Commission file number 000-28985

 

VOIP, INC.

(Name of small business issuer in its charter)

 

Texas (State or other jurisdiction of incorporation or organization) 151 South Wymore Rd, Suite 3000 Altamonte Springs, Florida (Address of principal executive offices)

75-2785941 (I.R.S. Employer Identification No.)   32714 (Zip Code)

Issuer's telephone number, including area code: (407) 389-3232

 

Securities registered pursuant to Section 12(b) of the Act: None.

 

Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.001.

 

Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. o

 

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the issuer was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o

 

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained herein, and none will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. x

 

Indicate by a check mark whether the registrant is a shell company (as defined by Rule12b-2 of the Exchange Act). YES o NOx

 

The issuer's revenues for its most recent fiscal year were $ 15,507,145.

 

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the issuer, based on the average bid and asked price of such stock, was $90,522,977 at March 22, 2006. At March 22, 2006, the registrant had outstanding 68,838,766 shares of par value $.001 common stock.

 

NOTE K - LIQUIDITY AND CAPITAL RESOURCES

 

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplates continuation of the Company as a going concern.

 

The Company has incurred operating losses and negative cash flows from operations since inception of its business in 2004 and has been dependent on issuances of debt and equity instruments to fund its operations and capital expenditures.

 

At December 31, 2005 the Company's contractual obligations for debt, leases and capital expenditures totaled approximately $11.5 million. Included in this amount is approximately $4.7 million due on a loan from a lending institution. The Company was not in compliance with certain covenants under the loan agreement for this debt.

 

In January and February, 2006, the Company issued and sold $11,959,666 principal amount of Convertible Notes to nine accredited investors, for net proceeds of $9,879,400 (at a 12.121% original issue discount) in a private placement. The investors also received five-year warrants to purchase a total of 4,537,053 shares for an exercise price of $1.46 per share, and one-year warrants to purchase 4,537,053 shares for an exercise price of $1.59 per share.

 

Of the convertible notes approximately $7.6 million are secured by a subordinated lien on our assets, and of all these notes bear interest at an effective rate of 20%, are payable over two years beginning 90 to 180 days after closing in cash or at the option of the Company in registered common stock at the lesser of $1.40 per share or 85% of the weighted average price of the stock on the OTCBB. The holders may at their election convert all or part of the notes into shares of common stock at the conversion rate of $1.32 per share.

 

F-14

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The subscription agreements for the sale of these convertible notes contain provisions that could impact the Company’s future capital raising efforts and its capital structure, including:

 

·

In February 2006, the Company filed a registration statement to register 200% of the shares issuable upon conversion of these notes and all of the shares issuable upon exercise of the warrants (the “Notes Registration Statement”). If the Notes Registration Statement is not declared effective by late April 2006, the Company is liable for liquidated damages each month at a rate of 1.5% of the outstanding note principal until the Registration Statement is declared effective.

 

·

Unless consent is obtained from the note holders, the Company may not file any new registration statements or amend any existing registrations until the sooner of (i) 60 days following the effective date of the Note Registration Statement or (ii) all the notes have been converted into shares and such shares and the warrant shares have been sold by the note holders.

 

·	Until the Notes Registration Statement has been effective for 365 days the note holders must be given the right of first refusal to purchase any proposed sale of the Company’s common stock or debt obligations.

 

·

Unless we consent is obtained from the note holders for so long as 20% or more of the note principal, warrants or common stock issued or issuable for the notes remains outstanding, the Company may not issue any new shares of common stock, convertible securities or warrants at a price per share, conversion price per share or exercise price per share that is lower than those prices in effect for the notes and warrants without issuing the note holders sufficient additional shares or warrants at prices such that their warrant exercise price or per share price on average is equal to that for the proposed securities to be issued.

 

The Company will need to continue to raise additional debt or equity capital to provide the funds necessary to restructure or repay its $4.7 million loan, meet its other contractual commitments, and continue its operations. The Company is actively seeking to raise this additional capital but may not be successful in obtaining further 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 shares of stock consist of 100,000,000 shares of common stock. As of April 2006, 68,838,766 common shares issued and outstanding, and there are approximately 45 million additional shares that may become outstanding upon the exercise or conversion of outstanding stock options, warrants and convertible securities. A proxy statement has been filed in connection with annual meeting of shareholders at which a proposal will be submitted to increase the authorized shares of capital stock to 250,000,000 shares of common stock and 25,000,000 shares of “blank check” preferred stock. If such proposal is not approved, the Company will be unable to satisfy the contractual obligations it has undertaken to issue future shares of common stock.

 

NOTE L - STOCK BASED COMPENSATION

 

A total of 4,000,000 shares of common stock have been reserved for issuance under the Company's 2004 Employee Stock Option Plan. The activity in this 2004 Option Plan for the year ended December 31, 2005 is as follows:

 

F-15

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			Number			Exercise Price Range			Wtd. Avg. Exercise Price
Options outstanding at December 31, 2004			3,650,000		$	0.85 - $1.56		$	1.14
Options returned to the plan due
to employee terminations			(528,438	)	$	0.85 - $1.10		$	0.95
Options granted			625,000		$	1.01 - $1.53		$	1.37
Options outstanding at December 31, 2005			3,746,562		$	0.85 - $1.56		$	1.21

 

In addition to options issued under the 2004 option plan, the Company granted 800,000 options during 2005 to two executive officers at an exercise price of $1.56, all of which remain outstanding at December 31, 2005

 

The Company recorded compensation expense of $894,333 and $1,103,309 for the years ended December 31, 2005 and 2004 respectively in connection with stock options granted. As of December 31, 2005, approximately $1,994,000 in total compensation cost related to nonvested options remains to be expensed in future periods.

 

During the years ended December 31, 2005 and 2004, the Company issued to employees and a financial services firm warrants to purchase 3,300,000 and 4,800,000 shares, respectively, of common stock for prices ranging from $0.93 to $1.07 per share. During year ended December 31, 2005 the Company issued 2,025,630 shares of common stock in exchange for related warrants. The Company recognized $1,044,917 and $2,217,600 in 2005 and 2004, respectively, in expense in connection with the issuance of these warrants.

 

On December 7, 2005, the Company’s Board of Directors approved, subject to shareholder approval, the Company’s 2006 Equity Incentive Plan (the “2006 Plan”). The 2006 Plan provides that key employees, consultants and non-employee directors of the Company or an affiliate may be granted: (1) options to acquire shares of the Company’s common stock, (2) shares of restricted common stock, (3) stock appreciation rights, (4) performance-based awards, (5) “Dividend Equivalents”, and (6) other stock-based awards. The Company is seeking shareholder approval at its 2006 shareholders’ meeting for the future issuance of options under the 2006 Plan to allow its participants to acquire up to 10,000,000 shares of our common stock.

 

NOTE M - WARRANTS

 

A summary of the Company's warrants as of December, 31 2005 and 2004 is presented below:

 

			2005						2004
			Warrants			Weighted average exercise price			Warrants			Weighted average exercise price
Warrants outstanding at beginning or year			4,800,000		$	1.06			-		$	-
Granted to company officers			2,450,000		$	1.51			4,400,000		$	1.00
Granted to a third party			850,000		$	1.60			400,000		$	1.75
Expired			-		$	-			-		$	-
Exercised			(4,400,000	)	$	1.00			-		$	-
Warrants outstanding at end of year			3,700,000		$	1.55			4,800,000		$	1.06

 

The value of warrants was estimated using the Black-Scholes option pricing model. (See Note I for Black-Scholes pricing assumptions).

F-16

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NOTE N - COMMITMENTS

 

The Company is obligated under non-cancelable operating leases for its office facilities and two apartments used by its employees. Future minimum lease payments under the Company's non-cancelable operating leases as of December 31, 2005 are as follows:

 

Year ending Dec 31
2006		$	386,846
2007			320,848
Total		$	707,694

 

During the years ended December 31, 2005 and 2004, $285,993 and $41,957, respectively, were charged to operations for rent expense related to these operating leases.

 

NOTE O - RELATED PARTY TRANSACTIONS

 

As of December 31, 2005 and 2004 the amount due from (to) related parties consisted of the following:

 

			2005			2004
DTNet, Inc. (1)		$	-		$	134,317
DTNet International (1)			-			119,974
WQN, Inc.			161,530			-
Mozart Communication			-			21,794
Com Laser			-			5,850
Other			-			(36,533	)
Total		$	161,530		$	245,402

 

(1) The above entities are related to a shareholder of the Company. These advances are unsecured, due upon demand and non-interest bearing. However, $250,000 of these amounts was written off as uncollectible in 2005.

 

In December 2004 the Company issued a $560,000 note payable to a shareholder, bearing interest at 3.75%, with an original maturity date of December 2005. In January 2005 the Company added another note payable for $1,040,000 to the same shareholder under similar terms. At December 31, 2005 and 2004, the outstanding balance of these notes was $1,572,894 and $560,000, respectively. The notes are currently due on demand.

 

Interest paid under these notes was $50,613 during the year ended December 31, 2005.

 

 

F-21

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VoIP, Inc

Proforma Condensed Combined Statement of Operations (Unaudited)

Year Ended December 31, 2005

		VoIP, Inc			Caerus, Inc			WQN, Inc			Adjustments			Consolidated
Revenues		$	3,277,323		$	11,307,620		$	31,790,296		$	-		$	46,375,239
Cost of sales			2,754,073			14,814,907			30,397,628			-			47,966,608
Gross profit			523,250			(3,507,287	)		1,392,668			-			(1,591,369	)
Operating expenses			19,393,232			6,558,373			5,024,616			3,968,437			34,944,658
Loss from operations			(18,869,982	)		(10,065,660	)		(3,631,948	)		(3,968,437	)		(36,536,027	)
Interest expense			1,078,138			786,390			-			643,200			2,507,728
Gain on sale of fixed assets			(206,184	)		-			(148,236	)		-			(354,420	)
Provision for income taxes			-			-			-			-			-
Net loss before discontinued operations			(19,741,936	)		(10,852,050	)		(3,483,712	)		(4,611,637	)		($38,689,335	)
Income from discontinued operations,
net of income taxes			-			-			-			-			-
Net Loss		$	(19,741,936	)	$	(10,852,050	)	$	(3,483,712	)	$	(4,611,637	)	$	(38,689,335	)
Basic and diluted loss per share:														$	(0.79	)
Weighted average number of shares outstanding															48,870,602

The accompanying notes are an integral part of this pro forma condensed combined statement of operations.

F-22

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CAERUS, INC.

CONSOLIDATED BALANCESHEETS

December 31, 2004 and 2003

ASSETS

 

		2004			2003
CURRENT ASSETS
Cash and cash equivalents		$	19,414		$	25,078
Restricted cash			60,224			196
Accounts receivable			2,098,598			358,522
Note receivable - related party			-			179,974
Supplies, deposits and prepaid expenses			70,999			350,199
TOTAL CURRENT ASSETS			2,249,235			913,969
PROPERTY AND EQUIPMENT
Telecommunications equipment and computers			6,390,973			732,205
Furniture and fixtures			61,960			21,624
Leasehold improvements			163,808			146,358
Purchased and developed software			473,228			598,243
			7,089,969			1,498,430
Less accumulated depreciation and amortization			(824,580	)		(183,408	)
NET PROPERTY AND EQUIPMENT			6,265,389			1,315,022
OTHER ASSETS
Deferred loan origination costs, net			285,075			-
Lease deposit and other			28,959			65,000
TOTAL ASSETS		$	8,828,658		$	2,293,991
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable and accrued expenses		$	7,137,293		$	452,094
Note payable			6,006,899			-
Convertible notes payable - related party			1,830,000			1,050,000
Deferred revenue and customer deposits			38,750			60,576
TOTAL CURRENT LIABILITIES			15,012,942			1,562,670
STOCKHOLDERS’ EQUITY (DEFICIT)
Common stock - $.01 par value; 50,000,000 shares authorized;
14,940,508 and 11,948,367 shares issued and outstanding, respectively			149,405			119,484
Preferred stock - $.01 par value; 25,000,000 shares authorized;
-0- shares issued and outstanding			-			-
Additional paid-in capital			4,618,253			2,952,184
Accumulated deficit			(10,951,942	)		(2,340,347	)
TOTAL SHAREHOLDERS’ EQUITY (DEFICIT)			(6,184,284	)		731,321
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)		$	8,828,658		$	2,293,991

 

The accompanying notes are an integral part of the consolidated financial statements.

F-25

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CAERUS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

For The Year Ended December 31, 2004, and

The Period May 15, 2002 (Date of Inception) Through December 31, 2003

 

		2004			2002-2003
					(Development Stage)
SALES		$	14,379,365		$	1,191,287
COST OF SALES
Network and termination costs			15,103,149			900,681
Testing and sales concessions			662,052			-
TOTAL COST OF SALES			15,765,201			900,681
GROSS PROFIT (LOSS)			(1,385,836	)		290,606
OPERATING EXPENSES
Equipment and computer expenses			603,189			97,068
Office expenses			228,108			206,215
Labor-related expenses			2,973,070			1,214,240
Professional fees			814,243			400,872
Marketing			217,835			16,689
Litigation settlement			326,205			-
Rent, utilities and security			246,545			355,481
Taxes and licenses			55,527			25,390
Travel, lodging and entertainment			163,555			90,928
Depreciation and amortization			641,172			183,409
Asset impairment charge			299,122			-
TOTAL EXPENSES			6,568,571			2,590,292
LOSS FROM OPERATIONS			(7,954,407	)		(2,299,686	)
OTHER EXPENSES
Interest expense, net			(657,238	)		(19,654	)
Other expense, net			50			(21,007	)
NET LOSS		$	(8,611,595	)	$	(2,340,347	)

 

The accompanying notes are an integral part of the consolidated financial statements.

F-26

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Related 2004 compensation expense was $76,917, determined by amortizing the options' estimated fair value at grant date over their vesting period. The weighted average remaining contractual life of the options outstanding at December 31, 2004 was 9.8 years (see Note 8). The Company had no stock options outstanding at December 31, 2003.

 

F-33

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Stock Warrants

 

In 2004, the Company granted a series of warrants to purchase shares of preferred stock, the specific terms of which had yet to be determined, at an exercise price of $0.85 per share, in conjunction with the long-term note payable issuance (see Note 4). These warrants expire at the earlier of ten years from their issuance date, or five years after a potential initial public securities offering. At the warrant holder's election, these warrants may be exercised on a non-cash basis whereby the warrant holder uses the surplus of the preferred stock's then-fair market value per share over the $0.85 exercise price as payment for the preferred stock purchased under these warrants.

 

These warrants had estimated fair values totaling $218,813 at their grant dates, recognized as additional paid-in capital and deferred loan origination costs. Additional information pertaining to these warrants issued and outstanding at December 31, 2004 is as follows:

 

Also in conjunction with the long-term note payable issuance (see Note 4), the Company granted warrants to purchase up to $1.0 million of common or preferred stock that may be issued in conjunction with any future securities offering of at least $5.0 million, upon the same price and conditions as afforded to third-party investors in said potential securities offering.

 

In August 2004, the Company issued warrants to purchase 150,000 shares of common stock to a former employee whose employment was terminated in June 2004. Such warrants are exercisable at $0.85 per share, and expire on June 26, 2006. The Company had no stock warrants outstanding at December 31, 2003.

 

 

		Year ended December 31,
		2004			2003
Net loss as reported		$	(3,507,205	)	$	(3,345,392	)
Pro forma stock-based employee compensation expense			(202,499	)		(170,863	)
Pro forma net loss		$	(3,709,704	)	$	(3,516,255	)
Net loss per share:
As reported - basic and diluted			(0.53	)		(0.52	)
Pro forma - basic and diluted		$	(0.56	)	$	(0.55	)

F-44

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WQN, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The fair value of options granted was estimated at the date of grant using the Black-Scholes option pricing model. The following weighted average assumptions used in the December 31, 2004 calculation were as follows: risk free interest rate of 3.5%, dividend yield of zero, volatility factor of 1.1, and average expected life of 4 years. The weighted average assumptions used in the December 31, 2003 calculation were as follows: risk free interest rate of 3.25%, dividend yield of zero, volatility of .85 and average expected life of 5 years. The options granted during 2004 and 2003 had a weighted average fair value of $1.50 and $1.40 per share, respectively.

 

Net Loss per Share

 

Basic and diluted net loss per share is computed using the Company’s net loss for each period presented divided by the average common shares outstanding during the period. Stock options and warrants convertible into 1,267,759 and 1,790,556 shares of the Company’s common stock for the years ended December 31, 2004 and 2003, respectively, are excluded from the calculation of diluted earning per share because the Company reported losses from continuing operations in those periods and their effect would be antidilutive.

 

Comprehensive Income

 

Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. For the years ended December 31, 2004 and 2003, the Company had no transactions other than those reported in its statement of operations.

 

Fair Value of Financial Instruments

 

The Company’s financial instruments consist primarily of cash equivalents, accounts and notes receivable, accounts payable and long-term debt. At December 31, 2004 and 2003, the carrying amount of the Company’s financial instruments approximates their fair values. Management believes the Company’s debt approximates fair value due to its short maturity and its variable interest rate.

 

Concentration of Credit and Business Risks

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, accounts receivable and notes receivable. Accounts receivable consist of amounts owed by credit card processing companies relating to retail telephony sales, amounts owed by distributors for the purchase of telephony products and money transfer services. We bill our retail customers on a prepaid basis through credit cards. Credit is extended to some wholesale customers with terms that generally allow them to pay for our products within two weeks. All other wholesale customers pay for our products upfront.

 

Customers purchase the Company’s retail telephony products using major credit cards, which are reimbursed by credit card processing companies. The Company does not routinely perform on-going credit evaluations of its retail customers but does evaluate its credit card processors. The Company performs credit evaluations and establishes credit limits for its wholesale traffic and whole sale distribution customers, including requiring deposits when applicable.

F-45

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WQN, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

For the years ended December 31, 2004 and 2003, a substantial portion of our retail customers were calling from the United States to India. The India international telephony market continues to experience downward pricing pressures, which has resulted in a decrease in our average selling price to our retail customers. It is unlikely that this trend will reverse in the near future.

 

At December 31, 2004, one customer accounted for 19% of total accounts receivable and no receivables from credit card processing companies accounted for more than 10% of total accounts receivable. At December 31, 2003, three credit card processing companies accounted for 35%, 13%, and 10% of total accounts receivable. At December 31, 2004 and 2003, accounts receivable are stated net of an allowance for doubtful accounts of $25,000. Bad debt expense for the years ended December 31, 2004 and 2003 was $189,000 and $83,000, respectively. For the year ended December 31, 2004, the Company purchased data communication and telecommunication services from three suppliers, which accounted for 18%, 13% and 11% of cost of goods sold for telecommunication services. For the year ended December 31, 2003, the Company purchased data communication and telecommunication services from three suppliers, which accounted for 35%, 18%, and 11% of cost of goods sold for telecommunication services.

 

New Accounting Pronouncements

 

F-46

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WQN, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

3.  Discontinued Operations

 

 

		Year ended December 31,
		2004			2003
Revenue		$	340,027		$	556,462
Cost of revenue			(134,969	)		(200,880	)
Gross profit			205,058			355,582
Operating Expenses			(438,833	)		(813,461	)
Net loss			(233,775	)		(457,879	)
Gain on disposal			777,114			—
Income (loss) from discontinued operations		$	543,339		$	(457,879	)

 

 

		2004			2003
Cash and cash equivalents		$	—		$	514,635
Accounts receivable			—			409,717
Prepaid expenses and other current assets			—			71,988
Property and equipment, net			—			236,308
Accounts payable and accrued expenses			—			(210,658	)
		$	—		$	1,021,990

 

F-47

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WQN, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4.  Merger Agreement with Ntera Holdings

 

On March 16, 2004, the Company entered into an Agreement and Plan of Merger (the “Agreement”) with Ntera Holdings, Inc., a Delaware corporation (“Ntera”), providing for a transaction that would have resulted in a change of control of WQN. In connection with the Agreement, WQN extended to Ntera a bridge loan in the principal amount of $2 million bearing interest of 7% per annum, which is secured by the assets of Ntera. On September 2, 2004, the Company terminated the Agreement with Ntera. Under the terms of the loan agreement, the full amount of the loan and accrued interest are due and payable within six months of the termination of the Agreement. The Company and Ntera have amended the repayment provisions of the loan agreement whereby Ntera will make installment payments to repay the loan and accrued interest by March 31, 2005. The balance of the note and accrued interest at December 31, 2004 was $2,058,679, which is net of a payment of approximately $56,000 received during 2004 in the form of telecommunication services. During the first quarter of 2005, the Company received debt payments from Ntera totaling $1,650,000. The unpaid principal and interest as of March 1, 2005 from Ntera was $408,679 and is expected to be collected on its due date. The loan is secured by the assets of Ntera.

 

5.  Value Communications Transaction

 

In April 2004, the Company purchased from Value Communications Corporation (“ValuCom”), a wholly owned subsidiary of Rediff.com India Limited, certain assets consisting primarily of ValuCom’s customer list, brand, trademarks, web sites, internally built software, and certain hardware for $500,000 in order to increase its customer base. The Company paid $200,000 of the total consideration at closing with the remaining $300,000 to be paid in twelve monthly installments of $25,000 commencing May 2004. In addition, the Company entered into an advertising agreement with Rediff.com, Inc. (“Rediff”) entitling WQN to marketing services including exclusive rights to prominent online advertising space on the Rediff.com U.S. website, the premier online destination for Indians in North America. Under the terms of the advertising agreement, the Company will pay Rediff $50,000 for twelve consecutive months commencing in May 2004 for the advertising services. The Company provided both ValuCom and Rediff irrevocable letters of credit for the Company’s remaining obligation under the agreements. The letters of credit are secured by deposits in money market funds and the amount of the letters of credit and the deposits are reduced as the monthly installments are paid. At December 31, 2004, the Company’s obligation under both the agreements totaled $300,000. Substantially all of the ValuCom purchase consideration was allocated to customer lists, which is included in other assets and is being amortized over four years.

 

6.  Distribution and Marketing Agreement

 

In September 2004, we entered into a distribution and marketing agreement with a privately held company. As a result of the agreement, the Company’s products will be sold in more than 5,000 retail outlets in the Southern California market. We sell telephony and other products to a network of distributors who then re-sell the product to the retail outlets. The revenues generated through this agreement are included in wholesale telephony revenues. In connection with the agreement, we paid the private company $50,000 and issued a warrant to purchase 40,000 shares of our common stock for a total consideration of approximately $126,000 as valued with the Black-Scholes pricing model which is included in other assets and is being amortized over the three year term of the agreement. The warrants exercise price is $.01.

F-48

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WQN, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

7.  Investment in partnership

 

In November 2004, the Company invested $3 million in a partnership managed by an affiliate of a director of the Company. The majority of the partnership assets are to be invested in private investments in public entities. The partnership investments will take the form of common equity, preferred equity, convertible debt and/or equity or debt securities. Although the partnership will endeavor to engage in hedging transactions in order to mitigate downside risk, there can be no assurance that the partnership’s investments will be successful and, as a result, the Company may lose all or some of its investment. The partnership agreement contains certain restrictions, including limits on the Company’s ability to withdraw capital from the partnership and limits on the transferability of the Company’s interests in the partnership. The Company can receive a distribution on its partner capital account by giving the partnership 60 days written notice. The Company records its proportionate share of earnings and losses from the partnership based on its share of the partnership and for the year ended December 31, 2004 recorded a loss from its partnership investment of $55,757.

 

8.  Notes Receivable

 

 

		2004			2003
Loan to Ntera Holdings, Inc.		$	2,058,679		$	—
Note from sale of Cash2India subsidiary			554,167			—
Less amounts classified as current			(2,408,679	)		—
Long-term portion		$	204,167		$	—

 

During 2004, in connection with the Agreement and plan of merger with Ntera Holding Inc., WQN extended to Ntera a bridge loan in the principal amount of $2 million bearing interest of 7% per annum (see Note 4). The balance of the note and accrued interest at December 31, 2004 was $2,058,679. The full amount of the loan and accrued interest are to be repaid in installments by March 31, 2005. During the first quarter of 2005 the Company has received debt payments from Ntera totaling $1,650,000. The unpaid principal and interest as of March 1, 2005 from Ntera was $408,679. The loan is secured by the assets of Ntera.

 

In July 2004, the Company sold all of the outstanding capital stock of its wholly-owned subsidiary Cash2India and received as a component of the purchase price a promissory note for $700,000 (See Note 3). The promissory note bears interest at 5% per annum, is secured by the capital stock of Cash2India, and is to be repaid in twenty-four consecutive monthly payments of $29,167 plus interest. During 2004, the Company received principal and interest payments of $159,290 and the balance of the promissory note and accrued interest was $554,167 as of December 31, 2004.

 

9.  Prepaid Expenses and Other Current Assets

 

 

		2004			2003
Prepaid telecommunication services		$	534,181		$	33,222
Deposits			151,781		$	316,936
Prepaid expenses			120,106			207,419
		$	806,068		$	557,577

 

F-49

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		2004			2003
Accrued franchise, property and sales taxes		$	44,471		$	130,608
Accrued payroll expenses			67,467			62,115
ValuCom payable			300,000			—
Other accrued expenses			45,521			279,023
		$	457,459		$	471,746

 

12.  Debt

 

Long-term debt consists of the following as of December 31:

 

		2004			2003
Promissory note		$	300,000		$	300,000
Less current portion			(300,000	)		—
Long term debt net of current portion		$	—		$	300,000

 

In 2001, the Company borrowed $300,000 from a financial institution under a term promissory note agreement (the “Note”). The Note bears interest at the financial institution’s prime rate as adjusted from time to time (5.25% at December 31, 2004) less 2.25% per annum. The Note, originally due in October 2003 was extended and is now due in October 2005. The Note is collateralized by a $300,000 certificate of deposit bearing interest of 1.47 % per annum.

 

F-50

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WQN, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

13.  Related Party Transactions

 

The Company’s founder, Chief Executive Officer and President holds a controlling interest in Eagle Venture Capital, which owns approximately 2.6 million outstanding shares of the common stock of the Company as of December 31, 2004 and 2003.

 

A consulting company managed by one of the Company’s directors holds warrants to acquire 100,000 shares of the Company’s common stock. The warrants have an exercise price of $6.00 per share and expire in 2005.

 

In November 2004, the Company invested $3 million in a partnership managed by an affiliate of a director of the Company (see Note 7). Certain other company directors and officers have also invested separately in the partnership.

 

14.  Income Taxes

 

 

		2004			2003
Deferred tax assets/(liability):
Property and equipment		$	21,265		$	(35,341	)
Capital loss carry forward			195,941			195,941
Other			66,162			29,075
Net operating loss carry forwards			9,281,128			9,292,073
Total deferred tax assets			9,564,496			9,481,748
Valuation allowance			(9,564,496	)		(9,481,748	)
Net deferred tax assets		$	—		$	—

 

The Company has U.S. net operating loss carry forwards of approximately $25,104,000 as of December 31, 2004. The Company has not recognized a deferred tax asset in the accompanying balance sheets due to the uncertainty of future realization. Accordingly, no tax benefit has been recognized in the accompanying consolidated statements of operations. Net operating loss carry forwards associated with the sale of our Cash2India subsidiary of approximately $2,900,000 have not been included in the deferred tax assets at December 31, 2004. No other significant reconciling items exist between the actual effective tax rate and the expected effective tax rate. During 2004 and 2003, the valuation allowance increased by approximately $83,000 and $1,232,000, respectively. If unused, accumulated net operating losses expire as follows: 2011 - $214,000; 2012 - $1,531,000; 2018 - $1,447,000; 2019 - $1,999,000; 2020 - $4,628,000; 2021 - $8,210,000; 2022 - $3,828,000; 2023 - $3,247,000.

F-51

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WQN, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

15.  Stockholders’ Equity

 

Common and Preferred Stock

 

The Company’s authorized share capital consists of 50,000,000 shares of common stock with par value of $0.01 per share, and 10,000,000 shares of preferred stock with par value of $0.01 per share.

 

Warrants

 

At December 31, 2004 and 2003, the Company had outstanding warrants to purchase 414,775 and 720,775 shares of its common stock, respectively. These warrants expire March 2005 through July 2006 and have a weighted average exercise price of $16.98 per share. At December 31, 2004, all of the warrants were exercisable. The warrants outstanding include warrants granted to a consulting company managed by one of the Company’s directors to acquire 100,000 shares of common stock (see Note 13); warrants granted to representatives of the Company’s underwriters in connection with the Company’s initial public offering to acquire 275,000 shares of common stock; and warrants granted to various service providers and others to acquire 39,775 shares of common stock. In 2004, we issued warrants to purchase 40,000 shares of our common stock to a privately held company in connection with a distribution and marketing agreement (See Note 6).

 

Stock Options

 

 

		Number of Shares			Weighted Average Exercise Price
Outstanding at December 31, 2002			886,080		$	4.05
Granted			55,000			2.04
Exercised			—			0.00
Cancelled			(39,166	)		3.82
Outstanding at December 31, 2003			901,914		$	3.93
Granted			265,500			2.65
Exercised			(275,996	)		2.51
Cancelled			(38,434	)		2.10
Outstanding at December 31, 2004			852,984		$	4.11
Options exercisable:
December 31, 2003			794,258			4.18
December 31, 2004			662,486		$	4.57

 

F-52

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