SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007 COMMISSION FILE NUMBER: 0-51111
PROTOCALL TECHNOLOGIES INCORPORATED
-----------------------------------
(Name of small business issuer in its charter)
NEVADA 41-2033500
----------------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
47 MALL DRIVE
COMMACK, NEW YORK 11725-5717
----------------------------------------- ------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (631) 543-3655
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
COMMON STOCK, PAR VALUE
$.001 PER SHARE
Check whether the issuer is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange Act [ ]
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for
such shorter period that the issuer was required to file such reports), and (2)
has been subject to the filing requirements for the past 90 days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B and no disclosure will be contained, to the best of the
issuer's knowledge, in definitive proxy or information statements incorporated
by reference in Part III of this Form 10-KSB or any amendment to this Form
10-KSB. [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The issuer's revenues for the fiscal year ended December 31, 2007 were
$954,792.
The aggregate market value of the voting and non-voting stock held by
non-affiliates of the issuer was approximately $ 1,132,975 BASED ON THE CLOSING
PRICE OF $0.007 PER SHARE ON MAY 8, 2008, AS QUOTED BY THE OTC BULLETIN BOARD.
The number of shares outstanding of the issuer's Common Stock as of MAY
16, 2008 WAS 161,853,500.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
--------------------------------------------------------------
DOCUMENTS INCORPORATED BY REFERENCE
None
PROTOCALL TECHNOLOGIES INCORPORATED
2007 FORM 10-KSB ANNUAL REPORT
TABLE OF CONTENTS
PART I
Item 1. Description of Business 1
Item 2. Description of Property 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 11
PART II
Item 5. Market for Common Equity, Related Stockholder Matters and Small
Business Issuer Purchases of Equity Securities 12
Item 6. Management's Discussion and Analysis or Plan of Operation 28
Item 7. Financial Statements 40
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 40
Item 8A. Controls and Procedures 40
Item 8B. Other Information 40
PART III
Item 9. Directors, Executive Officers, Promoters, Control Persons and Corporate
Governance Compliance with Sections 16(a) of the Exchange ACT 41
Item 10. Executive Compensation 46
Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 48
Item 12. Certain Relationships and Related Transactions 49
Item 13. Exhibits and Reports on Form 8-K 50
Item 14. Principal Accountant Fees and Services 51
PART I
ITEM 1. DESCRIPTION OF BUSINESS
OUR BUSINESS
Protocall Technologies Incorporated is engaged in the development and
commercialization of an electronic sell-through platform that enables retailers
to produce premium DVD movie, consumer software and video game products in
retail packaging at their stores and website distribution centers. Our service
offers retailers a virtual inventory of digital media products that can be
produced on-demand, thereby reducing or potentially eliminating the cost of
physical inventories. Our service condenses the traditional manufacturing,
storage and shipping process and allows a greater number of digital media
products to be offered by retailers with minimal capital outlays and dedicated
floor space.
Our company also provides outsourced fulfillment services to web retailers
whereby digital media product orders are electronically routed to our facilities
for on-demand production and shipment to the retailer's customer. The on-demand
process is transparent to consumers and ensures 100% product availability with
no delays due to out-of-stock situations or back orders.
According to the Digital Entertainment Group, 2007 U.S. purchases and
rentals of DVD movies amounted to $25 billion in sales while sales of consumer
software and PC game products totaled approximately $4 billion according to the
NPD Group. Based on internal estimates, we believe that on-demand production of
digital media products in general, by our company and others, is an emerging
channel of distribution that can potentially account for approximately 20-25% of
overall DVD unit sales in the next five to seven years. We expect our revenues
to increase as adoption of our service increases in the retail sector.
We commenced a commercial pilot of our service in January 2004 with
CompUSA in three U.S. regions where it was used to produce a variety of consumer
software products from suppliers including Microsoft, IBM/Lotus, Symantec,
Corel, McAfee, Roxio and others. We believe the CompUSA pilot was the first-ever
commercial implementation of a "burn-on-demand" service in a retail venue. The
pilot, which ran in 25 stores provided demanding usage of our service in a live
retail environment and led to numerous performance and usability upgrades. In
2006, we began an expansion into the DVD movie market and started to reduce and
eventually discontinued the CompUSA pilot sites in an effort to reduce
expenditures in preparation for the launch of our TitleMatch DVD On-Demand(TM)
service. In November 2006, we created a wholly-owned subsidiary called
TitleMatch Entertainment Group Inc. to focus on our business expansion in the
home entertainment market.
In September 2007, the DVD CCA, an organization of Hollywood studios and
hardware makers, issued final approval for a copy-protection system called CSS
to be used with recordable DVDs, which is the type of disk used in on-demand
production. CSS is used on commercially-pressed DVDs to limit unauthorized
copying and its availability for recordable DVDs was crucial to movie studios
releasing their libraries to retailers for on-demand production.
2
We executed our first TitleMatch DVD On-Demand retailer agreement in May
2007 with a national 6,000 store retailer that planned to initially use our
service at approximately 200 of their stores in various US markets during 2008.
We are however evaluating our ability to perform under this agreement based on
the resignation of our Chief Technology Officer on May 5, 2008. As a result, we
anticipate significant delays in the implementation of our service with this
retailer or termination of the agreement in its entirety. As part of our initial
focus on consumer software products, we signed a fulfillment services agreement
in 2004 with TigerDirect.com, which continues to be an active customer for us.
In 2007, we signed agreements with Overstock.com and RightStuf.com to provide
fulfillment services for both software and eventually movie products. Our
revenue in 2007 was principally derived from our outsourced fulfillment
services. We are in discussions with other web retailers to use our outsourcing
services and we anticipate revenue from these services to increase as additional
software and movie titles are licensed by us from content owners.
To date, we have signed content provider agreements with approximately 15
movie studios and 200 publishers of consumer software products. We anticipate
additional movie content agreements, which are obtained in conjunction with
retailers that use our service.
CORPORATE INFORMATION AND HISTORY
Our corporate predecessor, Protocall Technologies Incorporated was formed
in December 1992. In 1998, we began focusing on the development and
commercialization of our on-demand service, which was re-branded from
SoftwareToGo to TitleMatch in 2006. Until 1998, Protocall was primarily focused
on licensing proprietary font software to large businesses and operated through
its Precision Type, Inc. subsidiary which was discontinued in 2004.
On July 22, 2004, we completed a reverse merger transaction with Quality
Exchange, Inc., a Nevada corporation formed in June 1998. Prior to the merger,
Quality Exchange was a developmental stage company which, through its
wholly-owned subsidiary, Orion Publishing, Inc., planned to provide an
Internet-based vehicle for the purchase and exchange of collectible and
new-issue comic books. We discontinued these activities simultaneously with the
merger by the sale of that business to Quality Exchange's principal shareholder.
Upon the closing of the merger, the directors and management of Protocall became
the directors and management of Quality Exchange which then changed its name to
Protocall Technologies Incorporated.
Our principal executive offices are located at 47 Mall Drive, Commack, New
York 11725-5717, and our telephone number is (631) 543-3655. Our website is
located at www.protocall.com.
HOW RETAILERS USE OUR SERVICE
Our TitleMatch DVD On-Demand service is used in conjunction with computer
hardware that is provided by retailers. Each walk-in store installation of our
service includes a behind-the-counter TitleMatch Factory(TM) to produce DVD
orders and an optional TitleMatch StoreFront(TM) touch-screen and display rack
to promote available products to consumers. The TitleMatch
3
Factory can be used by web retailers at their distribution centers and is
scalable in production capacity to meet volume requirements. To process an order
from the TitleMatch Factory at retail stores, authorized personnel enter a
user-specific password and product order number. At website distribution
centers, orders are processed electronically based on website purchases. Once
initiated, the TitleMatch Factory automatically connects to our rights
management server via a secure Internet connection to register the order and
receive a one-time product decryption key. The decryption key is used by the
Factory to automatically release the selected product onto a DVD/CD disc and
print title-specific graphics onto the surface of the disc and package cover and
separate promotional sheet - each of which are placed inside a DVD case.
For most titles, the entire process takes from three to eight minutes,
depending on the content size of the product being produced. Orders can be
produced in quantities for display on sales racks or individually at the time of
sale. We use the latest DVD/CD recorder technology and our service can be scaled
to handle larger volume sales by integrating multiple DVD/CD recorders that
process orders simultaneously. A standard two DVD/CD recorder can produce an
average of 34 single CD orders per hour and approximately 15 single DVD orders
per hour. Products can be made in advance of anticipated sales for display on
retail racks, or as single-item orders.
BUSINESS GROWTH STRATEGY
Based on our continued investments in R&D, systems development, market
testing and long-standing business relationships, we believe our company is
uniquely positioned in the entertainment industry to benefit from the recent DVD
CCA decision to approve copy protection for on-demand production. These
investments, in combination with lower pricing for hardware, have drastically
reduced the cost for retailers to implement our service to approximately $5,000
- $8,000 per store - down from about $50,000 in earlier versions of our service.
We believe by lowering up-front implementation costs and expanding the range of
available products, we can promote adoption of our service by retailers and
simultaneously increase the barriers to entry for potential competitors. In the
near term we plan to focus our resources toward developing our outsourced
fulfillment services business.
RESEARCH AND PRODUCT DEVELOPMENT
We have conducted research and product development of electronic
distribution systems and services since our inception in 1998. Research and
product development expenditures were approximately $272,987 and $117,970 in the
years ended December 31, 2007 and 2006, respectively.
EQUIPMENT PRODUCTION, INSTALLATION AND SUPPORT
Implementation of our TitleMatch DVD On-Demand service requires various
hardware and software components including computers, data storage and CD/DVD
duplication equipment, most of which are readily available in the market from
numerous suppliers. Hardware requirements are specified by us, however all
components, installation and ongoing
4
service is paid for by retailers. In the case of our outsourced fulfillment
services, the orders are produced at our facilities in which case retailers
incur no cost for equipment.
TECHNICAL SUPPORT
Our experience has shown that most technical support issues, although
infrequent, are easily resolved through telephone support. First level technical
support is expected to be provided by a retailer's internal IT staff. Inoperable
hardware components can be easily replaced in the field to minimize service
downtime. We also provide direct telephone support to a retailer's IT staff
should issues develop relating to our software or overall performance.
REVENUE STREAMS
Our revenue is primarily derived from site licensing and order transaction
fees that we charge to retailers for using our service. Site licensing fees are
generally calculated based on the number of stores in which our service is used.
Order transaction fees are charged for each product produced through our service
by a retailer.
For some retailers, we also serve as an aggregator of content in which
case our transaction fee includes a content fee for the actual movie or software
product being produced. There are no minimum purchase requirements in our
content agreements and there are no limitations on the price at which we can
resell products to the retailer. The price that the retailer or we pay content
owners is generally lower than standard wholesale pricing due to their savings
on packaging, storage and transportation costs. Additionally, we provide
advertising capabilities through trailer inserts onto DVDs at the time of
production, in-box promotions and touch-screen advertisements.
As more fully explained in the section entitled "Factors That May Affect
the Future Results of our Business," we are experiencing an extreme shortage of
cash and do not currently have sufficient cash on hand to continue business
operations unless additional financing is secured within the next month.
MARKET OPPORTUNITY
According to the DVD Release Report, there are over 80,000 movies and
television episodes now available on DVD with new titles being released weekly.
Nielsen Media Research also reports that DVD viewing devices are now used in
over 80% of U.S. households thereby representing an immense installed base of
DVD viewers in the multi-billion home entertainment market.
For most retailers, the cost of managing a rapidly changing product
inventory as diverse as DVD movies is prohibitive and invariably restricts
product availability and sales. Moreover, as demonstrated by Amazon and Netflix,
sales of previously released or "long-tail" titles can
5
continue indefinitely and collectively produce greater revenue than new release
titles if a sufficient offering is available to consumers. DVD on-demand brings
a virtual inventory of new release and long-tail movie titles to retailers
without the cost of carrying a product inventory.
DVD ON-DEMAND VALUE PROPOSITION
On-demand production of digital media products offers distinct advantages
over physical distribution methods for retailers, content owners and consumers,
as discussed below:
LARGER SELECTION OF TITLES FOR RETAILERS AND CONSUMERS - Movie, television
episodes, console video games and software products have wide consumer
appeal, yet maintaining a sufficient physical inventory is expensive
for most retailers. An expanded offering of digital media products
using virtual inventory can increase a retailer's sales, limit its
inventory costs and provide consumers with a broader selection of
titles to choose from.
REDUCTION IN PRODUCTION COSTS FOR CONTENT OWNERS - Content owners often
make only a small percentage of their content library available to
consumers due to minimum production-run and storage costs. By
eliminating up-front printing, packaging, inventory and shipping costs,
content owners can bring their entire libraries of content to market.
INCREASES EXPOSURE FOR INDEPENDENT MOVIE STUDIOS - Products from smaller
content owners are not always carried by retailers. On-demand
production makes it practical for retailers to carry a more varied
selection of titles including documentaries, art-house movies and other
less well-known films that might never have had a theatrical release.
INCREASED SECURITY - On-demand production offers the ability to include
unique copy-protection and other security solutions that can be
randomized to thwart unauthorized copying.
SPEEDS TIME TO MARKET - Content owners can be ready for their commercial
launches within days of completion of the digital master. Faster
launches reduce working capital needs for content owners and speed the
return on investment for their products.
INTELLECTUAL PROPERTY AND PATENTS
Our electronic sell-through platform is comprised of four primary
functions: Content Ingestion - preparation of products for on-demand production;
Content Distribution - delivery and updating of encrypted products to retail
stores; Content Production - on-site recording to DVD discs or other digital
media, and Content Reporting - reporting of all product sales to content owners.
We have developed proprietary software and technologies to automate each of
6
these and several hundred supporting processes based on our many years of direct
experience with on-demand production. We also provide retailers with hardware
purchase specifications and point-of-sale / network integration services.
We regard our intellectual property as proprietary and rely on a
combination of patent, copyright, trademark and trade secret laws of general
applicability, employee confidentiality and invention assignment agreements,
distribution and OEM software protection agreements and other intellectual
property protection methods to safeguard our technology, processes and internal
systems.
We have received two United States patents for various aspects of our
on-demand service. U.S. Patent #5,784,460 covers a proprietary process whereby
encrypted products can be added to an optical disc or other storage media and
subsequently unlocked by a consumer from their home computer. U.S. patent
#6,502,685 covers an electronic return process whereby the original optical disc
or other storage media is rendered unusable thereby eliminating the need for
return of the physical product. We are in the process of expanding our patent
portfolio to include several important innovations that we believe will be key
in the future of on-demand production.
Our intellectual property includes the source code for our on-demand
software platform and internal systems. We also rely upon our continuing efforts
to design and implement improvements to our service to maintain a competitive
position in the marketplace.
NEXT GENERATION ON-DEMAND
Our DVD on-demand service is based on an end-to-end system architecture
that can easily deliver products to other types of digital media storage
devices, e.g., iPod(R), cell phones, USB thumb drives and console video games.
COMPETITION
Our competition includes several privately-held companies that produce
music CD delivery systems and self-serve DVD disc dispensing kiosks that are
similar in functionality to our service. These companies could conceivably
re-engineer their products to compete with us more directly, however, they would
still face numerous obstacles related to replicating our service and production
processes.
Hewlett-Packard (HP) has reportedly began providing a centralized DVD
on-demand order fulfillment service to Wal-Mart and potentially other web
retailers thereby presenting formidable competition to our order fulfillment
business. We believe, however, that our in-store solution in combination with
our web order fulfillment service provides an overall stronger value proposition
for retailers.
Other forms of product delivery, including Internet downloading and
streaming of movies to a consumer's PC, are new channels of delivery that could
potentially grow over time. Additionally, there are other forms of physical
storage media including HD-DVD and USB thumb drives that are likely to begin
market penetration in the coming years, each of which is easily integrated into
our service.
7
REGULATION
Our business activities currently are subject to no particular regulation
by governmental agencies other than those that are routinely imposed on
corporate businesses, and no such regulation is now anticipated.
PROTOCALL VIRTUAL INVENTORY SYSTEM DEVELOPMENT AND COMMERCIALIZATION TIMELINE
2000-05 o Initial R&D, systems architecture, security processes,
hardware configuration, rights management/royalty
reporting systems, software coding, field testing,
service enhancements, store and web fulfillment pilots.
2006 o TitleMatch DVD On-demand service and TitleMatch
Entertainment Group subsidiary launched.
2007 o Consumer Electronics Show demonstration of DVD On-Demand
service with CSS copy-protection.
o Content agreements signed for content from SEGA
animation of Japan, Eros Entertainment, KOAN, City
Lights Entertainment and other movie studios.
o CSS copy-protection final approval by top studios.
EMPLOYEES
As of May 9, 2008, we had 5 employees including general and administrative
staff and executive management. None of these employees is covered by a
collective bargaining agreement and management considers relations with
employees to be good.
ITEM 2. DESCRIPTION OF PROPERTY.
Our corporate headquarters are located at 47 Mall Drive, Commack, New York
11725-5717, in approximately 5,000 square feet of space occupied under a lease
with a monthly rental rate of $5,631. We believe that this facility is adequate
for our current business operations.
8
ITEM 3. LEGAL PROCEEDINGS.
Upon his termination from employment with the Company, the former CEO
asserted monetary claims under his employment agreement, and by demand dated
October 19, 2005, sought arbitration of those claims which for purposes of the
arbitration demand he had valued at $366,979. The Company settled on January 23,
2006. The terms of the settlement require the Company to make periodic cash
payments totaling $100,000 and the issuance of a warrant to purchase 240,000
shares of common stock at an exercise price of $1.06 per share with registration
rights. The warrant was valued at $24,274 on the settlement date and recorded as
expense and as a liability in 2006. In accordance with EITF 00-19, this
liability is marked to fair value at each reporting date until the warrant is
exercised. On December 31, 2007 and 2006, the warrant was valued at $23,750 and
$13,986 respectively. As of December 31, 2006, the Company has paid the $100,000
as per the terms of the agreement.
On August 23, 2005, First Providence Financial Group, LLC ("First
Providence") filed a Demand for Arbitration against the Company with the
American Arbitration Association. The demand alleged that the Company breached a
January 2000 placement agency agreement with First Providence. The demand sought
$5 million in damages, plus fees and costs. The demand alleged that First
Providence had a right of first refusal and that the Company disregarded it. The
Company believed that First Providence was not then in business, incapable of
performing and failed to do so when requested to perform.
The Company reached a settlement agreement with First Providence on
January 31, 2006. The Company issued First Providence 1,000,000 shares of common
stock and reimbursed First Providence $8,000 for out of pocket costs. The shares
valued at $140,000 were accrued in December 2005 and issued in February 2006.
First Providence withdrew the arbitration request.
The case of Code Ventures LLC v. Protocall Software Delivery Systems,
Inc., et al. was filed in the Superior Court of the State of California, San
Diego Judicial District, on or about August 31, 2005. The complaint asserted
claims for: (i) breach of a software development agreement between the parties
dated October 13, 1999; (ii) quantum merit; and (iii) goods sold, and sought
damages of at least $200,000, plus interest, attorneys' fees, and cost. The
plaintiff also sought a judgment declaring that it is entitled to exercise
certain options for stock in Protocall Software Delivery Systems, Inc. We filed
a cross complaint asserting claims for breach of contract, restitution of money
plaintiff had received, and declaratory relief. We also sought recovery of
$43,700 for the value of equipment not returned to us by Code Ventures. On
September 13, 2006, the parties participated in mediation. As a result of the
mediation, the parties settled the matter for $100,000, with payments to be made
by the Company in four installments from October 16, 2006 through February 20,
2007. On January 26, 2007, the court heard the plaintiff's two post-settlement
motions, for attorneys' fees and costs, and to add an additional judgment
debtor. Both motions were granted and the plaintiff was awarded an additional
$5,520 in attorneys' fees and costs. All payments have been made. The plaintiff
filed an Acknowledgement of Satisfaction of Judgment in Full with the court and
the court dismissed the lawsuit on December 4, 2006 without prejudice.
9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On February 8, 2008, holders of 50.3% of our common stock voted to
increase the number of authorized shares from 200,000,000 to 550,000,000. A
preliminary information statement was filed on February 25, 2008 and resubmitted
on March 18, 2008 and April 18, 2008 in response to comments received from the
Securities and Exchange Commission. We are in the process of filing a definitive
information statement. Immediately after the definitive information statement is
filed, we expect to mail the information statement to shareholders of record at
February 12, 2008. Immediately after the completion of the required waiting
period, we will increase the number of authorized shares to 550,000,000.
10
PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL
BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES.
COMMON STOCK INFORMATION
As of May 9, 2008, there were 161,853,500 shares of our common stock
outstanding.
Our shares of common stock are quoted on the OTC Bulletin Board under the
trading symbol PCLI.OB.
The following table sets forth the high and low bid prices for our common
stock for the periods indicated as reported by the OTC Bulletin Board:
High Low
------- -------
YEAR ENDED DECEMBER 31, 2006:
First Quarter $ .29 $ .08
Second Quarter .28 .08
Third Quarter .16 .08
Fourth Quarter .20 .05
YEAR ENDING DECEMBER 31, 2007:
First Quarter $ .21 $ .09
Second Quarter .15 .02
Third Quarter .05 .01
Fourth Quarter .20 .01
These bid prices represent prices quoted by broker-dealers on the OTC
Bulletin Board. These quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commissions, and may not represent actual transactions.
DIVIDEND POLICY
We have not previously declared or paid any dividends on our common stock
and do not anticipate declaring any dividends in the foreseeable future. The
payment of dividends on our common stock is within the discretion of our board
of directors, subject to our articles of incorporation. We intend to retain any
earnings for use in our operations and the expansion of our business. Payment of
dividends in the future will depend on our future earnings, future capital needs
and our operating and financial condition, among other factors that we may deem
relevant.
Holders of our Series A Convertible Preferred Stock are entitled to
receive out of funds legally available, cash dividends equal to 1% of quarterly
gross sales in excess of $3,000,000 resulting from any and all contracts entered
into by the Company to provide its TitleMatch DVD On-Demand service.
11
EQUITY COMPENSATION PLAN INFORMATION
See the notes to the accompanying consolidated financial statements for a
detailed description of our option plans.
The following table provides information regarding the status of our
existing equity compensation plans at December 31, 2007:
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
FUTURE ISSUANCE UNDER
NUMBER OF SHARES OF EQUITY COMPENSATION PLANS
COMMON STOCK TO BE WEIGHTED-AVERAGE (EXCLUDING SECURITIES
ISSUED UPON EXERCISE EXERCISE PRICE OF REFLECTED IN THE PREVIOUS
PLAN CATEGORY OF OUTSTANDING OPTIONS OUTSTANDING OPTIONS COLUMNS)
------------------------------------------ ---------------------- ------------------- -------------------------
Equity compensation plans approved by
security holders 17,907,901 $ 0.27 1,654,458
Equity compensation plans not approved by
security holders -- -- --
----------
RECENT SALES AND ISSUANCES OF UNREGISTERED SECURITIES
In December 2007, we entered into an agreement with certain investors, whereby
the Company sold convertible notes in the aggregate principal amount of
$200,000. Additionally, these investors were issued warrants to purchase up to
15,000,000 shares of common stock at an exercise price of $.03. The convertible
notes are convertible into shares of the Company's common stock at a Variable
Conversion Price, as defined, subject to adjustment if the Company were to issue
any additional shares of common stock at a price per share less than the
applicable conversion rate then in effect, without a floor. The Variable
Conversion Price is 40% multiplied by the average of the lowest 3 Trading Prices
for the Common Stock during the 20 Trading Day period prior to conversion. The
issuance and sale of such securities were exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933.
In December 2007, we sold 30 shares of Series A Preferred Stock in a private
offering with accredited investors for an aggregate subscription price of
$300,000. Each share of Series A Preferred shall automatically convert into
100,000 shares of the Company's Common Stock, without any further payment on the
earlier of: the date on which total dividends paid per share of Series A
Preferred equal $50,000 or December 31, 2010. The issuance and sale of such
securities were exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
12
On January 31, 2008, we entered into a securities purchase agreement with
investors, under which unpaid accrued interest on previously-issued 6%
convertible notes were rolled into new convertible notes in the principal amount
of $123,135. The note bears interest of 2% per annum, payable quarterly. No
interest is due for any month in which the trading price of our common stock is
greater than $.14975 for each trading day. Any amount of principal or interest
on the note which is not paid when due, bears interest at the rate of 15% per
annum. The convertible notes are convertible into shares of the Company's common
stock at a Variable Conversion Price, as defined, subject to adjustment if the
Company were to issue any additional shares of common stock at a price per share
less than the applicable conversion rate then in effect, without a floor. The
Variable Conversion Price is 40% multiplied by the average of the lowest 3
Trading Prices for the Common Stock during the 20 Trading Day period prior to
conversion. The issuance of such securities were exempt from registration
pursuant to Section 4(2) of the Securities Act of 1933.
In February 2008, we entered into a securities purchase agreement with an
investor, under which we sold a convertible note in the principal amount of
$150,000. In connection with the agreement, we granted the investor seven-year
warrants to purchase a total of 540,000 shares of common stock at an exercise
price of $.10 per share, subject to adjustment for dilutive share issuances. The
warrants were exercisable immediately and allow the holder to purchase the
shares within seven years of the issue date. The exercise price is subject to
adjustment upon the occurrence of the following events during the period that
the conversion right remains outstanding: common stock reclassifications, stock
splits, combinations and dividends. The notes bear interest of 8% per annum,
payable quarterly. No interest is due for any month in which the trading price
of our common stock is greater than $.14975 for each trading day. Any amount of
principal or interest on the notes which is not paid when due bears interest at
the rate of 15% per annum. The convertible notes are convertible into shares of
the Company's common stock at a Variable Conversion Price, as defined, subject
to adjustment if the Company were to issue any additional shares of common stock
at a price per share less than the applicable conversion rate then in effect,
without a floor. The Variable Conversion Price is 50% multiplied by the average
of the lowest 3 Trading Prices for the Common Stock during the 20 Trading Day
period prior to conversion. The issuance and sale of such securities were exempt
from registration pursuant to Section 4(2) of the Securities Act of 1933.
In March 2008, we issued a 3 year convertible note in the principal amount of
$120,000 for which we received consideration of $100,000. The note accrues
interest at a rate of 8% per annum. Unconverted principal and accrued interest
are payable at time of maturity. The conversion price is 55% of the lowest
closing price in the 20 trading days prior to conversion. We also entered into
an agreement with the same investor whereby we issued the investor a convertible
secured and collateralized promissory note in the principal sum of $600,000. The
investor can reduce the collaterized note by converting $50,000 per month into
shares of the
13
company's common stock beginning seven months from the date of the agreement.
The issuance and sale of such securities were exempt from registration pursuant
to Section 4(2) of the Securities Act of 1933.
In March 2008, we entered into a securities purchase agreement with an investor,
under which we sold convertible notes in the principal amount of $100,000. In
connection with the agreement, we granted the investors seven-year warrants to
purchase a total of 360,000 shares of common stock at an exercise price of $.10
per share, subject to adjustment for dilutive share issuances. The warrants were
exercisable immediately and allow the holder to purchase the shares within seven
years of the issue date. The exercise price is subject to adjustment upon the
occurrence of the following events during the period that the conversion right
remains outstanding: common stock reclassifications, stock splits, combinations
and dividends. The notes bear interest of 8% per annum, payable quarterly. No
interest is due for any month in which the trading price of our common stock is
greater than $.14975 for each trading day. Any amount of principal or interest
on the note which is not paid when due bears interest at the rate of 15% per
annum. The convertible notes are convertible into shares of the Company's common
stock at a Variable Conversion Price, as defined, subject to adjustment if the
Company were to issue any additional shares of common stock at a price per share
less than the applicable conversion rate then in effect, without a floor. The
Variable Conversion Price is 50% multiplied by the average of the lowest 3
Trading Prices for the Common Stock during the 20 Trading Day period prior to
conversion. The issuance and sale of such securities were exempt from
registration pursuant to Section 4(2) of the Securities Act of 1933.
In March 2008, we entered into a securities purchase agreement with an investor,
under which we sold a convertible note in the principal amount of $50,000. In
connection with the agreement, we granted the investor seven-year warrants to
purchase a total of 180,000 shares of common stock at an exercise price of $.10
per share, subject to adjustment for dilutive share issuances. The warrants were
exercisable immediately and allow the holder to purchase the shares within seven
years of the issue date. The exercise price is subject to adjustment upon the
occurrence of the following events during the period that the conversion right
remains outstanding: common stock reclassifications, stock splits, combinations
and dividends. The notes bear interest of 8% per annum, payable quarterly. No
interest is due for any month in which the trading price of our common stock is
greater than $.14975 for each trading day. Any amount of principal or interest
on the notes which is not paid when due bears interest at the rate of 15% per
annum. The convertible notes are convertible into shares of the Company's common
stock at a Variable Conversion Price, as defined, subject to adjustment if the
Company were to issue any additional shares of common stock at a price per share
less than the applicable conversion rate then in effect, without a floor. The
Variable Conversion Price is 50% multiplied by the average of the lowest 3
Trading Prices for the Common Stock during the 20 Trading Day period prior to
conversion. The issuance and sale of such securities were exempt from
registration pursuant to Section 4(2) of the Securities Act of 1933.
14
FACTORS THAT MAY AFFECT THE FUTURE RESULTS OF OUR BUSINESS
SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS.
Certain statements in "Management's Discussion and Analysis or Plan of
Operation" below, and elsewhere in this annual report, are not related to
historical results, and are forward-looking statements. Forward-looking
statements present our expectations or forecasts of future events. You can
identify these statements by the fact that they do not relate strictly to
historical or current facts. These statements involve known and unknown risks,
uncertainties and other factors that may cause our actual results, levels of
activity, performance or achievements to be materially different from any future
results, levels of activity, performance or achievements expressed or implied by
such forward-looking statements. Forward-looking statements frequently are
accompanied by such words such as "may," "will," "should," "could," "expects,"
"plans," "intends," "anticipates," "believes," "estimates," "predicts,"
"potential" or "continue," or the negative of such terms or other words and
terms of similar meaning. Although we believe that the expectations reflected in
the forward-looking statements are reasonable, we cannot guarantee future
results, levels of activity, performance, achievements, or timeliness of such
results. Moreover, neither we nor any other person assumes responsibility for
the accuracy and completeness of such forward-looking statements. We are under
no duty to update any of the forward-looking statements after the date of this
annual report. Subsequent written and oral forward looking statements
attributable to us or to persons acting in our behalf are expressly qualified in
their entirety by the cautionary statements and risk factors set forth below and
elsewhere in this annual report, and in other reports filed by us with the SEC.
RISK FACTORS:
DUE TO OUR CONTINUAL DEPENDENCE UPON OUTSIDE FINANCING, THERE IS SUBSTANTIAL
DOUBT AS TO WHETHER WE CAN CONTINUE AS A GOING CONCERN.
For the years ended December 31, 2007 and 2006 we had operating losses (as
reported on the accompanying financial statements' statement of operations) of
$3,792,982 and $4,791,893. We incurred net losses for the years ended December
31, 2007 and 2006 of $14,625,936 and $5,988,672 respectively, have an
accumulated deficit of $58,731,513 and a working capital deficit of $20,106,026
at December 31, 2007. Through 2007, we have been continually dependent upon
borrowings through private offerings of convertible and non-convertible debt and
equity from related and non-related parties to finance our business operations.
We do not have sufficient cash on hand to continue business operations
unless additional financing is secured within the next month. We expect to seek
additional financing to meet our short-term and long-term liquidity
requirements, although there can be no assurances that such financing will be
available, or if available, that it will be on terms acceptable to us. The
accompanying financial statements have been prepared on the basis that we will
continue as a going concern, which assumes the realization of assets and
satisfaction of liabilities in the normal course of business. The uncertainties
regarding the availability of continued financing and commencement of adequate
commercial revenues raise substantial doubt about our ability to
15
continue as a going concern, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. Accordingly, our
independent auditors opinions express substantial doubt about our ability to
continue as a going concern. Until such time as we can rely on revenues
generated from operations, we have a need for subsequent funding; if we are not
successful in obtaining such funding, we will be forced to curtail or cease our
activities.
WE HAVE INCURRED SIGNIFICANT LOSSES IN THE PAST AND EXPECT LOSSES IN THE FUTURE,
WHICH CAN HAVE A DETRIMENTAL EFFECT ON THE LONG-TERM CAPITAL APPRECIATION OF OUR
COMMON STOCK.
We have a limited operating history on which to base an evaluation of our
business and prospects. Our prospects must be considered in light of inherent
risks, expenses and difficulties encountered by companies in their early stage
of development, particularly companies in new and evolving markets. Such risks
include acceptance by content providers, retailers and consumers in an evolving
and unpredictable business environment, the lack of a well developed brand
identity and the ability to bring products to market on a timely basis. For the
years ended December 31, 2007 and 2006 we had operating losses (as reported on
the accompanying financial statements' statement of operations) of $3,792,982
and $4,791,893. For the years ended December 31, 2007 and 2006, we had net
losses of $14,625,936 and $5,988,672, respectively. As of December 31, 2007, we
had total stockholders' deficiency of $20,351,898. No assurance can be given
that we will ever generate significant revenue or become profitable. This could
have a detrimental effect on the long-term capital appreciation of our capital
stock.
WE DEPEND ON CONTINUING RELATIONSHIPS WITH OUR CONTENT PROVIDERS, AND IF WE LOSE
THESE RELATIONSHIPS OUR PRODUCT OFFERINGS WOULD BE LIMITED AND LESS DESIRABLE TO
CONSUMERS AND RETAILERS.
We generate revenue as a just-in-time distributor of software and movie
products to retail stores and e-commerce retailers. If we cannot develop and
maintain satisfactory relationships with content providers on acceptable
commercial terms, we will likely experience a decline in revenue. We also depend
on these content providers to create, support and provide updates and/or new
products that consumers will purchase. If we are unable to license a sufficient
number of titles from content providers, or if the quality of titles provided by
these content providers does not reach a satisfactory level, we may not be able
to generate adequate interest among retailers or consumers to utilize the
system. Our contracts with our content provider clients are generally one to two
years in duration, with an automatic renewal provision for additional one-year
periods, unless we are provided with a written notice at least 90 days before
the end of the contract. As is common in our industry, we have no long-term or
exclusive contracts or arrangements with any content provider that guarantee the
availability of products. Content providers that currently supply products to us
may not continue to do so and we may be unable to establish new relationships
with content providers to supplement or replace existing relationships.
OUR AGREEMENTS WITH OUR SUPPLIERS OF PRODUCTS AND SERVICES PROVIDE FOR SPECIFIC
PAYMENT TERMS, AND IF WE MISS THOSE PAYMENT TERMS, OUR SUPPLIERS COULD DECLINE
TO CONTINUE TO DO BUSINESS WITH US.
16
Our agreements with our suppliers provide for specific payment terms and,
as of May 9, 2008, we have not met these payment terms with respect to a number
of our suppliers. If these suppliers decline to do business with us as a result
of delayed payment, it could possibly result in the loss of substantial business
for us and our ability to continue as a going concern.
OUR CONTENT LICENSE ACQUISITION PROCESS IS LENGTHY, WHICH MAY CAUSE US TO INCUR
SUBSTANTIAL EXPENSES AND EXPEND MANAGEMENT TIME WITHOUT GENERATING CORRESPONDING
REVENUE, WHICH WOULD IMPAIR OUR CASH FLOW.
We market our services directly to content providers and retailers. These
relationships are typically complex and take time to finalize. Due to operating
procedures in many organizations, a significant amount of time may pass between
selection of our products and services by key decision-makers and the signing of
a contract. The period between the initial sales call and the signing of a
contract with significant sales potential is difficult to predict and typically
ranges from one to twelve months for content providers. If, at the end of a
sales effort, a prospective content provider does not license its products to
us, we may have incurred substantial expenses and expended management time that
cannot be recovered and that will not generate corresponding revenue. As a
result, our cash flow and our ability to fund expenditures incurred during the
content license acquisition process may be impaired.
MOVIE-ON-DEMAND AND SOFTWARE-ON-DEMAND TECHNOLOGY IS STILL EVOLVING AND UNPROVEN
AND THE INDUSTRY MAY ULTIMATELY FAIL TO ACCEPT THIS TECHNOLOGY, RESULTING IN OUR
PRODUCTS NOT BEING IN DEMAND.
Our success will depend in large part on the growth in consumer acceptance
of software-on-demand and movie-on-demand technology as a method of distributing
products. Our business model is based on a relatively new method of distributing
products to consumers, and unless it gains widespread market acceptance, we will
be unable to achieve our business plan. Factors that will influence the market
acceptance of the technology include:
The willingness of software publishers and movie and television content
providers to license content for distribution through our system.
o Continuing demand by consumers for software products distributed on
CD media and movie and television content on DVD media;
o Consumer behavior relating to product selection through touch-screen
terminals for walk-in store deployments; and
o Consumer acceptance of DVD-style packages, which are the same as
traditional packages for movie and television content on DVD, but
smaller than traditional software packages.
Even if our technology achieves widespread acceptance, we may be unable to
overcome the substantial existing and future technical challenges associated
with on-site delivery of software and movies reliably and consistently on a
long-term basis. Our failure to do so would impair our ability to execute our
business plan.
17
OUR INDUSTRY IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE THAT MAY MAKE OUR
TECHNOLOGY AND SYSTEMS OBSOLETE OR CAUSE US TO INCUR SUBSTANTIAL COSTS TO ADAPT
TO THESE CHANGES.
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of our system and the underlying
network infrastructure. If we incur significant costs without adequate results,
or are unable to adapt rapidly to technological changes, we may fail to achieve
our business plan. The electronic commerce industry is characterized by rapid
technological change, changes in user and client requirements and preferences,
frequent new product and service introductions embodying new technologies and
the emergence of new industry standards and practices that could render our
technology and systems obsolete. To be successful, we must adapt to rapid
technological change by licensing and internally developing leading technologies
to enhance our existing services, developing new products, services and
technologies that address the increasingly sophisticated and varied needs of our
clients, and responding to technological advances and emerging industry
standards and practices on a cost-effective and timely basis. The development of
our system and other proprietary technologies involves significant technical and
business risks. We may fail to use new technologies effectively or fail to adapt
our proprietary technology and systems to client requirements or emerging
industry standards.
SYSTEM FAILURES COULD REDUCE THE ATTRACTIVENESS OF OUR SERVICE OFFERINGS; ANY
PROLONGED INTERRUPTIONS IN OUR OPERATIONS COULD CAUSE CONSUMERS TO SEEK
ALTERNATIVE PROVIDERS OF SOFTWARE.
We provide electronic delivery of digital media products and product
marketing services to our clients and end-users through our proprietary
technology and rights management systems. These systems also maintain an
electronic inventory of products. The satisfactory performance, reliability and
availability of the technology and the underlying network infrastructure are
critical to our operations, level of client service, reputation and ability to
attract and retain clients. While we have engaged an outside service company to
perform regular service on the systems in the field, we have experienced
periodic interruptions, affecting all or a portion of our systems, which we
believe will continue to occur from time to time. Any systems damage or
interruption that impairs our ability to accept and fill client orders could
result in an immediate loss of revenue to us, and could cause us to lose
clients. In addition, frequent systems failures could harm our reputation.
WE MAY BECOME LIABLE TO CLIENTS WHO ARE DISSATISFIED WITH OUR SYSTEM, WHICH
WOULD DIRECTLY IMPACT OUR PROSPECTS.
We design, develop, implement and manage electronic commerce solutions
that are crucial to the operation of our clients' businesses. Defects in the
solutions we develop could result in delayed or lost revenue, adverse consumer
reaction, and/or negative publicity which could require expensive corrections.
As a result, clients who experience these adverse consequences either directly
or indirectly as a result of our services could bring claims against us for
substantial damages. Any claims asserted could exceed the level of any insurance
coverage that may be available to us. Moreover, the insurance we carry may not
continue to be available on economically reasonable terms, or at all. The
successful assertion of one or more large claims
18
that are uninsured, that exceed insurance coverage or that result in changes to
insurance policies (including premium increases) could adversely affect our
operating results or financial condition.
BECAUSE OF THE RELATIVELY SMALL NUMBER OF EMPLOYEES EACH OF WHOM POSSESS
SPECIALIZED KNOWLEDGE ABOUT OUR BUSINESS WE WOULD BE ADVERSELY IMPACTED IF ANY
ONE OF THOSE EMPLOYEES WERE TO BECOME UNAVAILABLE.
Accordingly, it is important that we are able to attract, motivate and
retain highly qualified and talented personnel.
WE ARE AND WILL CONTINUE TO BE DEPENDENT ON BRUCE NEWMAN, OUR CHIEF EXECUTIVE
OFFICER, , THE LOSS OF WHOSE SERVICES WOULD IMPAIR OR POTENTIALLY CEASE OUR
BUSINESS OPERATIONS.
Our chief executive officer, Bruce Newman, is responsible for the
development and execution of our business. He is under no contractual obligation
to remain employed by us. If he should choose to leave us for any reason before
we have hired additional qualified personnel, our operations may fail. Even if
we are able to find additional personnel, it is uncertain whether we could find
someone who could develop our business along the same lines. Our business may
fail without Mr. Newman or an appropriate replacement(s). We currently carry
key-man life insurance on the life of our chief executive officer, Bruce Newman.
OUR LIABILITY INSURANCE MAY NOT BE ADEQUATE IN A CATASTROPHIC SITUATION.
Substantially all of our products are produced at our headquarters in
Commack, New York or assembled in retailers' stores. We currently maintain
property damage insurance covering our inventory, furniture and equipment in our
corporate headquarters. We maintain liability insurance, products and completed
operations liability insurance and an umbrella liability policy. We also
maintain insurance coverage for liability claims resulting from the use of our
equipment located in retail stores and for equipment in-transit to and from
retail stores. We also purchase business interruption insurance for losses
relating to our facilities. Nevertheless, material damage to, or the loss of,
our facilities, equipment or system data files, due to fire, severe weather,
flood or other catastrophe, even if insured against, could result in a
significant loss to us. We are currently preparing a disaster recovery plan.
OUR FAILURE TO PROTECT OUR INTELLECTUAL PROPERTY COULD CAUSE AN EROSION OF OUR
CURRENT COMPETITIVE STRENGTHS.
We regard the protection of our patents, trademarks, copyrights, trade
secrets and other intellectual property as critical to our success. We rely on a
combination of patent, copyright, trademark, service mark and trade secret laws
and contractual restrictions to protect our proprietary rights. We have entered
into confidentiality and non-disclosure agreements with our employees and
contractors, and non-disclosure agreements with parties with whom we conduct
19
business, in order to limit access to and disclosure of our proprietary
information. See "Business - Patents and Intellectual Property." These
contractual arrangements and the other steps taken by us to protect our
intellectual property may not prevent misappropriation of our technology or
deter independent third-party development of similar technologies. We also seek
to protect our proprietary position by filing U.S. and foreign patent
applications related to our proprietary technology, inventions and improvements
that are important to the development of our business. Proprietary rights
relating to our technologies will be protected from unauthorized use by third
parties only to the extent they are covered by valid and enforceable patents or
are effectively maintained as trade secrets. We pursue the registration of our
trademarks and service marks in the United States and internationally. Effective
patent, trademark, service mark, copyright and trade secret protection may not
be available in every country in which our services are made available online.
THE STEPS WE HAVE TAKEN TO PROTECT OUR PROPRIETARY RIGHTS MAY BE INADEQUATE AND
THIRD PARTIES MAY INFRINGE OR MISAPPROPRIATE OUR TRADE SECRETS, TRADEMARKS AND
SIMILAR PROPRIETARY RIGHTS.
Any significant failure on our part to protect our intellectual property
could make it easier for our competitors to offer similar services and thereby
adversely affect our market opportunities. In addition, litigation may be
necessary in the future to enforce our intellectual property rights, to protect
our trade secrets or to determine the validity and scope of the proprietary
rights of others. Litigation could result in substantial costs and diversion of
management and technical resources and may not be successful.
CLAIMS AGAINST US RELATED TO THE PRODUCTS THAT WE DELIVER ELECTRONICALLY AND THE
PRODUCTS THAT WE DELIVER PHYSICALLY COULD ALSO REQUIRE US TO EXPEND SIGNIFICANT
RESOURCES.
Claims may be made against us for negligence, copyright or trademark
infringement, product liability or other theories based on the nature and
content of software products or tangible goods that we deliver electronically
and physically. Because we did not create these products, we are generally not
in a position to know the quality or nature of the content of these products.
Although we carry general liability insurance that requires our customers to
indemnify us against consumer claims, our insurance and indemnification measures
may not cover potential claims of this type, may not adequately cover all costs
incurred in defense of potential claims, or may not reimburse us for all
liability that may be imposed. Any costs or imposition of liability that are not
covered by insurance or indemnification measures could be expensive and
time-consuming to address, distract management and/or delay product deliveries,
even if we are ultimately successful in the defense of these claims.
SECURITY BREACHES COULD HINDER OUR ABILITY TO SECURELY TRANSMIT CONFIDENTIAL
INFORMATION AND COULD HARM OUR CLIENTS.
A significant barrier to electronic commerce and communications is the
secure transmission of confidential information over public networks. Any
compromise or elimination of our security could be costly to remedy, damage our
reputation and expose us to liability, and dissuade existing and new clients
from using our services. We rely on encryption and authentication technology
licensed from third parties to provide the security and authentication
20
necessary for secure transmission of confidential information, such as consumer
credit card numbers. A party who circumvents our security measures could
misappropriate proprietary information or interrupt our operations.
WE MAY BE REQUIRED TO EXPEND SIGNIFICANT CAPITAL AND OTHER RESOURCES TO PROTECT
AGAINST SECURITY BREACHES OR ADDRESS PROBLEMS CAUSED BY BREACHES.
Concerns over the security of the Internet and other online transactions
and the privacy of users could deter people from using the Internet to conduct
transactions that involve transmitting confidential information, thereby
inhibiting the growth of our business. To the extent that our activities or
those of third-party contractors involve the storage and transmission of
proprietary information, such as credit card numbers, security breaches could
damage our reputation and expose us to a risk of loss or litigation and possible
liability. Our security measures may not prevent security breaches and failure
to prevent security breaches could lead to a loss of existing clients and deter
potential clients away from our services.
WE RELY TO A LARGE DEGREE ON THIRD PARTIES FOR THE MANUFACTURE AND MAINTENANCE
OF OUR SYSTEM, WHO COULD SUBJECT US TO DELAYS IN SATISFYING CUSTOMER NEEDS.
We rely heavily upon third parties to perform such tasks as assembly and
on-site maintenance of our system. Our ability to enter new markets and sustain
satisfactory levels of sales in each market will depend in significant part upon
the ability of these companies to perform effectively on our behalf. There can
be no assurance that we will be successful in entering into agreements with all
of these companies when necessary. In addition, once we enter into such
manufacturing contracts, we face the possibility that such contracts will not be
extended or replaced.
IMPLEMENTATION OF OUR SYSTEM REQUIRES CAPITAL, WHICH WE MAY NOT BE ABLE TO
PROVIDE, WHICH COULD PRECLUDE US FROM ENTERING INTO OTHERWISE PROMISING
AGREEMENTS.
Utilizing our system in a retail environment requires a capital commitment
for equipment and deployment costs, which we may not be able to provide. In
agreements that call for users of our system to fund equipment and deployment
costs themselves, we may be required to reduce our selling prices when compared
to agreements in which we finance equipment and deployment costs. The retailer's
financial risk/reward decision might prevent it from entering an agreement with
us or it may demand price concessions to mitigate the financial risk, which may
ultimately result in the agreement not being economically feasible for us to
perform.
SALES ARE HIGHLY DEPENDENT ON OBTAINING LICENSE RIGHTS, THE FAILURE OF WHICH
WOULD RESULT IN INSUFFICIENT REVENUE TO PAY FOR SYSTEM EQUIPMENT AND DEPLOYMENT
COSTS.
Sales of products through our system are highly dependent on the
qualitative mix of titles that we are able to license from software publishers
and movie studios for inclusion on our system. Although we have executed
licensing agreements with more than 200 software publishers covering
approximately 1,000 titles, our current product offering is not adequate to
achieve sufficient revenue for either a retailer or us to pay for system
equipment and deployment
21
costs. In order for us to be successful, we will need to improve the quality and
increase the volume of titles on our system.
RISK RELATED TO OUR COMMON STOCK.
THE LIQUIDITY OF OUR COMMON STOCK IS AFFECTED BY ITS LIMITED TRADING MARKET.
Shares of our common stock are quoted on the OTC Bulletin Board under the
symbol PCLI.OB. We expect our shares to continue to be quoted in that market and
not to be de-listed, as we have no intention to stop publicly reporting. An
"established trading market" may never develop or be maintained. Active trading
markets generally result in lower price volatility and more efficient execution
of buy and sell orders. The absence of an active trading market reduces the
liquidity of an investment in our shares. The trading volume of our common stock
historically has been limited and sporadic which may expose the price of our
common stock to volatility. Further, if we cease to be quoted, holders would
find it more difficult to dispose of, or to obtain accurate quotations as to the
market value of, our common stock and the market value of our common stock would
likely decline.
OUR COMMON STOCK MAY BE CONSIDERED A "PENNY STOCK" AND MAY BE DIFFICULT TO SELL
WHEN DESIRED.
The SEC has adopted regulations which generally define "penny stock" to be
an equity security that has a market price of less than $5.00 per share or an
exercise price of less than $5.00 per share, subject to specific exemptions. The
market price of our common stock is less than $5.00 per share and therefore may
be designated as a "penny stock" according to rules of the SEC. This designation
requires any broker or dealer selling these securities to disclose certain
information concerning the transaction, obtain a written agreement from the
purchaser and determine that the purchaser is reasonably suitable to purchase
the securities. These rules may restrict the ability of brokers or dealers to
sell our common stock and may affect the ability of our stockholders to sell
their shares. In addition, since our common stock is currently quoted on the OTC
Bulletin Board, stockholders may find it difficult to obtain accurate quotations
of our common stock and may experience a lack of buyers to purchase the stock or
a lack of market makers to support the stock price.
A SIGNIFICANT NUMBER OF OUR SHARES HAVE BECOME ELIGIBLE FOR SALE AND THEIR SALE
OR POTENTIAL SALE MAY DEPRESS THE MARKET PRICE OF OUR COMMON STOCK.
As shares of our common stock become available for resale in the public
market, the supply of our common stock will increase, which could decrease its
price. We could also register further shares in connection with future
financings. As of December 31, 2007, there were an additional 17,907,901 shares
of our common stock issuable upon exercise of outstanding stock options, an
additional 101,326,968 shares of our common stock issuable upon exercise of
outstanding warrants, convertible notes outstanding that may be converted into
an estimated 193,909,773 shares of common stock at current market prices and 30
shares of Preferred Convertible Series A stock that may be converted into
3,000,000 shares of common stock. Some or all of the shares of common stock may
be offered from time to time in the open market pursuant to Rule 144, and these
sales may have a depressive effect on the market for our shares
22
of common stock. Pursuant to Rule 144, a person who has held restricted shares
for a period of six months may begin selling these shares into the market.
OUR PRINCIPAL STOCKHOLDERS HAVE SIGNIFICANT VOTING POWER AND MAY TAKE ACTIONS
THAT MAY NOT BE IN THE BEST INTEREST OF OTHER STOCKHOLDERS.
Our officers, directors and principal stockholders control 41.9% of our
outstanding common stock (excluding presently exercisable stock options and
warrants), of which Peter Greenfield, our Chairman, controls approximately 6.34%
and Joachim Anzer, another significant stockholder controls approximately
27.31%. If these stockholders act together, they may be able to exert
significant control over our management and affairs requiring stockholder
approval, including approval of significant corporate transactions. This
concentration of ownership may have the effect of delaying or preventing a
change in control and might adversely affect the market price of our common
stock. This concentration of ownership may not be in the best interests of all
our stockholders.
INVESTORS SHOULD NOT ANTICIPATE RECEIVING CASH DIVIDENDS ON OUR COMMON STOCK.
We have never declared or paid any cash dividends or distributions on our
capital stock. We currently intend to retain any future earnings to support
operations and to finance expansion and, therefore, we do not anticipate paying
any cash dividends on our common stock in the foreseeable future. In addition
our recently issued preferred stock will pay dividends to the holders of the
preferred stock upon the occurrence of the company generating quarterly revenue
of $3,000,000 or greater. The preferred stock holders receive preferential
treatment and if any dividends are declared on our common stock, preferred stock
holders will receive dividends before common stock holders.
RISKS RELATED TO OUR CURRENT FINANCING ARRANGEMENT
THERE ARE A LARGE NUMBER OF SHARES UNDERLYING OUR CONVERTIBLE NOTES, PREFERRED
STOCK AND WARRANTS THAT MAY BE AVAILABLE FOR FUTURE SALE AND THE SALE OF THESE
SHARES MAY DEPRESS THE MARKET PRICE OF OUR COMMON STOCK.
As of December 31, 2007, we had 123,131,341 shares of common stock issued
and 122,971,341 outstanding, convertible notes outstanding that may be converted
into an estimated 193,909,773 shares of common stock at current market prices,
30 shares of Preferred Convertible Series A stock that may be converted into
3,000,000 shares of common stock and 101,326,968 shares of our common stock
issuable upon exercise of outstanding warrants. In addition, the number of
shares of common stock issuable upon conversion of the outstanding convertible
notes may increase if the market price of our stock declines. The sale of these
shares may adversely affect the market price of our common stock. Additionally,
the recent change to SEC Rule 144, shortens the holding period of restricted
stock to six months which could accelerate the selling of shares not registered
under the current registration statement.
23
THE CONTINUOUSLY ADJUSTABLE CONVERSION PRICE FEATURE OF OUR SECURED CONVERTIBLE
NOTES COULD REQUIRE US TO ISSUE A SUBSTANTIALLY GREATER NUMBER OF SHARES, WHICH
WILL CAUSE DILUTION TO OUR EXISTING SHAREHOLDERS.
Our obligation to issue shares upon conversion of our secured convertible notes
is essentially limitless. The following is an example of the amount of shares of
our common stock that are issuable upon conversion of our $2,830,510 secured 6%
and 8% secured convertible notes (excluding accrued interest), based on market
prices 25%, 50% and 75% below the market price, as of December 31, 2007 of
$0.13.
6% NOTES (OUTSTANDING PRINCIPAL $2,230,510):
------------------------------------------------------------------------
Number of Shares
% Below Market Price Per Share Discount of 40% Issuable
------------------------------------------------------------------------
25% $ 0.0975 $ 0.0488 45,754,051
------------------------------------------------------------------------
50% $ 0.065 $ 0.0325 68,631,077
------------------------------------------------------------------------
75% $ 0.0325 $ 0.0163 137,262,154
------------------------------------------------------------------------
8% NOTES (OUTSTANDING PRINCIPAL $600,000):
------------------------------------------------------------------------
Number of Shares
% Below Market Price Per Share Discount of 40% Issuable
------------------------------------------------------------------------
25% $ 0.0975 $ 0.039 15,384,615
------------------------------------------------------------------------
50% $ 0.065 $ 0.026 85,788,846
------------------------------------------------------------------------
75% $ 0.0325 $ 0.013 171,577,692
------------------------------------------------------------------------
As illustrated, the number of shares of common stock issuable upon conversion of
our secured convertible notes will increase if the market price of our stock
declines, which will cause dilution to our existing stockholders.
24
ANTI DILUTION PROVISIONS CONTAINED IN RECENT PRIVATE OFFERINGS MAY TRIGGER
SUBSTANTIAL DILUTION TO OUR EXISTING SHAREHOLDERS.
The issuance of shares due to anti dilution provisions contained in recent
private offerings may trigger substantial dilution to our existing shareholders.
The price per share of recent private offerings is contingent upon our stock
price. In the event that our stock price declines, we may have to issue a
substantial amount of additional shares to these investors. This may cause
substantial dilution to existing shareholders.
THE ISSUANCE OF SHARES UPON CONVERSION OF THE CONVERTIBLE NOTES AND EXERCISE OF
OUTSTANDING WARRANTS MAY CAUSE IMMEDIATE AND SUBSTANTIAL DILUTION TO OUR
EXISTING STOCKHOLDERS.
The issuance of shares upon conversion of the convertible notes and
exercise of warrants may result in substantial dilution to the interests of
other stockholders since the selling stockholders may ultimately convert and
sell the full amount issuable on conversion. Although the selling stockholders
may not convert their convertible notes and/or exercise their warrants if such
conversion or exercise would cause them to own more than 4.99% of our
outstanding common stock, this restriction does not prevent the selling
stockholders from converting and/or exercising some of their holdings and then
converting the rest of their holdings. In this way, the selling stockholders
could sell more than this limit while never holding more than this limit. There
is no upper limit on the number of shares that may be issued which will have the
effect of further diluting the proportionate equity interest and voting power of
holders of our common stock. We recently granted a waiver to one of the
convertible note holders allowing them to own up to 9.99% of our common stock.
THE SHARES OF COMMON STOCK ALLOCATED FOR CONVERSION OF THE CONVERTIBLE NOTES AND
REGISTERED PURSUANT TO THE REGISTRATION STATEMENT THAT WENT EFFECTIVE IN JUNE
2007 IS NOT ADEQUATE AND WE MAY BE REQUIRED TO FILE A SUBSEQUENT REGISTRATION
STATEMENT COVERING ADDITIONAL SHARES. IF WE ARE REQUIRED TO FILE AN ADDITIONAL
REGISTRATION STATEMENT, WE MAY INCUR SUBSTANTIAL COSTS.
Based on our current market price and the potential decrease in our market
price as a result of the issuance of shares upon conversion of the convertible
notes, we have made a good faith estimate as to the amount of shares of common
stock that we are required to register and allocate for conversion of the
convertible notes. Accordingly, we have registered 17,600,000 shares to cover
the conversion of the convertible notes. Due to the drop in our stock price,,
the amount of shares of common stock we have allocated for conversion of the
convertible notes is not adequate. If we are required to file an additional
registration statement, we may incur substantial costs in connection with the
preparation and filing of that registration statement. We are required to
maintain the effectiveness of the registration statement until the earliest of
(i) the date of which all of the registrable securities have been sold and (ii)
the date on which the registrable securities may be immediately sold to the
public without registration or restriction.
We have agreed, pursuant to the terms of the registration rights
agreements with the investors, to (i) file a shelf registration statement with
respect to the resale of shares of our common stock sold to the investors and
shares of our common stock issuable upon exercise of
25
the warrants with the SEC within 45 days after the initial closing date; (ii)
use our best efforts to have the shelf registration statement declared effective
by the SEC as soon as practicable after the initial filing, and in any event no
later than 120 days after the final closing date, (iii) promptly respond to any
and all comments received from the SEC, (iv) promptly file an acceleration
request as soon as practicable following the resolution or clearance of all SEC
comments, (v) promptly file with the SEC a final prospectus pursuant to SEC Rule
424(b) as soon as practicable following the effective date of the registration
statement; and (vi) keep the shelf registration statement effective until the
earlier of (x) the date on which all of the registrable securities have been
sold and (y) the date on which the registrable securities may be immediately
sold to the public without registration or restriction. If we are unable to
comply with any of the above covenants, we will be required to issue the
investors additional shares of our common stock in an amount of 2% per month of
the outstanding principal to a maximum of 6% to be paid in cash or shares of our
common stock at that dates' conversion price.
WE ARE IN THE PROCESS OF INCREASING THE NUMBER OF AUTHORIZED SHARES OF OUR
COMMON STOCK TO 550,000,000.
We are required under the terms of the convertible notes to have a
sufficient number of authorized shares at all times to allow for full conversion
of the notes. In order to be in compliance with the terms of these agreements,
we recently began the process to increase the number of authorized shares to
550,000,000. The conversion price of the notes is contingent upon our current
stock price. If the market price of our common stock dictates the issuance of
the full amount of authorized shares, it will create substantial dilution to
existing shareholders.
FAILURE TO ACHIEVE AND MAINTAIN EFFECTIVE INTERNAL CONTROLS IN ACCORDANCE WITH
SECTION 404 OF THE SARBANES-OXLEY ACT OF 2002 COULD PREVENT US FROM PRODUCING
RELIABLE FINANCIAL REPORTS OR IDENTIFYING FRAUD. IN ADDITION, SHAREHOLDERS COULD
LOSE CONFIDENCE IN OUR FINANCIAL REPORTING, WHICH COULD HAVE AN ADVERSE EFFECT
ON OUR STOCK PRICE.
Effective internal controls are necessary for us to provide reliable
financial reports and effectively prevent fraud, and a lack of effective
controls could preclude us from accomplishing these critical functions. As of
December 31, 2007, we were required to document and test our internal control
procedures in order to satisfy the requirements of Section 404 of the
Sarbanes-Oxley Act of 2002, which requires annual management assessments of the
effectiveness of our internal controls over financial reporting. Commencing
December 31, 2008 our independent registered accountants will be required to
audit our internal controls though there is a current SEC proposal to defer this
requirement for an additional year. Assigned to accounting issues at present are
only our Chief Financial Officer and a staff accountant, which may be deemed to
be inadequate. Although we intend to augment our internal controls procedures
and expand our accounting staff, there is no guarantee that this effort will be
adequate.
During the course of our testing, we may identify deficiencies which we
may not be able to remediate in time to meet the deadline imposed by the
Sarbanes-Oxley Act for compliance with the requirements of Section 404. In
addition, if we fail to maintain the adequacy of our internal accounting
controls, as such standards are modified, supplemented or amended from
26
time to time, we may not be able to ensure that we can conclude on an ongoing
basis that we have effective internal controls over financial reporting in
accordance with Section 404. Failure to achieve and maintain an effective
internal control environment could cause us to face regulatory action and also
cause investors to lose confidence in our reported financial information, either
of which could have an adverse effect on our stock price.
Based on management's assessment, it was determined that material weaknesses
existed as of December 31, 2007 with regard to accounting for complex
transactions such as derivatives associated with the Company's convertible
notes, ineffective controls related to significant transactions and a lack of
segregation of duties resulting from a lack of personnel. As a result of errors
that we believe are a direct result of these material weaknesses, the Company
has restated its condensed consolidated financial statements for the three
months ended March 31, 2007, June 30, 2007 and September 30, 2007.
27
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
You should read the following description of our financial condition and
results of operations in conjunction with the consolidated financial statements
and accompanying notes included in this report beginning on page F-1.
OVERVIEW
--------
For much of 2006 and 2007, we have focused on supporting our current
software on-demand service, pursuing new customers and content owners and
developing our new TitleMatch DVD on-demand service.
Our on-demand service is currently utilized for delivery of software
products under the product name "SoftwareToGo(R);" however, we have been
vigorously pursuing an expansion of available products to include DVD movie and
television content. We believe our technology is readily adaptable to these and
other types of digital products without additional significant investment. In
connection with movie and television content, we announced our new 'TitleMatch'
service and TitleMatch Entertainment Group subsidiary in November 2006.
Due to very limited revenues to date, management has not yet developed nor
relied on any key performance indicators to assess our business.
REVENUE MODEL
We employ two revenue models in our Protocall and TitleMatch businesses:
one for conventional ("bricks and mortar") retailers, and another for
online/catalog retailers. Under the "bricks and mortar" revenue model we license
content, integrate, install and maintain system site equipment, provide system
training to store personnel, supply the physical deliverables (CD, case,
packaging and labeling), provide system help desk support during store hours and
act as an on-demand distributor to the retailer. The retailer, in accordance
with store configuration and consumer merchandising/promotion plans developed
jointly with us, supplies prominent space for consumer touch screens within
their stores as well as an appropriate location for the order production
station, and provides promotion for products available through our system. Prior
to deployment, we and the retailer jointly develop plans relating to sales
reporting procedures, communication line setup, network wiring, POS system
integration and product pricing.
For web retailers, which is applicable to our agreement with
TigerDirect.com, the business model differs somewhat. For these retailers, a
high-capacity production station is used without the need for a consumer touch
screen. The system can be installed either at our facilities or at the
customer's shipping center. If the system is installed at our facility, the
system is operated by us and our employees drop-ship products to the retailer's
customer. Under this model, we expect much higher capacity utilization for the
production station and, consequently, a faster payback on invested capital.
We secure the right to replicate titles through licensing agreements with
content providers, paying a licensing fee to each provider per product vended.
In instances where a consumer returns a system-produced product, the content
license fee is credited to us.
28
We expect to be able to improve our licensing terms as the number of
installed system sites increase. Because our agreements with content providers
typically allow for a longer time period to pay the licensing fees due for
products sold than the period of time provided to the retailers to pay us for
the products produced by the system, we do not anticipate an increase to working
capital requirements from this aspect of the business as the business grows. We
do not usually prepay or guarantee any minimum license fees to publishers. Our
agreements provide for a fixed selling price for each product licensed through
our system. We invoice our customers on a monthly basis, based on 30-day payment
terms, for each unit sold during the prior month.
Revenue from the sale of physical inventory purchased in September 2006 is
recognized when the products are shipped to the customer. We invoice these
customers at time of shipment. Revenue generated from the sale of prepackaged
goods from third party distributors through Internet retailers is recognized
when the product is shipped by us or by a third party vendor.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of results of operations and financial
condition are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these consolidated financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. We evaluate our estimates on an ongoing
basis, including those related to provisions for uncollectible accounts
receivable, inventories, and contingencies and litigation. We base our estimates
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
The accounting policies that we follow are set forth in Note A to our
consolidated financial statements as included herein. These accounting policies
conform to accounting principles generally accepted in the United States of
America, and have been consistently applied in the preparation of the financial
statements. The following are believed to be the policies that are most
sensitive to judgments and estimates.
REVENUE RECOGNITION
We recognize revenue from retailers' sales of product through our system
and through Internet retailers, upon shipment to the retail customer or
consumer.
Customer returns, although not material, are also reflected as a reduction
in revenue in the period that they are returned or earlier if any such returns
are anticipated.
Revenue from the licensing of font software is recognized over the
licensing period. Revenue from the sale of software products and font reference
guide books is recognized when the product is delivered or shipped to the
customer.
29
Revenue from the sale of physical inventory purchased in September 2006 is
recognized when the products are shipped to the customer. We invoice these
customers at time of shipment. Revenue generated from the sale of prepackaged
goods from third party distributors through Internet retailers is recognized
when the product is shipped by us or by a third party vendor.
In accordance with EITF Issue No. 99-19, we recognize revenue from
Internet sales through our TitleMatch subsidiary on a gross basis. We have
concluded for the following reasons that we are the principal in our Internet
sale transactions. Those reasons are as follows: we are the primary obligor in
all transactions, we have latitude in establishing pricing, we are subject to
risk of loss when the item is transferred to the freight carrier, title is
transferred to us at the time the order is placed with our third party vendor
and we are at risk for the billing to our customer. Revenue from these sales is
recognized when the product is shipped to the customer.
DERIVATIVE FINANCIAL INSTRUMENTS
We evaluate our convertible debt, options, warrants or other contracts to
determine if those contracts or embedded components of those contracts qualify
as derivatives to be separately accounted for under Statement of Financial
Accounting Standards ("SFAS") 133 "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133") and related interpretations including EITF
00-19 "Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock" ("EITF 00-19"). Should any of
these instruments qualify as a derivative, then the fair value of the embedded
derivative is marked-to-market each reporting date and recorded as a liability
and the change in fair value is recorded in the consolidated statement of
operations. Upon conversion or exercise of a derivative instrument, the
instrument is marked to fair value at the conversion date and then that fair
value is reclassified to equity.
In circumstances where the embedded conversion feature in a convertible
instrument is required to be bifurcated and there are also other embedded
derivative elements in the convertible instrument that are required to be
bifurcated, the bifurcated derivative instruments are accounted for as a single,
compound derivative instrument.
The classification of derivative instruments, including whether such instruments
should be recorded as liabilities or as equity, is re-assessed at the end of
each reporting period. Equity instruments that are initially classified as
equity that become subject to reclassification under SFAS 133 are reclassified
to a liability at the fair value of the instrument on the reclassification date.
Derivative instrument liabilities are classified in the balance sheet as current
as net cash settlement of the derivative instruments, based on their contractual
terms, generally could occur within 12 months of the balance sheet date.
30
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2007 COMPARED TO YEAR ENDED DECEMBER 31, 2006
NET LOSS. We had net losses of $14,625,936 and $5,988,672 for the years
ended December 31, 2007 and 2006, respectively. During these periods, operations
were financed through various equity and debt financing transactions.
NET SALES. Net sales for the year ended December 31, 2007 decreased
$116,289 or 10.86% to $954,792 compared to $1,071,081 for the year ended
December 31, 2006. The decrease in net sales was due to the sale in 2006 of a
one time inventory purchase of approximately $320,000, offset by sales from new
customers in 2007 in the amount of approximately $210,000
GROSS PROFIT (LOSS). Gross Profit (Loss) increased $313,774 or 267.43%
from $(117,328) for the year ended December 31, 2006 to $196,446 for the year
ended December 31, 2007. Our gross profit/(loss) % increased from -11% in 2006
to 21% in 2007 as a result of a $350,066 inventory reserve recorded in 2006.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expense,
increased by $155,017 or 131.40%, from $117,970 to $272,987 for the year ended
December 31, 2007 as compared to the year ended December 31, 2006 due to
enhancements made to the DVD on demand system in 2007.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased by $840,155, or 18.44%, to $3,716,441 for the
year ended December 31, 2007 from $4,556,595 for the year ended December 31,
2006.
Total salaries increased $149,242, or 9.48%, to $1,723,180 in 2007 from
$1,573,938 in 2006. Depreciation expense decreased $333,313 in 2007, or 83.07%,
to $67,909 from $401,222 in 2006, due to certain assets becoming fully
depreciated in 2006. Marketing expenses decreased $44,236 in 2007, or 28.50%, to
$110,978 from $155,214 in 2006, due to limited cash resources. Legal and
professional fees decreased $163,673 in 2007, or 67.38%, to $79,250 from
$242,923 in 2006 due to litigation in 2006. Accounting fees increased $129,950
in 2007, or 92.15% to $270,975 from $141,025 in 2006 due to fees relating to the
filing of a registration statement in 2007 and fees relating to the issuance of
additional convertible notes in 2007. Deployment expenses decreased $97,310 in
2007, or 83.63%, to $19,049 from $116,359 in 2006 as a result of CompUSA closing
the majority of their stores and our subsequent removal of our system from their
stores. Litigation and settlement fees decreased $105,813 or 63.71% in 2007, to
$60,262 from $166,075 in 2006. This decrease was due to the $100,000 judgment
accrued for Code Ventures litigation. Consulting fees decreased $203,539 or
32.81% in 2007 to $416,872 from $620,411 resulting from a decreased use of
outside consultants due to limited cash resources. Investor relations expense
decreased $202,904 in 2007, or 64.26%, to $112,849 from $315,753 in 2006 due to
a charge of $125,770 for the fair value of shares issued to an investor
relations firm in 2006.
CHANGE IN FAIR VALUE OF DERIVATIVE FINANCIAL INSTRUMENT LIABILITY. The net
charge recorded as change in the fair value of Derivative financial instrument
liability increased
31
$5,918,722 in 2007 to $4,954,800, or 614.02% as compared to $(963,922) in 2006,
due to the valuation of convertible notes issued.. The change in valuation was
due to the fluctuating stock price in 2007 and the issuance of additional
convertible notes in May, July, August and December 2007. Fair value of
derivative instruments in excess of proceeds received at issuance increased
2,858,787 or 157.06% to 4,678,954 in 2007 from 1,820,167 in 2006 due to the
fluctuating stock price in 2007.
INTEREST AND FINANCE CHARGES. Interest and finance expense increased
$865,627, or 256.27%, to $1,203,400 in 2007 from $337,773 in 2006 due to
additional convertible note issuances in May, July, August and December 2007 and
subsequent amortization of note discounts.
LIQUIDITY AND CAPITAL RESOURCES. At December 31, 2007 we had a working
capital deficit of $20,106,026 as compared to a working capital deficit of
$2,502,522 at December 31, 2006. At December 31, 2007, we had an accumulated
deficit in the amount of $58,731,513 as compared to an accumulated deficit of
$44,105,577 at December 31, 2006. The accumulated losses resulted principally
from costs incurred in developing our business plan, research and development,
general and administrative expenses, seeking and establishing sales channels,
capital raising activities and non cash charges for the change in fair value of
derivative financial instruments liability. As of April 15, 2008, we had a cash
balance of approximately $12,500.
We do not have sufficient cash on hand to continue business operations
unless additional financing is secured within the next month. We are actively
pursuing additional short-term funding from existing shareholders and long-term
funding from institutional investors. Our plan is to secure sufficient
short-term capital to fund our operations through the completion of a larger
institutional financing, although there can be no assurances that any financing
will be available, or if available, that it will be on terms acceptable to us.
We believe that our ability to secure short-term and long-term financing is
directly related to our progress with new customers and movie content
agreements, which are actively being pursued by us.
In the event that sufficient short-term or long-term financing is not
obtained, in order to enable us to continue to pursue our customer and content
negotiations over a longer term, we will reduce our operating expenditures or
cease operations entirely.
The accompanying financial statements have been prepared on the basis that
we will continue as a going concern, which assumes the realization of assets and
satisfaction of liabilities in the normal course of business. The uncertainties
regarding the availability of continued financing and commencement of adequate
commercial revenues raise substantial doubt about our ability to continue as a
going concern. Accordingly, our independent auditors' opinion for the year ended
December 31, 2007 expresses substantial doubt about our ability to continue as a
going concern. The financial statements do not include any adjustments relating
to the recoverability of the recorded assets or the classification of
liabilities that may be necessary should we be unable to continue as a going
concern.
In February 2007, we entered into a securities purchase agreement with
accredited investors in a private placement. In connection with the private
placement, the Company sold an aggregate of 2,764,423 shares of common stock, at
a share price of $.104 per share and warrants (the
32
"February 2007 Warrants") to purchase up to 2,764,423 shares of common stock,
for an aggregate amount of $287,500. Additionally, in February 2007 we had
another private placement and sold an aggregate of 1,704,545 shares of common
stock at a share price of $.088 and warrants (the "February 2007 Warrants") to
purchase up to 3,409,091 shares of common stock, for an aggregate amount of
$150,000.
The February 2007 Warrants have an exercise price of $.20 per share of common
stock, are exercisable immediately and expire on the third year anniversary of
the initial warrant date. The exercise price of the February 2007 Warrants is
subject to adjustment in the event of specified dilutive or accretive events,
such as stock splits and stock combinations. The exercise price, as well as the
per share price of the common stock sold in the private placement is subject to
further adjustment if we issue any shares of common stock or securities
convertible or exercisable into common stock (subject to customary exceptions
such as securities issued pursuant to equity incentive plans) through February
2008 at a price per share less than the per share price of the common stock
and/or the exercise price of the February 2007 Warrants, in which case the per
share price and/or the exercise price, as applicable, will be adjusted to equal
the price of the securities in the new issuance. The adjustment in the share
price would result in the issuance of additional shares of common stock to the
holders. Due to the subsequent February private offering entered into at a share
price of $.088, the Company issued an additional 502,622 shares of common stock
and adjusted the February 2007 Warrants' exercise price to $.088 per share
pursuant to anti-dilution provisions contained in the February 2007 securities
purchase agreement.
In April 2007, we collected $12,500 in subscriptions from the February 2007
private placement. We issued 142,046 shares of common stock at a share price of
$.088 and warrants to purchase 120,192 shares of common stock at an exercise
price of $.088 under the same terms as the February 2007 private placement. The
finder who assisted with the private placement was issued a warrant to purchase
24,038 shares of common stock at an exercise price of $.088 under the same terms
as the investors.
In May 2007, we collected $250,000 in subscriptions from the February 2007
private placement. We issued 2,840,909 shares of common stock at a share price
of $.088 and warrants to purchase 5,681,818 shares of common stock at an
exercise price of $.088 under the same terms as the February 2007 private
placement. The finder who assisted with the private placement was issued a
warrant to purchase 1,136,364 shares of common stock at an exercise price of
$.088 under the same terms as the investors.
In a series of closings in August 2006, September 2006, November 2006, May 2007
and July 2007 we issued $2,717,750 of convertible notes. The notes carry
interest at 6% per annum payable quarterly. In August 2007 and December 2007 we
issued $600,000 of convertible notes. The notes carry interest at 8% per annum
payable quarterly. All notes mature 3 years from the date of issuance. The 6%
notes convert to common shares at 55% of the average of the three lowest prices
in the 20 trading days prior to conversion. On December 24, 2007, the 55% was
reset to 40% for the convertible notes issued in August and September 2006 and
May, July and August 2007 pursuant to the terms of the new funding. The 8% notes
convert to common shares at 40% of the average of the three lowest prices in the
20 trading days prior to conversion. At
33
December 31, 2007 outstanding principal on the 6% and 8% notes totaled
$2,830,510. In connection with the issuance of these convertible notes we also
issued warrants exercisable into 58,281,730 shares of common stock at prices
ranging from $.10 to $.02 per share. The notes and warrants are subject to
registration rights agreements which require us to register the underlying
shares and maintain the effectiveness of the registration statements. Should we
fail to perform under the terms of the Registration Statements could be required
to pay to the note holders 2% per month of the outstanding principle up to a
maximum of 6% in cash or common stock. At December 31, 2007 we had accrued
$121,065 of registration rights penalties.
In December 2007, we sold 30 shares of Series A Preferred Stock in a private
offering with accredited investors for an aggregate subscription price of
$300,000. Each share of Series A Preferred shall automatically convert into
100,000 shares of the Company's Common Stock, without any further payment on the
earlier of: the date on which total dividends paid per share of Series A
Preferred equal $50,000 or December 31, 2010.
On January 31, 2008, we entered into a securities purchase agreement with
investors, under which unpaid accrued interest on previously-issued 6%
convertible notes were rolled into new convertible notes in the principal amount
of $123,135. The note bears interest of 2% per annum, payable quarterly. No
interest is due for any month in which the trading price of our common stock is
greater than $.14975 for each trading day. Any amount of principal or interest
on the note which is not paid when due, bears interest at the rate of 15% per
annum. No cash proceeds were received in connection with these notes.
In February 2008, we entered into a securities purchase agreement with an
investor, under which we sold a convertible note in the principal amount of
$150,000. In connection with the agreement, we granted the investor seven-year
warrants to purchase a total of 540,000 shares of common stock at an exercise
price of $.10 per share, subject to adjustment for dilutive share issuances. The
warrants were exercisable immediately and allow the holder to purchase the
shares within seven years of the issue date. The exercise price is subject to
adjustment upon the occurrence of the following events during the period that
the conversion right remains outstanding: common stock reclassifications, stock
splits, combinations and dividends. The notes bear interest of 8% per annum,
payable quarterly. No interest is due for any month in which the trading price
of our common stock is greater than $.14975 for each trading day. Any amount of
principal or interest on the notes which is not paid when due bears interest at
the rate of 15% per annum. The convertible notes are convertible into shares of
the Company's common stock at a Variable Conversion Price, as defined, subject
to adjustment if the Company were to issue any additional shares of common stock
at a price per share less than the applicable conversion rate then in effect,
without a floor. The Variable Conversion Price is 50% multiplied by the average
of the lowest 3 Trading Prices for the Common Stock during the 20 Trading Day
period prior to conversion.
34
In March 2008, we issued a 3 year convertible note in the principal amount
of $120,000 for which we received consideration of $100,000. The note accrues
interest at a rate of 8% per annum. Unconverted principal and accrued interest
are payable at time of maturity. The conversion price is 55% of the lowest
closing price in the 20 trading days prior to conversion. We also entered into
an agreement with the same investor whereby we issued the investor a convertible
secured and collateralized promissory note in the principal sum of $600,000. The
investor can reduce the collaterized note by converting $50,000 per month into
shares of the company's common stock beginning seven months from the date of the
agreement.
In March 2008, we entered into a securities purchase agreement with an investor,
under which we sold convertible notes in the principal amount of $100,000. In
connection with the agreement, we granted the investors seven-year warrants to
purchase a total of 360,000 shares of common stock at an exercise price of $.10
per share, subject to adjustment for dilutive share issuances. The warrants were
exercisable immediately and allow the holder to purchase the shares within seven
years of the issue date. The exercise price is subject to adjustment upon the
occurrence of the following events during the period that the conversion right
remains outstanding: common stock reclassifications, stock splits, combinations
and dividends. The notes bear interest of 8% per annum, payable quarterly. No
interest is due for any month in which the trading price of our common stock is
greater than $.14975 for each trading day. Any amount of principal or interest
on the note which is not paid when due bears interest at the rate of 15% per
annum. The convertible notes are convertible into shares of the Company's common
stock at a Variable Conversion Price, as defined, subject to adjustment if the
Company were to issue any additional shares of common stock at a price per share
less than the applicable conversion rate then in effect, without a floor. The
Variable Conversion Price is 50% multiplied by the average of the lowest 3
Trading Prices for the Common Stock during the 20 Trading Day period prior to
conversion.
In March 2008, we entered into a securities purchase agreement with an investor,
under which we sold a convertible note in the principal amount of $50,000. In
connection with the agreement, we granted the investor seven-year warrants to
purchase a total of 180,000 shares of common stock at an exercise price of $.10
per share, subject to adjustment for dilutive share issuances. The warrants were
exercisable immediately and allow the holder to purchase the shares within seven
years of the issue date. The exercise price is subject to adjustment upon the
occurrence of the following events during the period that the conversion right
remains outstanding: common stock reclassifications, stock splits, combinations
and dividends. The notes bear interest of 8% per annum, payable quarterly. No
interest is due for any month in which the trading price of our common stock is
greater than $.14975 for each trading day. Any amount of principal or interest
on the notes which is not paid when due bears interest at the rate of 15% per
annum. The convertible notes are convertible into shares of the Company's common
stock at a Variable Conversion Price, as defined, subject to adjustment if the
Company were to issue any additional shares of common stock at a price per share
less than the applicable conversion rate then in effect, without a floor. The
Variable Conversion Price is 50% multiplied by the average
35
of the lowest 3 Trading Prices for the Common Stock during the 20 Trading Day
period prior to conversion.
RELATED PARTY TRANSACTIONS
On October 14, 2003, a shareholder/director opened an irrevocable standby
letter of credit on our behalf as required by our equipment lease agreement,
which is to be retained for the entire term of the lease obligation or until
such time as we are able to replace this letter of credit, in the amount of
$1,040,000. As compensation, we issued a warrant to purchase 520,000 shares of
common stock exercisable at the lower of $2.75 per share or the sales price of
common stock in subsequent offerings. The fair value of the warrant was $269,470
utilizing the Black-Scholes option-pricing model with the following assumptions:
50% volatility, seven-year expected life, risk-free interest rate of 3.86% and
dividend yield of 0%. The warrant was originally scheduled to expire on October
14, 2010, but was converted into approximately 95,047 shares of common stock in
connection with the reverse merger on July 22, 2004. The fair value of the
warrant has been recorded as a deferred lease cost and is being amortized, on a
straight-line basis, over the term of the original lease obligation which was
April 1, 2007. As of December 31, 2007, these costs have been fully amortized.
In November 30, 2005, the balance of this letter of credit was reduced to
$750,462. We are contingently liable for the amounts of this letter of credit in
the event the stockholder/director is obligated to make payments thereunder as a
result of our noncompliance with the terms of the lease agreement.
In March 2007, Peter Greenfield, a shareholder and director, advanced the
Company $175,000 to use as working capital until the Company received long term
funding. The $175,000, plus interest calculated at a rate of 10% per annum, will
be returned to the shareholder upon receipt of long term funding. As of December
31, 2007, interest totaling $14,192 has been accrued and was included in accrued
expenses on the accompanying consolidated balance sheet.
In November 2007, Peter Greenfield, a shareholder and director, advanced the
Company $105,000 to use as working capital until the Company received long term
funding. The $105,000, plus interest calculated at a rate of 10% per annum, will
be returned to the shareholder upon receipt of long term funding. As of December
31, 2007, interest totaling $1,697 has been accrued and was included in accrued
expenses on the accompanying consolidated balance sheet.
At December 31, 2007, accrued but unpaid salaries totaled $317,634 to Brenda
Meyer, a current officer.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2006, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income
Taxes." This interpretation applies to all tax positions accounted for in
accordance with SFAS No. 109, "Accounting for Income Taxes." FIN 48 clarifies
the application of SFAS No. 109 by defining the criteria that an individual tax
position must meet in order for the position to be recognized within the
financial statements and provides guidance on measurement, derecognition,
36
classification, interest and penalties, accounting in interim periods,
disclosure and transition for tax positions. The Company adopted the
interpretation effective January 1, 2007. The adoption of this interpretation
did not have a material impact on the Company's consolidated financial
statements.
In June 2006, the Emerging Issues Task Force ("EITF") reached a consensus
on EITF Issue No. 06-3, "How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income Statement (That Is,
Gross versus Net Presentation)" ("EITF 06-3") to clarify diversity in practice
on the presentation of different types of taxes in the financial statements. The
Task Force concluded that, for taxes within the scope of the issue, a company
may adopt a policy of presenting taxes either gross within revenue or net. That
is, it may include charges to customers for taxes within revenues and the charge
for the taxes from the taxing authority within cost of sales, or, alternatively,
it may net the charge to the customer and the charge from the taxing authority.
If taxes subject to this Issue are significant, a company is required to
disclose its accounting policy for presenting taxes and the amounts of such
taxes that are recognized on a gross basis. The guidance in this consensus was
effective for the first interim reporting period beginning after December 15,
2006. The Company adopted the Net Presentation. The adoption of this EITF did
not have a material impact on the Company's consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 157 "Fair Value Measurements". This Statement defines fair
value, establishes a framework for measuring fair value in generally accepted
accounting principles (GAAP), and expands disclosures about fair value
measurements. This Statement applies under other accounting pronouncements that
require or permit fair value measurements, the Board having previously concluded
in those accounting pronouncements that fair value is the relevant measurement
attribute. Accordingly, this Statement does not require any new fair value
measurements. This Statement is effective for us beginning January 1, 2008. The
Company is currently evaluating the effect of this pronouncement on its
consolidated financial statements.
In December 2006, the FASB issued FASB Staff Position EITF 00-19-2 "Accounting
for Registration Payment Arrangements," ("EITF 00-19-2"), which specifies that
the contingent obligation to make future payments or otherwise transfer
consideration under a registration payment arrangement should be separately
recognized and measured in accordance with SFAS No. 5, "Accounting for
Contingencies." Adoption of EITF 00-19-2 was required for fiscal years beginning
after December 15, 2006. The adoption of EITF 00-19-2 resulted in the accrual of
approximately $121,000 of registration penalties as of December 31, 2007.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial LiabilitieS" ("SFAS 159"). SFAS 159 expands
opportunities to use fair value measurements in financial reporting and permits
entities to choose to measure many financial instruments and certain other items
at fair value. SFAS 159 is effective beginning January 1, 2008, and permits
earlier application. The Company is currently evaluating the effect of this
pronouncement on its consolidated financial statements.
37
In June 2007, the EITF reached a consensus on EITF Issue No. 06-11,
"Accounting for Income Tax Benefits on Dividends on Share-Based Payment Awards"
("EITF 06-11"). EITF 06-11 addresses share-based payment arrangements with
dividend protection features that entitle employees to receive (a) dividends on
equity-classified non-vested shares, (b) dividend equivalents on
equity-classified non-vested share units, or (c) payments equal to the dividends
paid on the underlying shares while an equity-classified share option is
outstanding, when those dividends or dividend equivalents are charged to
retained earnings under SFAS 123(R) and result in an income tax deduction for
the employer. A realized income tax benefit from dividends or dividend
equivalents that are charged to retained earnings are paid to employees for
equity-classified non-vested shares, non-vested equity share units, and
outstanding equity share options should be recognized as an increase in
additional paid in capital. The amount recognized in additional paid-in capital
for the realized income tax benefit from dividends on those awards should be
included in the pool of excess tax benefits available to absorb potential future
tax deficiencies on share-based payments. The Company does not expect the
adoption of this pronouncement to have a material impact on its consolidated
financial Statements,
In December 2007, the Securities Exchange Commission ("SEC") published
Staff Accounting Bulletin ("SAB") No. 110, which amends SAB No. 107 to allow for
the continued use, under certain circumstances, of the "simplified" method in
developing an estimate of the expected term of so-called "plain vanilla" stock
options accounted for under SFAS 123R beyond December 31, 2007. Companies can
use the simplified method if they conclude that their stock option exercise
experience does not provide a reasonable basis upon which to estimate expected
term. SAB No. 110 will not have a significant impact on the Company's
consolidated financial statements. The Company has concluded that their stock
option exercise experience does not provide a reasonable basis upon which to
estimate expected term, therefore beginning in 2008, for any stock option awards
granted, the Company will continue to use the "simplified" method to calculate
estimates of the expected term of stock options.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests
in Consolidated Financial Statements -- an amendment of ARB No. 51" ("SFAS
160"). SFAS 160 establishes new accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. Specifically, this statement requires the recognition of a
noncontrolling interest (minority interest) as equity in the consolidated
financial statements and separate from the parent's equity. The amount of net
income attributable to the noncontrolling interest will be included in
consolidated net income on the face of the income statement. SFAS 160 clarifies
that changes in a parent's ownership interest in a subsidiary that do not result
in deconsolidation are equity transactions if the parent retains it controlling
financial interest. In addition, this statement requires that a parent recognize
a gain or loss in net income when a subsidiary is deconsolidated. Such gain or
loss will be measured using the fair value of the noncontrolling equity
investment on the deconsolidation date. SFAS 160 also includes expanded
disclosure requirements regarding the interests of the parent and its
noncontrolling interest. SFAS 160 is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008.
Earlier adoption is prohibited. The Company will assess the impact of SFAS 160
if and when a future acquisition occurs.
38
In December 2007, the FASB issued SFAS No. 141R, "Business Combinations" ("SFAS
141R"), which replaces SFAS No. 141. SFAS 141R establishes principles and
requirements for how an acquirer in a business combination recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any controlling interest; recognizes and measures the
goodwill acquired in the business combination or a gain from a bargain purchase;
and determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination. SFAS 141R is to be applied prospectively to business combinations
for which the acquisition date is on or after an entity's fiscal year that
begins after December 15, 2008. The Company will assess the impact of SFAS 141R
if and when a future acquisition occurs.
In March 2008, the FASB issued SFAS No. 161 "Disclosures about Derivative
Instruments and Hedging Activities" ("SFAS 161"), which requires disclosures
about the fair value of derivative instruments and their gains or losses in
tabular format as well as disclosures regarding credit-risk-related contingent
features in derivative agreements, counterparty credit risk and strategies and
objectives for using derivative instruments. SFAS 161 amends and expands SFAS
133 and is effective prospectively beginning January 1, 2009. The Company is
currently evaluating the impact to its consolidated financial statements.
ITEM 7. FINANCIAL STATEMENTS.
The response to this item is submitted as a separate section of this
report beginning on page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On February 14, 2008, the Company dismissed Eisner LLP (Eisner) as its
independent registered public accounting firm. The reports of Eisner on the
Company's financial statements as of and for the fiscal years ended December 31,
2006 and 2005 did not contain an adverse opinion or disclaimer of opinion, nor
were they qualified or modified as to audit scope or accounting principles.
Eisner's report on the Company's financial statements as of and for the years
ended December 31, 2006 and 2005 included an explanatory paragraph and expressed
substantial doubt about the Company's ability to continue as a going concern.
During the period of their engagement and through the date of dismissal, there
were no disagreements, resolved or not, with Eisner on any matters of accounting
principles or practices, financial statement disclosure or auditing scope or
procedures, which disagreements, if not resolved to the satisfaction of Eisner,
would have caused Eisner to make reference to the subject matter of the
disagreement in connection with their report on the financial statements for
such years.
On February 14, 2008, the Company engaged Marcum & Kliegman LLP (Marcum
Kliegman) as its independent registered public accounting firm for the Company's
fiscal year ended December 31, 2007. The decision to change accountants was
approved by the Company's board of directors.
39
ITEM 8A. CONTROLS AND PROCEDURES
EVALUATION OF OUR DISCLOSURE CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures (as defined in
Exchange Act Rule 13a-15(e) and 15d-15(e)) that are designed to ensure that
information required to be disclosed in reports that it files or submits under
the Securities Exchange Act of 1934 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 its management, including its Chief Executive Officer and
Principal Financial Officer, as appropriate to allow timely decisions regarding
the required disclosures. In designing and evaluating the disclosure controls
and procedures, the Company recognizes that any controls and procedures, no
matter how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives.
The Company carried out an evaluation, under the supervision and with the
participation of management, including its Chief Executive Officer and
PrincipalFinancial Officer, of the effectiveness of the design and operation of
its disclosure controls and procedures as of December 31, 2007. The Company's
Chief Executive Officer and Principal Financial Officer determined that the
Company has a material weakness as a result of several significant deficiencies
including lack of personnel, lack of segregations of duties, inadequate
derivative valuation controls and ineffective controls related to significant
transactions. The temporary shift in the Company's focus and resources toward
keeping the Company solvent contributed to the material weakness. As a result of
the material weakness identified the Chief Executive Officer and Principal
Financial Officer concluded that as of December 31, 2007, its disclosure
controls and procedures were not designed properly and were not effective in
ensuring that the information required to be disclosed by the Company in the
reports that we file and submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Commission's
rules and forms.
While the Company continues the engagement of outside experts to provide
counsel and guidance in areas where it cannot economically maintain the required
expertise internally, the lack of personnel has adversely impacted the Company
on exercising the necessary internal control over financial reporting for the
quarter ended December 31, 2007. In 2007 the Company initiated the process of
implementing a financial system that it believes would improve the internal
control over financial reporting and eliminate any identified deficiencies.
Because of the financial condition the Company faced in 2007, and pending the
obtaining of adequate financing to support the implementation of the necessary
controls and procedures, the full implementation of this system is now delayed.
(b) Management's Annual Report on Internal Control Over Financial Reporting.
The Company is responsible for establishing and maintaining adequate
internal control over financial reporting as defined in Rules 13a-15(f) or 15d -
15(f) under the Securities Exchange Act of 1934. Our internal control over
financial reporting is designed to provide reasonable assurance regarding the
reliability of financial reporting and preparation of financial statements for
external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Therefore, even those systems
determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and presentation.
Management assessed the effectiveness of our internal control over
financial reporting as of December 31, 2007. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission ("COSO") in Internal Control -
Integrated Framework.
Based on management's assessment, management concluded that internal controls
over financial reporting were not effective, as of December 31, 2007, due to
significant deficiencies including lack of segregations of duties, lack of
personnel, inadequate derivative valuation controls and ineffective controls
related to significant transactions which
40
aggregated to a material weakness. This annual report does not include an
attestation report of the Company's independent registered public accounting
firm, regarding internal control over financial reporting. Managements report
was not subject to attestation by the Company's independent registered public
accounting firm pursuant to temporary rules of the Securities and Exchange
Commission that permit the Company to provide only managements report in this
annual report.
As a result of errors that the Company believes are a direct result of these
material weaknesses, the Company has restated its condensed consolidated
financial statements for the three months ended March 31, 2007, June 30, 2007
and September 30, 2007.
ITEM 8B. OTHER INFORMATION
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND
CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE
ACT.
DIRECTORS AND EXECUTIVE OFFICERS
Our Board of Directors currently consists of only two persons. The
following table sets forth the names and ages of our directors and executive
officers.
NAME AGE POSITION DIRECTOR SINCE
---------------------------------------------------------------------------------------
Bruce Newman 47 Chief Executive Officer, Founder and Director 2004
Peter 66 Chairman of the Board of Directors 2004
Greenfield
Syd Dufton 43 President --
Brenda Meyer 47 Senior Vice President, Operations and Rights --
Management
The principal occupations for the past five years (and, in some instances,
for prior years) of each of our directors and executive officers are as follows:
DIRECTORS
BRUCE NEWMAN - CHIEF EXECUTIVE OFFICER, FOUNDER AND DIRECTOR. Mr. Newman
was the President, Chief Executive Officer and a member of the board of
directors of privately-held Protocall since its formation in December 1992. He
became our President and Chief Executive Officer and a member of our board of
directors on July 22, 2004, resigned as chief executive officer and a director
on June 13, 2005, and rejoined the board of directors on September 9, 2005. He
resumed his role as Chief Executive Officer on May 17, 2006. Mr. Newman has more
than 20 years of entrepreneurial investment and management experience with
technology and software distribution companies. Prior to forming Protocall, Mr.
Newman was the President of Precision Type & Form, Inc. (no relation to
Protocall's Precision Type font software licensing
41
subsidiary), a computer photocomposition and high-resolution electronic imaging
service company, from 1982 to 1993, when the two operating businesses were sold.
PETER GREENFIELD - CHAIRMAN OF THE BOARD OF DIRECTORS. Mr. Greenfield was
a member of the board of directors of privately-held Protocall since 1998. He
became the Chairman of our board of directors on July 22, 2004. He founded and
has served as the President of Greenfield Industries, a manufacturer and
supplier of quality aluminum and zinc castings, since 1966.
EXECUTIVE OFFICERS
SYD DUFTON - PRESIDENT. Mr. Dufton became our President in December 2006.
Mr. Dufton has more than 17 years of senior level experience with technology
companies. Most recently, Mr. Dufton served as a Partner and Managing Director
of City Capital Partners, a venture capital investment firm focused on privately
held technology companies. Prior to that Mr. Dufton was our Vice President of
Sales and Marketing until August 2005. Before joining Protocall, Mr. Dufton was
a founder of AdvanceWork International - a mobile distance learning technology
company. Mr. Dufton was also a principal and Vice President of Syracuse Language
Systems before the company was sold to Cendant Software. As a result of the sale
to Cendant, Mr. Dufton became a Vice President in Cendant's SLS Division.
Cendant Software was eventually sold to Vivendi Universal, where Mr. Dufton
continued in his role as Vice President.
BRENDA MEYER - SENIOR VICE PRESIDENT, OPERATIONS AND RIGHTS MANAGEMENT.
Ms. Meyer has been the Senior Vice President-Operations and Rights Management of
Protocall since December 1992. She became our Senior Vice President-Operations
and Rights Management on July 22, 2004. Ms. Meyer has in-depth experience in the
licensing, multi-channel distribution and reporting of digitally-based
intellectual property. She served as Executive Vice President of Protocall's
Precision Type subsidiary, where she managed day-to-day operations and oversaw
the trademark, copyright, and digital rights management with over 100 suppliers
and approximately 18,000 individual software products. Ms. Meyer also served as
Executive Vice President in two computer service companies, where she managed
technical operations. Ms. Meyer and Bruce Newman are siblings.
All directors hold office until the next annual meeting of stockholders
and the election and qualification or their successors. Officers are elected
annually by the board of directors and serve at the discretion of the board. We
are currently seeking to fill two board positions. We have undertaken to
identify and hire a Chief Financial Officer. Mr. Newman, our Chief Executive
Officer, is currently serving in such capacity.
On May 17, 2006, Don Hoffmann resigned as the Company's Chief Executive
Officer and from the Board of Directors. Bruce Newman, our former President and
Chief Executive Officer and a director was renamed Chief Executive Officer.
INDEBTEDNESS OF EXECUTIVE OFFICERS AND DIRECTORS
No executive officer, director or any member of these individuals'
immediate families or any corporation or organization with whom any of these
individuals is an affiliate is or has been indebted to us since the beginning of
our last fiscal year.
42
FAMILY RELATIONSHIPS
There are no family relationships among our executive officers and
directors, except that Bruce Newman, CEO, founder and one of our directors, and
Brenda Meyer, our Senior Vice-President, Operations and Rights Management, are
siblings.
LEGAL PROCEEDINGS
As of the date of this filing, there are no material proceedings to which
any of our directors, executive officers, affiliates or stockholders is a party
adverse to us.
THE BOARD OF DIRECTORS AND CORPORATE GOVERNANCE
Our Board of Directors is responsible for establishing broad corporate
policies and for overseeing our overall management. In addition to considering
various matters which require Board approval, the Board provides advice and
counsel to, and ultimately monitors the performance of, our senior management.
The Board, its committees and our management strive to perform and fulfill
their respective duties and obligations in a responsible and ethical manner. The
Board and the Audit and Compensation Committees each perform annual self
evaluations. We have adopted a comprehensive Code of Business Conduct and Ethics
for all directors, officers and employees and a Code of Ethics for our Chief
Executive Officer and our senior financial officer.
COMMITTEES OF THE BOARD
We have established an audit committee and a compensation committee;
however, in view of the fact that at this time there are only two directors, the
entire board is currently responsible for execution of the responsibilities
delegated to the audit committee and compensation committee by the board.
Neither of the two directors is "independent" as that term is used in Rule
10A-3(b)(1) under the Securities Exchange Act of 1934.
AUDIT COMMITTEE. The entire Board of Directors is acting as our audit
committee, as specified in section 3(a)(58)(B) of the Exchange Act. The Audit
Committee functions pursuant to a written Charter which was adopted by the
Board. The Audit Committee has such powers as may be assigned to it by the Board
from time to time. The Audit Committee conducted 4 formal meetings in 2007. The
Audit Committee is currently charged with, among other things:
o recommending to the Board of Directors the engagement or discharge
of our independent public accountants, including pre-approving all
audit and non-audit related services;
o the appointment, compensation, retention and oversight of the work
of the independent auditor engaged by us for the purpose of
preparing or issuing an audit report or performing other audit
review or attest services for us;
43
o establishing procedures for the receipt, retention and treatment of
complaints received by us regarding accounting, internal accounting
controls or auditing matters and for the confidential, anonymous
submission by our employees of concerns regarding questionable
accounting or auditing matters;
o approving the scope of the financial audit;
o requiring the rotation of the lead audit partner;
o consulting regarding the completeness of our financial statements;
o reviewing changes in accounting principles;
o reviewing the audit plan and results of the auditing engagement with
our independent auditors and with our officers;
o reviewing with our officers, the scope and nature and adequacy of
our internal accounting and other internal controls over financial
reporting and disclosure controls and procedures;
o reviewing the adequacy of the Audit Committee Charter at least
annually;
o meeting with our Internal Auditor on a regular basis;
o performing an internal evaluation of the Audit Committee on an
annual basis; and
o reporting to the Board of Directors on the Audit Committee's
activities, conclusions and recommendations.
COMPENSATION COMMITTEE. The Entire Board is acting as the Compensation
Committee. The Compensation Committee functions pursuant to a written Charter
which was adopted by the Board. The Compensation Committee has such powers as
may be assigned to it by the Board from time to time. It is currently charged
with, among other things, assisting the Board in:
o approving and evaluating the compensation of directors and executive
officers;
o establishing strategies and compensation policies and programs for
employees to provide incentives for delivery of value to our
shareholders;
o establishing policies to hire and retain senior executives, with the
objective of aligning the compensation of senior management with our
business and the interests of our shareholders;
o together with management, surveying the amount and types of
executive compensation paid by comparable companies, and engaging
consultants as necessary to assist them;
o periodically reviewing corporate goals and objectives relevant to
executive compensation and making recommendations to the Board for
changes;
o assisting management in evaluating each executive officer's
performance in light of corporate goals and objectives, and
recommending to the Board (for approval by the independent
directors) the executive officers' compensation levels based on this
evaluation;
44
o overseeing our stock option plan or other stock-based plans with
respect to our executive officers and employee Board members, who
are subject to the short-swing profit restrictions of Section 16 of
the Securities Exchange Act of 1934, as amended;
o reviewing the overall performance of our employee benefit plans and
making recommendations to the Board regarding incentive-compensation
plans and equity-based plans;
o together with the full Board, reviewing and making recommendations
to the independent directors of the Board regarding the form and
amount of director compensation;
o ensuring that our compensation policies meet or exceed all legal and
regulatory requirements and any other requirements imposed on us by
the Board; and
o producing an annual report on executive compensation for inclusion
in our proxy statement.
In general, the Compensation Committee formulates and recommends
compensation policies for Board approval, oversees and implements these
Board-approved policies, and keeps the Board apprised of its activities on a
regular basis. In addition, the Compensation Committee together with the full
Board develops criteria to assist the Board's assessment of the Chief Executive
Officer's leadership of our Company.
DIRECTOR COMPENSATION
Directors are expected to timely and fully participate in all regular and
special board meetings, and all meetings of committees that they serve on. We
have agreed to pay each non-employee director a retainer fee of $5,000 per
quarter, but deferred until we have sufficient cash flow as determined by our
board, and no participation fee for attendance at regular or special meetings of
the board. There is no participation fee for attendance at meetings of a
committee of the board. We will also reimburse each director for reasonable
accommodations, coach travel and other miscellaneous expenses relating to each
director's attendance at board meetings and committee meetings promptly upon
submission of actual receipts to our chief financial officer.
All of the option grants to non-employee directors are pursuant to our
2004 Stock Option Plan. Other terms and conditions of the option grants are on
the standard terms and conditions as those option grants to employees. Effective
December 1, 2006, due to a reduced number of board members and greater levels of
work effort, our Chairman received an additional grant of non-qualified stock
options to purchase 3,660,000 shares.
The Compensation Committee will review the director compensation plan
annually, and adjust it according to then current market conditions and good
business practices.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Rules adopted by the SEC under Section 16(a) of the Exchange Act, require
our officers and directors, and persons who own more than 10% of the issued and
outstanding shares of our equity securities, to file reports of their ownership,
and changes in ownership, of such securities
45
with the SEC on Forms 3, 4 or 5, as appropriate. Such persons are required by
the regulations of the SEC to furnish us with copies of all forms they file
pursuant to Section 16(a).
Based solely upon a review of Forms 3, 4 and 5 and amendments thereto
furnished to us during our most recent fiscal year, and any written
representations provided to us, we believe that all of the officers, directors,
and owners of more than ten percent of the outstanding shares of our common
stock complied with Section 16(a) of the Exchange Act for the year ended
December 31, 2007.
ITEM 10. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION AND RELATED MATTERS
The following table sets forth the compensation (including cash bonuses)
awarded, paid or accrued by us for our years ended December 31, 2007, and 2006,
to our Chief Executive Officer and our two most highly compensated officers
other than the Chief Executive Officer at December 31, 2007.
SUMMARY COMPENSATION TABLE
NONQUALIFIED
STOCK OPTION NON-EQUITY DEFERRED ALL OTHER
SALARY BONUS AWARDS AWARDS INCENTIVE PLAN COMPENSATION COMPENSATION TOTAL
NAME YEAR ($) ($) ($) ($) (2) COMPENSATION EARNINGS (1) ($)
-----------------------------------------------------------------------------------------------------------------------------------
BRUCE NEWMAN 2007 221,400 -- -- -- -- 26,400 247,800
Chief Executive Officer 2006 225,750 -- -- 355,274 -- -- -- 581,024
through June 2005 and
through June 2006 and
director and consultant
from September 2005 to May
2006
SYD DUFTON 2007 145,000 -- -- -- 145,000
Vice President Sales and
Channel Marketing through
August 2005, President from
November 2006 (3) 2006 84,270 10,000 -- 231,510 -- -- -- 325,780
BRENDA NEWMAN 2007 147,000 -- -- -- -- 147,000
Senior Vice President 2006 143,608 -- -- 364,304 -- -- -- 507,912
Content and Digital Rights
Management of Protocall
46
(1) Other Compensation does not include the cost to Protocall for health and
welfare benefits received by the above named officers. The aggregate
amounts of such personal benefits did not exceed the lesser of $50,000 or
10% of the total annual compensation of such officer.
(2) Represents the aggregate fair value computed in accordance with FAS 123R.
(3) Mr. Dufton was employed by the Company from September 2004 through August
2005. Mr. Dufton returned to the Company and became our President in
November 2006. Amounts paid to Mr. Dufton include $15,990 in severance and
$26,542 as a consultant prior to rejoining the Company., Mr. Dufton
resigned from his position as President on April 20, 2008.
OPTION GRANTS IN LAST FISCAL YEAR
There were no stock option grants to our executive officers during the
fiscal year ended December 31, 2007.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR END
EQUITY INCENTIVE
PLAN AWARDS:
NUMBER OF NUMBER OF NUMBER OF
SECURITIES SECURITIES SECURITIES
UNDERLYING UNDERLYING UNDERLYING
UNEXERCISED UNEXERCISED UNEXERCISED
OPTIONS (#) OPTIONS UNEARNED OPTIONS OPTION EXERCISE OPTION EXPIRATION
NAME EXERCISABLE (#) UNEXERCISABLE (#) PRICE ($) DATE
---------------------------------------------------------------------------------------------------------
BRUCE NEWMAN 398,294 -- $ 1.25 7/31/07-1/31/09
113,600 -- 1.875 1/29/2008
93,600 -- 2.750 7/31/2007
270,875 -- 0.330 11/3/2015
3,660,000 -- 0.140 12/1/2016
BRENDA NEWMAN 482,118 1.250 7/31/07-1/31/09
64,447 1.875 1/29/2008
44,447 2.750 7/31/2007
103,750 1.250 7/22/2014
183,334 16,666 1.350 3/28/2015
46,250 0.330 11/3/2015
350,000 0.250 8/29/2016
2,166,669 1,083,331 0.100 12/1/2016
DONALD
HOFFMANN 262,500 1.350 5/17/2008
16,667 1.250 5/17/2008
200,000 0.330 5/17/2008
SYD DUFTON 150,000 1.35 3/28/2015-1/28/2016
166,000 .33 1/28/2016-2/28/2016
16,667 1.250 1/25/2016
1,400,008 699,992 0.100 12/1/2016
47
EMPLOYMENT AGREEMENTS
We currently have no employment agreements with our executive officers.
On May 17, 2006, Don Hoffmann resigned as our Chief Executive Officer and
from the Board of Directors. Bruce Newman, our former Chief Executive Officer
and a director was renamed Chief Executive Officer.
On April 21, 2008, Protocall Technologies Incorporated accepted the resignation
of Syd Dufton as the Company's President. Mr. Dufton will be pursuing other
interests and will assist Protocall on a limited basis through April 30, 2008 in
the transition of any business matters. Founder & CEO Bruce Newman will assume
Mr. Dufton's responsibilities and take an expanded role in the day to day
operations and business affairs of Protocall.
DIRECTOR COMPENSATION
NONQUALIFIED
FEES NON-EQUITY DEFERRED
FISCAL EARNED STOCK OPTION INCENTIVE PLAN COMPENSATION TOTAL
NAME YEAR (1) AWARDS ($) AWARDS ($) COMPENSATION EARNINGS ($) ($)
---------------------------------------------------------------------------------------------------------
Peter Greenfield 2007 $ 20,000 -- -- -- -- 20,000
Bruce Newman, (2) 2007 -- -- -- -- -- --
--------------------------------------------------------------------------------
(1) Fees have not yet been paid.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information regarding the number of shares
of our common stock beneficially owned as of December 31, 2007 by (i) each
person known to us to be the beneficial owner of more than 5% of our common
stock; (ii) each director; (iii) each executive officer; and (iv) all of our
directors and executive officers as a group. Unless otherwise indicated in the
footnotes following the table, the persons as to whom the information is given
had sole voting and investment power over the shares of common stock shown as
beneficially owned by them. Unless otherwise indicated, the address of each
person shown is c/o Protocall Technologies Incorporated, 47 Mall Drive, Commack,
New York 11725-5717.
48
NUMBER OF SHARES PERCENTAGE OF SHARES
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED (1) BENEFICIALLY OWNED (1)
Bruce Newman 5,218,965 (2) 4.12%
Peter Greenfield 11,874,732 (4) 9.40%
Brenda Newman 4,985,461 (3) 3.94%
Syd Dufton 1,907,677 (5) 1.54%
CIMOS, Inc 12,110,982 (6) 9.64%
Joachim R Anzer 51,841,471 (7) 36.85%
Monarch Capital Fund 12,298,133 (8) 9.83%
Directors and executive officers as a group (four persons) 23,986,835 (9) 17.74%
--------------------------------------------------------------------------------
(1) In accordance with Rule 13d-3(d)(1)(i) of the Securities Exchange Act of
1934, as amended, shares beneficially owned at any date include shares
issuable upon the exercise of stock options, warrants, rights or
conversion privileges within 60 days after that date. For the purpose of
computing the percentage of outstanding shares beneficially owned by a
particular person, any securities not outstanding that are subject to
stock options, warrants, rights or conversion privileges exercisable by
that person within 60 days after December 31, 2007 have been deemed to be
outstanding, but have not been deemed outstanding for the purpose of
computing the percentage of the class beneficially owned by any other
person.
(2) Includes 605,494 shares of common stock issuable upon exercise of stock
options granted under the Protocall 2000 Stock Incentive Plan, which are
currently exercisable and 3,930,871 shares of common stock issuable upon
exercise of stock options granted under the Protocall 2004 Stock Incentive
Plan which are currently exercisable.
(3) Includes 591,012 shares of common stock issuable upon exercise of stock
options granted under the Protocall 2000 Stock Incentive Plan, which are
currently exercisable and 3,711,849 shares of common stock issuable upon
exercise of stock options granted under the Protocall 2004 Stock Incentive
Plan which are currently exercisable.
(4) Includes 4,130,871 shares of common stock issuable upon the exercise of
stock options granted and currently exercisable under the Protocall 2004
Stock Incentive Plan.
(5) Includes 1,907,677 shares of common stock issuable upon the exercise of
stock options granted and currently exercisable under the Protocall 2004
Stock Incentive Plan.
(6) Includes 3,385,452 shares of common stock issuable upon the exercise of
currently exercisable warrants. Based on a Schedule 13G filed on February
27, 2006, and other information known to us.
(7) Includes 18,468,336 shares of common stock issuable upon the exercise of
currently exercisable warrants that expire between June 2008 and July
2009.
(8) Includes 2,884,615 shares of common stock issuable upon the exercise of
currently exercisable seven-year warrants that expire November 2013.
(9) Includes 1,196,506 shares of common stock issuable upon exercise of stock
options granted and currently exercisable under the Protocall 2000 Stock
Incentive Plan. Also includes 13,681,268 shares of common stock issuable
upon exercise of stock options granted under the Protocall 2004 Stock
Incentive Plan.
On May 17, 2006, Don Hoffmann resigned as the Company's Chief Executive
Officer and from the Board of Directors. Bruce Newman, our former
President and Chief Executive Officer and a director was renamed Chief
Executive Officer.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTORS
INDEPENDENCE.
On October 14, 2003, a stockholder/director opened an irrevocable standby
letter of credit on our behalf as required by our equipment lease agreement,
which is to be retained for the entire term of the lease obligation or until
such time as we are able to replace this letter of credit, in the amount of
$1,040,000. As compensation, we issued a warrant to purchase 520,000 shares of
common stock exercisable at the lower of $2.75 per share or the sales price of
common stock
49
in subsequent offerings. The fair value of the warrant was $269,470 utilizing
the Black-Scholes option-pricing model with the following assumptions: 50%
volatility, seven-year expected life, risk-free interest rate of 3.86% and
dividend yield of 0%. The warrant was originally scheduled to expire on October
14, 2010, but was converted into approximately 95,047 shares of common stock in
connection with the reverse merger on July 22, 2004. The fair value of the
warrant has been recorded as a deferred lease cost and is being amortized, on a
straight-line basis, over the term of the original lease obligation which was
April 1, 2007. In November 30, 2005, the balance of this letter of credit was
reduced to $750,462. We are contingently liable for the amounts of this letter
of credit in the event the stockholder/director is obligated to make payments
thereunder as a result of our noncompliance with the terms of the lease
agreement.
In March 2007, Peter Greenfield,a shareholder and director, advanced the Company
$175,000 to use as working capital until the Company received long term funding.
The $175,000, plus interest calculated at a rate of 10% per annum, will be
returned to the shareholder upon receipt of long term funding. As of December
31, 2007, interest totaling $14,192 has been accrued and was included in accrued
expenses on the accompanying consolidated balance sheet.
In November 2007, Peter Greenfield, a shareholder and director, advanced the
Company $105,000 to use as working capital until the Company received long term
funding. The $105,000, plus interest calculated at a rate of 10% per annum, will
be returned to the shareholder upon receipt of long term funding. As of December
31, 2007, interest totaling $1,697 has been accrued and was included in accrued
expenses on the accompanying consolidated balance sheet.
At December 31, 2007, accrued but unpaid salaries to Brenda Meyer a current
officer totaled $317,634.
DIRECTOR INDEPENDENCE
Neither of our directors would be considered independent by SEC governance
standards.
ITEM 13. EXHIBITS.
(a) Exhibits:
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
3.0 S-8 Filed on December 27, 2006
3.1 Form of Note, Form of Warrant, and Securities Purchase Agreement
for Convertible Notes dated July 3, 2007.
3.2 Form of Note, Form of Warrant, and Securities Purchase Agreement
for Convertible Notes dated August 21, 2007.
3.3 Form of Note, Form of Warrant, and Securities Purchase Agreement
for Convertible Notes dated December 24, 2007.
4.1 Form of Warrant.(1)
10.1 2000 Stock Incentive Plan.(2)
50
10.2 2004 Stock Option Plan.(1)
10.4 Electronic Software Distribution and Site Location Agreement,
dated November 29, 2002, between Protocall Software Delivery
Systems Inc. and CompUSA Inc., as amended by Amendment No. 1
thereto, dated as of June 15, 2004. (3)
10.5 Electronic Software Distribution and Site Location Agreement,
dated March 25, 2004, between Protocall Software Delivery Systems
Inc. and Systemax Inc. (3)
14.1 Code of Business Conduct and Ethics.(1)
14.2 Code of Ethics for CEO and Senior Financial Officers.(1)
21.1 Subsidiaries of Protocall Technologies Incorporated.
24.1 Power of Attorney (set forth on signature page of the Annual
Report).
31.1 Certification of Principal Executive Officer Required by Exchange
Act Rule 13a-14(a).
31.2 Certification of Principal Financial Officer Required by Exchange
Act Rule 13a-14(a).
32.1 Joint Certification of Principal Executive Officer and Principal
Financial Officer Required by Exchange Act Rule 13a-14(b).
--------------------------------------------------------------------------------
(1) Incorporated by reference to the exhibits filed with the Registration
Statement on Form SB-2 (filed with the SEC on January 13, 2005).
(2) Incorporated by reference to the exhibits filed with the Current Report on
Form 8-K, dated July 22, 2004 (filed with the SEC on August 6, 2004).
(3) To be filed by amendment to the Registration Statement on Form SB-2.
(b) Reports on Form 8-K. None filed during the three months ended
December 31, 2007.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
AUDIT FEES
We incurred fees of approximately $150,000 to Marcum & Kliegman for the
audit of the annual financial statements of Protocall Technologies Incorporated
for the year ended December 2007. We incurred fees of approximately $200,000 to
Eisner LLP for the audit of the annual financial statements of Protocall
Technologies Incorporated for the year ended December 31, 2006 and the reviews
of the quarterly 2006 financial statements.
TAX FEES
There were no fees billed to us by Marcum & Kliegman LLP in 2007 or by
Eisner, LLP in 2006 for services rendered to us for tax compliance, tax advice,
or tax planning.
51
ALL OTHER FEES
There were no fees billed to us by Marcum & Kliegman LLP in 2007 or by
Eisner, LLP in 2006 for services rendered to us, other than the services
described above under "Audit Fees" and "Audit-Related Fees."
It is the audit committee's policy to pre-approve all services provided by
Marcum & Kliegman, LLP. All services provided by Eisner LLP in 2006 were
approved by the audit committee.
As of the date of this filing, our current policy is not to engage Marcum
& Kliegman to provide, among other things, bookkeeping services, appraisal or
valuation services, or international audit services. The policy provides that we
engage Marcum & Kliegman, LLP to provide audit, tax, and other assurance
services, such as review of SEC reports or filings.
52
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PROTOCALL TECHNOLOGIES INCORPORATED
Date: May 16, 2008 By: /s/Bruce Newman
------------------------------------------------
Bruce Newman
Chief Executive Officer
(Principal Executive and Financial Officer and
Principal Accounting Officer)
POWER OF ATTORNEY
We, the undersigned officers and directors of Protocall Technologies
Incorporated, hereby severally constitute and appoint Bruce Newman, our true and
lawful attorney-in-fact and agent, with full power of substitution, for us and
in our stead, in any and all capacities, to sign any and all amendments to this
annual report and all documents relating thereto, and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the U.S.
Securities and Exchange Commission, granting to said attorney-in-fact and agent,
full power and authority to do and perform each and every act and thing
necessary or advisable to be done in and about the premises, as full to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming the said attorney-in-fact and agent, or his substitute or substitutes
may lawfully do or cause to be done by virtue hereof.
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated:
/s/Peter Greenfield
------------------------------------------------
May 16, 2008 Peter Greenfield
Chairman of the Board of Directors
/s/Bruce Newman
------------------------------------------------
May 16, 2008 Bruce Newman
Director, Chief Executive Officer
53
PROTOCALL TECHNOLOGIES INCORPORATED
FORM 10-KSB
ITEM 7
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
--------------------------------------------------------------------------------
Reports of Registered Public Accounting Firms F-1
Consolidated Balance Sheet at December 31, 2007 F-4
Consolidated Statements of Operations for the years ended December 31,
2007, and 2006 F-5
Consolidated Statements of Stockholders' Deficiency for the years ended
December 31, 2007, and 2006 F-6
Consolidated Statements of Cash Flows for the years ended December 31,
2007, and 2006 F-7
Notes to Consolidated Financial Statements F-9
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Audit Committee of
the Board of Directors and Stockholders
Protocall Technologies, Inc.
We have audited the accompanying consolidated balance sheet of Protocall
Technologies, Inc. and Subsidiaries (the "Company") as of December 31, 2007, and
the related consolidated statements of operations, stockholders' deficiency, and
cash flows for the year then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatements. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over reporting.
Accordingly, we express no such opinion. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Protocall
Technologies, Inc. and Subsidiaries as of December 31, 2007 and the results of
its operations and its cash flows for the year then ended, in conformity with
United States generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note A-2 to
the consolidated financial statements, the Company has suffered recurring losses
from operations, and has an accumulated deficit of $58,731,513, stockholders'
deficiency of $20,351,898 and a working capital deficit of $20,106,026 at
December 31, 2007. The Company also experienced severe cash short falls and has
been unable to pay some of its operating expenses as they became due. These
uncertainties raise substantial doubt about the Company's ability to continue as
a going concern. The consolidated financial statements do not include any
adjustments that might result from the outcome of these uncertainties.
/s/ Marcum & Kliegman LLP
Melville, New York
May 16, 2008
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Protocall Technologies Incorporated
We have audited the consolidated statements of operations, stockholders'
deficiency and cash flows of Protocall Technologies Incorporated and
subsidiaries ("the Company") for the year ended December 31, 2006. These
financial statements are the responsibility of Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred above present fairly, in all
material aspects, the consolidated results of operations and the consolidated
cash flows of Protocall Technologies Incorporated and subsidiaries for the year
ended December 31, 2006, in conformity with accounting principles generally
accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note A[2] to the
financial statements, the Company has incurred significant losses since
inception, has a working capital deficiency and stockholders' deficiency and
has been dependant upon funds generated from the sale of common stock and loans.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management's plans in regard to these matters are also
described in Note A[2]. The financial statements do not include any adjustments
that might result from the outcome of uncertainty.
Eisner LLP
New York, New York
April 16, 2007
F-2
Protocall Technologies, Inc. and Subsidiaries
Consolidated Balance Sheet
December 31, 2007
ASSETS
Current assets:
Cash $ 164,356
Accounts receivable, net of allowance for doubtful accounts of $14,748 78,345
Other current assets 5,853
------------
Total current assets 248,554
Property and equipment, net 33,604
Patents, net 20,762
Deferred financing costs 641,624
Security deposits 20,825
------------
TOTAL ASSETS $ 965,369
============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable $ 1,082,454
Accrued expenses 979,940
Payroll taxes payable 99,003
Deferred revenue 12,500
Accrued salaries - officers/stockholders 317,634
Loans payable 49,114
Loans payable - related parties 347,300
Other notes payable 149,782
Note payable-related party 414,565
Derivative financial instrument liability 16,640,856
Current portion of obligations under capital leases 261,432
------------
Total current liabilities 20,354,580
Loan payable, less current portion 48,131
Obligations under capital leases, less current portion 55,282
Convertible notes payable, net of discount of $1,971,236 859,274
------------
Total liabilities 21,317,267
------------
Commitments and Contingencies
Stockholders' deficiency:
Preferred stock, $0.001 par value, 4,500 shares authorized; none outstanding --
Series A, Convertible Preferred Stock, $0.001 par value, 500 shares authorized; 30
shares issued and outstanding ($60,000 liquidation preference) --
Common stock, $0.001 par value, 200,000,000 shares authorized,
123,131,341 shares issued and 122,971,341 outstanding 123,130
Additional paid-in capital 38,256,645
Accumulated deficit (58,731,513)
Treasury stock 160,000 shares at cost (160)
------------
Total stockholders' deficiency (20,351,898)
------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY $ 965,369
============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-3
Protocall Technologies, Inc. and Subsidiaries
Consolidated Statements of Operations
FOR THE YEARS ENDED
DECEMBER 31,
2007 2006
Net sales $ 954,792 $ 1,071,081
Cost of sales 758,346 1,188,409
------------ ------------
Gross profit (loss) 196,446 (117,328)
------------ ------------
Selling, general and administrative expenses 3,716,441 4,556,595
Research and development expenses 272,987 117,970
------------ ------------
Operating loss (3,792,982) (4,791,893)
Other income (expense)
Interest expense, including amortization of debt discounts (1,203,400) (337,773)
Fair value of derivative financial instrument in excess of
proceeds received at issuance (4,678,954) (1,820,167)
Change in fair value of derivative financial instrument liability (4,954,800) 963,922
Loss on disposal of property and equipment -- (19,561)
Other income, net 4,200 16,800
------------ ------------
Net loss $(14,625,936) $ (5,988,672)
============ ============
Net loss per share - basic and diluted $ (0.17) $ (0.10)
============ ============
Weighted average number of shares - basic and diluted 86,654,471 61,014,827
============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-4
Protocall Technologies, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Deficiency
For the Years Ended December 31, 2007 and 2006
SERIES A PREFERRED
STOCK COMMON STOCK TREASURY STOCK AT COST
------------------ -------------------------- ----------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
BALANCE AT JANUARY 1, 2006 -- $ -- 47,789,364 $ 47,790 -- $ --
Common shares issued in private placements-net of costs 20,004,877 20,005
Common shares issued for settlement of litigation 1,000,000 1,000
Common shares issued for consulting fees 1,423,078 1,423
Treasury stock from common Shares Forfeited (80,000) (80)
Common shares for conversion of convertible note 1,181,741 1,180
Warrants Issued for consulting fees
Derivative liability of tainted warrants
Amortization and write off of deferred sales fee
Amortization of deferred consulting fees
Stock based compensation expense
Net loss
------ ------ ----------- ------------ -------- --------
Balance at December 31, 2006 -- -- 71,399,060 71,398 (80,000) (80)
Common shares issued for private placements - net of costs -- -- 7,430,000 7,430 -- --
Common shares issued due to anti dilution provisions -- -- 524,475 524 -- --
Stock based compensation expense -- -- -- -- -- --
Common shares issued for investor relations -- -- 225,000 225 -- --
Conversion of principal and interest on convertible
notes into common shares -- -- 43,552,806 43,552 -- --
Reclassification of fair value of financial instrument
liability upon conversion
Forfeiture of common shares into treasury stock -- -- -- -- (80,000) (80)
Preferred shares issued - net of costs and discount 30 -- -- -- -- --
Net loss -- -- -- -- -- --
------ ------ ----------- ------------ -------- --------
Balance at December 31, 2007 30 $ -- 123,131,341 $ 123,130 (160,000) $ (160)
====== ====== =========== ============ ======== ========
ADDITIONAL DEFERRED SALES TOTAL
PAID IN AND CONSULTING ACCUMULATED STOCKHOLDERS'
CAPITAL FEES (NET) DEFICIT DEFICIENCY
----------- -------------- ------------ -------------
BALANCE AT JANUARY 1, 2006 $36,083,721 $ (204,488) $(38,116,905) $ (2,189,882)
Common shares issued in private placements-net of costs 938,799 958,804
Common shares issued for settlement of litigation 139,000 140,000
Common shares issued for consulting fees 172,040 173,463
Treasury stock from common Shares Forfeited 80 --
Common shares for conversion of convertible note 104,627 105,807
Warrants Issued for consulting fees 45,005 (45,005) --
Derivative liability of tainted warrants (1,678,527) (1,678,527)
Amortization and write off of deferred sales fee 204,488 204,488
Amortization of deferred consulting fees 45,005 45,005
Stock based compensation expense 884,848 884,848
Net loss (5,988,672) (5,988,672)
----------- -------------- ------------ -------------
Balance at December 31, 2006 36,689,593 -- (44,105,577) (7,344,666)
Common shares issued for private placements - net of costs (7,430) --
Common shares issued due to anti dilution provisions (524) -- --
Stock based compensation expense 870,262 870,262
Common shares issued for investor relations 20,025 -- 20,250
Conversion of principal and interest on convertible
notes into common shares 460,279 503,831
Reclassification of fair value of financial instrument
liability upon conversion 224,361 224,361
Forfeiture of common shares into treasury stock 80 -- --
Preferred shares issued - net of costs and discount --
Net loss -- (14,625,936) (14,625,936)
----------- -------------- ------------ -------------
Balance at December 31, 2007 $38,256,645 $ -- $(58,731,513) $ (20,351,898)
=========== ============== ============ =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-5
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
Protocall Technologies, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Years Ended December 31
2007 2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from operations $ (14,625,936) $ (5,988,672)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 70,345 401,222
Loss on disposal of property and equipment -- 19,561
Common stock and warrants issued for services 255,498 213,331
Change in fair value of derivative financial instrument liability 4,954,800 (963,922)
Fair value of derivative financial instrument in excess of proceeds
received at issuance 4,678,954 1,820,167
Equity compensation cost 870,262 884,848
Amortization of deferred financing costs 184,335 39,208
Amortization of deferred lease costs 19,489 77,916
Amortization of deferred consulting fees -- 45,005
Write off of deferred selling costs -- 204,488
Amortization of note discounts 759,338 107,652
Changes in:
Accounts receivable 164,693 (186,058)
Prepaid expenses and other current assets 39,102 38,453
Security deposits -- (6,392)
Other assets 50,000 (50,000)
Accounts payable 230,503 301,983
Accrued expenses 195,814 (251,986)
Payroll taxes payable 29,897 1,842
Deferred revenue (5,000) 17,500
Accrued salaries -officers /stockholders (734)
Accrued interest on notes payable 170,873 51,505
-------------- -------------
NET CASH USED IN OPERATING ACTIVITIES (1,957,033) (3,223,083)
-------------- -------------
CASH FLOWS USED IN INVESTING ACTIVITY:
Purchase of property and equipment (5,272) (3,985)
-------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock including amounts allocated
to derivative financial instrument liability 635,000 1,115,000
Proceeds from loans payable - related party 298,468 40,413
Proceeds from issuance of convertible notes, net of costs 1,163,600 1,910,250
Proceeds from issuance of preferred stock including amounts allocated
to derivative financial instrument liability 270,000 --
Repayment of loans payable (9,261) (4,209)
Repayment of loans payable - related party (22,441) --
Repayment of obligations under capital leases (237,563) (207,749)
-------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 2,097,803 2,853,705
-------------- -------------
NET INCREASE (DECREASE) IN CASH 135,498 (373,363)
CASH - BEGINNING OF YEAR 28,858 402,221
-------------- -------------
CASH - END OF YEAR $ 164,356 $ 28,858
============== =============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for:
Interest $ 34,155 $ 49,623
============== =============
Income taxes $ -- $ --
============== =============
Non cash transactions:
Common stock issued for settlement $ -- $ 140,000
============== =============
F-6
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
============== =============
Derivative liability in connection with tainted warrants $ -- $ 1,678,527
============== =============
Conversion of accrued salaries to notes payable $ -- $ 75,907
============== =============
Warrants issued for services $ $ 180,583
============== =============
Warrants issued for finder's fee $ 340,684 $ 24,465
============== =============
Warrants issued with common stock $ 635,000 $ 131,731
============== =============
Common stock issued for anti-dilution provisions $ 524 $ --
============== =============
Conversion of principal and interest into common shares $ 503,831 $ 105,807
============== =============
Discount on convertible notes payable $ 1,032,987 $ 1,806,126
============== =============
Conversion option embedded in preferred stock $ 270,000 $ --
============== =============
Forfeiture of common shares into treasury stock $ 80 $ --
============== =============
Reduction in financial instrument liability due to note conversions $ 224,361 $ --
============== =============
Reclassification of accrued interest on notes to accrued expenses $ 233,173 $ --
============== =============
Reclassification of accrued expense to loan payable - related party $ -- $ 22,933
============== =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-7
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RELATED MATTERS
[1] DESCRIPTION OF BUSINESS:
The accompanying consolidated financial statements include the accounts of
Protocall Technologies Incorporated ("PTI") and its wholly owned subsidiaries,
TitleMatch Entertainment Group Inc. ("TitleMatch"), Protocall Software Delivery
Systems, Inc. ("PSD") and Precision Type, Inc. (collectively, the "Company"). On
July 22, 2004, we completed a reverse merger transaction with Quality Exchange,
Inc., a Nevada corporation formed in June 1998. Upon the closing of the merger,
the directors and management of Protocall became the directors and management of
Quality Exchange which then changed its name to Protocall Technologies
Incorporated. The Company has recently focused all of its time and resources on
its on-demand virtual inventory service in its TitleMatch and PSD subsidiaries.
PSD was founded in 1998 to develop and commercialize a proprietary service that
enables software retailers to produce fully packaged software CDs, on-demand, at
their stores and at their web site fulfillment centers. TitleMatch was founded
in 2006 to expand the Company's virtual inventory service to retailers of DVD
movies and episodic television shows. The "Service" is an electronic
sell-through platform that enables retailers to produce premium DVD movie,
consumer software and video game products in retail packaging at their stores
and website distribution centers. The Service is designed to offer retailers a
virtual inventory of digital media products that can be produced on-demand,
thereby reducing or potentially eliminating the cost of physical inventories.
The Company also uses its Service to provide outsourced fulfillment services to
web retailers whereby digital media product orders are electronically routed to
the Company for on-demand production and shipment to the retailer's customer.
The Company plans to market its service to major retailers. The Company signs
license agreements with movie studios, software publishers and other content
owners, which allow the Company to resell their products to one or more of the
Company's retail customers. The Company intends to pursue an expansion of
available products to include audio books and console video games.
[2] GOING CONCERN
For the years ended December 31, 2007 and 2006 we had operating losses (as
reported on the accompanying consolidated statement of operations) of $3,792,982
and $4,791,893. The Company incurred net losses for the years ended December 31,
2007 and 2006 of $14,625,936 and $5,988,672 respectively, has an accumulated
deficit of $58,731,513, stockholder's deficiency of $20,351,898 and working
capital deficit of $20,106,026, at December 31, 2007. Through 2007, the Company
has been continually dependent upon borrowings through private offerings of
convertible and non-convertible debt and equity securities from related and
non-related parties to finance its business operations. The Company's agreements
with its suppliers provide for specific payment terms and, as of March 31, 2008,
the Company has not met these payment terms with respect to a number of
suppliers. If these suppliers decline to do business with the Company as a
result of delayed payment, it could possibly result in the loss of substantial
business for the Company and its ability to continue as a going concern.
While management has obtained approximately $400,000 of financing in the first
quarter of 2008 (Note Y), management believes the Company does not have
sufficient cash on hand to continue
F-8
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
business operations unless additional financing is secured within the next month
and as such there is substantial doubt about the Company's ability to continue
as a going concern. The Company is attempting to obtain additional short-term
financing from existing stockholders and outside sources. The Company is also
actively pursuing long-term funding from institutional investors. Management's
plan is to secure sufficient short-term capital to fund its operations through
the completion of a larger institutional financing, although there can be no
assurances that any financing will be available, or if available, that it will
be on terms acceptable to the Company. Management believes that its ability to
secure short-term and long-term financing is directly related to the Company's
progress with new customers and movie content agreements, which are actively
being pursued by the Company.
In the event that sufficient short-term or long-term financing is not obtained,
in order to help the Company to continue to pursue its customer and content
negotiations over a longer term, the Chief Executive Officer has agreed to defer
compensation and to cause the Company to increasingly reduce its operating
expenditures. However, these actions alone may not be sufficient in which case
the Company may be forced to cease operations.
The accompanying consolidated financial statements have been prepared on the
basis that the Company will continue as a going concern, which assumes the
realization of assets and satisfaction of liabilities in the normal course of
business. The uncertainties regarding the availability of continued financing
and commencement of adequate commercial revenues raise substantial doubt about
the Company's ability to continue as a going concern. The financial statements
do not include any adjustments relating to the recoverability of the recorded
assets or the classification of liabilities that may be necessary should the
Company be unable to continue as a going concern.
[3] BASIS OF CONSOLIDATION:
The consolidated financial statements include the accounts of PTI and its wholly
owned subsidiaries. All significant intercompany balances and transactions have
been eliminated in consolidation.
[4] REVENUE RECOGNITION:
The Company recognizes revenue from retailers' sales of product through the
Company's on-demand service and through Internet retailers, upon shipment to the
retail customer or consumer.
Customer returns, although not material, are also reflected as a reduction in
revenue in the period that they are returned or earlier if any such returns are
anticipated.
Revenue from the licensing of font software is recognized over the licensing
period. Revenue from the sale of software and movie products is recognized when
the product is delivered or shipped to the customers.
In accordance with Emerging Issue Task Force ("EITF") Issue No. 99-19 "Reporting
Revenue Gross as a Principal versus Net as an Agent", the Company recognizes
revenue from Internet sales through its TitleMatch subsidiary on a gross basis.
The Company has concluded that it is
F-9
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
the principal in Internet sale transactions. The basis for this is as follows:
the Company is the primary obligor in all transactions, the Company has latitude
in establishing pricing, the Company is subject to risk of loss when the item is
transferred to the freight carrier, title is transferred to the Company at the
time the order is placed with third party vendors and the Company is at risk for
the billing to its customer. Revenue from these sales is recognized when the
product is shipped to the customer.
Revenue from the sale of physical inventory purchased in September 2006 (see
Note T) is recognized when the products are shipped to the customer. The Company
invoices these customers at time of shipment. Revenue generated from the sale of
prepackaged goods from third party distributors through Internet retailers is
recognized when the product is shipped by the Company or by a third party
vendor.
[5] CASH AND CASH EQUIVALENTS:
The Company considers all highly liquid investments with original maturities of
three months or less when purchased to be cash equivalents. At December 31,
2007, the Company has approximately $64,000 in excess of the federal deposit
insurance corporation limit of $100,000.
[6] INVENTORY:
DVD and CD media purchased in the Inventory Purchase of September 2006 (see
Note T) are valued at the lower of cost or market.
[7] PROPERTY AND EQUIPMENT:
Property and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation is calculated using the straight-line method over the
estimated useful lives of the assets, which generally are three years for
deployed equipment and computer equipment, three years for office equipment and
machinery and seven years for furniture and fixtures. Leasehold improvements and
assets capitalized under capital leases are amortized over the shorter of the
lease term or the assets' estimated useful lives. When items of property and
equipment are sold or retired, the related costs and accumulated depreciation
are removed from the accounts and any gain or loss is included in operations.
[8] SOFTWARE DEVELOPMENT COSTS:
Costs associated with the development and enhancement of proprietary software
incurred between the achievements of technological feasibility and availability
for general release to the public were insignificant, and therefore not
capitalized.
[9] PATENTS:
Costs associated with obtaining patents for the Company's proprietary software
are capitalized and amortized over their estimated useful lives, or, the life of
the patent, upon completion and approval, whichever is shorter.
F-10
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
[10] INCOME TAXES:
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income for the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in the period that
includes the enactment date. The measurement of the net tax assets is reduced to
the amount that based on available evidence is more likely than not to be
realized with a valuation allowance established for those tax benefits not
expected to be realized. The Company has recorded a full valuation allowance
against its deferred tax assets at December 31, 2007 and 2006.
[11] FAIR VALUE OF FINANCIAL INSTRUMENTS:
The fair values of cash, accounts receivable, accounts payable and accrued
expenses approximate their carrying values in the consolidated financial
statements because of the short-term maturity of these instruments. The carrying
value of notes payable to banks approximates fair value since those instruments
carry prime-based interest rates that are adjusted for market rate fluctuations.
The fair values of notes payable to related parties and notes payable to
officers/stockholders are not reasonably determinable.
The Company evaluates its convertible debt, options, warrants or other contracts
to determine if those contracts or embedded components of those contracts
qualify as derivatives to be separately accounted for under Statement of
Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") and related interpretations
including EITF 00-19 "Accounting for Derivative Financial Instruments Indexed
to, and Potentially Settled in, a Company's Own Stock" ("EITF 00-19"). Should
any of these instruments qualify as a derivative, then the fair value of the
embedded derivative is marked-to-market each reporting date and recorded as a
liability and the change in fair value is recorded in the consolidated statement
of operations. Upon conversion or exercise of a derivative instrument, the
instrument is marked to fair value at the conversion date and then that fair
value is reclassified to equity.
In circumstances where the embedded conversion feature in a convertible
instrument is required to be bifurcated and there are also other embedded
derivative elements in the convertible instrument that are required to be
bifurcated, the bifurcated derivative instruments are accounted for as a single,
compound derivative instrument.
The classification of derivative instruments, including whether such instruments
should be recorded as liabilities or as equity, is re-assessed at the end of
each reporting period. Equity instruments that are initially classified as
equity that become subject to reclassification under SFAS 133 are reclassified
to liability at the fair value of the instrument on the reclassification date.
Derivative instrument liabilities are classified in the balance sheet as current
as net-cash settlement of the derivative instrument, based on their contractual
terms, generally could occur within 12 months of the balance sheet date.
F-11
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
[12] LONG-LIVED ASSETS:
The Company reviews long-lived assets, such as computers and equipment and
identifiable intangibles for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If the sum of the expected undiscounted cash flow is less than the
carrying amount of the asset, an impairment loss is recognized as the amount by
which the carrying amount of the asset exceeds its fair value.
[13] USE OF ESTIMATES:
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period.
Significant estimations include valuations of warrants issued in connection with
various forms of financing by the Company. Actual results could differ from
those estimates.
[14] ACCOUNTING FOR STOCK OPTIONS:
The Company adopted the provisions of SFAS No. 123R "Share Based Payment" ("SFAS
123R"), effective January 1, 2006, using the modified prospective transition
method. Under the modified prospective transition method, non-cash compensation
expense is recognized for the portion of outstanding stock option awards granted
prior to the adoption of SFAS 123R for which service has not been rendered, and
for any future stock option grants. The Company recognizes share-based
compensation costs on a straight-line basis over the requisite service periods
of awards. That cost is recognized as compensation expense over the service
period, which would normally be the one to three year vesting period of the
options. Under SFAS 123R forfeitures are estimated at the time of valuation and
reduce expense ratably over the vesting period.
[15] LOSS PER SHARE AND COMMON SHARE EQUIVALENT:
Basic loss per share is computed by dividing the net loss by the weighted
average number of common shares outstanding during the year. Diluted loss per
share adjusts basic loss per share for the effects of convertible securities,
warrants, stock options and other potentially dilutive financial instruments,
only in the periods in which such effect is dilutive. The shares issuable upon
the conversion of secured convertible notes and preferred stock, and the
exercise of stock options and warrants are excluded from the calculation of net
loss per share for the periods presented as their effect would be anti-dilutive.
F-12
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
Securities that could potentially dilute earnings per share ("EPS") in the
future that were not included in the computation of diluted loss per share
consist of the following:
YEAR ENDED DECEMBER 31
------------------------
2007 2006
----------- ----------
Options 17,907,901 20,465,993
Warrants 101,326,968 48,187,225
Convertible Notes 188,700,666 22,000,000
Preferred Shares "if converted" 3,000,000 --
----------- ----------
Total dilutive shares 310,935,535 90,653,218
=========== ----------
Subsequent to December 31, 2007 through May 16, 2008, the Company has issued
38,882,159 shares of common stock, of which 35,001,704 was due to conversions of
convertible notes. See Note Y for additional issuances of convertible securities
and warrants.
[16] RECENT ACCOUNTING PRONOUNCEMENTS:
In June 2006, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income
Taxes." This interpretation applies to all tax positions accounted for in
accordance with SFAS No. 109, "Accounting for Income Taxes." FIN 48 clarifies
the application of SFAS No. 109 by defining the criteria that an individual tax
position must meet in order for the position to be recognized within the
financial statements and provides guidance on measurement, derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition for tax positions. The Company adopted the
interpretation effective January 1, 2007. The adoption of this interpretation
did not a material impact on the Company's consolidated financial statements,
results of operations or cash flows.
In June 2006, the EITF reached a consensus on EITF No. 06-3, "How Taxes
Collected from Customers and Remitted to Governmental Authorities Should Be
Presented in the Income Statement (That Is, Gross versus Net Presentation)"
("EITF 06-3") to clarify diversity in practice on the presentation of different
types of taxes in the financial statements. The Task Force concluded that, for
taxes within the scope of the issue, a company may adopt a policy of presenting
taxes either gross within revenue or net. That is, it may include charges to
customers for taxes within revenues and the charge for the taxes from the taxing
authority within cost of sales, or, alternatively, it may net the charge to the
customer and the charge from the taxing authority. If taxes subject to this
Issue are significant, a company is required to disclose its accounting policy
for presenting taxes and the amounts of such taxes that are recognized on a
gross basis. The guidance in this consensus was effective for the first interim
reporting period beginning after December 15, 2006. The Company adopted the net
presentation. The adoption of this EITF did not have a material impact on the
Company's consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157 "Fair Value Measurements".
This Statement defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles (GAAP), and expands
disclosures about fair value measurements.
F-13
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
This Statement applies under other accounting pronouncements that require or
permit fair value measurements, the Board having previously concluded in those
accounting pronouncements that fair value is the relevant measurement attribute.
Accordingly, this Statement does not require any new fair value measurements.
This Statement is effective for the Company beginning January 1, 2008. The
Company is currently evaluating the effect of this pronouncement on its
consolidated financial statements.
In December 2006, the FASB issued FASB Staff Position EITF 00-19-2 "Accounting
for Registration Payment Arrangements," ("EITF 00-19-2"), which specifies that
the contingent obligation to make future payments or otherwise transfer
consideration under a registration payment arrangement should be separately
recognized and measured in accordance with SFAS No. 5, "Accounting for
Contingencies." Adoption of EITF 00-19-2 was required for fiscal years beginning
after December 15, 2006. In accordance with EITF 00-19-2 the Company has
recorded approximately $121,000 in accrued registration penalties as of December
31, 2007.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial LiabilitieS" ("SFAS 159"). SFAS 159 expands
opportunities to use fair value measurements in financial reporting and permits
entities to choose to measure many financial instruments and certain other items
at fair value. SFAS 159 is effective beginning January 1, 2008, and permits
earlier application. The Company is currently evaluating the effect of this
pronouncement on its consolidated financial statements.
In June 2007, the EITF reached a consensus on EITF Issue No. 06-11,
"Accounting for Income Tax Benefits on Dividends on Share-Based Payment Awards"
("EITF 06-11"). EITF 06-11 addresses share-based payment arrangements with
dividend protection features that entitle employees to receive (a) dividends on
equity-classified non-vested shares, (b) dividend equivalents on
equity-classified non-vested share units, or (c) payments equal to the dividends
paid on the underlying shares while an equity-classified share option is
outstanding, when those dividends or dividend equivalents are charged to
retained earnings under SFAS 123(R) and result in an income tax deduction for
the employer. A realized income tax benefit from dividends or dividend
equivalents that are charged to retained earnings are paid to employees for
equity-classified non-vested shares, non-vested equity share units, and
outstanding equity share options should be recognized as an increase in
additional paid in capital. The amount recognized in additional paid-in capital
for the realized income tax benefit from dividends on those awards should be
included in the pool of excess tax benefits available to absorb potential future
tax deficiencies on share-based payments. This EITF is effective for the Company
January 1, 2008, and the Company does not expect the adoption of this
pronouncement to have a material impact on its consolidated financial
statements.
In December 2007, the Securities Exchange Commission ("SEC") published
Staff Accounting Bulletin ("SAB") No. 110, which amends SAB No. 107 to allow for
the continued use, under certain circumstances, of the "simplified" method in
developing an estimate of the expected term of so-called "plain vanilla" stock
options accounted for under SFAS 123R beyond December 31, 2007. Companies can
use the simplified method if they conclude that their stock option exercise
experience does not provide a reasonable basis upon which to estimate expected
term. The Company has concluded that their stock option exercise experience does
not provide a
F-14
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
reasonable basis upon which to estimate expected term, therefore beginning in
2008, for any stock option awards granted, the Company will continue to use the
"simplified" method to calculate estimates of the expected term of stock
options.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests
in Consolidated Financial Statements -- an amendment of ARB No. 51" ("SFAS
160"). SFAS 160 establishes new accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. Specifically, this statement requires the recognition of a
noncontrolling interest (minority interest) as equity in the consolidated
financial statements and separate from the parent's equity. The amount of net
income attributable to the noncontrolling interest will be included in
consolidated net loss on the face of the consolidated statement of operations.
SFAS 160 clarifies that changes in a parent's ownership interest in a subsidiary
that do not result in deconsolidation are equity transactions if the parent
retains it controlling financial interest. In addition, this statement requires
that a parent recognize a gain or loss in net loss when a subsidiary is
deconsolidated. Such gain or loss will be measured using the fair value of the
noncontrolling equity investment on the deconsolidation date. SFAS 160 also
includes expanded disclosure requirements regarding the interests of the parent
and its noncontrolling interest. SFAS 160 is effective for fiscal years, and
interim periods within those fiscal years, beginning on or after December 15,
2008. Earlier adoption is prohibited. The Company will assess the impact of SFAS
160 if and when a future acquisition occurs.
In December 2007, the FASB issued SFAS No. 141R, "Business Combinations" ("SFAS
141R"), which replaces SFAS No. 141. SFAS 141R establishes principles and
requirements for how an acquirer in a business combination recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any controlling interest; recognizes and measures the
goodwill acquired in the business combination or a gain from a bargain purchase;
and determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination. SFAS 141R is to be applied prospectively to business combinations
for which the acquisition date is on or after an entity's fiscal year that
begins after December 15, 2008. The Company will assess the impact of SFAS 141R
if and when a future acquisition occurs.
In March 2008, the FASB issued SFAS No. 161 "Disclosures about Derivative
Instruments and Hedging Activities" ("SFAS 161"), which requires disclosures
about the fair value of derivative instruments and their gains or losses in
tabular format as well as disclosures regarding credit-risk-related contingent
features in derivative agreements, counterparty credit risk and strategies and
objectives for using derivative instruments. SFAS 161 amends and expands SFAS
133 and is effective prospectively beginning January 1, 2009. The Company is
currently evaluating the impact to its consolidated financial statements.
[17] RESEARCH AND DEVELOPMENT:
The Company expenses research and development costs as incurred.
F-15
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
[18] SEGMENT REPORTING:
The Company operates in one reporting segment.
[19] RECLASSIFICATIONS
Certain accounts in the prior year consolidated financial statements have been
reclassified for comparative purposes to conform with the presentation in the
current year consolidated financial statements. These reclassifications have no
effect on previously reported net loss.
NOTE B - INTERIM PERIOD RESTATEMENTS (UNAUDITED)
The Company has restated its consolidated financial statements for the three
months ended March 31, 2007, June 30, 2007 and September 30, 2007 and applicable
year to date periods to correct the accounting for certain "tainted" warrants
issued with a private offering of common stock ("Private Offering") in February,
April and May 2007 and to correct the accounting for conversions of convertible
notes. The corrected accounting reclassifies the fair value of the "tainted"
warrants in excess of the cash received in the Private Offering to change in
fair value of financial instruments liabilities. Previously the excess fair
value was included in additional paid in capital during the quarters ended March
31, 2007 and June 30, 2007 and was considered as a deemed dividend during the
quarter ended June 30, 2007. Additionally, the Company is correcting the
accounting to reclassify the fair value of the conversion option upon a debt
conversion to additional paid in capital and any unaccreted discount associated
with the conversion to interest expense. Previously additional paid in capital
and common stock were not credited with the principle amount of debt converted
but was recorded based on the fair value of the common stock issued and included
as a change in fair value during the three months ended September 30, 2007.
The effect of the restatement on specific amounts previously reported in the
quarterly consolidated financial statements is as follows:
March 31, 2007
-----------------------------
As previously
Consolidated Balance Sheet and Statement of Stockholders' Deficiency Reported As restated
Additional Paid in Capital $ 36,411,347 $ 36,936,081
Accumulated Deficit $ (46,815,390) $ (47,340,124)
F-16
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
Three Months Ended
March 31, 2007
----------------------------
As previously
Consolidated Statement of Operations Reported As restated
Change in fair value of financial instrument liability $ (1,428,114) $ (1,952,848)
Net Loss $ (2,709,813) $ (3,234,547)
EARNINGS PER SHARE BASIC AND DILUTED $ (0.04) $ (0.04)
Three Months Ended
March 31, 2007
----------------------------
As previously
Consolidated Statement of Cash Flows Reported As restated
Net Loss $ (2,709,813) $ (3,234,547)
Change in fair value of financial instrument liability $ 1,428,114 $ 1,952,848
Non cash transactions:
Warrants issued for finders fee $ 154,081 $ --
Warrants issued with common stock $ 770,404 $ 399,751
June 30, 2007
----------------------------
As previously
Consolidated Balance Sheet and Statement of Stockholders' Deficiency Reported As restated
Additional Paid in Capital $ 36,119,970 $ 37,244,631
Accumulated Deficit $ (43,282,717) $(44,407,378)
Six Months Ended Three Months Ended
June 30, 2007 June 30, 2007
---------------------------- ---------------------------
As previously As previously
Consolidated Statement of Operations Reported As restated Reported As restated
Interest Expense, including amortization of debt discount
and beneficial conversion feature $ (416,122) $ (453,112) $ (209,935) $ (246,925)
Change in fair value of financial instrument liability $ 3,211,276 $ 2,123,605 $ 4,639,390 $ 4,076,453
Net Income (Loss) $ 822,860 $ (301,801) $ 3,532,672 $ 2,932,745
Deemed Dividend $ (1,095,123) $ -- $ (1,095,123) $ --
Net Income (Loss) available to common shareholders $ (272,263) $ (301,801) $ 2,437,549 $ 2,932,745
Earnings per share basic $ (0.00) $ (0.00) $ 0.03 $ 0.04
Earnings (loss) per share diluted $ (0.00) (0.00) $ (0.01) $ 0.01
F-17
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
Six Months Ended
June 30,2007
----------------------------
As previously
Consolidated Statement of Cash Flows Reported As restated
Net Income (Loss) $ 822,860 $ (301,801)
Change in fair value of financial instrument liability $ (3,211,276) $ (2,123,605)
Net cash used in operating activities $ (1,064,021) $ (1,101,011)
Conversion of Convertible Notes $ (36,990) $ --
Net cash provided by financing activities $ 1,101,669 $ 1,138,659
Non cash transactions:
Warrants issued for finders fee $ 287,116 $ --
Warrants issued with common stock $ 1,435,578 $ 635,000
Conversion of note payable to common stock $ -- $ 51,000
September 30, 2007
-----------------------------
As previously
Consolidated Balance Sheet and Statement of Stockholders' Deficiency Reported As restated
Additional Paid in Capital $ 36,687,787 $ 37,636,824
Accumulated Deficit $ (43,667,500) $ (44,616,537)
Nine Months Ended Three Months Ended
September 30, 2007 September 30, 2007
---------------------------- --------------------------
As previously As previously
Consolidated Statement of Operations Reported As restated Reported As restated
Interest expense-including amortization of discount and
beneficial conversion feature of debt $ 1,203,458 $ 1,203,458 $ (787,336) $ (750,346)
Change in fair value of financial instrument liability $ 4,529,917 $ 3,580,880 $ 1,318,641 $ 1,457,275
Net Income (Loss) $ 438,077 $ (510,960) $ (384,782) $ (209,158)
Deemed Dividend $ (1,095,123) $ -- $ -- $ --
Net Loss available to common shareholders $ (657,046) $ (510,960) $ (384,782) $ (209,158)
Earnings per share basic and diluted $ (0.01) $ (0.01) $ (0.00) $ (0.00)
F-18
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
Nine Months Ended
September 30,2007
-----------------------------
As previously
Consolidated Statement of Cash Flows Reported As restated
Net Income (Loss) $ 438,077 $ (510,960)
Change in fair value of financial instrument liability $ (4,529,917) $ (3,580,880)
Non cash transactions:
Warrants issued for finders fee $ 287,116 $ --
Warrants issued with common stock $ 1,435,578 $ 635,000
NOTE C - PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31, 2007:
ESTIMATED
2007 USEFUL LIVES
----------- ------------
Computer and other equipment $ 1,458,388 3 years
Furniture and fixtures 34,284 7 years
Purchased software 79,062 3 years
Leasehold improvement 65,463 Various
-----------
1,637,197
Accumulated depreciation and amortization (1,603,593)
-----------
Property and equipment, net $ 33,604
===========
Included in property and equipment are assets under capital leases with no net
book value at December 31, 2007. The assets under capital leases were fully
depreciated in 2006. Depreciation and amortization expense was $67,909 and
$398,854 for the years ended December 31, 2007 and 2006, respectively.
NOTE D - LOANS PAYABLE
Loans payable consist of the following as of December 31, 2007:
AMOUNT
Loan payable with interest at prime plus 2% (10.25%) (1) $ 72,195
Loan payable non-interest bearing, due on demand 25,050
---------
97,245
Less current portion 49,114
---------
Loans payable, less current portion $ 48,131
=========
(1) The Company obtained a $100,000 line of credit from a bank in 1994.
Interest is payable on a monthly basis. The bank has the option to
terminate the line of credit at its sole discretion, at which time the
Company can elect to pay the then outstanding balance in
F-19
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
thirty-six monthly installments of principal and interest at the rate then
in effect. The bank can demand immediate payment if the Company is in
default of the terms of the line of credit. The loan is personally
guaranteed by certain officers/stockholders of the Company. At March 31,
2008, the bank had not terminated the line of credit.
Aggregate principal payments of the loan payable to the bank in the amount of
$72,195 are shown based on the repayment of the loan over a thirty-six month
period commencing January 2008 as follows:
FOR THE YEAR ENDING DECEMBER 31, AMOUNT
----------------------------------- ----------
2008 $ 24,064
2009 24,065
2010 24,066
----------
72,195
Less current portion 24,064
----------
Loans payable, less current portion $ 48,131
==========
NOTE E - NOTE AND LOANS PAYABLE TO RELATED PARTIES
Note and Loans payable to related parties consist of the following as of
December 31, 2007:
AMOUNT
----------
Loan payable (1) $ 7,927
Credit card payable (2) 59,373
Bridge loan payable (3) 175,000
Bridge loan payable (4) 105,000
----------
$ 347,300
==========
Note payable (5) $ 414,565
==========
(1) Non interest bearing demand loan payable to officer.
(2) Represents purchases made by the Company on an officer's personal credit
card.
(3) In March 2007, a stockholder advanced the Company $175,000 to use as
working capital until the Company receives long term funding. The
$175,000, plus interest calculated at a rate of 10% per annum, will be
returned to the stockholder upon receipt of long term funding. As of
December 31, 2007, accrued interest totaling $14,192 is included in
accrued expenses on the consolidated balance sheet.
(4) In November 2007, a stockholder advanced the Company $105,000 to use as
working capital until the Company receives long term funding. The
$105,000, plus interest calculated at a rate of 10% per annum, will be
returned to the stockholder upon receipt
F-20
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
of long term funding. As of December 31, 2007, accrued interest
totaling $1,697 is included in accrued expenses on the consolidated
balance sheet.
(5) On July 22, 2004, in connection with the reverse merger, $414,565 of
previously accrued interest on a convertible note payable due to the
in-laws of our Chief Executive Officer was converted into a new
promissory note, bearing interest at 4% per annum. As of December
31, 2007, the total accrued interest on the note payable amounted to
$57,066. All principal and accrued interest on the note was due and
payable in full on July 22, 2007. As of March 31, 2008, no portion
of principal or interest has been paid and, as a result, the notes
are currently in default. The Company will seek to renegotiate the
notes sometime in 2008. These amounts are shown as a current
liability in the accompanying balance sheet as of December 31, 2007.
NOTE F- ACCRUED EXPENSES
Accrued expenses consist of the following as of December 31, 2007:
Amount
Payroll and related benefits $ 187,790
Accounting, legal and other professional fees 240,625
Royalties and litigation settlement 45,805
Registration Rights Penalties 121,064
Interest 262,623
Other 122,033
-----------
Total accrued expenses $ 979,940
===========
NOTE G - FINANCIAL INSTRUMENT LIABILITY, CONVERTIBLE NOTES PAYABLE AND DEFERRED
FINANCING COSTS
As of December 31, 2007 Convertible Notes Payable consist of the following:
-------------------------------------------------------------------------------------
Issuance Date Amount Interest Maturity Date Rate to Market Price upon
rate conversion
-------------------------------------------------------------------------------------
August 6, 2006 $ 588,089 6% August 6, 2009 40%
-------------------------------------------------------------------------------------
September 28, 731,725 6% September 28, 40%
2006 2009
-------------------------------------------------------------------------------------
November 7, 210,696 6% November 7, 55%
2006 2009
-------------------------------------------------------------------------------------
May 31, 2007 500,000 6% May 31, 2010 40%
-------------------------------------------------------------------------------------
July 3, 2007 200,000 6% July 3, 2010 40%
-------------------------------------------------------------------------------------
August 21, 2007 400,000 8% August 21, 2010 40%
-------------------------------------------------------------------------------------
December 24, 200,000 8% December 24, 40%
2007 2010
-------------------------------------------------------------------------------------
2,830,510
-------------------------------------------------------------------------------------
Less: Discount 1,971,236
-------------------------------------------------------------------------------------
$ 859,274
-------------------------------------------------------------------------------------
F-21
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
As of December 31, 2007 the convertible notes payable would convert into
188,700,666 shares of common stock.
Future annual maturities of convertible notes as of December 31, 2007 are as
follows:
--------------------------------------------------------------------------------
2009 $ 1,530,510
--------------------------------------------------------------------------------
2010 1,300,000
--------------------------------------------------------------------------------
$ 2,830,510
--------------------------------------------------------------------------------
In April 2006, the Company issued a Convertible Promissory Note (the "April 2006
Note") for $100,000 in a private placement. The note holder has the option, to
convert the April 2006 Note and receive shares of the Company in any financing
transaction from third parties conducted by the Company under the same general
terms and conditions as provided for in such a financing transaction
("conversion pricing provision"). The April 2006 Note bears interest at 12% per
annum and is payable at the earlier of (i) October 31, 2006, or (ii) completion
of a subsequent financing of no less than $5,000,000 in gross proceeds to the
Company. In connection with the issuance of the April 2006 Note, the Company
issued the note holder a warrant to purchase 125,000 shares of common stock at
an exercise price of $.20 per share. The warrants may be exercised up to three
years from date of issuance. The fair value of the warrants on the date of
issuance was $20,700 as determined utilizing the Black-Scholes option-pricing
model with the following assumptions: 172.65% volatility, three year contractual
life, 4.96% risk free interest rate, and a dividend yield ratio of 0%. The
Company allocated the net proceeds between the April 2006 Note and the warrants
based on the relative fair value based method. The proceeds allocated to the
value of the warrant were recorded as a finance expense. In July 2006, the April
2006 Note was fully converted into 1,136,364 shares of common stock at a share
price of $.088.
In August 2006, the Company entered into an agreement with certain investors,
whereby the Company sold convertible notes (the "August 2006 Note") in the
principal amount of $700,000. During the same month, in connection with the
Securities Purchase Agreement, the Company granted the holders seven year common
stock purchase warrants to purchase a total of 15,000,000 shares of common stock
at an exercise price of $0.10 per share, subject to adjustment for dilutive
share issuances. The warrants are exercisable immediately and allows the holder
to purchase the shares within seven years of the issue date. The exercise price
is subject to adjustment upon the occurrence of the following events during the
period that the conversion right remains outstanding: common stock
reclassification; stock splits, combinations and dividends.
The August 2006 Note bear interest of 6% per annum, computed based on a 365-day
year and payable quarterly. No interest is due for any month in which the
trading price is greater than $.14975 for each trading day. Any amount of
principal or interest on the August 2006 Note
F-22
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
which is not paid when due bears interest at the rate of 15%. The principal
payments on the August 2006 Note are payable in full on the maturity date of
August 8, 2009.
At the time of issue, the Company determined the probability weighted discounted
cash flow of the August 2006 Note with the various embedded derivatives and
determined the discounted cash flow of the August 2006 Note without the embedded
derivatives. The cash flows were discounted by the risk-free rate based on the
remaining term of the August 2006 Note. The implied value of the compound
embedded derivatives was $608,021 at issuance. The valuation was calculated
using a lattice model with the following assumptions: the stock price would
increase in the short term at the cost of equity with a 150% volatility, there
was a 85% probability the Company would not be in default of its registration
requirements, assuming an event of default occurring 5% of the time increasing
..10% per month, reset events projected to occur 25% of the time at an exercise
price of $0.085, the holder would automatically convert at a stock price of $.20
if the registration was effective and the Company was not in default, the
Company would trigger redemption of the August 2006 Note when available at a
stock price of $0.15 or higher, alternative financing would be initially
available to redeem the note 0% of the time and increase monthly by 5% to a
maximum of 25% and the trading volume would increase at 1% per month. In
addition, the fair value of the warrants issued to the holder was $1,611,366 at
issuance based on a Black Scholes valuation with the following assumptions: 160%
volatility, risk free rate of 4.86% and a term of 7 years.
In September 2006, the Company entered into an agreement with certain investors,
whereby the Company sold convertible notes (the "September 2006 Notes") in the
principal amounts of $600,000 and $217,750. The holder of the $217,750 note was
issued seven year common stock purchase warrants to purchase a total of
2,512,500 shares of common stock at an exercise price of $0.10 per share,
subject to adjustment for dilutive share issuances. The warrants are exercisable
immediately. The exercise price is subject to adjustment as described in the
August 2006 Note financing.
The September 2006 Notes bear interest of 6% per annum, computed based on a
365-day year and payable quarterly. No interest is due for any month in which
the trading price is greater than $.14975 for each trading day. Any amount of
principal or interest on the September 2006 Notes which is not paid when due
bears interest at the rate of 15%. The principal payments on the September 2006
Notes are payable in full on September 29, 2009.
At the time of issue, the Company determined the probability weighed discounted
cash flow of the September 2006 Notes with the various embedded derivatives and
determined the discounted cash flow of the September 2006 Notes without the
embedded derivatives. The cash flows were discounted by the risk-free rate based
on the remaining term of the September 2006 Notes. The implied value of the
compound embedded derivatives contained within the September 2006 Notes at
issuance was $529,324 at issuance. The valuation was calculated using a lattice
model with the following assumptions: the stock price would increase in the
short term at the cost of equity with a 150% volatility, there was a 85%
probability the Company would not be in default of its registration
requirements, assuming an event of default occurring 5% of the time increasing
..10% per month, reset events projected to occur 25% of the time at an exercise
price of $0.085, the holder would automatically convert at a stock price of $.20
if the registration was effective
F-23
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
and the Company was not in default, the Company would trigger redemption of the
September 2006 Notes when available at a stock price of $0.15 or higher,
alternative financing would be initially available to redeem the September 2006
Notes 0% of the time and increase monthly by 5% to a maximum of 25% and the
trading volume would increase at 1% per month. In addition, the fair value of
the warrants issued to the holder was $194,455 at issuance based on a Black-
Scholes valuation with the following assumptions: volatility of 160%, risk free
rate of 4.60% and term of 7.01 years.
In October 2006, the holder of a convertible note issued in July 2004, elected
to convert the principal and accrued interest into common stock. The Company
issued the investor 45,377 shares of common stock at a conversion price of $.128
and a warrant to purchase 3,978 shares of common stock at an adjusted exercise
price of $.128. The remaining July 2004 convertible noteholders waived their
conversion rights.
In November 2006, the Company entered into an agreement with certain investors,
whereby the Company sold convertible notes (the "November 2006 Note") in the
principal amount of $500,000. The holder was also issued a seven year common
stock purchase warrant to purchase a total of 5,769,230 shares of common stock
at an exercise price of $0.10 per share, subject to adjustment for dilutive
share issuances. The warrants were exercisable immediately. The exercise price
is subject to adjustment as described in August 2006 Note financing.
The November 2006 Note bears interest of 6% per annum, computed based on a
365-day year and payable quarterly. No interest is due for any month in which
the trading price is greater than $.14975 for each trading day. Any amount of
principal or interest on the November 2006 Note which is not paid when due bears
interest at the rate of 15%. The principal payments on the November 2006 Note
are payable in full on November 7, 2009.
At the time of issue, the Company determined the probability weighted discounted
cash flow of the November 2006 Note with the various embedded derivatives and
determined the discounted cash flow of the November 2006 Note without the
embedded derivatives. The cash flows were discounted by the risk-free rate based
on the remaining term of the November 2006 Note. The implied value of the
compound embedded derivatives contained within the November 2006 Note at
issuance was $264,974. The valuation was calculated using a lattice model with
the following assumptions: the stock price would increase in the short term at
the cost of equity with a 150% volatility, there was a 85% probability the
Company would not be in default of its registration requirements, assuming an
event of default occurring 5% of the time increasing .10% per month, reset
events projected to occur 25% of the time at an exercise price of $0.085, the
holder would automatically convert at a stock price of $.20 if the registration
was effective and the Company was not in default, the Company would trigger
redemption of the November 2006 Note when available at a stock price of $0.15 or
higher, alternative financing would be initially available to redeem the note 0%
of the time and increase monthly by 5% to a maximum of 25% and the trading
volume would increase at 1% per month. In addition, the warrants issued to the
holder were valued at $418,153 at issuance based on a Black-Scholes valuation
using the following assumptions: 160% volatility, risk free rate of 4.63% and
term of 7.01 years.
F-24
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
In May 2007, the Company sold additional 6% convertible notes (the "May 2007
Note") at a total face value of $500,000 (net proceeds received of $460,000)
under the same terms as the convertible notes issued in 2006. At the time of
issue, the Company determined the probability weighted discounted cash flow of
the May 2007 Note with the various embedded derivatives and determined the
discounted cash flow of the May 2007 Note without the embedded derivatives. The
cash flows were discounted by the risk-free rate based on the remaining term of
the May 2007 Note. The implied value of the embedded conversion option was
$341,851 at issuance. The valuation was calculated using a lattice model with
the following assumptions: the stock price would increase in the short term at
the cost of equity with a 170% volatility, there was a 95% probability the
Company would not be in default of its registration requirements, assuming an
event of default occurring 5% of the time increasing 0.10% per month, reset
events projected to occur 25% of the time at an exercise price of $0.085, the
holder would automatically convert at a stock price of $.20 if the registration
was effective and the Company was not in default, the Company would trigger
redemption of the May 2007 Note when available at a stock price of $0.15 or
higher, alternative financing would be initially available to redeem the May
2007 Note 0% of the time and increase monthly by 5% to a maximum of 25% and the
trading volume would increase at 1% per month.
In July 2007, the Company sold additional 6% convertible notes (the "July 2007
Note") at a total face value of $200,000 under the same terms as the convertible
notes issued in 2006. At the time of issue, the Company determined the
probability weighted discounted cash flow of the July 2007 Note with the various
embedded derivatives and determined the discounted cash flow of the July 2007
Note without the embedded derivatives. The cash flows were discounted by the
risk-free rate based on the remaining term of the July 2007 Note. The implied
value of the embedded conversion option was $91,135 at issuance. The valuation
was calculated using a lattice model with the following assumptions: the stock
price would increase in the short term at the cost of equity with a 160%
volatility, there was a 95% probability the Company would not be in default of
its registration requirements, assuming an event of default occurring 5% of the
time increasing 0.10% per month, reset events projected to occur 25% of the time
at an exercise price of $0.085, the holder would automatically convert at a
stock price of $.20 if the registration was effective and the Company was not in
default, the Company would trigger redemption of the July 2007 Note when
available at a stock price of $0.15 or higher, alternative financing would be
initially available to redeem the July 2007 Note 0% of the time and increase
monthly by 5% to a maximum of 25% and the trading volume would increase at 1%
per month.
The implied value of the compound embedded derivatives within the August,
September and November 2006 and May 2007 Notes and July 2007 Notes described
above at December 31, 2007 was $2,019,727.
In August 2007, the Company entered into an agreement with certain investors,
whereby the Company sold convertible notes (the "August 2007 Note") in the
principal amount of $400,000 (net proceeds received of $380,000). During the
same month, in connection with the Securities Purchase Agreement, the Company
granted the investors seven year common stock purchase warrants to purchase a
total of 20,000,000 shares of common stock at an exercise price of $0.02 per
share, subject to adjustment for dilutive share issuances. The warrants are
exercisable immediately and allow the holder to purchase the shares within seven
years of the issue date. The exercise price is subject to adjustment upon the
occurrence of the following events during
F-25
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
the period that the conversion right remains outstanding: common stock
reclassification; stock splits, combinations and dividends.
The August 2007 Note bears interest of 8% per annum, computed based on a 365-day
year and payable quarterly. No interest is due for any month in which the
trading price is greater than $.01875 for each trading day. Any amount of
principal or interest on the August 2007 Note which is not paid when due bears
interest at the rate of 15%. The principal payments on the August 2007 Note are
payable in full on the maturity date of August 21, 2010.
At the time of issue, the Company determined the probability weighted discounted
cash flow of the August 2007 Note with the various embedded derivatives and
determined the discounted cash flow of the August 2007 Note without the embedded
derivatives. The cash flows were discounted by the risk-free rate based on the
remaining term of the August 2007 Note. The implied value of the embedded
conversion option was $377,864 at issuance. The valuation was calculated using a
lattice model with the following assumptions: the stock price would increase in
the short term at the cost of equity with a 160% volatility, there was a 95%
probability the Company would not be in default of its registration
requirements, assuming an event of default occurring 5% of the time increasing
0.10% per month, reset events projected to occur 25% of the time at an exercise
price of $0.015, the holder would automatically convert at a stock price of $.02
if the registration was effective and the Company was not in default, the
Company would trigger redemption of the August 2007 Note when available at a
stock price of $0.019 or higher, alternative financing would be initially
available to redeem the note 0% of the time and increase monthly by 5% to a
maximum of 25% and the trading volume would increase at 1% per month. In
addition, the fair value of the warrants issued to the holder was $400,075 at
issuance based on a Black Scholes valuation with the following assumptions: 220%
volatility, risk free rate of 4.41% and a term of 7 years. The fair value of the
embedded conversion option and warrants in excess of cash received was $337,931
at issuance. This charge was recorded as an expense in the Company's
consolidated statement of operations. The finder who assisted with this
financing was granted a warrant to purchase 2,000,000 shares of common stock at
share price of $.02 per share. The warrant was valued at $40,008 at issuance
based on a Black-Scholes valuation with the following assumptions: 220%
volatility, a risk free rate of 4.41% and a remaining term of 7 years.
In December 2007, the Company entered into an agreement with certain investors,
whereby the Company sold convertible notes (the "December 2007 Note") in the
aggregate principal amount of $200,000. During the same month, in connection
with the Securities Purchase Agreement, the Company granted the investors seven
year common stock purchase warrants to purchase a total of 15,000,000 shares of
common stock at an exercise price of $0.03 per share, subject to adjustment for
dilutive share issuances. The warrants are exercisable immediately and allows
the holder to purchase the shares within seven years of the issue date. The
exercise price is subject to adjustment upon the occurrence of the following
events during the period that the conversion right remains outstanding: common
stock reclassification; stock splits, combinations and dividends. The December
2007 Note bears interest of 8% per annum, computed based on a 365- day year and
payable quarterly. No interest is due for any month in which the trading price
is greater than $.01875 for each trading day. Any amount of principal or
interest on the December 2007 Note which is not paid when due bears interest at
the rate of 15%. The principal payments on the December 2007 Note are payable in
full on the maturity date of December 24, 2010.
F-26
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
At the time of issue, the Company determined the probability weighted discounted
cash flow of the December 2007 Note with the various embedded derivatives and
determined the discounted cash flow of the December 2007 Note without the
embedded derivatives. The cash flows were discounted by the risk-free rate based
on the remaining term of the December 2007 Note. The implied value of the
embedded conversion option was $370,345 at issuance. The valuation was
calculated using a lattice model with the following assumptions: the stock price
would increase in the short term at the cost of equity with a 160% volatility,
there was a 95% probability the Company would not be in default of its
registration requirements, assuming an event of default occurring 5% of the time
increasing 0.10% per month, reset events projected to occur 25% of the time at
an exercise price of $0.015, the holder would automatically convert at a stock
price of $.02 if the registration was effective and the Company was not in
default, the Company would trigger redemption of the December 2007 Note when
available at a stock price of $0.019 or higher, alternative financing would be
initially available to redeem the December 2007 Note 0% of the time and increase
monthly by 5% to a maximum of 25% and the trading volume would increase at 1%
per month. In addition, the fair value of the warrant issued to the holder was
$3,006,768 at issuance based on a Black-Scholes valuation with the following
assumptions: 230% volatility, a risk free rate of 3.70% and a remaining term of
7 years. The fair value of the embedded conversion option and warrants at
issuance in excess of cash received was $3,177,113. The charge was recorded in
the Company's consolidated statement of operations.
The finder who assisted with the December 2007 Note financing was granted a
warrant to purchase 1,500,000 shares of common stock at share price of $.03 per
share. The warrant was valued at $300,676 at issuance based on a Black-Scholes
valuation with the following assumptions: 230% volatility, a risk free rate of
3.70% and a remaining term of 7 years.
The warrants issued to the holders of the August 2007 Notes and December 2007
Notes had a collective value of $5,865,131 at December 31, 2007. The implied
value of the embedded conversion option in August and December 2007 was
$1,046,815 at December 31, 2007.
The convertible notes described above are convertible into shares of the
Company's common stock at a Variable Conversion Price, as defined, subject to
adjustment if the Company were to issue any additional shares of common stock at
a price per share less than the applicable conversion rate then in effect,
without a floor. The Variable Conversion Price is the Applicable Percentage (40%
for all the notes except the 6% notes issued in November 2006 for which the
percentage is 55%) multiplied by the average of the lowest 3 Trading Prices for
the Common Stock during the 20 Trading Day periods. The Applicable Percentage
for the 6% notes issued in November 2006 is capped at 55% due to the untimely
effectiveness of the Company's registration statement. The Applicable Percentage
for the balance of the 6% notes was adjusted to 40% pursuant to the terms of the
Convertible notes issued in December 2007. Conversions, including warrant
exercises (as noted below), are limited monthly to the greater of $80,000 or the
10 day average daily volume, and in total are limited to the beneficial
ownership of 4.99% (in some instances 9.99%). The Conversion Price and the
number of shares to be issued upon conversion are subject to adjustment upon the
occurrence of these events: major announcements defined as an intent to
consolidate or merge with any other corporation other than a merger in which the
Company is the surviving or continuing corporation and its capital stock is
unchanged or sell or transfer all or substantially all of the assets of the
Company or if any person, group or entity publicly announces a tender offer to
purchase 50% or more of the Company's Common
F-27
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
Stock any common stock reclassification; stock splits, combinations and
dividends. In addition, the Fixed Conversion Price, as defined, and the Variable
Conversion Price are subject, in each case, to equitable adjustments for stock
splits, stock dividends or rights offerings by the Company relating to the
Company's securities or the securities of any subsidiary of the Company,
combinations, recapitalization, reclassifications and similar events.
Events of default under the convertible notes include: the Company's failure to
perform any of its obligations, pay principal, interest and other fees, breach
of covenant, breach of representations and warranties, default under related
agreements, bankruptcy, failure to remain listed on Amex, NYSE, NASDAQ or OTCBB,
failure to maintain enough authorized shares to allow for full conversion of the
notes and warrants and failure to deliver the common stock or replacement note
to holder free of restrictions and other conditions. The default interest rate
is 15%. Upon occurrence of default, the holder may demand immediate repayment of
the Convertible Debentures at 140% of the principal balance.
The Company has registration requirements as detailed in the Registration Rights
Agreement. If the Company fails to meet the registration deadlines, then the
Company must pay the holder liquidated damages equal to 2.0%, not to exceed 6%
of the principal balance per month pro-rated for each month in which the
registration requirements are not met. The agreement obligated the Company to
file an SB-2 Registration Statement within 45 days from the Closing Date to
register 100% of the then shares to be issued upon conversion of the convertible
notes within 120 days from the Closing Date. The convertible notes are secured
by all of the assets of the Company. In November 2006, the Company entered into
a revised registration agreement with the holder whereby the Company was
obligated to file an SB-2 registration statement by November 17, 2006, which was
to become effective by January 5, 2007. The Company did not file a registration
statement until February 12, 2007 and has accrued the potential cash penalties
due as of December 31, 2006 of $59,187. The Company accrued an additional
$61,878 in penalties as of April 13, 2007 due to the late filing. On April 16,
2007, the Company received a waiver from the holders extending the Company's
obligation to file an SB-2 registration until May 31, 2007. The registration
statement was declared effective in June 2007. The Company has also received a
waiver from the holders with respect to the covenant that the Company maintain a
certain specified number of authorized common shares until January 1, 2009, and
was granted an extension on the filing of the registration statement for the 8%
notes to June 30, 2008. The Company also received a waiver from the holders for
the covenant regarding quarterly payment of accrued interest. The Company is not
obligated to pay accrued interest on the notes until June 30, 2008.
The Company has the call option to prepay ("redeem") the convertible notes
assuming the Common Stock is trading at or below $.20 per share on the 6% notes
and $.01875 per share on the 8% notes. The Company will pay in cash for
prepayments: 120% if occurring within 30 days of the issue date; 130% for
prepayments occurring between 31 and 60 days of the Issue Date, or 140% for
prepayments occurring after the 60th day following the Issue Date. The Company
has a partial call option if the volume weighted average price of the common
stock for the 5 trading days is below $.1198 for the 6% notes and $.02 on the 8%
notes. For a partial call option the Company will prepay a portion of the
outstanding principal amount of the Notes equal to 101%
F-28
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
of the principal divided by 36 plus one month's interest and this will apply to
all conversions for the month.
The derivative financial instruments in connection with the convertible notes
have been accounted for in accordance with SFAS No. 133. These derivative
financial instruments were recorded as liabilities in the consolidated balance
sheet and measured at fair value. The Company will mark to market these
derivative liabilities each quarter and record the change in fair value in the
statement of operations. The recorded value of these debt features may fluctuate
significantly based on fluctuations in the fair value of the Company's common
stock, as well as the volatility of the stock price during the term used for
observation and the term remaining for the warrants. These fluctuations can
create significant gains and losses in the consolidated statement of operations.
The convertible notes described above contain more than one embedded derivative
feature which would individually warrant separate accounting as derivative
instruments under SFAS 133. The various embedded derivative features have been
bundled together as a single, compound embedded derivative instrument that has
been bifurcated from the debt host contract, and referred to as the "Single
Compound Embedded Derivatives within Convertible Note". The single compound
embedded derivative features include the conversion feature with the reset
provisions within the convertible notes, the call/redemption options, the
interest rate adjustment, the cash prepayment penalties, and liquidated damages.
The value of the single compound embedded derivative liability was bifurcated
from the debt host contract and recorded as a derivative liability, which
results in a reduction of the initial carrying amount (as unamortized discount)
of the convertible notes of the value at inception. The unamortized discount has
been amortized to interest expense using the effective interest method over the
life of the convertible notes. Through December 31, 2007, $753,261 has been
amortized with an unamortized discount balance remaining of $1,979,636.
Due to the floorless conversion feature of the convertible notes, the Company
cannot necessarily share settle the existing debt or any outstanding
warrants/options. This is due to the fact that the Company may not have
sufficient authorized and un-issued shares available to settle these
obligations. Therefore, all existing outstanding warrants as of August 8, 2006
and all warrants issued thereafter, are "tainted" and have been treated as
derivative liabilities under SFAS 133 and EITF 00-19.
The warrants outstanding as of December 31, 2007 (referred to as "Tainted
Warrants") in aggregate allow the holders to purchase 38,026,161 shares with
various expirations dates ending December 31, 2010 (3 and 5 year terms). The
Tainted Warrants have a combined value of $4,105,837 at December 31, 2007 using
a Black Scholes valuation model with the following assumptions: 230% volatility,
risk free rates between 3.05 - 3.49% and a remaining term ranging from .44 -2.58
years.
For the year ended December 31, 2007, the mark to market change in the value of
the convertible note warrants was a loss of $3,147,275, the mark to market
change in the Compound Embedded Derivatives was a loss of $915,078 and the mark
to market change in the value of the Tainted Warrants was a loss of $837,354.
These changes effected an increase in the financial instrument
F-29
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
liability. The change in fair value of these liabilities was charged as an
expense in the Company's consolidated statement of operations.
The Company incurred legal and finder's fees totaling $865,167 (of which
$521,267 is the value of a warrant issued to the finder) associated with the
convertible notes. These fees are treated as deferred financing costs and are
being amortized over the term of the convertible notes. For the years ended
December 31, 2007 and 2006, amortization of deferred financing costs totaled
$184,335 and $39,208.
During the year ended December 2007, the noteholders converted $490,820 of
principal and interest into an aggregate of 42,795,061 shares of common stock at
share prices ranging from $.00485-$.0052. In accordance with waivers received
from prior private placement investors, anti dilution provisions from prior
private offerings do not apply to the convertible note conversions.
In December 2007, the Company sold 30 shares of Series A Preferred Stock
("Series A") in a private offering with accredited investors for an aggregate
subscription amount of $300,000 ($270,000 net of costs) (see Preferred Stock
Note W). One share of Series A is convertible into 100,000 shares of the
Company's common stock. Due to the floorless conversion feature of the
convertible notes described above, the Company may not have sufficient
authorized and unissued common stock to convert the Series A. Therefore the
conversion feature embedded in the Series A is considered "tainted" and has been
treated as a derivative liability. The fair value of the embedded conversion
feature on the date of issuance was $346,239 which was recorded as a discount of
$270,000 and change in fair value of $76,239. The tainted conversion feature had
a fair value of $401,332 at December 31, 2007.
The derivative financial instruments in connection with the tainted conversion
feature have been accounted for in accordance with SFAS No. 133 and EITF 00-19.
These derivative financial instruments were recorded as liabilities in the
consolidated balance sheet and measured at fair value. The Company will mark to
market these derivative liabilities each quarter and record the change in fair
value in the statement of operations. The recorded value of these debt features
may fluctuate significantly based on fluctuations in the fair value of the
Company's common stock, as well as the volatility of the stock price during the
term remaining until conversion. These fluctuations can create significant gains
and losses in the consolidated statement of operations. The loss related to the
change in fair value of the tainted conversion feature at December 31, 2007 was
$55,093.
The valuation was calculated using a lattice model with the following
assumptions: the stock price would increase in the short term at the cost of
equity with a 0% volatility, a stock price annual growth rate of 26.375%, and a
1% chance of a liquidation event.
F-30
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
NOTE H - RELATED PARTY TRANSACTIONS
On October 14, 2003, a stockholder/director opened an irrevocable standby letter
of credit on the Company's behalf as required by its equipment lease agreement,
which is to be retained for the entire term of the lease obligation or until
such time as the Company is able to replace this letter of credit, in the amount
of $1,040,000. As compensation, the Company issued a warrant to purchase 520,000
shares of common stock exercisable at the lower of $2.75 per share or the sales
price of common stock in subsequent offerings. The warrant was originally
scheduled to expire on October 14, 2010, but was converted into approximately
95,047 shares of common stock in connection with the reverse merger on July 22,
2004. The fair value of the warrant was recorded as a deferred lease cost and is
being amortized, on a straight-line basis, over the term of the original lease
obligation which was April 1, 2007. In November 2005, the balance of this letter
of credit was reduced to $750,462 and the lease was extended through December
2008. The Company is contingently liable for the amounts of this letter of
credit in the event the stockholder/director is obligated to make payments
thereunder as a result of its noncompliance with the terms of the lease
agreement. The balance of the warrant has been fully amortized as of December
31, 2007.
Upon the termination of employment of another officer in September 2005, $75,906
of accrued but unpaid salary was converted to a note. Interest is payable
monthly at a rate of 12% per annum. For the year ended December 31, 2007 $9,109
of interest was paid. The note was payable in four equal quarterly installments
beginning January 2007. As of April 15, 2008, no portion of the principal amount
has been paid and, as a result, the note is currently in default, however the
holder has not declared the note to be in default. The Company continues to make
monthly interest payments. Provisions in the note state that upon default, the
entire principal amount plus any accrued interest become immediately due and
payable by the Company. The Company will seek to renegotiate the note sometime
in 2008.
At December 31, 2007, accrued but unpaid salaries to an officer of the Company
totaled $317,634.
See Note L for related party information in connection with a capital lease by
the Company.
NOTE I - STOCK BASED COMPENSATION
On March 24, 2000, the Company adopted a stock compensation plan for the
issuance of up to 3,000,000 shares of common stock to employees, directors and
consultants (the "2000 Plan"). The 2000 Plan provides that the exercise price
per share of all incentive stock options granted shall not be less than 100% of
the fair value of the stock and for non-incentive options shall not be less than
85% of their fair value of the stock on the date of grant. Options become
exercisable at such time or times as determined by the Compensation Committee of
the Board (the "Committee"). Outstanding options must generally be exercised
within ten years from the date of grant. The Committee may at any time cause the
Company to offer to buy out an option previously granted, based on such terms
and conditions set forth by the Committee. In addition, the 2000 Plan provides
for the grant of stock appreciation rights and stock awards subject to such
terms and conditions as shall be determined at the time of grant. Through
December 31, 2007, no stock appreciation rights or shares of stock have been
awarded under the 2000 Plan.
F-31
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
Upon the closing of the reverse merger, the board of directors of the Company
adopted the 2004 Stock Option Plan (the "2004 Plan") under which a total of
1,000,000 common stock options were reserved for issuance, subject to approval
by stockholders at the Company's 2005 annual meeting of stockholders. In
November 2004, the Board of Directors increased the number of shares available
under the Plan to 2,000,000 and, in March 2005, the Board of Directors
authorized a further increase to 4,500,000 shares. In August 2006, holders of
approximately 63% of our common stock voted to increase the stock option pool of
the 2004 Plan to 19,000,000. As of December 31, 2007, options to purchase
17,345,542 shares of common stock are outstanding pursuant to the 2004 Plan
including 5,610,000 options to directors, with exercise prices ranging between
$.10 and $1.35 per share. Non-employee director options vest monthly or
quarterly over a one-year period and are exercisable over either five or ten
year periods. Most employee options vest annually or quarterly over a three-year
period, and are exercisable over either five or ten year periods. Stock options
granted pursuant to the 2004 Plan were ratified during the Company's annual
stockholder meeting held on May 18, 2005.
Option transactions are summarized as follows:
2000 PLAN 2004 PLAN
2007 2006 2007 2006
--------------------- --------------------- --------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE EXERCISE
# SHARES PRICE # SHARES PRICE # SHARES PRICE # SHARES PRICE
--------------------- --------------------- --------------------- ---------------------
Outstanding at beginning of year 2,075,651 $ 1.70 2,537,785 $ 1.64 18,390,342 $ 0.23 4,142,988 $ 0.71
Granted (1) -- -- -- -- -- -- 16,037,667 0.14
Exercised -- -- -- -- -- -- -- --
Forfeited (2) (1,513,292) 1.72 (462,134) 1.39 (1,044,800) 0.23 (1,790,313) 0.52
---------- --------- ---------- ----------
Outstanding at end of year 562,359 1.64 2,075,651 1.70 17,345,542 0.23 18,390,342 0.23
Exercisable at end of year 562,359 1.64 2,075,651 1.70 14,570,232 0.24 7,264,586 0.34
---------- --------- ---------- ----------
The weighted average grant date fair value of options granted in 2006 was
$.0996.
(1) 940,000 of these options with an exercise price of $.25 were granted March
31, 2006 subject to stockholder approval. These options were approved by
stockholders on August 29, 2006 and are included in the stock option
charge for the quarter ended September 30, 2006. These options have a ten
year life with immediate vesting for half of these options and the
balance, vesting March 31, 2007.
(2) 1,362,000 options were rescinded subsequent to March 31, 2006 as a result
of Board of Directors action to correct option grants in November 2005
inconsistent with the Company's 2004 Stock Option Plan. The rescinded
options include: (a) 300,000 of 500,000 shares granted to the former CEO,
(b) 103,750 of 150,000 shares granted to the Senior VP of Digital Rights
and Content Management, (c) 479,125 of 750,000 shares granted to a
Director, and (d) 479,125 of 750,000 shares granted to a Director and the
current President and CEO.
F-32
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
These options were not included in stock based compensation for the year ended
December 31 2006 and are incorporated above as being forfeited in 2006.
The following summarizes information about stock options at December 31, 2006:
------------------------------------------------------------------------------
OPTIONS EXERCISABLE
----------------------
RANGE WEIGHTED WEIGHTED WEIGHTED
OF AVERAGE REMAINING AVERAGE
NUMBER EXERCISE EXERCISE LIFE NUMBER EXERCISE
OUTSTANDING PRICE PRICE IN YEARS EXERCISABLE PRICE
--------------------------------------------------------------------------------
12,670,000 $.10-$.14 $ 0.112 9.93 4,223,333 $ 0.112
3,110,000 .20-.25 0.223 9.85 720,000 0.23
1,166,000 .33 - .49 0.330 7.61 1,058,000 0.330
175,000 .50 - .99 0.89 8.38 175,000 0.89
2,515,521 1.00-1.49 1.25 3.07 2,334,432 1.248
829,472 1.50-2.75 2.42 .75 829,472 2.42
----------- ----------
20,465,993 0.38 9,340,237 0.65
=========== ==========
The following summarizes information about stock options at December 31, 2007:
------------------------------------------------------------------------------
OPTIONS EXERCISABLE
----------------------
RANGE WEIGHTED WEIGHTED WEIGHTED
OF AVERAGE REMAINING AVERAGE
NUMBER EXERCISE EXERCISE LIFE NUMBER EXERCISE
OUTSTANDING PRICE PRICE IN YEARS EXERCISABLE PRICE
--------------------------------------------------------------------------------
12,670,000 $.10-$.14 $ 0.112 8.93 10,886,677 $ 0.113
2,155,000 .20-.25 0.228 8.83 1,231,664 0.237
1,086,000 .33 - .49 0.330 6.51 1,058,668 0.330
175,000 .50 - .99 0.89 7.38 175,000 0.89
1,504,384 1.00-1.49 1.214 3.68 1,463,065 1.210
317,517 1.50-2.75 1.875 .08 317,517 1.875
----------- 0.28 -----------
17,907,901 15,132,591 0.26
=========== ===========
The Company recognizes share-based compensation costs on a straight-line basis
over the requisite service periods of awards. That cost is recognized as
compensation expense over the service period, which would normally be the one to
three year vesting period of the options. The fair value of options at date of
grant was estimated using the Black Scholes option pricing model using the
following weighted average assumptions:
F-33
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
YEAR ENDED DECEMBER 31,
2006
-----------------------
Risk-free interest rate 4.41%
Expected life of options 5 years
Expected dividend yield 0.00%
Expected volatility 196.48%
Weighted average fair value $.10
No options were issued for the year ended December 31, 2007.
The expected life of options granted represents the period of time that options
granted are expected to be outstanding. Expected volatilities are based on
historical volatility of the Company's stock.
Stock based compensation expense recognized in the consolidated statement of
operations for the year ended December 31, 2007 was $870,262, of which $643,309
relates to employee compensation and $226,953 is for options issued to
directors. All of these expenses are recorded in selling general and
administrative expense. The unrecognized compensation cost of $348,975 for
non-vested options at December 31, 2007 will be recorded over the remaining two
year life of the options. As of December 31, 2007 and 2006, there was no
intrinsic value associated with the Company's outstanding and exercisable stock
options.
NOTE J - INCOME TAXES
INCOME TAXES
For the years ended December 31, 2007 and 2006, there was NO INCOME TAX expense.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of the assets and liabilities for financial
reporting purposes and the amounts reported for income tax purposes. Significant
components of the Company's net deferred income tax assets and liabilities as of
December 31, 2007 are as follows:
2007
----
Deferred tax asset
Net operating loss carryforward $ 3,092,000
Depreciation and amortization 104,000
Accrued compensation 133,000
-------------
Total deferred tax asset 3,329,000
Less valuation allowance (3,329,000)
-------------
$ --
=============
Income taxes computed at the statutory rate for the years ended December 31,
2007 and 2006 differ from amounts provided as follows:
2007 2006
---- ----
Tax provision (benefit) at statutory rate 34% 34%
State and local taxes, net of federal benefit 6% 6%
Derivative expenses (26)% (6)%
Stock based compensation (3)% (6)%
Amortization of deferred costs 0% (1)%
Change in valuation allowance (11)% (27)%
---- ----
Effective income tax rate 0% 0%
==== ====
F-34
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
The Company adopted Financial Accounting Standards Board's Interpretation No.
48, "Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement No. 109" (FIN 48"), effective January 1, 2007. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in financial statements
and requires the impact of a tax position to be recognized in the financial
statements if that position is more likely than not of being sustained by the
taxing authority. FIN 48 is to be applied to all open tax years as of the date
of effectiveness. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition.
The Company has identified its federal tax return and its state tax return in
New York as "major" tax jurisdictions, as defined in FIN 48. Based on the
Company's evaluations, it has been concluded that there are no significant
uncertain tax positions requiring recognition in the Company's financial
statements. The Company's evaluation was performed for tax years ended 2004
through 2007, the only periods subject to examination. The Company believes that
its income tax positions and deductions will be sustained upon audit and does
not anticipate any adjustments that will result in a material change to its
financial position. In addition, the Company did not record a cumulative effect
adjustment related to the adoption of FIN 48. The Company has elected to
classify interest and penalties incurred on income taxes, if any, as income tax
expense. No interest or penalties on income taxes have been recorded during the
year ended December 31, 2007. The Company does not expect its unrecognized tax
benefit position to change during the next twelve months. Management is
currently unaware of any issues under review that could result in significant
payments, accruals or material deviations from its position. The adoption of FIN
48 did not have a material effect on our consolidated financial position,
results of operations or cash flows.
Under Federal Tax Law pursuant to Internal Revenue Code Section 382 certain
significant changes of ownership, as defined, may restrict the utilization of a
company's net operating losses ("NOL"). These ownership changes may limit the
amount of NOL that can be utilized annually to offset future taxable income.
Since the Company's formation, the Company has raised capital through the
issuance of capital stock and convertible debentures which, combined with other
stockholder's purchases and dispositions may have resulted in a change of
control.
The Company has completed an evaluation of the effect of Section 382 on its NOLs
in order to apply this provision for the applicability of deferred tax asset
recognition and FIN 48. Based on this analysis, the Company believes it is more
likely than not that a change of control pursuant to Section 382 occurred during
2007. As a result, the Company has reduced its NOL carryforward from
approximately $35,120,000 to $7,700,000. The carrying amount of the Deferred Tax
Asset and related valuation allowance have also been reduced due to the
applicability of this provision. The remaining NOL will be available to offset
future taxable income.
F-35
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
The ultimate interpretation of the application of Section 382 may differ from
the above estimate. The effect of the above change did not have any effect on
the net carrying value of the deferred tax asset which has been fully offset by
a valuation allowance.
NOTE K - OPERATING LEASE OBLIGATIONS
The Company is obligated, under an operating lease for its facility of
approximately 5,000 square feet. The required minimum lease payment for 2008 is
$5,631 per month. The lease expires in January 2009. Rent and related expenses
were $77,148 and $89,141 for the years ended December 31, 2007 and 2006.
NOTE L - OBLIGATIONS UNDER CAPITAL LEASES
The Company has two capital leases to finance the acquisition of computer and
deployed equipment. At December 31, 2007, the future minimum payments required
under such leases are summarized as follows:
YEAR ENDED DECEMBER 31, 2007 LEASE (1) LEASE (2) TOTAL
---------------------------- --------- --------- ---------
2008 $ 30,600 $ 247,200 $ 277,800
2009 30,600 -- 30,600
2010 30,600 -- 30,600
--------- --------- ---------
Total minimum lease payments 91,800 247,200 339,000
Less amounts representing interest 12,753 9,533 22,286
--------- --------- ---------
Present value of minimum lease payment 79,047 237,667 316,714
Less current portion of capital lease obligations 23,765 237,667 261,432
--------- --------- ---------
Long-term portion of capital lease obligations $ 55,282 $ -- $ 55,282
========= ========= =========
(1) The lease is secured by the underlying equipment. The terms of the
lease were renegotiated in December 2007. The payment period was
extended by 17 months. The new lease agreement has an imputed
interest rate of 10% and is payable monthly through December 2010.
(2) The lease is secured by the underlying equipment and by an
irrevocable standby letter of credit in the amount of $750,462
opened by a stockholder/director in the Company's behalf as required
by the Company's equipment lease agreement, which is to be retained
for the entire term of the lease obligation. The terms of the lease
were renegotiated in 2005. Pursuant to the terms of the
renegotiation, the lease buyout amount of $50,000 was added to the
principal balance of the lease and the payment period was extended
by two years. The new lease agreement has an imputed interest rate
of 7.32% and is payable monthly through November 2008.
NOTE M - OTHER NOTES PAYABLE
On July 22, 2004, in connection with the reverse merger, $73,875 of previously
accrued interest on convertible notes payable was converted into new promissory
notes, bearing interest at 4% per annum. As of December 31, 2007, the total
accrued interest on the notes payable amounted to $10,468. All principal and
accrued interest on the notes were due and payable in full on July
F-36
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
22, 2007. As of March 31, 2008, no portion of principal or interest has been
paid and, as a result, the notes are currently in default. The Company will seek
to renegotiate the notes sometime in 2008. These amounts are shown as a current
liability in the accompanying consolidated balance sheet as of December 31,
2007.
NOTE N - CONSULTING AGREEMENTS
In February 2006, the Company entered into a consulting agreement with a third
party for investor relations services. The Company agreed to pay the third party
a non refundable retainer fee of 1,153,846 shares of stock. Half of the shares
valued at $.10 per share were issued three days after executing the agreement
and 115,385 shares were issued on the first of each month thereafter through
July 2006 and were valued at $.25, $.17, $.08 and $.11 respectively. All shares
were valued at market price on the date of issuance. The Company recorded a
total consulting fee of $125,770, in connection with the issuance of these
shares.
In April 2006, the Company entered into an investor relations consulting
agreement with a third party. Pursuant to this agreement, the Company issued the
consultant a warrant to purchase 100,000 shares of the Company's common stock at
an exercise price of $.19 per share in exchange for past due invoices totaling
$6,000. The Company also issued to the consultant a warrant to purchase 60,000
shares of the Company's common stock at an exercise price of $.19 per share, for
future services. The warrants are exercisable over 4 years and had a fair value
of $28,080 using a Black Scholes valuation with the following assumptions:
172.65% volatility, 4.96% risk free rate and projected term of 4 years. This
charge has been recorded as an investor relations expense in selling, general
and administrative expense on the consolidated statements of operations for the
year ended December 31, 2006.
In June 2006, the Company entered into an investor relations consulting
agreement with a third party. Pursuant to the terms of the agreement, the
Company issued the consultant a warrant to purchase 250,000 shares of common
stock at an exercise price of $.13 per share. The fair value of the warrant was
$16,925 at issuance using a Black Scholes valuation with the following
assumptions: volatility of 174.66%, risk free rate of 5.03% and projected term
of 3 years. This charge has been recorded as an investor relations expense in
selling, general and administrative expense on the consolidated statements of
operations for the year ended December 31, 2006.
In August 2006, the Company entered into an agreement with a third party
intellectual property patent consultant. The Company issued the third party
269,230 shares valued at $0.13 per share or $35,000 as payment for services
rendered.
In November 2006, the Company entered into an agreement with a third party
consultant to provide guidance in developing its ecommerce business. The
agreement called for the Company to make cash payments and to issue the
consultant a warrant to purchase 200,000 shares of common stock at an exercise
price of $.20 per share. The Company terminated the agreement in January 2007
and is currently disputing the issuance of the warrants although the Company has
recorded the expense for the warrants in 2006. The warrants were valued at
$13,993 using a
F-37
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
Black Scholes valuation with the following assumptions: 180% volatility, risk
free rate of 4.74% and remaining term of 2.89 years.
On January 3, 2007, the Company issued to a third party consultant a four year
warrant to purchase 10,000 shares of common stock at an exercise price of $.19
per share. The fair value of the warrant at issuance was $791. The warrant was
valued using a Black Scholes method with the following assumptions: 220%
volatility, 4.54% risk free rate and term of 4 years. This charge was recorded
as an investor relations expense in selling, general and administrative expense
on the consolidated statement of operations for the year ended December 31,
2007. On April 4, 2007, the Company issued to a third party consultant 225,000
shares of common stock. The shares were valued at $20,250 using a share price of
$.10 at issuance. The charge was recorded as investor relations expense in
selling, general and administrative expense on the consolidated statement of
operations for the year ended December 31, 2007..
On May 1, 2007, the Company issued to a third party consultant a three year
warrant to purchase 583,333 shares of common stock at an exercise price of
$0.132 per share. The warrant is exercisable August 1, 2007. The fair value of
the warrant at issuance was $64,172. The warrant was valued using a Black
Scholes method with the following assumptions: 220% volatility, 4.89% risk free
rate and term of 3.25 years. This charge was recorded as consultant expense in
selling, general and administrative expense on the consolidated statement of
operations for the year ended December 31, 2007.
Due to the convertible notes discussed in Note G, the warrants are considered a
derivative liability.
NOTE O - DEFERRED SALES FEE
On November 29, 2002, as amended on June 15, 2004, the Company and its major
customer entered into an Electronic Software and Distribution and Site Location
Agreement ("Software Agreement"), which expires June 14, 2008, as amended. As
part of the Software Agreement, on June 15, 2004, the Company granted the
customer a warrant to purchase 1,456,124 shares of common stock at $.01 per
share in recognition of the sales benefit of the Software Agreement to the
Company. Upon consummation of the private placement and reverse merger, in
accordance with the terms of the Software Agreement, this warrant was
automatically exchanged for 266,154 restricted shares of the Company's common
stock. These shares were issued, in three tranches; 66,540 shares upon
consummation of the reverse merger, 66,540 shares on each of the two years
subsequent to the anniversary date of the agreement, and assuming the agreement
remains in effect on each date, 66,534 shares on the final anniversary date.
These shares have been valued at $1.25 per share totaling $332,693 and have been
recorded as a "Deferred Sales Fee" and reflected as a reduction to equity, to be
amortized over the term of the Software Agreement. The balance of the deferred
selling fees was fully amortized in September 2006.
F-38
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
NOTE P - DEFERRED REVENUE
In June 2006, the Company licensed font software owned by its Precision Type
subsidiary to a customer for $20,000 over a term of four years. The Company
recorded the sale as deferred revenue and is recognizing the revenue over the
life of the license. As of December 31, 2007, $7,500 has been recognized.
NOTE Q - PRIVATE OFFERINGS
In January 2006, the Company entered into a securities purchase agreement with
an accredited investor in a private placement. In connection with the private
placement, the Company sold 2,222,222 shares of common stock, at $.135 per
share, and warrants (the "January 2006 Warrants") to purchase up to 1,111,111
shares of the Company's common stock, for an aggregate of $300,000.
The January 2006 Warrants have an exercise price of $.50 per share of common
stock, are exercisable immediately and expire on the third year anniversary of
the initial warrant date. The exercise price of the January 2006 Warrants as
well as the share price of the common stock is subject to adjustment through
January 2007, on the same terms as the June 2005 private placement. Due to the
private offerings entered into in February, June and July 2006 (see below), the
Company issued an additional 1,392,236 shares of common stock and adjusted the
January 2006 Warrants' exercise price to $.083 per share pursuant to
anti-dilution provisions contained in the January 2006 securities purchase
agreement.
In February 2006, the Company entered into a securities purchase agreement with
an accredited investor in a private placement. In connection with the private
placement, the Company sold 390,625 shares of common stock, at $.128 per share,
and warrants (the "February 2006 Warrants") to purchase up to 585,938 shares of
the Company's common stock, for an aggregate of $50,000.
The February 2006 Warrants have an exercise price of $.128 per share of common
stock, are exercisable immediately and expire on the third year anniversary of
the initial warrant date. The exercise price of the February 2006 Warrants as
well as the share price of the common stock is subject to adjustment through
February 2007, on the same terms as the June 2005 private placement. Due to the
private offerings entered into in June and July 2006 (see below), the Company
issued an additional 211,787 shares of common stock and adjusted the February
2006 Warrants' exercise price to $.083 per share pursuant to anti dilution
provisions contained in the February 2006 securities purchase agreement.
In April 2006, the Company entered into a securities purchase agreement with
accredited investors in a private placement. In connection with the private
placement, the Company sold an aggregate of 1,819,363 shares of common stock, at
par value $0.001 per share, at $0.162 and $0.171 per share, and warrants (the
"April 2006 Warrants") to purchase up to 1,218,324 shares of our common stock,
for an aggregate of $300,000.
F-39
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
The April 2006 Warrants have an exercise price of $.20 per share of common
stock, are exercisable immediately and expire on the third year anniversary of
the initial warrant date. The exercise price of the April 2006 Warrants as well
as the share price of the common stock was subject to adjustment through April
2007, on the same terms as the June 2005 private placement. Due to the private
offerings entered into in June and July 2006 (see below), the Company issued an
additional 1,795,094 shares of common stock to the April investors and adjusted
the April 2006 Warrants' exercise price to $.083 per share pursuant to
anti-dilution provisions contained in the April 2006 securities purchase
agreement.
In May 2006, the Company entered into a securities purchase agreement with
accredited investors in a private placement. In connection with the private
placement, the Company sold an aggregate of 1,079,136 shares of common stock, at
$.139 per share, and warrants (the "May 2006 Warrants") to purchase up to
539,568 shares of common stock, for an aggregate of $150,000.
The May 2006 Warrants have an exercise price of $.20 per share of common stock,
are exercisable immediately and expire on the third year anniversary of the
initial warrant date. The exercise price of the May 2006 Warrants as well as the
share price of the common stock was subject to adjustment through May 2007, on
the same terms as the June 2005 private placement. Due to the private offerings
entered into in June and July 2006 (see below), the Company issued an additional
728,092 shares of common stock to the May investors and adjusted the May 2006
Warrants' exercise price to $.083 per share pursuant to anti-dilution provisions
contained in the May 2006 securities purchase agreement.
In June 2006, the Company entered into a securities purchase agreement with an
accredited investor in a private placement. In connection with the private
placement, the Company sold an aggregate of 1,059,322 shares of common stock, at
$.094 per share, and warrants (the "June 2006 Warrants") to purchase up to
1,059,322 shares of common stock, for an aggregate of $100,000.
The June 2006 Warrants have an exercise price of $.20 per share of common stock,
are exercisable immediately and expire on the third year anniversary of the
initial warrant date. The exercise price of the June 2006 Warrants as well as
the share price of the common stock was subject to adjustment through June 2007,
on the same terms as the June 2005 private placement. Due to the private
offering entered into in July 2006 (see below), the Company issued an additional
145,497 shares of common stock to the June investor and adjusted the June 2006
Warrants' exercise price to $.083 per share pursuant to anti dilution provisions
contained in the June 2006 securities purchase agreement.
In July 2006, the Company entered into securities purchase agreements with two
accredited investors in a private placement with each investor. In connection
with the private placements, the Company sold an aggregate of 1,170,592 shares
of common stock, at $.083 and $.088 per share, and warrants (the "July 2006
Warrants") to purchase up to 1,170,592 shares of common stock, for an aggregate
of $100,000.
The July 2006 Warrants have an exercise price of $.20 per share of common stock,
are exercisable immediately and expire on the third year anniversary of the
initial warrant date. The exercise price of the July 2006 Warrants as well as
the share price of the common stock was subject to adjustment through July 2007,
on the same terms as the June 2005 private placement.
F-40
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
In July 2006, the $100,000 convertible note was converted into equity at a share
price of $.088. The Company issued the investor 1,136,364 shares of common stock
at a share price of $.088 and warrants to purchase up to 1,136,364 shares of
common stock at an exercise price of $.20 per share.
In August 2006, the Company entered into an agreement with certain investors
whereby the Company sold the August 2006 Notes in the principal amount of
$700,000. In September 2006, the Company sold the September 2006 Notes in the
aggregate amounts of $817,750 under the same terms as the initial issue. The
holder was issued warrants for 15,000,000 shares in August, and 2,512,500
warrants in September at an exercise price of $0.10 (see Note G).
In October 2006, the Company entered into a securities purchase agreement with
an accredited investor in a private placement. In connection with the private
placement, the Company sold an aggregate of 568,182 shares of common stock, at
$.088 per share, and warrants (the "October 2006 Warrants") to purchase up to
568,182 shares of common stock, for an aggregate of $50,000.
The October 2006 Warrants have an exercise price of $.20 per share of common
stock, are exercisable immediately and expire on the third year anniversary of
the initial warrant date. The exercise price of the October 2006 Warrants as
well as the share price of the common stock was subject to adjustment through
October 2007, under the same terms as the June 2005 private placement.
In November 2006, the Company entered into a joinder agreement to the financing
agreement of August 8, 2006 as amended on September 30, 2006 with the initial
Investors and two additional accredited investors. Under the terms of the
agreement, the additional investors purchased convertible notes in the aggregate
amount of $500,000 under the same terms as the initial Investors (see Note G).
The additional investors were each issued a warrant to purchase 2,884,615 shares
of common stock at an exercise price of $.10. The initial Investors are no
longer obligated to fund any additional amounts pursuant to the original August
2006 financing agreement.
The warrants and common stock issuable upon exercise of the warrants have not
been registered under the Securities Act, and were issued and sold in reliance
upon the exemption from registration contained in Section 4(2) of the Securities
Act and Regulation D promulgated thereunder. These securities may not be offered
or sold in the United States in the absence of an effective registration
statement or exemption from the registration requirements under the Securities
Act.
In November 2006, the Company entered into securities purchase agreements with
several accredited investors in a private placement. In connection with the
private placement, the Company sold an aggregate of 1,420,455 shares of common
stock, at $.088 per share, and warrants (the "November 2006 Warrants") to
purchase up to 1,420,455 shares of common stock, for an aggregate of $125,000.
The November 2006 Warrants have an exercise price of $.20 per share of common
stock, are exercisable immediately and expire on the third year anniversary of
the initial warrant date. The
F-41
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
exercise price of the November 2006 Warrants as well as the share price of the
common stock was subject to adjustment through November 2007 under the same
terms as the June 2005 private placement.
In December 2006, the Company entered into a securities purchase agreement with
an accredited investor in a private placement. In connection with the private
placement, the Company sold an aggregate of 284,091 shares of common stock, at
$.088 per share, and warrants (the "December 2006 Warrants") to purchase up to
284,091 shares of common stock, for an aggregate of $25,000.
The December 2006 Warrants have an exercise price of $.20 per share of common
stock, are exercisable immediately and expire on the third year anniversary of
the initial warrant date. The exercise price of the December 2006 Warrants as
well as the share price of the common stock was subject to adjustment through
December 2007 under the same terms as the June 2005 private placement.
In February 2007, the Company entered into a securities purchase agreement with
accredited investors in a private placement. In connection with the private
placement, the Company sold an aggregate of 2,764,423 shares of common stock, at
a share price of $.104 per share and warrants (the "February 2007 Warrants") to
purchase up to 2,764,423 shares of common stock, for an aggregate amount of
$287,500. Additionally, in February 2007 the Company had another private
placement and sold an aggregate of 1,704,545 shares of common stock at a share
price of $.088 and warrants (the "February 2007 Warrants") to purchase up to
3,409,091 shares of common stock, for an aggregate amount of $150,000.
The February 2007 Warrants have an exercise price of $.20 per share of common
stock, are exercisable immediately and expire on the third year anniversary of
the initial warrant date. The exercise price of the February 2007 Warrants is
subject to adjustment in the event of specified dilutive or accretive events,
such as stock splits and stock combinations. The exercise price, as well as the
per share price of the common stock sold in the private placement is subject to
further adjustment if the Company issues any shares of common stock or
securities convertible or exercisable into common stock (subject to customary
exceptions such as securities issued pursuant to equity incentive plans) through
February 2008 at a price per share less than the per share price of the common
stock and/or the exercise price of the February 2007 Warrants, in which case the
per share price and/or the exercise price, as applicable, will be adjusted to
equal the price of the securities in the new issuance. The adjustment in the
share price would result in the issuance of additional shares of common stock to
the holders. Due to the subsequent February private offering entered into at a
share price of $.088, the Company issued an additional 502,622 shares of common
stock and adjusted the February 2007 Warrants' exercise price to $.088 per share
pursuant to anti-dilution provisions contained in the February 2007 securities
purchase agreement ("2007 Purchase Agreement").
Warrants to purchase 1,234,704 shares of common stock were also issued to a
finder in connection with the February 2007 private placement under the same
terms as those provided to the investors. All warrants issued in connection with
the February 2007 private offering are considered Tainted Warrants as discussed
in Note G.
F-42
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
The warrants issued to the finder and those issued to the investors were valued
at $154,081 and $770,404 respectively at issuance using a Black Scholes
valuation model with the following assumptions: volatility of 220%, risk free
rate of 4.54% and a term of three years.
In April 2007, the Company collected $12,500 in subscriptions from the February
2007 private placement. The Company issued 142,046 shares of common stock at a
share price of $.088 and warrants to purchase 120,192 shares of common stock at
an exercise price of $.088 under the same terms as the February 2007 private
placement. Due to the subsequent February and April private offerings entered
into at a share price of $.088, the Company issued an additional 21, 853 shares
of common stock pursuant to anti dilution provisions in the 2007 Purchase
Agreement. The finder who assisted with the private placement was issued a
warrant to purchase 24,038 shares of common stock at an exercise price of $.088
under the same terms as the investors.
In May 2007, the Company collected $250,000 in subscriptions from the February
2007 private placement. The Company issued 2,840,909 shares of common stock at a
share price of $.088 and warrants to purchase 5,681,818 shares of common stock
at an exercise price of $.088 under the same terms as the February 2007 private
placement. The finder who assisted with the private placement was issued a
warrant to purchase 1,136,364 shares of common stock at an exercise price of
$.088 under the same terms as the investors.
The warrants issued to the finder and those issued to the investors were valued
at $133,035 and $665,174 respectively at issuance using a Black Scholes
valuation model with the following assumptions: volatility of 220%, risk free
rate of 4.88% and a term of three years. Fees paid to finders in 2007 amounted
to $65,000.
The warrants issued in connection with these private offerings are considered
Tainted as discussed in Note G. The fair value of the warrants received in
connection with these private offerings were $1,087,671 in excess of cash
received. This is included in the change in fair value of the financial
instrument liability in the consolidated statement of operations on the date of
issuance.
In May 2007, the Company entered into an agreement with certain investors,
whereby the Company sold the May 2007 Note in the principal amount of $500,000.
In July 2007, the Company sold additional convertible notes in the aggregate
amounts of $200,000 under the same terms as the initial issue (see Note G).
In August 2007, the Company entered into an agreement with certain investors,
whereby the Company sold the August 2007 Note in the principal amount of
$400,000. In December 2007, the Company sold additional Convertible Debentures
in the aggregate amount of $200,000. The holder was issued warrants for
20,000,000 shares in August at an exercise price of $0.02, and 15,000,000
warrants in December at an exercise price of $0.03 (see Note G).
In December 2007, the Company sold 300 shares of Series A Preferred Stock in a
private offering with accredited investors for an aggregate subscription amount
of $300,000 (see Note X).
F-43
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
The following table summarizes warrant transactions for the years ended December
31, 2006 and 2007:
--------------------------------------------------------------------------------
Warrant Shares Exercise Price
--------------------------------------------------------------------------------
Balance January 1, 2006 7,569,936
--------------------------------------------------------------------------------
Granted 40,617,289 $.083-$1.06
--------------------------------------------------------------------------------
Exercised --
--------------------------------------------------------------------------------
Expired --
--------------------------------------------------------------------------------
Balance December 31, 2006 48,187,225
--------------------------------------------------------------------------------
Granted 54,313,962 $.02-$.19
--------------------------------------------------------------------------------
Exercised --
--------------------------------------------------------------------------------
Expired (1,174,219) $1.50-$2.75
--------------------------------------------------------------------------------
Balance December 31, 2007
Outstanding and Exercisable 101,326,968
--------------------------------------------------------------------------------
NOTE R - LITIGATION
Upon his termination from employment with the Company, a former CEO asserted
monetary claims under his employment agreement, and by demand dated October 19,
2005, sought arbitration of those claims which for purposes of the arbitration
demand he had valued at $366,979. The Company settled on January 23, 2006. The
terms of the settlement require the Company to make periodic cash payments
totaling $100,000 and the issuance of a warrant to purchase 240,000 shares of
common stock at an exercise price of $1.06 per share with registration rights.
The warrant was valued at $24,274 on the settlement date and recorded as expense
and as a liability in 2006. In accordance with EITF 00-19, this liability is
marked to fair value at each reporting date until the warrant is exercised. On
December 31, 2007 and 2006, the warrant was valued at $23,750 and $13,986
respectively. The Company will incur a liability of up to $25,000 if it fails to
register the warrants as per the terms of the agreement. The Company has not
recorded registration rights damages since the Company determined it not to be
material. As of December 31, 2006, the Company has paid the $100,000 as per the
terms of the settlement agreement.
On August 23, 2005, First Providence Financial Group, LLC ("First Providence")
filed a Demand for Arbitration against the Company with the American Arbitration
Association. The demand alleged that the Company breached a January 2000
placement agency agreement with First Providence. The demand sought $5 million
in damages, plus fees and costs. The demand alleged that First Providence had a
right of first refusal and that the Company disregarded it. The
F-44
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
Company believed that First Providence was not then in business, incapable of
performing and failed to do so when requested to perform. The Company reached a
settlement agreement with First Providence on January 31, 2006. The Company
issued First Providence 1,000,000 shares of common stock and reimbursed First
Providence $8,000 for out of pocket costs. The shares valued at $140,000 were
accrued in December 2005 and issued in 2006. First Providence withdrew the
arbitration request.
The case of Code Ventures LLC v. Protocall Software Delivery Systems, Inc., et
al. was filed in the Superior Court of the State of California, San Diego
Judicial District, on or about August 31, 2005. The complaint asserts claims
for: (i) breach of a software development agreement between the parties dated
October 13, 1999; (ii) quantum merit; and (iii) goods sold, and seeks damages of
at least $200,000, plus interest, attorneys' fees, and cost. The plaintiff also
seeks a judgment declaring that it is entitled to exercise certain options for
stock in Protocall Software Delivery Systems, Inc. The Company filed a cross
complaint asserting claims for breach of contract, restitution of money and
declaratory relief. The Company also sought recovery of $43,700 for the value of
equipment not returned to the Company by Code Ventures. On September 13, 2006,
the parties participated in mediation. As a result of the mediation, the parties
settled the matter for $100,000, with payments to be made by the Company in four
installments from October 16, 2006 through February 20, 2007. On January 26,
2007, the court heard the plaintiff's two post settlement motions, for
attorneys' fees and costs, and to add an additional judgment debtor. Both
motions were granted and the plaintiff was awarded an additional $5,520 in
attorneys' fees and costs. All payments have been made. The plaintiff was to
file an Acknowledgement of Satisfaction of Judgment in Full with the court and
the matter will be concluded. The Court dismissed the lawsuit on December 4,
2006 without prejudice.
NOTE S - SIGNIFICANT CUSTOMERS
For the year ended December 31, 2007 one customer accounted for 64.3% of net
sales and 81% of accounts receivable at December 31, 2007. For the year ended
December 31, 2006, one customer accounted for 62.6% of net sales.
NOTE T - INVENTORY PURCHASE
On September 29, 2006, the Company purchased movie and music media at a purchase
price of $625,000 and movie and television show masters at a purchase price of
$50,000. The masters were classified as other assets. Under the terms of the
agreement, the Company was contractually obligated to sell a portion of this
inventory with a cost of $273,000 to a stipulated third party by September 30,
2006. The third party is obligated to return any unsold inventory by December
31, 2006 to the Company for destruction. The Company sold approximately $238,000
worth of this inventory and was granted an extension to sell $35,423 worth of
this inventory by February 28, 2007. The Company set up a reserve of $35,423
against this unsold inventory in the event that the inventory is not sold by the
February 2007 deadline. The Company subsequently sold this inventory in February
2007.
In April 2007, the Company sold inventory purchased in this sale with a cost of
$331,000 for $16,560. The Company set up a reserve against this inventory of
approximately $314,440 in 2006.
F-45
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
NOTE U - STOCK FORFEITURE
In July 2006, an officer of the Company forfeited 80,000 shares of common stock
issued upon conversion of accrued salary in July 2004. The accrued salary of
$100,000 was also forgiven by the officer.
Upon the departure of the CEO, in 2005, the Company's Board and CEO informally
agreed that he would return 80,000 shares of the Company's stock issued to him
in 2004. The CEO has since returned to the Company. In April 2007, it came to
the CEO'S attention that no formal documentation reflecting the return of these
shares was ever prepared. In keeping with the spirit of what was discussed with
the Company Board in 2005, the CEO returned the 80,000 shares to the Company in
2007.
NOTE V - DEFERRED LEASE COSTS
On October 14, 2003, a stockholder/director opened an irrevocable standby letter
of credit on our behalf as required by our equipment lease agreement, which is
to be retained for the entire term of the lease obligation or until such time as
we are able to replace this letter of credit, in the amount of $1,040,000. As
compensation, the Company issued a warrant to purchase 520,000 shares of common
stock exercisable at the lower of $2.75 per share or the sales price of common
stock in subsequent offerings. The fair value of the warrant was $269,470
utilizing the Black-Scholes option-pricing model with the following assumptions:
50% volatility, seven-year expected life, risk-free interest rate of 3.86% and
dividend yield of 0%. The warrant was originally scheduled to expire on October
14, 2010, but was converted into approximately 95,047 shares of common stock in
connection with the reverse merger on July 22, 2004. The fair value of the
warrant has been recorded as a deferred lease cost and is being amortized, on a
straight-line basis, over the term of the original lease obligation which was
April 1, 2007. As of December 31, 2007, the balance has been fully amortized. In
November 30, 2005, the balance of this letter of credit was reduced to $750,462
and the lease was extended through December 2008. The Company is contingently
liable for the amounts of this letter of credit in the event the
stockholder/director is obligated to make payments thereunder as a result of the
Company's noncompliance with the terms of the lease agreement.
NOTE W - PREFERRED STOCK
The Company is authorized to issue 5,000 shares of preferred stock, par value
$0.001. The Company's board of directors may issue the authorized Preferred
Stock in one or more series and to fix the number of shares of each series of
Preferred Stock. The board of directors also has the authority to set the voting
powers, designations, preferences and relative, participating, optional or other
special rights of each series of Preferred Stock, including the dividend rights,
dividend rate, terms of redemption, redemption price or prices, conversion and
voting rights and liquidation preferences. Preferred Stock can be issued and its
terms set by the board of directors without any further vote or action by the
Company's stockholders. The Company has designated 500 shares of Preferred Stock
as Series A. In December 2007, the Company sold 30 shares of Series A for cash
proceeds of $270,000( net of costs of $30,000). As of December 31, 2007, there
were 30 shares of Series A issued and outstanding.
F-46
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
The holder of each share of Series A shall be entitled to receive out of funds
legally available therefore, cash dividends equal to 1% of the gross revenue
received by the Company and its wholly-owned subsidiary, TitleMatch resulting
from any and all contracts entered into by the Company and TitleMatch to provide
its TitleMatch Service. All contracts currently in force or entered into through
the second anniversary of the initial closing of the Preferred Stock Offering
shall be included as part of the dividends (the "Included Contracts"). Dividends
shall be calculated on quarterly sales of $3,000,000 or greater and will be
issued 10 business days after the Company reports its financial results on Form
10-QSB or Form 10-KSB, unless otherwise notified by the holders of their intent
to convert (see "Conversion at Holder's Option" below). Dividends will be
calculated on a pro-rata basis based on date of purchase. The Company did not
declare or accrue any dividends as of December 31, 2007.
Each share of Series A shall automatically convert into 100,000 shares of the
Company's Common Stock, without any further payment on the earlier of:
o The date on which total dividends paid per share of Series A equal
$50,000; or
o December 31, 2010.
The number of shares of Common Stock issuable upon conversion of the Series A is
subject to adjustment upon the occurrence of certain events, including, among
others: a stock split, reverse stock split or combination of Common Stock; the
Company's issuance of Common Stock or other securities as a dividend or
distribution on the Common Stock; a reclassification, exchange or substitution
of the Common Stock; or a capital reorganization.
At the end of any calendar quarter beginning on March 31, 2008 and continuing
until September 30, 2010, each holder of Series A shall have a one-time option
to convert all unpaid dividends attributable to all shares of Series A owned
into the Company's Common Stock. The conversion price shall be the closing
market price on the last trading day of that quarter; provided, however, in no
event shall the conversion price be less than $0.10 per share. Holders must
notify the Company of their intent to convert within five business days after
the Company reports its financial results on Form 10-QSB or 10-KSB.
Upon a merger or consolidation with or into another company, or any transfer,
sale or lease by the Company of substantially all of its Common Stock or assets,
the Series A Preferred will be treated as Common Stock for all purposes,
including the determination of any assets, property or stock to which holders of
the Series A Preferred are entitled to receive, or into which the Series A is
converted, by reason of the consummation of such merger, consolidation, sale or
lease.
Holders of Series A are entitled to vote their shares on an "as-if-converted" to
Common Stock basis, and vote together with the holders of the Common Stock, and
not as a separate class. Holders of Series A shall also have any voting rights
to which they are entitled by law.
In the event of the Company's voluntary or involuntary liquidation, dissolution
or winding-up, holders of Series A are entitled to receive out of the Company's
assets available for distribution to shareholders, before any distribution is
made to holders of the Company's Common Stock,
F-47
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
liquidating distributions in an amount equal to $.02 per share. As of December
31, 2007, holders of Series A had $60,000 liquidation preference.
One share of Series A is convertible into 100,000 shares of the Company's common
stock. Due to the floorless conversion feature of the convertible notes
described in Note G, the Company may not have sufficient authorized and unissued
common stock to convert the Series A. Therefore the conversion feature embedded
in the Series A is considered "tainted" and has been treated as a derivative
liability. The fair value of the embedded conversion feature on the date of
issuance was $346,239 which was recorded as a discount of $270,000 and change in
fair value of $76,239. The tainted conversion feature had a fair value of
$401,332 at December 31, 2007.
NOTE X - DEFAULTS UNDER AGREEMENTS
Upon the termination of employment of one of the officers of the Company in
October 2005, $75,907 of accrued, but unpaid, salary was converted to a note
bearing interest at the rate of 12% per year. Interest is payable monthly. All
interest owed as of June 30, 2007 has been paid. The principal of the note was
payable in four equal quarterly installments beginning January 2007. As of March
31, 2008, no portion of the principal amount has been paid and, as a result, the
note is currently in default although the Company continues to make monthly
interest payments. Provisions in the note state that upon default, the entire
principal amount plus any accrued interest become immediately due and payable by
the Company. The Company will seek to renegotiate the note sometime in 2008.
The Company is in default of one of its capital lease obligations due to
missed/delinquent payments. The Company has not been formally served a notice of
default and is currently working with the lessee to correct the delinquency. As
a result, amounts due are shown as a current liability in the accompanying
balance sheet as of December 31, 2007.
On July 22, 2007, notes payable with principal and interest totaling $546,575
came due. As of March 31, 2008, no portion of principal or interest has been
paid and, as a result, the notes are currently in default. The Company will seek
to renegotiate the notes sometime in 2008. These amounts are shown as a current
liability in the accompanying balance sheet as of December 31, 2007.
NOTE Y - SUBSEQUENT EVENTS
On January 31, 2008, the Company entered into a securities purchase agreement
with investors, under which unpaid accrued interest on previously-issued 6%
convertible notes were rolled into new convertible notes in the principal amount
of $123,135. The note bears interest of 2% per annum, payable quarterly. No
interest is due for any month in which the trading price of our
F-48
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
Common stock is greater than $.14975 for each trading day. Any amount of
principal or interest on the note which is not paid when due, bears interest at
the rate of 15% per annum. The convertible notes are convertible into shares of
the Company's common stock at a Variable Conversion Price, as defined, subject
to adjustment if the Company were to issue any additional shares of common stock
at a price per share less than the applicable conversion rate then in effect,
without a floor. The Variable Conversion Price is 40% multiplied by the average
of the lowest 3 Trading Prices for the Common Stock during the 20 Trading Day
periods.
In January 2008, the Company entered into an agreement with an investor
relations consultant. The Company issued the consultant 909,091 shares valued at
$0.11 per share and a three year warrant to purchase 454,545 shares of common
stock at an exercise price of $0.11.
In February 2008, the Company entered into a securities purchase agreement with
an investor, under which we sold a convertible note in the principal amount of
$150,000. In connection with the agreement, we granted the investor seven-year
warrants to purchase a total of 540,000 shares of common stock at an exercise
price of $.10 per share, subject to adjustment for dilutive share issuances. The
warrants were exercisable immediately and allow the holder to purchase the
shares within seven years of the issue date. The exercise price is subject to
adjustment upon the occurrence of the following events during the period that
the conversion right remains outstanding: common stock reclassifications, stock
splits, combinations and dividends. The notes bear interest of 8% per annum,
payable quarterly. No interest is due for any month in which the trading price
of our common stock is greater than $.14975 for each trading day. Any amount of
principal or interest on the notes which is not paid when due bears interest at
the rate of 15% per annum. The convertible notes are convertible into shares of
the Company's common stock at a Variable Conversion Price, as defined, subject
to adjustment if the Company were to issue any additional shares of common stock
at a price per share less than the applicable conversion rate then in effect,
without a floor. The Variable Conversion Price is 50% multiplied by the average
of the lowest 3 Trading Prices for the Common Stock during the 20 Trading Day
periods.
In March 2008, we issued a 3 year convertible note in the principal amount of
$120,000 for which we received consideration of $100,000. The note bears
interest at a rate of 8% per annum. Unconverted principal and accrued interest
are payable at time of maturity. The conversion price is 55% of the lowest
closing price in the 20 trading days prior to conversion. The Company also
entered into an agreement with the same investor whereby the Company issued the
investor a convertible secured and collateralized promissory note in the
principal sum of $600,000. The investor can reduce the collaterized note by
converting $50,000 per month into shares of the Company's common stock beginning
seven months from the date of the agreement.
In March 2008, we entered into a securities purchase agreement with an investor,
under which we sold convertible notes in the principal amount of $100,000. In
connection with the agreement, we granted the investors seven-year warrants to
purchase a total of 360,000 shares of
F-49
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
common stock at an exercise price of $.10 per share, subject to adjustment for
dilutive share issuances. The warrants were exercisable immediately and allow
the holder to purchase the shares within seven years of the issue date. The
exercise price is subject to adjustment upon the occurrence of the following
events during the period that the conversion right remains outstanding: common
stock reclassifications, stock splits, combinations and dividends. The notes
bear interest of 8% per annum, payable quarterly. No interest is due for any
month in which the trading price of our common stock is greater than $.14975 for
each trading day. Any amount of principal or interest on the note which is not
paid when due bears interest at the rate of 15% per annum. The convertible notes
are convertible into shares of the Company's common stock at a Variable
Conversion Price, as defined, subject to adjustment if the Company were to issue
any additional shares of common stock at a price per share less than the
applicable conversion rate then in effect, without a floor. The Variable
Conversion Price is 50% multiplied by the average of the lowest 3 Trading Prices
for the Common Stock during the 20 Trading Day periods.
In March 2008, we entered into a securities purchase agreement with an investor,
under which we sold a convertible note in the principal amount of $50,000. In
connection with the agreement, we granted the investor seven-year warrants to
purchase a total of 180,000 shares of common stock at an exercise price of $.10
per share, subject to adjustment for dilutive share issuances. The warrants were
exercisable immediately and allow the holder to purchase the shares within seven
years of the issue date. The exercise price is subject to adjustment upon the
occurrence of the following events during the period that the conversion right
remains outstanding: common stock reclassifications, stock splits, combinations
and dividends. The notes bear interest of 8% per annum, payable quarterly. No
interest is due for any month in which the trading price of our common stock is
greater than $.14975 for each trading day. Any amount of principal or interest
on the notes which is not paid when due bears interest at the rate of 15% per
annum. The convertible notes are convertible into shares of the Company's common
stock at a Variable Conversion Price, as defined, subject to adjustment if the
Company were to issue any additional shares of common stock at a price per share
less than the applicable conversion rate then in effect, without a floor. The
Variable Conversion Price is 50% multiplied by the average of the lowest 3
Trading Prices for the Common Stock during the 20 Trading Day periods.
On April 4, 2008 the Company adopted the 2008 Non-Qualified stock option
plan (the "Plan") for officers, employees, directors and consultants whereby
21,000,000 authorized unissued shares were reserved for issuance under the Plan.
The Company issued 17,750,000 stock options on April 4, 2008 at an exercise
price of $.014 which was the market price of the Company's common stock on the
date of issuance. The options had a ten year life and vesting periods ranging
from immediate to quarterly over 18 months.
F-50
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
On February 8, 2008, holders of 50.3% of the Company's common stock voted
to increase the number of authorized shares from 200,000,000 to 550,000,000. A
preliminary information statement was filed on February 25, 2008 and resubmitted
on March 18, 2008 and April 18, 2008 in response to comments received from the
SEC. The Company is in the process of filing a definitive information statement.
Immediately after the definitive information statement is filed, the Company
expects to mail the information statement to stockholders of record at February
12, 2008. Immediately after the completion of the required waiting period, the
Company expects to increase the number of authorized shares to 550,000,000.
F-51
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S CONSENT
We consent to the incorporation by reference in the Registration Statement of
Protocall Technologies, Inc. on Form S-8, (File No. #333-139687) of our report,
which includes an explanatory paragraph as to the Company's ability to continue
as a going concern, dated May 16, 2008 with respect to our audits of the
consolidated financial statements and related consolidated statements of
operations, stockholders' deficiency and cash flows of Protocall Technologies,
Inc. and Subsidiaries as of December 31, 2007 and for the year ended, which
report is included in this Annual Report on Form 10-KSB of Protocall
Technologies, Inc. for the year ended December 31, 2007.
/s/ Marcum & Kliegman LLP
Melville, New York
May 16, 2008
F-52
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the Registration Statements on
Form S-8 (No. 333-139687) of our report, dated April 16, 2007, relating to the
audit of the consolidated financial statements of Protocall Technologies
Incorporated and subsidiaries for the year ended December 31, 2006, which
included an explanatory paragraph concerning the Company's ability to continue
as a going concern, included in Protocall Technologies Incorporated's Annual
Report on Form 10-KSB for the year ended December 31, 2007.
Eisner LLP
New York, New York
May 16, 2008
F-53
GREENBERG TRAURIG, LLP
MetLife Building
200 Park Avenue
New York, New York 10166
Spencer G. Feldman
212-801-9221
May 16, 2008
------------
VIA EDGAR
---------
Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549
Re: Protocall Technologies Incorporated -- Annual Report on Form 10-KSB
for the Fiscal Year ended December 31, 2007
-------------------------------------------------------------------
Dear Sirs:
On behalf of Protocall Technologies Incorporated, a Nevada corporation
(the "Company"), we hereby submit in electronic format for filing with the
Securities and Exchange Commission pursuant to the Securities Exchange Act of
1934, as amended, and Rule 101(a) (1) (iii) of Regulation S-T, one copy of the
Company's Annual Report on Form 10-KSB for the fiscal year ended December 31,
2007.
The financial statements in the Annual Report do not reflect a change from
the preceding year in any accounting principles or practices, or in the method
of applying any such principles or practices.
Please address any comments or questions that you may have concerning the
Form 10-KSB to Bruce Newman, the Company's Chief Executive Officer, or to me.
Very truly yours,
/s/ Spencer G. Feldman
----------------------
Spencer G. Feldman
Encls.
cc: Mr. Bruce Newman
Eisner, LLP