Pursuant
to Rule 424(b)(3)
Registration
Number 333-127522
PROSPECTUS
SUPPLEMENT NUMBER TWO
(TO
PROSPECTUS DATED OCTOBER 18, 2005)
15,372,245
Shares
VoIP,
Inc.
COMMON
STOCK
This
prospectus supplement supplements the prospectus dated October 18, 2005 relating
to the offer and sale by the selling stockholders identified in the prospectus
of up to 15,372,245 shares of our common stock. This prospectus supplement
includes our Annual Report on Form 10-KSB for the year ended December
31, 2005, which was filed with the Securities and Exchange Commission on April
17, 2006.
The
information contained in such reports is dated as of the date of such reports.
This prospectus supplement should be read in conjunction with the prospectus
dated October 18, 2005, which is to be delivered with this prospectus
supplement. This prospectus supplement is qualified by reference to the
prospectus except to the extent that the information in this prospectus
supplement updates and supercedes the information contained in the prospectus
dated October 18, 2005, including any supplements or amendments
thereto.
Investing
in the shares involves risks. See “Risk Factors” beginning on page 5 of the
prospectus dated October 18, 2005.
Neither
the Securities and Exchange Commission nor any state securities commission
has
approved or disapproved of these securities or determined if this prospectus
is
truthful or complete. Any representation to the contrary is a criminal
offense.
The
date of this prospectus supplement is April 18, 2006.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2005
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period ____________to____________
Commission file number 000-28985
VOIP, INC.
(Name of small business issuer in its charter)
Texas 75-2785941
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
12330 SW 53rd Street, Suite 712
Fort Lauderdale, Florida 33330
(Address of principal executive offices) (ZIP Code)
Issuer's telephone number, including area code: (954) 434-2000
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. |_|
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 |_|
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 Rule 12b-2 of the Exchange Act). YES |_| NO |X|
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.
DOCUMENTS INCORPORATED BY REFERENCE
None.
Transitional Small Business Disclosure Format (Check one): Yes |_|; No |X|
TABLE OF CONTENTS
PART I 1
ITEM 1. DESCRIPTION OF BUSINESS 3
ITEM 2. DESCRIPTION OF PROPERTY 20
ITEM 3. LEGAL PROCEEDINGS 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 21
PART II 21
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 21
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 22
ITEM 7. FINANCIAL STATEMENTS 27
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE 27
ITEM 8A. CONTROLS AND PROCEDURES 27
ITEM 8B. OTHER INFORMATION 29
PART III 29
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT 29
ITEM 10. EXECUTIVE COMPENSATION 31
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS 33
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 35
ITEM 13. EXHIBITS 35
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 38
2
VOIP, INC.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
Cautionary Statement Regarding Forward-Looking Statements
This Form 10-KSB contains forward-looking statements relating to events
anticipated to happen in the future. These forward-looking statements are based
on the beliefs of our management, as well as assumptions made by and information
currently available to our management. Forward-looking statements also may be
included in other written and oral statements made or released by us. You can
identify forward-looking statements by the fact that they do not relate strictly
to historical or current facts. The words "believe," "anticipate," "intend,"
"expect," "estimate," "project," "may", "could" and similar expressions are
intended to identify forward-looking statements. Forward-looking statements
describe our expectations today of what we believe is most likely to occur or
may be reasonably achievable in the future, but they do not predict or assure
any future occurrence and may turn out to be wrong. Forward-looking statements
are subject to both known and unknown risks and uncertainties and can be
affected by inaccurate assumptions we might make. Consequently, no
forward-looking statement can be guaranteed. Actual future results may vary
materially. We do not undertake any obligation to publicly update any
forward-looking statements to reflect new information or future events or
occurrences. These statements reflect our current views with respect to future
events and are subject to risks and uncertainties about us, including, among
other things:
o our ability to market our services successfully to new subscribers;
o our ability to retain a high percentage of our customers;
o the possibility of unforeseen capital expenditures and other upfront
investments required to deploy new technologies or to effect new
business initiatives;
o our ability to raise capital;
o network developments and operations;
o our expansion, including consumer acceptance of new price plans and
bundled offerings;
o additions or departures of key personnel;
o competition, including the introduction of new products or services
by our competitors;
o existing and future laws or regulations affecting our business and
our ability to comply with these laws or regulations;
o our reliance on the systems and provisioning processes of regional
Bell operating companies;
o technological innovations;
o the outcome of legal and regulatory proceedings;
o general economic and business conditions, both nationally and in the
regions in which we operate; and
o other factors described in this document.
We caution you not to place undue reliance on these forward-looking statements,
which speak only as of the date of this document.
We have restated our annual financial statements for 2004. Except as
otherwise noted, all financial information contained in this Annual Report on
Form 10-KSB gives effect to these restatements. For information concerning the
background of the restatement, the specific adjustments made, and management's
discussion and analysis of our results of operations for 2004 giving effect to
the restated information, see Item 6. "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Restatement of Financial
Statements."
3
OVERVIEW
We were incorporated under the laws of the State of Texas on August 3,
1998 under our original name of Millennia Tea Masters. In February 2004 we
exchanged 12,500,000 of our common shares for the assets of two start-up
telecommunication businesses, eGlobalphone, Inc. and VoIP Solutions, Inc. We
changed our name to VoIP, Inc. in April 2004. We consummated the acquisitions of
DTNet Technologies, Inc., a hardware supplier, and VoIP Americas, Inc., a VoIP
related company, in June and September, respectively, of 2004. We decided to
exit our former tea business in December 2004 and focus our efforts and
resources in the Voice over Internet Protocol (VOIP) telecommunications
industry. In May 2005 we completed the acquisition of Caerus, Inc., a VoIP
carrier and service provider, and in October 2005 we purchased substantially all
of the VOIP-related assets of WQN, Inc.
We are an emerging global provider of advanced communications products and
services utilizing Voice over Internet Protocol (VOIP) technology. VOIP 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.
Since 2004, we have developed our business through strategic acquisitions.
These acquisitions have provided us with important technology, intellectual
capital, VOIP expertise, trade names, domain names, VOIP enhanced service
applications, key business relationships and revenues. We own our network and
technology and have the ability to provide complete product and service
solutions, including outsourced customer service and hardware fulfillment. We
are a certified Competitive Local Exchange Carrier (CLEC) and Interexchange
Carrier (IXC) which allows us to receive more favorable rates from the Regional
Bell Operating Companies (RBOCs) and the traditional long-distance carriers than
telephony resellers who are not CLECs or IXCs, as well as provide regulatory
compliance in an industry that is moving quickly towards controls and
regulations. We expect to provide a comprehensive portfolio of advanced
telecommunications technologies, enhanced service solutions, and broadband
products to the VOIP industry. Our current and targeted customers include RBOCs,
CLECs, IXCs, wireless carriers, resellers, Internet Service Providers (ISPs),
cable system operators ("cable operators") and other providers of telephony
services in the United States and various countries around the world.
Our goal is to become the premier enabler for packet communication
services for carriers, service providers and cable operators seeking to offer
value-added voice, data and enhanced services products utilizing VOIP
technology.
OUR BUSINESS SEGMENTS
Our business is divided into three primary segments: (1)
telecommunications, which consists of consumer and wholesale telecommunication
services provided through our proprietary VOIP network and technology; (2)
wholesale sales of VOIP hardware and broadband components; and (3) the
wholesaling of prepaid calling cards.
Telecommunications Segment
Our Technology and Network
We began developing our proprietary hardware and software in 2002,
establishing strategic relationships with companies such as Intel, Brooktrout,
Sonus, iCable and other manufacturers of both hardware and software.
Our proprietary softswitch features tools that we believe will relieve
many of the interoperability and cost issues that have affected the
implementation of VOIP softswitch technology by traditional carriers, enabling
them to offer cost-competitive, viable VOIP services. Our softswitch
architecture is protocol agnostic, allowing seamless integration with the
legacy-based networks (referred to in the industry as Time Division
Multiplexing, or TDMs) employed by the traditional telephony companies and with
other packet technologies. Our network will allow TDM-based networks to access
the enhanced capabilities and efficiencies of packet technology networks. The
ability to control the underlying technology in our network allows us to provide
interoperable services with multiple hardware solutions which may be
pre-existing in customer networks.
Our network currently supports its own media gateways, softswitch
controller, unified messaging systems, voicemail, media trans-coding, billing
and many other integral parts of a complete solution.
Our network operations center located in Orlando, Florida, is a fully
manned, 24x7x365 operation. From this center we monitor all aspects of the
technical environment of our network, from our nationwide optical backbone to
network routers, signaling gateways and numerous routing gateways, soft switches
and other aspects of our VOIP infrastructure. Fully redundant technologies are
deployed in a scalable network environment that we believe will enable us to
effectively compete in the demanding Internet Protocol (IP) telephony
marketplace. Our network incorporates an advanced Multi-Protocol Label Switching
(MPLS) architecture which provides services to carriers and other service
providers. Our network features direct interconnection facilities with multiple
RBOCs, CLECs, IXCs, service providers, cable operators, wireless carriers and
resellers. We also operate a smaller combination TDM/IP network located in
Dallas, Texas.
4
Customers, Products and Services:
Our telecommunications products and service offerings target VOIP
wholesale customers such as RBOCs, CLECs, IXCs, wireless carriers, ISPs, cable
operators and other providers of telephony services in the United States and
various countries around the world. We also sell VOIP products, such as EasyTalk
and Rocket VOIP, that are targeted at individual consumers.
Call Termination:
We charge our wholesale customers termination fees to terminate calls on
our network. We pay termination fees when it is necessary to route calls from
our network to other networks for termination. Our revenues and profit margins
on those revenues are a function of the number and duration of calls handled by
our network and what we charge and pay to handle this traffic.
U.S. termination takes place either on our network or that of one of our
network partners to which we route traffic. Our international termination
product features direct routes and connections established to many international
voice carriers worldwide. Carriers use complex least-cost-routing algorithms
that direct traffic to the lowest cost carrier. We believe we are in the process
of establishing a competitive cost structure through the efficiencies of our
network design, the completion and implementation of our own least-cost-routing
algorithms, and through current and future partnerships with key off-net and
niche providers. Revenues generated from these services in 2005 all of which
were derived from one customer, amounted to $4,672,840 or 30% of our
consolidated 2005 revenues.
VoiceOne Carrier Direct:
We are in the early stages of implementing our VoiceOne Carrier Direct
program which we believe will enable us to develop a significant
facilities-based carrier customer base. We are a certified CLEC in 27 states,
and will continue to apply for CLEC certification in other states as required.
We believe that carriers that want to offer VOIP services have essentially
three options: create their own internal VOIP capabilities, acquire a VOIP
carrier, or partner with a VOIP carrier. The first of these options requires a
carrier to devote a significant amount of resources to (i) develop its VOIP
network capabilities and associated retail services; (ii) maintain its network
and develop new retail products, and; (iii) continuously upgrade its VOIP
capabilities to keep pace with technological changes. The acquisition of an
existing VOIP carrier could be relatively expensive and, once the acquisition is
complete, the facilities based carrier would still face on-going maintenance/
upgrade issues and costs and additional capital expenditures. With respect to
the third option, our VoiceOne Carrier Direct is a partner program for carriers
that provides them with our technology to IP-enable their TDM networks. With
this program the carriers receive our equipment and expertise, enabling them to
rapidly enter the VOIP services market without making significant capital
expenditures. Because our technology is protocol agnostic, by implementing the
VoiceOne Carrier Direct program we believe our customers can avoid significant
modifications to their TDM networks and the operability issues that can plague
the interface of legacy systems with IP technology. We interface our customers'
TDM systems to our VOIP network. We do not charge the carriers for equipment
that includes softswitch technology, a media gateway, a service creation
environment, a multi-protocol label switching network and access to our products
and services. In return for our equipment and expertise, the facilities based
carrier will pay us fees to terminate calls on our network and for other
services such as Hosted IP Centrex and local inbound. We anticipate that this
strategy will be attractive to carriers since it provides them with a new group
of customers and revenue sources without requiring them to modify their legacy
systems or expend capital. Once the carriers are part of our Carrier Direct
Program, we can obtain revenues from calls the carriers terminate on our
network, and can terminate calls on their network. Through December 31, 2005 we
had not generated any significant revenues from our Voice One Carrier Direct
program.
EasyTalk:
EasyTalk, our automated number identification (ANI) retail product,
marketed through our website, is a long distance service with "ease of use"
features for consumers. We believe that EasyTalk is a step beyond calling cards.
Our network is programmed to automatically recognize our customers' phone
numbers and to provide callers from these numbers immediate access to
long-distance services. No calling card or PIN number is required. Consumer
features include PIN-less dialing, fast *1 recharge of the service, speed dial,
and quick query of current balance. As of December 31, 2005 we had approximately
36,000 Easy Talk customers, and revenues generated for this product offering
amounted to approximately $1,477,000 in 2005.
RocketVoIP:
Our RocketVoIP retail product allows customers to use, through a media
terminal adapter we provide, their high speed internet connection to place
local, long distance and international calls. As of December 31, 2005 we had
approximately 1,800 Rocket VoIP customers, and revenues generated for this
product offering amounted to $171,000 in 2005.
5
Other Products:
We also sell various PIN and ANI products to consumers via our website.
Prepaid Calling Cards Segment
We sell prepaid calling cards that we purchase from other carriers to
private distributors located in southern California. Unlike our other
communications products the communication traffic arising from the use of these
cards to place telephone calls is handled by carriers affiliated with vendors we
purchase the cards from, and not by our network. We generated $4,932,229 in
revenues from the sale of these cards to approximately 40 distributors during
the year ended December 31, 2005.
Hardware Sales Segment
Our hardware sales subsidiary, doing business as DT Net Technologies,
operates a fulfillment center in Clearwater, Florida from which we sell a
variety of VOIP hardware and broadband components to broadband service
providers. DT Net's products are purchased from suppliers in Korea, Taiwan and
China. These products include cable modems, DSL modems, AV power line and home
plug adapters, and multimedia terminal adapters. Sales for this business segment
were $2,376,329 for the year ended December 31, 2005.
STRATEGY
Our objective is to provide reliable, scalable, and competitively-priced
worldwide VOIP communication services with unmatched quality. We plan to achieve
this objective by delivering innovative technologies and services and balancing
the needs of our customers with the needs of our business. We intend to bring
high quality voice products and services, at an affordable price, to other
communication providers, businesses and residential consumers to enhance the
ways in which these customers communicate with the rest of the world.
Specific strategies to accomplish this objective include:
o building our carrier/service provider customer base through
aggressive marketing of our VoiceOne Carrier Direct program;
o completing the expansion of our network (currently in process);
o capitalizing on our technological expertise to introduce new
products, services and features;
o customizing our service offerings for the purpose of pursuing
strategic partnerships with major customers and suppliers;
o offering the best possible service and support to our customers with
a world class customer support organization;
o developing additional distribution channels;
o expanding our market share for our retail calling services;
o increasing our customer base by introducing cost-effective solutions
to interconnect with our network; and
o controlling operating expenses and capital expenditures.
Competition
We compete primarily in the market for enhanced IP communications
services. This market is highly competitive and has numerous service providers.
The market for enhanced Internet and IP communications services is new and
rapidly evolving. We believe that the primary competitive factors determining
success in the Internet and IP communications market are:
o quality of service;
o the ability to meet and anticipate customer needs through multiple
service offerings and feature sets;
o responsive customer care services, and;
6
o price.
Future competition could come from a variety of companies both in the
Internet and telecommunications industries. These industries include major
companies who have greater resources and larger customer bases than we have, and
have been in operation for many years. We also compete in the growing market of
discount telecommunications services including "pure play" VoIP service
providers, prepaid calling cards, call-back services, dial-around or 10-10
calling and collect calling services. In addition, some Internet service
providers have begun to aggressively enhance their real time interactive
communications, including instant messaging, PC-to-PC and PC-to-Phone services,
and broadband phone services.
Some competitors may be able to bundle services and products that are not
offered by us together with enhanced Internet and IP communications services,
which could place us at a significant competitive disadvantage. Many of our
competitors enjoy economies of scale that can result in lower cost structure for
transmission and related costs, which could cause significant pricing pressures
within the industry. At the same time, we see these potential competitors as
potential customers, and have organized our various reseller and service
provider products and services to meet the emergent needs of these companies.
Our primary competitors include:
o carriers operating in the U.S. and abroad, which include the RBOCs,
AT&T, British Telecom, France Telecom, Deutsche Telecom, IDT,
Sprint, Verizon, Level 3, Infonet, Qwest, Broadwing, Ibasis, Primus,
and Teleglobe/VSNL;
o subscriber based service provider competitors, which include Vonage,
Packet8, DeltaThree, SunRocket, Time Warner, Comcast and Net2phone.
INDUSTRY OVERVIEW
The advance of broadband delivery of the Internet into residential and
small offices has opened up a large market for high-speed services to be
delivered in a manner that is independent of the actual wires connected to each
property. Nearly three out of four households with basic phone service have
Internet access, and almost half have of these households have broadband access
(DSL). (Source: Nielsen/NetRatings) The penetration of broadband is rising at
around 2.5% per month. These growth figures are even higher in other nations,
which have only recently been implementing systems after understanding and
modeling their platforms on what has become the standard in the United States.
An additional factor in the cost savings of VOIP is the relatively inexpensive
nature of IP transit data at the core of the Internet. In the late 90's, a large
amount of capital was invested in fiber connectivity between major metropolitan
areas. Due to market forces, this fiber became available at incredibly
inexpensive rates and a "bandwidth glut" or "fiber glut" occurred at the core of
the Internet, driving costs down.
VOIP is a technology that enables voice communications over the Internet
through the compression of voice into data packets that can be transmitted over
data networks and then converted back into voice at the other side. Data
networks, such as the Internet or local area networks (LANs), have always
utilized packet-switched technology to transmit information between two
communicating terminals (for example, a PC downloading a page from a web server,
or one computer sending an e-mail message to another computer). The most common
protocol used for communicating on these packet switched networks is internet
protocol, (IP). VOIP allows for the transmission of voice along with other data
over these same packet switched networks, and provides an alternative to
traditional telephone networks, which uses a fixed electrical connection to
carry voice signals through a series of switches to the final destination. VOIP
has experienced significant growth in recent months. The telephone networks
maintained by many local and long distance telephone companies were designed
solely to carry low-fidelity audio signals with a high level of reliability.
Although these traditional telephone networks are very reliable for voice
communications, they are not well suited to service the explosive growth of
digital communication applications for the following reasons:
o Until recently, telephone companies have avoided the use of packet
switched networks for transmitting voice calls due to the potential
for poor sound quality attributable to latency issues (delays) and
lost packets which can prevent real-time transmission. Recent
improvements in packet switch technology, compression and broadband
access technologies, as well as improved hardware and provisioning
techniques, have significantly improved the quality and usability of
packet-switched voice calls.
o Packet-switched networks have been built mainly for carrying non
real-time data, and the advantages of such networks are their
efficiency, flexibility, reliability and scalability. Bandwidth is
only consumed when needed, networks can be built in a variety of
configurations to suit the number of users, client/server
application requirements and desired availability of bandwidth and
many terminals can share the same connection to the network. As a
result, significantly more traffic can be transmitted over a packet
switched network, such as a home network or the Internet, than a
circuit-switched telephony network. Packet switching technology
allows service providers to converge their traditionally separate
voice and data networks and more efficiently utilize their networks
by carrying voice, video, fax and data traffic over the same
network. The improved efficiency of packet switching technology
creates network cost savings that can be passed on to the consumer
in the form of lower telephony rates. The exponential growth of the
Internet in recent years has proven the scalability and reliability
of these underlying packet switched IP based networks. As broadband
connectivity has become more available and less expensive, it is now
possible for service providers like us to offer voice services that
run over these IP networks to consumers and businesses worldwide.
7
The growth of the Internet in recent years has proven the scalability of
these underlying packet switched networks. As broadband connectivity, including
cable modem and digital subscriber line, or DSL, has become more readily
available and less expensive, it is now possible for service providers like us
to offer voice and other services that run over these IP networks to businesses
and residential consumers. Providing such services has the potential to both
substantially lower the cost of telephone service and equipment costs to these
customers and to increase the breadth of features available to our subscribers.
Services like full-motion, two-way video are now supported by the bandwidth
spectrum commonly available to broadband customers, whether business or
residential.
As the wireless industry has shown, disruptive new technology with better
product and service features has the effect of luring customers to regularly
change carriers. To minimize this risk of churn, carriers must continually
expand their service offering in order to retain their existing customers. With
the growing acceptance of packet and VoIP telephony, the incumbent carriers are
again faced with a disruptive technology with a lower cost of service.
HUMAN RESOURCES
We currently employ 72 people in the following capacities: 4 executive
officers, 41 general and administrative employees, and 27 technology personnel.
We consider our relations with our employees to be good. We have never had a
work stoppage, and none of our employees is represented by collective bargaining
agreements. We believe that our future success will depend in part on our
ability to attract, integrate, retain and motivate highly qualified personnel,
and upon the continued service of our senior management and key technical
personnel. None of our key personnel is bound by employment agreements that
prohibit them from ending their employment at any time. Competition for
qualified personnel in our industry and geographical location is intense. We
cannot assure that we will be successful in attracting, integrating, retaining
and motivating a sufficient number of qualified employees to conduct our
business in the future.
MANUFACTURING AND SOURCES OF SUPPLY
Many of our hardware products are manufactured by iCable System Co. Ltd. a
South Korean Company. iCableSystem provides offshore inventory and delivery
services worldwide and large scale orders are shipped directly from Korea to
providers at any destination. iCableSystem has in-house PC board pressing, case
design and manufacturing, and board processing facilities, making them less
susceptible to supply chain dropouts than other manufacturers.
The primary chipset used in the CPE units is the Broadcom chipset, for
which there is an available supply path and rapid delivery periods. It is not
anticipated that there will be any significant shortfalls in the ability to
produce equipment or deliver equipment, given past experience and current
operating procedures, even under heavy volume sales.
INVENTORIES
Our hardware inventories are kept in a warehouse facility in Clearwater,
Florida. Our hardware inventory and supply methods provide adequate capacity for
most order volumes, but special orders or multi-thousand unit deliveries are
typically drop-shipped from Korea. All softswitch and "back office" solution
materials are also kept on-site for customer deployment, except in cases where
local purchase of equipment is less difficult or less costly than in-country
sourcing.
We also maintain an inventory of prepaid calling cards in our office in
Artesia, CA.
INTELLECTUAL PROPERTY
We have developed several important intellectual property features.
VoiceOne has developed and the network provides an E911 solution to comply with
the FCC's recent order imposing E911 requirements on VoIP Service Providers.
VoiceOne's 911 service is known as Enhanced E911. A key feature of the E911
service is that it can route emergency calls for the customer whose location is
constant as well as the customer who often moves the location of his VoIP
device. Customers can update their location information in real time, so that
their E-911 call will be delivered to the appropriate Public Safety Answering
Point (PSAP) in the new location. To further support the FCC 911 mandate, VoIP,
Inc. has applied for a patent for its 911 compliant VoIP Multimedia Terminal
Adaptor.
VoIP Inc. has developed Pathfinder as a "cascading provisioning server"
feature for deployment of zero-touch hardware deployment and is a new
development that is exclusive to VoIP, Inc.'s platform. The system allows each
device to auto-provision without any customer interaction even in situations
where there are multiple levels of VAR or resellers to distribute the product to
their customers (to any number of resale levels.) This allows for installations
without any customer service or technical support time spent in configuration
issues.
8
REGULATION
The Company currently is a value added service provider. The hardware,
integration and softswitch portions of our business are expected to remain
unthreatened by regulation in major nations in which the Company expects to do
business. The eGlobalphone service offering may potentially experience
regulatory pressures as the United States makes changes in its
telecommunications slaw to encompass VoIP services. The imposition of government
regulation on our business could adversely affect our operations by requiring
additional expense to meet compliance requirements.
1) Regulation is expected to be applied to the following areas of
our service: E911, Communications Assistance for Law Enforcement Act (CALEA) and
USF taxation.
(a) Our existing E911 service addresses this concern already
and we are working with industry groups to also address E911 delivery via the
network when that technology becomes mature and affordable. The combined
delivery methods should adequately protect the Company against negative
regulatory or economic pressure in the future.
(b) CALEA data delivery is almost complete in the system for
the basics of call status and PIN tapping. The additional steps of call
monitoring and call splitting are yet to be even defined, though it is not
anticipated that their deployment would require anything other than minor
expense for adequate compliance with these laws, given current technology.
(c) USF (Universal Service Fee) taxation has been explicitly
not required for data services. The classification of VoIP as a value added data
service has clearly indicated that it is outside of the USF charter.
2) Comments by the FCC staff have indicated that VoIP will be
handled in a relatively "hands-off" manner until the industry is more mature and
capable of competing directly with RBOC and ILEC carriers. This is anticipated
to be at least another two years.
3) Even with additional regulations and if they were to be applied,
the costs of compliance would be significantly lower than those of traditional
telephony, as these regulatory structures are already being considered and
compensated for in design aspects of the network.
4) Our primary focus on non-US customers should limit our exposure
in the United States.
5) Federal Regulations
Federal Regulation:
The Federal Communications Commission (FCC) regulates interstate and
international telecommunications services. The FCC imposes extensive regulations
on common carriers such as incumbent local exchange carriers ("ILECs") that have
some degree of market power. The FCC imposes less regulation on common carriers
without market power, such as Volo. The FCC permits these non-dominant carriers
to provide domestic interstate services (including long-distance and access
services) without prior authorization; but it requires carriers to receive an
authorization to construct and operate telecommunications facilities and to
provide or resell telecommunications services between the United States and
international points. Under the Telecommunications Act of 1996 (the "1996 Act"),
any entity, including cable television companies and electric and gas utilities,
may enter any telecommunications market, subject to reasonable state regulation
of safety, quality and consumer protection. Because implementation of the 1996
Act is subject to numerous federal and state policy rulemaking proceedings and
judicial review, there is still uncertainty as to what impact it will have on
Volo. The 1996 Act is intended to increase competition. The 1996 Act opens the
local services market by requiring ILECs to permit interconnection to their
networks and establishing ILEC obligations with respect to:
o Reciprocal Compensation. Requires all ILECs and CLECs to complete
calls originated by competing carriers under reciprocal arrangements
at prices based on a reasonable approximation of incremental cost or
through mutual exchange of traffic without explicit payment.
o Resale. Requires all ILECs and CLECs to permit resale of their
telecommunications services without unreasonable restrictions or
conditions. In addition, ILECs are required to offer wholesale
versions of all retail services to other telecommunications carriers
for resale at discounted rates, based on the costs avoided by the
ILEC in the wholesale offering.
o Interconnection. Requires all ILECs and CLECs to permit their
competitors to interconnect with their facilities. Requires all
ILECs to permit interconnection at any technically feasible point
within their networks, on nondiscriminatory terms and at prices
based on cost (which may include a reasonable profit). At the option
of the carrier seeking interconnection, collocation of the
requesting carrier's equipment in an ILECs premises must be offered,
except where the ILEC can demonstrate space limitations or other
technical impediments to collocation.
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o Unbundled Access. Requires all ILECs to provide nondiscriminatory
access to specified unbundled network elements (including certain
network facilities, equipment, features, functions and capabilities)
at any technically feasible point within their networks, on
nondiscriminatory terms and at prices based on cost (which may
include a reasonable profit).
o Number Portability. Requires all ILECs and CLECs to permit, to the
extent technically feasible, users of telecommunications services to
retain existing telephone numbers without impairment of quality,
reliability or convenience when switching from one
telecommunications carrier to another.
o Dialing Parity. Requires all ILECs and CLECs to provide "1+" equal
access to competing providers of telephone exchange service and toll
service, and to provide nondiscriminatory access to telephone
numbers, operator services, directory assistance, and directory
listing, with no unreasonable dialing delays.
o Access to Rights-of-Way. Requires all ILECs and CLECs to permit
competing carriers access to poles, ducts, conduits and
rights-of-way at regulated prices.
The FCC has to date treated ISPs as "enhanced service providers," exempt
from federal and state regulations governing common carriers, including the
obligation to pay access charges and contribute to the universal service fund.
Nevertheless, regulations governing disclosure of confidential communications,
copyright, excise tax and other requirements may apply to the provision of
Internet access services.
The FCC, on March 10, 2004, adopted a Notice of Proposed Rulemaking, which
will address a variety of issues concerning the regulatory treatment of VoIP
telephony. At the same time, the FCC ruled on a petition which dealt with a VoIP
service that never used the PSTN, was offered free to members of the service,
and did not involve the transport of the calls. The FCC determined the service
was not a telecommunications service under the Act. We cannot predict the
outcome of these proceedings or other FCC or state proceedings that may affect
our operations or impose additional requirements, regulations or charges upon
our provision of Internet access and related Internet Protocol-based telephony
services.
The FCC and many state public utilities commissions have implemented rules
to prevent unauthorized changes in a customer's pre-subscribed local and long
distance carrier services (a practice commonly known as "slamming.") Pursuant to
the FCC's slamming rules, a carrier found to have slammed a customer is subject
to substantial fines. In addition, the FCC's slamming rules allow state public
utilities commissions to elect to administer and enforce the FCC's slamming
rules. These slamming liability rules substantially increase a carrier's
possible liability for unauthorized carrier changes, and may substantially
increase a carrier's administrative costs in connection with alleged
unauthorized carrier changes. The Communications Assistance for Law Enforcement
Act (CALEA) provides rules to ensure that law enforcement agencies would be able
to properly conduct authorized electronic surveillance of digital and wireless
telecommunication services.
CALEA requires telecommunications carriers to modify their equipment,
facilities, and services used to provide telecommunications services to ensure
that they are able to comply with authorized surveillance requirements. Our
switches are CALEA compliant. The FCC is currently looking at whether VoIP and
other Internet enabled communications services should continue to be unregulated
Internet services. We cannot predict the outcome of such proceedings or that any
increased level of regulation resulting there from will not have a material
adverse affect on our business or operations.
State Regulation:
The 1996 Act is intended to increase competition in the telecommunications
industry, especially in the local exchange market. With respect to local
services, ILECs are required to allow interconnection to their networks and to
provide unbundled access to network facilities, as well as a number of other
pro-competitive measures. Because the implementation of the 1996 Act is subject
to numerous state rulemaking proceedings on these issues, it is currently
difficult to predict how quickly full competition for local service will become
effective.
Local Regulation:
Our network is subject to numerous local regulations such as building
codes and licensing. Such regulations vary on a city-by-city, county- by-county
and state-by-state basis.
10
RISK FACTORS
You should carefully consider each of the following risk factors and all
of the other information in this Form 10-KSB. If any of the following risks and
uncertainties develops into actual events, our business, financial condition or
results of operations could be materially and adversely affected. The risk
factors below contain forward-looking statements regarding our company. Actual
results could differ materially from those set forth in the forward-looking
statements.
RISKS RELATED TO OUR COMPANY
We have a history of losses and negative cash flows from operations and we
anticipate such losses and negative cash flows will continue.
We have incurred significant losses since inception, and we anticipate
continuing to incur significant losses for the foreseeable future. Our net
losses for the years ended December 31, 2005 and 2004 were $28,313,333 and
$5,862,120, respectively. Our net cash amount used for operating activities for
the years ended December 31, 2005 and 2004 was $18,831,402 and $2,926,871,
respectively. As of December 31, 2005, our accumulated deficit was $34,800,100.
Our revenues may not grow or even continue at their current level. We will need
to significantly increase our revenues and gross margins to become profitable.
In order to increase our revenues, we need to attract and maintain customers to
increase the fees we collect for our services. If our revenues do not increase
as much as we expect, we may never be profitable. Even if our revenues increase,
if we are unable to generate sufficiently profitable margins on these revenues,
we may never be profitable. If we become profitable, we may not be able to
sustain or increase profitability.
We have a limited operating history upon which you can evaluate us.
We have only a limited operating history upon which you can evaluate our
business and prospects. We commenced operations of our current business in 2004
and the majority of our operations are comprised of businesses we acquired in
2005. You should consider our prospects in light of the risks, expenses and
difficulties we may encounter as an early stage company in the new and rapidly
evolving market for internet protocol (IP) communications services. These risks
include our ability:
o to successfully integrate our recent acquisitions;
o to increase acceptance of our VOIP communications services, thereby
increasing the number of users of our IP telephony services;
o to compete effectively, and;
o to develop new products and keep pace with developing technology.
In addition, because we expect an increasing percentage of our revenues to
be derived from our IP communications services, our past operating results may
not be indicative of our future results.
We may not be able to expand our revenue base and achieve profitability.
Our business strategy is to expand our revenue sources by providing IP
communications services to several different customer groups. We can neither
assure you that we will be able to accomplish this nor that this strategy will
be profitable. Approximately 30% of our consolidated revenues for the year ended
December 31, 2005 were derived from one customer, and our gross margins for
these revenues were negative. Currently, our revenues are generated by providing
termination services for other carriers and end users, from the sales of retail
VOIP services to consumers, the wholesaling of prepaid calling cards, and from
hardware product sales. These services have not been profitable to date and may
not be profitable in the future.
In the future, we intend to generate increased revenues from IP
communications services from multiple sources, many of which are unproven. We
expect that our revenues for the foreseeable future will be dependent on, among
other factors:
o acceptance and use of IP telephony;
o growth in the number of our customers;
o expansion of service offerings;
o traffic levels on our network;
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o the effect of competition, regulatory environment, international
long distance rates and access and transmission costs on our prices,
and;
o continued improvement of our global network quality.
We cannot assure you that a market for our services will develop. Our
market is new and rapidly evolving. Our ability to sell our services may be
inhibited by, among other factors, the reluctance of some end-users to switch
from traditional communications carriers to IP communications carriers and by
concerns with the quality of IP telephony and the adequacy of security in the
exchange of information over the Internet, and the reluctance of our resellers
and service providers to utilize outsourced solutions providers.
End-users in markets serviced by recently deregulated telecommunications
providers are not familiar with obtaining services from competitors of these
providers and may be reluctant to use new providers, such as us. We will need to
devote substantial resources to educate customers and end-users about the
benefits of IP communications solutions in general and our services in
particular. If enterprises and their customers do not accept our enhanced IP
communications services as a means of sending and receiving communications, we
will not be able to increase our number of paid users or successfully generate
revenues in the future.
We may incur goodwill and intangible asset impairment charges.
Our balance sheet at December 31, 2005 includes $24,343,442 in goodwill
and $15,097,930 in other intangible assets recorded in connection with our
acquisitions.
In accordance with Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets," we test our goodwill and our other
intangible assets for impairment at least annually by comparing the fair values
of these assets to their carrying values. During the year ended December 31,
2005 we recorded an impairment charge to our operating results of $4,173,452
relating to goodwill previously recorded for an acquisition. We may be required
to record additional impairment charges in the future, which could materially
adversely affect our financial position and results of operations.
We are not in compliance with the terms of our loan agreement.
We are not in compliance with certain covenants of the agreement for our
loan from a lending institution (which amounted to $4,685,236 at December 31,
2005). Our lender has not declared a default under the loan agreement. We
presently are current with the principal and interest payments on this loan but
we will need to raise additional debt or equity capital to repay or restructure
this loan. If we experience delays in raising capital or are unable to raise a
sufficient amount of capital, we could be required to seek modifications to the
terms of the loan agreement or another source of financing to continue
operations.
Potential fluctuations in our quarterly financial results may make it difficult
for investors to predict our future performance.
Our quarterly operating results may fluctuate significantly in the future
as a result of a variety of factors, many of which are outside our control.
Such factors also may create other risks affecting our long-term success,
as discussed in the other risk factors. We believe that quarter-to-quarter
comparisons of our historical operating results may not be a good indication of
our future performance, nor would our operating results for any particular
quarter be indicative of our future operating results.
We expect to need additional capital to continue our operations.
Our operations currently require significant amounts of cash. We will need
to continue to enhance and expand our network in order to be competitive and
meet the increasing demands for service quality, capacity and competitive
pricing. Also, our pursuit of new customers and the introduction of new products
and/or services will require significant marketing and promotional expenses that
we often incur before we begin to receive the related revenue. Our operations
have consumed, rather than generated, cash. Our working capital and capital
expenditure requirements have been met by sales of debt and equity securities.
We anticipate we will need to raise additional capital to continue our
operations. We may not be able to raise additional capital. If we are able to
raise such additional capital through the issuance of additional equity or debt,
our current investors could experience dilution.
Our network may not be able to accommodate our capacity needs.
We expect the volume of traffic we carry over our network to increase
significantly as we expand our operations and service offerings. Our network may
not be able to accommodate this additional volume. In order to ensure that we
are able to handle additional traffic, we may have to enter into long-term
agreements for leased capacity. To the extent that we overestimate our capacity
needs, we may be obligated to pay for more transmission capacity than we
actually use, resulting in costs without corresponding revenues. Conversely, if
we underestimate our capacity needs, we may be required to obtain additional
transmission capacity from more expensive sources. If we are unable to maintain
sufficient capacity to meet the needs of our users, our reputation could be
damaged and we could lose customers and revenues.
12
Additionally, our success depends on our ability to handle a large number
of simultaneous calls. We expect that the volume of simultaneous calls will
increase significantly as we expand our operations. If this occurs, additional
stress will be placed upon the network hardware and software that manages our
traffic. We cannot assure stockholders of our ability to efficiently manage a
large number of simultaneous calls. If we are not able to maintain an
appropriate level of operating performance, or if our service is disrupted, then
we may develop a negative reputation and our business, results of operations and
financial condition could be materially adversely affected.
We may be unsuccessful selecting the most economical call routing.
Our telecommunications services segment relies on vendors to terminate
calls. Vendor charges for these services vary by call route, and costs between
vendors for the same routes vary. Because of the heavy volume of calls handled
by our network, automation of the call routing to the "least-cost" vendor for
each route is typically required to generate a positive gross margin. The
Company is currently developing such automation, but may not be successful on
its implementation or further maintenance, which would adversely affect the
Company's financial performance.
We face a risk of failure of computer and communications systems used in our
business.
Our business depends on the efficient and uninterrupted operation of our
computer and communications systems as well as those that connect to our
network. We maintain communications systems (also referred to as network access
points) in facilities in Orlando, Atlanta, New York, Dallas, Los Angeles and we
are currently constructing a network access point in Chicago. Our systems and
those that connect to our network are subject to disruption from natural
disasters or other sources such as power loss, communications failure, hardware
or software malfunction, network failures and other events both within and
beyond our control. Any system interruptions that cause our services to be
unavailable, including significant or lengthy telephone network failures or
difficulties for users in communicating through our network or portal, could
damage our reputation and result in a loss of users.
Our computer systems and operations may be vulnerable to security breaches.
Our computer infrastructure is potentially vulnerable to physical or
electronic computer viruses, break-ins and similar disruptive problems and
security breaches that could cause interruptions, delays or loss of services to
our users. We believe that the secure transmission of confidential information
over the Internet, such as credit card numbers, is essential in maintaining user
confidence in our services. We rely on licensed encryption and authentication
technology to effect secure transmission of confidential information, including
credit card numbers. It is possible that advances in computer capabilities, new
technologies or other developments could result in a compromise or breach of the
technology we use to protect user transaction data. A party that is able to
circumvent our security systems could misappropriate proprietary information or
cause interruptions in our operations. Security breaches also could damage our
reputation and expose us to a risk of loss or litigation and possible liability.
Although we have experienced no security breaches to date of which we are aware,
we cannot guarantee you that our security measures will prevent security
breaches.
Online credit card fraud can harm our business.
The sale of our products and services over the Internet exposes us to
credit card fraud risks. Some of our products and services can be ordered or
established (in the case of new accounts) over the Internet using a major credit
card for payment. As is prevalent in retail telecommunications and Internet
services industries, we are exposed to the risk that some of these credit card
accounts are stolen or otherwise fraudulently obtained. In general, we are not
able to recover fraudulent credit card charges from such accounts. In addition
to the loss of revenue from such fraudulent credit card use, we also remain
liable to third parties whose products or services are engaged by us (such as
termination fees due telecommunications providers) in connection with the
services which we provide. In addition, depending upon the level of credit card
fraud we experience, we may become ineligible to accept the credit cards of
certain issuers. We are currently authorized to accept American Express, Visa,
MasterCard, and Discover. The loss of eligibility for acceptance of credit cards
could significantly and adversely affect our business. We will attempt to manage
fraud risks through our internal controls and our monitoring and blocking
systems. If those efforts are not successful, fraud could cause our revenue to
decline significantly and our business, financial condition and results of
operations to be materially and adversely affected.
We depend on highly qualified technical and managerial personnel.
Our future success also depends on our continuing ability to attract,
retain and motivate highly qualified technical expertise and managerial
personnel necessary to operate our businesses. We may need to give retention
bonuses and stock incentives to certain employees to keep them, which can be
costly to us. The loss of the services of members of our management team or
other key personnel could harm our business. Our future success depends to a
significant extent on the continued service of key management, client service,
product development, sales and technical personnel. We do not maintain key
person life insurance on any of our executive officers and do not intend to
purchase any in the future. Although we generally enter into non-competition
agreements with our key employees, our business could be harmed if one or more
of our officers or key employees decided to join a competitor or otherwise
compete with us.
13
We may be unable to attract, assimilate or retain highly qualified
technical and managerial personnel in the future. Wages for managerial and
technical employees are increasing and are expected to continue to increase in
the future. We may have difficulty in hiring and retaining highly skilled
employees with appropriate qualifications. If we were unable to attract and
retain the technical and managerial personnel necessary to support and grow our
businesses, our businesses would likely be materially and adversely affected.
International operations may expose us to additional and unpredictable risks.
We may enter international markets such as Eastern Europe, the Middle
East, Latin America, Africa and Asia and may expand our existing operations
outside the United States. International operations are subject to inherent
risks, including:
o potentially weaker protection of intellectual property rights;
o political and economic instability;
o unexpected changes in regulations and tariffs;
o fluctuations in exchange rates;
o varying tax consequences, and;
o uncertain market acceptance and difficulties in marketing efforts
due to language and cultural differences.
Our entry into new lines of business, as well as potential future acquisitions,
joint ventures or strategic transactions entail numerous risks and uncertainties
that could have an adverse effect on our business.
We may enter into new or different lines of business, as determined by
management and our Board of Directors. Our acquisitions, as well as any future
acquisitions or joint ventures could result, and in some instances have
resulted, in numerous risks and uncertainties including:
o potentially dilutive issuances of equity securities, which may be
issued at the time of the transaction or in the future if certain
performance or other criteria are met or not met, as the case may
be. These securities may be freely tradable in the public market or
subject to registration rights which could require us to publicly
register a large amount of our common stock, which could have a
material adverse effect on our stock price;
o diversion of management's attention and resources from our existing
businesses;
o significant write-offs if we determine that the business acquisition
does not fit or perform up to expectations;
o the incurrence of debt and contingent liabilities or impairment
charges related to goodwill and other long-lived assets;
o difficulties in the assimilation of operations, personnel,
technologies, products and information systems of the acquired
companies;
o regulatory and tax risks relating to the new or acquired business;
o the risks of entering geographic and business markets in which we
have limited (or no) prior experience;
o the risk that the acquired business will not perform as expected;
and
o material decreases in short-term or long-term liquidity.
14
We depend upon a contract manufacturer for our hardware products and any
disruption in its business may cause us to fail to meet the demands of our
customers and damage our customer relationships.
We rely on iCable System Co. Ltd., a South Korean company, to manufacture
certain of our hardware products. iCable provides comprehensive manufacturing
services, including assembly of our products and procurement of materials.
iCable directly ships finished products from Korea to our customers around the
world. We do not have a long-term supply contract with iCable and they are not
required to manufacture products for any specified period. Qualifying a new
contract manufacturer and commencing commercial-scale production is expensive
and time consuming and could result in a significant interruption in the supply
of our products. If a change in contract manufacturers results in delays of our
fulfillment of customer orders or if a contract manufacturer fails to make
timely delivery of orders, we may lose revenues and suffer damage to our
customer relationships.
Additionally, iCable currently purchases the primary chipset used in our
customer premise equipment, or CPE, from Broadcom. Currently, there is an
available supply path and rapid delivery for these chipsets. It is not
anticipated that there will be any significant shortfalls in the ability to
produce equipment or deliver equipment, given past experience and current
operating procedures, even under heavy volume sales. Our customers rely upon our
ability to meet committed delivery dates, and any disruption in the supply of
key components would seriously impact our ability to meet these dates and could
result in legal action by our customers, loss of customers or harm to our
ability to attract new customers.
Increased costs associated with corporate governance compliance may
significantly affect our results of operations.
The Sarbanes-Oxley Act of 2002 will require changes in some of our
corporate governance and securities disclosure and compliance practices, and
will require a thorough documentation and evaluation of our internal control
procedures. We expect this to increase our legal compliance and financial
reporting costs. This could also make it more difficult and more expensive for
us to obtain director and officer liability insurance, and we may be required to
accept reduced coverage or we may incur higher costs to obtain such coverage. In
addition, it may be more difficult for us to attract and retain qualified
members of our board of directors, or qualified executive officers. We are
presently evaluating and monitoring regulatory developments and cannot estimate
the timing or magnitude of additional costs we may incur in this regard.
Our internal controls over financial reporting may not be adequate and our
independent auditors may not be able to certify as to their adequacy, which
could have a significant and adverse effect on our business and reputation.
Section 404 of the Sarbanes-Oxley Act of 2002 and the rules and
regulations of the Securities Exchange Commission associated with this Act,
which we refer to as Section 404, require a reporting company to, among other
things, annually review and disclose its internal controls over financial
reporting, and evaluate and disclose changes in its internal controls over
financial reporting quarterly. Under Section 404 a reporting company is required
to document and evaluate such internal controls in order to allow its management
to report on, and its independent auditors attest to, these controls. We will be
required to comply with Section 404 not later than our fiscal year ending
December 2007 and may become subject to Section 404 one year sooner. We are
currently evaluating our strategy to begin performing the system and process
documentation, evaluation and testing required (and any necessary remediation)
in an effort to comply with management certification and auditor attestation
requirements of Section 404. In the course of our ongoing evaluation, we may
identify areas of our internal controls requiring improvement, and plan to
design enhanced processes and controls to address issues that might be
identified through this review. As a result, we expect to incur additional
expenses and diversion of management's time. We cannot be certain as to the
timing of completion of our documentation, evaluation, testing and remediation
actions or the impact of the same on our operations and may not be able to
ensure that the process is effective or that the internal controls are or will
be effective in a timely manner. If we are not able to implement the
requirements of Section 404 in a timely manner or with adequate compliance, our
independent auditors may not be able to certify as to the effectiveness of our
internal control over financial reporting and we may be subject to sanctions or
investigation by regulatory authorities, such as the Securities and Exchange
Commission. As a result, there could be an adverse reaction in the financial
markets due to a loss of confidence in the reliability of our financial
statements. In addition, we may be required to incur costs in improving our
internal control system and the hiring of additional personnel. Any such actions
could adversely affect our results of operations, cash flows and financial
condition.
RISKS RELATED TO OUR INDUSTRY
Our future success depends on the growth in the use of Internet Protocol as a
means of communications.
If the market for IP communications, in general, and our services in
particular, does not grow or does not grow at the rate we anticipate, we will
not be able to increase our number of customers or generate the revenues we
anticipate. To be successful, IP communications requires validation as an
effective, quality means of communication and as a viable alternative to
traditional telephone service. Demand and market acceptance for recently
introduced services are subject to a high level of uncertainty. The Internet may
not prove to be a viable alternative to traditional telephone service for
reasons including:
o inconsistent quality or speed of service;
o traffic congestion;
15
o potentially inadequate development of the necessary infrastructure;
o lack of acceptable security technologies;
o lack of timely development and commercialization of performance
improvements, and;
o unavailability of cost-effective, high-speed access.
If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it by such growth, or its performance or
reliability may decline. In addition, Web sites may from time to time experience
interruptions in their service as a result of outages and other delays occurring
throughout the Internet network infrastructure. If these outages or delays
frequently occur in the future, Internet usage, as well as usage of our
communications portal and our services, could be adversely affected.
Intense competition could reduce our market share and harm our financial
performance.
Competition in the market for IP communications services is becoming
increasingly intense and such competition is expected to increase significantly
in the future. The market for Internet and IP communications is new and rapidly
evolving. We expect that competition from companies both in the Internet and
telecommunications industries will increase in the future. Our competitors
include both start-up IP telephony service providers and established traditional
communications providers. Many of our existing competitors and potential
competitors have broader portfolios of services, greater financial, management
and operational resources, greater brand-name recognition, larger subscriber
bases and more experience than we have. In addition, many of our IP telephony
competitors use the public Internet instead of a private network to transmit
traffic. Operating and capital costs of these providers may be less than ours,
potentially giving them a competitive advantage over us in terms of pricing. We
also compete against the growing market of discount telecommunications services
including prepaid calling cards, call-back services, dial-around or 10-10
calling and collect calling services. In addition, some Internet service
providers have begun to aggressively enhance their real time interactive
communications, focusing on instant messaging, PC-to-PC and PC-to-phone, and/or
broadband phone services.
In addition, traditional carriers, cable companies and satellite
television providers are bundling services and products not offered by us with
internet telephony services. While this provides us with the opportunity to
offer these companies our products and services as a way for them to offer
internet telephony services, it also introduces the risk that they will
introduce these services on their own utilizing other options while at the same
time making it more difficult for us to compete against them with direct to
consumer offerings of our own. If we are unable to provide competitive service
offerings, we may lose existing users and be unable to attract additional users.
In addition, many of our competitors, especially traditional carriers, enjoy
economies of scale that result in a lower cost structure for transmission and
related costs, which cause significant pricing pressures within the industry. In
order to remain competitive we intend to increase our efforts to promote our
services, and we cannot be sure that we will be successful in doing this.
In addition to these competitive factors, recent and pending deregulation
in some of our markets may encourage new entrants. We cannot assure you that
additional competitors will not enter markets that we plan to serve or that we
will be able to compete effectively.
Decreasing telecommunications rates may diminish our revenues and profitability.
International and domestic telecommunications rates have decreased
significantly over the last few years in most of the markets in which we
operate, and we anticipate that rates will continue to be reduced in all of the
markets in which we do business or expect to do business. Users who select our
services to take advantage of the current pricing differential between
traditional telecommunications rates and our rates may switch to traditional
telecommunications carriers as such pricing differentials diminish or disappear,
and we will be unable to use such pricing differentials to attract new customers
in the future. In addition, our ability to market our carrier transmission
services to telecommunications carriers depends upon the existence of spreads
between the rates offered by us and the rates offered by traditional
telecommunications carriers, as well as a spread between the retail and
wholesale rates charged by the carriers from which we obtain wholesale service.
Continued rate decreases will require us to lower our rates to remain
competitive could reduce our revenues and reduce or possibly eliminate our gross
profit from our carrier transmission services. If telecommunications rates
continue to decline, we may lose users for our services.
We may not be able to keep pace with rapid technological changes in the
communications industry.
Our industry is subject to rapid technological change. We cannot predict
the effect of technological changes on our business. In addition, widely
accepted standards have not yet developed for the technologies we use. We expect
that new services and technologies will emerge in the market in which we
compete. These new services and technologies may be superior to the services and
technologies that we use, or these new services may render our services and
technologies obsolete. To be successful, we must adapt to our rapidly changing
market by continually improving and expanding the scope of services we offer and
by developing new services and technologies to meet customer needs. Our success
will depend, in part, on our ability to license leading technologies and respond
to technological advances and emerging industry standards on a cost-effective
and timely basis. We may need to spend significant amounts of capital to enhance
and expand our services to keep pace with changing technologies.
16
Third parties might infringe upon our proprietary technology.
We cannot assure you that the steps we have taken to protect our
intellectual property rights will prevent misappropriation of our proprietary
technology. To protect our rights to our intellectual property, we rely on a
combination of trademark and trade secret protection, confidentiality agreements
and other contractual arrangements with our employees, affiliates, strategic
partners and others. We may be unable to detect the unauthorized use of, or take
appropriate steps to enforce, our intellectual property rights. Effective
copyright and trade secret protection may not be available in every country in
which we offer or intend to offer our services. Failure to adequately protect
our intellectual property could harm our brand, devalue our proprietary content
and affect our ability to compete effectively. Further, defending our
intellectual property rights could result in the expenditure of significant
financial and managerial resources.
If we are not able to obtain necessary licenses of third-party technology at
acceptable prices, or at all, some of our products may become obsolete.
From time to time, we may be required to license technology from third
parties to develop new products or product enhancements. Third-party licenses
may not be available or continue to be available to us on commercially
reasonable terms. The inability to maintain or re-license any third-party
licenses required in our current products, or to obtain any new third-party
licenses to develop new products and product enhancements could require us to
obtain substitute technology of lower quality or performance standards or at
greater cost, and delay or prevent us from making these products or
enhancements, any of which could seriously harm the competitiveness of our
products. We currently license third party technology for products acquired
through the WQN acquisition.
Government regulation and legal uncertainties relating to IP telephony could
harm our business.
Historically, voice communications services have been provided by
regulated telecommunications common carriers. We offer voice communications to
the public for international and domestic calls using IP telephony. Based on
specific regulatory classifications and recent regulatory decisions, we believe
we qualify for certain exemptions from telecommunications common carrier
regulation in many of our markets. However, the growth of IP telephony has led
to close examination of its regulatory treatment in many jurisdictions making
the legal status of our services uncertain and subject to change as a result of
future regulatory action, judicial decisions or legislation in any of the
jurisdictions in which we operate. Established regulated telecommunications
carriers have sought and may continue to seek regulatory actions to restrict the
ability of companies such as ours to provide services or to increase the cost of
providing such services. In addition, our services may be subject to regulation
if regulators distinguish phone-to-phone telephony service using IP technologies
over privately-managed networks such as our services from integrated PC-to-PC
and PC-originated voice services over the Internet. Some regulators may decide
to treat the former as regulated common carrier services and the latter as
unregulated enhanced or information services. Application of new regulatory
restrictions or requirements to us could increase our costs of doing business
and prevent us from delivering our services through our current arrangements. In
such event, we would consider a variety of alternative arrangements for
providing our services, including obtaining appropriate regulatory
authorizations for our local network partners or ourselves, changing our service
arrangements for a particular country or limiting our service offerings. Such
regulations could limit our service offerings, raise our costs and restrict our
pricing flexibility, and potentially limit our ability to compete effectively.
Further, regulations and laws which affect the growth of the Internet could
hinder our ability to provide our services over the Internet.
Recent regulatory enactments by the FCC will require us to provide
enhanced Emergency 911 dialing capabilities to our subscribers as part of our
standard VOIP services and to comply with certain notification requirements with
respect to such capabilities, these requirements will result in increased costs
and risks associated with the delivery of our VOIP services.
On June 3, 2005, the FCC released the "IP-Enabled Services and E911
Requirements for IP-Enabled Service Providers, First Report and Order and Notice
of Proposed Rulemaking" (the "E911 Order"). The E911 Order requires, among other
things, that VOIP service providers that interconnect to the public switched
telephone network ("Interconnected VOIP Providers") supply enhanced emergency
911 dialing capabilities ("E911") to their subscribers no later than 120 days
from the effective date of the E911 Order. The effective date of the E911 Order
is July 29, 2005. As part of such E911 capabilities, Interconnected VOIP
Providers are required to reproduce the 911 emergency calling capabilities
offered by traditional landline phone companies. Specifically, all
Interconnected VOIP Providers must deliver 911 calls to the appropriate local
public safety answering point ("PSAP"), along with call back number and
location, where the PSAP is able to receive that information. Such E911
capabilities must be included in the basic service offering of the
Interconnected VOIP Providers; it cannot be an option or extra feature. The PSAP
delivery obligation, along with call back number and location information must
be provided regardless of whether the service is "fixed" or "nomadic." User
registration of location is permissible initially, although the FCC is committed
to an advanced form of E911 that will determine user location without user
intervention, one of the topics of the further Notice of Proposed Rulemaking to
be released.
17
Additionally, the E911 Order required that, by July 29, 2005 (the
effective date of the E911 Order), each Interconnected VOIP Provider must have:
(1) specifically advised every new and existing subscriber, prominently and in
plain language, of the circumstances under which the E911 capabilities service
may not be available through its VOIP services or may in some way be limited by
comparison to traditional landline E911 services; (2) obtained and kept a record
of affirmative acknowledgement from all subscribers, both new and existing, of
having received and understood the advisory described in the preceding item (1);
and (3) distributed to its existing subscribers warning stickers or other
appropriate labels warning subscribers if E911 service may be limited or not
available and instructing the subscriber to place them on or near the equipment
used in conjunction with the provider's VOIP services. We have complied with the
requirements set forth in the preceding items (1) and (3). However, despite
engaging in significant efforts, as of October 12, 2005, we had received the
affirmative acknowledgements required by the preceding item (2) from less than
15% of our VOIP subscribers.
On July 26, 2005, noting the efforts made by Interconnected VOIP Providers
to comply with the E911 Order's affirmative acknowledgement requirement, the
Enforcement Bureau of the FCC (the "EB") released a Public Notice communicating
that, until August 30, 2005, it would not initiate enforcement action against
any Interconnected VOIP Provider with respect to such affirmative
acknowledgement requirement on the condition that the provider file a detailed
report with the FCC by August 10, 2005. The report must set forth certain
specific information relating to the provider's efforts to comply with the
requirements of the E911 Order. Furthermore, the EB stated its expectation that
that if an Interconnected VOIP Provider has not received such affirmative
acknowledgements from 100% of its existing subscribers by August 29, 2005, then
the Interconnected VOIP Provider would disconnect, no later than August 30,
2005, all subscribers from whom it has not received such acknowledgements. On
August 26, 2005, the EB released another Public Notice communicating that it
would not, until September 28, 2005, initiate enforcement action regarding the
affirmative acknowledgement requirement against those providers that: (1)
previously filed reports on or before August 10, 2005 in accordance with the
July 26 Public Notice; and (2) file two separate updated reports with the FCC by
September 1, 2005 and September 22, 2005 containing certain additional required
information relating to such provider's compliance efforts with respect to the
E911 Order's requirements. The EB further stated in the second Public Notice its
expectation that, during the additional period of time afforded by the
extension, all Interconnected VOIP Providers that qualified for such extension
would continue to use all means available to them to obtain affirmative
acknowledgements from all of their subscribers.
Our VOIP services that are subject to the E911 Order do not presently
account for a material portion of our current VOIP revenues.
With the recent acquisition on WQN, Inc.'s VOIP assets we confirmed that
WQN filed and complied with the E911 order. We filed the required acknowledgment
letter relating to WQN RocketVOIP subscribers on October 25, 2005.
Even assuming our full compliance with the E911 Order, such compliance and
our efforts to achieve such compliance, will increase our cost of doing business
in the VOIP arena and may adversely affect our ability to deliver our VOIP
telephony services to new and existing customers in all geographic regions.
Our products must comply with industry standards, FCC regulations, state,
country-specific and international regulations, and changes may require us to
modify existing products.
In addition to reliability and quality standards, the market acceptance of
telephony over broadband IP networks is dependent upon the adoption of industry
standards so that products from multiple manufacturers are able to communicate
with each other. There is currently a lack of agreement among industry leaders
about which standard should be used for a particular application, and about the
definition of the standards themselves. These standards, as well as audio and
video compression standards, continue to evolve. We also must comply with
certain rules and regulations of the Federal Communications Commission (FCC)
regarding electromagnetic radiation and safety standards established by
Underwriters Laboratories, as well as similar regulations and standards
applicable in other countries. Standards are continuously being modified and
replaced. As standards evolve, we may be required to modify our existing
products or develop and support new versions of our products. The failure of our
products to comply, or delays in compliance, with various existing and evolving
industry standards could delay or interrupt volume production of our IP
telephony products, which would have a material adverse effect on our business,
financial condition and operating results.
RISKS RELATED TO OUR STOCK
Our stock price has been and may continue to be volatile.
The market for technology stocks in general and our common stock in
particular, has been and will likely continue to be extremely volatile. The
following factors could cause the market price of our common stock to fluctuate
significantly:
o the addition or loss of any major customer;
o changes in the financial condition or anticipated capital
expenditure purchases of any existing or potential major customer;
18
o quarterly variations in our operating results;
o changes in financial estimates by securities analysts;
o speculation in the press or investment community;
o announcements by us or our competitors of significant contracts, new
products or acquisitions, distribution partnerships, joint ventures
or capital commitments;
o sales of common stock or other securities by us or by our
shareholders in the future;
o securities and other litigation;
o announcement of a stock split, reverse stock split, stock dividend
or similar event;
o economic conditions for the telecommunications, networking and
related industries; and
o economic instability.
In addition, the volume of shares to be sold in this offering represents a
major increase in the number of our tradable shares outstanding and could result
in a decline in our stock price.
We expect to need additional capital in the future, which may not be available
to us, and if it is available, may dilute the ownership of our common stock.
We continue to seek to raise additional funds through public or private
debt or equity financings in order to:
o fund ongoing operations and capital requirements;
o take advantage of opportunities, including more rapid expansion or
acquisition of complementary products, technologies or businesses;
o develop new products; or
o respond to competitive pressures.
Any additional capital raised through the sale of convertible debt or
equity may further dilute an investor's percentage ownership of our common
stock. Furthermore, additional financings may not be available on terms
favorable to us, or at all. A failure to obtain additional funding could prevent
us from making expenditures that may be required to continue our operations.
We do not expect to pay dividends.
We do not anticipate paying any cash dividends on our common stock in the
foreseeable future. We intend to retain profits, if any, to fund growth and
expansion.
We do not have sufficient authorized shares.
As of March 22, 2006, our authorized shares of stock consisted of
100,000,000 shares of common stock, of which we had 68,838,766 shares issued and
outstanding, and we had approximately 45,000,000 additional shares contingently
issuable 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, we may not be able to satisfy the contractual obligations we have
undertaken to issue future shares of common stock.
19
ITEM 2. DESCRIPTION OF PROPERTY
Our headquarters are in Fort Lauderdale, Florida. We have offices and
facilities in a number of other locations. Following is a list of our offices
and facilities, all of which are leased, as of December 31, 2005.
Location Purpose Approx. Sq. Ft. Annual Rent
------------------------------------ ------------------------------- ------------------ ---------------
12330 SW 53rd Street, Suite 712 Principal executive offices 3,200 $ 39,648
Ft. Lauderdale, FL 33330
151 S. Wymore Rd, Suite 3000 Network facilities and offices 11,500 196,872
Altamonte Springs, FL 32714
13101 56th Court N., Suite 813 Fullfillment center 4,500 36,722
Clearwater, FL 33760
14911 Quorum Dr., Suite 140 Offices 6,250 54,000
Dallas, Texas 75254
17806 Pioneer Blvd, Suite 106 Offices 1,000 41,000
Artesia, California 90701
ITEM 3. LEGAL PROCEEDINGS
MCI
On April 8, 2005, Volo Communications, Inc. ("Volo") (a wholly-owned
subsidiary of Caerus) 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 5 days. By
this action Volo alleges claims for (1) breach of contract; (2) fraud in the
inducement; (3) primary estoppel; and (4) deceptive and unfair trade practices.
Volo also seeks a declaratory judgment that (1) MCI WorldCom is in breach of the
Services Agreement; (2) $8,365,980 billed by MCI WorldCom is not "due and
payable" under that agreement; and (3) MCI WorldCom's default letter to Volo is
in violation of the Services Agreement. Volo seeks direct, indirect and punitive
damages in an amount to be determined at trial.
On May 26, 2005, MCI WorldCom filed an Answer, Affirmative Defenses,
Counterclaim and Third-Party Complaint naming Caerus as a third-party defendant.
MCI WorldCom asserts a breach of contract claim against Volo, a breach of
guarantee claim against Caerus, and a claim for unjust enrichment against both
parties, seeking an amount to be determined at trial. On July 11, 2005, Volo and
Caerus answered the counterclaim and third-party complaint, and filed a
third-party counterclaim against MCI WorldCom for declaratory judgment, fraud in
the inducement, and breach of implied duty of good faith and fair dealing. Volo
and Caerus seek direct, indirect and punitive damages in an amount to be
determined at trial.
On August 1, 2005, MCI WorldCom moved to strike most of Volo's and Caerus'
affirmative defenses and demand for attorney's fees, and to dismiss Caerus'
counterclaims. On October 6, 2005, the Court denied the motions in part, granted
them in part with leave to amend, and deferred ruling on the motions in part. On
October 13, 2005, Volo and Caerus filed amended affirmative defenses, and Caerus
filed amended counterclaims.
Discovery is in progress. MCI WorldCom has served requests for documents
and for admissions and interrogatories on Volo and Caerus, to which Volo and
Caerus have responded. Document production is ongoing. Volo has served document
requests and interrogatories on MCI WorldCom. Volo has also initiated third
party discovery. The Court on March 9, 2006 granted in part and denied in part
motions to compel disclosures brought by Volo and MCI WorldCom. A pretrial
conference is set for May 2, 2006. The Court has not issued a scheduling order
or set a trial date. The Company is currently unable to assess the likelihood of
a favorable or unfavorable outcome for this litigation.
20
Netrake
The Company and its subsidiaries Caerus and Volo are involved in pending
disputes with Netrake Communications ("Netrake") arising from an equipment
purchase contract under which Volo agreed to purchase approximately $2,000,000
worth in Netrake telephonic equipment and software. The Company has paid
approximately $200,000 on the contract but has withheld further payments due to
dissatisfaction with the performance of the equipment. In arbitration pending in
Dallas, Texas, Netrake has brought claim against the Company and its
subsidiaries for (1) breach of contract in the amount of $1.8 million plus
interest, (2) business disparagement, (3) misappropriation of trade secrets, (4)
tortuous interference with prospective business relations and (5) conversion.
Netrake also seeks to recover its attorneys' fees. Within this same arbitration
Volo and Caerus seek damages against Netrake for breach of contract and breach
of warranty claiming that the Netrake product did not perform in accordance with
agreed upon specifications and warranties.
Volo and Caerus have initiated litigation in Broward County, Florida
claiming damages and recession against Netrake for alleged fraudulent
misrepresentations, negligent misrepresentations, violation of Florida's
Deceptive and Unfair Trade Practices Act and seeking declaratory relief. Netrake
claims all of these claims fall within the arbitration clause of the equipment
purchase contract, and has removed the action to arbitrate in Dallas.
The Company is presently unable to determine what impact, if any, this
arbitration and litigation will have on its financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 2005.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Dividends
We have no current plans to pay any future cash dividends on the common
stock. Instead, we intend to retain all earnings, other than those required to
be paid to the holders of any preferred stock we may issue in the future, to
support our operations and future growth. The payment of any future dividends on
the common stock will be determined by the Board of Directors based upon our
earnings, financial condition and cash requirements, possible restrictions in
future financing agreements, if any, business conditions and such other factors
deemed relevant.
Market Information
The common stock is traded on the Over-the-Counter Bulletin Board under
the symbol VOII. The quotations below reflect inter-dealer prices, without
retail markup, markdown or commissions and may not represent actual
transactions. The following table shows the bid price range of our common stock
for the time periods indicated:
From To High Low
------------ ------------ ------------ ------------
01/01/02 12/31/03 * *
01/01/04 03/31/04 $ 0.85 $ 0.80
04/01/04 06/30/04 6.75 1.35
07/01/04 09/30/04 3.20 1.10
10/01/04 12/31/04 4.75 1.05
10/01/05 03/31/05 4.08 1.61
04/01/05 06/30/05 1.65 1.03
07/01/05 09/30/05 2.30 0.95
10/01/05 12/31/05 2.07 1.27
*Trading in the shares of our predecessor was sporadic and did not produce
reported quotations.
Holders
As of March 06, 2006 there were approximately 490 shareholders of record
and an unknown number of beneficial holders holding through brokers.
21
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
The following discussion should be read in conjunction with the
Consolidated Financial Statements and the notes thereto and the other financial
information appearing elsewhere in this Form 10-KSB. Certain statements
contained in this Form 10-KSB 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 its business and meet its 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 this Form 10-KSB. 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.
Restatement of Financial Statements
We have restated our 2004 annual consolidated financial statements to
correct certain misstatements of revenues that occurred in the third and fourth
quarters of 2004. See Note B to our Consolidated Financial Statements for an
explanation of these restatements. The following table shows the net impact of
the restatements on our revenues, loss from operations, net loss, and net loss
per share.
Balance Sheet Data: As of December 31, 2004
----------------------------------
As Previously
Reported As Restated
----------- ------------
Accounts receivable $ 818,071 $ 166,239
Inventory 187,451 324,185
Accumulated deficit (6,024,149) (6,486,768)
Statement of Operations Data: Year Ended December 31, 2004
----------------------------------
As Previously
Reported As Restated
----------- ------------
Revenue $ 2,619,393 $ 1,828,193
Loss from operations (5,544,813) (6,007,431)
Net loss (5,399,502) (5,862,120)
Net loss per common share (0.37) (0.40)
For discussion of the impact of these restatements on current management's
evaluation of disclosure controls and procedures, the separate Board of
Directors investigation of these misstatements and the steps we are taking to
address concerns associated with these misstatements see Item 8A. "Controls and
Procedures."
22
Financial Summary
Balance Sheet Data: December 31, 2005 December 31, 2004
----------------- -----------------
Goodwill and other intangible assets $ 39,441,372 $ 6,923,854
Total assets 56,390,015 9,656,683
Notes and loans payable, current 11,085,034 200,000
Total liabilities 27,164,095 2,011,863
Shareholders' equity 29,225,920 7,644,820
For the Years Ended December 31
-------------------------------
Statement of Operations Data: 2005 2004
------------ ------------
Revenues $ 15,507,145 $ 1,828,193
Loss from operations (26,881,028) (6,007,431)
Net loss (28,313,333) (5,862,120)
Net loss per share (0.67) (0.40)
Comparison of Years Ended December 31, 2005 And 2004
The comparability of our 2005 results to those for 2004 is greatly
impacted by the acquisition in May 2005 of Caerus, Inc. and by the purchase in
October 2005 of substantially all of the VOIP-related assets and business of
WQN, Inc. The following table presents our Proforma results of operations for
the year ended December 31, 2005 on a stand-alone basis for each acquisition and
in total, assuming each of these business combinations had occurred at the
beginning of 2005:
Proforma
Combined
------------
Revenues $ 46,375,239
Net loss $(38,689,335)
Net loss per share $ (0.79)
Consolidated Results
Our consolidated revenues for the years ended December 31, 2005 and 2004
were $15,507,145 and $1,828,193, respectively. Our consolidated net loss was
$28,313,333 ($0.67 per share) for the year ended December 31, 2005 as compared
to a net loss of $5,862,120 ($0.40 per share) for the year ended December 31,
2004. The increases in our revenues and net loss from 2004 to 2005 reflects the
inclusion of the results of Caerus and the VOIP business of WQN, Inc. from the
dates of their acquisitions. Revenues for the year ended December 31, 2005
include approximately $4.7 million and $7.6 million in revenues generated by the
acquired Caerus and WQN businesses, respectively. Substantially all of the
Caerus revenues for 2005 (which represents 30% of our consolidated revenues for
2005) were generated by one customer. Our 2005 results include operating losses
of $7.9 million generated by Caerus' operations and $650,000 attributable to the
business formerly owned by WQN, Inc.
We incurred significantly greater corporate operating expenses in 2005
($26.1 million) than in 2004 ($6.5 million). Our corporate overhead expense
(excluding goodwill impairment charge of $4,173,452 discussed below) grew by
more than $10.6 million, reflecting the increased size and complexity of our
operations. Included in 2005 operating expenses are $7.7 million in compensation
and benefits, $4.9 million in commissions and fees paid to third parties
primarily in connection with our capital raising efforts, professional and legal
fees of $1.9 million, and $3.1 million of depreciation and amortization.
Under Statement of Financial Accounting Standards No. 142 we are required
to periodically evaluate the carrying value of our goodwill and intangible
assets. During 2005, we recognized impairment expense of $4,173,452 related to
goodwill recorded for our hardware sales business segment. If in the future such
carrying values exceed 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.
Total assets at December 31, 2005 were $56.4 million, up $46.7 million
from December 31, 2004. This increase in assets (which includes additions to
property of $9.7 million) and the corresponding increase in accounts payable and
other current liabilities are almost entirely related to the acquisitions of
Caerus and WQN businesses in 2005. We recorded significant amounts of goodwill
and intangible assets in connection with the acquisitions, resulting in goodwill
and other intangibles increasing by $32.5 million in 2005. Goodwill and other
intangible assets comprised 70% of our consolidated total assets at December 31,
2005, attributable to the current year's acquisitions.
23
Results by Segment
Our results by segment for 2005 and 2004 were as follows:
2005:
-----------------------
Telecommunications Hardware Sales Calling Cards Corporate Consolidated
------------------ -------------- ------------- ------------ ------------
Revenues $ 8,198,587 $ 2,376,329 $ 4,932,229 $ -- $ 15,507,145
Gross profit (loss) (1,506,037) 578,495 103,024 -- (824,518)
Operating expenses 7,181,127 5,459,193 96,676 13,319,514 26,056,510
Operating income (loss) (8,687,164) (4,880,698) 6,348 (13,319,514) (26,881,028)
Other income (expense) (560,351) 206,184 -- (1,078,138) (1,432,305)
------------------ -------------- ------------- ------------ ------------
Net income (loss) $ (9,247,515) $ (4,674,514) $ 6,348 $(14,397,652) $(28,313,333)
================== ============== ============= ============ ============
2004:
-----------------------
Telecommunications Hardware Sales Calling Cards Corporate Consolidated
------------------ -------------- ------------- ------------ ------------
Revenues $ 649,230 $ 1,178,963 $ -- $ -- $ 1,828,193
Gross profit (loss) 184,628 271,420 -- -- 456,047
Operating expenses 569,695 1,046,619 -- 4,847,164 6,463,477
Operating income (loss) (385,067) (775,199) -- (4,847,164) (6,007,431)
Other income (expense) -- -- -- 145,311 145,311
------------------ -------------- ------------- ------------ ------------
Net income (loss) $ (385,067) $ (775,199) $ -- $ (4,701,853) $ (5,862,120)
================== ============== ============= ============ ============
Telecommunications Segment:
The net loss from our telecommunications segment grew from $385,067 in
2004 to $9,247,515 in 2005. Revenue for our telecommunications segment grew by
$7.6 million in 2005 to $8.2 million. These increases are attributable almost
entirely to the acquisitions mentioned previously.
The negative gross profit for this segment of $1.5 million in 2005
reflects variable costs paid to third party vendors that exceeded the revenues
we charged to terminate the calls of our customers. We do not expect to generate
positive margins on our network traffic until such time as we are able to(1)
increase the overall volume of traffic handled by our network by growing our
customer base and (2) lower the average cost per minute we pay for call
termination through (i) negotiation of more favorable pricing (ii) expanding our
selection of third party vendors and (iii) improving our routing process to
ensure we are using the lowest cost route available to us to terminate each
call.
Operating expenses in 2005 for this segment rose to $7.2 million and
include compensation and benefits expenses of $1.7 million and depreciation and
amortization aggregating $2.9 million.
Hardware Sales Segment:
Hardware sales increased from $1.2 million in 2004 to $2.4 million in 2005
reflecting the inclusion of a full year of the results for DT Net operations
(which was acquired in June 2004) in our 2005 results. The operating loss for
this segment went from $775,199 in 2004 to $4,880,689 in 2005 mainly due to the
impairment charge discussed below.
In accordance with SFAS No. 142 we perform an evaluation of the fair
values of our operating segments at least annually. During this evaluation for
2005 we determined, based upon market conditions, discounted projected cash
flows, and other factors, that the carrying value of our hardware sales
operating segment exceeded its fair value at December 31, 2005. Accordingly we
recorded an impairment charge of $4,173,452 in our 2005 statement of operations
and reduced goodwill for this segment by that amount.
Liquidity and Capital Resources
Cash and cash equivalents increased by $2.1 million for the year ended
December 31, 2005 to $3.2 million. Our consolidated net cash flow used in
operating activities for the year ended December 31, 2005 used $17.9 million in
cash, due primarily to the net loss increase described above. We funded our
operating activities principally through issuances of notes payable that
generated net proceeds of $9.6 million and sales of common stock in private
transactions that provided $11.7 million.
24
Our consolidated net cash used in investing activities increased by $3.5
million, related primarily to the acquisitions of the businesses of Caerus, Inc.
and WQN, Inc., and capital expenditures. Our consolidated net cash provided by
financing activities rose from $4.2 million in 2004 to $23.6 million in 2005, as
a result of notes payable and common stock sales noted in the preceding
paragraph.
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 support our
operations and continue our business.
At December 31, 2005 our current liabilities totaled approximately $26.9
million. Included in this amount was an outstanding balance of approximately
$4.7 million on a loan from a lending institution. We are not in compliance with
certain related loan covenants. To date our lender has not declared a default
under this loan agreement. At December 31, 2005 our negative working capital was
$20.5 million.
In January, 2006, we issued and sold $11.9 million principal amount of
convertible notes to accredited investors (at a 12.121% original issue discount)
in a private placement and received approximately $9.9 million in net proceeds.
The investors also received five-year warrants to purchase a total of 4,537,053
shares at a price of $1.46 per share, and one-year warrants to purchase
4,537,053 shares at a price of $1.59 per share.
Of the convertible notes approximately $7.6 million is secured by a
subordinated lien on our assets, and all of 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 our option, in our registered common stock at the lesser
of $1.40 per share or 85% of the weighted average price of the stock on the
OTCBB for the 15 day period prior to the payment due date. 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.
The subscription agreements for the sale of these convertible notes
contain provisions that could impact our future capital raising efforts and our
capital structure, including:
o In February 2006, we 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, we are liable for liquidated
damages each month at a rate of 1.5% of the outstanding note
principal until the Notes Registration Statement is declared
effective.
o Unless we obtain the consent of the note holders, we may not file
any new registration statements or amend any existing registrations
until the sooner of (i) 60 days following the effective date of the
Notes Registration Statement or (ii) all the notes have been
converted into shares and such shares and the warrant shares have
been sold by the note holders.
o 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 common stock or debt obligations of
our company.
o Unless we obtain the consent of 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, we may not issue any new
shares of common stock, convertible securities or warrants at a
price per share, conversion price per share or exercise price per
share that is lower than those prices in effect for the notes and
warrants without issuing the note holders sufficient additional
shares or warrants at prices such that their warrant exercise price
or per share price on average is equal to that for the proposed
securities to be issued.
We anticipate that we will continue to report net losses and experience
negative cash flows from operations. We will need to raise additional debt or
equity capital to provide the funds necessary to repay or restructure our $4.7
million loan, meet our other current contractual obligations and continue our
operations. We are actively seeking to raise this additional capital. However,
we may not be successful in obtaining further equity or debt financing for our
business. Our auditors have added an explanatory paragraph to their opinion on
our consolidated financial statements, regarding our ability to continue as a
going concern.
Our authorized shares of stock consist of 100,000,000 shares of common
stock, of which there are currently 68,838,766 shares issued and outstanding.
Approximately another 45 million additional shares are contingently issuable
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, we may be unable to satisfy the contractual obligations we have
undertaken to issue future shares of common stock.
25
Capital Expenditure Commitments
We had outstanding commitments to purchase capital equipment of
approximately $464,000 at December 31, 2005.
Payments Due by Period
The following table illustrates our outstanding debt, purchase
obligations, and related payment projections as of December 31, 2005:
Less than
Contractual Obligations Total 1 Year 1-3 Years 3-5 Years
------------------------------------- ---------------- ---------------- --------------- -------------
Convertible Notes $ 5,195,106 $ 4,364,825 $ 830,281 $ --
Less Convertible note discount (1,795,308)
------------
Net Convertible notes 3,399,798
Loans payable 4,685,236 4,685,236 -- --
Unsecured advanced 3,000,000 1,285,714 1,714,286
Due to related parties 1,572,894 1,572,894 -- --
Other liabilities 245,248 50,465 129,037 65,746
------------ ------------ ------------ ------------
Subtotal 12,903,176 11,959,134 2,673,604 65,746
Purchase Obligations 569,000 569,000 -- --
Operating leases 704,532 386,846 317,686 --
------------ ------------ ------------ ------------
Total $ 14,176,708 $ 12,914,980 $ 2,991,290 $ 65,746
============ ============ ============ ============
Critical Accounting Policies and Estimates
We have identified the policies and significant estimation processes below
as critical to our business operations and the understanding of our results of
operations. This listing is not intended to be a comprehensive list. In many
cases, the accounting treatment of a particular transaction is specifically
dictated by accounting principles generally accepted in the United States, with
no need for management's judgment in their application. In other cases,
management is required to exercise judgment in the application of accounting
principles with respect to particular transactions. The impact and any
associated risks related to these policies on our business operations is
discussed throughout "Management's Discussion and Analysis of Financial
Condition and Results of Operations" where such policies affect reported and
expected financial results. For a detailed discussion on the application of
these and other accounting policies, see Note B in the Notes to Consolidated
Financial Statements for the year ended December 31, 2004, included in this Form
S-1. Our preparation of our consolidated financial statements requires us to
make estimates and assumptions that affect the reported amount of assets and
liabilities, disclosure of contingent assets and liabilities at the date of our
consolidated financial statements, and the reported amounts of revenue and
expenses during the reporting periods. Management bases its estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances. There can be no assurance that actual
results will not differ from those estimates and such differences could be
significant.
Revenue recognition - Our revenue is primarily derived from fees charged
to terminate voice services over our network and from monthly recurring charges
associated with internet services and from sales of hardware product and calling
cards.
Variable revenue is earned based on the number of minutes during a call
and is recognized upon completion of a call. Revenue for each customer is
calculated from information received through the our network switches.We track
the information received from the switch and analyze the call detail records and
apply the respective revenue rate for each call.
Fixed revenue is earned from monthly recurring services provided to
customers that are fixed and recurring in nature, and are connected for a
specified period of time. Revenue recognition commences after the provisioning,
testing, and acceptance of the service by the customer. Revenues are recognized
as the services are provided and continue until the expiration of the contract
or until cancellation of the service by the customer.
Revenues from hardware product and calling card sales is recognized when
persuasive evidence of an arrangement exists, delivery to the customer has
occurred, the sales price is fixed and determinable, and collectibility of the
related receivable is considered probable.
Accounts Receivable - Accounts receivable are stated at the amount
management expects to collect from outstanding balances. Management provides for
probable uncollectible amounts based on its assessment of the current status of
the individual receivables and after using reasonable collection efforts. As of
December 31, 2005 and December 31, 2004, the balance of the allowance for
uncollectible accounts amounted to $177,489 and $136,795, respectively.
26
Goodwill - In accordance with Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets," the Company tests its goodwill
and intangible assets for impairment at least annually by comparing the fair
values of these assets to their carrying values, and the Company may be required
to record impairment charges for these assets if in the future their carrying
values exceed their fair values. During the year ended December 31, 2005 we
recorded an impairment charge of $4,173,452 relating to goodwill recorded as a
result of a prior acquisition. We may be required to record additional
impairment charges in the future.
Convertible Debt - Convertible debt with beneficial conversion features,
whereby the conversion feature is "in the money" are accounted for in accordance
with guidance supplied by Emerging Issues Task Force ("EITF") No. 98-5
"Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios" and EITF No. 00-27 "Application of
Issue 98-5 to Certain Convertible Instruments." The relative fair value of the
warrants and the Beneficial Conversion Feature has been recorded as a discount
against the debt and is amortized over the term of the debt.
Recently Issued Accounting Pronouncements
In November 2004, FASB issued Statement No. 151, "Inventory Costs - an
amendment of ARB No. 43, Chapter 4." Statement No. 151 requires that abnormal
amounts of costs, including idle facility expense, freight, handling costs and
spoilage, should be recognized as current period charges. The provisions of this
Statement are effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. The Company does not expect the adoption of this
Statement to have a material impact on its financial statements.
In December 2004, FASB issued Statement No. 153, "Exchanges of Nonmonetary
Assets - an amendment of Accounting Principles Board ("APB") Opinion No. 29."
Statement No. 153 amends APB Opinion No. 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have a
commercial substance. A nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. The provisions of this Statement are effective for nonmonetary
exchanges occurring in fiscal periods beginning after June 15, 2005. The Company
does not expect the adoption of this Statement to have a material impact on its
financial statements.
In May 2005, FASB issued SFAS No. 154, Accounting Changes and Error
Corrections or SFAS 154, which supersedes APB Opinion No. 20, Accounting Changes
and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements.
SFAS 154 changes the requirements for the accounting for and reporting of
changes in accounting principle. The statement requires the retroactive
application to prior periods' financial statements of changes in accounting
principles, unless it is impracticable to determine either the period specific
effects or the cumulative effect of the change. SFAS 154 does not change the
guidance for reporting the correction of an error in previously issued financial
statements or the change in an accounting estimate. SFAS 154 is effective for
accounting changes and corrections or errors made in fiscal years beginning
after December 15, 2005. We do not expect the adoption of SFAS 154 to have a
material impact on our consolidated results of operations or financial
condition.
Inflation
We do not believe inflation has a significant effect on our operations at
this time.
ITEM 7. FINANCIAL STATEMENTS
The financial statements required by this item begin at Page F-1 herein.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On November 16, 2004, Registrant was informed by Tschopp, Whitcomb & Orr
(the "Auditor") that such firm was resigning as Registrant's Auditor. During the
two most recent fiscal years and during the interim period from December 31,
2003 until November 16, 2004, the Company did not have any disagreements with
the Auditor on any matter of accounting principles or practices, financial
statement disclosure or auditing scope or procedures that would require
disclosure in this Form 10-KSB. During such period, there were no reportable
events as described in Item 304(a) (1) (v) of Regulation S-K.
On December 1, 2004, Registrant retained the accounting firm of Berkovits,
Lago & Company, LLP, to conduct an audit of Registrant's financial statements
for the year ending December 31, 2004, and to issue a report thereon. The Board
of Directors of Registrant approved the selection of Berkovits, Lago and
Company, LLP as new independent auditors. Neither management nor anyone on its
behalf has consulted with Berkovits, Lago and Company, LLP regarding the
application of accounting principles to a specified transaction, either
completed or proposed, or the type of audit opinion that might be rendered on
the Registrant's financial statements, and neither a written report nor oral
advice was provided to the Registrant that Berkovits, Lago and Company, LLP
concluded was an important factor considered by the Registrant in reaching a
decision as to the accounting, auditing or financial reporting issue during the
Registrant's two most recent fiscal years prior to engaging Berkovits, Lago and
Company, LLP.
ITEM 8A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), as of the end of the period covered by this
Annual Report, our management conducted an evaluation with the participation of
our Chief Executive Officer and Chief Financial Officer (collectively, the
"Certifying Officers") regarding the effectiveness of the design and operation
of the Company's disclosure controls and procedures (as defined in
Rules13a-15(e) and 15d-15(e) under the Exchange Act). Our management with the
participation of the Certifying Officers also conducted an evaluation of our
Company's internal control over financial reporting and identified three control
deficiencies, which in combination resulted in a material weakness.
27
A significant deficiency is a control deficiency, or combination of
control deficiencies, that adversely affects the company's ability to initiate,
authorize, record, process or report external financial data reliably in
accordance with generally accepted accounting principles such that there is more
than a remote likelihood that a misstatement of the company's 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. The control deficiencies identified by our
management and the Certifying Officers which in combination resulted in a
material weakness were: (a) misstatements in amounts reported for a consolidated
subsidiary, (b) insufficient personnel resources with appropriate accounting
expertise, and (c) a lack of independent verification of amounts billed to
certain customers.
Based on this evaluation and in accordance with the requirements of
Auditing Standard No. 2 of the Public Company Accounting Oversight Board, our
Chief Executive Officer and Chief Financial Officer conclude that the Company's
disclosure controls and procedures were ineffective as of December 31, 2005.
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. The Company's 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:
o pertain to the maintenance of records that, in reasonable detail
accurately and fairly reflect the transactions and dispositions of
the assets of the Company;
o provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles and, that
receipts and expenditures of the Company are being made only in
accordance with authorization of management and directors of the
Company; and
o provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the
Company's assets that could have a material effect on the financial
statements.
Our management, including the Certifying Officers, assessed as of December
31, 2005, the effectiveness of the Company's internal control over financial
reporting. In making this assessment, management used the criteria set forth in
the framework in Internal Control - Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO).
As of December 31, 2005, our management, including the Certifying
Officers, has concluded that the Company had the following control deficiencies
that when combined resulted in a material weakness:
(a) In March 2006, during their review and analysis of 2005 results and
financial condition in connection with the preparation of the 2005 financial
statements and this Form 10-KSB, our senior financial management discovered
certain overstatements of the revenues, expenses and receivables reported, and
understatement of net loss, for our consolidated subsidiary doing business as
DTNet Technologies ("DTNet"). Based upon an assessment of the impact of the
adjustments to our financial results arising from this matter, we have restated
the financial information presented in this Form 10-KSB for the year ended
December 31, 2004. Adjustments to reduce the overstatements of revenues and
receivables, and the understatement of net loss, aggregated $791,200, $651,832,
and $462,618 respectively, for the year ended December 31, 2004.
28
(b) We do not have sufficient personnel resources at corporate
headquarters with appropriate accounting expertise or experience in financial
reporting for public companies. Our management with the participation of the
Certifying Officers determined that the potential magnitude of a misstatement
arising from this deficiency is more than inconsequential to the annual and/or
interim financial statements.
(c) The amounts invoiced to our wholesale telecommunications customers are
calculated by our engineering department. This billing process is overseen
solely by the head of that department, our Chief Technology Officer. We do not
presently employ a separate revenue assurance process whereby these bills would
be recalculated and independently verified by a department other than
engineering. Our management with the participation of the Certifying Officers
determined that the potential magnitude of a misstatement arising due to this
deficiency is more than inconsequential to the annual and/or interim financial
statements.
Management has concluded that the above deficiencies when combined
together 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 the Company's 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 Chief Executive Officer and Chief
Financial Officer concluded that the Company did not maintain effective internal
control over financial reporting as of December 31, 2005 based on the criteria
in the Internal Control - Integrated Framework.
Remediation Steps to Address Control Deficiencies
The Company is in the process of addressing the identified material
weakness by remediating the control deficiencies in the Company's internal
control over financial reporting which comprise this material weakness as
follows:
(a) In March 2006 our Board of Directors retained counsel to conduct a
thorough investigation of the accounting misstatements of our DTNet subsidiary.
Such counsel, in turn, retained an independent forensic accounting firm to
assist its investigation. Based on this investigation our Board and management
have concluded that these intentional overstatements of revenues, expenses and
receivables were limited to the unauthorized actions of two individuals. One of
these individuals was employed at corporate headquarters and other was employed
at DT Net's headquarters. The individual employed at corporate headquarters
resigned shortly after the initiation of the investigation and we terminated the
employment of the other individual immediately following the receipt of the
preliminary findings of the investigation in early April 2006. We have changed
the individual responsible for the day-to-day management of DTNet, relocated its
accounting to our corporate offices and increased our analysis of this
subsidiary's transactions.
(b) We continue to seek to improve our in-house accounting resources.
During the fourth quarter of 2005 we hired a new CFO with significant accounting
and public company experience. During the first quarter of 2006 we did not hire
any new accounting personnel, However, we significantly supplemented our
internal accounting resources during these three months by using independent
accounting and financial consulting firms. We expect to continue to use such
third parties until such time as we are able to hire sufficient in-house
accounting expertise. In April 2006 we promoted the former Finance Director of
one of our recently acquired subsidiaries to the position of Corporate
Controller. This individual has significant financial experience (including five
years with the audit department of the accounting firm of KPMG Peat Marwick),
has served as the CFO and/or controller of various companies (including a public
registrant), and is a Certified Public Accountant.
(c) We are in the process of designing a revenue assurance process for the
billing of our wholesale telecommunications customers to provide independent
recalculation and verification of amounts billed. We anticipate implementing
this methodology by the end of the third quarter of 2006.
Changes in Control Over Financial Reporting
There were no changes in the Company's internal control over financial
reporting identified in connection with the evaluation of such internal control
that occurred during the Company's last fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
ITEM 8B. OTHER INFORMATION
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
29
The following table sets forth information concerning our executive
officers and directors as of the periods set forth below:
Name Age Position with Company Date Started with Company
----------------------------- ---- --------------------------------------------- --------------------------------
B. Michael Adler 58 Chief Executive Officer, Prospective Director October 2005
Hal H. Bibee, Sr. 53 President November 2005
Shawn M. Lewis 38 Chief Technology Officer, Prospective Director May 2005
David W. Sasnett 49 Chief Financial Officer October 2005
George Firestone 73 Director November 2005
Stuart Kosh 49 Director February 2006 to present
Nicholas A. Iannuzzi, Jr. 40 Prospective Director
Thomas Reeves 58 Prospective Director
John N. Spencer, Jr. 65 Prospective Director
B. Michael Adler became our Chief Executive Officer in October 2005. Mr.
Adler is the founder of WQN, Inc., has been a member of its board of directors
since its inception in 1996, and served as its Chief Executive Officer from 1996
to 2001. Mr. Adler is the Chief Executive Officer of Eagle Venture Capital, LLC,
a Delaware limited liability company, formerly known as WorldQuest Networks,
LLC, and a former Director of Intellicall, Inc., a publicly-traded manufacturer
of pay phones and call processing equipment (New York Stock Exchange symbol
"ICL"). Mr. Adler founded Intellicall in 1984 and served as Chairman or Vice
Chairman of the Board from its inception until November 1993. From 1994 to July
1999, Mr. Adler was the Chairman of the Board of the Payphone Company Limited, a
company that owns a wireless pay telephone network in Sri Lanka. Mr. Adler is a
nominee for election to our Board at our upcoming shareholders meeting.
Hal H. Bibee, Sr. is an entrepreneur and corporate financial consultant.
He is a Certified Public Accountant (inactive), formerly with Ernst & Ernst. In
1984 he co-founded MetroTel, which at that time was the largest private pay
telephone company in New York City, and served as its Chief Executive Officer
through 1985. Mr. Bibee was a founding shareholder of the First Bank of East
Tennessee and served on its Board of Directors from 1988 to 1997. As an
entrepreneur in the telecommunications industry, Mr. Bibee has engineered,
constructed and operated cable television systems throughout the Southeast. As a
Board member, stockholder and consultant for Mega Force Staffing Services, Inc.
from 1995-1997, Mr. Bibee was in charge of all mergers & acquisitions and
investment banking activities. In 1998, he founded FiberLink, LLC, and in 2000,
INTELLICAD, LLC. These firms provide consulting, engineering and construction
services to the telecommunications industry. He is a General Partner in ASETZ, a
diversified real estate investment and development company, and a General
Partner in Parkway Properties, a self storage development and operating company.
From 2004 to the present, he has served on the Board of Directors, and as the
Audit Committee Chairman, of WQN, Inc., a publicly-held telecom company that
offered voice over internet protocol services to domestic and international
markets until it sold the assets for that business to our Company in October
2005.
Shawn M. Lewis oversees all of our technological and engineering
activities. Mr. Lewis founded and was the President and CEO of Caerus, Inc. and
its three subsidiaries, Volo Communications, Caerus Networks, Inc., and Caerus
Billing & Mediation, Inc. from 2001 to 2005. We acquired Caerus, Inc. in May
2005 at which time Mr. Lewis became our Chief Technology Officer. Prior to
Caerus Mr. Lewis co-founded XCOM Technologies, a competitive local exchange
carrier, where he served in an executive capacity and led the development of
patents for the first softswitch and SS7 Media Gateway. XCOM Technologies was
sold to Level 3 in 1998. His next venture, set-top box vendor River Delta, was
sold to Motorola. His most recent venture, Caerus, Inc. empowers carriers and
service providers to begin selling advanced voice over internet protocol related
services. In 2004, Mr. Lewis plead guilty to a felony drug possession offense
and received probation. Mr. Lewis is also a nominee for election as a Director
at our next shareholders meeting. Mr. Lewis is presently engaged in a Chapter 11
bankruptcy in Orlando, Florida.
David W. Sasnett has more than 25 years of experience in providing
management, accounting and advisory services to a wide variety of companies,
both public and private. Immediately prior to joining our company Mr. Sasnett
was a consultant with Corevision Strategies, LLC, a financial and management
services consulting firm. During 2004 Mr. Sasnett held the positions of Vice
President of Finance and Controller of Mastec, Inc., a publicly-traded specialty
contractor engaged in the design, construction, installation, maintenance and
upgrade of infrastructures for companies and government entities operating in
the telecommunication, broadband, energy services, traffic control and homeland
security services industries. In 2003 Mr. Sasnett founded, and continues to be
the President of, Secure Enterprises, LLC, a successful consumer product
manufacturer and distributor and in 2002 he was an Executive Vice President with
Platinum Products, Inc., a privately-held importer and distributor of consumer
products. Mr. Sasnett was employed from 1994 to 2002 by Catalina Lighting, Inc.,
a global, publicly-traded manufacturer and distributor of residential lighting
and other consumer products. From 1996 to 2002 he served as Catalina's Chief
Financial Officer. Mr. Sasnett's prior experience also includes more than 12
years with the audit department of the international accounting and consulting
firm of Deloitte & Touche, LLP.
George Firestone was elected Florida's 20th Secretary of State in 1978 and
was re-elected for two additional terms. Previously, he served as a member of
the House of Representatives and as a member of the Florida Senate. During this
legislative tenure, he was responsible for the passage of laws permitting
international banking and foreign trade zones. Senator Firestone currently
serves as the State of Florida's "Special Envoy" to the Foreign Consular Corp of
Florida. He has a long history of valued legislative service, including serving
as a member of the Florida Cabinet, the State's Chief Elections Officer, and
Chief Cultural Officer.
30
For the past five years Senator Firestone has been the Chairman and CEO of
Tecton International, Inc., a financial and operations management company
specializing in the management and workout of non-performing businesses and
distressed real estate. Senator Firestone is a vice president, general manager
and stockholder of Gray Security Service, which provides security investigations
of commercial and industrial matters. He serves on the board of Eastern National
Bank of Miami. His long public service support includes serving as chairman of
the City of Miami Economic Advisory Board; member of the Dade County Personnel
Advisory Board; and receiver and trustee of the U.S. Bankruptcy Court. Senator
Firestone is a licensed real estate broker and developer, and insurance broker
specializing in the field of estate planning and business insurance for
individuals and corporations.
Stuart Kosh moved to Florida in 1978 to join his father and brother at
Kosh Ophthalmic, Inc., a wholesale optical laboratory with annual sales of $15
million, where he managed 100 employees. In 1998, the company was sold to
Essilor of America, and Mr. Kosh maintains his position as General Manager. His
leadership roles have included involvement with the Big Brothers Big Sisters
Program of Broward County as a mentor to needy youth. For the past 15 years, Mr.
Kosh has been involved with the National Multiple Sclerosis Society. He has
served on their board and chairs their annual golf tournament. Presently he is
serving on the Temple Dor Dorim Board of Directors. Mr. Kosh was appointed a
Director of our company in February 2006.
The following additional individuals are nominees for election as a Director at
our next shareholders meeting:
Thomas Reeves, age 58, has a broad professional career that began with
Shaklee Corporation, initially as Contract Manufacturing Manager and later as
Director of Purchasing. In 1980 he accepted a Vice President position with
Nutrition Pak Corporation. From 1984 to 1992 Mr. Reeves was President of Torick
Inc. an electrical wire harness manufacturer. In 1992 he started Transportation
Safety Technologies where he was President and Chief Executive Officer. From
2000 to present he has been President of TRJB Inc. a holding company for various
companies in the hospitality industry. Mr. Reeves has been actively involved in
supporting the American Cancer Society and is a committee member of the Cystic
Fibrosis Foundation. He holds a BS in Business Administration from California
State University.
John N. Spencer, Jr., age 65, served a broad range of clients for more
than 38 years while at Ernst & Young. He began his Ernst & Young career in
Boston in 1962 and worked in the Firm's National office in New York assisting
with the development of professional policies and in resolving client matters
nationwide in the audit, accounting and SEC areas. Mr. Spencer served as the
Managing Partner of E&Y's Providence, Rhode Island office before transferring to
Atlanta in 1981. Most recently he was the Market Segment Team Leader for Ernst &
Young's Life Sciences industry practice in the Southeast. He retired from Ernst
& Young in 2000.
Mr. Spencer has significant expertise in coordinating services to publicly
held companies, including involvement in more than 200 registration statements
and over 25 initial public offerings. He provided audit and financial related
services for over 100 merger and acquisition transactions and has significant
experience with numerous Boards and Audit Committees. Active in Georgia's
technology community, he served as president and a director of the Business and
Technology Alliance. He was a cofounder and is treasurer of the Atlanta Venture
Forum, an association of venture capital investors in the Southeast, and he
recently completed two years as the President of the Georgia Biomedical
Partnership. Mr. Spencer is a member of the National Association of Corporate
Directors, and he serves as a member of the Board of Directors of: A C
Therapeutics, Inc.; GeneEx, Inc.; and OrthoHelix Surgical Designs, Inc. He also
serves on the Board of Directors of Firstwave Technologies, Inc. (NASDAQ - FSTW)
and is the Chair of its Audit Committee. In addition, Mr. Spencer is a Director
of BioFlorida and of the Georgia Biomedical Partnership.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth information with respect to the
compensation, for the last three fiscal years, of our Chief Executive Officer
and each person who served as an executive officer of our Company for the last
three fiscal years and whose total annual salary and bonus exceeded $100,000. In
accordance with the rules of the SEC, the compensation set forth in the table
below does not, unless otherwise noted, include medical, group life or other
benefits that are available to all of our salaried employees, and perquisites
and other personal benefits, securities or property that do not exceed the
lesser of $50,000 or 10% of the total annual salary and bonuses for each of the
individuals shown in the table.
31
Summary Compensation Table
Annual Compensation Long-Term Compensation
---------------------------- ------------------------
Securities
Underlying
Options or All Other
Name/Principal Position Year Salary Bonus Warrants Compensation
-------------------------------------------------------------------------- ------------------------
Steven Ivester (1) 2005 $231,722 $250,000 -- $ 33,563
Former Chief Executive Officer 2004 $125,000 $ -- -- $ 2,475
2003 $ -- $ -- -- $ --
Bill Burbank (2) 2005 $146,156 $ 1,923 -- $ --
Former Chief Operating Officer 2004 $ 2,116 $ -- -- $ --
2003 $ -- $ -- -- $ --
Osvaldo Pitters (3) 2005 $100,000 $ 1,923 -- $ --
Former Chief Financial Officer; 2004 $ 50,000 $ -- -- $ --
Former Senior Vice President of Finance 2003 $ -- $ -- -- $ --
Shawn Lewis 2005 $115,385 $ 37,115 -- $ --
Chief Technology Officer
B. Michael Adler 2005 $ 48,739 $ 2,769 -- $ --
Chairman; Chief Executive Officer 2004 $ -- $ -- -- $ --
2003 $ -- $ -- -- $ --
(1) Mr. Ivester resigned his position as CEO in October 2005 and his
position as Director in December 2005.
(2) Mr. Burbank resigned his position in January 2006.
(3) Mr. Pitters resigned his position in March 2006.
Stock Options
Number of Securities
Underlaying
Unexercised Value of Unexercised
Options at In-the-Money Options at
Stock Options December 31, 2005 December 31, 2005
--------------------------- ----------------------------- -------------------------------
Number of
Shares Acquired Realized
Name or Exercised Value Exercisable Unexercisable Exercisable Unexercisable
------------------------------ --------------- -------- ----------- ------------- ----------- -------------
B. Michael Adler -- -- 125,000 375,000 -- --
Hal Bibee -- -- 125,000 375,000 -- --
David Sasnett -- -- 75,000 225,000 -- --
32
Long-Term Incentive Plans
Number of Securities
Underlaying
Unexercised
Options at
December 31, 2005
--------------------------------------
Number of
Shares Acquired Realized Threshold Target Maximum
Name or Exercised Value ($ or #) ($ or #) ($ or #)
----------- --------------- --------- ----------- ----------- -----------
(None)
Stock Option Plans
The Company's current Stock Option Plan (the "2004 Option Plan") provides
for the grant to eligible employees and directors of options for the purchase of
common stock. The 2004 Option Plan covers, in the aggregate, a maximum of
4,000,000 shares of common stock and provides for the granting of both incentive
stock options (as defined in Section 422 of the Internal Revenue Code of 1986)
and nonqualified stock options (options which do not meet the requirements of
Section 422). Under the 2004 Option Plan, the exercise price may not be less
than the fair market value of the Common Stock on the date of the grant of the
option.
The Board of Directors administers and interprets the 2004 Option Plan and
is authorized to grant options there under to all eligible employees of the
Company, including officers. The Board of Directors designates the optionees,
the number of shares subject to the options and the terms and conditions of each
option. Each option granted under the 2004 Option Plan must be exercised, if at
all, during a period established in the grant which may not exceed 10 years from
the later of the date of grant or the date first exercisable. An optionee may
not transfer or assign any option granted and may not exercise any options after
a specified period subsequent to the termination of the optionee's employment
with the Company.
On December 7, 2005, our 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. We are seeking shareholder
approval at our upcoming 2006 shareholders' meeting (which we believe will be
held in May 2006) 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.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth information as of March 24, 2006, except as
otherwise noted, with respect to the beneficial ownership of our common stock:
o each person known by the Company to own beneficially more than five
percent of our outstanding common stock;
o each director and prospective director of the Company;
o the Company's Chief Executive Officer and each person who serves as
an executive officer of the Company; and
o all executive officers and directors of the Company as a group.
The number of shares beneficially owned by each stockholder is determined
under rules promulgated by the SEC. The information is not necessarily
indicative of beneficial ownership for any other purpose. Under these rules,
beneficial ownership includes any shares as to which the individual has sole or
shared voting power or investment power and any shares as to which the
individual has the right to acquire beneficial ownership within 60 days, except
as otherwise noted, through the exercise or conversion of any stock option,
warrant, preferred stock or other right. The inclusion in the following table of
those shares, however, does not constitute an admission that the named
stockholder is a direct or indirect beneficial owner of those shares. Unless
otherwise indicated, to our knowledge based upon information produced by the
persons and entities named in the table, each person or entity named in the
table has sole voting power and investment power, or shares voting and/or
investment power with his or her spouse, with respect to all shares of capital
stock listed as owned by that person or entity.
33
Shares of Common Stock Ownership of
Name of Beneficial Owner Beneficially Owned Common Stock (9)
------------------------------------ ---------------------- ----------------
YTMJ, LLC 5,950,615 8.6%
5600 PGA Boulevard, Suite 204
Palm Beach Gardens, FL 33412
WQN, Inc. (1) 10,236,995 14.2%
14911 Quorum Drive, Suite 140
Dallas, Texas 75240
Steven Ivester 4,410,000 6.4%
Shawn M. Lewis 5,446,231 7.9%
B. Michael Adler (2) 1,125,000 1.6%
Hal Bibee, Sr (3) 1,687,500 2.4%
David W. Sasnett (4) 500,000 *
George Firestone (5) 16,666 *
Stuart Kosh (6) 1,284,477 1.9%
Thomas Reeves (7) 585,000 0.8%
John N. Spencer, Jr -- --
All directors and executive officers
as a group (5 persons) (8) 8,775,397 12.2%
* Less than one percent.
(1) Consists of 6,764,429 shares of Common Stock and 3,700,000 shares
issuable upon conversion of a Convertible Promissory Note.
(2) Consists of (a) 500,000 shares of common stock; (b) currently
exercisable options to purchase 125,000 shares of common stock; and
(c) warrants to purchase 500,000 shares of common stock.
(3) Consists of (a) 375,000 shares of common stock; (b) currently
exercisable options to purchase 125,000 shares of common stock; and
(c) warrants to purchase 1,187,500 shares of common stock.
(4) Consists of currently exercisable options to purchase 75,000 shares
of common stock, and warrants to purchase 425,000 shares of common
stock.
(5) Consists of 8,333 shares of common stock and currently exercisable
options to purchase 8,333 shares of common stock.
(6) Consists of 778,227 shares of common stock and warrants to purchase
506,250 shares of common stock.
(7) Consists of 438,500 shares of common stock and warrants to purchase
146,500 shares of common stock
(8) Represents the combined beneficial ownership of the executives and
the Company's one director as of January 24, 2006 which consist of
Messrs. Adler, Bibee, Lewis, Sasnett and Firestone.
(9) Based upon 68,838,766 shares of common stock issued and outstanding
as of March 24, 2006.
34
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Our Company was organized by Kevin Halter and members of his family in
1998, when they purchased 1,000,000 shares at its par value. Then in March 2004,
the Company sold 12,500,000 shares of stock to Steven Ivester for par value
($12,500), plus his agreement to contribute two operating companies. Such
companies were contributed in May 2004, effective April 15, 2004.
In October 2005, we purchased all of the assets of WQN, Inc. Mr. Adler was
the Chief Executive Officer of WQN, Inc. and owns approximately 39% of WQN's
outstanding common stock. In connection with the transaction, our Company,
through an acquisition subsidiary, purchased the assets for a purchase price
consisting of (1) a convertible promissory note, in the principal amount of
$3,700,000 (the "Note"), (2) 1,250,000 shares of restricted common stock and (3)
a warrant to purchase 5,000,000 shares of common stock. The aggregate
outstanding principal amount of the Note, together with interest, is convertible
into either shares of preferred stock or shares of common stock. The Note, in
the principal amount of $3,700,000, will accrue interest at the rate of 6% per
annum. In addition, we issued WQN, Inc. an additional 500,000 shares of
restricted common stock relating to the difference between the amount of
accounts receivable and the accounts payable transferred in the transaction.
At December 31, 2004 we owed Steven Ivester, a shareholder, $560,000 under
a note payable bearing interest at 3.75% and maturing December 31, 2005. The
Company owed Steven Ivester $1,572,894 as of December 31, 2005 under a demand
note payable bearing interest at 3.75%.
We entered into a consulting agreement with Mr. Ivester on October 18,
2005. Pursuant to the consulting agreement, Mr. Ivester provides general
business strategy, financing and product development advice. Mr. Ivester
receives $200,000 per year for his services under the consulting agreement, as
well as a $2,500 per month vehicle allowance. Mr. Ivester is eligible to receive
bonuses, as determined by the Board of Directors. Mr. Ivester is eligible for
participation in the Company's 2006 Stock Option Plan, as determined by the
Board of Directors. Mr. Ivester is entitled to severance payments under the
consulting agreement if the consulting agreement is terminated under certain
circumstances.
Promoters
On February 27, 2004, the Company issued and sold 12,500,000 shares of
common stock to Steven Ivester in exchange for cash of $12,500 and his agreement
to contribute the intellectual property rights and related assets of two
start-up companies formed to engage in the telecommunications industry. The
shares issued represented approximately 88% of the shares outstanding after the
exchange, as a result of which Mr. Ivester became the controlling shareholder of
the Company.
On August 4, 2004, the Company issued warrants to purchase 2,200,000
shares of common stock for an exercise price of $1.00 per share to each of John
Todd and Clive Raines. Mr. Todd's warrants were exchanged for 750,000 shares in
a net cashless exercise in February 2005.
Messrs. Ivester, Todd and Raines may be considered to be "promoters" of
the Company.
ITEM 13. EXHIBITS
(b) Exhibits
(3) 2.1 Stock Contribution Agreement dated May 25, 2004, between
Registrant and Steven Ivester
(11) 2.2 Agreement and Plan of Merger with Caerus, Inc. dated as of
May 31, 2005
(12) 2.3 Asset Purchase Agreement dated as of August 3, 2005, by and
between VoIP, Inc. Acquisition Company and WQN, Inc.
(1) 3.1.1 Articles of Incorporation
(3) 3.1.2 Amendment of Articles of Incorporation
(1) 3.2 Bylaws
(3) 10.1 2004 Stock Option Plan
(15) 10.1.2 2006 Equity Incentive Plan
(2) 10.2 Stock Purchase Agreement dated February 27, 2004 between
Registrant and Steven Ivester
35
(4) 10.3 Stock Purchase Agreement dated June 25, 2004 among
Registrant, DTNet Technologies and Marc Moore
(5) 10.4 Stock Purchase Agreement among Carlos Rivas, Albert
Rodriguz, Registrant and Vox Consulting Group
Inc.
(6) 10.5.1 Subscription Agreement
(6) 10.5.2 Form of Class A Warrant
(6) 10.5.3 Form of Class B Warrant
(7) 10.6.1 Stock Purchase Warrant issued to Ivano Angelaftri
(7) 10.6.2 Stock Purchase Warrant issued to Ebony Finance
(8) 10.7 Net Exercise Agreement with John Todd
(9) 10.8 Asset Purchase Agreement dated February 23, 2005
(10) 10.9.1 Subscription Agreement
(10) 10.9.2 Form of Class C Warrant
(10) 10.9.3 Form of Class D Warrant
(10) 10.9.4 Form of Convertible Note
(10) 10.9.5 Security Agreement
(10) 10.9.6 Security and Pledge Agreement
(10) 10.9.7 Guaranty
(10) 10.10 Caerus, Inc. Merger Documents dated May 31, 2005:
(11) 10.10.1 Option Exchange Agreement
(11) 10.10.2 Registration Rights Agreement
(11) 10.10.3 Exchange Agreement
(11) 10.10.4 Registration Rights Agreement
(11) 10.10.5 Consent and Waiver Agreement
(11) 10.10.6 Guaranty
(11) 10.10.7 Security Agreement
(11) 10.10.8 Employment Agreement
10.11 WQN, Inc. Documents dated August 3, 2005:
(12) 10.11.1 Warrant
(12) 10.11.2 Security Agreement between VoIP, Inc. and WQN, Inc.
(12) 10.11.3 Consent, Waiver and Acknowledgement by and among Cedar
Boulevard Lease Funding, Inc., VoIP, Inc. and certain
Subsidiaries of VoIP, Inc.
36
(12) 10.11.4 Third Amendment to Subordinated Loan and Security Agreement
by and among Cedar Boulevard Lease Funding, Inc., VoIP, Inc.
and certain subsidiaries of VoIP, Inc.
(12) 10.11.5 Security Agreement between Cedar Boulevard Lease Funding,
Inc. and VoIP Acquisition Company
(12) 10.11.6 Guaranty between Cedar Boulevard Lease Funding, Inc. And
VoIP Acquisition Company Promissory Note
(13) 10.12.1 Subscription Agreement for Secured Note dated January 6,
2006
(13) 10.12.2 Subscription Agreement for Unsecured Note dated January 6,
2006
(14) 10.12.3 Subscription Agreement dated February 3, 2006
(15) 21.1 Subsidiaries of the Registrant
(15) 31.1 Certification of Chief Executive Officer under Section 302
of the Sarbanes-Oxley Act of 2002
(15) 31.2 Certification of Chief Financial Officer under Section 302
of the Sarbanes-Oxley Act of 2002
(15) 32.1 Certification of Chief Executive Officer under U.S.C. 1350,
as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
(15) 32.1 Certification of Chief Financial Officer under U.S.C. 1350,
as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
(1) Filed as exhibits to Registrant's Form 10SB filed January 19,
2000
(2) Filed as exhibit to Form 8-K filed March 3, 2004
(3) Filed as exhibit to Form 8-K filed June 9, 2004
(4) Filed as exhibit to Form 8-K filed July 7, 2001
(5) Filed as exhibit to Form 8-K filed September 16, 2004
(6) Filed as exhibit to form 8-K filed November 17, 2004
(7) Filed as exhibit to form 8-K filed December 15, 2004
(8) Filed as exhibit to form 8-K filed February 16, 2005
(9) Filed as exhibit to form 8-K filed March 1, 2005
(10) Filed as exhibit to form 8-K filed June 6, 2005
(11) Filed as exhibit to form 8-K filed July 11, 2005
(12) Filed as exhibit to form 8-K filed August 9, 2005
(13) Filed as exhibit to Form 8-K filed January 12, 2006
(14) Filed as exhibit to Form 8-K filed February 8, 2006
(15) Filed herewith
37
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The Audit Committee has appointed Berkovits Lago & Company, LLP as the
Company's independent auditors for 2004.
Audit Fees.
Berkovits Lago & Company billed audit fees to the Company of $106,721 in
2005 and $10,000 in 2004.
Tax Fees. None.
38
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
VoIP, Inc. and Subsidiaries
Ft. Lauderdale, Florida
We have audited the accompanying consolidated balance sheets of VoIP, Inc. and
Subsidiaries ("the Company") as of December 31, 2005 and 2004, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of VoIP, Inc. and Subsidiaries
("the Company") as of December 31, 2005 and 2004, and the results of its
operations and its cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note L to the
financial statements, the Company's dependence on outside financing, lack of
sufficient working capital, and recurring losses raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans are
described in Note L to the financial statements. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
As described in Note B to the consolidated financial statements, the
accompanying consolidated financial statements of VoIP, Inc. and Subsidiaries as
of December 31, 2004 and for the year then ended have been restated to correct
for misstatements in the December 31, 2004 financial statements previously
filed.
/s/ Berkovits, Lago & Company, LLP
Fort Lauderdale, Florida
April 12, 2006
F-1
VoIP, Inc.
Consolidated Balance Sheets
December 31
-----------------------------
2005 2004
------------ ------------
(As Restated)
ASSETS
Current assets:
Cash and cash equivalents $ 3,228,745 $ 1,141,137
Accounts receivable, net of allowance of
$177,489 and $136,795 respectively 1,320,062 166,239
Due from related parties 161,530 245,402
Inventory 797,074 324,185
Assets from discontinued operations less
valuation allowance of $392,000 in 2005 -- 412,419
Other current assets 936,520 --
------------ ------------
Total current assets 6,443,931 2,289,382
Property and equipment, net 10,155,507 419,868
Goodwill and other intangible assets 39,441,372 6,923,854
Other assets 349,205 23,579
------------ ------------
TOTAL ASSETS $ 56,390,015 $ 9,656,683
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 13,304,915 $ 1,148,833
Loans payable 4,685,236 200,000
Convertible notes payable 3,399,798 --
Advances from investors 3,000,000 --
Due to related parties 1,572,894 560,000
Other current liabilities 956,004 103,030
------------ ------------
Total current liabilities 26,918,847 2,011,863
Other liabilities 245,248 --
------------ ------------
TOTAL LIABILITIES 27,164,095 2,011,863
------------ ------------
Shareholders' equity:
Common stock - $0.001 par value;
100,000,000 shares authorized;
61,523,397 and 24,258,982 shares
issued and outstanding, respectively 61,523 24,259
Additional paid-in capital 63,964,497 14,107,328
Accumulated deficit (34,800,100) (6,486,768)
------------ ------------
Total shareholders' equity 29,225,920 7,644,820
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 56,390,015 $ 9,656,683
============ ============
The accompanying notes are an integral part of these financial statements.
F-2
VoIP Inc.
Consolidated Statements of Operations
Year Ended December 31
-----------------------------
2005 2004
------------ ------------
(As Restated)
Revenues $ 15,507,145 $ 1,828,193
Cost of sales 16,331,663 1,372,146
------------ ------------
Gross profit (loss) (824,518) 456,047
Operating expenses
Compensation and related expenses 7,730,795 4,254,477
Commissions and fees to third parties 4,949,612 407,498
Professional and legal 1,868,263 430,432
Depreciation and amortization 3,140,401 82,832
General and administrative expenses 4,193,987 1,288,239
Impairment of goodwill 4,173,452 --
------------ ------------
Loss from operations (26,881,028) (6,007,431)
Interest expense 1,638,489 --
Gain on sale of fixed assets (206,184) --
------------ ------------
Net loss before discontinued operations (28,313,333) (6,007,431)
Income from discontinued operations,
net of income taxes -- 145,311
------------ ------------
Net loss $(28,313,333) $ (5,862,120)
============ ============
Basic and diluted loss per share:
Loss before discontinued operations $ (0.67) $ (0.41)
Income from discontinued operations,
net of income taxes -- 0.01
------------ ------------
Net loss per share $ (0.67) $ (0.40)
============ ============
Weighted average number of shares outstanding 42,022,906 14,597,312
============ ============
The accompanying notes are an integral part of these financial statements.
F-3
VoIP, Inc.
Consolidated Statements of Cash Flows
Year Ended December 31
-----------------------------
2005 2004
------------ ------------
(As Restated)
Cash flows from operating activities:
Continuing operations:
Net loss $(28,313,333) $ (6,007,431)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 3,140,401 82,832
Goodwill impairment 4,173,452 --
Amortization of debt discounts 416,175 --
Common shares issued for services 3,380,474 599,166
Options and warrants issued for services and compensation 2,181,350 3,320,763
Changes in operating assets and liabilities, net of assets & liabilities
acquired:
Accounts receivable (17,368) 233,620
Due from related parties 83,872 (245,402)
Inventory 100,080 8,179
Other current assets (582,685) 52,233
Accounts payable (4,549,404) (372,446)
Due to related parties 812,894 --
Other current liabilities 852,974 (335,696)
------------ ------------
Net cash used in continuing operating activities (18,321,118) (2,664,182)
------------ ------------
Discontinued operations:
Income (loss) from discontinued operations -- 145,311
Changes in assets, liabilities, and net results 412,419 (408,000)
------------ ------------
Net cash provided by (used in) discontinued operating activities 412,419 (262,689)
------------ ------------
Net cash used in operating activities (17,908,699) (2,926,871)
------------ ------------
Cash flows from investing activities:
Cash from acquisitions -- 104,872
Purchase of property and equipment (2,566,122) (157,881)
Acquisition of Caerus and WQN (Note K) (1,290,727) --
Purchase of other assets 267,940 (71,100)
------------ ------------
Net cash used in investing activities (3,588,909) (124,109)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of notes payable 9,616,104 560,000
Proceeds from sales of common stock 11,719,614 3,628,618
Issuance of stock for note conversions 2,465,286 --
Repayment of notes payable (215,788) --
------------ ------------
Net cash provided by financing activities 23,585,216 4,188,618
------------ ------------
Net increase in cash 2,087,608 1,137,638
Cash and cash equivalents at beginning of year 1,141,137 3,499
------------ ------------
Cash and cash equivalents at end of year $ 3,228,745 $ 1,141,137
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
VoIP, Inc.
Consolidated Statements of Changes in Shareholders' Equity
Years Ended December 31, 2005 and 2004
(As Restated for 2004)
Additional
Common Stock Common Stock Paid-in Accumulated
Shares Amount Capital Deficit Total
-----------------------------------------------------------------------
Balance as of December 31, 2003 1,730,939 $ 1,731 $ 731,208 $ (624,647) $ 108,292
Common stock issued 12,500,000 12,500 -- -- 12,500
Common stock issued to investors for cash received 5,520,566 5,521 3,610,598 -- 3,616,119
Common stock issued for services 907,477 907 493,259 -- 494,166
Common Stock issued for acquisition of DTNet Tech 2,500,000 2,500 4,747,500 -- 4,750,000
Common Stock issued for acquisition of VoipAmericas 1,000,000 1,000 1,099,000 -- 1,100,000
Warrants issued to two company officers -- -- 3,320,763 -- 3,320,763
Warrants issued for intellectual property 100,000 100 105,000 -- 105,100
Loss for the year -- -- -- (5,862,120) (5,862,120)
-----------------------------------------------------------------------
Balance December 31, 2004 24,258,982 24,259 14,107,328 (6,486,767) 7,644,820
Common Stock issued for services 2,994,592 2,995 3,377,479 -- 3,380,474
Common stock issued to investors for cash received 6,740,038 6,740 8,022,598 -- 8,029,338
Common stock issued for cash received, pursuant to
exercise of warrants 3,292,778 3,293 3,919,360 -- 3,922,653
Common stock issued for debt conversions 4,054,536 4,054 2,461,232 -- 2,465,286
Common Stock issued for acquisition of Caerus, Inc. 18,932,471 18,932 19,956,068 -- 19,975,000
Options issued for acquisition of Caerus, Inc. -- -- 355,000 -- 355,000
Common Stock issued for acquisition of WQN 1,250,000 1,250 1,298,250 -- 1,299,500
Value of warrants issued for acquisition of WQN -- -- 5,200,000 -- 5,200,000
Value of warrants and conversion features of debt issued -- -- 3,085,832 -- 3,085,832
Stock compensation - amortization -- -- 242,101 242,101
Option and warrant compensation - amortization -- -- 1,939,249 -- 1,939,249
Loss for the year -- -- -- (28,313,333) (28,313,333)
-----------------------------------------------------------------------
Balance December 31, 2005 61,523,397 $ 61,523 $ 63,964,497 $(34,800,100) $ 29,225,920
=======================================================================
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
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 VCS
Technologies, Inc. d/b/a DT Net Technologies, a hardware supplier, and VoIP
Americas, Inc., a VoIP related company, 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
telecommunications industry. In May 2005 the Company acquired Caerus, Inc., a
VoIP carrier and service provider. In October 2005 the Company purchased
substantially all of the assets of WQN Inc.'s voice over internet protocol
business.
The Company is an emerging global provider of advanced communications services
utilizing Voice over Internet Protocol (VoIP) technology. Internet Protocol
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 provides a portfolio
of advanced telecommunications technologies, enhanced service solutions, and
broadband products to the VoIP industry. Current and targeted customers include
RBOCs, CLECs, IXCs, wireless carriers, resellers, internet service providers,
cable multiple system operators and other providers of telephony services.
The Company's operations consist of three segments, as follows:
Telecommunication Services, Hardware Sales and Calling Cards.
NOTE B - RESTATEMENT OF FINANCIAL STATEMENTS
On March 22, 2006, the Company concluded that its consolidated financial
statements for the year ended December 31, 2004 were misstated, resulting in
overstated revenues, expenses and receivables, and understated net loss. These
misstatements were discovered by the senior financial management personnel that
commenced their employment with the Company in the fourth quarter of 2005 during
their review and analysis in connection with the preparation of the 2005
financial statements. The misstatements occurred in the financial statements of
the Company's consolidated subsidiary doing business as DTNet Technologies,
which was acquired in June 2004. The Company therefore decided to restate its
2004 consolidated financial statements to correct these misstatements. The
following table sets forth the impact of the restatement on certain amounts
previously reported in our 2004 consolidated financial statements.
Balance Sheet Data: As of December 31, 2004
------------------- --------------------------------
As Previously
Reported As Restated
--------------- ------------
Accounts receivable $ 818,071 $ 166,239
Inventory 187,451 324,185
Accumulated deficit (6,024,149) (6,486,768)
Statement of Operations Data: Year Ended December 31, 2004
----------------------------- --------------------------------
As Previously
Reported As Restated
--------------- ------------
Revenue $ 2,619,393 $ 1,828,193
Loss from operations (5,544,813) (6,007,431)
Net loss (5,399,502) (5,862,120)
Net loss per common share (0.37) (0.40)
F-6
NOTE C - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries, Caerus, Inc., eGlobalphone, Inc., VoIP Solutions,
Inc., DTNet Technologies, and VoIP Americas, Inc. from their respective dates of
acquisition. All significant intercompany balances and transactions have been
eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities; disclosure of contingent
assets and liabilities at the date of the financial statements; and the reported
amounts of revenues and expenses. Actual results could differ from those
estimates.
Cash and cash equivalents
For purposes of reporting cash flows, the Company considers all cash on hand, in
banks, including amounts in book overdraft positions, certificates of deposit
and other highly liquid debt instruments with a maturity of three months or less
at the date of purchase to be cash and cash equivalents. Cash overdraft
positions may occur from time to time due to the timing of making bank deposits
and releasing checks, in accordance with the Company's cash management policies.
Accounts Receivable
Accounts receivable are stated at the amount management expects to collect from
outstanding balances. Management provides for probable uncollectible amounts
based on its assessment of the current status of the individual receivables and
after using reasonable collection efforts. As of December 31, 2005 and 2004 the
balance of the allowance for uncollectible accounts amounted to $177,489 and
$136,795 respectively.
Inventory
Inventory consists of finished goods and is valued at the lower of cost or
market using the first-in, first-out method.
Convertible Debt
Convertible debt with beneficial conversion features, whereby the conversion
feature is "in the money" are accounted for in accordance with guidance supplied
by Emerging Issues Task Force ("EITF") No. 98-5 "Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios" and EITF No. 00-27 "Application of Issue 98-5 to Certain
Convertible Instruments." The relative fair value of the warrants and the
Beneficial Conversion Feature has been recorded as a discount against the debt
and is amortized over the term of the debt.
Income Taxes
The Company follows Statement of Financial Accounting Standards No. 109
"Accounting for Income Taxes" ("SFAS No. 109"). Under the asset and liability
method of SFAS No. 109, deferred tax assets and liabilities are recognized for
the future tax consequences attributed to differences between the financial
statements carrying amounts of existing assets and liabilities and their
respective tax base. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Under SFAS
No. 109, the effect on deferred tax assets and liabilities of a change in tax
rates is recognized in the results of operations in the period that includes the
enactment date. If it is more likely than not that some portion of a deferred
tax asset will not be realized, a valuation allowance is recognized
Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing the net income (loss)
for the year by the weighted-average number of shares of common stock
outstanding. The calculation of fully diluted earnings per share assumes the
dilutive effect of all potential outstanding common shares attributable to
outstanding options, warrants, and convertible notes. Potential outstanding
shares are not included in the computation of fully diluted loss per share as
their effect is anti-dilutive.
Fair Value of Financial Instruments
The carrying amount of cash, accounts receivable, accounts payable and notes
payable, as applicable, approximates fair value due to the short term nature of
these items and/or the current interest rates payable in relation to current
market conditions.
Revenue Recognition
Revenues are primarily derived from fees charged to terminate voice services
over the Company's network and from monthly recurring charges associated with
internet services and from sales of hardware product and calling cards.
Variable revenue is earned based on the number of minutes during a call and is
recognized upon completion of a call. Revenue for each customer is calculated
from information received through the Company's network switches. The Company
tracks the information received from the switch and analyzes the call detail
records and applies the respective revenue rate for each call.
Fixed revenue is earned from monthly recurring services provided to customers
that are fixed and recurring in nature, and are connected for a specified period
of time. Revenue recognition commences after the provisioning, testing, and
acceptance of the service by the customer. Revenues are recognized as the
services are provided and continue until the expiration of the contract or until
cancellation of the service by the customer.
Revenues from hardware product sales and calling cards are recognized when
persuasive evidence of an arrangement exists, delivery to the customer has
occurred, the sales price is fixed and determinable, and collectibility of the
related receivable is considered probable.
F-7
Property, Plant, and Equipment
Property, plant, and equipment are stated at cost. Depreciation is provided over
the estimated useful lives of the related assets using the straight line method.
The useful life of assets ranges from three to five years. The leasehold
improvements are amortized over the life of the related leases.
Business Combinations
The Company accounts for business combinations in accordance with Statement of
Financial Accounting Standard No. 141, "Business Combinations" (SFAS No. 141).
SFAS No. 141 requires that the purchase method of accounting be used for all
business combinations. SFAS No. 141 requires that goodwill and intangible assets
with indefinite useful lives no longer be amortized, but instead be tested for
impairment at least annually by comparing carrying value to the respective fair
value in accordance with the provisions of Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142). This
pronouncement also requires that the intangible assets with estimated useful
lives be amortized over their respective estimated useful lives.
Impairment of Long-Lived Assets
VoIP, Inc. reviews the recoverability of its long-lived assets, such as plant,
equipment and intangibles when events or changes in circumstances occur that
indicate that the carrying value of the asset group may not be recoverable. The
assessment of possible impairment is based on the Company's ability to recover
the carrying value of the asset or asset group from the expected future pre-tax
cash flows (undiscounted and without interest charges) of the related
operations. If these cash flows are less than the carrying value of such asset,
an impairment loss is recognized for the difference between estimated fair value
and carrying value. The measurement of impairment requires management to
estimate future cash flows and the fair value of long-lived assets.
Goodwill and Other Intangible Assets
In accordance with Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets," the Company tests its goodwill and
intangible assets for impairment at least annually by comparing the fair values
of these assets to their carrying values, and the Company may be required to
record impairment charges for these assets if in the future their carrying
values exceed their fair values. During the year ended December 31, 2005 the
Company recorded an impairment charge of $4,173,452 relating to goodwill
recorded as a result of a prior acquisition. The Company may be required to
record additional impairment charges in the future.
Stock Based Compensation
The Company applies the fair value method of Statement of Financial Accounting
Standards No. 123R, "Accounting for Stock Based Compensation" ("SFAS No. 123R")
in accounting for its stock options. This standard states that compensation cost
is measured at the grant date based on the value of the award and is recognized
over the service period, which is usually the vesting period. The fair value for
each option granted is estimated on the date of the grant using the
Black-Scholes option pricing model. The fair value of all vested options granted
has been charged to salaries, wages, and benefits in accordance with SFAS No.
123.
Recent Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board "FASB" issued
Statement No. 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4."
Statement No. 151 requires that abnormal amounts of costs, including idle
facility expense, freight, handling costs and spoilage, should be recognized as
current period charges. The provisions of this Statement are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005. The
Company does not expect the adoption of this Statement to have a material impact
on its financial statements.
In December 2004, FASB issued Statement No. 153, "Exchanges of Nonmonetary
Assets - an amendment of Accounting Principles Board ("APB") Opinion No. 29."
Statement No. 153 amends APB Opinion No. 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have a
commercial substance. A nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. The provisions of this Statement are effective for nonmonetary
exchanges occurring in fiscal periods beginning after June 15, 2005. The Company
does not expect the adoption of this Statement to have a material impact on its
financial statements.
In May 2005, FASB issued SFAS No. 154, Accounting Changes and Error Corrections
or SFAS 154, which supersedes APB Opinion No. 20, Accounting Changes and SFAS
No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154
changes the requirements for the accounting for and reporting of changes in
accounting principle. The statement requires the retroactive application to
prior periods' financial statements of changes in accounting principles, unless
it is impracticable to determine either the period specific effects or the
cumulative effect of the change. SFAS 154 does not change the guidance for
reporting the correction of an error in previously issued financial statements
or the change in an accounting estimate. SFAS 154 is effective for accounting
changes and corrections or errors made in fiscal years beginning after December
15, 2005. We do not expect the adoption of SFAS 154 to have a material impact on
our consolidated results of operations or financial condition.
NOTE D - BUSINESS SEGMENT INFORMATION
The Company has three reportable segments: telecommunication services, hardware
sales, and calling cards. The telecommunications services segment terminates
wholesale and retail, local and long distance calls placed on our network. Such
termination is either on our network or through other telecommunication
providers. This segment is also in the early stages of implementing wholesale
VOIP services. The hardware sales segment supplies broadband components and VOIP
hardware to broadband service providers. The calling card segment sells prepaid
telephone calling cards that we purchase from other carriers through a network
of private distributors located primarily in southern California.
F-8
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. Information about operations by
business segment, as of and for the years ended December 31, 2005 and 2004, is
as follows:
Corporate
Telecommunication Hardware Calling and
Services Sales Cards Eliminations Consolidated
------------ ------------ ------------ ------------ ------------
2005
-----------------------------
Revenues $ 8,198,587 $ 2,376,329 $ 4,932,229 $ -- $ 15,507,145
Interest expense $ 560,351 $ -- $ -- $ 1,078,138 $ 1,638,489
Depreciation and amortization $ 2,916,380 $ 161,047 $ -- $ 62,974 $ 3,140,401
Net income (loss) $ (9,247,515) $ (4,674,514) $ 6,348 $(14,397,652) $(28,313,333)
Capital expenditures $ 2,403,902 $ 13,572 $ -- $ 148,648 $ 2,566,122
Identifiable assets $ 11,979,115 $ 562,576 $ 1,448,236 $ 2,958,716 $ 16,948,643
Goodwill $ 23,306,341 $ 1,037,101 $ -- $ -- $ 24,343,442
Other intangible assets, net $ 14,792,930 $ -- $ -- $ 305,000 $ 15,097,930
2004
-----------------------------
Revenues $ 649,230 $ 1,178,963 $ -- $ -- $ 1,828,193
Interest expense $ -- $ -- $ -- $ -- $ --
Depreciation and amortization $ 55,221 $ 19,164 $ -- $ 8,447 $ 82,832
Net income (loss) $ (385,067) $ (775,199) $ -- $ (4,701,853) $ (5,862,120)
Capital expenditures $ 39,931 $ 15,427 $ -- $ 102,523 $ 157,881
Identifiable assets $ 414,042 $ 891,020 $ -- $ 1,427,768 $ 2,732,831
Goodwill $ 1,408,301 $ 5,210,553 $ -- $ -- $ 6,618,854
Other intangible assets, net $ -- $ -- $ -- $ 305,000 $ 305,000
NOTE E - PROPERTY AND EQUIPMENT, NET
As of December 31, 2005 and 2004, property and equipment consists of the
following:
2005 2004
------------ ------------
Equipment $ 9,381,372 $ 519,810
Furniture & Fixtures 216,402 56,748
Software 1,667,864 --
Vehicles 15,269 4,769
Leasehold improvements 248,952 4,562
------------ ------------
Total 11,529,859 585,889
Less accumulated depreciation (1,374,352) (166,021)
------------ ------------
Total $ 10,155,507 $ 419,868
============ ============
Depreciation expense for 2005 and 2004 amounted to $1,208,331 and $82,832
respectively.
F-9
NOTE F - GOODWILL AND OTHER INTANGIBLE ASSETS
As of December 31, 2005 and 2004 goodwill and other intangible assets consisted
of the following:
Goodwill, by segment: 2005 2004
------------ ------------
Telecommunications services $ 23,306,341 $ 1,408,301
Hardware sales 1,037,101 5,210,553
Calling cards -- --
Corporate and other -- --
------------ ------------
Subtotal, goodwill 24,343,442 6,618,854
------------ ------------
Other intangible assets:
Useful Life (Years)
-------------------
Technology 4.0 $ 6,000,000 $ --
Customer relationships 5.0 - 6.0 8,325,000 --
Trade names 9.0 1,300,000 --
Non-compete agreement 1.0 500,000 --
Other intangible assets Indefinite 600,000 305,000
------------ ------------
Subtotal 16,725,000 305,000
Accumulated amortization (1,627,070) --
------------ ------------
Other intangible assets, net 15,097,930 305,000
------------ ------------
Total goodwill and other intangible assets $ 39,441,372 $ 6,923,854
============ ============
In accordance with SFAS No. 142 the Company performs an evaluation of the fair
values of our operating segments at least annually. During this evaluation for
2005 the Company determined, based upon market conditions, projected discounted
cash flows, and other factors, that the carrying value of our hardware sales
operating segment exceeded its fair value at December 31, 2005. Accordingly the
Company recorded an impairment charge of $4,173,452 in our 2005 statement of
operations and reduced goodwill for this segment by that amount.
NOTE G - ACCOUNTS PAYABLES AND ACCRUED EXPENSES
As of December 31, 2005 and 2004 accounts payables and accrued expenses
consisted of the following:
2005 2004
----------- -----------
Accounts payable-trade $11,155,401 $ 912,674
Accrued Expenses 2,149,514 233,711
Other -- 2,448
----------- -----------
Total $13,304,915 $ 1,148,833
=========== ===========
See Note S for a discussion of litigation with two vendors, certain amounts for
which are included in accounts payable - trade.
NOTE H - LOANS PAYABLE
As of December 31, 2005 loans payable consisted of a loan payable to a lending
institution. These borrowings are repayable over a three-year period and bear
interest at 12.5% per annum. Additional borrowings under this facility are
contingent upon, among other things, the Company raising certain levels of
additional equity financing. Interest paid under this debt facility during the
year ended December 31, 2005, was $399,551.
This loan agreement contains customary covenants and restrictions and provides
the lender the right to a perfected first-priority, secured interest in all of
the Company's assets, as well as rights to preferred stock warrants. The Company
was in violation of certain requirements of this debt facility at December 31,
2005, and, while the lending institution has not declared the loan in default,
the full amount of the note at December 31, 2005 has been classified as current.
As of December 31, 2004, loans payable consisted of a revolving line of credit
at prime plus 1.0% and a promissory note bearing interest at 7.5%. These loans
were collateralized by receivables, inventory and equipment, and both these
loans were fully paid in January 2005.
NOTE I - CONVERTIBLE NOTES PAYABLE
As of December 31, 2005, convertible notes payable consisted of the following:
Payable to WQN, Inc. $ 3,700,000
Payable to accredited investors 1,496,804
-----------
Subtotal, principal 5,196,804
Less discount (1,797,006)
-----------
Total $ 3,399,798
===========
F-10
During 2005, the Company issued and sold $3,085,832 principal amount of
convertible notes to accredited investors at a discount, receiving net proceeds
of $2,520,320. These notes are immediately convertible at the option of the note
holders into 3,857,290 shares of common stock. These note holders also received
five-year warrants to purchase 3,857,290 shares of common stock for prices
ranging from $1.38 to $1.65 per share. These notes are secured by a subordinated
lien on the Company's assets, and the notes bear interest at an effective rate
of approximately 20%. Half of these notes are repayable beginning in October
2005, and the other half beginning in January 2006 (3 months following their
respective issuances), in 21 equal monthly principal payments, plus interest,
until the notes are either repaid or converted.
The fair market value of the conversion feature and the warrants, calculated
using the Black-Scholes pricing model, was $3,085,832, which was recognized as a
debt discount and an addition to paid-in capital. Interest expense at the dates
of issuance was recognized for the difference between the principal value of the
notes and their related net proceeds (original issue discount). The debt
discount is being amortized to interest expense over the notes' 24-month contact
terms.
The Black-Scholes pricing calculations were made using volatilities at either
one-year or three-year, monthly or weekly, trailing measures, as appropiate, and
risk-free rates as determined by the nearest maturity treasury yield as of
respective valuation dates.
No interest was paid under these debt facilities during the year ended December
31, 2005.
NOTE J - ADVANCES FROM INVESTORS
The unsecured advances of $3,000,000 at December 31, 2005 represents funds
deposited with the Company in anticipation of the issuance of convertible notes
payable, which were issued in January 2006, (see NOTE T). The advance is not
interest bearing, and is unsecured.
NOTE K - ACQUISITIONS
On May 31, 2005 the Company acquired 100 percent of Caerus, Inc. and its wholly
owned subsidiaries Volo Communications, Inc., Caerus Networks, Inc., and Caerus
Billing, Inc. in exchange for approximately16.9 million of the Company's common
shares (plus 2.0 million escrowed shares).
The goodwill, intangible assets and property recorded for the acquisition of
Caerus, Inc. (Caerus) represent the fair market value of liabilities as of the
date of acquisition, plus approximately $18.3 million which represents the value
of the Company's common stock and options issued pursuant to the acquisition.
On October 5, 2005 the Company acquired substantially all of the operating
assets and liabilities of WQN, Inc., for a total purchase price of $9.8 million.
The acquisition was financed with the issuance of $3.2 million of convertible
debt, 1.3 million shares of the Company's common stock, and 5.0 million warrants
to purchase the Company's common stock at $0.001 per share.
Condensed balance sheets of the Caerus and WQN acquisitions, reflecting the net
fair value amounts assigned to each major asset and liability, as of their
respective acquisition dates are as follows:
Caerus, Inc. WQN, Inc.
------------ ------------
Current assets $ 617,000 $ 3,775,000
Property and equipment, net 7,869,000 508,000
Other assets 131,000 463,000
Accounts payable and other current liabilities (14,674,000) (2,031,000)
Note payable (4,832,000) --
------------ ------------
Net liabilities assumed (10,889,000) 2,715,000
Goodwill 17,778,000 4,120,000
Intangible assets - other 13,800,000 2,925,000
------------ ------------
Intangible assets 31,578,000 7,045,000
------------ ------------
Net fair value assets acquired $ 20,689,000 $ 9,760,000
============ ============
F-11
NOTE L - 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.
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:
o 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 Notes Registration Statement is
declared effective.
o Unless consent is obtained from the note holders, the Company may
not file any new registration statements or amend any existing
registrations until the sooner of (i) 60 days following the
effective date of the Notes Registration Statement or (ii) all the
notes have been converted into shares and such shares and the
warrant shares have been sold by the note holders.
o 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.
o 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 March 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.
F-12
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 activity in this 2004
Option Plan for the year ended December 31, 2005 is as follows:
Exercise Price Wtd. Avg.
Number Range 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 N - WARRANTS
A summary of the Company's warrants as of December, 31 2005 and 2004 is
presented below:
2005 2004
--------------------------- ----------------------------
Weighted Weighted
average average
Warrants exercise price Warrants 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-13
NOTE O - 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 P - 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.
NOTE Q - INCOME TAXES
The components of the Company's consolidated income tax provision are as
follows:
Year ended December 31,
2005 2004
----------- -----------
Current benefit $ 7,479,000 $ 2,040,000
Deferred benefit 1,051,000 --
----------- -----------
Subtotal $ 8,530,000 $ 2,040,000
Less valuation allowances (8,530,000) (2,040,000)
----------- -----------
Net $ -- $ --
=========== ===========
The reconciliation of the income tax provision at the statutory rate to the
reported income tax expense is as follows:
Year ended December 31,
2005 2004
----- -----
Computed at statutory rate 34% 34%
Value of options and warrants expensed,
not deductible for tax purposes (4%) --
Valuation allowance (30%) (34%)
----- -----
Total -- --
===== =====
F-14
At December 31, 2005 the Company's net deferred tax assets consisted of the
following:
Net operating loss carryforwards $ 9,519,000
Excess of goodwill impairment charge over
tax basis amortization 773,000
Amortization of intangible assets 278,000
------------
Subtotal 10,570,000
Less valuation allowances (10,570,000)
------------
Total $ --
============
The Company's net operating loss carryforwards for federal income tax purposes
were approximately $28 million as of December 31, 2005. These carryforwards
expire in 2018 ($6,000,000) and 2019 ($22,000,000).
NOTE R - DISCONTINUED OPERATIONS
In December 2004, the Company decided to exit the tea business and sold its
entire tea inventory, therefore, those transactions have been presented as
discontinued operations for the year ended December 31, 2004.
Assets, liabilities, and results of the discontinued tea operations of the
Millennia Tea Master division for 2004 are as follows:
Assets from discontinued operations:
Cash $ 4,419
Notes receivable from purchaser of tea (non-interest bearing
due in four equal installments through December 31, 2005) 408,000
Tea inventory at net realizable value --
Other assets --
--------
Total $412,419
========
Liabilities from discontinued operations:
Due to related parties $ --
--------
Total $ --
========
Results from discontinued operations:
Revenues $408,613
Cost of sales 263,302
--------
Gross Profit 145,311
Other expenses --
--------
Income (loss) from discontinued operations $145,311
========
NOTE S - LEGAL PROCEEDINGS
MCI
On April 8, 2005, Volo Communications, Inc. ("Volo") (a wholly-owned
subsidiary of Caerus) 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 5 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.
F-15
On August 1, 2005, MCI WorldCom moved to strike most of Volo's and Caerus'
affirmative defenses and demand for attorney's fees, and to dismiss Caerus'
counterclaims. On October 6, 2005, the Court denied the motions in part, granted
them in part with leave to amend, and deferred ruling on the motions in part. On
October 13, 2005, Volo and Caerus filed amended affirmative defenses, and Caerus
filed amended counterclaims.
Discovery is in progress. MCI WorldCom has served requests for documents
and for admissions and interrogatories on Volo and Caerus, to which Volo and
Caerus have responded. Document production is ongoing. Volo has served document
requests and interrogatories on MCI WorldCom. Volo has also initiated third
party discovery. The Court on March 9, 2006 granted in part and denied in part
motions to compel disclosures brought by Volo and MCI WorldCom. A pretrial
conference is set for May 2, 2006. The Court has not issued a scheduling order
or set a trial date. The Company is currently unable to assess the likelihood of
a favorable or unfavorable outcome for this litigation.
Netrake
The Company and its subsidiaries Caerus and Volo are involved in pending
disputes with Netrake Communications ("Netrake") arising from an equipment
purchase contract under which Volo agreed to purchase approximately $2,000,000
worth in Netrake telephonic equipment and software. The Company has paid
approximately $200,000 on the contract but has withheld further payments due to
dissatisfaction with the performance of the equipment. In arbitration pending in
Dallas, Texas, Netrake has brought claim against the Company and its
subsidiaries for (1) breach of contract in the amount of $1.8 million plus
interest, (2) business disparagement, (3) misappropriation of trade secrets, (4)
tortuous interference with prospective business relations and (5) conversion.
Netrake also seeks to recover its attorneys' fees. Within this same arbitration
Volo and Caerus seek damages against Netrake for breach of contract and breach
of warranty claiming that the Netrake product did not perform in accordance with
agreed upon specifications and warranties.
Volo and Caerus have initiated litigation in Broward County, Florida
claiming damages and recession against Netrake for alleged fraudulent
misrepresentations, negligent misrepresentations, violation of Florida's
Deceptive and Unfair Trade Practices Act and seeking declaratory relief. Netrake
claims all of these claims fall within the arbitration clause of the equipment
purchase contract, and has removed the action to arbitrate in Dallas.
The Company is presently unable to determine what impact, if any, this
arbitration and litigation will have on its financial condition or results of
operations.
F-16
VOIP, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The Following unaudited pro forma condensed combined financial statements are
derived from and should be read in conjunction with the historical consolidated
financial statements and related notes of VOIP, INC. ("VOIP" or the "Company"),
CAERUS, INC. ("CAERUS"), and WQN, Inc. ("WQN").
On June 1, 2005, the Company, and Caerus announced the closing of the merger of
Volo Acquisition Corp., a wholly-owned subsidiary of the Company with and into
Caerus, with Caerus as the surviving corporation (the "Merger"). The Merger was
completed pursuant to an Agreement and Plan of Merger (the "Merger Agreement'),
executed on May 31, 2005.
On October 6, 2005, the Company purchased substantially all of the assets of
WQN, Inc. relating to WQN's "Voice over Internet Protocol" business. Such assets
consist of WQN's properties and infrastructure for its services platform for
both retail and wholesale voice over internet business.
The unaudited pro forma condensed combined statements of operation for the year
ended December 31, 2005 assumes that the mergers of Caerus, WQN and the Company
were consummated at the beginning of the respective periods.
The unaudited pro forma condensed combined statements of operations has been
prepared based on currently available information and assumptions that are
deemed appropriate by the Company's management. The pro forma information is for
informational purposes only and is not intended to be indicative of the actual
consolidated results that would have been reported had the transactions occurred
on the dates indicated, nor does the information represent a forecast of the
consolidated financial position at any future date or the combined financial
results of the Company, Caerus and WQN for any future period.
F-17
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-18
VOIP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED
FINANCIAL STATEMENTS
(1) VoIP, INC. Basis of Presentation
Historical financial information for VoIP, Inc. for the year ended December 31,
2005 has been derived from VoIP, Inc.'s historical statements.
(2) Caerus, Inc. Basis of Presentation
Historical financial information for Caerus, Inc. for the year ended December
31, 2005 has been derived from Caerus, Inc.'s historical statements.
(3) Historical financial information for WQN, Inc. for the year ended December
31, 2005 has been derived from WQN, Inc.'s historical financial statements.
(4) VoIP, Inc. and Caerus, Inc. Merger
On June 1, 2005, the Company and Caerus, Inc. announced the closing of the
merger of Volo Acquisition Corp., a wholly-owned subsidiary of the Company with
and into Caerus, Inc. with Caerus, Inc. as the surviving corporation (the
"Merger"). The Merger was completed pursuant to an Agreement and Plan of Merger
(the "Merger Agreement'), executed on May 31, 2005 by the conversion of all
Caerus, Inc. capital stock into 16,434,470 shares of common stock, par value
$0.001, of the Company.
(5) On October 6, 2005, the Company purchased substantially all of the assets of
WQN, Inc. relating to WQN's "Voice over Internet Protocol" business. Such assets
consist of WQN's properties and infrastructure for its services platform for
both retail and wholesale voice over internet business.
(6) Pro Forma Statements of Operations Adjustments
Adjustments to the pro forma Statements of Operations represent amortization of
intangible assets and interest expense related to convertible debt recorded in
connection with the acquisitions.
F-19
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Caerus, Inc.
Altamonte Springs, Florida
We have audited the accompanying consolidated balance sheets of Caerus, Inc. as
of December 31, 2004 and 2003, and the related consolidated statements of
operations, changes in stockholders' equity (deficit), and cash flows for the
year ended December 31, 2004 and for period May 15, 2002 (date of inception)
through December 31, 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Caerus,
Inc. as of December 31, 2004 and 2003, and the results of its operations and
cash flows for the year ended December 31, 2004 and for the period May 15, 2002
(date of inception) through December 31, 2003 in conformity with accounting
principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 1 to the consolidated
financial statements, the Company has incurred significant losses and negative
cash flows from operations, has a working capital deficit, and has significant
unresolved litigation as discussed in Note 8 to the financial statements. These
matters, among other things, raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans related to these matters are
also discussed in Note 1. These financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ Moore Stephens Lovelace, P.A.
-----------------------------------------
Certified Public Accountants
Orlando, Florida
July 25, 2005
F-20
CAERUS, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2003
ASSETS
2004 2003
------------ ------------
CURRENT ASSETS
Cash and cash equivalents $ 19,414 $ 25,078
Restricted cash 60,224 196
Accounts receivable 2,098,598 358,522
Note receivable - related party -- 179,974
Supplies, deposits and prepaid expenses 70,999 350,199
------------ ------------
TOTAL CURRENT ASSETS 2,249,235 913,969
------------ ------------
PROPERTY AND EQUIPMENT
Telecommunications equipment and computers 6,390,973 732,205
Furniture and fixtures 61,960 21,624
Leasehold improvements 163,808 146,358
Purchased and developed software 473,228 598,243
------------ ------------
7,089,969 1,498,430
Less accumulated depreciation and amortization (824,580) (183,408)
------------ ------------
NET PROPERTY AND EQUIPMENT 6,265,389 1,315,022
------------ ------------
OTHER ASSETS
Deferred loan origination costs, net 285,075 --
Lease deposit and other 28,959 65,000
------------ ------------
TOTAL ASSETS $ 8,828,658 $ 2,293,991
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 7,137,293 $ 452,094
Note payable 6,006,899 --
Convertible notes payable - related party 1,830,000 1,050,000
Deferred revenue and customer deposits 38,750 60,576
------------ ------------
TOTAL CURRENT LIABILITIES 15,012,942 1,562,670
------------ ------------
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock - $.01 par value; 50,000,000 shares authorized;
14,940,508 and 11,948,367 shares issued and outstanding, respectively 149,405 119,484
Preferred stock - $.01 par value; 25,000,000 shares authorized;
-0- shares issued and outstanding -- --
Additional paid-in capital 4,618,253 2,952,184
Accumulated deficit (10,951,942) (2,340,347)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) (6,184,284) 731,321
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) $ 8,828,658 $ 2,293,991
============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
F-21
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-22
CAERUS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
For The Year Ended December 31, 2004, and
The Period May 15, 2002 (Date of Inception) Through December 31, 2003
Common Stock
$.01 Par Value Additional Total
------------ ------------ Paid-In Accumulated Stockholders'
Shares Amount Capital Deficit Equity (Deficit)
------------ ------------ ------------ ------------ ---------------
BALANCE - MAY 15, 2002 -- $ -- $ -- $ -- $ --
ISSUANCE OF FOUNDER STOCK 5,400,000 54,000 -- -- 54,000
SALE OF COMMON STOCK 6,186,592 61,866 2,721,909 -- 2,783,775
ISSUANCE OF COMMON STOCK
FOR SERVICES 150,000 1,500 81,750 -- 83,250
ISSUANCE OF COMMON STOCK
FOR PROPERTY AND EQUIPMENT 211,775 2,118 148,525 -- 150,643
NET LOSS -- -- -- (2,340,347) (2,340,347)
------------ ------------ ------------ ------------ ------------
BALANCE - DECEMBER 31, 2003 11,948,367 119,484 2,952,184 (2,340,347) 731,321
ISSUANCE OF COMMON STOCK 712,071 7,121 273,139 -- 280,260
ISSUANCE OF COMMON STOCK
FOR DEBT 2,280,070 22,800 1,097,200 -- 1,120,000
ISSUANCE OF STOCK WARRANTS IN CONNECTION
WITH SECURED NOTE-PAYABLE -- -- 218,813 -- 218,813
EMPLOYEE STOCK OPTIONS - COMPENSATION
EXPENSE RECOGNIZED -- -- 76,917 -- 76,917
NET LOSS -- -- -- (8,611,595) (8,611,595)
------------ ------------ ------------ ------------ ------------
BALANCE - DECEMBER 31, 2004 14,940,508 $ 149,405 $ 4,618,253 $(10,951,942) $ (6,184,284)
============ ============ ============ ============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
F-23
CAERUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For The Year Ended December 31, 2004, and
The Period May 15, 2002 (Date of Inception) Through December 31, 2003
2004 2002-2003
----------- -----------
(Development
Stage)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(8,611,595) $(2,340,347)
Adjustments to reconcile net loss to net cash used in operating activities:
Litigation settlement 326,205 --
Depreciation and amortization 641,172 183,408
Asset impairment charge 299,122 --
Amortization of deferred loan fees 56,613 --
Stock issued to Founder -- 54,000
Stock issued for services -- 83,250
Expense related to employee stock options 76,917 --
Forgiveness of related-party loan 415,323 --
Changes in:
Restricted cash (60,028) (196)
Accounts receivable (2,066,281) (358,522)
Supplies, deposits and prepaid expenses 279,200 (415,199)
Other assets 36,041 --
Accounts payable and accrued expenses 6,685,199 452,094
Deferred revenue (21,826) 60,576
----------- -----------
NET CASH USED IN OPERATING ACTIVITIES (1,943,938) (2,280,936)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property and equipment (5,890,661) (1,347,787)
Additions to related-party loan (235,349) (179,974)
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (6,126,010) (1,527,761)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings 8,900,000 1,050,000
Repayment of note payable (993,101) --
Proceeds from issuance of common stock 280,260 2,783,775
Payments for loan origination costs (122,875) --
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 8,064,284 3,833,775
----------- -----------
NET CHANGE IN CASH (5,664) 25,078
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 25,078 --
----------- -----------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 19,414 $ 25,078
=========== ===========
The accompanying notes are an integral part of the
consolidated financial statements.
F-24
Caerus, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Year Ended December 31, 2004 and For The Period May 15, 2002 (Date of
Inception) Through December 31, 2003
NOTE 1 - DESCRIPTION OF BUSINESS
Caerus, Inc. and subsidiaries (collectively referred to as the "Company") were
incorporated on May 15, 2002 and are wholesale providers of advanced
telecommunications technologies and services to carriers and service providers,
including Inter Exchange Carriers ("IXCs"), Competitive Local Exchange Carriers
("CLECs"), Internet Service Providers, Cable Operators and Enhanced Voice and
Data Service Providers. Through its wholesale-only model, the Company has
positioned itself as a "carrier's carrier" and offers protocol-agnostic packet
switched technologies to address the gap between traditional communications and
"next generation" platforms.
During the period May 15, 2002 (date of inception) to December 31, 2003, the
Company was in the process of developing its resources, enhancing its
proprietary technology, building a nationwide network with five physical
interconnection points (cities), working with potential customers on testing its
network, and attracting key engineering professionals; accordingly, the Company
was considered to be a development stage enterprise. In January 2004, the
Company became fully operational and management determined that the Company was
no longer in a development stage.
The Company offers a comprehensive suite of Internet Protocol ("IP")-based
broadband packet voice services, IP and Time Division Multiplexing ("TDM")
origination/termination services, IP PBX-hosted services, and unified messaging
services that include enhanced voice and data solutions. The suite of services
is complemented by a Service Creation Environment that enables the Company to
develop custom applications and features "on the fly" for its customers.
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.
The Company has incurred significant losses and negative cash flows from
operations since its inception. Additionally, the Company has a working capital
deficit of $12,763,707 and an accumulated deficit of $10,951,942 at December 31,
2004. Management continues to undertake steps as part of a plan to attempt to
improve liquidity and operating results with the goal of sustaining Company
operations. These steps include seeking (a) to increase high-margin sales; and
(b) to control overhead costs and operating expenses. Management plans, in this
regard, to continue the implementation of a stabilized and fully operational
network, adding recurring-revenue customers, attracting an experienced
management team capable of building a profitable company, and securing funding
to meet current obligations.
There can be no assurance that the Company can successfully accomplish these
steps. Accordingly, the Company's ability to continue as a going concern is
uncertain and dependent upon continuing to achieve improved operating results
and cash flows or obtaining additional financing. These consolidated financial
statements do not include any adjustments to the amounts and classification of
assets and liabilities that might be necessary should the Company be unable to
continue in business.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
For financial presentation purposes, the Company considers short-term, highly
liquid investments with original maturities of three months or less to be cash
equivalents.
Restricted Cash and Letters of Credit
Certain cash is restricted to support standby letters of credit which, in turn,
support operating license bonds required by several states' regulatory agencies.
These standby letters of credit are generally in force for one year with
automatic one-year extensions. Maximum draws available to the beneficiary as of
December 31, 2004 were $60,000. If the Company was required to obtain
replacement standby letters of credit as of December 31, 2004 for those
currently outstanding, it is the Company's opinion that the replacement costs
would not significantly vary from the present fee structure.
Accounts Receivable
Accounts receivable result from the sale of the Company's services, net of
estimated allowances. The Company estimates an allowance for doubtful accounts
based on a specific-identification basis. The Company had no allowance for
doubtful accounts as of December 31, 2004 and 2003.
F-25
Property and Equipment
Property and equipment are recorded at cost. Depreciation and amortization are
calculated on a straight-line basis over the assets' useful lives, which range
from three to ten years. Leasehold improvements are amortized over the estimated
useful lives of the improvements, or the term of the lease, if shorter.
Maintenance and repairs are expensed as incurred, while renewals and betterments
are capitalized. Upon the sale or other disposition of property, the cost and
related accumulated depreciation are removed from the accounts, and any gain or
loss is recognized in operations.
Under the Statement of Position ("SOP") 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use," the Company expenses
computer software costs related to internal-use software that is incurred in the
preliminary project stage. When the capitalization criteria of SOP 98-1 have
been met, costs of developing or obtaining internal-use computer software are
capitalized. The Company capitalized approximately $772,350 of costs incurred
for internally developed software during the period from inception through
December 31, 2004. Amortization of internal-use software over a 5-year estimated
useful life commenced upon the software being placed in service beginning
January 1, 2004. Amortization of internal-use software for the periods ended
December 31, 2004 and 2003 was approximately $77,000 and $-0-, respectively.
During 2004, the Company suspended a number of software development projects
and, accordingly, recognized a related asset impairment charge of $299,122 in
2004.
Deposits
Deposits consist primarily of an equipment deposit, a refundable office lease
deposit and various other deposits outstanding with service providers.
Deferred Revenue
Deferred revenue represents fees for services that have not yet met the criteria
to be recognized as revenue.
Revenue Recognition
Revenue is recognized when earned. Revenue related to long distance, carrier
access service and certain other usage-driven charges are billed monthly in
arrears, and the associated revenues are recognized during the month of service.
Income Taxes
The Company utilizes the asset and liability method of accounting for income
taxes. Under this method, deferred income taxes are recorded to reflect the tax
consequences in future years of differences between the tax basis of assets and
liabilities and their financially reported amounts at each year-end, based on
enacted laws and statutory rates applicable to the periods in which differences
are expected to affect taxable income. As of December 31, 2004, the Company had
a deferred tax asset of approximately $3,000,000, the components of which
consisted primarily of the Company's net losses, fixed asset depreciation and
stock-based compensation. Also at December 31, 2004, the Company had a net
operating loss carryforward of approximately $11,000,000 for federal income tax
purposes that will begin to expire in 2022, and that is subject to significant
limitations based upon the occurrence of certain changes in ownership of the
Company.
A valuation allowance is provided against the future benefits of deferred tax
assets if it is determined that it is more likely than not that the future tax
benefits associated with the deferred tax asset will not be realized. Due to
recurring losses since inception and the resultant uncertainty of the
realization of the tax loss carryforward, the Company has established a 100%
valuation allowance against the carryforward benefit. Accordingly, no
provision/benefit for income taxes has been included in these consolidated
financial statements.
Concentration of Credit Risk
Financial instruments that may subject the Company to concentrations of credit
risk consist principally of cash and cash equivalents and accounts receivable.
The Company has investment policies and procedures that are reviewed
periodically to minimize credit risk.
One customer represented approximately 98% and 90% of the Company's accounts
receivable as of December 31, 2004 and 2003, respectively, and approximately 91%
and 95% of the Company's revenues for the year ended December 31, 2004 and for
the period May 15, 2002 (date of inception) through December 31, 2003,
respectively. The loss of this customer would have a significant adverse affect
on the Company's operations.
Concentration of Supplier Risk
One supplier represented approximately 86% of the Company's accounts payable as
of December 31, 2004, and approximately 94% of the Company's cost of sales for
the year ended December 31, 2004 (see Note 8).
F-26
Stock-based Compensation
The Company uses the fair value method of Statement of Financial Accounting
Standards No. 123R, "Accounting for Stock Based Compensation" in accounting for
its stock options. This standard states that compensation cost is measured at
the grant date based on the value of the award and is recognized over the
service period, which is usually the vesting period. The fair value for each
option granted is estimated on the date of the grant using the minimum value
method.
Estimates
The preparation of these consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements. Estimates also affect the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. Significant management estimates
affect the carrying value of, among other things, internal-use software, cost of
goods sold (see Note 7), the estimating of the fair value of the Company's
common stock (see Note 3), and the evaluation of existing disputes and claims
(see Notes 7 and 8).
Reclassifications
Certain reclassifications have been made to the 2003 financial statements to
conform to the 2004 presentation.
NOTE 3 - CONVERTIBLE NOTES PAYABLE - RELATED PARTY
During 2003, the Company issued two one-year convertible notes to a stockholder
of the Company, $1,050,000 and $70,000 of which were funded in the periods ended
December 31, 2003 and 2004, respectively. These notes accrued interest at 12%
per annum, with all interest and principal due in September and December 2004.
These notes, which had certain anti-dilution provisions and which were
collateralized by substantially all of the assets of the Company, were converted
into common stock in May 2004 (see Note 6) and the convertible notes were
cancelled and the principal amount was satisfied in full.
The Company determined the conversion rates based upon its evaluation of the
Company's common stock on the issuance dates. The Company's evaluations were
based upon, among other things, peer company valuations, industry and market
conditions, the Company's current financial position, terms and conditions of
funding available to the Company at the time of issuance, etc.
During 2004, the Company issued two one-year convertible notes to a stockholder
of the Company, totaling $1,830,000. These notes accrue interest at 12% per
annum, with monthly principal and interest payments originally scheduled through
August and November 2004. Restrictive covenants pertaining to the note payable
discussed in Note 4 to these financial statements precluded payment of scheduled
principal and interest on these notes; therefore, these notes are currently due.
However, the same covenants preclude payment until the note described in Note 4
to these financial statements is paid in full. These one-year notes are
collateralized by substantially all of the assets of the Company (see Note 8).
Interest expense incurred with respect to these notes during the year ended
December 31, 2004 and the period May 15, 2002 (date of inception) through
December 31, 2003, was $122,223 and $19,653, respectively.
Interest payments made with respect to these notes during the year ended
December 31, 2004 and the period May 15, 2002 (date of inception) through
December 31, 2003, were $42,560 and $-0-, respectively.
NOTE 4 - NOTE PAYABLE
In June 2004, the Company secured a $15,000,000 debt facility and drew down the
first $7,000,000 traunch primarily for the purpose of funding network equipment
purchases. These borrowings are repayable over a three-year period and bear
interest at 12.5% per annum. Additional borrowings under this facility are
contingent upon, among other things, the Company raising certain levels of
additional equity financing. The loan agreement contains customary covenants and
restrictions and provides the lender the right to a perfected first-priority,
secured interest in all of the Company's assets, as well as rights to preferred
stock warrants (see Notes 6 and 8).
Interest paid under this debt facility during the year ended December 31, 2004,
was $484,867.
The Company is currently in violation of several of the restrictive covenants in
this debt facility. Under its provisions, the lender has the right to call the
related note payable due. Accordingly, the full amount of the note at December
31, 2004 has been classified as current.
NOTE 5 - NOTE RECEIVABLE - RELATED PARTY
During the period May 15, 2002 (date of inception) through December 31, 2004,
the Company advanced $415,323 to an officer of the Company. In 2005, these
advances were characterized as compensation and were forgiven; accordingly,
their carrying value was reduced to zero at December 31, 2004. In addition, the
Company agreed to pay the related federal income tax withholding of
approximately $104,000 on behalf of the related party, which was accrued at
December 31, 2004.
F-27
NOTE 6 - STOCKHOLDERS' EQUITY
In June 2002, the Company increased its authorized shares to 100,000 shares of
$0.01 par value common stock. In July 2002, the Company increased its authorized
shares to 3,000,000 shares of $0.01 par value common stock and approved a
2-for-1 common stock split. In October 2002, the Company increased its
authorized shares to 6,000,000 shares of $0.01 par value common stock. In July
2003, the Company approved an additional 3-for-1 common stock split and an
increase in the authorized shares of common stock to 18,000,000. The Articles of
Amendment for this amendment were not filed with the state of Delaware until
2004. The accompanying consolidated financial statements and related notes
present all of these amendments as if they were affected for all periods
presented.
In 2002, 5,400,000 shares of common stock were issued to the founder of the
Company. These shares were recorded at their par value.
In 2002, the Company issued 150,000 shares of its common stock for legal
services provided to the Company, which were recorded at their estimated fair
value of $83,250.
During the period May 15, 2002 (date of inception) through December 31, 2003,
the Company issued 5,965,957 shares of its common stock and received net
proceeds of $2,783,775. Offering costs related to these sales consisted of the
issuance of an additional 220,635 shares of the Company's common stock.
During the period May 15, 2002 (date of inception) through December 31, 2003,
the Company issued 211,775 shares of its common stock in consideration for
leasehold improvements and equipment, of which 190,211 of the shares were issued
to the founder of the Company. These shares were recorded at their estimated
fair value of $150,643.
In May 2004, $1,120,000 of convertible notes payable to a shareholder were
converted into 2,280,070 shares of common stock.
In May and August 2004, the Company issued 500,000 and 212,071 shares of its
common stock for cash of $100,000 and $180,260, respectively.
In May 2004, the Company authorized the issuance of up to 25,000,000 shares of
$.01 par value preferred stock, the terms of which will be decided upon by the
Company's Board of Directors.
In August 2004, the Company approved increasing the authorized common stock to
50,000,000 shares. However, the related state filing has yet to be effected.
Rights to Convert to Preferred Stock
At December 31, 2004, related parties held 12,989,445 shares of common stock
that had the right to be converted into preferred shares; however, as of
December 31, 2004, no shares of preferred stock had been issued by the Company
(see Note 8).
Stock Options
During October 2004, the Board approved the Company's 2004 Stock Option Plan
(the "Plan"), whereby 4,000,000 shares of the Company's common stock were
reserved for issuance under the Plan to selected directors, officers, employees
and consultants of the Company. As of December 31, 2004, options to purchase
2,164,969 shares of common stock for $0.85 per share were issued and outstanding
under the Plan. These options expire ten years from the date of issuance. They
vest from 36 to 48 months of employment following the date of option issuance.
These options had an estimated fair value of $330,599 at the date of grant,
using the minimum-value method with the following assumptions:
Expected life (in years) 10.0
Risk-free interest rate 2.0%
Dividend yield 0.0%
Related 2004 compensation expense was $76,917, determined by amortizing the
options' estimated fair value at grant date over their vesting period. The
weighted average remaining contractual life of the options outstanding at
December 31, 2004 was 9.8 years (see Note 8). The Company had no stock options
outstanding at December 31, 2003.
Stock Warrants
In 2004, the Company granted a series of warrants to purchase shares of
preferred stock, the specific terms of which had yet to be determined, at an
exercise price of $0.85 per share, in conjunction with the long-term note
payable issuance (see Note 4). These warrants expire at the earlier of ten years
from their issuance date, or five years after a potential initial public
securities offering. At the warrant holder's election, these warrants may be
exercised on a non-cash basis whereby the warrant holder uses the surplus of the
preferred stock's then-fair market value per share over the $0.85 exercise price
as payment for the preferred stock purchased under these warrants.
F-28
These warrants had estimated fair values totaling $218,813 at their grant dates,
recognized as additional paid-in capital and deferred loan origination costs.
Additional information pertaining to these warrants issued and outstanding at
December 31, 2004 is as follows:
Date Granted Shares
---------------------------------- ---------
June, 2004 1,235,294
August, 2004 766,020
October, 2004 383,010
---------
Total Issued and Outstanding 2,384,324
=========
Also in conjunction with the long-term note payable issuance (see Note 4), the
Company granted warrants to purchase up to $1.0 million of common or preferred
stock that may be issued in conjunction with any future securities offering of
at least $5.0 million, upon the same price and conditions as afforded to
third-party investors in said potential securities offering.
In August 2004, the Company issued warrants to purchase 150,000 shares of common
stock to a former employee whose employment was terminated in June 2004. Such
warrants are exercisable at $0.85 per share, and expire on June 26, 2006. The
Company had no stock warrants outstanding at December 31, 2003.
NOTE 7 - OTHER COMMITMENTS AND CONTINGENCIES
Operating Leases
In August 2002, the Company entered into an operating lease for office space,
which expires in February 2008. Approximate minimum future lease payments due
under this operating lease, are as follows:
Year Ending December 31, Amount
------------------------- ---------
2005 $ 196,000
2006 $ 202,000
2007 $ 208,000
2008 $ 35,000
During the year ended December 31, 2004 and the period May 15, 2002 (date of
inception) through December 31, 2003, $172,700 and $234,000, respectively, were
charged to operations for rent expense related to this operating lease.
Legal and Regulatory Proceedings
The Company's 100%-owned subsidiary, Volo Communications, Inc., settled its
breach of contract dispute related to a 2003 "take or pay" sales contract with
the Company. In connection with this settlement, the Company wrote off its
previously recorded account receivable of $326,205 in 2004.
Vendor Dispute
Certain transport and termination costs incurred by the Company are recorded at
vendor invoice amount less any amounts that have been formally disputed, for
which the Company expects to receive a credit. Disputed amounts are based upon
management's detailed review of vendor call records and contract provisions;
accordingly, the recorded transport and termination costs represent management's
estimates of what is ultimately due and payable. During the year ended December
31, 2004, and the period May 15, 2002 (date of inception) through December 31,
2003, $4,500,000 and $2,500,000, respectively, of one vendor's charges were
formally disputed. As of December 31, 2004, approximately $4,759,000 remained in
dispute and are, therefore, not included in the accompanying financial
statements (see Note 8). Differences between the disputed amounts and final
settlements, if any, are reported in operations in the year of settlement.
Other
Telecommunications industry revenues are subject to statutory and regulatory
changes, interpretations of contracts, etc., all of which could materially
affect our revenues. Generally, our customers have sixty days from the invoice
date to dispute any billed charges. Management reviews all billings for
compliance with applicable rules, regulations and contract terms and believes
that it is in compliance therewith; accordingly, no allowance has been recorded
in the accompanying financial statements for potential disputed charges.
F-29
NOTE 8 - SUBSEQUENT EVENTS
Capital Stock Transactions
In February 2005, the Company issued 511,750 shares of Series B preferred stock
for $818,800 cash. In May 2005, 7,289,445 shares of common stock were converted
into 5,944,669 shares of Series A preferred stock. Both Series A and Series B
preferred stock are convertible into common stock, and they carry voting rights
equal to the equivalent number of common shares into which they are convertible.
Also, both Series A and Series B preferred stock contain equal and ratable
dividend and liquidation preferences over common stock.
Litigation
On April 8, 2005, Volo Communications, Inc. ("Volo") (a wholly-owned subsidiary
of Caerus, Inc.) filed suit against MCI Worldcom Network Services, Inc. d/b/a
UUNET ("MCI"). Volo alleges that MCI engaged in a pattern and practice of
over-billing Volo for the telecommunications services it provided pursuant to
the parties' Services Agreement, and that MCI refused to negotiate such
overcharges in good faith. Volo also seeks damages arising out of MCI's alleged
fraudulent practice of submitting false bills by, among other things, re-routing
long distance calls over local trunks to avoid access charges, and then billing
Volo for access charges that were never incurred. On April 4, 2005, MCI declared
Volo in default of its obligations under the Services Agreement, claiming that
Volo owes a past due amount of $8,365,980 through March, 2005, and threatening
to terminate all services to Volo within 5 days. On April 12, 2005, MCI
terminated all services to Volo. By these actions, Volo alleges claims for (1)
breach of contract; (2) fraud in the inducement; (3) primary estoppel; and (4)
deceptive and unfair trade practices. Volo also seeks a declaratory judgment
that (1) MCI is in breach of the Services Agreement; (2) $8,365,980 billed by
MCI is not "due and payable" under that agreement; and (3) MCI's default letter
to Volo is in violation of the Services Agreement. Volo seeks direct, indirect
and punitive damages in an amount to be determined at trial.
On May 26, 2005, MCI filed an Answer, Affirmative Defenses, Counterclaim and
Third-Party Complaint naming Caerus, Inc. as a third-party defendant. MCI
asserts a breach of contract claim against Volo, a breach of guarantee claim
against Caerus, Inc., and a claim for unjust enrichment against both parties,
seeking an amount to be determined at trial. On July 11, 2005, Volo and Caerus,
Inc. answered the counterclaim and third-party complaint, and filed a
third-party counterclaim against MCI for declaratory judgment, fraud in the
inducement, and breach of implied duty of good faith and fair dealing. Volo and
Caerus, Inc. seek damages in an amount to be determined at trial. MCI has filed
a motion to strike certain of Caerus' affirmative defenses and a motion to
dismiss Caerus' counterclaims. Discovery should commence shortly. While
management is optimistic about the outcome of this litigation, it is currently
unable to assess the ultimate likelihood of a favorable or unfavorable outcome;
accordingly, no related provision or liability has been made in the accompanying
financial statements.
F-30
Merger
On May 31, 2005, the Company consummated an Agreement and Plan of Merger
("Merger Agreement") with VoIP, Inc. ("VoIP") (OTCBB:VOII.OB), whereby 100% of
Caerus, Inc.'s common and preferred stock, stock options and warrants were
exchanged for the common stock of a wholly-owned subsidiary of VoIP. The VoIP
subsidiary's name was then changed to Caerus, Inc. Also in conjunction with this
merger, the holder of the $1,830,000 notes payable at December 31, 2004 referred
to in Note 3 agreed to exchange those notes plus accrued interest for an
equivalent number of shares of VoIP common stock valued at $1.23 per share.
F-31
SIGNATURES
Pursuant to the requirements of the Securities Act, the Company has duly caused
this Annual Report to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Fort Lauderdale, State of Florida, on April 17, 2006.
VOIP, INC.
By: /s/ B. Michael Adler
-------------------------------------
B. Michael Adler
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report has been signed below by the following persons in the capacities and on
the dates indicated.
Name Office Date
/s/ B. Michael Adler
----------------------------
B. Michael Adler Chief Executive Officer April 17, 2006
(Principal Executive Officer)
/s/ David Sasnett
----------------------------
David Sasnett Chief Financial Officer April 17, 2006
(Principal Financial and
Accounting Officer)
/s/ George Firestone
----------------------------
George Firestone Director April 17, 2006
/s/ Stuart Kosh
----------------------------
Stuart Kosh Director April 17, 2006