
|
|
|
193,750
|
|
|
193,750
|
|
Total
loans payable
|
|
$
|
193,750
|
|
$
|
2,574,835
|
|
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”). Under the Loan Agreement, Cedar was granted a
perfected, first-priority security interest in all of the Company's assets.
This
loan bears interest at 17.5%, and is repayable through May 2007. Interest
expensed and paid under this debt facility during the three months ended
March
31, 2007 and 2006 was $11,575, and $128,000, respectively.
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. 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 in Note G, on February 16, 2006 the Note's common stock
conversion rate was reduced to $0.18 per share.
Due
to
the Note’s amendment discussed in the preceding paragraph allowing its
conversion into the Company’s common stock, the balance owing at March 31, 2007
has been reclassified from loans payable to convertible notes payable on
the
Company’s consolidated balance sheet at March 31, 2007 (see Note G). The Company
was in violation of certain requirements of this Loan Agreement at March
31,
2007. However, the Investors have currently not declared this loan in default.
As a result, the full amount of the loan at March 31, 2007 has been classified
as current.
The
other
notes payable at December 31, 2006 were previously classified as common
stock
and additional paid-in capital, 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
March
31, 2007 and December 31, 2006, convertible notes payable and the fair
value
liability for related warrants consisted of the following:
|
|
Convertible
Notes Payable
|
|
Fair
Value Liability for Warrants
|
|
|
|
March
31,
|
|
December
31,
|
|
March
31,
|
|
December
31,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Payable
to WQN, Inc. (1)
|
|
$
|
3,700,000
|
|
$
|
3,700,000
|
|
$
|
-
|
|
$
|
-
|
|
Payable
to accredited investors:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
July
& October 2005 (2)
|
|
|
488,543
|
|
|
488,543
|
|
|
-
|
|
|
441,313
|
|
January
& February 2006 (3)
|
|
|
8,353,102
|
|
|
8,353,102
|
|
|
-
|
|
|
980,409
|
|
October
2006 (4)
|
|
|
2,905,875
|
|
|
2,905,875
|
|
|
-
|
|
|
1,971,844
|
|
"Cedar"
notes (5)
|
|
|
1,917,581
|
|
|
-
|
|
|
-
|
|
|
-
|
|
February
2007 (6)
|
|
|
3,808,990
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May
2005 private placement (7)
|
|
|
|
|
|
-
|
|
|
-
|
|
|
58,510
|
|
August
2005 subscription agreement (8)
|
|
|
|
|
|
-
|
|
|
-
|
|
|
400,500
|
|
Other
- see Note M
|
|
|
|
|
|
-
|
|
|
-
|
|
|
1,250,155
|
|
Subtotal
|
|
|
21,174,091
|
|
|
15,447,520
|
|
|
-
|
|
|
5,102,731
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
discounts
|
|
|
(7,693,906
|
)
|
|
(5,870,928
|
)
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
13,480,185
|
|
$
|
9,576,592
|
|
$
|
-
|
|
$
|
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 March 31, 2007 and 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. 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 below, the note's common stock conversion rate was
effectively
reduced to $0.18 per share. At March 31, 2007, the Company had
not made
scheduled principal payments of $3,700,000. At March 31, 2007,
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
March 31, 2007, has been classified as current. WQN, Inc.
notified the Company on March 16, 2007 that it was exercising
its right to
convert this note plus related accrued interest into shares of
the
Company’s common stock. Accordingly, on April 2, 2007, the Company issued
21,413,002 restricted common shares to WQN,
Inc.
|
|
(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 $488,543 at March 31, 2007 and
December 31, 2006, 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 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,
the fair value of these outstanding warrants was $441,313, which
was
recorded as a liability on the Company's consolidated balance
sheet. (At
March 31, 2007, liability accounting for these warrants was not
required -
see Note B.) At March 31, 2007, the Company had not made scheduled
principal payments of $266,793 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 $418,001 at March 31, 2007, and will incur
additional damages of $36,996 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 March 31, 2007 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 $8,353,102
at
March 31, 2007, 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 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,
the fair
value of these outstanding warrants was $980,409, which was recorded
as a
liability on the Company's consolidated balance sheet. (At March
31, 2007,
liability accounting for these warrants was not required - see
Note B.) At
March 31, 2007, the Company had not made scheduled principal
payments of
$1,892,970 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 $1,070,794 at
March 31, 2007, and will incur additional damages of $127,037
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
March 31, 2007 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 March 31, 2007.
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 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. 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. (At March
31, 2007,
liability accounting for these warrants was not required - see
Note B.)
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. (Such approval was actually obtained on
March 16,
2007.) Failing this, the holders of the convertible notes are
entitled to
liquidated damages that accrued 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, which has not
yet taken
place. Because of the Company’s violations of these authorized share and
registration requirements, the Company owed related liquidated
damages of
$170,478 at March 31, 2007, and will incur additional damages
of $58,925
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
March 31, 2007 has been classified as
current.
|
|
(5)
|
See
Note F for a discussion of the Cedar note and related loan
agreement.
|
|
(6)
|
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. 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 received 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
issued a
total of 4,000,000 common shares in April 2007 to the former
holders of
the above-referenced promissory notes, in lieu of and in payment
for
accrued damages associated with these promissory notes. Also
pursuant to
the Subscription Agreement, the Company was to 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 are entitled to liquidated damages 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. While the investors have not declared
the
notes currently in default, the full amount of the notes at
March 31, 2007 has been classified as current.
|
|
(7)
|
See
Note C for a discussion of the May 2005 private placement and
the August
2005 subscription agreement.
|
|
(8)
|
See
Note B for a discussion of the accounting for the fair value
liability for
warrants at March 31, 2007, which were reclassified to additional
paid-in
capital by March 31, 2007.
|
No
interest was paid on any of the convertible notes described above during
the
three months ended March 31, 2007 and 2006.
NOTE
H - NONREGISTRATION PENALTIES AND OTHER STOCK-BASED
PAYABLES
At
March
31, 2007 and December 31, 2006, nonregistration penalties and other stock-based
payables consisted of the following:
|
|
March
31,
|
|
December
31,
|
|
|
|
2007
|
|
2006
|
|
Nonregistration
penalties payable:
|
|
|
|
|
|
In
cash
|
|
$
|
2,454,123
|
|
$
|
1,658,858
|
|
In
common stock and warrants
|
|
|
1,465,035
|
|
|
1,342,299
|
|
Common
stock payable to officer
|
|
|
732,678
|
|
|
732,678
|
|
Common
stock payable to directors
|
|
|
298,500
|
|
|
210,000
|
|
Common
stock payable to investors
|
|
|
1,485,346
|
|
|
365,345
|
|
Common
stock payable for other services rendered
|
|
|
677,700
|
|
|
439,200
|
|
Total
|
|
$
|
7,113,382
|
|
$
|
4,748,380
|
|
As
discussed in Note G, 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
$3,919,158 and $3,001,157 as of March 31, 2007 and December 31, 2006,
respectively.
As
discussed in Note M, 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
in 2006, and the balance of 2,035,218 shares (originally valued at $732,678)
were issued on April 2, 2007 following the Company’s March 16, 2007 shareholder
approval of sufficient increased authorized common shares. Common stock
payable
to directors, investors and others for services rendered as of March 31,
2007
were also issued in April 2007 following the increase in the Company’s
authorized common shares.
NOTE
I - 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 confidential settlement term sheet on
March 27, 2007. The confidential term sheet contains a due diligence
provision that permitted MCI WorldCom to decide whether or not to
proceed with the settlement. The parties have completed the due diligence
requirements and are in the process of finalizing mutually acceptable
settlement documents reflecting the confidential settlement term sheet.
It is
anticipated that the case will be dismissed immediately following
the execution of acceptable final settlement documents.
Pending
the finalization and execution of the mutually acceptable settlement
documents, the Company is unable to assess the likelihood of a favorable or
unfavorable outcome.
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, 116
th
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 is in settlement negotiations with Cross Country, 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 has accrued an $85,212 litigation gain on its
consolidated balance sheet as of March 31, 2007, 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 three months ended March
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 has accrued $290,750 in litigation charges on its
consolidated balance sheet as of March 31, 2007.
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
$1,611,000 (including the Cross Country matter described above) on
its
consolidated balance sheet as
of
March 31, 2007. 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
J - NOTES AND ADVANCES FROM INVESTORS
Notes
and
advances from investors represent funds loaned to or deposited with the
Company
in anticipation of the issuance of future notes payable. The $300,000 at
March
31, 2007 represents funds advanced to the Company in February 2007, in
anticipation of the issuance of convertible notes payable, which were issued
in
April 2007 (see Note Q). 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 G).
These
notes and advances were unsecured. The $300,000 advance at March 31, 2007
was
not interest bearing, and the $616,667 notes at December 31, 2006 bore
interest
at 18%.
NOTE
K - RELATED PARTY TRANSACTIONS
As
of
March 31, 2007 and December 31, 2006, the amount due from related parties
of
$42,789 and $31,227, respectively, consisted of advances to Anthony Cataldo,
the
Company’s Chief Executive Officer, and to Shawn M. Lewis, the Company's Chief
Operating Officer.
On
March
29, 2007, the Company 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, the Company will also be required to pay the sum of $750,000
as
liquidated damages.
NOTE
L - 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 three
months ended March 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 in the third quarter of
2006,
primarily related to inventory and accounts receivable write-offs, and
filed
suit in Los Angeles County against the primary Phone House, Inc. employee
to
recover same. On April 4, 2007, a settlement was reached with the Phone
House,
Inc. employee recovering most of the assets. Accordingly, the above impairment
loss was reduced by $665,221 through a credit to earnings in the three
months
ended March 31, 2007.
The
following summarizes the combined operating results of DTNet Technologies
and
the calling card business of Phone House, Inc. for the three months ended
March
31, 2007 and 2006 (through the respective dates of sale or termination),
classified as discontinued operations for all periods presented.
|
|
2007
|
|
2006
|
|
Revenues
|
|
$
|
-
|
|
$
|
5,661,146
|
|
Cost
of sales
|
|
|
-
|
|
|
5,476,887
|
|
Gross
profit
|
|
|
-
|
|
|
184,259
|
|
|
|
|
|
|
|
|
|
Compensation
and benefits
|
|
|
-
|
|
|
97,491
|
|
Asset
impairment charges
|
|
|
-
|
|
|
839,101
|
|
Litigation
credit
|
|
|
(665,221
|
)
|
|
-
|
|
Other
operating expenses
|
|
|
-
|
|
|
-
|
|
Net
income (loss)
|
|
$
|
665,221
|
|
$
|
(752,333
|
)
|
NOTE
M - 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 three months ended March 31, 2007 is as follows:
|
|
Number
|
|
Exercise
Price Range
|
|
Wtd.
Avg. Exercise Price
|
|
Options
outstanding at December 31, 2006
|
|
|
644,350
|
|
$
|
0.85
- $1.56
|
|
$
|
1.11
|
|
Options
returned to the plan due
|
|
|
-
|
|
|
|
|
|
|
|
to
employee terminations
|
|
|
-
|
|
|
|
|
|
|
|
Options
granted
|
|
|
-
|
|
|
|
|
|
|
|
Options
exercised
|
|
|
-
|
|
|
|
|
|
|
|
Options
outstanding at March 31, 2007
|
|
|
644,350
|
|
|
|
|
|
|
|
In
September 2006, the Company entered into employment agreements with its
Chief
Executive Officer (“CEO”) and Chief Operating Officer (“COO”). These agreements,
as subsequently amended by the Company’s board of directors, provided for, among
other things, the award of 10,000,000 common shares each, upon sufficient
underlying shares of common stock being authorized and available. Messrs.
Cataldo and Lewis are also to receive sufficient additional common shares
to
assure that they maintain a minimum of 5% and 8% beneficial ownership,
respectively, of the Company's issued and outstanding common stock, before
considering stock sales.
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 was recognized in the Company's
results of operations as compensation expense in the fourth quarter of
2006.
Separate
from the CEO and COO options noted in the preceding paragraphs, at March
31,
2007 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 $517,212 and $1,819,056 for the
three
months ended March 31, 2007 and 2006, respectively, in connection with
options,
warrants and stock granted to employees. As of March 31, 2007, approximately
$8,149,642 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
N - WARRANTS
Through
March 31, 2007 the Company has issued to employees, institutional investors,
and
financial services firms warrants to purchase the Company's common stock.
During
the three months ended March 31, 2007 and 2006, the Company issued zero
and
206,250 shares, respectively, of common stock in exchange for these warrants.
As
of March 31, 2007, the Company had outstanding 17,463,607 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 $0.18 to $2.60 per share, and at a weighted average
exercise
price of $0.98 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. As discussed more fully in Note B,
on
March 16, 2007, the warrant liability was transferred from the fair value
liability for warrants to additional paid-in capital on the Company’s
consolidated balance sheet as required by EITF 00-19.
NOTE
O - 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
March 31, 2007 are as follows:
Year
ending December 31,
|
|
|
|
2007
(nine months)
|
|
$
|
202,400
|
|
2008
|
|
|
98,400
|
|
2009
|
|
|
43,700
|
|
Total
|
|
$
|
344,500
|
|
Rent
expense for these leases for the three months ended March 31, 2007 and
2006 was
$51,837 and $68,189, respectively.
NOTE
P - INCOME TAXES
The
components of the Company's consolidated income tax provision are as
follows:
|
|
Three
months ended March 31,
|
|
|
|
2007
|
|
2006
|
|
Current
benefit
|
|
$
|
1,448,630
|
|
$
|
3,260,372
|
|
Deferred
benefit (expense)
|
|
|
757,554
|
|
|
336,294
|
|
Subtotal
|
|
|
2,206,184
|
|
|
3,596,666
|
|
Less
valuation allowances
|
|
|
(2,206,184
|
)
|
|
(3,596,666
|
)
|
Net
|
|
$
|
-
|
|
$
|
-
|
|
The
reconciliation of the income tax provision at the statutory rate to
the reported
income tax expense is as follows:
|
|
Three
months ended March 31,
|
|
|
|
2007
|
|
2006
|
|
Computed
at statutory rate
|
|
|
34
|
%
|
|
34
|
%
|
Options,
warrants and stock-related expenses
|
|
|
-7
|
%
|
|
-8
|
%
|
Change
in fair value liability for warrants
|
|
|
-9
|
%
|
|
-
|
|
Goodwill
impairments and intangible asset amortization
|
|
|
-2
|
%
|
|
-
|
|
Valuation
allowance
|
|
|
-16
|
%
|
|
-26
|
%
|
Total
|
|
|
-
|
|
|
-
|
|
At
March
31, 2007, the Company's net deferred tax assets consisted of the
following:
Net
operating loss carryforwards
|
|
$
|
16,152,414
|
|
Excess
tax over book depreciation expense
|
|
|
549,033
|
|
Excess
book over tax amortization of debt discounts
|
|
|
2,844,403
|
|
Discontinued
operations impairment charge
|
|
|
92,106
|
|
Noncash
litigation charges
|
|
|
580,493
|
|
Subtotal
|
|
|
20,218,449
|
|
Less
valuation allowances
|
|
|
(20,218,449
|
)
|
Total
|
|
$
|
-
|
|
The
Company's net operating loss carryforwards for federal income tax purposes
were
approximately $47,500,000 as of December 31, 2006. These carryforwards
expire in
2018 ($4,200,000), 2019 ($20,600,000), 2020 ($18,400,000), and 2021
($4,300,000), respectively.
NOTE
Q - SUBSEQUENT EVENTS
On
April
6, 2007, VoIP, Inc. (the “Company”) issued and sold $375,000 in secured
convertible notes (the “Convertible Notes”) to two institutional investors, for
a net purchase price of $300,000 (after a 20% original issue discount)
in a
private placement. The investors also received five-year warrants to purchase
a
total of 2,083,333 shares of the Company's common stock at an exercise
price of
$0.18 per share (the “Class D Warrants”). The Company received an unsecured
advance of $300,000 on February 23, 2007 from these investors, and these
funds
were credited to the purchase price of the Convertible Notes. The Convertible
Notes are secured by a subordinated lien on the Company's assets, are not
interest bearing, and are due on February 23, 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.
ITEM
2. 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-Q. Certain statements contained
in this Form 10-Q and other written material and oral statements made from
time
to time by us do not relate strictly to historical or current facts. As such,
they are considered "forward-looking statements" that provide current
expectations or forecasts of future events. Such statements are typically
characterized by terminology such as "believe," "anticipate," "should,"
"intend," "plan," "will," "expect," "estimate," "project," "strategy," and
“may,” and similar expressions. Our forward-looking statements generally relate
to the prospects for future sales of our products, the success of our marketing
activities, and the success of our strategic corporate relationships. These
statements are based upon assumptions and assessments made by our management
in
light of its experience and its perception of historical trends, current
conditions, expected future developments and other factors our management
believes to be appropriate. These forward-looking statements are subject to
a
number of risks and uncertainties, including the following: our ability to
achieve profitable operations and to maintain sufficient cash to operate our
business and meet our liquidity requirements; our ability to obtain financing,
if required, on terms acceptable to it, if at all; the success of our research
and development activities; competitive developments affecting our current
products; our ability to successfully attract strategic partners and to market
both new and existing products; exposure to lawsuits and regulatory proceedings;
our ability to protect our intellectual property; governmental laws and
regulations affecting operations; our ability to identify and complete
diversification opportunities; and the impact of acquisitions, divestitures,
restructurings, product withdrawals and other unusual items. A further list
and
description of these risks, uncertainties and other matters can be found
elsewhere in our Form 10-K for the year ended December 31, 2006. Except as
required by applicable law, we undertake no obligation to update any
forward-looking statements, whether as a result of new information, future
events or otherwise.
Financial
Summary
Balance
Sheet Data:
|
|
March
31,
|
|
December
31,
|
|
|
|
2007
|
|
2006
|
|
Goodwill
and other intangible assets
|
|
$
|
31,908,793
|
|
$
|
32,687,822
|
|
Total
assets
|
|
|
39,904,525
|
|
|
40,925,121
|
|
Notes
and loans payable, current
|
|
|
14,273,935
|
|
|
12,768,094
|
|
Total
liabilities
|
|
|
38,071,937
|
|
|
37,880,305
|
|
Shareholders'
equity (deficit)
|
|
|
1,832,588
|
|
|
3,044,816
|
|
Statement
of Operations Data:
|
|
For
the Three Months Ended March 31,
|
|
|
|
2007
|
|
2006
(1)
|
|
Revenues
|
|
$
|
3,189,543
|
|
$
|
4,700,400
|
|
Cost
of sales
|
|
|
3,054,571
|
|
|
5,419,430
|
|
Gross
profit (loss)
|
|
|
134,972
|
|
|
(719,030
|
)
|
Operating
expenses
|
|
|
4,900,848
|
|
|
8,276,597
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
|
(4,765,876
|
)
|
|
(8,995,627
|
)
|
Other
expenses, net
|
|
|
9,389,649
|
|
|
3,838,335
|
|
|
|
|
|
|
|
|
|
Loss
before discontinued operations
|
|
|
(14,155,525
|
)
|
|
(12,833,962
|
)
|
Loss
from discontinued operations
|
|
|
665,221
|
|
|
(973,072
|
)
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(13,490,304
|
)
|
$
|
(13,807,034
|
)
|
|
|
|
|
|
|
|
|
Per
common share:
|
|
|
|
|
|
|
|
Loss
before discontinued operations
|
|
$
|
(0.15
|
)
|
$
|
(0.20
|
)
|
Net
loss
|
|
$
|
(0.14
|
)
|
$
|
(0.21
|
)
|
(1) |
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.
|
Revenues
Our
consolidated revenues for the three months ended March 31, 2007 and 2006 were
$3.2 million and $4.7 million, respectively. Our consolidated net loss was
$13.5
million ($0.14 per share) for the three months ended March 31, 2007 as compared
to a net loss of $13.8 million ($0.21 per share) for the three months ended
March 31, 2006. Revenues associated with our retail-based EasyTalk and Rocket
VoIP products declined $1.1 million due to a related increased international
competitive environment affecting revenues.
Cost
of Sales and Gross Profit (Loss)
Consolidated
cost of sales was $3.1 million and $5.4 million for the three months ended
March
31, 2007 and 2006, respectively. The
negative gross profit of $719 thousand (15% of revenues) in 2006 reflects costs
paid to third party vendors that exceeded the revenues we charged to terminate
the calls of our customers. For the same period in 2007, our gross profit was
$135 thousand (4% of revenues). The gross profit improvement in 2007 was
achieved by using lower cost routes and negotiating more favorable pricing.
We
do not expect to generate more 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; (2) continue the
expansion of our network which in turn requires additional capital expenditures;
and (3) 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.
Operating
Expenses
Consolidated
operating expenses were $4.9 million and $8.3 million for the three months
ended
March 31, 2007 and 2006, respectively. Compensation and related expenses
accounted for $1.3 million of the decrease from 2006, primarily due to
accelerated recognition of vested noncash stock and warrant compensation in
the
2006 period pertaining to the employment termination of the Company’s former
Chief Operating Officer. Commissions and fees to third parties, and general
and
administrative services decreased $0.9 million and $0.4 million, respectively,
from 2006 to 2007, due primarily to higher stock for service awards in the
2006
period.
Other
Expenses, Net
Consolidated
net other expenses were $9.4 million and $3.8 million for the three months
ended
March 31, 2007 and 2006, respectively. Amortization of debt discounts, the
primary component of our reported interest expense, increased by $0.8 million
in
2007, reflecting our significantly higher convertible note balances in 2007
used
to finance our operations, all which were issued at significant discounts as
part of our fund raising activities. Financing penalties and expenses increased
by $1.9 million in 2007, 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 the $2.3
million financing penalties and expenses during the three months ended March
31,
2007, $1.4 million was paid or is payable in our common stock or warrants.
Litigation charges increased by $1.0 million, due to litigation matters
discussed in Note I to our consolidated financial statements.
As
a
result of our 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 our authorized common shares. Therefore, as required
by
Emerging Issues Task Force Issue No. 00-19 (“EITF 00-19”), asset or liability
classification of the warrants was required (as opposed to permanent equity
classification) for the excess warrant shares. From January to May 2006,
only a portion of our warrants were subject to liability classification and
their values subsequently marked-to-market, including a related charge of $1.3
million to earnings for the three months ended March 31, 2007. In May 2006,
we
repriced certain of our warrants to $0.78 per share in conjunction with a
financing transaction, which in turn 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 at the time to approximately 129 million, relative to our then-authorized
100 million common shares. Our total warrants then outstanding were
approximately 28 million. As required by EITF 00-19, we classified all remaining
warrants at that time as a liability, transferring $5.4 million from additional
paid-in capital to fair value liability for warrants on our consolidated balance
sheet. This warrant liability, along with the original earlier 2006 warrant
liability discussed above, was subsequently marked-to-market, resulting in
a
$5.1 million liability at December 31, 2006, and a corresponding credit to
earnings for the year ended December 31, 2006 of $7.2 million.
On
March
16, 2007, we obtained shareholder approval to increase our authorized common
stock to 400 million shares, sufficient to satisfy all of our outstanding
warrant obligations. The warrant liability was then marked-to-market, resulting
in a charge to earnings of $3.6 million for the three months ended March 31,
2007. The fair value of these warrants at that time was $10.2 million, and
this
amount was transferred from the fair value liability for warrants to additional
paid-in capital on our consolidated balance sheet as required by EITF 00-19,
and
the related mark-to-market accounting then ceased. However, should we in the
future have insufficient common shares to satisfy all of our warrant and
convertible debt obligations, we will be subject to noncash mark-to-market
income or expense to the extent that the fair value of these warrants changes,
which is in turn primarily dependent upon our common stock market price per
share.
In
accordance with SFAS No. 142, we are required to periodically evaluate the
carrying value of our goodwill and other intangible assets. During the three
months ended March 31, 2006, we recognized an impairment expense of $839,101
related to goodwill recorded for our former hardware sales business segment,
which is 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 three
months ended March 31, 2006.
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. On April
4, 2007 we settled this suit, recovering assets and limiting our liabilities.
Accordingly, a gain of $665,221 was recognized for the three months ended March
31, 2007.
The
following summarizes the combined operating results of DTNet Technologies and
the calling card business of Phone House, Inc. for the three months ended March
31, 2007, and 2006, classified as discontinued operations for all periods
presented.
|
|
2007
|
|
2006
|
|
Revenues
|
|
$
|
-
|
|
$
|
5,661,146
|
|
Cost
of sales
|
|
|
-
|
|
|
5,476,887
|
|
Gross
profit
|
|
|
-
|
|
|
184,259
|
|
|
|
|
|
|
|
|
|
Compensation
and benefits
|
|
|
-
|
|
|
97,491
|
|
Asset
impairment charges
|
|
|
-
|
|
|
839,101
|
|
Litigation
credit
|
|
|
(665,221
|
)
|
|
-
|
|
Other
operating expenses
|
|
|
-
|
|
|
-
|
|
Net
income (loss)
|
|
$
|
665,221
|
|
$
|
(752,333
|
)
|
Assets
Total
assets (adjusted for discontinued operations classification) at March 31, 2007
were $39.9 million, down only slightly from $40.9 million at December 31, 2006.
Goodwill and other intangible assets comprised 80% of our consolidated total
assets at March 31, 2007, attributable primarily to the acquisitions of Caerus
and WQN assets.
Liquidity
and Capital Resources
Cash
and
cash equivalents were approximately $70 thousand at March 31, 2007. Our
consolidated net cash used in operating activities for the three months ended
March 31, 2007, was $2.1 million, due primarily to the losses described above.
We funded our operating activities principally through financing activities
that
generated net proceeds of $2.5 million ($2.1 million net of debt repayments)
during the three months ended March 31, 2007. At March 31, 2007 our negative
working capital was $36.4 million, and our contractual obligations for debt,
leases and capital expenditures totaled approximately $33.6 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.
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 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 our assets, and the notes bear
interest at an effective rate of approximately 20%. The principal balance of
these notes was $488,543 and $488,543 at March 31, 2007 and
December 31, 2006, 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 the Company 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, the fair value of these outstanding warrants was $441,313,
which was recorded as a liability on our consolidated balance sheet. (At March
31, 2007, liability accounting for these warrants was not required - see Note
B
to our consolidated financial statements on page **.) At March 31, 2007, we
had
not made scheduled principal payments of $266,793 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
$418,001 at March 31, 2007, and will incur additional damages of $36,996 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 March 31, 2007
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 our 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 our assets. The principal balance of the notes was $8,353,102 at March
31, 2007, 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, the fair value of these outstanding warrants was $980,409, which was
recorded as a liability on our consolidated balance sheet. (At March 31, 2007,
liability accounting for these warrants was not required - see Note B to our
consolidated financial statements.) At March 31, 2007, the Company had not
made
scheduled principal payments of $1,892,970 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 $1,070,794 at
March 31, 2007, and will incur additional damages of $127,037 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 March 31, 2007
has been classified as current. Since March 31, 2007, in accordance with
conversion notices submitted by certain of the investors, we have retired
$775,013 in principal and $76,188 in interest due on these notes through the
issuance of 4,728,891 restricted common shares.
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. 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 our common stock at an exercise price of $0.407 per share. The
principal balance of the notes was $2,905,875 at March 31, 2007. 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 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 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. At December 31, 2006, the fair value of these outstanding
warrants was $1,971,844, which was recorded as a liability on our consolidated
balance sheet. (At March 31, 2007, liability accounting for these warrants
was
not required - see Note B to our consolidated financial statements.) Pursuant
to
the subscription agreement, we were 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. (Such approval
was actually obtained on March 16, 2007.) Failing this, the holders of the
convertible notes are entitled to liquidated damages that accrued 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, which has not yet taken place. Because of our
violations of these authorized share and registration requirements, we owed
related liquidated damages of $170,478 at March 31, 2007, and will incur
additional damages of $58,925 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 March 31, 2007 has been classified as current.
As
of
December 31, 2006 we owed $2.4 million to Cedar Boulevard Lease Funding LLC
(“Cedar”) pursuant to a subordinated loan and security agreement (the “Loan
Agreement”). Under the Loan Agreement, Cedar was granted a perfected,
first-priority security interest in all of the Company's assets. This loan
bears
interest at 17.5%, and is repayable through May 2007. 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. 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. The Company was in violation of certain requirements of this Loan
Agreement at March 31, 2007. However, the Investors have currently not declared
this loan in default. As a result, the full amount of the loan at March 31,
2007
has been classified as current. Since
March 31, 2007, in accordance with conversion notices submitted by certain
of
the investors, we have retired $639,610 in principal and $12,572 in interest
due
on these notes through the issuance of 3,401,008 unrestricted common
shares.
On
February 16, 2007, we 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 our common stock
at an effective exercise price of $0.18 per share. The 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. 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 received 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,
we issued a total of 4,000,000 common shares in April 2007 to the former holders
of the above-referenced promissory notes, in lieu of and in payment for accrued
damages associated with these promissory notes. Also pursuant to the
Subscription Agreement, we were to 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 are entitled to liquidated damages
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. While the investors have not
declared the notes currently in default, the full amount of the notes at
March 31, 2007 has been classified as current.
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”), the Company is liable for liquidated
damages totaling $1,704,123 through March 31, 2007, and will continue
to
incur additional liquidated damages of $226,455 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, the Late 2006 Notes, and the 2007
Notes.
While the investors have not declared these notes currently in default,
the full amount of the notes at March 31, 2007 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 the Company's assets.
The principal balance of the note was $3,700,000 at March 31, 2007 and
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. 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 below, the note's
common stock conversion rate was effectively reduced to $0.18 per share. At
March 31, 2007, the Company had not made scheduled principal payments of
$3,700,000. At March 31, 2007, 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 March 31, 2007, has been classified as
current. WQN, Inc. notified us on March 16, 2007 that it was exercising its
right to convert this note plus related accrued interest into shares of our
common stock. Accordingly on April 2, 2007, 21,413,002 restricted common shares
were so issued to WQN, Inc.
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. 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 substantially tradable under Rule 144 and,
in
accordance with the terms of the subscription agreements, accrual of liquidated
damages ceased. Based on subsequent agreements with the investors, in April
2007
the Company issued 350,000 common shares, and expects to issue an additional
1,270,219 common shares and warrants to purchase 364,219 common shares at $0.18
per share, and to reprice 2,051,501 of the above-referenced originally issued
warrants to $0.18 per share, in full settlement of the related liquidated
damages owed. At March 31, 2007, this liquidated damage obligation was
recognized as a $1,465,035 current liability on our consolidated 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 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 above, the
subscription agreement's per share purchase price and the warrants' exercise
prices were effectively reduced to $0.18 per share. 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 $750,000 through March 31,
2007, and will continue to incur additional liquidated damages of $50,000 per
month until the required shares and warrants are registered. As the result
of
ongoing settlement negotiations, the Company has recognized an additional
$1,430,500 liability for non-registration related damages.
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.
On
April
6, 2007, we issued and sold $375,000 in secured convertible notes (the
“Convertible Notes”) to two institutional investors, for a net purchase price of
$300,000 (after a 20% original issue discount) in a private placement. The
investors also received five-year warrants to purchase a total of 2,083,333
shares our common stock at an exercise price of $0.18 per share (the “Class D
Warrants”). We received an unsecured advance of $300,000 on February 23, 2007
from these investors, and these funds were credited to the purchase price of
the
Convertible Notes. The Convertible Notes are secured by a subordinated lien
on
our assets, are not interest bearing, and are due on February 23, 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 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.
We
anticipate that we will continue to report net losses and experience negative
cash flows from operations. We need to continue to raise additional debt or
equity capital to provide the funds necessary to restructure or repay our debt
obligations, meet our other contractual commitments, and continue our
operations. We are actively seeking to raise this additional capital but may
not
be successful in obtaining the imminently-required debt or equity financing.
Our
authorized shares of stock consist of 400,000,000 shares of common stock. As
of
May 1, 2007, 142.1 million common shares were issued and outstanding, and
approximately 163.7 million additional shares are currently issuable upon the
conversion of all convertible debt, and the exercise of all options and
warrants. We are also obligated to issue 54.1 million shares under various
agreements, including penalty shares for nonregistration of securities. We
are
also required to reserve an additional 84.8 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 as of May 1, 2007, 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.
|
|
|
|
|
|
|
|
|
|
|
|
Minimim
Total
|
|
|
|
Additional
Common Stock Outstanding
Upon
Conversion/Exercise 1
|
|
Additional
Reservation
Requirements
2
|
|
Current
Obligations
|
|
Additional
Authorized
|
|
|
|
Convertible
|
|
|
|
|
|
|
|
Convertible
|
|
|
|
|
|
To
Issue
|
|
Shares
|
|
|
|
Notes
|
|
Warrants
|
|
Options
|
|
Subtotal
|
|
Notes
|
|
Options
|
|
Subotal
|
|
Shares
3
|
|
Required
|
|
May
2005 private placement
|
|
|
-
|
|
|
2,571,970
|
|
|
-
|
|
|
2,571,970
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
1,270,219
|
|
|
3,842,189
|
|
July
and October 2005 convertible notes and warrants
|
|
|
2,714,130
|
|
|
3,713,542
|
|
|
-
|
|
|
6,427,672
|
|
|
12,798,060
|
|
|
-
|
|
|
12,798,060
|
|
|
10,083,930
|
|
|
29,309,662
|
|
January
and February 2006 convertible notes and warrants
|
|
|
42,154,246
|
|
|
9,074,104
|
|
|
-
|
|
|
51,228,350
|
|
|
9,663,863
|
|
|
-
|
|
|
9,663,863
|
|
|
6,165,068
|
|
|
67,057,281
|
|
November
2005 financing agreement
|
|
|
-
|
|
|
2,225,000
|
|
|
-
|
|
|
2,225,000
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
11,125,000
|
|
|
13,350,000
|
|
WQN,
Inc.
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
October
06 convertible notes and warrants
|
|
|
16,143,750
|
|
|
10,378,125
|
|
|
-
|
|
|
26,521,875
|
|
|
16,143,750
|
|
|
-
|
|
|
16,143,750
|
|
|
-
|
|
|
42,665,625
|
|
Feb
07 Cedar convertible notes
|
|
|
8,710,951
|
|
|
-
|
|
|
-
|
|
|
8,710,951
|
|
|
8,710,951
|
|
|
|
|
|
8,710,951
|
|
|
-
|
|
|
17,421,902
|
|
Feb/Apr
07 convertible notes
|
|
|
23,452,724
|
|
|
21,528,991
|
|
|
-
|
|
|
44,981,715
|
|
|
23,452,724
|
|
|
|
|
|
23,452,724
|
|
|
-
|
|
|
68,434,439
|
|
Nov/Dec
06 & Jan 07 bridge notes
|
|
|
-
|
|
|
2,410,995
|
|
|
-
|
|
|
2,410,995
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
2,410,995
|
|
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
|
|
|
1,972,313
|
|
|
6,321,640
|
|
|
-
|
|
|
|
|
|
-
|
|
|
1,660,606
|
|
|
7,982,246
|
|
Current
and former officer and employee securities 4
|
|
|
-
|
|
|
6,800,000
|
|
|
1,562,500
|
|
|
8,362,500
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
23,798,235
|
|
|
32,160,735
|
|
Securities
owned by or owed to shareholders
|
|
|
-
|
|
|
3,892,385
|
|
|
-
|
|
|
3,892,385
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
3,892,385
|
|
Totals
|
|
|
93,175,801
|
|
|
66,944,439
|
|
|
3,534,813
|
|
|
163,655,053
|
|
|
70,769,348
|
|
|
14,000,000
|
|
|
84,769,348
|
|
|
54,103,058
|
|
|
302,527,459
|
|
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.
4
In
addition, our Chief Executive Officer and Chief Operating Officer may receive
additional common shares sufficient to maintain their common share
ownership at 5% and 8%, respectively, of our fully diluted common
shares.
Capital
Expenditure Commitments
We
did
not have any substantial outstanding commitments to purchase capital equipment
at March 31, 2007.
Payments
Due by Period
The
following table illustrates our outstanding debt, purchase obligations, and
related payment projections as of March 31, 2007:
|
|
|
|
Less
than
|
|
|
|
|
|
Contractual
Obligations
|
|
Total
|
|
1
Year
|
|
1-3
Years
|
|
3-5
Years
|
|
Convertible
notes (principal)
|
|
$
|
21,174,091
|
|
$
|
21,174,091
|
|
$
|
-
|
|
$
|
-
|
|
Loan
payable
|
|
|
493,750
|
|
|
493,750
|
|
|
-
|
|
|
-
|
|
Unsecured
advances
|
|
|
300,000
|
|
|
300,000
|
|
|
-
|
|
|
-
|
|
Nonregistration
penalties and other stock-based payables
|
|
|
7,113,382
|
|
|
7,113,382
|
|
|
-
|
|
|
-
|
|
Accrued
litigation charges
|
|
|
2,012,350
|
|
|
2,012,350
|
|
|
-
|
|
|
-
|
|
Other
liabilities
|
|
|
2,165,314
|
|
|
1,965,717
|
|
|
199,597
|
|
|
-
|
|
Subtotal
|
|
|
33,258,887
|
|
|
33,059,290
|
|
|
199,597
|
|
|
-
|
|
Purchase
obligations
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Operating
leases
|
|
|
328,168
|
|
|
252,931
|
|
|
75,237
|
|
|
-
|
|
Total
|
|
$
|
33,587,055
|
|
$
|
33,312,221
|
|
$
|
274,834
|
|
$
|
-
|
|
ITEM
3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET
RISK
As
a
result of our 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 our authorized common shares. Therefore, as required
by
Emerging Issues Task Force Issue No. 00-19 (“EITF 00-19”), asset or liability
classification of the warrants was required (as opposed to permanent equity
classification) for the excess warrant shares. From January to May 2006,
only a portion of our warrants were subject to liability classification and
their values accordingly marked-to-market, including a related charge of
$1,281,278 million to earnings for the three months ended March 31, 2006. In
May
2006, we repriced certain of our warrants to $0.78 per share in conjunction
with
a financing transaction, which in turn 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 at the time to approximately 129 million, relative to our then-authorized
100 million common shares. Our total warrants then outstanding were
approximately 28 million. As required by EITF 00-19, we classified all remaining
warrants at that time as a liability, transferring $5,406,284 from additional
paid-in capital to fair value liability for warrants on its consolidated balance
sheet. This warrant liability, along with the original earlier 2006 warrant
liability discussed above, was subsequently marked-to-market, resulting in
a
$5,102,731 fair value warrant liability at December 31, 2006, and a
corresponding credit to earnings for the year ended December 31, 2006 of
$7,226,430.
On
March
16, 2007, we obtained shareholder approval to increase our authorized common
stock to 400 million shares, sufficient to satisfy all of our outstanding
warrant obligations. The warrant liability was then marked-to-market, resulting
in a charge to earnings of $3.6 million for the three months ended March 31,
2007. The fair value of these warrants at that date was $10,209,324, and this
amount was transferred from the fair value liability for warrants to additional
paid-in capital on our consolidated balance sheet as required by EITF 00-19,
and
the related mark-to-market accounting then ceased. However, should we in the
future have insufficient common shares to satisfy all of our warrant and
convertible debt obligations, we will be subject to noncash mark-to-market
income or expense to the extent that the fair value of these warrants changes,
which is in turn primarily dependent upon our common stock market price per
share.
We
are
not exposed to significant interest rate or foreign currency exchange rate
risk.
ITEM
4. CONTROLS AND PROCEDURES
Evaluation
of Controls and Procedures
As
required by Rule 13a-15(b) under the Securities Exchange Act, as amended
(the “Exchange Act”), as of March 31, 2007, 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 three 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 March 31, 2007. 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 accounting
personnel resources; 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
March 31, 2007.
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 March 31, 2007, and concluded
that we had the following control deficiencies as of March 31, 2007,
that, when combined, resulted in a material weakness:
|
a. |
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.
|
|
b. |
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.
|
|
c. |
The
amounts invoiced to our wholesale telecommunications customers are
calculated by our engineering department. This billing process is
overseen
solely by the head of that department, our Chief Technology Officer.
We do
not presently employ a separate revenue assurance process whereby
these
bills would be recalculated and independently verified by a department
other than engineering. Our management with the participation of
the
Certifying Officers determined that the potential magnitude of a
misstatement arising due to this deficiency is more than inconsequential
to the annual and/or interim financial
statements.
|
|
d. |
Section
402 of the Sarbanes-Oxley Act of 2002 prohibits personal loans to
or from
any of our directors or executive officers. As of March 31, 2007,
we have
paid outstanding travel and expense advances to our Chief Executive
Officer and Chief Operating Officer totaling $137,789, which may
be in
violation of this prohibition.
|
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
March 31, 2007 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
late 2006, we 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.
|
|
b. |
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.
|
|
c. |
We
are in the process of designing a revenue assurance process for the
billing of our wholesale telecommunications customers to provide
independent recalculation and verification of amounts billed. We
anticipate implementing this methodology in
2007.
|
|
d. |
Beginning
in the second quarter of 2007, travel advances to directors and executive
officers will not be allowed. Any such advances remaining at June
30, 2007
(those advances that may not be supported with related approved employee
expense reports) will be required to be
repaid.
|
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.
PART
II - OTHER INFORMATION
ITEM
1. LEGAL
PROCEEDINGS
The
Company is involved from time to time in legal proceedings and litigation
incidental to the conduct of its business. See Note K to our consolidated
financial statements for a discussion of litigation between Volo (a wholly-owned
subsidiary of Caerus) and MCI WorldCom, and between the Company and Cross
Country Capital Partners, L.P.
ITEM
1.A RISK
FACTORS
See
the
risk factors set forth in our Annual Report on Form 10-K for the year ended
December 31, 2006. See
also
Management’s Discussion and Analysis of Financial Condition and Results of
Operations beginning on page 20.
ITEM
2. UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Previously
reported on Form 8-K.
ITEM
3. DEFAULTS
UPON SENIOR SECURITIES
None.
ITEM
4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
At
the
Company’s annual shareholder meeting held on March 16, 2007, shareholders
approved proposals to amend and restate the Company's Articles of Incorporation
to increase the Company's authorized common stock to 400 million
shares, and to authorize 25 million shares of preferred stock. Shareholders
on March 16, 2007 also approved the election of Anthony Cataldo, the Company's
Chairman and Chief Executive Officer as a director of VoIP, Inc. along with
Gary
Post, Stuart Kosh and Nicholas A. Iannuzzi, Jr. Shareholders also approved
the
Company's 2006 Equity Incentive Plan, and Berkovits, Lago & Company LLP as
the Company's independent auditors for the fiscal year ended December 31, 2006.
The following table summarizes the number of votes cast, out of a total of
98,609,701 common shares issued and outstanding at that time, for each of these
proposals.
|
|
Number
of Shares Voted
|
|
|
|
For
|
|
Against
|
|
Abstain
|
|
Board
of Directors:
|
|
|
|
|
|
|
|
|
|
|
Anthony
Cataldo
|
|
|
86,662,607
|
|
|
664,006
|
|
|
221,431
|
|
Gary
Post
|
|
|
82,175,946
|
|
|
5,150,667
|
|
|
221,431
|
|
Stuart
Kosh
|
|
|
86,314,194
|
|
|
1,012,419
|
|
|
221,431
|
|
Nicholas
A. Iannuzzi, Jr.
|
|
|
85,924,617
|
|
|
1,401,996
|
|
|
221,431
|
|
|
|
|
|
|
|
|
|
|
|
|
VoIP,
Inc.2006 Equity Incentive Plan
|
|
|
54,477,885
|
|
|
3,094,860
|
|
|
115,161
|
|
Authorize
25,000,000 shares of preferred stock
|
|
|
53,060,758
|
|
|
3,510,989
|
|
|
1,115,159
|
|
Increase
the number of authorized shares of
|
|
|
|
|
|
|
|
|
|
|
common
stock to 400,000,000
|
|
|
54,144,735
|
|
|
3,386,082
|
|
|
157,089
|
|
Approve
Berkovits, Lago & Company, LLP as the
|
|
|
|
|
|
|
|
|
|
|
Company's
independent auditors for 2006
|
|
|
87,166,408
|
|
|
140,608
|
|
|
240,947
|
|
ITEM
5. OTHER
INFORMATION
None.
ITEM
6. EXHIBITS
10.1
|
Form
of Subscription Agreement dated April 6,
2007
|
10.2
|
Form
of Convertible Note dated April 6,
2007
|
10.3
|
Form
of Class D Common Stock Purchase Warrant dated April 6,
2007
|
10.4
|
Amendment
to Employment Agreement Between VoIP, Inc. and Robert Staats, dated
May 4,
2007.
|
10.5
|
Amendment
to Employment Agreement Between VoIP, Inc. and Anthony Cataldo, dated
May
4, 2007.
|
10.6
|
Third
Amendment to Employment Agreement Between VoIP, Inc. and Shawn Lewis,
dated May 4, 2007.
|
10.7
|
Korompis
Consulting Agreement dated April 2,
2007.
|
10.8
|
Advisory
Services Agreement with Mark L. Baum, dated May 9,
2007.
|
10.9
|
Advisory
Services Agreement with James B. Panther II, dated May 9,
2007.
|
31.1 |
Certification by Chief Executive Officer under
SEC Rule
13a-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of
2002. |
31.2 |
Certification
by Chief Accounting Officer under SEC Rule 13a-14, as adopted
pursuant to
Section 302 of the Sarbanes-Oxley Act of
2002.
|
32.1 |
Certification
by Chief Executive Officer pursuant to 18 USC Section 1350
as adopted by
Section 906 of the Sarbanes-Oxley Act of
2002.
|
32.2 |
Certification
by Chief Accounting Officer pursuant to 18 USC Section 1350
as adopted by
Section 906 of the Sarbanes-Oxley Act of
2002.
|
SIGNATURES
In
accordance with the requirements of the Exchange Act, the registrant caused
this
Quarterly Report on Form 10-Q for the period ended March 31, 2007 to be signed
on its behalf by the undersigned, thereunto duly authorized.
|
|
VoIP,
INC.
|
|
|
|
Date:
May 15, 2007 |
|
/s/
Robert V. Staats |
|
Robert
V. Staats
Chief
Accounting Officer
|
EXHIBIT
INDEX
Exhibit
Number
10.1
|
Form
of Subscription Agreement dated April 6,
2007
|
10.2
|
Form
of Convertible Note dated April 6,
2007
|
10.3
|
Form
of Class D Common Stock Purchase Warrant dated April 6,
2007
|
10.4
|
Amendment
to Employment Agreement Between VoIP, Inc. and Robert Staats, dated
May 4,
2007.
|
10.5
|
Amendment
to Employment Agreement Between VoIP, Inc. and Anthony Cataldo, dated
May
4, 2007.
|
10.6
|
Third
Amendment to Employment Agreement Between VoIP, Inc. and Shawn Lewis,
dated May 4, 2007.
|
10.7
|
Korompis
Consulting Agreement dated April 2,
2007.
|
10.8
|
Advisory
Services Agreement with Mark L. Baum, dated May 9,
2007.
|
10.9
|
Advisory
Services Agreement with James B. Panther II, dated May 9,
2007.
|
31.1
|
Certification
by Chief Executive Officer under SEC Rule 13a-14, as adopted pursuant
to
Section 302 of the Sarbanes-Oxley Act of
2002.
|
31.2
|
Certification
by Chief Accounting Officer under SEC Rule 13a-14, as adopted pursuant
to
Section 302 of the Sarbanes-Oxley Act of
2002.
|
32.1
|
Certification
by Chief Executive Officer pursuant to 18 USC Section 1350 as adopted
by
Section 906 of the Sarbanes-Oxley Act of
2002.
|
32.2
|
Certification
by Chief Accounting Officer pursuant to 18 USC Section 1350 as adopted
by
Section 906 of the Sarbanes-Oxley Act of
2002.
|