UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended June 30, 2006
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number: 001-12155
One IP Voice, Inc.
(Exact name of registrant as specified in its charter)
Delaware 06-1205743
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
22 Prestige Park Circle
East Hartford, CT 06108
(Address of principal executive offices) (Zip Code)
(860) 610-6000
(Registrant's telephone number)
Farmstead Telephone Group, Inc.
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [x]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
As of July 31, 2006, the registrant had 4,057,532 shares of its $0.001 par value
Common Stock outstanding.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Page
----
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
Consolidated Balance Sheets - June 30, 2006 and December 31, 2005.................................. 3
Consolidated Statements of Operations - Three and Six Months Ended June 30, 2006 and 2005.......... 4
Consolidated Statement of Changes in Stockholders' Equity (Deficiency) - Six Months Ended
June 30, 2006...................................................................................... 5
Consolidated Statements of Cash Flows - Six Months Ended June 30, 2006 and 2005.................... 6
Notes to Consolidated Financial Statements......................................................... 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS................................................................ 20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ........................................ 27
ITEM 4. CONTROLS AND PROCEDURES ........................................................................... 27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.................................................................................. 27
ITEM 1A. RISK FACTORS....................................................................................... 27
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS........................................ 27
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................................................... 27
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................................ 28
ITEM 5. OTHER INFORMATION.................................................................................. 28
ITEM 6. EXHIBITS .......................................................................................... 28
SIGNATURES.................................................................................................. 28
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ONE IP VOICE, INC.
(f/k/a Farmstead Telephone Group, Inc.)
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(In thousands) 2006 2005
---------------------------------------------------------------------------------------------------------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 732 $ 222
Accounts receivable, net 3,147 3,125
Inventories, net 861 723
Other current assets 228 281
---------------------------------------------------------------------------------------------------------------
Total Current Assets 4,968 4,351
Property and equipment, net 733 615
Deferred financing costs 487 535
Other assets 116 103
---------------------------------------------------------------------------------------------------------------
Total Assets $ 6,304 $ 5,604
===============================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 3,044 $ 3,105
Accrued expenses and other current liabilities 524 539
Current portion of convertible debt, net of unamortized discount (Note 4) 661 860
Derivative financial instruments (Note 5) 618 385
Current portion of long-term debt (Note 3) 41 30
---------------------------------------------------------------------------------------------------------------
Total Current Liabilities 4,888 4,919
Postretirement benefit obligation 790 719
Convertible debt, net of unamortized discount (Note 4) 8 8
Derivative financial instruments (Note 5) 2,931 406
Long-term debt (Note 3) 55 49
---------------------------------------------------------------------------------------------------------------
Total Liabilities 8,672 6,101
---------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' Equity (Deficiency):
Preferred stock, $0.001 par value; 2,000,000 shares authorized; 259,426 and 0
Series A shares issued and outstanding at June 30, 2006 and December 30, 2005 177 -
Common stock, $0.001 par value; 30,000,000 shares authorized;
4,047,532 and 3,817,132 shares issued and outstanding at
June 30, 2006 and December 31, 2005, respectively 4 4
Additional paid-in capital 13,093 13,249
Accumulated deficit (15,630) (13,734)
Accumulated other comprehensive loss (12) (16)
---------------------------------------------------------------------------------------------------------------
Total Stockholders' Equity (Deficiency) (2,368) (497)
---------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity (Deficiency) $ 6,304 $ 5,604
===============================================================================================================
See accompanying notes to consolidated financial statements.
3
ONE IP VOICE, INC.
(f/k/a Farmstead Telephone Group, Inc.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three For the Six
Months Ended Months Ended
June 30, June 30,
------------------ -------------------
(In thousands, except loss per share amounts) 2006 2005 2006 2005
---------------------------------------------------------------------------------------------------
Revenues:
Equipment $ 2,482 $3,723 $ 5,946 $ 5,688
Services and other revenue 773 760 1,723 1,204
---------------------------------------------------------------------------------------------------
Total revenues 3,255 4,483 7,669 6,892
Cost of Revenues:
Equipment 1,918 2,695 4,335 4,014
Services and other revenue 546 321 1,191 555
Other cost of revenues 80 131 187 233
---------------------------------------------------------------------------------------------------
Total cost of revenues 2,544 3,147 5,713 4,802
---------------------------------------------------------------------------------------------------
Gross profit 711 1,336 1,956 2,090
Selling, general and administrative expenses 2,761 1,765 5,375 3,148
---------------------------------------------------------------------------------------------------
Operating loss (2,050) (429) (3,419) (1,058)
---------------------------------------------------------------------------------------------------
Other income (expense):
Interest expense (61) (48) (145) (56)
Derivative instrument income (Note 1) 4,297 681 1,663 287
Other income 13 1 15 4
---------------------------------------------------------------------------------------------------
Total other income (expense) 4,249 634 1,533 235
---------------------------------------------------------------------------------------------------
Income (loss) before income taxes 2,199 205 (1,886) (823)
Provision for income taxes 3 3 10 7
---------------------------------------------------------------------------------------------------
Net income ( loss) 2,196 202 (1,896) (830)
Accretion of discount on preferred stock 25 - 26 -
---------------------------------------------------------------------------------------------------
Net income (loss) attributable to common stockholders $ 2,171 $ 202 $(1,922) $ (830)
===================================================================================================
Net income (loss) per common share:
Basic $ .54 $ .06 $ (.49) $ (.25)
Diluted $ (.14) $ .05 $ (.49) $ (.25)
Weighted average common shares outstanding:
Basic 4,002 3,353 3,930 3,340
Diluted 9,152 4,391 3,930 3,340
===================================================================================================
See accompanying notes to consolidated financial statements.
4
ONE IP VOICE, INC.
(f/k/a Farmstead Telephone Group, Inc.)
CONSOLIDATED STATEMENT OF CHANGES IN
STOCKHOLDERS' EQUITY (DEFICIENCY)
(UNAUDITED)
For the Six Months Ended June 30, 2006
Accumulated
Preferred Stock Common Stock Additional Accum- Other
---------------- ---------------- Paid-in ulated Comprehensive
(In thousands) Shares Amount Shares Amount Capital Deficit Loss Total
--------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2005 - $ - 3,817 $4 $13,249 $(13,734) $(16) $ (497)
Net loss - - - - - (1,896) - (1,896)
Amortization of pension liability
adjustment - - - - - - 4 4
-------
Comprehensive loss (1,892)
Stock-based compensation - - - - 179 - - 179
Common stock issued under stock
option and stock purchase plans - - 30 - 42 - - 42
Shares issued upon conversion of
Laurus debt - - 190 - 202 - - 202
Warrants issued for notes payable - - - - 852 - - 852
Issuance of preferred stock 259 151 - - - - - 151
Issue costs and expenses in
connection with issuance of
convertible note and Series A
preferred stock - - - - (507) - - (507)
Warrants for preferred and common
stock issued in connection with
issuance of convertible note and
Series A preferred stock - - - - (913) - - (913)
Common stock issued to consultant
for services - - 10 - 15 - - 15
Accretion of discount on Series A
preferred stock - 26 - - (26) - - -
---------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2006 259 $177 4,047 $4 $13,093 $(15,630) $(12) $(2,368)
================================================================================================================================
See accompanying notes to consolidated financial statements.
5
ONE IP VOICE, INC.
(f/k/a Farmstead Telephone Group, Inc.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended June 30, 2006 and 2005
(In thousands) 2006 2005
----------------------------------------------------------------------------------
Cash Flows From Operating Activities:
Net loss $(1,896) $ (830)
Adjustments to reconcile net loss to net cash used in
operating activities:
Provision for doubtful accounts receivable 18 18
Provision for losses on inventories 24 18
Depreciation and amortization of property and equipment 105 53
Amortization of deferred financing costs 48 23
Amortization of discounts on convertible notes 48 19
Unrealized (gain) loss on derivative instruments (1,663) (287)
Stock-based compensation expense 179 -
Value of common stock issued for services 15 -
Decrease in accumulated other comprehensive loss 4 5
Changes in operating assets and liabilities:
Increase in accounts receivable (40) (2,032)
(Increase) decrease in inventories (162) 180
Decrease in other assets 40 277
(Decrease) increase in accounts payable (61) 1,564
(Decrease) increase in accrued expenses and other
current liabilities (15) 99
Increase in postretirement benefit obligation 71 63
----------------------------------------------------------------------------------
Net cash used in operating activities (3,285) (830)
----------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (188) (18)
----------------------------------------------------------------------------------
Net cash used in investing activities (188) (18)
----------------------------------------------------------------------------------
Cash flows from financing activities:
Repayment of BACC revolving loan advances - (179)
Borrowings under Laurus revolving loan facility 55 1,450
Proceeds from issuance of convertible note, net 913 -
Proceeds from issuance of Series A preferred stock, net 2,991 -
Deferred financing costs - (257)
Repayment of long-term debt and capital lease obligations (18) (10)
Proceeds from exercise of stock options and employee
stock purchases 42 17
----------------------------------------------------------------------------------
Net cash provided by financing activities 3,983 1,021
----------------------------------------------------------------------------------
Net increase in cash and cash equivalents 510 173
Cash and cash equivalents at beginning of period 222 217
----------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 732 $ 390
==================================================================================
6
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 68 $ 20
Income taxes 2 2
Supplemental disclosure of non-cash financing and
investing activities:
Purchase of equipment under capital lease 35 56
Common stock issued upon Laurus minimum borrowing
note conversions 202 -
Discount on warrants issued to Laurus - 335
Warrants issued in connection with convertible notes 852 -
Preferred shares issued on conversion of convertible note 628 -
Warrants issued to placement agent in connection with
preferred shares and warrants issued to investors 3,460 -
Discounts on issuance of convertible debt - 557
See accompanying notes to consolidated financial statements.
ONE IP VOICE, INC.
(f/k/a Farmstead Telephone Group, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION, BUSINESS OPERATIONS, AND SIGNIFICANT ACCOUNTING
POLICIES
Basis of Presentation
The consolidated financial statements presented herein consist of the
accounts of One IP Voice, Inc., formerly known as Farmstead Telephone Group,
Inc., and its wholly-owned subsidiaries. The accompanying consolidated
financial statements as of June 30, 2006 and for the three and six months ended
June 30, 2006 and 2005 have been prepared in accordance with accounting
principles generally accepted in the United States of America and the rules and
regulations of the Securities and Exchange Commission for interim financial
statements. In the Company's opinion, the unaudited interim consolidated
financial statements and accompanying notes reflect all adjustments, consisting
of normal and recurring adjustments, that are necessary for a fair statement of
results for the interim periods presented. The results of operations for the
interim periods are not necessarily indicative of the results to be experienced
for the entire fiscal year. This Form 10-Q should be read in conjunction with
the consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2005.
Corporate Name Change: Effective July 19, 2006 Farmstead Telephone Group, Inc.
changed its corporate name to "One IP Voice, Inc.". Concurrently, the Company's
wholly-owned subsidiary, One IP Voice, Inc., changed its corporate name to "OIPV
Corp.".
Use of Estimates
The preparation of 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, revenues and expenses and related
disclosures in the consolidated financial statements. Actual results could
differ from those estimates. Estimates are used in accounting for the
allowances for uncollectible receivables, inventory obsolescence, depreciation,
taxes and contingencies, among others. Estimates include the identification and
valuation of derivative instruments, the amortization periods for debt issuance
costs, and the amortization of discounts on convertible securities arising from
bifurcated derivative instruments. Estimates are also used in determining
product sales returns, which
7
are reflected as reductions to revenues. Estimates and assumptions are reviewed
periodically and the effects of revisions are reflected in the consolidated
financial statements in the period they are determined to be necessary.
Derivative financial instruments
The identification of, and accounting for, derivative instruments is
complex. Derivative financial instruments are initially measured at their fair
value. For derivative financial instruments that are accounted for as
liabilities, the derivative instrument is initially recorded at its fair value
and is then revalued at each reporting date, with changes in the fair value
reported as charges or credits to income. We determine the fair value of these
instruments using the Black-Scholes option pricing model. That model requires
assumptions related to the remaining term of the instruments and risk-free rates
of return, our current common stock price and expected dividend yield, and the
expected volatility of our common stock price over the life of the conversion
option. We estimate the future volatility of our common stock price based on
several factors, including the history of our stock price and the experience of
other entities considered comparable to us. The identification of, and
accounting for, derivative instruments and the assumptions used to value them
can significantly affect our financial position and results of operations.
Derivative instrument liabilities are classified in the balance sheet as current
or non-current based on whether or not net-cash settlement of the derivative
instrument could be required within 12 months of the balance sheet date.
During the three and six months ended June 30, 2006, we recorded
derivative instrument income of $4,297,000 and $1,633,000 respectively, as
compared to derivative instrument income of $681,000 and $287,000 for the
respective three and six months ended June 30, 2005. The recording of derivative
instrument income during these periods resulted from the decline in the
calculated fair market value of such derivative instrument liabilities,
primarily attributable to a decline in the market value of the Company's common
stock. Income or losses generated from these derivative liabilities principally
arise from changes in the fair market value of the Company's common stock price
during each reporting period, as the Company is required to record
"mark-to-market" adjustments to the value of its derivative liabilities. These
"mark-to-market" adjustments are non-cash, with no impact on liquidity.
Business Operations
As presented in the consolidated financial statements contained in this
report, the Company has incurred operating losses of $2,050,000 and $3,419,000
for the three and six months ended June 30, 2006, as compared to operating
losses of $429,000 and $1,058,000 for the three and six months ended June 30,
2005. Approximately $1,241,000 and $2,217,000 of the operating losses reported
for the three and six months ended June 30, 2006 were attributable to the
start-up operations of the Company's wholly-owned subsidiary, OIPV Corp. The
remaining operating losses are attributable to the Company's legacy
telecommunications equipment business which has been negatively impacted by
declining profit margins.
In May, 2005, OIPV Corp. was formed to provide carrier-based VoIP
telephony solutions along with network services. Its primary target market is
the small-to-medium sized business ("SMB") market, which the Company believes is
the fastest growing segment of the telecommunications systems business. OIPV's
product offerings include Hosted IP Centrex and IP Trunking services, bundled
with private OIPV "last mile" connectivity on a national basis, long distance
calling, On Net calling, local area calling, 911 capabilities and Wide Area
Network ("WAN") voice and data connectivity. In January 2006, the Company
launched the national marketing of OIPV's products and services; however
revenues generated to date have been insufficient to cover its operating costs,
and operating losses are expected to continue into 2007.
The Company continues to experience negative cash flows from operations
and continues to be dependent upon its revolving credit facility and raising
cash from private and public placements of debt and equity in order to fund its
business operations. During the six months ended June 30, 2006, the Company
raised approximately $3.9 million from private placements of convertible notes
and preferred stock, which was used for working capital. Significant amounts of
additional external financing, however, will be required in order to sustain
current operations and for the further development of the OIPV Corp. IP
telephony business to the operating levels anticipated by management. No
assurance can be given, however, that such additional funding will be available.
For additional discussion on the Company's operating results and financial
condition, refer to Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations, contained herein.
8
2. SUPPLEMENTARY FINANCIAL INFORMATION
Balance Sheet Information
June 30, December 31,
(In thousands) 2006 2005
----------------------------------------------------------------------------
ACCOUNTS RECEIVABLE, NET: (1)
Trade accounts receivable $ 2,866 $ 2,815
Less: allowance for doubtful accounts (86) (75)
------- -------
Trade accounts receivable, net 2,780 2,740
Other receivables 367 385
------- -------
Accounts receivable, net $ 3,147 $ 3,125
======= =======
INVENTORIES, NET: (2)
Finished goods and spare parts $ 793 $ 1,136
Work in process 209 202
Rental equipment 64 12
------- -------
1,066 1,350
Less: reserves for excess and obsolete inventories (205) (627)
------- -------
Inventories, net $ 861 $ 723
======= =======
PROPERTY AND EQUIPMENT, NET:
Computer and office equipment $ 1,162 $ 1,065
IP network equipment and licenses 442 391
Furniture and fixtures 304 288
Leasehold improvements 171 171
Capitalized software development costs 98 98
Automobiles 73 50
Leased computer equipment under capital lease 91 56
------- -------
2,341 2,119
Less: accumulated depreciation and amortization (1,608) (1,504)
------- -------
Property and equipment, net $ 733 $ 615
======= =======
ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES:
Salaries, commissions and benefits $ 293 $ 296
Legal fees and expenses 32 104
State and local taxes 48 36
Customer deposits and unearned revenue 58 30
Employee Stock Purchase Plan deposits 15 28
Other 78 45
------- -------
Accrued expenses and other current liabilities $ 524 $ 539
======= =======
Other receivables primarily consist of commissions, rebates and other
dealer incentives due from Avaya and are recorded in the consolidated
financial statements when earned.
Work in process consists of used equipment requiring repair or
refurbishing. The amounts shown in this table for December 31, 2005 for
finished goods and spare parts, and for the reserves for excess and
obsolete inventories reflect a correction of a typographical error
in the consolidated financial statements included in the Form 10-K for
the year ended December 31, 2005. The amounts originally reported were
$947 and ($438), respectively. This correction had no effect on the net
reported value.
9
3. DEBT OBLIGATIONS
June 30, December 31,
(In thousands) 2006 2005
-------------------------------------------------------------
Installment purchase note $ 36 $ 40
Obligations under capital lease 60 39
------------------------------------------------------------
96 79
Less: current portion (41) (30)
------------------------------------------------------------
Long-term debt obligations $ 55 $ 49
============================================================
Installment Purchase Note:
The Company is financing an automobile through a $50,056, 3.75% note
payable to a finance company. The note is payable in 38 monthly installments of
$799, with a final payment of $24,236 on January 7, 2008. The note balance at
June 30, 2006 was $35,788, of which $8,154 was classified under current portion
of long-term debt.
Obligations under Capital Lease:
During 2005, the Company entered into non-cancelable lease agreements to
finance $56,000 of computer equipment with payment terms ranging from 24 to 36
months. In 2006, an additional $34,971 of computer equipment was leased under
similar terms. Monthly lease payments aggregate $3,146 and the agreements
contain a $1.00 purchase option at the end of the lease term. The effective
interest rate on the lease obligations is 10.4% to 12.7%. The principal balance
of these obligations at June 30, 2006 was $60,453, of which $33,338 was
classified under current portion of long-term debt.
4. CONVERTIBLE DEBT
June 30, December 31,
(In thousands) 2006 2005
--------------------------------------------------------------------------
Borrowing under secured revolving credit
facility note, including accrued interest $1,464 $1,409
Secured convertible Minimum Borrowing Note 182 423
Less: unamortized discount attributable to
the revolving credit facility note (803) (549)
Less: unamortized discount attributable to
the Minimum Borrowing Note (174) (415)
--------------------------------------------------------------------------
Convertible Debt, net of unamortized discounts 669 868
Less: current portion (661) (860)
--------------------------------------------------------------------------
Convertible Debt, net of unamortized discounts $ 8 $ 8
==========================================================================
During 2006, $241,300 of debt under the existing Minimum Borrowing Note
was converted to 190,000 shares of common stock.
As of June 30, 2006, the amount of available borrowings under the
revolving portion of the credit facility, pursuant to borrowing formulas, was as
follows (in thousands):
Available borrowings supported by collateral base $ 1,666
Less: amount borrowed under revolving credit facility (1,464)
Less: amount borrowed under the Minimum Borrowing Note (182)
-------
Available to borrow as of June 30, 2006 $ 20
=======
The average and highest amounts borrowed under the Laurus credit facility
during the three months ended June 30, 2006 were approximately $1,410,000 and
$2,017,000, respectively. The average and highest amounts borrowed under the
Laurus credit facility during the six months ended June 30, 2006 were
approximately $1,418,000 and $2,017,000, respectively. The Company was in
compliance with the provisions of its loan agreement as of June 30, 2006. Future
required principal repayments under the Minimum Borrowing Note as of June 30,
2006 are: 2006 - $0; 2007 - $0; and 2008 - $181,700.
10
5. DERIVATIVE FINANCIAL INSTRUMENTS
The following derivative liabilities related to warrants and embedded
derivative instruments were outstanding as of June 30, 2006 and December 31,
2005 (in thousands):
Issue Expiration Exercise Value- Value- Value-
Instrument: Date Date Price Issue date 6/30/06 12/31/05
-------------------------------------------------------------------------------------------------------------------------------
Laurus Minimum Borrowing Note (Note 4) 9/2/2005 3/31/2008 $1.27 $ 323 $ 72 $ 135
Laurus Revolving Note (Note 4) 3/31/2005 3/31/2008 1.27 824 618 385
58,970 shares of Series A preferred stock issued
in connection with convertible note (Notes 7
and 8) 2/17/2006 - - 625 386 -
200,456 shares of Series A preferred stock issued 2/17/2006-
in private placement (Note 7) 4/17/2006 - - 2,340 1,313 -
-------------------------------------------------------------------------------------------------------------------------------
Fair value of bifurcated embedded derivative
instrument liabilities 2,389 520
500,000 common stock warrants issued to Laurus 3/31/2005 3/31/2010 1.82 335 254 271
150,000 common stock warrants issued to placement
agent in connection with convertible note (Note 8)
2/8/2006 2/8/2011 1.27 197 103 -
1,002,280 common stock warrants issued in private 2/17/2006- 2/17/2011-
placement (Note 7) 4/17/2006 4/17/2011 2.125 1,120 543 -
30,067 preferred stock warrants issued to 2/17/2006- 2/17/2011-
placement agent in private placement (Note 7) 4/17/2006 4/17/2011 17.00 345 179 -
150,335 common stock warrants issued to placement 2/17/2006- 2/17/2011-
agent in private placement (Note 7) 4/17/2006 4/17/2011 2.125 222 81 -
-------------------------------------------------------------------------------------------------------------------------------
Total derivative financial instruments 3,549 791
Less: amount attributable to the Revolving Note,
reported in current liabilities (618) (385)
-------------------------------------------------------------------------------------------------------------------------------
Derivative financial instruments recorded in
non-current liabilities $2,931 $ 406
===============================================================================================================================
The Company uses the Black-Scholes option pricing model to value warrants,
and the embedded conversion option components of any bifurcated embedded
derivative instruments that are recorded as derivative liabilities. In valuing
the (i) Laurus warrants and the embedded conversion option components of
Laurus's bifurcated embedded derivative instruments; and (ii) the warrants to
acquire common stock issued to the Series A investors and the placement agent,
at the time they were issued and at each quarter ending date, we used the
following assumptions: market price of our common stock on the date of
valuation; an expected dividend yield of 0%; an expected life equal to either
the remaining period to the expiration date of the warrants or maturity date of
the convertible debt instruments; implied volatility of 65%; and a risk-free
rate of return based on constant maturity rates published by the U.S. Federal
Reserve, applicable to the remaining life of the instruments. In valuing the
shares of Series A preferred stock issued to investors, as well as the warrants
to acquire preferred stock issued to the placement agent, in addition to using
the same yield, volatility and rate-of-return assumptions as above, we initially
used an expected life of 4.5 years which considered the fact that there is a
mandatory conversion option once the market price of the Company's common stock
exceeds $5.00 per share for 20 trading days. In valuing these securities as of
June 30, 2006, we changed the expected life assumption to 5.3 years, which
reflects the remaining period of time to the beginning of the contractual
redemption period.
11
6. STOCK-BASED COMPENSATION
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based
Payment," ("SFAS No. 123R"), revising FASB Statement 123, "Accounting for
Stock-Based Compensation" and superseding APB Opinion No. 25, "Accounting for
Stock Issued to Employees" and its related implementation guidance. This
Statement establishes standards for the accounting for transactions in which an
entity exchanges its equity instruments for goods or services, focusing
primarily on transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123 (revised 2004) requires a public
entity to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award
(with limited exceptions). That cost will be recognized over the period during
which an employee is required to provide service in exchange for the award.
Accounting for share-based compensation transactions using the intrinsic method
supplemented by pro forma disclosures will no longer be permissible. This
statement became effective as of the beginning of the first interim or annual
reporting period that began after December 15, 2005.
Effective January 1, 2006, the Company adopted SFAS 123R using the
modified prospective method as permitted under SFAS 123R. Under this transition
method, compensation cost recognized during 2006 includes: (a) compensation cost
for all share-based payments granted prior to, but not yet vested as of December
31, 2005, based on the grant-date fair value estimated in accordance with the
provisions of SFAS 123, and (b) compensation cost for all share-based payments
granted subsequent to December 31, 2005, based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123R. In accordance with the
modified prospective method of adoption, the Company's results of operations and
financial position for prior periods have not been restated.
Stock Option Plans: The Company has outstanding options granted under the
following plans: (i) the Farmstead Telephone Group, Inc. 2002 Stock Option Plan
(the "2002 Plan") and (ii) the Farmstead Telephone Group, Inc. 1992 Stock Option
Plan (the "1992 Plan"). The 1992 Stock Option Plan terminated in May 2002;
however options previously granted under the 1992 Plan may continue to be
exercised in accordance with the terms of the individual grants. The Company
grants options with varying vesting terms, including 100% exercisable after 1
year, 50% per year over 2 years, and 25% or 20% per year over 4 or 5 years. The
vesting terms vary depending upon the circumstances (for example, options
included in an employment offer may be subject to negotiation with the
prospective employee) and are reviewed with the Board of Directors.
The 2002 Plan permits the granting of options to purchase shares of common
stock to employees, directors and consultants of the Company, which shall be
either incentive stock options ("ISOs") as defined under Section 422 of the
Internal Revenue Code, or non-qualified stock options ("NSOs"). ISOs may be
granted at no less than market value at the time of grant, with a maximum term
of ten years except, for a 10% or more stockholder, the exercise price shall not
be less than 110% of market value, with a maximum term of five years. NSOs may
be granted at no less than 50% of market value at the time of grant, with a
maximum term of 10 years. Any option granted pursuant to this Plan which for any
reason fails to qualify as an ISO shall be deemed to have been granted as an
option not qualified under Section 422 of the Code. As of June 30, 2006, the
maximum number of shares issuable under the 2002 Plan, which expires April 3,
2012, was 2,300,000. At the Company's Annual Meeting of Stockholders, held July
13, 2006, the stockholders approved an increase in the maximum number of shares
issuable under the 2002 Plan to 3,300,000.
Employee Stock Purchase Plans - The Company also has an employee stock
purchase plan ("ESPP") that allows eligible employees to purchase, through
payroll deductions, shares of the Company's common stock at a discount from the
fair market value of the common stock at specified dates. Employees may withdraw
from an offering before the purchase date and obtain a refund of the amounts
withheld. In the semi-annual offering period that ended February 2006, the
Company amended the terms of the ESPP such that the discount was reduced from
15% to 5% of the market value of the common stock as of the last day of the
offering period. This change in the plan resulted in the expense related to the
ESPP to be non-compensatory under SFAS 123R. During the six months ended June
30, 2006 employees purchased 18,900 shares of common stock for $33,642.
Under SFAS 123R, the Company recognized $96,025 and $179,497 of
compensation expense during the three and six months ended June 30, 2006, which
was charged to SG&A expense. The following table details the effect on net loss
and loss per share had stock-based compensation expense been recorded for the
three and six months ended June 30, 2005 based on the fair-value method under
SFAS 123, "Accounting for Stock-based Compensation" (in thousands, except per
share amounts).
12
Three months Six months
Ended Ended
June 30, 2005 June 30, 2005
-------------------------------------------------------------------------------
Net income (loss), as reported $202 $ (830)
Add: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (37) (239)
-------------------------------------------------------------------------------
Pro forma net income (loss) 165 (1,069)
Pro forma net income (loss) per share:
Basic $.05 $ (.32)
Diluted $.04 $ (.32)
-------------------------------------------------------------------------------
Grant-Date Fair Value
---------------------
The Company uses the Black-Scholes option pricing model to calculate the
grant-date fair value of an award. The fair value of options granted were
calculated using the following estimated weighted average assumptions:
Six Months Ended June 30,
-------------------------
2006 2005
---- ----
Risk-free rate of return 4.73% 3.8%
Expected life of award (years) 3.73 3.5
Expected dividend yield of stock 0% 0%
Expected volatility of stock 65% 55%
Weighted-average fair value $.92 $.40
Risk-free interest rate - the Company uses the constant maturity rates on U.S.
Treasury securities published by the U. S. Federal Reserve for a period that is
commensurate with the expected term assumption.
Expected term - the Company estimates the expected term of its option grants
through a review of its historical employee exercise behavior and through
consultation with an independent third-party advisor with the requisite
expertise in stock option valuations who also considered the Company's history
of stock price appreciation/decline and studies on employee exercise behavior.
Expected dividend yield - the Company assumes a 0% yield since it has never
declared a dividend on its common stock and is currently prohibited from doing
so without the consent of its lender.
Expected volatility - the Company estimates volatility by considering both
historical volatility and implied (future) volatility in consultation with an
independent third-party advisor with expertise in this area. In determining
implied volatility, the Company and advisor consider such factors as the
thinly-traded nature of the Company's stock over significant time-spans, and a
review of volatility in the Company's industry sector. The Company currently
believes that the use of implied volatility results in a more accurate estimate
of the grant-date fair value of employee stock options because it more
appropriately reflects the market's expectations of future volatility.
Historical volatility during the period commensurate with the expected term of
the Company's stock options over the past several years included a period of
time that the Company's stock price experienced unprecedented increases and
subsequent declines. The Company believes that this past stock price volatility
is unlikely to be indicative of future stock price behavior.
Option Plan Activity
--------------------
A summary of the activity under the Company's stock option plans during
the six months ended June 30, 2006 is as follows (aggregate intrinsic value in
thousands):
13
Weighted
Weighted average
average remaining Aggregate
Number exercise contractual intrinsic
of shares price term (years) value
-------------------------------------------------------------------------------------------------
Outstanding at December 31, 2005 2,684,619 $1.45 5.3 $582
Granted 229,000 1.79
Exercised (11,500) .66
Canceled (1,500) 1.76
Forfeited (18,750) 1.21
-------------------------------------------------------------------------------------------------
Outstanding at June 30, 2006 2,881,869 $1.48 5.1 $572
=================================================================================================
Exercisable at June 30, 2006 2,358,619 $1.39 4.2 $551
Vested or expected to vest at June 30, 2006 2,867,795 1.48 5.1 571
During the six months ended June 30, 2006 (i) the weighted-average
grant-date fair value of options granted was $.92; (ii) the total intrinsic
value of options exercised was $13,757; and (iii) the total fair value of
options vested was $88,431. Cash received from stock option exercises during the
six months ended June 30, 2006 was $7,630.
Warrants:
---------
As of June 30, 2006, there were 900,000 warrants outstanding that were
issued to certain executive officers of the Company, all of which were fully
vested at December 31, 2005. As of June 30, 2006, the warrants had a
weighted-average exercise price of $.67, a weighted-average remaining
contractual term of 3.5 years, and an aggregate intrinsic value of $409,500.
Expense
-------
The Company recognizes expense using the straight-line prorated allocation
method. The amount of stock-based compensation recognized during a period is
based on the value of the portion of the awards that are ultimately expected to
vest. SFAS 123R requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from
those estimates. The term "forfeitures" is distinct from "cancellations" or
"expirations" and represents only the unvested portion of the surrendered
option. The Company has applied an annual forfeiture rate of 4% to all unvested
options as of January 1, 2006. Ultimately, the actual expense recognized over
the vesting period will only be for those shares that vest. As of June 30, 2006,
there was $309,000 of total unrecognized compensation cost related to unvested
share-based awards. That cost is expected to be recognized into expense over a
weighted-average period of 1.2 years.
7. PREFERRED STOCK
June 30,
(In thousands) 2006
------------------------------------------------------------------------------
Series A redeemable convertible preferred stock, par value $.001,
259,426 shares issued and outstanding (also see Note 8) $ 4,410
Less: unamortized discount related to warrants issued to investors
and bifurcated embedded derivative instruments (Note 5) (4,233)
------------------------------------------------------------------------------
Carrying amount at June 30, 2006 $ 177
==============================================================================
On February 17, 2006, March 17, 2006 and April 17, 2006, the Company sold
an aggregate of 200,456 Units of Series A Preferred Stock to several accredited
investors (the "Investors") at a price of $17.00 per Unit. Each Unit consists of
(i) one share of the Company's Series A Preferred Stock, $.001 par value per
share, and (ii) a Warrant to purchase five shares of the Company's Common Stock,
par value $.001 per share, at an exercise price of $2.125 per share (the Series
A Preferred Stock and the Warrant together "Securities"). The Securities were
not registered under the Securities Act of 1933, as amended, or applicable state
securities laws as of their dates of issuance. The Securities are subject to
restrictions on transferability and resale and may not be transferred or resold
except as permitted under the Securities Act of 1933, as amended, and applicable
state securities laws, pursuant to registration or exemption from those laws.
The proceeds received by the Company, net of $272,634 placement agent fees and
$144,156 expenses incurred by the Company, were $2,991,071.
14
The following describes certain of the material terms of these
transactions. The description below is not a complete description of the terms
of the financing transaction and is qualified in its entirety by reference to
the agreements entered into in connection therewith which are included as
exhibits to previously filed Current Reports on Form 8-K.
Series A Preferred Stock. Each share of Series A Preferred Stock is
convertible into ten shares of common stock, based upon an initial conversion
price of $1.70 per common share. The conversion price of the Series A Preferred
Stock will be subject to a weighted average adjustment (based on all deemed
outstanding shares of Common Stock and shares of Preferred Stock) and to reduce
dilution in the event that the Company issues additional equity securities
(other than the shares reserved for issuance under or to Laurus Master Fund
Ltd., the Company's 2002 Stock Option Plan, the Company's Employee Stock
Purchase Plan, employees, officers, consultants and directors of the Company,
and under other currently existing options, warrants and obligations to issue
shares) at a purchase price less than the Series A Preferred Stock conversion
price. The Series A Preferred Stock conversion price will also be subject to
proportional adjustment for stock splits, stock dividends, recapitalizations and
the like.
Dividends accrue at an 8% annual rate; however the Company is under no
obligation to pay such accruing dividends except under the following conditions:
(i) the Investors have the right to receive in preference to any dividend on the
Common Stock a cumulative non-compounding dividend at the rate of 8% per annum
of the original Preferred A Per Share Price; (ii) in the event of any
liquidation or winding up of the Company, the Investors shall be entitled to
receive in preference to the holders of the Common Stock an amount equal to two
times the original Preferred A Per Share Price plus any declared but unpaid
dividends; and (iii) in the event of a redemption, as further described below.
The Series A Preferred Stock is subject to mandatory conversion into
shares of common stock upon the earliest to occur of (a) the closing of the sale
of shares of common stock to the public at a price of at least $5.00 per share,
subject to anti-dilution adjustments, which results in at least $10 million of
gross proceeds to the Company; (b) the consent of the majority of the holders of
the then outstanding Series A Preferred Stock; or (c) the date upon which the
closing sale price of the common stock exceeds $5.00 per share for twenty
consecutive trading days. All of the outstanding shares of Series A Preferred
Stock shall be redeemed by the Company at its original issue price plus accrued
dividends in three annual installments commencing 270 days after receipt by the
Company at any time on or after February 17, 2011 and prior to February 17,
2013, of written notice from the holders of a majority of the then outstanding
shares of Series A Preferred Stock.
The Series A Preferred Stock will vote together with the Common Stock and
not as a separate class except as required by law, however, the holders of the
Series A Preferred Stock, exclusively and as a separate class, will be entitled
to elect one (1) director of the Corporation. Each share of Series A Preferred
Stock shall have a number of votes equal to the number of shares of Common Stock
then issuable upon conversion of such share of Series A Preferred Stock.
Warrant to Purchase Shares of Stock. The Investors received warrants to
purchase up to an aggregate of 1,002,280 shares of the Company's common stock at
an exercise price of $2.125 per share. The warrants expire five years from
issuance. In lieu of exercising the warrant with cash, the Holder may elect to
receive that number of shares of common stock equal to the value of the warrant
(or that portion being exercised) at the time of exercise.
Registration rights. The Company has registered the common stock
underlying the Securities for resale on Form S-1, which was declared effective
by the Securities and Exchange Commission on July 18, 2006.
Because the Series A Preferred Stock is not considered to be "conventional
convertible preferred stock", the embedded conversion option is subject to the
accounting requirements of EITF Issue 00-19. Because of the penalties we may
have to pay under the Investor Rights Agreement, and the fact that the
conversion price can be adjusted in certain circumstances, we are required by
EITF 00-19 to bifurcate the embedded conversion option and account for it as a
derivative instrument liability. This derivative instrument liability was
initially valued, using the Black-Scholes options pricing model, at $10.64 -
$13.59 per preferred share, attributable to three separate closing dates. It is
then adjusted to fair value at the end of each subsequent period, with any
changes in fair value charged or credited to income in the period of change.
Refer to Note 5 for further information on the assumptions used in determining
fair market value of the derivative instruments. The Company allocated the
$2,340,374 fair value of the embedded conversion options and $916,790 of the
$1,119,919 aggregate fair value of the 1,002,280 common stock purchase warrants
issued to the investors in the February, March and April 2006 closings, to the
$3,407,937 gross proceeds received, resulting in the recording of a $3,257,170
discount and an aggregate initial net carrying value of the preferred stock of
$150,767. The net carrying value will be adjusted, through accretion of the
discount, to $3,407,937 using the effective interest method over the 5.75 year
period to the date the holders can redeem the shares for
15
cash, of which 5.3 years remained as of June 30, 2006. The $203,123 difference
between the fair value of the investor warrants and that which was allocated was
immediately charged to Additional paid-in capital, resulting from an excess in
the calculated fair market value of the embedded conversion option and investor
warrants in the April 2006 closing over the proceeds received in that closing.
In connection with the above Series A Preferred Stock transactions, the
Company issued to its placement agent warrants (the "Placement Agent Warrants")
(i) to purchase up to an aggregate of 150,335 shares of the Company's common
stock at an exercise price of $2.125 per share and (ii) to purchase up to an
aggregate of 30,067 shares of the Company's Series A Preferred Stock at an
exercise price of $17.00 per share. The Placement Agent Warrants expire five
years from issuance. In lieu of exercising the warrants with cash, the placement
agent may elect to receive that number of shares of common stock or Series A
Preferred Stock, as applicable, equal to the value of the warrant (or that
portion being exercised) at the time of exercise. The Company also paid the
placement agent a fee of $272,634 representing 8% of the gross proceeds. The
placement agent fees, the $716,546 calculated fair value of the placement agent
warrants, and $144,156 of other transaction costs, aggregating $1,133,336, was
charged to Additional paid-in capital.
8. CONVERTIBLE NOTES
On February 8, 2006, the Company issued a $1,000,000 Principal Amount
Convertible Promissory Note (the "Sotomar Note") to Sotomar - Empreendimentos
Industriais e Imobiliarios, SA (the "Holder") pursuant to a Convertible Note and
Warrant Purchase Agreement (the "Purchase Agreement"). The proceeds received by
the Company, net of an $80,000 placement agent fee and other expenses, were
$913,000. Under the terms of the Sotomar Note, the outstanding principal, plus
any accrued but unpaid interest thereon, shall automatically convert into shares
of Series A Preferred Stock upon the sale of Series A Preferred Stock and
warrants to purchase Common Stock to accredited investors in a private placement
transaction pursuant to Regulation D (collectively, "Offered Securities") which
produces at least $500,000 of aggregate gross proceeds to the Company (a
"Preferred Offering"). As a result of the February 17, 2006 sale of Series A
Preferred Stock to an accredited investor for $750,000, the Sotomar Note,
together with $2,490 interest accrued thereon, converted into 58,970 shares of
Series A Preferred Stock.
In connection with the issuance of the Sotomar Note, the Holder received a
warrant to purchase up to an aggregate 529,134 shares of the Company's common
stock at an exercise price of $1.27 per share. The warrant expires ten years
from issuance. In lieu of exercising the warrant with cash, the Holder may elect
to receive that number of shares of common stock equal to the value of the
warrant (or that portion being exercised) at the time of exercise. The warrants
were valued using the Black-Scholes options pricing model, resulting in an
$834,000 discount against the proceeds of the Sotomar Note. Because the exercise
price and the number of shares are fixed, subject to normal anti-dilution
adjustments, and the Company can deliver unregistered shares, the Company
recorded the $834,000 directly to Additional paid-in capital. Because the Series
A Preferred Stock into which the Sotomar Note converted has the same
characteristics as the other issued Series A Preferred Stock, the Company has
bifurcated the embedded conversion option and is accounting for it as a
derivative instrument liability, in the same manner as the other issued Series A
Preferred Stock. Since the value of the embedded conversion option of $627,500
exceeded the net carrying value of the Sotomar Note of $168,469 at the date of
conversion, the Company reduced the initial carrying value of the associated
Series A Preferred Stock to zero and recorded an immediate charge to income of
$459,031. The series A Preferred Stock will be accreted to its redemption value
of $1,002,490 using the effective interest method and an estimated life to
conversion of 5.3 years.
In connection with the Sotomar Note transaction, and pending receipt of
proceeds from the issuance of the Sotomar Note, on January 30, 2006 an affiliate
of the placement agent advanced the Company $400,000 pursuant to a convertible
note with terms similar to the Sotomar Note. The advance was repaid with $1,111
of interest on February 8, 2006. A warrant for the purchase of 22,047 shares of
common stock was issued to the affiliate for providing the advance. The warrant
has a 5 year life and is exercisable at $1.27 per share. Using Black-Scholes the
Company calculated an $18,127 value to the warrant. Because the exercise price
and the number of shares are fixed, subject to normal anti-dilution adjustments,
and the Company can deliver unregistered shares without penalty, the Company
recorded this amount directly to Additional paid-in capital. Upon repayment of
the advance, the $18,127 unamortized discount was charged to interest expense.
In connection with the Sotomar Note, the placement agent received an
$80,000 fee and a warrant (the "Placement Agent Warrant") to purchase up to an
aggregate 150,000 shares of the Company's common stock at an exercise price of
$1.27 per share. The Placement Agent Warrant expires five years from issuance.
In lieu of exercising this warrant with cash, the placement agent may elect to
receive that number of shares of common stock equal to the value of the warrant
(or that portion
16
being exercised) at the time of exercise. Because these warrants are subject to
the same registration rights and associated penalties as described in Note 7,
the Company has accounted for the warrant as a derivative instrument liability.
See Notes 1 and 5 for further accounting information.
9. INTEREST EXPENSE
Three months ended Six months ended
June 30 June 30
------------------ ----------------
(In thousands) 2006 2005 2006 2005
--------------------------------------------------------------------------------------------
Interest expense on outstanding borrowings $32 $17 $ 76 $25
Amortization of deferred financing costs (1) 9 12 22 12
Amortization of discounts on convertible notes (2) 20 19 47 19
------------------------------------------------------------------------------------------
Total interest expense $61 $48 $145 $56
==========================================================================================
Consists of amortization of an imputed discount of $335,000 on warrants
issued to the Laurus Master Fund Ltd. ("Laurus"), and amortization of a
prepaid facility fee of $117,000 in connection with a revolving credit
facility entered into with Laurus on March 31, 2005. These costs are
included in deferred financing costs on the Consolidated Balance Sheet,
and are being amortized to interest expense over the three-year term of
the facility.
Consists of (i) the write-off of a $18,127 discount recorded in valuing
free-standing warrants issued in connection with a convertible note which
was subsequently repaid (see Note 13); and (ii) amortization of discounts
imputed in accounting for the Company's convertible revolving and minimum
borrowing notes with Laurus (see Note 4).
10. SEGMENT INFORMATION
Historically, the Company had operated in a single business segment,
selling telecommunications equipment to businesses. During 2005, the Company
formed OIPV and commenced activities related to the development of a new
business segment which provides hosted carrier-based Voice over IP products and
related network services to the small-to-medium business marketplace. The hosted
VoIP business, presented below as the "IP Telephony Services" business segment,
commenced sales operations in January 2006. Summarized financial information for
the Company's reportable business segments for the three and six months ended
June 30, 2006 and 2005, is presented below. Geographic information is not
presented because the Company does not operate outside of the United States.
Corporate expenses consist primarily of compensation and benefits, costs
associated with corporate governance and compliance, investor relations, and
other shared general expenses not allocated to the business segments. There are
no inter-segment sales.
Business segment information as of and for the three months ended June 30,
2006 and 2005 is as follows:
Telecom- IP
munication Telephony
(In thousands) Equipment Services Corporate Consol.
----------------------------------------------------------------------------------
2006:
Revenues $3,200 $ 55 $ - $ 3,255
Operating loss (478) (1,241) (331) (2,050)
Depreciation and amortization
of property and equipment 23 33 - 56
Identifiable assets 5,074 743 487 6,304
Capital expenditures 38 55 - 93
2005:
Revenues $4,483 $ - $ - $ 4,483
Operating loss (14) (150) (265) (429)
Depreciation and amortization
of property and equipment 24 1 3 28
Identifiable assets 5,783 - 569 6,352
Capital expenditures 35 - - 35
17
Business segment information as of and for the six months ended June 30,
2006 and 2005 is as follows:
Telecom- IP
munication Telephony
(In thousands) Equipment Services Corporate Consol.
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
2006:
Revenues $7,607 $ 62 $ - $ 7,669
Operating loss (613) (2,217) (589) (3,419)
Depreciation and amortization
of property and equipment 50 55 - 105
Identifiable assets 5,074 743 487 6,304
Capital expenditures 59 164 - 223
2005:
Revenues $6,892 $ - $ - $ 6,892
Operating loss (324) (243) (491) (1,058)
Depreciation and amortization
of property and equipment 45 3 5 53
Identifiable assets 5,783 - 569 6,352
Capital expenditures 74 - - 74
The following table reconciles the totals reported for the operating loss
of the segments to the Company's reported loss before income taxes:
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
(In thousands) 2006 2005 2006 2005
----------------------------------------------------------------------------------------
Total segment operating losses $(1,719) $(164) $(2,830) $(567)
Unallocated amounts:
Corporate expenses (331) (265) (589) (491)
Interest expense (61) (48) (145) (56)
Derivative instrument income (expense) 4,297 681 1,663 287
Other income 13 1 15 4
----------------------------------------------------------------------------------------
Consolidated income (loss) before income taxes $ 2,199 $ 205 $(1,886) $(823)
========================================================================================
11. EMPLOYEE BENEFIT PLANS
The components of the net periodic benefit cost included in the results of
operations for the three and six months ended June 30, 2006 and 2005 are as
follows:
Three months ended Six months ended
June 30, June 30,
------------------- ----------------
(In thousands) 2006 2005 2006 2005
----------------------------------------------------------------------
Service cost $22 $21 $44 $43
Interest cost 11 10 23 20
Recognized actuarial losses 2 3 4 5
----------------------------------------------------------------------
Net expense $35 $34 $71 $68
======================================================================
18
12. INCOME (LOSS) PER SHARE
Basic income (loss) per share is computed by dividing the net income
(loss) attributable to the common stockholders (the numerator) by the weighted
average number of shares of common stock outstanding (the denominator) during
the reporting periods. Diluted income (loss) per share is computed by increasing
the denominator by the weighted average number of additional shares that could
have been outstanding from securities convertible into common stock, such as
stock options and warrants (using the "treasury stock" method), and convertible
preferred stock and debt (using the "if-converted" method), unless their effect
on net income (loss) per share is antidilutive. Under the "if-converted" method,
convertible instruments are assumed to have been converted as of the beginning
of the period or when issued, if later, and any proceeds received on conversion
are assumed to have been used to purchase treasury stock at the average market
price for the period. Net income is adjusted to eliminate interest expense and
any gains or losses from derivative instruments during the period.
Three months ended Six months ended
June 30, June 30,
------------------ ------------------
2006 2005 2006 2005
------- ------ ------- ------
Numerator:
Net income (loss) $ 2,196 $ 202 $(1,896) $ (830)
Less: accretion of discount on preferred stock 25 - 26 -
------- ------ ------- ------
Net income (loss) attributable to common stockholders
- Basic 2,171 202 (1,922) (830)
Effect of dilutive securities:
Laurus convertible debt (391) - - -
Placement agent warrants for common stock (148) - - -
Series A preferred stock (2,927) - - -
------- ------ ------- ------
Net income (loss) attributable to common stockholders
- Diluted $(1,295) $ 202 $(1,922) $ (830)
======= ====== ======= ======
Denominator:
Weighted-average shares outstanding - Basic 4,002 3,353 3,930 3,340
Dilutive potential common shares:
Employee stock options and warrants 1,207 1,038 - -
Warrants issued in connection with convertible notes 137 - - -
Laurus convertible debt 1,296 - - -
Placement agent warrants for common stock 37 - - -
Series A convertible preferred stock 2,473 - - -
------- ------ ------- ------
Weighted-average shares outstanding - diluted 9,152 4,391 3,930 3,340
Basic net income (loss) per share $ .54 $ .06 $ (.49) $ (.25)
======= ====== ======= ======
Diluted net income (loss) per share $ (.14) $ .05 $ (.49) $ (.25)
======= ====== ======= ======
Weighted-average securities excluded from the computation
of diluted earnings (loss) per share (1):
Employee stock options and warrants 1,685 1,424 2,844 2,370
Warrants issued to Laurus 500 500 500 250
Laurus convertible debt - 324 1,296 162
Series A convertible preferred stock - - 1,553 -
Warrants for preferred and common shares issued in
private placements 1,365 - 787 -
------- ------ ------- ------
3,550 2,248 6,980 2,782
======= ====== ======= ======
These securities have been excluded because (i) their exercise or
conversion prices were higher than the average market price during the
period, or (ii) their inclusion would reduce net loss per share and,
therefore, be anti-dilutive.
19
13. SUBSEQUENT EVENTS
Effective July 3, 2006, the Company entered into an agreement with Rhyne
Communications, Inc. (RCI"), Rhyne Capital Corporation ("RCC") and Mr. Henry
Delgado (the sole owner of RCI and RCC) (the "Agreement") to acquire certain
fixed assets, telephone equipment, existing maintenance contracts, and vehicles.
The purchase price consisted of (i) $15,000 cash for the acquired fixed assets,
consisting primarily of computer equipment, office furniture and equipment; and
(ii) 50,000 shares of restricted common stock which had a market value at June
30, 2006 of $61,000. The acquired maintenance contracts, which have remaining
terms of less than one year, have an annualized contract value of $94,000, of
which $33,000 is billable by the Company through their current renewal dates.
The Company additionally acquired 4 vehicles currently being financed under
installment notes, with remaining terms ranging from 12-59 months, by agreeing
to assume their remaining installment payments, which aggregated $61,717 at June
30, 2006.
The Company entered into the Agreement in order to expand its direct
installation and maintenance business. In connection with the Agreement, the
Company entered into a two-year employment agreement with Mr. Delgado, and hired
five former installation technicians of RCI. In addition, the Company agreed to
an assignment of RCI's existing lease contract, pending approval by the
landlord, for office space in Pine Brook, NJ, from which the Company will locate
its installation and maintenance operations. Under the lease, the Company will
be leasing 5,328 square feet of office space under a term expiring March 31,
2011. The monthly rental payments will range from $3,996 to $4,493 over the
lease term.
The Company has not completed a valuation of the tangible and intangible
assets acquired, net of assumed liabilities; however the value of the net assets
acquired will not be material to the Company's consolidated balance sheet.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The discussions set forth below and elsewhere in this Quarterly Report on
Form 10-Q contain certain statements, based on current expectations, estimates,
forecasts and projections about the industry in which we operate and
management's beliefs and assumptions, which are not historical facts and are
considered forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 ("the Act"). Forward-looking statements
include, without limitation, any statement that may predict, forecast, indicate,
or imply future results, performance, or achievements, and may contain the words
"believe," "will be," "will continue," "will likely result," "anticipates,"
"seeks to," "estimates," "expects," "intends," "plans," "predicts," "projects,"
and similar words, expressions or phrases of similar meaning. Our actual results
could differ materially from those projected in the forward-looking statements
as a result of certain risks, uncertainties and assumptions, which are difficult
to predict. Many of these risks and uncertainties are described under the
heading "Risks, Uncertainties and Other Factors That May Affect Future Results"
below. All forward-looking statements included in this document are based upon
information available to us on the date hereof. We undertake no obligation to
update publicly any forward-looking statements, whether as a result of new
information, future events or otherwise. In addition, other written or oral
statements made or incorporated by reference from time to time by us or our
representatives in this report, other reports, filings with the Securities and
Exchange Commission ("SEC"), press releases, conferences, or otherwise may be
forward-looking statements within the meaning of the Act.
RESULTS OF OPERATIONS
Overview
For the three months ended June 30, 2006, we reported net income of
$2,196,000 or $.54 per share, on revenues of $3,255,000. This compares with net
income of $202,000 or $.06 per share, on revenues of $4,483,000 recorded for the
three months ended June 30, 2005. Net income in each quarterly period included
non-cash derivative instrument income of $4,297,000 and $681,000, respectively,
primarily arising from decreases in the fair market value of the Company's
derivative financial instruments during this period, as more fully described in
Notes 1 and 5 of the Notes to Consolidated Financial Statements contained
herein. Excluding the non-cash derivative instrument income, we otherwise
incurred a $2,101,000 loss for the three months ended June 30, 2006 as compared
with a $479,000 loss for the three months ended June 30, 2005. The operating
results for the three months ended June 30, 2006 and 2005 include an operating
loss of approximately $1,241,000
20
and $150,000, respectively, attributable to the start-up operations of our
wholly-owned subsidiary OIPV Corp. as further described below.
For the six months ended June 30, 2006, we reported a net loss of
$1,896,000 or $(.49) per share, on revenues of $7,669,000. This compares with a
net loss of $830,000 or $(.25) per share, on revenues of $6,892,000 recorded for
the six months ended June 30, 2005. The net loss in each period included
non-cash derivative instrument income of $1,663,000 and $287,000, respectively.
Excluding the non-cash derivative instrument income, we otherwise incurred a
$3,559,000 loss for the six months ended June 30, 2006 as compared with a
$1,117,000 loss for the six months ended June 30, 2005. The operating results
for the six months ended June 30, 2006 and 2005 include an operating loss of
approximately $2,217,000 and $243,000, respectively, attributable to OIPV Corp.
As further described in our Annual Report on Form 10-K for the year ended
December 31, 2005, we have taken several measures to turnaround our operating
performance. The turnaround strategy is principally based upon trying to
stabilize our legacy telecommunications business through building a larger and
more highly qualified sales force and diversifying our product offerings and
targeted customers, increasing our focus on the small-to-medium size business
("SMB") market along with continuing to serve our base of large, "Enterprise"
customers., while at the same time developing an IP telephony services business
in order to transition the Company's business model to a broader communications
solutions provider. In January 2006, OIPV Corp became operational, offering
carrier-based hosted IP telephony services along with network services
nationwide. Its primary target is also the SMB market. Although our efforts to
date have resulted in increased revenues in 2006 to date as compared to 2005, we
are continuing to incur operating losses from both our legacy telecommunications
and IP telephony services businesses.
In order to finance our business turnaround and expansion plans, we
increased our credit lines in March 2005, obtaining a $3 million credit facility
from Laurus Master Fund Ltd. which replaced a $1.7 million credit facility.
During 2006, the Company raised approximately $4 million of additional capital
through offerings of convertible debt and preferred stock to unaffiliated
private investors. This new capital has been used to continue the build out and
national deployment of our IP telephony products and services, and to fund our
2006 operating losses. Significant amounts of additional external financing,
however, will be required in order to sustain current operations and for the
further development of the OIPV Corp. IP telephony business to the operating
levels anticipated by management. For additional information on our financial
condition refer to the Liquidity and Capital Resources section which follows.
Additional information on our results of operations and financial
condition for the three and six ended June 30, 2006 follows below.
Revenues
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
(In thousands) 2006 2005 2006 2005
--------------------------------------------------------------------------
Equipment:
End-user equipment sales $2,389 $3,660 $5,716 $5,534
Equipment sales to resellers 93 63 230 154
--------------------------------------------------------------------------
Total equipment sales 2,482 3,723 5,946 5,688
--------------------------------------------------------------------------
Services:
Installations 526 401 1,193 659
Other services 20 18 44 48
IP telephony services 33 - 40 -
--------------------------------------------------------------------------
Total services 579 419 1,277 707
Other revenue 194 341 446 497
--------------------------------------------------------------------------
Total services and other revenue 773 760 1,723 1,204
--------------------------------------------------------------------------
Consolidated revenues $3,255 $4,483 $7,669 $6,892
==========================================================================
Revenues by business segment:
Telecommunications Equipment $3,200 $4,483 $7,607 $6,892
IP Telephony Services 55 - 62 -
--------------------------------------------------------------------------
Consolidated revenues $3,255 $4,483 $7,669 $6,892
==========================================================================
21
Equipment Sales. End user equipment sales for the three months ended June
30, 2006 decreased by $1,271,000 or 35% from the comparable 2005 period, of
which $935,000 or 74% of the decrease was attributable to lower systems sales,
with the balance of the shortfall attributable to lower parts sales. The
comparable prior year period included a $500,000
system sale to one customer. End user equipment sales for the six months ended
June 30, 2006 increased by $182,000 or 3% over the comparable 2005 period, as a
result of a $208,000 increase in system sales, offset by a $26,000 decline in
parts sales. During the three and six months ended June 30, 2006, OIPV Corp.
generated $19,000 in equipment sales. The telecommunications equipment business
has become extremely price-competitive, especially among the larger businesses.
Equipment has become more of a "commodity" business and less of a "value-added"
business, and has therefore become more prone to price-shopping by customers.
This situation has affected our sales levels, and we expect that this business
environment will continue. Since March 2005, we have increased our focus on
capturing more market share in the small-to-medium - sized business ("SMB")
marketplace in order to generate incremental equipment sales revenues. Sales
growth in the SMB sector has contributed to our year-to-date 2006 growth in
equipment sales.
Services revenue for the three months ended June 30, 2006 increased by
$160,000 or 38% over the comparable 2005 period, attributable primarily to a
$123,000 increase in the legacy telecommunications business installation
revenues, and $35,000 of hosted and network service revenues generated by OIPV
Corp. Services revenue for the six months ended June 30, 2006 increased by
$570,000 or 81% over the comparable 2005 period, attributable primarily to a
$532,000 increase in the legacy telecommunications business installation
revenues, and $40,000 of hosted and network service revenues generated by OIPV
Corp. An increase or decrease in installation revenues, however, does not always
coincide with the reported increase or decrease in system sales since
installations may occur in different periods than the related system sale.
Other revenue for the three months ended June 30, 2006 decreased by
$147,000 or 43% from the comparable 2005 period, primarily attributable to a
$135,000 decrease in commissions earned on Avaya maintenance contract sales.
Other revenue for the six months ended June 30, 2006 decreased by $51,000 or 10%
from the comparable 2005 period, primarily attributable to a $72,000 decrease in
commissions earned on Avaya maintenance contract sales. In the sale of Avaya
maintenance contracts, the Company receives a one-time commission, and all of
the equipment service obligations are borne entirely by Avaya.
Cost of Revenues and Gross Profit. Total cost of revenues for the three
months ended June 30, 2006 was $2,544,000, a decrease of $603,000 or 19% from
the comparable 2005 period. The gross profit for the three months ended June 30,
2006 was $711,000, a decrease of $625,000 or 47% from the comparable 2005
period. As a percentage of revenue, the overall gross profit margin was 22% for
2006, compared to 30% for the comparable 2005 period. Total cost of revenues for
the six months ended June 30, 2006 was $5,713,000, an increase of $911,000 or
19% from the comparable 2005 period. The gross profit for the six months ended
June 30, 2006 was $1,956,000, a decrease of $134,000 or 6% from the comparable
2005 period. As a percentage of revenue, the overall gross profit margin was 26%
for 2006, compared to 30% for the comparable 2005 period.
Gross profit by business segment is as follows (in thousands):
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
2006 2005 2006 2005
----- ------ ------ ------
Telecommunications Equipment:
Gross profit $ 781 $1,336 $2,115 $2,090
Percent of revenues 24% 30% 28% 30%
IP Telephony Services:
Gross profit (loss) (70) - (159) -
Percent of revenues (128)% - (257)% -
----- ------ ------ ------
Consolidated:
Gross profit $ 711 $1,336 $1,956 $2,090
Percent of revenues 22% 30% 26% 30%
----- ------ ------ ------
The overall gross margin was adversely impacted by a $70,000 and $159,000
negative gross profit recorded by the IP Telephony Services business segment
(OPIV Corp.) during the three and six months ended June 30, 2006, respectively.
This
22
segment, which commenced sales operations in January 2006, has not currently
generated enough business volume to cover its network operating costs.
Gross Profit Margins on Equipment Sales. For the three months ended June
30, 2006, the gross profit margin on equipment sales decreased to 23% from 28%
in 2005. The decline is attributable to lower profit margins on both end user
parts and systems sales. For the six months ended June 30, 2006, the gross
profit margin on equipment sales decreased to 27% from 29% in 2005. The decline
is attributable to lower profit margins on end user parts sales. Profit margins
on system sales were the same as the prior year period, due in part to increased
sales to the SMB marketplace at higher average profit margins than we generate
from sales to large, "Enterprise level" companies. The telecommunications
equipment business has become extremely price-competitive, especially among the
larger businesses. Equipment has become more of a "commodity" business and less
of a "value-added" business, and has therefore become more prone to
price-shopping by customers, which has had a negative impact on profit margins.
We expect that this business environment will continue.
Gross Profit Margins on Services and Other Revenue. For the three months
ended June 30, 2006, the Company recorded an overall 29% profit margin on its
combined services and other revenue, compared with a 58% profit margin recorded
in the comparable 2005 period. Excluding the negative profit margin generated by
OIPV Corp, as further described below, the profit margin for 2006 on services
and other revenue was 41%. For the six months ended June 30, 2006, the Company
recorded an overall 31% profit margin on its combined services and other
revenue, compared with a 54% profit margin recorded in the comparable 2005
period. Excluding the negative profit margin generated by OIPV Corp, as further
described below, the profit margin on services and other revenue for the six
months ended June 30, 2006 was 41%.
The gross profit margin on services revenue was 4% for the three months
ended June 30, 2006 compared with 31% in the comparable 2005 period. The 2006
profit margin consisted of a 26% profit margin generated by the legacy
telecommunications equipment business segment, compared to 31% in the prior year
period, offset by a negative profit margin from the IP telephony services
business segment (OIPV Corp). OIPV Corp generated $72,000 of hosted and network
service costs in excess of its realized revenues during this period, which
represented its second quarter of sales operations. The 5 percentage point
decline in the legacy telecommunications equipment business segment was
attributable to the significant increase in installation revenues at lower
profit margins than in the prior year period.
The gross profit margin on services revenue was 13% for the six months
ended June 30, 2006 compared with 31% in the comparable 2005 period. The 2006
profit margin consisted of a 27% profit margin generated by the legacy
telecommunications equipment business segment, compared to 31% in the prior year
period, offset by a negative profit margin from OIPV Corp. OIPV Corp generated
$160,000 of hosted and network service costs in excess of its realized revenues
during 2006. The 4 percentage point decline in the legacy telecommunications
equipment business segment was attributable to the significant increase in
installation revenues at lower profit margins than in the prior year period.
OIPV Corp's hosted and network service costs, which include its network
operations center, facility costs, fees paid to third-party carriers, and
depreciation of its network equipment and licenses, currently provide "excess
capacity", and as such will continue to have a negative impact on the Company's
profit margins until such time as the volume of business generated exceeds these
costs.
The gross profit margin on other revenues was 82% and 81%, respectively
during the three and six months ended June 30, 2006, compared with 90% and 87%
during the comparable prior year period. Other revenue primarily consists of
one-time commissions earned on the sale of Avaya maintenance contracts which
generate a 100% profit margin. The decrease in gross profit margin in each
current period resulted from lower sales of these maintenance contracts.
Other Cost of Revenues. Other cost of revenues consist of product
handling, purchasing and facility costs and expenses incurred by the
telecommunications equipment business segment. They represented approximately 3%
of equipment revenues during the three and six months ended June 30, 2006,
compared to 4% of equipment revenues during the prior year periods.
Selling, General and Administrative ("SG&A") Expenses.
Three months ended June 30, 2006:
SG&A expenses for the three months ended June 30, 2006 were $2,761,000, an
increase of $996,000 or 56% from the comparable 2005 period. SG&A expenses for
the three months ended June 30, 2006 were 85% of revenues, compared to
23
39% of revenues in 2005. Approximately $1,171,000 of SG&A expenses were incurred
by, or allocated to, OIPV Corp. in 2006 as compared to $150,000 allocated in
2005. OIPV Corp. was formed in May 2005 and commenced sales operations in
January 2006.
Sales and marketing expenses accounted for $337,000 of the increase in
SG&A for the three months ended June 30, 2006, of which $294,000 was
attributable to salaries and commissions from the buildout to date of OIPV
Corp's sales and marketing team. The Company also recognized $43,000 of non-cash
stock option expense from the implementation of the accounting requirements of
SFAS 123R, as further described in Note 6 - Stock-Based Compensation.
General and administrative expenses accounted for $659,000 of the increase
in SG&A, of which $428,000 was directly incurred by OIPV Corp. and related to
the hiring of management and administrative personnel, office rent and related
expenses associated with its national operations center in Denver, Colorado,
costs associated with the outsourcing of its billing operations, and other
employee-related expenses including insurance, depreciation and business travel.
Other items contributing to the increase in SG&A expense during the current
quarter of 2006 include increased legal and investor relations fees, and project
consulting fees related to development of web-based training materials. The
increase in SG&A includes $53,000 of non-cash stock option expense as referred
to above.
Six months ended June 30, 2006:
SG&A expenses for the six months ended June 30, 2006 were $5,375,000, an
increase of $2,227,000 or 71% from the comparable 2005 period. SG&A expenses for
the six months ended June 30, 2006 were 70% of revenues, compared to 46% of
revenues in 2005. Approximately $2,058,000 of SG&A expenses were incurred by, or
allocated to, OIPV Corp. in 2006 as compared to $243,000 allocated in 2005.
Sales and marketing expenses accounted for $1,117,000 of the increase in
SG&A for the six months ended June 30, 2006, of which $599,000 was attributable
to salaries and commissions from the buildout to date of OIPV Corp's sales and
marketing team, and $329,000 was attributable to salaries and commissions
associated with the legacy telecommunications equipment sales team. The
remaining $189,000 increase in sales and marketing expenses were primarily
attributable to product marketing, training and travel expenses incurred by OIPV
Corp. in the development of its product materials and business partners. The
increase in sales and marketing expenses includes $82,000 of non-cash stock
option expense.
General and administrative expenses accounted for $1,110,000 of the
increase in SG&A, of which $654,000 was directly incurred by OIPV Corp related
to the hiring of management and administrative personnel, office rent and
related expenses associated with its national operations center in Denver,
Colorado, costs associated with the outsourcing of its billing operations, and
other employee-related expenses including insurance, depreciation and business
travel. Other items contributing to the increase in SG&A expense during the
current six-month period include increased legal and investor relations fees,
and project consulting fees related to development of web-based training
materials. The increase in general and administrative expenses includes $97,000
of non-cash stock option expense as referred to above. Included in general and
administrative expense in 2005 was $84,000 of expense related to the early
termination of the Company's credit facility with BACC.
We expect our SG&A expenses to increase as we continue the infrastructure
development and deployment of our OIPV Corp. product offerings.
OTHER INCOME (EXPENSE). Other income (expense) for the three and six
months ended June 30, 2006 was $4,249,000 and $1,663,000, respectively, compared
with $681,000 and $287,000, respectively, for 2005. The principal components of
other income (expense) are as follows.
Interest Expense:
Three months ended Six months ended
June 30 June 30
------------------ ----------------
(In thousands) 2006 2005 2006 2005
----------------------------------------------------------------------------------------
Interest expense on outstanding borrowings $32 $17 $ 76 $25
Amortization of deferred financing costs 9 12 22 12
Amortization of discounts on convertible notes 20 19 47 19
----------------------------------------------------------------------------------------
Total interest expense $61 $48 $145 $56
========================================================================================
24
The increase in interest expense on outstanding borrowings was primarily
attributable to higher average borrowing levels and interest rates under the
Company's credit facilities. Amortization of deferred financing costs consists
of (i) the amortization of a $335,000 imputed discount on warrants issued to the
Laurus and (ii) the amortization of a $117,000 prepaid facility fee in
connection with the Laurus revolving credit facility entered into March 31,
2005. These costs are included in deferred financing costs on the Consolidated
Balance Sheet, and are being amortized to interest expense over the three-year
term of the facility. Amortization of discounts on convertible notes includes
(i) amortization of the imputed discount on the
Laurus Minimum Borrowing Note and Revolving Note (see Note 4), and (ii) for the
three and six months ended June 30, 2006 a $(5,092) and $18,128 write-off of the
unamortized balance of a discount recorded in valuing warrants issued in
connection with the issuance of a $400,000 convertible note which was repaid in
full. The discount was originally recorded at $23,220 in the first quarter of
2006, but adjusted to $18,128 upon an amendment to the underlying warrant which
reduced its term from 10 to 5 years. Discounts imputed in accounting for the
Company's convertible notes and warrants issued to the Laurus Master Fund
pursuant to this credit facility, are being amortized to interest expense over
their term using the effective interest method.
Derivative instrument income. The Company recorded income of $4,297,000
and $1,663,000 during the three and six months ended June 30, 2006,
respectively, from a reduction in the calculated fair market value of derivative
instrument liabilities arising from its 2006 private placements of convertible
debt, convertible Series A preferred stock and associated common and preferred
stock warrants, as well as from its Laurus convertible notes and issued
free-standing warrants. The Company recorded income of $681,000 and $287,000
during the three and six months ended June 30, 2005, respectively, from
derivative instrument liabilities arising from its Laurus convertible notes and
issued free-standing warrants. The recording of derivative income resulted from
the decline in the fair market value of such derivative instrument liabilities
from their inception to the end of each reporting period due to a decline in the
market value of the Company's common stock. Income or losses generated from
these derivative liabilities principally arise from changes in the fair market
value of the Company's common stock price during each reporting period, as the
Company is required to record "mark-to-market" adjustments to the value of its
derivative liabilities. These "mark-to-market" adjustments are non-cash, with no
impact on liquidity.
Other income for all periods presented consisted of interest earned on
invested cash.
PROVISION FOR INCOME TAXES. The provision for income taxes represents
estimated minimum state taxes in all reported periods. We maintain a full
valuation allowance against our net deferred tax assets, which consist primarily
of net operating loss and capital loss carryforwards, and timing differences
between the book and tax treatment of inventory and other asset valuations.
Realization of these net deferred tax assets is dependent upon our ability to
generate future taxable income.
LIQUIDITY AND CAPITAL RESOURCES
Working capital, defined as current assets less current liabilities, was
$80,000 at June 30, 2006, compared to a deficiency of ($568,000) at December 31,
2005. The working capital ratio was 1.02 to 1 at June 30, 2006, compared to .88
to 1 at December 31, 2005. Working capital at June 30, 2006 included a $618,000
non-cash derivative instrument liability related to the Company's convertible
revolving credit facility which was recorded in current liabilities. Similarly,
the working capital deficiency at December 31, 2005 included a $385,000 non-cash
derivative instrument liability related to the Company's convertible revolving
credit facility. Excluding the effect on working capital resulting from the
derivative instrument liabilities, working capital otherwise improved by
$881,000 from December 31, 2005 attributable to proceeds received from the
issuance of a $1,000,000 convertible note, and from the sale of Series A
preferred stock as further described below.
Operating activities used $3,285,000 during the six months ended June 30,
2006, compared to using $830,000 in the comparable 2005 period. Net cash used by
operating activities in 2006 consisted of a net loss of $1,896,000 plus non-cash
items credited to income aggregating $1,222,000, and net cash used by changes in
operating assets and liabilities of $167,000. The non-cash items included
$1,663,000 of net unrealized gains arising from the net decrease in value of the
Company's derivative instrument liabilities, as more fully presented in Notes 1
and 5. The operations of the Company's wholly-owned subsidiary, OIPV Corp.
accounted for approximately $2.2 million of the use of cash from operating
activities arising from a $2.2 million net loss for the current period.
Investing activities used $188,000 during the six months ended June 30,
2006, compared to $18,000 in 2005. Net cash used by investing activities in 2006
and 2005 consisted of capital expenditures. Capital expenditures during 2006
were
25
principally for the purchase of network equipment and software in connection
with OIPV Corp's continuing build out of its IP telephony platform, and for
computer and office equipment to support our expanded personnel levels. Pursuant
to our loan agreement with Laurus, we may obtain external financing on capital
expenditures of up to $500,000 in any fiscal year period before requiring
Laurus's prior approval.
Financing activities provided $3,983,000 during the six months ended June
30, 2006, principally from net proceeds of $913,000 from the issuance of a $1
million convertible note and net proceeds of $2,991,000 from the sale of Series
A preferred stock.
The Company is not currently generating sufficient cash flow from
operations to cover the operating costs of both our legacy telecommunications
business and OIPV Corp, and we are highly dependent upon our current credit
facility and generating cash through offerings of Company securities in order to
sustain current operating levels. As of June 30, 2006 the Company's borrowing
availability under the revolving loan portion of the Laurus credit facility was
only $20,000. Our borrowing availability has been negatively impacted by (i)
lower sales volume than expected; (ii) $1.1 million of "ineligible" accounts
receivable by formula - primarily represented by accounts that are over 90 days
old; and (iii) continuing negative cash flow from operating and investing
activities.
During the period January through April of 2006, the Company completed
several private placements of convertible debt and equity securities, raising
approximately $3.9 million, for use in its current business and the working
capital requirements of OIPV Corp. Refer to Notes 7 and 8 of the Notes to
Consolidated Financial Statements contained herein, for a description of the
material terms of these financing transactions. To summarize:
* On January 30, 2006, the Company issued a $400,000 Convertible
Promissory Note and a Warrant to purchase 22,047 shares of common stock
to an affiliate of the placement agent, pursuant to a Convertible
Promissory Note and Purchase Agreement. This note was subsequently
repaid in full, with interest, on February 8, 2006.
* On February 8, 2006, the Company issued a $1,000,000 Principal Amount
Convertible Promissory Note (the "Sotomar Note") to Sotomar -
Empreendimentos Industriais e Imobiliarios, SA (the "Holder") pursuant
to a Convertible Note and Warrant Purchase Agreement (the "Purchase
Agreement") of even date. The proceeds received by the Company, net of
$80,000 placement agent fees and $6,909 of expenses, amounted to
$913,091. Pursuant to the terms of the Sotomar Note, as a result of the
sale of Units described below, on February 17, 2006 the Sotomar Note,
together with interest accrued thereon, converted into 58,970 shares of
Series A Preferred Stock.
* On February 17, 2006, March 17, 2006 and April 17, 2006 the Company
sold an aggregate of 200,456 Unit shares of Series A Preferred Stock to
several accredited investors (the "Investors") at a price of $17.00 per
Unit. Each Unit consists of (i) one share of the Company's Series A
Preferred Stock, $.001 par value per share, and (ii) a Warrant to
purchase five shares of the Company's Common Stock, par value $.001 per
share, at an exercise price of $2.125 per share (the Series A Preferred
Stock and the Warrant together "Securities"). The proceeds received by
the Company, net of $272,634 placement agent fees and $144,156 expenses
incurred by the Company's placement agent, were $2,991,071.
Significant amounts of additional external financing will be required in
order to sustain current operations and for the further development of the OIPV
Corp IP telephony business to the operating levels anticipated by management. At
a Special Meeting of the Stockholders of the Company, held December 16, 2005,
the Company received shareholder approval to conclude one or a series or
combination of private offerings to investors of the Company's Securities, and a
secondary offering to the public of Common Stock, in the range of approximately
$6,000,000 to $26,000,000 (exclusive of any securities which may be sold upon
exercise of any overallotment options). No assurances can be given, however,
that we will continue to be successful in raising cash through securities
offerings, since they are dependent upon, among other factors, the market
conditions prevailing during the offering periods. In order to conclude such
additional financing, we may also need to demonstrate improved operating
performance.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion included in Item 7 of our Annual Report on Form 10-K for
the year ended December 31, 2005 under the subheading "Critical Accounting
Policies and Estimates" is still considered current and applicable, and is
hereby incorporated into this Quarterly Report on Form 10-Q.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The discussion included in Item 7A of our Annual Report on Form 10-K for
the year ended December 31, 2005, "Quantitative and Qualitative Disclosures
About Market Risk", is still considered current and applicable, and is hereby
incorporated into this Quarterly Report on Form 10-Q.
ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures. We maintain
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) that
are designed to ensure that information required to be disclosed in our reports
filed under the Exchange Act, is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission's
rules and forms, and that such information is accumulated and communicated to
our management, including our Chief (principal) Executive Officer and Chief
(principal) Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.
An evaluation was conducted by our Chief Executive Officer and Chief
Financial Officer of the effectiveness of the Company's disclosure controls and
procedures as of the end of the period covered by this report. Based on that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective to ensure that
information required to be disclosed in our reports filed under the Exchange
Act, is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms.
(b) Changes in Internal Controls. There have been no changes in our
internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) during the most recently completed fiscal
quarter that materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.
PART II. OTHER INFORMATION.
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 1A. RISK FACTORS
The discussion included in Item 1A of our Annual Report on Form 10-K for
the year ended December 31, 2005 under the subheading "Risk Factors" is still
considered current and applicable, and is hereby incorporated into this
Quarterly Report on Form 10-Q.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The Company hereby incorporates by reference the information contained in
Current Reports on Form 8-K filed with the Securities and Exchange Commission on
the following dates: February 14, 2006, February 24, 2006, March 21, 2006 and
April 21, 2006. In connection with the reported transactions, the Company's
placement agent received aggregate cash fees of $272,634, and warrants to
purchase shares of common stock and Series A preferred stock as described in the
aforementioned Current Reports and in Notes 7 and 8 of the Notes to Consolidated
Financial Statements contained herein.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
27
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS:
The following documents are filed as Exhibits to this Quarterly Report on
Form 10-Q:
3.1 Certificate of Amendment of Certificate of Incorporation of the
Company dated July 19, 2006.
10.1 Asset Purchase Agreement effective as of July 3, 2006 with Rhyne
Communications, Inc., Rhyne Capital Corporation and Henry Delgado.
31.1 Certification of the Chief Executive Officer, pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer, pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer, pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer, pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the un
dersigned thereunto duly authorized.
ONE IP VOICE, INC.
Dated: August 14, 2006 /s/ Jean-Marc Stiegemeier
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Jean-Marc Stiegemeier
Chief Executive Officer, President
Dated: August 14, 2006 /s/ Robert G LaVigne
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Robert G. LaVigne
Executive Vice President,
Chief Financial Officer
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