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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004 COMMISSION FILE NUMBER: 0-51111
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PROTOCALL TECHNOLOGIES INCORPORATED
(Name of small business issuer in its charter)
NEVADA 11-3386214
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
47 MALL DRIVE
COMMACK, NEW YORK 11725-5717
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(Address of principal (Zip Code)
executive offices)
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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: (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]
The issuer's revenues for the fiscal year ended December 31, 2004 were
$206,005.
The aggregate market value of the Common Stock held by non-affiliates
of the issuer was $16,438,827 as of March 29, 2005.
The number of shares outstanding of the issuer's Common Stock as of
March 29, 2005 was 25,383,710 shares.
__________________________________
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III will be incorporated by reference
from portions of a definitive Proxy Statement, which is expected to be filed by
the issuer within 120 days after the close of its fiscal year.
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PROTOCALL TECHNOLOGIES INCORPORATED
2004 FORM 10-KSB ANNUAL REPORT
TABLE OF CONTENTS
PART I.........................................................................2
Item 1. Description of Business......................................2
Item 2. Description of Property.....................................10
Item 3. Legal Proceedings...........................................10
Item 4. Submission of Matters to a Vote of Security Holders.........10
PART II.......................................................................10
Item 5. Market for Common Equity, Related Stockholder Matters
and Small Business Issuer Purchases of Equity
Securities..................................................10
Item 6. Management's Discussion and Analysis or Plan of
Operation...................................................17
Item 7. Financial Statements........................................23
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.........................23
Item 8A. Controls and Procedures.....................................23
PART III......................................................................25
Item 9, 10, 11 and 12....................................................25
Item 13. Exhibits and Reports on Form 8-K............................25
Item 14. Principal Accountant Fees and Services......................26
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
OUR BUSINESS
Protocall Technologies Incorporated is engaged in the development and
commercialization of a proprietary system that enables retailers to produce
fully packaged software, music, audio books and movie digital media products, on
demand, at their stores and at their website fulfillment centers. Our system is
an electronic display, storage and CD/DVD production system, similar in size to
an ATM cash machine. Each retailer installation of our system is comprised of at
least one Product Preview Station, for product merchandising and customer order
placement (for walk-in stores), and one Order Fulfillment Station where CD and
DVD products are produced and packaged.
Unlike conventional distribution and retailing, our system operates on
a platform of virtual inventory, where each product remains in encrypted form on
the Order Fulfillment Station until it is burned onto a compact disk (CD), or
digital video disk (DVD), thereby reducing or potentially eliminating the need
for physical stock at the retail or website location. We believe that our system
has the capability to streamline purchases and upgrade offerings of digital
media products at traditional sales outlets and will allow these products to be
sold in new venues with minimal capital outlays and dedicated floor space. Based
on statistics compiled from The NPD Group, an independent market research firm,
we estimate that U.S. retail software sales alone totaled approximately $5.7
billion in 2004, with unit sales exceeding 100 million. We expect our revenues
to increase as our system gains acceptance among retailers, cataloguers and
online distributors. We believe that there are formidable challenges to
potential competitors in terms of time and resources that would be required to
duplicate our five years of systems development, licensing agreements with
content providers, field testing and resolution of content provider security
concerns.
Following five years of system development and three rounds of field
testing, we commenced commercial rollout of our system in December 2003 at 25
CompUSA retail stores in the Dallas, San Francisco and Seattle markets. Based on
our discussions with CompUSA, we anticipate additional installations at a
portion or at all of CompUSA's 225 U.S. store locations. In August 2004,
TigerDirect, a leading online direct marketer and subsidiary of Systemax, Inc.,
commenced its utilization of our system to fulfill a portion of its online
software sales. Our management team believes that in addition to generating
sales from these traditional pre-existing channels, our system can also be
installed in other types of locations that have not historically sold digital
media products due to inventory cost and space constraints.
Our system is currently utilized for delivery of software products
under the product name "SoftwareToGo(R);" however, we are vigorously pursuing an
expansion of available products to include music, audio books, console video
games and movies. We believe our technology is readily adaptable to other
digital products without additional significant investment.
Our system offers advantages over current physical distribution methods
throughout the value chain from content publisher, to retailer and online
distributors, to consumer. By offering meaningful value to each constituency
along the chain, we believe that our system will be accepted in the general
marketplace. By modernizing the distribution of digital media products, we
believe our system enhances the availability of these products to consumers.
From a content publisher's perspective, our system accelerates the time to
market for new titles, speeds implementation of publisher upgrades (e.g.,
software patches and revisions), increases exposure for niche content publishers
and titles, enhances security to protect against piracy, extends product life
cycles and expands the number and variety of outlets selling its content.
We have spent five years negotiating licensing agreements with more
than 229 software publishers to distribute select titles through the
SoftwareToGo system. Among our publishers are Activision, Atari, Symantec, and
Vivendi Universal. We have more than 229 licensing agreements currently covering
approximately 1,129 software titles.
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From a retailer's perspective, the SoftwareToGo system can reduce or
potentially eliminate the need for inventory, minimize floor space allocated to
physical inventory, reduce shipping and inventory tracking, prevent shrinkage
and out-of-stock situations, offer better insights into product features (thus
reducing potential returns), expand the number of software titles available for
sale, and improve operating margins. Being able to deliver software on demand to
many retail locations can potentially position us to capture market share and to
increase the overall size of the market. For consumers, our system can allow
software to be purchased anywhere the SoftwareToGo system is located, provide a
broader selection of titles, ensure consistent in-stock availability for current
offerings, and offer product previews so consumers have more information with
which to make a purchase decision.
We license software products directly from their publishers and then
distribute the software to retailers through the SoftwareToGo system, with the
retailer determining final consumer pricing. License fees paid to the publishers
are proportional to the retail price of the software. In our relationship with
software publishers, we act as a software wholesaler.
CORPORATE HISTORY AND JULY 2004 TRANSACTIONS
Protocall Technologies Incorporated was formed in December 1992. In
1998, we began focusing on the development and commercialization of the
SoftwareToGo system. Until 1998, Protocall was primarily focused on licensing
proprietary font software to large businesses and operated through its recently
discontinued Precision Type, Inc. subsidiary. Active marketing of Protocall's
font software licensing business was discontinued in 2001, when Protocall
determined to focus solely on developing its current software distribution
business; however, revenues from the font software business continued through
June 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. For a more complete description of the
reverse merger transaction and concurrent private offering in which we received
approximately $7.25 million in gross proceeds, see our current report on Form
8-K dated July 22, 2004 and filed with the SEC on August 6, 2004.
Since our business is that of Protocall only, and the former Protocall
stockholders control the merged companies, the information in this annual report
is that of Protocall as if Protocall had been the registrant for all of the
periods presented in this annual report. The section "Management's Discussion
and Analysis or Plan of Operation" and the audited consolidated financial
statements presented in this annual report are those of Protocall, as these
provide the most relevant information about us on a continuing basis.
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. Information on our website is not part of this
annual report.
INTRODUCTION TO TECHNOLOGY
Each walk-in store installation of SoftwareToGo is comprised of one or
more Product Preview Stations to merchandise software and an Order Fulfillment
Station to produce orders. In the case of installations at internet/catalog
retailers, the Product Preview Stations are usually not required. Collectively,
these stations are controlled from our digital rights management servers via a
virtual private network.
Retailers can also elect to produce products from the system in
quantities in advance of consumer sale, thereby eliminating any change for
consumers in how they shop for software.
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PRODUCT PREVIEW STATION (PPS)
To help consumers at retail stores quickly find the product they want,
the system's touch-screen Product Preview Station provides intuitive drill-down
menus as well as key word and product sorting search options. Product
descriptions include screen shots, video/audio demonstrations, text
descriptions, independent product reviews and technical specifications that,
together, provide a more rapid and complete understanding of the product than
could be obtained from a printed box. Retailers can add additional Product
Preview Stations to meet their customer traffic requirements. The PPS is
designed to provide a maximum amount of information, including the retail price,
in a minimum amount of time.
Once a consumer chooses a software title, the Product Preview Station
prints a bar-coded order ticket that is used to pay for the selected product at
the store's cashier or customer service area. After payment is made, authorized
store personnel produce the selected product using the SoftwareToGo Order
Fulfillment Station.
ORDER FULFILLMENT STATION (OFS)
The Order Fulfillment Station, which is used to produce software CDs
and associated packaging, is located at the retailer's store or website
fulfillment center. To initiate an order from the OFS, store personnel enter a
user-specific password and the product order number that appears on the
consumer's order-ticket. The OFS then automatically connects to our Digital
Rights Management Server via a private network connection to register the order
and retrieve an order authorization.
The system uses the authorization to release the selected software
product onto a CD and then prints the publisher's title-specific graphics and
information onto the surface of the disk. Simultaneously, the system prints a
title-specific four-color package cover and separate "getting started"
installation sheet. As with many software products sold today, product manuals
are provided in digital form on the CD and are supplemented by
publisher-sponsored online help. The finished CD, package cover and "getting
started" sheet are placed into a DVD-style CD case and the case is sealed to
complete the order.
For most software titles, the entire process takes several minutes,
depending on the content size of the software being produced. Consumption of
supplies (CD, case, packaging and labeling) is tracked electronically and
automatically replenished based on system usage. The system uses the latest CD
writer technology and can be scaled to incorporate and handle larger volume /
multi-CD orders by integrating up to four CD writers that process orders
simultaneously. A standard two-CD writer system can produce an average of 34
single CD orders per hour. Products can be made in advance of anticipated sales
for display on retail shelves, or they can be produced on-demand as single-item
orders.
RESEARCH AND PRODUCT DEVELOPMENT
We have conducted research and product development of electronic
software distribution systems since 1998. Research and product development
expenditures were approximately $153,123 and $560,912 in the years ended
December 31, 2004 and 2003, respectively.
EQUIPMENT PRODUCTION, INSTALLATION AND SUPPORT
As more fully described below, we outsource the component purchasing,
warehousing, testing and on-site unit assembly to third parties. Unit cost for
each installation can range from $10,000 to $40,000, depending on system
requirements and configuration, though this cost is expected to decline somewhat
over time, assuming the continuing decline in computer hardware prices, of which
there can be no assurance. The SoftwareToGo system consists of personal
computers, data storage equipment and CD replication equipment, all of which are
generally available in the market from numerous suppliers.
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ASSEMBLY AND INSTALLATION
To facilitate the deployment, in December 2003, at 25 CompUSA stores,
we retained an outside consulting firm to assist in overseeing the procurement
of components, integration and on-site installation. We intend to use third
party resources if and when we have additional deployments. We believe there are
numerous companies that can provide this service.
We have also selected a national enterprise solutions and service
provider, GA Services, to perform on-site SoftwareToGo unit installation
services to our customers, as well as on-site maintenance and break-fix
services. We pay this firm on the basis of each on-site visit. We paid $57,422
to GA Services in 2004.
TECHNICAL SUPPORT AND UNIT MAINTENANCE
We maintain a call-in technical support team at our headquarters,
available during all store hours (9:00 a.m. EST to 9:00 p.m. PST), seven days a
week. Based on feedback from our retailer customers, we believe that we have
established a reputation for excellent technical support by making it one of our
top priorities. Our experience is that most problems are easily resolved through
telephone and online support. However, if a customer requires on-site service
and/or replacement of computer components or equipment, we contact our
enterprise solutions and service provider to perform these services. Currently,
technical support is furnished without additional charge to customers.
COMPETITIVE POSITION
SOFTWARETOGO VS. TRADITIONAL SOFTWARE DISTRIBUTION
SoftwareToGo offers advantages over current software distribution
methods throughout the value chain from publisher through retailer to the
consumer. By offering value to each constituency along the chain, we believe
SoftwareToGo will be generally accepted in the marketplace. The relative
advantages to each group are discussed below.
SOFTWARE PUBLISHER PERSPECTIVE - SoftwareToGo provides benefits for
publishers, including:
o Reduction in production costs - By avoiding printing,
packaging, shipping and inventory costs in advance of anticipated
needs, publishers who use SoftwareToGo can potentially expect margins
equal to or greater than with conventional distribution.
o Increases distribution exposure for niche publishers and titles
- Software from smaller publishers and even niche products from larger
publishers are not always carried in retail stores. SoftwareToGo makes
it practical for stores to carry these titles.
o Increased security - SoftwareToGo offers the ability to produce
individual serial numbers, digital security certificates and other
measures for each copy of software produced. These security features
can be placed on the packaging, the software CD and even digitally
encoded and embedded in the software.
o Addresses consumer concerns about the availability of software
for alternative computing platforms (e.g., Apple Computer and Linux) -
Promoters of alternative platforms often encounter consumer resistance
based on software availability. SoftwareToGo addresses these concerns
and thus improves their competitive position.
o Extends product life cycles - As sales of software decline
normally over the product life cycle, it eventually becomes
uneconomical for publishers to produce and distribute titles by
traditional means. SoftwareToGo improves the economics of software
publishing by capturing incremental cash flows from software with
fully sunk development costs.
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o Speeds time to market - Producing and distributing stock for a
myriad of retailer outlets in preparation for product launches is a
daunting task, from both logistical and financial perspectives. Using
SoftwareToGo, publishers can be ready for their commercial launches
within days of completion of the software master. Faster launches
reduce working capital needs and speed the monetization of the
investment that publishers have made in their products.
CONSUMER PERSPECTIVE - Compared to current distribution techniques,
consumers enjoy a number of benefits with no increase in cost:
o Improved selection - By offering a virtual inventory of
software, SoftwareToGo helps consumers get the exact software they are
looking for in a single store visit. Consumers never miss out on hot
titles that might otherwise be out of stock.
o Latest software versions - The networked architecture of the
SoftwareToGo system enables us to remotely update software in
individual stores as updates become available from publishers.
RETAILER PERSPECTIVE - The SoftwareToGo distribution model offers
retailers many advantages compared to current distribution methods:
o Larger selection of titles - The SoftwareToGo system currently
has approximately 1,129 titles from more than 229 publishers. We
regularly discuss increasing these numbers with publishers. In
comparison, we estimate that, based on discussions with our retail
customers and other large retailers, with which we keep in contact,
most retailers carry software stock of between 100 and 500 titles.
Expanded offerings enable retailers to capture incremental sales that
would otherwise be lost to competitors - all while improving the
customer experience.
o Minimal Footprint - The SoftwareToGo systems occupy
approximately 10 square feet. This enables retailers that stock
software to greatly increase their product offerings without
increasing outlays for floor space.
o Eliminates stocking risk - Because SoftwareToGo can be used to
restock products in the event of strong sales and supply disruptions,
retailers can eliminate the risk of lost sales. In addition, by
eliminating out-of-stock conditions, retailers can operate with leaner
inventories and reduced floor space, while minimizing costs associated
with personnel handling typical inventory. Finally, because products
on the SoftwareToGo system can be remotely updated to the latest
version, retailers avoid the expense of product recalls and obsolete
product returns.
o Expands addressable base of retailers by allowing retailers
with limited floor and shelf space to increase their software product
selection. Many computer retailers have unexploited synergies with
software.
o Potentially eliminates shrinkage - By producing software only
as it is sold, retailers effectively eliminate the risk of customer
and employee theft. With many software titles priced over $100, this
can measurably improve margins at the store level.
Many of these advantages also apply to catalog and online-based
software mail-order retailers. We believe our pricing maintains or slightly
improves the margins presently enjoyed by retailers.
ALTERNATIVE SOFTWARE DISTRIBUTION
Aside from traditional software distribution methods, our competition
falls into two general categories: direct competition from companies offering
similar solutions and potential competition from other industry players. Both
categories include companies that are larger and more established than we are
and that have access to greater resources.
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Direct competition may come from Tribeka Ltd., a company based in the
United Kingdom. Tribeka has developed an electronic software delivery system
that is similar in architecture and functionality to SoftwareToGo. The system is
operational in England under the name Softwide at a number of Tribeka-owned
retail-site locations in Europe. It is also believed that Tribeka is planning to
deploy its system in the United States, but we are not aware of the timing of
any such development.
Potential competition comes from several independent companies that
produce music delivery systems that are similar in functionality to our system.
These companies could conceivably re-engineer their systems to deliver software;
however, they would still face numerous issues related to establishing publisher
and retailer agreements in the software industry. In particular, potential
entrants would face substantial development expense and delay stemming from
their need to duplicate our elaborate end-to-end security capabilities without
potentially infringing on aspects of our patented technology.
Potential competition also exists with application service providers,
known as ASPs. These companies enable businesses and consumers to use software
that is installed on remote servers, thereby eliminating the need to purchase
physical products. While the ASP market is expected to grow, we believe most
consumers and businesses have been reluctant to outsource software and
information requirements.
Software downloading is another source of competition. While this
represents a growing source of competition, we believe that, based on
discussions with software publishers, downloading will only represent 5% to 20%
of their overall business in the long-term. This is because downloading is a
major facilitator of software piracy, which is one of the primary reasons why
many major publishers are reluctant to distribute their products via electronic
download. In additional to security concerns, downloading is only practical for
products that are small in size. For example, for a consumer purchasing a
typical 350 megabyte product today, downloading via the internet is a time
consuming process that could take up to 45 minutes via a broadband connection
and over 15 hours via a dial-up connection. Many software products are
significantly larger than this, and historical trends point toward increasingly
sophisticated, even larger software applications.
MARKET OPPORTUNITY AND COMPOSITION
Hundreds of companies in the United States produce a broad selection of
software titles for distribution to consumers. We estimate that there are as
many as 20,000 individual software titles available in today's market. Most
publishers have set up web sites to facilitate sales and to provide consumers
with information about their products. However, the majority of sales still
occur through traditional distribution and retail channels.
SOFTWARETOGO DEVELOPMENT AND COMMERCIALIZATION TIMELINE
1998 - Initial concept definition complete.
Protocall initiates design of the SoftwareToGo system.
Protocall files for patent protection on portions of its
SoftwareToGo architecture.
1999 - SoftwareToGo software and hardware development continues.
2000 - Protocall signs first software publisher license agreement.
2001 - Protocall conducts "alpha" testing of SoftwareToGo.
Protocall incorporates over 30 improvements from field testing
into SoftwareToGo. 39 Publisher licensing agreements
completed.
2002 - Protocall conducts "beta" testing of SoftwareToGo in CompUSA
stores.
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Based on success of the Beta testing, Protocall signs
deployment agreement with CompUSA. 100+ Publisher licensing
agreements completed.
2003 - Apple Computer endorses SoftwareToGo to its Apple Developer
Connection members. (See http://developer.apple.com/
business/softwaretogo.html.) CompUSA deployment commences
(25 stores). 200+ Publisher licensing agreements completed.
2004 - 229+ Publisher agreements completed; more are under
negotiation. Protocall signs deployment agreement with web
retailer TigerDirect.com. TigerDirect deployment commences
Discussions begin with other major web and in-store
retailers.
2005 - Wireless communication within stores implemented.
ROLLOUT STRATEGY
As an intermediary between software publishers and retailers, our
rollout strategy has consisted of assembling a core group of publishers and
successfully testing SoftwareToGo in the field. After achieving demonstrable
success in these areas, we have moved to monetize our technology and
relationships by deploying SoftwareToGo with both traditional and web-based
software retailers. To date, two important retailer contracts have been secured,
and we are continuing efforts to enlarge our retailer customer base.
COMPLETED RETAILER CONTRACTS
After successful field testing of the system at three CompUSA stores
from April through July 2002, we signed our first electronic software
distribution and site location agreement for the rollout of SoftwareToGo at
several of CompUSA's 225 stores. Store installations began in December 2003, and
SoftwareToGo has been deployed in 25 stores to date. As economics allow,
deployment will proceed in additional CompUSA stores. The term of the CompUSA
agreement extends through June 2008. The agreement provides that CompUSA will
provide site locations in its stores meeting certain specifications, and that we
will install, operate and maintain the SoftwareToGo system units in those sites.
The agreement further provides that we will provide CompUSA with software titles
through the system at competitive prices, and that CompUSA is entitled to
determine the retail price at which the titles are sold to customers. CompUSA is
one of the country's largest retailers of consumer software and is using
SoftwareToGo to ensure in-stock availability for current shelf offerings, while
expanding the breadth and selection of titles available at its stores.
In March 2004, we signed an agreement to deploy SoftwareToGo with
web-based retailer TigerDirect, Inc. TigerDirect is a subsidiary of Systemax
Inc., a leading direct marketer of computers and computer-related products.
Under the terms of our agreement with Systemax, we have begun to fulfill
TigerDirect's order flow for software that is available via SoftwareToGo. The
term of the TigerDirect agreement extends through March 2006, with the term
automatically extended for successive one-year terms unless otherwise
terminated. The agreement provides that we will provide TigerDirect with
software titles through the system at competitive prices, and that TigerDirect
is entitled to determine the retail price at which the titles are sold to
customers. We are responsible for the payment of shipping costs for deliveries
to customers.
SOFTWARE PUBLISHER CONTRACTS
We have signed agreements with more than 229 software publishers to
distribute select titles through SoftwareToGo, including Activision, Atari,
Symantec and Vivendi Universal, and are in the process of finalizing agreements
with others. Our licensing agreements currently cover over 1,129 titles. Most
publishers have signed our standard publisher license agreement. These
agreements allow us to resell the publisher's products to one or more of our
retail customers. The agreements set a price that we pay for each product
licensed through our system. There are no minimum purchase requirements, and
there are no limitations on the price we can resell their products to our
customers. We pay the software publishers 45 days after month end with respect
to sales during that month,
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which has allowed us to collect our accounts receivable prior to payment to the
publishers. For a further description of the risks associated with maintaining
our relationships with software publishers, see "Factors that May Affect the
Future Results of our Business" in Item 5 below.
ADDITIONAL CONTRACT OPPORTUNITIES
We are in various stages of discussions with other major United States
computer and software retailers to use the SoftwareToGo system, though we cannot
be certain that any of these discussions will lead to definitive agreements.
System testing with one of these retailers is expected to begin in mid-2005. The
agreements with our two customers establish our fixed selling price for each
product licensed through our system. There are no minimum purchase requirements.
and there are no limitations on the price at which the retailer can license the
product to the consumer.
In our retailer agreements to date, we are obligated to install,
maintain and provide technical support for the system. We are also required to
provide the consumable items used in production of a final product. These
consumables include; a CD-R disk, a DVD-style case, a printed cover sheet and a
"getting started" instructional booklet. In future agreements, we expect that
some or all of these costs may be borne by our customer, which will be offset by
increased discounts on license fees paid by the customer to us.
SoftwareToGo is potentially valuable in situations where inventory
management is complicated by the need to offer language-specific titles. With
SoftwareToGo, these titles could be produced on demand, avoiding the need to
physically import and simultaneously pay duty on inventory with limited appeal
outside of the specific country.
Our marketing and distribution program involves a direct sales force,
headed by Bruce Newman, our President and Chief Executive Officer, and Syd
Dufton, our Vice President - Sales and Channel Marketing. We use our direct
sales force to support our existing retailer contracts and to take advantage of
direct sales opportunities.
REGULATION
Our business activities currently are subject to no particular
regulation by governmental agencies other than that routinely imposed on
corporate businesses, and no such regulation is now anticipated.
PATENTS AND INTELLECTUAL PROPERTY
We regard our SoftwareToGo system as proprietary and rely primarily 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 system.
We have received two United States patents for various aspects of the
SoftwareToGo system. One patent protects the SoftwareToGo system by covering the
retrieval of encrypted software from secure storage. This patent extends
coverage into the field software distribution to include a three-tier system
having an end user, who can be selectively coupled to a remote vendor who is in
turn connected to a remote server.
The patent protects systems and methods where an end user, such as a
retailer or consumer, may access software products from a CD-ROM or other
storage device which is connected to the end user's station or computer. The end
user's station is connected to a vendor station which requests decryption keys
generated by a remote server. The software product is secured by an encryption
technique that allows the retailer or consumer to access the software product
upon receipt of the decryption key.
The second patent further expands our intellectual property protection
over the SoftwareToGo system and its use in the retail environment. The patent
covers systems and methods of implementing a supply chain's return policy for
digital products. Important proprietary aspects for managing digital products
include:
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o verifying the origin of digital products to determine if it was
produced from the supply chain, rendering the product unusable, and
voiding the transaction for the product;
o rendering digital products unusable based upon the physical
nature of the product;
o preventing the removal of returned digital products from
physical storage until the origin of the product is verified or the
product is rendered unusable;
o examining the returned digital product's internal files or
external indicia to ascertain the product's origin or return policy;
and
o using a record of the destruction which allows for a reversal
of the entire transaction within the supply chain.
Our intellectual property also includes the copyrighted source code for
the SoftwareToGo Product Preview Station, Order Fulfillment Station, back-end
digital rights management system, B2B software delivery system and Internet web
delivery engine.
We are the exclusive licensee for the use of the registered trademark
SoftwareToGo(R). We intend to submit a trademark application for our Protocall
logo. We also rely upon our efforts to design and implement improvements to our
SoftwareToGo system to maintain a competitive position in the marketplace.
EMPLOYEES
As of February 22, 2005, we had 26 employees, of whom 9 were in product
development, engineering and help desk support, 3 in sales and marketing, and 14
in general, administrative 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 10,000 square feet of space occupied under a
lease with a monthly rental rate of $11,500 that expires in January 2006. We
believe that this facility is adequate for our current business operations.
ITEM 3. LEGAL PROCEEDINGS.
We are not a party to any material litigation or threatened litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the
fourth quarter of 2004.
PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL
BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES.
COMMON STOCK INFORMATION
As of February 22, 2005, there were 379 record holders of our common
stock and there were 25,383,710 shares of our common stock outstanding.
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Our shares of common stock are quoted on the OTC Bulletin Board under
the trading symbol PCLI.OB. We have applied for listing on the American Stock
Exchange, but cannot be certain that we will receive approval.
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, 2003:
Second Quarter (April 22 to June 30) $.02 $.01
Third Quarter .01 .01
Fourth Quarter .01 .01
YEAR ENDED DECEMBER 31, 2004:
First Quarter $.01 $.01
Second Quarter .01 .01
Third Quarter (July 1 to July 22) .01 .01
Third Quarter (July 23 to September 30) 4.00 2.60
Fourth Quarter (October 1 to December 31) 4.45 2.50
YEAR ENDING DECEMBER 31, 2005:
First Quarter (through March 16) $3.75 $0.80
The prices are adjusted to reflect a 4-for-1 stock split effective June
29, 2004 prior to the reverse merger. Third quarter 2004 market information is
divided at July 22, 2004, the closing date of our reverse merger transaction.
Our shares of common stock became eligible for quotation on the OTC Bulletin
Board in April 2003, at which time it related only to Quality Exchange (under
the symbol QEXI.OB). In July 2004, the symbol was changed to PCLI.OB. See Item
1, "Corporate History and July 2004 Transactions."
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.
EQUITY COMPENSATION PLAN INFORMATION
We assumed all of Protocall's obligations under the Protocall
Technologies Incorporated 2000 Stock Incentive Plan. At the time of the merger,
Protocall had outstanding stock options to purchase 2,951,922 shares of common
stock, which outstanding options were assumed by action of our board of
directors after the closing of the merger to become stock options to purchase
shares of our common stock. Following the merger, our board voted to cease using
the 2000 Stock Incentive Plan for future stock option grants, and adopted a new
2004 Stock Option Plan. Our board of directors then granted stock options to
purchase a total of 1,027,750 shares, of our common stock, net of cancellations,
under the 2004 Plan. See Note J of the notes to the accompanying consolidated
financial statements for a detailed description of our option plans.
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The following table provides information regarding the status of our
existing equity compensation plans at March 15, 2005:
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SHARES OF FUTURE ISSUANCE UNDER
COMMON STOCK TO BE ISSUED WEIGHTED-AVERAGE EQUITY COMPENSATION PLANS
UPON EXERCISE OF EXERCISE PRICE OF (EXCLUDING SECURITIES
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, REFLECTED IN THE PREVIOUS
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS COLUMNS)
------------------------------------- -------------------------- --------------------- ----------------------------
Equity compensation plans approved
by security holders (1) 2,951,922 $1.74 --
Equity compensation plans not
approved by security holders (2) 1,027,750 1.25 972,250
----------------------------------------------------------------------------------
Total 3,979,672 $1.61 972,250
==================================================================================
____________________
(1) Represents Protocall's 2000 Stock Incentive Plan, which we assumed as
part of the reverse merger in July 2004.
(2) Represents Protocall's 2004 Stock Option Plan.
RECENT SALES OF UNREGISTERED SECURITIES
On July 22, 2004, we completed a reverse merger transaction with
Quality Exchange, Inc., a Nevada corporation formed in June 1998. For a more
complete description of the reverse merger transaction and concurrent private
offering in which we received approximately $7.25 million in gross proceeds, see
our current report on Form 8-K dated July 22, 2004 and filed with the SEC on
August 6, 2004. We issued 16,733,074 shares of our common stock to the former
security holders of Protocall in the reverse merger and 5,859,200 shares of our
common stock to accredited investors in the private offering.
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.
WE ARE STILL IN AN EARLY STAGE OF DEVELOPMENT, AND 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 software publishers, retailers and consumers in an
evolving and unpredictable business environment,
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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, 2004 and 2003, we had
net losses of $6,939,078 and $4,287,455, respectively. As of December 31, 2004,
we had total stockholders' equity of $149,367. 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.
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 estimate
that we will require additional cash resources by the middle of the quarter
ending June 30, 2005, based on our current operating plan. As of February 28,
2005, cash available to us was approximately $1,282,000. Our continued
operations thereafter will depend upon the availability of cash flow, if any,
from our operations or our ability to raise additional funds through equity or
debt financing. There can be no assurance that we will be able to obtain
additional funding when it is needed, or that such funding, if available, will
be obtainable on terms favorable to or affordable by us. If we cannot obtain
needed funds, we may be forced to curtail or cease our activities. The
uncertainties regarding the availability of subsequent funding and commencement
of adequate commercial revenues raise substantial doubt about our ability to
continue as a going concern, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business.
WE ARE CURRENTLY DEPENDENT ON TWO RETAILERS AND, IF OUR CONTRACTS WITH
THEM ARE CANCELLED OR DEPLOYMENTS ARE UNSUCCESSFUL, WE MAY NOT BE ABLE TO OFFSET
ANY POTENTIAL LOSS OF THIS BUSINESS. Our only current agreements relating to the
deployment of our SoftwareToGo system are with CompUSA and TigerDirect, and a
significant portion of our efforts is focused on making these deployments
successful. Although it is our goal to deploy our system with CompUSA throughout
the United States, there can be no assurance that such a deployment will be
achieved. Our dependence on the results of this deployment are significant and
anything less than a successful system deployment in a majority of CompUSA's
stores, as well as a successful deployment with TigerDirect, could have a
material impact on us, possibly resulting in an inability to continue as a going
concern.
WE DEPEND ON CONTINUING RELATIONSHIPS WITH OUR SOFTWARE PUBLISHERS, 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
software distributor to retail stores and e-commerce retailers. If we cannot
develop and maintain satisfactory relationships with software publishers on
acceptable commercial terms, we will likely experience a decline in revenue. We
also depend on these software publishers to create, support and provide updates
for software products that consumers will purchase. If we are unable to license
a sufficient number of titles from software publishers, or if the quality of
titles provided by these software publishers 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 software publisher
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
software publishers that guarantee the availability of software products.
Software publishers that currently supply software to us may not continue to do
so and we may be unable to establish new relationships with software publishers
to supplement or replace existing relationships. For example, in September 2004,
Microsoft Corporation notified us that, effective November 1, 2004, it was
discontinuing our license to sell its software titles due to inadequate sales
levels at one of our retail customers.
OUR PUBLISHER 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 software publishers 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 software publishers. If, at the end of a sales effort,
a prospective publisher 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 publisher
license acquisition process may be impaired.
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SOFTWARE-ON-DEMAND TECHNOLOGY IS STILL EVOLVING AND UNPROVEN AND THE
INDUSTRY MAY ULTIMATELY FAIL TO ACCEPT THIS TECHNOLOGY, RESULTING IN OUR
PRODUCTS BECOMING NO LONGER IN DEMAND. Our success will depend in large part on
the growth in consumer acceptance of software-on-demand technology as a method
of distributing software products. Software-on-demand is a relatively new method
of distributing software 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:
o Continuing demand by consumers for software products;
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 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 reliably and consistently on a long-term
basis. Our failure to do so would also impair our ability to execute our
business plan.
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 the SoftwareToGo
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 the SoftwareToGo 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
software and product marketing services to our clients and end-users through our
proprietary technology and digital 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 THE
SOFTWARETOGO 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 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 BRUCE NEWMAN POSSESSES SPECIALIZED KNOWLEDGE ABOUT OUR
BUSINESS, WE WOULD BE ADVERSELY IMPACTED IF HE WAS TO BECOME UNAVAILABLE TO US
WITHOUT A SUFFICIENT TRANSITION
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PERIOD. We believe that our continued success will depend to a significant
extent upon the efforts and abilities of Bruce Newman, our President and Chief
Executive Officer. Mr. Newman, who founded Protocall, has knowledge regarding
software-on-demand technology and business contacts that would be difficult to
replace. If Mr. Newman was to become unavailable to us, our operations would be
adversely affected. We do not currently carry key-man life insurance on the
lives of any of our executive officers.
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 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 software 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
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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 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 THE SOFTWARETOGO 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 the SoftwareToGo 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. We
anticipate that we can obtain in a timely manner alternative third party
services and that the failure to extend or replace existing contracts would not
have a material adverse effect on us, although we can give no assurance in this
regard.
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 software products through our system are highly
dependent on the qualitative mix of titles that we are able to license from
software publishers for inclusion on our system. Although we have executed
licensing agreements with more than 229 software publishers covering
approximately 1,129 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 costs. In order for us to be successful, we will need
to improve the quality of software titles on our system.
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. We
have applied for listing on the American Stock Exchange, but cannot be certain
that we will receive approval. 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. Our daily trading volume has averaged between 3,500 and 4,000 shares
over the past three months. As a result of this trading activity, the quoted
price for our common stock on the OTC Bulletin Board is not necessarily a
reliable indicator of its fair market value, and the low trading volume 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.
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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 WILL BE 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
pursuant to our pending registration of 24,346,710 shares of common stock and
otherwise, 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 February 22, 2005, there were an additional 3,979,672 shares
of our common stock issuable upon exercise of outstanding stock options and an
additional 1,774,219 shares of our common stock issuable upon exercise of
outstanding warrants. 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 of common stock. In
general, a person who has held restricted shares for a period of one year may,
upon filing with the SEC a notification on Form 144, sell into the market common
stock in an amount equal to the greater of 1% of the outstanding shares or the
average weekly number of shares sold in the last four weeks prior to such sale.
Such sales may be repeated once each three months, and any of the restricted
shares may be sold by a non-affiliate after they have been held two years. In
connection with the merger, substantially all of the former holders of Protocall
common stock entered into "lock-up agreements" with us that prohibit those
stockholders from, directly or indirectly, offering, selling, pledging or
otherwise transferring or disposing of any of the 14,551,268 shares of our
common stock acquired by them as a result of the merger until October 22, 2005
(15 months after the closing of the merger).
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 38.3% of our outstanding
common stock (excluding presently exercisable stock options and warrants), of
which Peter Greenfield, our Chairman, controls approximately 30.5%. 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.
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 financial statements and
accompanying notes included in this report beginning on page F-1.
OVERVIEW
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
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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. For a more complete description of the
reverse merger transaction and concurrent private offering in which we received
approximately $7.25 million in gross proceeds, see our current report on Form
8-K, dated July 22, 2004 and filed with the SEC on August 6, 2004.
Protocall Technologies Incorporated was formed in New York in December
1992. Until 1998, Protocall was focused primarily on licensing proprietary font
software to large businesses and operated through its recently discontinued
Precision Type, Inc. subsidiary. Active marketing of Protocall's font software
licensing business was discontinued in 2001, when Protocall determined to focus
solely on developing its current software distribution business; however,
revenues from the font software business continued through June 2004.
Since our business is that of Protocall only, the former officers of
Protocall were appointed to the same positions in our company and the former
Protocall stockholders received a majority of the total common stock of our
company in the reverse merger, the merger was accounted for as a
recapitalization of Protocall, and the information in this annual report is that
of Protocall.
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 existing retailer agreements: 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 SoftwareToGo 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 the Product Preview Stations
within its stores as well as an appropriate location for the Order Fulfillment
Station, and provides SoftwareToGo system promotion. 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 online and catalog retailers, the business model differs somewhat.
For these retailers, a high-capacity SoftwareToGo Order Fulfillment Station is
used without the need for a Product Preview Station. 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 ship
the products. Under this model, we expect much higher capacity utilization for
the Order Fulfillment Station and, consequently, a much faster payback on
deployed capital.
We secure the right to replicate titles through licensing agreements
with software publishers, paying a licensing fee to each publisher per product
vended. In instances where a consumer returns SoftwareToGo-produced products,
the publisher license fee is credited to us.
We expect to be able to improve our licensing terms as the number of
installed SoftwareToGo sites increase. Because our agreements with publishers
provide 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 software
produced by the SoftwareToGo system, we do not anticipate an increase to working
capital requirements from this aspect of the business as the business grows. We
do not 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.
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
18
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.
REVENUE RECOGNITION
We recognize revenue from retailers' sales of product through our
software delivery system and through catalogues, upon delivery to the retail
customer or consumer.
Revenue from the license or sale of software products and font
reference guide books from our discontinued business was recognized when the
products were delivered or shipped to the customer.
Part of our marketing strategy to acquire new consumers includes retail
promotions in which we pay retailers if they are successful in marketing
software products on our system to consumers. These payments are recorded as a
reduction in revenue in accordance with EITF No. 01-9. As a result of this
accounting treatment, these payments, which totaled $10,975 in 2004, which we
consider to be marketing costs, are not included in marketing expense, but
instead, recorded as a reduction in revenue. Estimated customer rebates are
reflected as a reduction in revenue in the period that the related sale is
recorded. 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.
SEASONALITY
We believe there will ultimately be a minor degree of seasonality in
our business. We anticipate that the fourth quarter of each fiscal year (October
to December) will show slightly higher revenues due to the holiday shopping
season.
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.
RESEARCH AND PRODUCT DEVELOPMENT COSTS
We expense research and product development costs as incurred.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Protocall
Technologies Incorporated and its wholly-owned subsidiaries. All intercompany
balances and transactions have been eliminated in consolidation.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003
NET LOSS FROM CONTINUING OPERATIONS. We had net losses from continuing
operations of $6,947,525 and $4,375,003 for the years ended December 31, 2004
and 2003, respectively. During these periods, operations were financed through
various equity and debt financing transactions.
19
NET INCOME FROM DISCONTINUED OPERATIONS. Due to the completion of the
development and the beginning of the commercialization of the SoftwareToGo
system, effective June 30, 2004, we discontinued the operations of our
wholly-owned subsidiary Precision Type, Inc. Accordingly, Precision Type's
assets and liabilities have been segregated from the assets and liabilities of
continuing operations in the consolidated balance sheets at December 31, 2004
and 2003 and its operating results have been segregated from continuing
operations and are reported as discontinued operations in the consolidated
financial statements of operations and cash flows for all periods reported.
Precision Type had net income of $8,447 and $87,548 for the years ended
December 31, 2004 and 2003, respectively.
NET SALES. Net sales for the year ended December 31, 2004 were $206,005
compared to $14,805 for the year ended December 31, 2003. This increase in net
sales is due to our agreements with, and sales to, CompUSA and TigerDirect
utilizing the latest version of our SoftwareToGo system, which was deployed in
December 2003.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expense, or
R&D, decreased by $407,789, or 72.7%, from $560,912 to $153,123, for the year
ended December 31, 2004 as compared to the year ended December 31, 2003. The
decrease in R&D was primarily due to the completion and deployment of the latest
version of our SoftwareToGo system during the fourth quarter of 2003.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $2,754,390, or 134.6%, to $4,801,472 for
the year ended December 31, 2004 from $2,047,082 for the year ended December 31,
2003.
Total salaries increased $882,962, or 92.6%, to $1,836,706 in 2004 from
$953,744 in 2003, due primarily to additional personnel. Depreciation and
amortization expense increased $473,961 in 2004, or 198.7%, to $712,445 from
$238,484 in 2003, due principally to the depreciation associated with fixed
assets acquired in connection with the CompUSA deployment. Consulting expenses
increased $361,388 in 2004, or 748.9%, to $409,642 from $48,254 in 2003, due to
the use of outside consultants to assist in financing, marketing and accounting
matters. Marketing expenses increased $278,440 in 2004, or 461.2%, to $338,812
from $60,372 in 2003, due to increased marketing of our SoftwareToGo system.
Professional fees increased $283,648 in 2004, or 122.9%, to $514,410 from
$230,762 in 2003, principally due to legal and accounting expenses related to
public reporting requirements.
INTEREST AND FINANCE CHARGES. Interest and finance expense combined
increased by $569,810, or 33.0%, to $2,298,278 from $1,728,468 for the year
ended December 31, 2004 compared to the year ended December 31, 2003.
Interest expense decreased $13,845, or 1.7%, to $779,772 from $793,617,
for 2004 as compared to 2003. The decrease in interest expense was primarily due
to the conversion of over $8 million of debt into common stock during 2004,
partially offset by an increase in debt during the first six months of 2004.
Finance expense increased $583,655, or 62.4%, to $1,518,506 from
$934,851 for 2004 as compared to 2003. This increase is primarily due to debt
discount amortized in 2004 associated with an additional $2,601,000 of newly
issued debt issued between January and June 2004 and the subsequent write-off of
$554,009 of unamortized debt discount upon conversion of the related debt to
equity in connection with the reverse merger.
FORGIVENESS OF INDEBTEDNESS. We recorded $392,995 as income from
forgiveness of indebtedness in 2004 as compared to $0 in 2003. This increase is
primarily due to negotiated agreements with creditors in connection with the
conversion of debt associated with the reverse merger in July 2004. These
creditors, pursuant to written agreements, provided us discounts and accepted
cash payments or our common stock upon the closing of our reverse merger.
OTHER INCOME. Other income increased $36,292, to $53,539 in 2004, or
210.4%, from $17,247 in 2003.
LIQUIDITY AND CAPITAL RESOURCES
As a result of the July 2004 closing of the reverse merger and private
offering, at December 31, 2004, our working capital amounted to $77,385 as
compared with a working capital deficit of $10,586,626 at December 31, 2003. At
December 31, 2004, we had an accumulated deficit in the amount of $32,962,900.
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 and capital raising
activities.
20
On July 22, 2004, concurrently with the closing of a private offering
of approximately $7.25 million in shares of our common stock (before related
fees of approximately $900,000 and including the conversion of $1,825,000 of
interim notes), we acquired the business of Protocall in a reverse merger
transaction and, with the proceeds of the offering, are continuing the existing
operations of Protocall as a publicly traded company. We issued 16,733,074
shares of our common stock to the former security holders of Protocall,
representing 66.0% of our outstanding common stock following the reverse merger
and giving effect to the shares issued in the private offering and to the
conversion of indebtedness described below in exchange for 100% of the
outstanding common stock of Protocall. Debt conversions, which were all effected
at $1.25 per share, included (i) $2,601,000 of debt incurred in 2004 and (ii)
$6,628,338 of prior debt, $199,102 of accrued interest and $981,571 of accounts
payable and accrued expenses. In addition, 17,647,377 of Protocall's warrants
were exchanged for 3,384,793 shares of our common stock. In order to facilitate
the reverse merger and without receiving consideration, Protocall's major
shareholder forgave $1,099,915 of accrued interest on notes held by him, which
notes were included in the prior debt described above. As part of the reverse
merger, warrants to purchase 1,774,219 shares of Protocall common stock and
stock options to purchase approximately 2,951,922 shares of Protocall common
stock were converted into warrants and stock options to purchase our common
stock.
As of February 28, 2005, we had a cash balance of approximately
$1,282,000. Based upon our current cash forecast, operating plan and financial
condition we will require additional cash resources, during the quarter ending
June 30, 2005. Until such time as we can rely on revenues generated from
operations, we will continue to seek additional sources of financing through
both public and private offerings. We believe that we have enough cash to
continue as a going concern until May 2005 based upon our current rate of
negative cash flow. Accordingly, if we fail to obtain additional financing, we
will be required to substantially reduce our operating expenses, capital
expenditures and potentially cease doing business. We are currently having
discussions with investment banking firms and potential investors regarding an
equity financing consisting of an issuance of either common stock or preferred
stock. Management has determined that it is unlikely that we would be successful
in obtaining bank or other debt financing. We have no current commitments for
additional funding. There can be no assurance that we will be successful in
obtaining additional financing. 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, which
contemplates the realization of assets and satisfaction of liabilities in the
normal course of business. 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.
The following table summarizes our fixed cash obligations as of
December 31, 2004 over various future years:
PAYMENTS DUE BY PERIOD
LESS THAN AFTER 5
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS YEARS
Notes payable and long-term debt $ 656,963 $ 34,547 $ 622,416 $ 0 $ 0
Capital leases 1,110,668 432,594 678,074 0 0
Operating leases 128,458 118,546 9,912 0 0
Employment contracts 1,336,792 470,000 562,917 303,875 0
----------- ----------- ----------- ---------- ---------
$ 3,232,881 $ 1,055,687 $ 1,873,319 $ 303,875 $ 0
=========== =========== =========== ========== =========
RELATED PARTY TRANSACTIONS
On September 30, 2003, a stockholder/director opened a one year,
irrevocable standby letter of credit on our behalf in the amount of $300,000, as
required by an agreement with a publisher to guarantee the payment of any
license fees due the publisher. As compensation to the stockholder/director, we
issued a warrant to purchase 150,000 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 $77,321, utilizing the
Black-Scholes option-pricing model with the following assumptions: 50%
volatility, seven-year expected life, risk-free interest rate of 3.63% and
dividend yield ratio of 0%. The warrant was originally scheduled to expire on
September 30, 2010 but was converted into approximately 27,413 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 finance cost and was amortized, on a
straight-line basis, over the one year term of the letter of credit. This letter
of credit was canceled during September 2004 due to the termination of the
publisher agreement and was never drawn upon.
21
On October 14, 2003, the same 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 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 lease
obligation which terminates April 1, 2007. 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.
As of December 31, 2004 and 2003, we had accrued salaries to employees,
including two of our executive officers, of $587,407 and $822,084, respectively.
As part of the July 22, 2004 reverse merger, the two executive officers each
converted $100,000 of their accrued salaries into 80,000 shares of common stock
at a rate of $1.25 per share.
Upon the consummation of the merger, our board of directors approved a
five-year employment agreement with the President and Chief Executive Officer,
providing for a base annual compensation of $195,000, along with standard fringe
benefits available to all employees and provides for bonus compensation and/or
stock options as determined by the board of directors.
Pursuant to an agreement entered into prior to becoming a stockholder
or director, we paid another stockholder $57,515 at closing of the reverse
merger for advisory services rendered in connection with the reverse
merger transaction. Subsequent to this transaction he was appointed to the board
of directors.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2003, we adopted the recognition and measurement
provisions of FASB Interpretation No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others (Interpretation 45). This interpretation elaborates on the disclosures to
be made by a guarantor in interim and annual financial statements about the
obligations under certain guarantees. Interpretation 45 also clarifies that a
guarantor is required to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee. The
initial recognition and initial measurement provisions of this interpretation
are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. We do not currently provide guarantees on a routine basis. As
a result, this interpretation did not have any impact on our financial position
or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities-an Interpretation of APB No. 51 (FIN 46), which
addresses consolidation of variable interest entities. FIN 46 expands the
criteria for consideration in determining whether a variable interest entity
should be consolidated by a business entity, and requires existing
unconsolidated variable interest entities (which include, but are not limited
to, special-purpose entities (SPEs) to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risks among parties
involved. On October 9, 2003, the FASB issued Staff Position No. 46-6 which
deferred the effective date for applying the provisions of FIN 46 for interests
held by public entities in variable interest entities or potential variable
interest entities created before February 1, 2003. On December 24, 2003, the
FASB issued a revision to FIN 46. Under the revised interpretation, the
effective date was delayed to periods ending after March 15, 2004 for all
variable interest entities other than SPEs. The adoption of FIN 46 did not have
an impact on our financial condition, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities (FAS 149). FAS 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. FAS 149 is effective for contracts entered into or modified after June
30, 2003, and for hedging relationships designated after June 30, 2003. The
adoption of FAS 149 did not have any impact on our financial position or results
of operations.
22
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity (FAS
150). FAS 150 establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. FAS 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. It is to be implemented by reporting the cumulative effect of a change
in accounting principle for financial instruments created before the issuance
date of the statement and still existing at the beginning of the interim period
of adoption. Restatement is not permitted. We do not have any financial
instruments with these characteristics. The adoption of FAS 150 did not have any
impact on our financial position or results of operations.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share
Based Payment (FAS 123R), which replaces FAS 123 and supersedes APB No. 25. FAS
123R requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based on
their fair values beginning with the first interim or annual period after
December 15, 2005 for public entities that file as small business issuers, with
early adoption encouraged. The pro forma disclosures previously permitted under
FAS 123 no longer will be an alternative to financial statement recognition. We
are required to adopt FAS 123R beginning January 1, 2006. Under FAS 123R, we
must determine the appropriate fair value model to be used for valuing
share-based payments, the amortization method for compensation cost and the
transition method to be used at date of adoption. The transition methods include
prospective and retroactive adoption options. We are evaluating the requirements
of FAS 123R and expect that the adoption of FAS 123R will have a material impact
on our consolidated results of operations and earnings per share. We have not
yet determined the impact of FAS 123R on our compensation policies or plans, if
any.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4 (FAS 151). FAS 151 amends Accounting Research
Bulletin No. 43, Chapter 4, to clarify that abnormal amounts of idle facility
expenses, freight, handling costs and wasted materials (spoilage) should be
recognized as current-period charges. In addition, FAS No. 151 requires that
allocation of fixed production overhead to inventory be based on the normal
capacity of the production facilities. We are required to adopt FAS 151
beginning January 1, 2006. We are currently assessing the impact that FAS No.
151 will have on our results of operations, financial position or cash flows.
In December 2004, the FASB issued SFAS No. 153, Exchange of Nonmonetary
Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions (FAS
153). FAS 153 amends APB No. 29 to eliminate the exception for nonmonetary
exchanges of similar productive assets and replaces it with a general exception
for exchanges of nonmonetary assets that do not have commercial substance. A
nonmonetary exchange has commercial substance if the future cash flows of the
entity are expected to change significantly as a result of the exchange. We are
required to adopt FAS 153, on a prospective basis, for nonmonetary exchanges
beginning after June 15, 2005. We have not yet determined if FAS No. 153 will
have an impact on our results of operations or financial position.
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.
None.
ITEM 8A. CONTROLS AND PROCEDURES EVALUATION OF OUR DISCLOSURE CONTROLS AND
PROCEDURES
We maintain disclosure controls and procedures that are designed to
provide reasonable assurance that information required to be disclosed in our
reports filed under the Securities Exchange Act of 1934, or the Exchange Act, is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms, and that such
information is accumulated and communicated to our management, including our
principal executive officer and principal financial officer, as appropriate, to
allow timely decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, management recognized that
any controls and procedures, no matter how well designed and operated, can
provide
23
only reasonable assurance of achieving the desired control objective, and
management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
As required by Rule 13a-15(b) under the Exchange Act, we carried out an
evaluation, under the supervision and with the participation of management,
including our principal executive officer and principal financial officer, of
the effectiveness of the design and operation of our disclosure controls and
procedures. Based on the foregoing, our principal executive officer and
principal financial officer concluded that, as of the end of the period covered
by this report, our disclosure controls and procedures were effective at the
reasonable assurance level to ensure that information required to be disclosed
by us in reports that we file under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in SEC rules and
forms.
There have been no changes in our internal controls over financial
reporting during the year ended December 31, 2004, that have materially
affected, or are reasonably likely to materially affect, our internal controls
over financial reporting.
24
PART III
ITEM 9, 10, 11 AND 12
Part III (Items 9 through 12) is omitted since we expect to file with
the U.S. Securities and Exchange Commission within 120 days after the close of
the fiscal year ended December 31, 2004, a definitive proxy statement pursuant
to Regulation 14A under the Securities Exchange Act of 1934 that involves the
election of directors. If for any reason such a statement is not filed within
such a period, this annual report will be appropriately amended.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
2.1 Agreement of Merger and Plan of Reorganization, dated July 22,
2004, among Quality Exchange, Inc., PTCL Acquisition Corp. and
Protocall Technologies Incorporated.(1)
3.1 Articles of Incorporation of Quality Exchange, Inc., filed
with the Nevada Secretary of State on June 3, 1998.(2)
3.2 Certificate of Amendment to Articles of Incorporation of
Quality Exchange, Inc., filed with the Nevada Secretary of
State on May 19, 2004.(3)
3.3 Certificate of Amendment to Articles of Incorporation of
Quality Exchange, Inc., filed with the Nevada Secretary of
State on July 22, 2004.(3)
3.4 Bylaws of Quality Exchange, Inc., adopted on June 17, 1998.(2)
4.1 Form of Warrant.(4)
10.1 2000 Stock Incentive Plan.(5)
10.2 2004 Stock Option Plan.(4)
10.3 Employment Agreement, dated as of July 22, 2004, between Bruce
Newman and Protocall Technologies Incorporated.(5)
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.(6)
10.5 Electronic Software Distribution and Site Location Agreement,
dated March 25, 2004, between Protocall Software Delivery
Systems Inc. and Systemax Inc.(6)
14.1 Code of Business Conduct and Ethics.(4)
14.2 Code of Ethics for CEO and Senior Financial Officers.(4)
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 Current Report
on Form 8-K, dated July 22, 2004 (filed with the SEC on July 26, 2004).
(2) Incorporated by reference to the exhibits filed with Registration
Statement on Form SB-2 (filed with the SEC on April 17, 2002).
25
(3) Incorporated by reference to the exhibits filed with Registration
Statement on Form 8-A, dated January 7, 2005 (filed with the SEC on
January 7, 2005).
(4) Incorporated by reference to the exhibits filed with the Registration
Statement on Form SB-2 (filed with the SEC on January 13, 2005).
(5) 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).
(6) To be filed by amendment to the Registration Statement on Form SB-2
referenced in Note 4 above.
(b) Reports on Form 8-K.
During the three months ended December 31, 2004, we filed the following
current reports on Form 8-K:
o Amendment No. 2 to Current Report on Form 8-K dated
July 22, 2004, filed with the SEC on October 21, 2004
(Item 9.01 and financial statements).
o Current Report on Form 8-K dated November 24, 2004,
filed with the SEC on November 24, 2004 (Item 5.02).
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
AUDIT FEES
We incurred fees of approximately $90,000 to Eisner, LLP for the audit
of the annual financial statements of Protocall Technologies Incorporated for
the year ended December 31, 2004. We did not incur any fees to Beckstead and
Watts, LLP, the auditor for Quality Exchange, Inc., for the audit of our annual
financial statements.
During 2004, we also incurred audit fees of $270,000 to Eisner, LLP in
connection with the audit of the financial statements of Protocall Technologies
Incorporated for the years ended December 31, 2003, 2002 and 2001 and the review
of our 2004 interim financial statements.
AUDIT-RELATED FEES
We did not incur or pay any fees to Eisner LLP or Beckstead and Watts,
LLP, and these firms did not provide any services related to assurance and other
audit-related fees, in either of the last two fiscal years.
TAX FEES
There were no fees billed to us by Eisner, LLP or Beckstead and Watts,
LLP for services rendered to us during the last two fiscal years for tax
compliance, tax advice, or tax planning.
ALL OTHER FEES
There were no fees billed to us by Eisner, LLP or Beckstead and Watts,
LLP for services rendered to us during the last two fiscal years, other than the
services described above under "Audit Fees."
It is the audit committee's policy to pre-approve all services provided
by Eisner, LLP.
As of the date of this filing, our current policy is not to engage
Eisner, LLP to provide, among other things, bookkeeping services, appraisal or
valuation services, or international audit services. The policy provides that we
engage Eisner, LLP to provide audit, tax, and other assurance services, such as
review of SEC reports or filings.
26
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.
Date: March 31, 2005
PROTOCALL TECHNOLOGIES INCORPORATED
By: /s/ Bruce Newman
-----------------------------------------
Bruce Newman
President and Chief Executive Officer
(principal executive officer)
By: /s/ Donald Hoffmann
-----------------------------------------
Donald Hoffmann
Vice President and Chief Operating Officer
(principal financial and accounting officer)
POWER OF ATTORNEY
We, the undersigned officers and directors of Protocall Technologies
Incorporated, hereby severally constitute and appoint Bruce Newman and Donald
Hoffmann, and each of them (with full power to each of them to act alone), our
true and lawful attorneys-in-fact and agents, 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
attorneys-in-fact and agents, and each of them, 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 all the said attorneys-in-fact and
agents, or any of them, or their 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 Greenfeld
---------------------- Chairman of the Board of Directors March 31, 2005
Peter Greenfield
/s/ Bruce Newman
---------------------- Director, President and Chief March 31, 2005
Bruce Newman Executive Officer
/s/ Jed Schutz
---------------------- Director March 31, 2005
Jed Schutz
/s/ Richard L. Ritchie
---------------------- Director March 31, 2005
Richard L. Ritchie
/s/ Donald Hoffmann
---------------------- Vice President and Chief March 31, 2005
Donald Hoffmann Operating Officer
27
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
PROTOCALL TECHNOLOGIES INCORPORATED
FORM 10-KSB
ITEM 7
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
--------------------------------------------------------------------------------
Report of Registered Public Accounting Firm F-1
Consolidated Balance Sheets at December 31, 2004 and 2003 F-2
Consolidated Statements of Operations for the years ended
December 31, 2004 and 2003 F-3
Consolidated Statements of Stockholders' Equity (Deficit) for
the years ended December 31, 2004 and 2003 F-4
Consolidated Statements of Cash Flows for the years ended December 31,
2004 and 2003 F-5
Notes to Consolidated Financial Statements F-7
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Protocall Technologies Incorporated
We have audited the accompanying consolidated balance sheets of Protocall
Technologies Incorporated and subsidiaries (the "Company") as of December 31,
2004 and 2003, and the related consolidated statements of operations,
stockholders' equity (deficit) and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present fairly, in all
material respects, the consolidated financial position of Protocall Technologies
Incorporated and subsidiaries as of December 31, 2004 and 2003, and the
consolidated results of their operations and their consolidated cash flows for
the years then ended, in conformity with U.S. generally accepted accounting
principles.
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 not generated any significant revenues,
has incurred losses since inception, has an accumulated deficit, and has been
dependent 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 regards 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 this uncertainty.
Eisner LLP
New York, New York
February 22, 2005
F-1
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
--------------------------------
2004 2003
------------- ------------
ASSETS
Current assets:
Cash $ 2,133,223 $ 154,244
Accounts receivable, net 64,301 5,243
Inventory 21,919 24,194
Prepaid expenses and other current assets 38,274
------------- ------------
Total current assets 2,219,443 221,955
Property and equipment, net 1,067,819 533,626
Patents, net 28,000 30,434
Deferred finance costs, net 213,789
Deferred lease costs 175,321 253,237
Other assets 15,890
------------- ------------
TOTAL ASSETS $ 3,506,473 $ 1,253,041
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 418,514 $ 1,388,377
Accrued expenses 500,132 524,617
Notes payable to related parties - includes convertible notes payable 754,939
Notes payable to officers/stockholders 18,802 33,554
Convertible notes payable - stockholder, net of debt discount of $0,
including accrued interest of $727,294 3,737,137
Non-convertible notes payable - stockholder, net of debt discount of
$217,830, including accrued interest of $11,723 1,493,893
Convertible notes payable - other, net of debt discount of $238,228,
including accrued interest of $117,032 1,303,804
Accrued salaries - officers/stockholders 587,407 822,084
Other current liabilities 30,750 242,511
Current portion of net liabilities of discontinued operations 224,463 356,164
Current portion of obligations under capital leases 361,990 81,756
------------- ------------
Total current liabilities 2,142,058 10,738,836
Net liabilities of discontinued operations, less current portion 64,138 69,745
Obligations under capital leases, less current portion 648,151 144,672
Other notes payable, including accrued interest of $8,721 502,759
------------- ------------
Total liabilities 3,357,106 10,953,253
------------- ------------
Commitments and contingencies
Stockholders' equity (deficit):
Common stock, $0.001 par value, 100,000,000 shares authorized, 25,383,710
and 6,480,271 shares issued and outstanding at December 31, 2004
and 2003, respectively 25,383 6,480
Additional paid-in capital 33,381,197 16,323,795
Stock subscription receivable (6,665) (6,665)
Deferred sales fee, net (287,648)
Accumulated deficit (32,962,900) (26,023,822)
------------- ------------
Total stockholders' equity (deficit) 149,367 (9,700,212)
------------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 3,506,473 $ 1,253,041
============= ============
See notes to consolidated financial statements
F-2
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
--------------------------------
2004 2003
------------- ------------
Net sales $ 206,005 $ 14,805
Cost of sales 160,097 13,731
------------- ------------
Gross profit 45,908 1,074
------------- ------------
Selling, general and administrative expenses 4,801,472 2,047,082
Research and development expenses 153,123 560,912
------------- ------------
Operating loss (4,908,687) (2,606,920)
>
Interest expense, including amortization of debt
discounts and beneficial conversion feature 2,298,278 1,728,468
Gain on forgiveness of indebtedness (392,995)
Loss on disposal of fixed assets 187,094 56,862
Other income, net (53,539) (17,247)
------------- ------------
Net loss from continuing operations (6,947,525) (4,375,003)
Net income from discontinued operations 8,447 87,548
------------- ------------
Net loss $ (6,939,078) $ (4,287,455)
============= ============
Per Share Data - basic and diluted:
Loss from continuing operations $ (.47) $ (.68)
Income from discontinued operations .00 .02
------------- ------------
Net loss $ (.47) $ (.66)
============= ============
Weighted average number of shares - basic and diluted 14,837,925 6,480,271
============= ============
See notes to consolidated financial statements
F-3
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
COMMON STOCK
PAR VALUE $0.001
---------------------
NUMBER ADDITIONAL STOCK DEFERRED
OF PAID-IN SUBSCRIPTION SALES FEE, ACCUMULATED
SHARES AMOUNT CAPITAL RECEIVABLE NET DEFICIT TOTAL
---------- -------- ----------- ------------ ---------- ------------ -----------
BALANCE - DECEMBER 31, 2002 6,480,271 $ 6,480 $14,739,639 $ (6,665) $(21,736,367) $(6,996,913)
Issuance of warrants in connection
with convertible notes payable 581,868 581,868
Issuance of warrants in connection
with non-convertible notes payable 290,731 290,731
Issuance of warrants in connection
with convertible notes payable
extension 310,657 310,657
Issuance of warrants in connection
with letters of credit opened by
stockholder
346,791 346,791
Issuance of warrants in connection
with private offering 54,109 54,109
Net loss (4,287,455) (4,287,455)
-------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2003 6,480,271 6,480 16,323,795 (6,665) (26,023,822) (9,700,212)
Contribution to capital from
forgiveness of indebtedness 1,099,915 1,099,915
Conversion of notes payable and
accounts payable to common stock 6,708,010 6,708 8,378,304 8,385,012
Conversion of accrued officers'
salaries to common stock 160,000 160 199,840 200,000
Issuance of warrants in connection
with convertible notes payable 658,272 658,272
Conversion of warrants to common
stock in connection with
reverse merger 3,384,793 3,385 (3,385)
Issuance of common stock in private
offering, net of costs 5,859,200 5,859 6,383,471 6,389,330
Issuance of common stock as private
offering fees 1,666,436 1,666 (1,666)
Issuance of common stock in exchange
for common stock of QEI 1,125,000 1,125 (1,125)
Issuance of warrants in connection
with software distribution & site
agreement 332,693 $(332,693)
Amortization of deferred sales fee 45,045 45,045
Options granted to employee as
compensation 11,083 11,083
Net loss (6,939,078) (6,939,078)
-------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2004 25,383,710 $25,383 $33,381,197 $(6,665) $(287,648) $(32,962,900) $149,367
===========================================================================================
See notes to consolidated financial statements
F-4
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
--------------------------------
2004 2003
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from continuing operations $ (6,947,525) $ (4,375,003)
Adjustments to reconcile net loss to net cash used in operating
Activities:
Loss on disposal of fixed assets 187,094 56,862
Depreciation and amortization 712,445 215,003
Amortization of deferred financing costs 213,789 334,954
Equity compensation cost 11,083
Noncash financing and interest expenses 1,114,332 630,833
Amortization of deferred lease costs 77,916 16,233
Gain on settlement of trade notes and accounts payable (392,995)
Common stock and warrants issued as premium to bridge lenders 112,467
Changes in:
Accounts receivable (59,058) (1,192)
Inventory 2,275 (23,475)
Prepaid expenses and other current assets 22,384 3,347
Loans due officers/stockholders (14,752)
Accounts payable and accrued expenses 117,565 237,034
Accrued salaries - officers/stockholders (34,677)
Other payables (19,750) (7,000)
Accrued interest on convertible notes 551,323 555,181
Accrued interest on capitalized lease obligations 23,792
Net cash (used in) provided by discontinued operations (128,861) 65,148
--------------------------------
Net cash used in operating activities (4,474,945) (2,268,283)
--------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (283,153) (228,510)
Proceeds from sale of fixed assets 1,528
--------------------------------
Net cash used in investing activities (281,625) (228,510)
--------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of convertible notes payable to stockholder 595,000 1,700,000
Proceeds from issuance of note payable to others 1,325,000
Proceeds from issuance of convertible bridge notes to others 500,000
Proceeds from issuance of convertible notes payable to others 181,000 1,000,000
Proceeds from issuance of note payable to stockholder 100,000
Proceeds from private offering issuance of common stock, net of costs 4,451,863
Repayment of loans - others (32,690)
Repayment of loans - related party (25,000)
Repayment of loan to officer/stockholder (62,668)
Repayment of capitalized lease obligations (284,624) (17,749)
Deferred financing costs (62,500)
--------------------------------
Net cash provided by financing activities 6,735,549 2,632,083
--------------------------------
NET INCREASE IN CASH 1,978,979 135,290
Cash - beginning of year 154,244 18,954
--------------------------------
CASH - END OF YEAR $ 2,133,223 $ 154,244
================================
See notes to consolidated financial statements
F-5
PROTOCALL TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEAR ENDED DECEMBER 31,
--------------------------------
2004 2003
------------- ------------
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for:
Interest $ 37,733 $ 10,785
Taxes 816 1,887
Noncash transactions:
Debt discount and beneficial conversion feature on convertible and
non-convertible notes $ 658,272 $ 872,599
Issuance of warrants in connection with Software Distribution and
Site Agreement 332,693
Conversion of accounts payable to common stock 781,571
Conversion of notes payable to common stock 9,428,440
Conversion of accrued officers' salaries to common stock 200,000
Contribution to capital from forgiveness of debt 1,099,915
Issuance of warrants in connection with private offering 54,109
Issuance of warrants in connection with opening of letters of
credit by a stockholder in behalf of the Company 346,791
Issuance of warrants in connection with convertible notes payable
Extension 310,657
Fixed assets acquired through capital lease 1,104,628
See notes to consolidated financial statements
F-6
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 and its wholly owned subsidiaries, Protocall
Software Delivery Systems, Inc. ("PSD") and Precision Type, Inc. (collectively,
the "Company"). The Company has recently focused all of its time and resources
on its SoftwareToGo(R) product in its PSD subsidiary. PSD was founded in 1998 to
develop and commercialize a proprietary system that enables software retailers
to produce fully packaged software CDs, on-demand, at their stores and at their
web site fulfillment centers. SoftwareToGo(R) (the "System") is a software
display, storage and production system, similar in size to an ATM cash machine.
The System is designed to complement physical inventory systems and enable
traditional resellers to create "on demand" inventory at point of sale for
walk-in as well as Internet customers. The Company intends to market and
distribute its System to major retailers. The Company signs license agreements
with software publishers, allowing the Company to resell their software products
to one or more of the Company's retail customers. The Company intends to pursue
an expansion of available products to include music, audio books, console video
games and movies. Management of the Company believes the Company's technology is
readily adaptable to other digital products without additional significant
investment.
Precision Type Inc., which marketed and distributed font software products using
its electronic software distribution system to dealers and commercial end-users,
was discontinued on June 30, 2004 (Note O).
[2] GOING CONCERN
The Company incurred net losses for the year ended December 31, 2004 and 2003 of
$(6,939,078) and $(4,287,455) respectively, and has an accumulated deficit of
$(32,962,900) at December 31, 2004. Significantly contributing to the
accumulated deficit was the interest expense related to the Company's notes
payable, which were converted to equity upon the consummation of the closing of
the reverse merger on July 22, 2004 (see Note A (3). Through 2004, the Company
has been dependent upon borrowings through private offerings of convertible and
non-convertible debt and equity from related and non-related parties to finance
its business operations.
Management believes that cash on hand at December 31, 2004 will enable the
Company to continue its business plan until at least May 2005, although
there can be no assurances that this will be the case. The Company is currently
seeking additional financing to meet its 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 the Company.
The accompanying 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, which contemplates the realization of
assets and satisfaction of liabilities in the normal course of business. 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] REVERSE MERGER AND 2004 PRIVATE OFFERING
On July 22, 2004, the Company completed a recapitalization in the form of a
"reverse acquisition" transaction with Quality Exchange, Inc. (QEI) in which QEI
acquired all the outstanding capital stock of the Company, in consideration for
the issuance of 16,733,074 shares of QEI's common stock, representing 65.9% of
the outstanding QEI stock. Prior to the completion of the reverse acquisition,
QEI redeemed and cancelled 7,875,000 shares of its 9,000,000 outstanding shares
of common stock for $15,000 and sold all of its assets and transferred all of
its liabilities to its majority stockholder. The reverse acquisition was
completed pursuant to an Agreement of Purchase and Sale, dated as of July 22,
2004. Immediately following the closing of the reverse acquisition, QEI changed
its name to Protocall Technologies Incorporated. Concurrent with
F-7
the closing of the reverse acquisition, the Company completed a private offering
of 5,859,200 shares of common stock at a price of $1.25 per share, and received
net proceeds of approximately $6,300,000, including $1,825,000 in proceeds from
10% bridge convertible promissory notes issued between April 8, 2004 and June
10, 2004. The Company issued 1,666,436 shares of its common stock as private
offering fees to the underwriter in the reverse merger. In addition, concurrent
with the closing of the above transactions, creditors of the Company converted
an aggregate of approximately $8.6 million of debt to common stock of the
Company. A stockholder/director of the Company forgave $1,099,915 of accrued
interest upon the consummation of the reverse merger.
In addition, 17,647,377 of the Company's warrants were exchanged for 3,384,793
shares of QEI common stock. As part of the reverse merger, warrants to purchase
1,774,219 shares of the Company's common stock and stock options to purchase
2,951,922 shares of the Company's common stock were converted into identical QEI
instruments.
For accounting purposes, the Company is considered the acquirer in the reverse
acquisition transaction, and consequently, the financial statements of the
Company are the historical financial statements of Protocall Technologies
Incorporated and the reverse merger has been treated as a recapitalization of
Protocall Technologies Incorporated.
[4] BASIS OF CONSOLIDATION:
The consolidated financial statements include the accounts of Protocall
Technologies Incorporated and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
[5] REVENUE RECOGNITION:
The Company recognizes revenue from retailer sales of product through its
software delivery system upon delivery to the consumer.
Revenue from the license or sale of software products and font reference guide
books from the discontinued business is recognized when the products are
delivered or shipped to the customer.
Rebates and refunds are recorded as a reduction of revenue in accordance with
Emerging Issues Task Force ("EITF") Issue No. 01-9, Accounting for Consideration
Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products).
[6] CASH EQUIVALENTS:
The Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.
[7] INVENTORY:
Inventory, consisting primarily of blank CDs, CD cases and other supplies
associated with software distributed on the Company's software distribution
system, are valued at the lower of cost (first-in, first-out) or market.
[8] 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 are three years for deployed
equipment, three or five years for computer and other equipment and seven years
for all other assets. Leasehold improvements and assets capitalized under
capital leases are amortized over the shorter of the lease term or the assets'
estimated useful lives.
F-8
[9] 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.
[10] 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 if shorter, upon the completion and approval of the patents.
[11] 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 income in the
period that includes the enactment date.
[12] 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 carrying amount of the convertible notes payable approximates fair value
based on interest rates and debt instruments with similar terms. The fair values
of notes payable to related parties and notes payable to officers/stockholders,
in the circumstances, are not reasonably determinable.
[13] LONG-LIVED ASSETS:
The Company reviews long-lived assets, such as computer 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 flows, 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.
[14] 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. Such
estimations include valuation of warrants issued in connection with various
forms of financing by the Company. Actual results could differ from those
estimates.
[15] ACCOUNTING FOR STOCK OPTIONS:
The Company applies Accounting Principles Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees and Related Interpretations, in accounting for its
stock option grants and, accordingly, records compensation cost, if any, in the
financial statements for its stock options to employees equal to the excess of
the fair value of the Company's shares at the grant date over the exercise
price.
Had compensation costs for the Company's stock option grants been determined
based on the fair value at the grant dates consistent with the methodology of
Statement of Financial Accounting Standards (SFAS) No. 123, the Company's net
loss per share for the periods indicated would have been increased to the pro
forma amounts indicated as follows:
F-9
YEAR ENDED DECEMBER 31
----------------------------
2004 2003
----------------------------
Net loss as reported $(6,939,078) $(4,287,455)
Stock-based employee compensation
expense included in reported net loss,
net of related tax effects 11,083 0
Stock-based employee compensation
determined under the fair value based
method (210,667) (221,057)
-----------------------------
Pro forma net loss $(7,138,662) $(4,508,512)
=============================
Net loss per share (basic and diluted):
As reported $(.47) $(.66)
=============================
Pro forma $(.48) $(.70)
=============================
The weighted average fair value of stock options is estimated at the grant date
using the Black-Scholes option-pricing model with the following weighted average
assumptions:
YEAR ENDED DECEMBER 31
----------------------
2004 2003
----------------------
Risk-free interest rate 3.52% 2.04%
Expected life of options 4.43 3
Expected dividend yield 0.00% 0.00%
Expected volatility 79.32% 50.00%
Weighted average fair value $.78 $.44
[16] LOSS PER SHARE AND COMMON SHARE EQUIVALENT:
The Company's basic and diluted net loss per share is computed by dividing net
loss by the weighted average number of outstanding common shares. Potentially
dilutive securities, which were excluded from the computation of diluted loss
per share because to do so would have been anti-dilutive, are as follows:
YEAR ENDED DECEMBER 31
------------------------
2004 2003
------------------------
Options 3,986,672 3,292,775
Warrants 1,774,219 16,864,971
Convertible notes 4,027,350
------------------------
Total dilutive shares 5,760,891 24,185,096
========================
[17] RECENT ACCOUNTING PRONOUNCEMENTS:
Effective January 1, 2003, the Company adopted the recognition and
measurement provisions of FASB Interpretation No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (Interpretation 45). This interpretation elaborates on
the disclosures to be made by a guarantor in interim and annual financial
statements about the obligations under certain guarantees. Interpretation 45
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and initial measurement
provisions of this interpretation are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002. The Company does not
currently provide guarantees on a routine basis. As a result, this
interpretation did not have any impact on the Company's financial position or
results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities-an Interpretation of APB No. 51 (FIN 46), which
addresses consolidation of variable interest entities. FIN 46 expands the
criteria for consideration in determining whether a variable interest entity
should be consolidated by a business
F-10
entity, and requires existing unconsolidated variable interest entities (which
include, but are not limited to, special-purpose entities (SPEs) to be
consolidated by their primary beneficiaries if the entities do not effectively
disperse risks among parties involved. On October 9, 2003, the FASB issued Staff
Position No. 46-6 which deferred the effective date for applying the provisions
of FIN 46 for interests held by public entities in variable interest entities or
potential variable interest entities created before February 1, 2003. On
December 24, 2003, the FASB issued a revision to FIN 46. Under the revised
interpretation, the effective date was delayed to periods ending after March 15,
2004 for all variable interest entities other than SPEs. The adoption of FIN 46
did not have an impact on the Company's financial condition, results of
operations or cash flows.
In May 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities (FAS 149). FAS 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. FAS 149 is effective for contracts entered into or modified after June
30, 2003, and for hedging relationships designated after June 30, 2003. The
adoption of FAS 149 did not have any impact on the Company's financial position
or results of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity (FAS
150). FAS 150 establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. FAS 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. It is to be implemented by reporting the cumulative effect of a change
in accounting principle for financial instruments created before the issuance
date of the statement and still existing at the beginning of the interim period
of adoption. Restatement is not permitted. The Company does not have any
financial instruments with these characteristics. The adoption of FAS 150 did
not have any impact on the Company's financial position or results of
operations.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share
Based Payment (FAS 123R), which replaces FAS 123 and supersedes APB No. 25. FAS
123R requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based on
their fair values beginning with the first interim or annual period after
December 15, 2005 for public entities that file as small business issuers, with
early adoption encouraged. The pro forma disclosures previously permitted under
FAS 123 no longer will be an alternative to financial statement recognition. The
Company is required to adopt FAS 123R beginning January 1, 2006. Under FAS 123R,
the Company must determine the appropriate fair value model to be used for
valuing share-based payments, the amortization method for compensation cost and
the transition method to be used at date of adoption. The transition methods
include prospective and retroactive adoption options. The Company is evaluating
the requirements of FAS 123R and expect that the adoption of FAS 123R will have
a material impact on the Company's consolidated results of operations and
earnings per share. The Company has not yet determined the impact of FAS 123R on
its compensation policies or plans, if any.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4 (FAS 151). FAS 151 amends Accounting Research
Bulletin No. 43, Chapter 4, to clarify that abnormal amounts of idle facility
expense, freight, handling costs and wasted materials (spoilage) should be
recognized as current-period charges. In addition, FAS No. 151 requires that
allocation of fixed production overhead to inventory be based on the normal
capacity of the production facilities. The Company is required to adopt FAS 151
beginning January 1, 2006. The Company is currently assessing the impact that
FAS No. 151 will have on its results of operations, financial position or cash
flows.
In December 2004, the FASB issued SFAS No. 153, Exchange of Nonmonetary
Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions (FAS
153). FAS 153 amends APB No. 29 to eliminate the exception for nonmonetary
exchanges of similar productive assets and replaces it with a general exception
for exchanges of nonmonetary assets that do not have commercial substance. A
nonmonetary exchange has commercial substance if the future cash flows of the
entity are expected to change significantly as a result of the exchange. The
Company is required to adopt FAS 153, on a prospective basis, for nonmonetary
exchanges beginning after June 15,
F-11
2005. The Company has not yet determined if FAS No. 153 will have an impact on
its results of operations or financial position.
[18] RESEARCH AND DEVELOPMENT:
The Company expenses research and development costs as incurred.
[19] SEGMENT REPORTING:
The Company formerly operated in two reporting segments; however, substantially
all assets and operating expenses relate to the Company's SoftwareToGo business
and the Company has discontinued its font software operations, effective June
30, 2004.
[20] RECLASSIFICATIONS:
The presentation and classification of certain 2003 operating expenses on the
accompanying Statements of Operations have been revised to conform to the
current year presentation.
NOTE B - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
DECEMBER 31, ESTIMATED USEFUL LIVES
2004 2003 (YEARS)
------------------------- -----
Deployed equipment $1,220,554 $130,705 3
Computer and other equipment 470,064 1,064,050 3 & 5
Furniture and fixtures 31,239 19,940 7
Purchased software 90,000 556,542 3
Leasehold improvement 65,463 54,320 Various
--------------------------
1,877,320 1,825,527
Less accumulated depreciation 809,501 1,291,931
--------------------------
$1,067,819 $533,626
==========================
Included in property and equipment are assets under capital leases with a net
book value of $727,595 and $87,966 at December 31, 2004 and 2003, respectively.
NOTE C - NOTES PAYABLE TO BANKS
Notes payable to banks are included in the net liabilities of discontinued
operations (See Note O) and consist of the following:
DECEMBER 31,
2004 2003
------------ ------------
Note payable with interest at prime
plus 1/2% (1) $ 0 $ 1,732
Note payable with interest at prime plus 2%
(7.25% at December 31, 2004) (2) 92,893 99,290
------------ ------------
92,893 101,022
Less current portion 28,755 31,277
------------ ------------
$ 64,138 $ 69,745
============ ============
(1) The note is payable to a bank in sixty equal monthly principal
installments through January 2004. A stockholder has pledged certain
marketable securities as collateral for the bank loan. All of the
unpledged assets of the Company have been pledged as collateral to the
related party. In addition, certain of the Company's officers/stock-
holders have agreed to indemnify the related party from any losses
incurred in connection with this loan.
(2) 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 thirty-six
monthly installments of principal and interest at the rate then in
effect. The loan is personally guaranteed by certain of the
officers/stockholders of the Company. At December 31, 2004, the bank
had not terminated the line of credit.
Aggregate principal payments are shown based on the repayment of the loan over a
thirty-six month period commencing January 2005 as follows:
F-12
YEAR AMOUNT
---- -------
2005 $28,755
2006 30,910
2007 33,228
-------
92,893
Less current portion 28,755
-------
$64,138
=======
NOTE D - NOTES PAYABLE TO RELATED PARTIES
Notes payable to related parties are secured by the assets of the Company. These
notes were either paid or converted to common stock as part of the reverse
merger on July 22, 2004. The notes were personally guaranteed by certain of the
officers/stockholders of the Company and are summarized as follows:
DECEMBER 31,
2003
------------
Convertible note payable with interest at 12%,
originally due September 30, 2004 and collateralized
by certain assets of the Company (1) $ 599,345
Convertible promissory note payable with interest
at 12%, originally due September 30, 2004 (1) 88,351
Note payable with interest at 12%, due on demand (2) 67,243
------------
$ 754,939
============
(1) The note was convertible at any time prior to maturity into common stock at
the lower of $2.75 per share or the sales price of common stock in subsequent
offerings. The note was converted at the closing of the reverse merger on July
22, 2004 at $1.25 per share.
(2) On July 22, 2004, upon the closing of the reverse merger, the Company paid
$30,000 of the outstanding debt and converted the balance of the note into
common stock at $1.25 per share.
NOTE E - NOTES PAYABLE TO OFFICERS/STOCKHOLDERS
Notes payable to officers/stockholders consists of the following:
DECEMBER 31,
------------------------
2004 2003
------------------------
Promissory notes due on demand, bearing no interest $ 18,802 $ 7,927
Variable balance promissory notes, due on demand, payable
to the officers/stockholders, at varying rates ranging
from 12% to 19.8% 25,627
------------------------
$ 18,802 $ 33,554
========================
NOTE F - CONVERTIBLE NOTES PAYABLE - STOCKHOLDER
As fully described in Note A, on July 22, 2004, in connection with the reverse
merger, a stockholder/director of the Company converted his entire principal
amount of convertible promissory notes, aggregating $5,304,843, into common
stock of the Company at a price of $1.25 per share. The stockholder
simultaneously forgave an aggregate of $1,099,915 of accrued interest on the
notes for no consideration and is included as capital contribution in the
accompanying financial statements. The convertible notes were issued as
described below:
During 2001, the Company received $1,350,000 of proceeds from the issuance of
convertible notes to a stockholder/director. The notes were automatically
convertible into common stock at such time as the Company received aggregate
proceeds of not less than $5,000,000 in equity financing as defined in the note
agreement. Notes issued subsequent to January 2, 2002 were to automatically
convert into common stock upon receipt of $2,000,000 in equity financing, as
defined in the note agreement. The holder had the option to convert all or any
portion of the note into shares of common stock, computed by dividing the
principal amount of the note together with accrued
F-13
interest at the lower of $2.75 or the sales price of the common stock in
subsequent offerings by the Company. The notes accrued interest at 12% per
annum, and were due on January 2, 2002. Upon issuance of the notes, the Company
also issued warrants to the note holder to purchase an aggregate of 3,080,000
shares of common stock, exercisable at the lower of $2.75 per share or the sales
price of the common stock in subsequent offerings. The warrants were exercisable
until the earlier of five years after the date of any initial registered public
offering of the common stock or seven years from date of issuance. The fair
value of the warrants was $2,220,136, utilizing the Black-Scholes option-pricing
model with the following assumptions: 50% volatility, seven-year expected life,
risk-free interest rate ranging from 4.06% to 5.5% and a dividend yield ratio of
0%. In accordance with EITF 00-27, "Application of Issue No. 98-5 to Certain
Convertible Instruments," the Company allocated the net proceeds between the
convertible notes and the warrants based on the relative fair value-based
method. The proceeds were allocated to the value of warrants of $965,969 as debt
discount, which, along with the value of the beneficial conversion feature of
$384,031 (based on a $1.25 value per common share), was amortized over the life
of the convertible notes as additional interest. On January 2, 2002, all the
2001 notes along with the interest of $54,843 that had accrued as of December
31, 2001 were rolled into one convertible promissory note bearing interest at
12% per annum due on December 31, 2002. The note was subsequently extended to
September 30, 2004, for consideration given to the note holder as described
below.
During 2002, the Company received $1,505,000 in proceeds from the issuance of
convertible notes to the same stockholder/director on the same terms and
conditions as above. Upon issuance of the notes, the Company also issued
warrants to the note holder to purchase an aggregate amount of 6,066,200 shares
of common stock with the same terms as above. The fair value of the warrants was
$4,350,891, utilizing the Black-Scholes option-pricing model with the following
assumptions: 50% volatility, seven-year expected life, risk-free interest rate
ranging from 3.63% to 5.26% and a dividend yield ratio of 0%. The proceeds were
allocated to the value of warrants of $1,063,996 as debt discount, which, along
with the value of the beneficial conversion feature (based on a $1.25 value per
common share) of $391,058, was being amortized over the life of the convertible
notes as additional interest expense. During 2003, the due dates on these notes
were extended to September 30, 2004 for consideration given to the note holder
as described below.
On January 10, 2003, the Company received $100,000 in proceeds from the issuance
of a convertible note to the same stockholder/director on the same terms and
conditions as above. The note accrued interest at 12% per annum, and had a due
date of March 31, 2003. Upon issuance of the note, the Company also issued
warrants to the note holder to purchase 50,000 shares of common stock with the
same terms as above. The fair value of the warrants was $52,133 utilizing the
Black-Scholes option-pricing model with the following assumptions: 50%
volatility, seven-year expected life, risk-free interest rate of 3.66% and a
dividend yield ratio of 0%. The proceeds were allocated to the value of warrants
of $34,268 as debt discount, which, along with the value of the beneficial
conversion feature (based on a $1.25 value per common share) of $34,268, was
being amortized over the life of the convertible note as additional interest
expense. On April 1, 2003, all the convertible notes issued to the
stockholder/director in 2001, 2002 and 2003 that had due dates of March 31, 2003
were extended to September 30, 2004, and in exchange, the holder received
266,484 warrants to purchase common stock exercisable at the lower of $2.75 per
share or the sales price of common stock in subsequent offerings. The warrants
were valued at $184,000 using the Black-Scholes option-pricing model with the
following assumptions: 50% volatility, seven-year expected life, risk-free
interest rate of 3.51%, and a dividend yield ratio of 0%. The value of the
warrants was amortized over the extension period as additional interest expense.
As of December 31, 2003, the total accrued interest on all of the outstanding
notes amounted to $727,294.
During 2004, the Company received from the same stockholder/director, $595,000
in proceeds in convertible promissory notes and seven-year warrants with a right
to purchase 297,500 shares of common stock at $4.00 per share. The bridge term
notes were originally scheduled to mature on September 30, 2004. The fair value
of the warrants was $206,167, utilizing the Black-Scholes option-pricing model
with the following assumptions: 50% volatility, seven year expected life,
risk-free interest rate ranging from 3.43% to 3.67% and a dividend yield ratio
of 0%. In accordance with EITF 00-27, "Application of Issue No. 98-5 to Certain
Convertible Instruments," the Company allocated the net proceeds between the
convertible notes and the warrants based on the relative fair value-based
method. The proceeds were allocated to the value of warrants of $153,113 as debt
discount which along with the value of the beneficial conversion feature (based
on a $1.25 value per common share) of $153,113 and was being amortized over the
life of the convertible notes as additional interest expense. Upon the
conversion of the notes
F-14
prior to maturity into common stock, the unamortized debt discount was
recognized as additional interest expense in the amount of $128,828.
NOTE G - CONVERTIBLE NOTES PAYABLE - OTHER
As fully described in Note A, on July 22, 2004, in connection with the reverse
merger, holders of convertible promissory notes of the Company converted their
notes and associated warrants into common stock of the Company at a price of
$1.25 per share. These notes are described below.
During the year ended December 31, 2002, the Company issued Convertible
Promissory Notes totaling $425,000 in a private offering. The notes were to
automatically convert into common stock upon the receipt by the Company of
$2,000,000 in equity financing, as defined in the note agreement. The holder had
the option to convert all or any portion of the note into the number of shares
of the Company's common stock, par value $.001 per share computed by dividing
the principal amount of the note to be converted together with accrued interest
by the lower of $2.75 per share or the sales price of common stock in subsequent
offerings by the Company. The notes bore interest at 12% and were due March 31,
2003. In connection with the issuance of the notes, the Company issued warrants
to the note holders to purchase 212,500 shares of common stock, exercisable at
the lower of $2.75 per share or the sales price of the common stock in
subsequent offerings. The warrants were to be exercised through the earlier of
five years after the date of any initial registered public offering of the
Company's common stock or seven years from date of issuance. The fair value of
the warrants was $146,585, utilizing the Black-Scholes option-pricing model with
the following assumptions: 50% volatility, seven-year expected life, risk-free
interest rate ranging from 3.31% to 3.65% and a dividend yield ratio of 0%. In
accordance with EITF 00-27, "Application of Issue No. 98-5 to Certain
Convertible Instruments," the Company allocated the net proceeds between the
convertible notes and the warrants based on the relative fair value-based
method. The proceeds were allocated to the value of warrants of $108,992 as debt
discount, which, along with the value of the beneficial conversion feature of
$108,992 (based on a $1.25 value per common share), was amortized over the life
of the convertible notes as additional interest expense. In connection with the
sale of these notes, the Company incurred an aggregate of $71,817 in costs
consisting of placement agent fees of approximately $42,500 and warrants to
placement agents to purchase 42,500 shares of common stock at the lower of $2.75
per share or the sales price of the common stock in subsequent offerings by the
Company valued at $29,317. The warrants were valued by utilizing the
Black-Scholes option-pricing model with the following assumptions: 50%
volatility, seven-year expected life, risk-free interest rate ranging from 3.31%
to 3.65% and a dividend yield ratio of 0%. During 2003, the due dates on these
notes were extended to September 30, 2004 for consideration given to the note
holder as described below.
During the year ended December 31, 2003, the Company issued Convertible
Promissory Notes totaling $1,000,000 in private offerings on the same terms and
conditions as above. The notes bore interest at a range of 9% to 12% and their
due dates ranged from March 31, 2003 to September 30, 2004. In connection with
the issuance of the notes, the Company also issued warrants to the note holders
to purchase 500,000 shares of common stock, generally with the same terms as
above. The fair value of the warrants was $345,299, utilizing the Black-Scholes
option-pricing model with the following assumptions: 50% volatility, seven-year
expected life, risk-free interest rate ranging from 2.93% to 3.76% and a
dividend yield ratio of 0%. In accordance with EITF 00-27, "Application of Issue
No. 98-5 to Certain Convertible Instruments," the Company allocated the net
proceeds between the convertible notes and the warrants based on the relative
fair value-based method. The proceeds were allocated to the value of warrants of
$256,666 as debt discount, which, along with the value of the beneficial
conversion feature of $256,666 (based on a $1.25 value per common share), was
amortized over the life of the convertible notes as additional interest expense.
Upon the conversion of the notes into common stock, the unamortized debt
discount balance was recognized as additional interest expense. In connection
with the sale of these notes, the Company incurred an aggregate of $116,609 in
costs consisting of placement agent fees of approximately $62,500 and warrants
to placement agents to purchase 65,000 shares of common stock at the lower of
$2.75 per share on the sales price of the common stock in the subsequent
offerings by the Company valued at $54,109. The warrants were valued by
utilizing the Black-Scholes option-pricing model with the following assumptions:
50% volatility, seven-year expected life, risk-free interest rate ranging from
2.93% to 3.66% and a dividend yield ratio of 0%. On April 1, 2003, all the notes
that had due dates of March 31, 2003 were extended to September 30, 2004 and in
exchange, the note holders received 112,500 warrants to purchase common stock
exercisable at the lower of $2.75 per share or the sales price of the common
stock in subsequent offerings. The warrants were valued at $126,657 using the
Black-Scholes option-pricing model with the following assumptions: 50%
volatility, seven-year expected life, risk-free interest rate of
F-15
3.51% and a dividend yield ratio of 0%. The value of the warrants was amortized
over the extension period as additional interest expense. As of December 31,
2003, the total accrued interest on all the outstanding notes amounted to
$117,032.
Between January and June, 2004, the Company raised additional debt financing
from third parties comprised of:
(i) Proceeds of $181,000 in 9% convertible promissory notes that were
originally scheduled to mature on September 30, 2004 and seven-year
warrants to purchase 85,500 shares of common stock at an exercise
price of $4.00 per share. The fair value of the warrants was $62,857,
utilizing the Black-Scholes option-pricing model with the following
assumptions: 50% volatility, seven year expected life, risk-free
interest rate ranging from 3.52% to 3.68% and a dividend yield ratio
of 0%. The proceeds were allocated to the value of the warrants of
$46,655 as debt discount, which, along with the value of the beneficial
conversion feature (based on a $1.25 value per common share) of
$46,655 was being amortized over the life of the convertible
notes as additional interest expense. Unamortized debt discount and
unamortized beneficial conversion at the closing of the merger was
written off to interest expense, and
(ii) Proceeds of $1,325,000 in 10% convertible interim notes that were
originally scheduled to mature on December 31, 2004. Terms of the
convertible promissory notes provided that the notes would
automatically convert into shares of a publicly traded company on the
date that the contemplated reverse merger closed (see Note A). In
addition, when the reverse merger closed, each 10% convertible interim
note holder received a premium equal to either 10% of the face amount
of his note in additional public company stock or warrants to purchase
additional public company stock equal to 10% of the face amount of
their note at $1.50 per share, and
(iii) Proceeds of $500,000 in 10% convertible interim notes that were
originally scheduled to mature on December 31, 2004. Initial
individual investors purchasing notes, in the aggregate, received
seven-year warrants to purchase 250,000 shares of common stock at an
exercise price of $4.00 per share. The fair value of the warrants was
$174,524, utilizing the Black-Scholes option-pricing model with the
following assumptions: 50% volatility, seven year expected life,
risk-free interest rate ranging from 3.73% to 3.90% and a dividend
yield ratio of 0%. The proceeds were allocated to the value of the
warrants of $129,368 as debt discount, which, along with the value of
the beneficial conversion feature (based on a $1.25 value per common
share) of $129,367 was being amortized over the life of the
convertible notes as additional interest expense. Terms of the
convertible promissory notes provide that the notes would
automatically convert into shares of a publicly-traded company on the
date that the contemplated reverse merger (see below) closed.
Unamortized debt discount and unamortized beneficial conversion at the
closing of the merger was written off to interest expense. In
addition, when the reverse merger closed, each 10% convertible
promissory note holder received a premium equal to either 10% of the
face amount of his note in additional public company stock or warrants
to purchase additional public company stock equal to 10% of the face
amount of their note at $1.50 per share.
An additional premium of 58,000 shares of common stock and warrants to purchase
88,000 shares of common stock at $1.50 per share were issued to the note holders
in connection with the interim notes in (ii) and (iii) above.
NOTE H - NON-CONVERTIBLE NOTES PAYABLE - STOCKHOLDER
During 2003, the Company received $1,700,000 of proceeds from the issuance of
promissory notes to a stockholder/director. The notes accrued interest ranging
from 12% to 15% per annum, and the due dates ranged from March 31, 2003 to
September 30, 2004. At issuance of the notes, the Company also issued warrants
to the note holder to purchase an aggregate amount of 542,000 shares of common
stock, exercisable at the lower of $2.75 per share or the sales price of the
common stock in subsequent offerings. The fair value of the warrants was
$290,731, utilizing the Black-Scholes option-pricing model with the following
assumptions: 50% volatility, seven-year expected life, risk-free interest rate
ranging from 2.9% to 4.04% and a dividend yield ratio of 0%. The value of the
warrants was charged as interest expense over the life of the notes. The
warrants expire upon the earlier of five years after an initial public offering
or seven years from the date of issuance. As of December 31, 2003, the total
accrued interest on these notes amounted to $11,723. Upon the conversion of the
notes prior to maturity into
F-16
common stock in July 2004, the unamortized value of the warrants was recognized
as additional interest expense in the amount of $217,830.
NOTE I - RELATED PARTY TRANSACTIONS
On September 30, 2003, a stockholder/director opened a one year, irrevocable
standby letter of credit on behalf of the Company in the amount of $300,000, as
required by an agreement with a publisher to guarantee the payment of any
license fees due the publisher. As compensation to the stockholder/director, the
Company issued a warrant to purchase 150,000 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 $77,321, utilizing the
Black-Scholes option-pricing model with the following assumptions: 50%
volatility, seven-year expected life, risk-free interest rate of 3.63% and
dividend yield ratio of 0%. The warrant was originally scheduled to expire on
September 30, 2010 but was converted into approximately 27,413 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 finance cost and was amortized, on a
straight-line basis, over the one year term of the letter of credit. This letter
of credit was canceled during September 2004 due to the termination of the
publisher agreement and was never drawn upon.
On October 14, 2003, the same stockholder/director opened an irrevocable standby
letter of credit on behalf of the Company as required by an equipment lease
agreement, for the entire term of the lease obligation, 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 lease obligation which
terminates April 1, 2007. The Company is contingently liable for the amounts of
the letter of credit in the event the stockholder/director is obligated to make
payments thereunder as a result of noncompliance with the terms of the lease
agreement.
Pursuant to an agreement entered into prior to becoming a stockholder or
director, another stockholder was paid $57,515 at closing of the reverse merger
by the Company for advisory services rendered in connection with the reverse
merger transaction. Subsequent to this transaction he was appointed to the board
of directors.
See Note L for related party information in connection with an operating lease
of the Company.
NOTE J - STOCK OPTION PLANS
On March 24, 2000, the Company adopted a stock incentive 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, 2004, no stock appreciation rights or shares of stock have been
awarded under the 2000 Plan.
In 2004, the board of directors of the Company adopted the 2004 Stock Option
Plan (the "2004 Plan") for the issuance of a total of an additional 2,000,000
shares of the Company's common stock subject to approval by stockholders in the
next annual meeting of the Company's stockholders. As of December 31, 2004,
options to purchase 1,034,750 shares of common stock were granted but not yet
ratified, pursuant to the 2004 Plan including 275,000 options to non-employee
directors, each with an exercise price of $1.25 per share. The non-employee
director options vest quarterly over a one-year period and are exercisable over
a five-year period. The remaining options vest and become exercisable in equal
annual installments over a three-year period and have a ten-year life. These
stock options will not be recorded
F-17
as compensation until the stockholders ratify the 2004 Stock Option Plan. If the
stockholders ratify the plan, the Company will be required to value the stock
options at their intrinsic value on the date of ratification. The value will be
equal to the per share price difference between the exercise price and the fair
value of the common stock on the date of ratification times the 1,034,750
options granted. This value will be expensed over the respective vesting periods
of the options. Had the 2004 Plan been ratified on December 31 2004, when the
Company's stock price was at $3.75 per share, the options would have had an
intrinsic value of $2,586.875.
Option transactions are summarized as follows:
2000 PLAN 2004 PLAN
-----------------------------------------------------------------------------
2004 2003 2004
------------------------ -----------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
# SHARES PRICE # SHARES PRICE # SHARES PRICE
------------------------ -----------------------------------------------
Outstanding at beginning of year 3,292,775 $1.89 3,003,011 $1.96 0
Granted 24,147 1.25 289,764 1.25 1,108,000 $1.25
Exercised -- --
Forfeited (365,000) 2.83 (73,250) 1.25
---------- --------- ---------
Outstanding at end of year 2,951,922 1.74 3,292,775 1.89 1,034,750 1.25
========== ========= =========
Exercisable at end of year 2,951,922 1.74 3,218,509 1.84 --
========== ========= =========
The following summarizes information about stock options at December 31, 2004:
OPTIONS EXERCISABLE
---------------------------
RANGE WEIGHTED WEIGHTED WEIGHTED
OF AVERAGE REMAINING AVERAGE
NUMBER EXERCISE EXERCISE LIFE NUMBER EXERCISE
OUTSTANDING PRICE PRICE IN YEARS EXERCISABLE PRICE
----------------------------------------------------------------------------------------
437,500 $1.00 $1.00 2.33 437,500 $1.00
2,246,563 1.25 1.25 5.37 1,211,813 1.25
469,319 1.88 1.88 2.68 469,319 1.88
798,290 2.75 2.75 2.06 798,290 2.75
35,000 3.00 3.00 0.22 35,000 3.00
--------- ---------
3,986,672 $1.61 2,951,922 $1.74
========= =========
NOTE K - INCOME TAXES
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets at December 31, 2004 and 2003 are presented below.
2004 2003
---------------------------
Deferred tax assets:
Net operating loss carryforward $8,677,000 $6,976,000
Depreciation and amortization 84,000 65,000
Accrued salaries 318,000 328,000
---------------------------
Total deferred tax assets 9,079,000 7,369,000
Less valuation allowance 9,079,000 7,369,000
---------------------------
Net deferred tax assets $ 0 $ 0
===========================
As of December 31, 2004, the Company had a net operating loss carryforward of
approximately $21,779,000 which will expire from 2011 through 2024. The ability
of the Company to utilize its operating loss carryforward in future years may be
subject to annual limitations in accordance with provisions of Section 382 of
the Internal Revenue Code. The Company has not recorded a benefit from its
deferred tax asset because realization of the benefit is uncertain. Accordingly,
a valuation allowance, which increased by approximately $1,710,000 and
$1,253,000 during
F-18
2004 and 2003, respectively, has been provided for the full amount of the
deferred tax assets.
RATE
Reconciliation of income tax rate: 2004 2003
-------------------------
Federal statutory tax rate 34 % 34 %
State taxes 4 6
Permanent differences and other (13) (10)
Valuation allowance (25) (30)
-------------------------
Effective tax rate 0 % 0 %
=========================
NOTE L - OPERATING LEASE OBLIGATIONS
The Company is obligated, under an operating lease for its facility (through a
related party). This lease expires on January 31, 2006. The operating lease
provides for minimum annual rental payments as follows:
YEAR ENDING DECEMBER 31, AMOUNT
------------------------ ----------
2005 $ 118,546
2006 9,912
---------
$ 128,458
=========
NOTE M - CAPITALIZED LEASE OBLIGATIONS
The Company has two capital leases to finance the acquisition computer
equipment. At December 31, 2004 the future minimum payments required under such
leases are summarized as follows:
YEAR LEASE (1) LEASE (2) TOTAL
----------------------------------------
2005 $ 66,574 $ 366,020 $ 432,594
2006 81,720 575,924 657,644
2007 20,430 0 20,430
----------------------------------------
Total minimum lease payments 168,724 941,944 1,110,668
Less amounts representing interest 0 100,527 100,527
----------------------------------------
Present value of minimum lease payment 168,724 841,417 1,010,141
Less current portion of capital lease obligations 66,574 295,416 361,990
----------------------------------------
Long-term portion of capital lease obligations $ 102,150 $ 546,001 $ 648,151
========================================
(1) The lease is secured by the underlying equipment, and no interest
expense based on renegotiated terms in 2004, and is payable monthly
through March 2007. Pursuant to FASB Statement No. 15, "Accounting by
Debtors and Creditors for Troubled Debt Restructurings," in connection
with the debt restructuring, no interest expense will be recorded on
future minimum payments and the Company has recorded a gain on
forgiveness of debt in the amount of $36,290 in 2004.
(2) The lease is secured by the underlying equipment and by an
irrevocable standby letter of credit 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 lease agreement has an interest rate of 10.0% and is
payable monthly through December 2006 (see Note I).
NOTE N - OTHER NOTES PAYABLE, LONG-TERM
On July 22, 2004, in connection with the reverse merger, $494,038 of accrued
interest on convertible notes payable was converted into new promissory notes,
bearing interest at 4% per annum. All principal and accrued interest on the
notes shall be due and payable in full on July 22, 2007. The payees have a right
to convert all or any portion of the outstanding principal balance and/or
accrued interest of the notes into shares of common stock in the Company's next
round of equity financing subsequent to July 22, 2004, on the same terms and
conditions as applicable to all other purchasers of such equity securities. As
of December 31, 2004, the total accrued interest on the notes payable amounted
to $8,721.
F-19
NOTE O - DISCONTINUED OPERATIONS
Effective June 30, 2004, the Company discontinued the operations of its wholly
owned subsidiary Precision Type, Inc. Accordingly, Precision Type's assets and
liabilities have been segregated from the assets and liabilities of continuing
operations in the consolidated balance sheets at December 31, 2004 and 2003 and
its operating results have been segregated from continuing operations and are
reported as discontinued operations in the consolidated statements of operations
and cash flows for each of the years ended December 31, 2004 and 2003.
EAR ENDED DECEMBER 31
---------------------------
Statements of Operations: 2004 2003
------------------------- ---------------------------
Net sales - font software products $41,942 $191,017
Cost of sales 18,636 84,829
---------------------------
Gross profit 23,306 106,188
General, selling and administrative expenses 14,859 18,640
---------------------------
Net income from discontinued operations $8,447 $87,548
===========================
Summarized financial information of discontinued
operations is as follows: DECEMBER 31,
---------------------------
Balance Sheets: 2004 2003
--------------- ---------------------------
Cash $0 $6,386
Accounts receivable, net 0 1,433
Inventory 0 6,515
Prepaid expenses and other current assets 0 13,845
Fixed assets, net 0 199
---------------------------
Total assets of discontinued operations 0 28,378
---------------------------
Accounts payable and accrued expenses 195,708 353,265
Notes payable, current 28,755 31,277
---------------------------
Total current liabilities of discontinued operations 224,463 384,542
Notes payable, non-current 64,138 69,745
---------------------------
Total liabilities of discontinued operations 288,601 454,287
---------------------------
Net liabilities of discontinued operations $288,601 $425,909
===========================
NOTE P - DEFERRED OFFICERS' COMPENSATION
On July 31, 2002, the Company entered into the Salary Adjustment Agreement (the
"Agreement") with its President and certain of its vice-presidents (the
"Officers/Stockholders"). The Agreement, which was authorized by the Company's
Board of Directors, provided that the Officers/Stockholders (i) voluntarily
accept a 25% reduction in salary for the period commencing August 1, 2002 and
(ii) agree to defer the receipt of $1,376,240 in accrued but unpaid salaries
(this amount was reduced to $811,137 after deducting authorized payments of
$565,103), until the Company achieves positive cash flow, in exchange for (a)
the immediate grant of an aggregate total of 777,167 five-year stock options
with an exercise price of $1.25 per share, (b) the monthly grant of an aggregate
of 24,147 five-year stock options at an exercise price at $1.25 per share
commencing August 2002, which aggregated 434,646 stock options between August
2002 and January 2004, (c) the automatic 100% vesting of 766,570 unvested
previously held stock options and (d) an exercise period of five years from the
date of the Agreement for any previously held stock options. This arrangement
would cease upon the return of the executives to their previous salaries.
Conditions for reinstatement of salaries were either (i) raising a minimum of
$1,500,000 in gross proceeds in a fund raising (excluding any funding from the
Company's largest shareholder) or (ii) the Company achieving positive cash flow
in excess of $75,000 in any quarter from operations. As of January 31, 2004, the
Company had raised capital in excess of $1,500,000 in defined gross proceeds,
and consequently restored the officers to their prior salaries and ceased the
monthly issuance of stock options. The deferred salaries were charged to expense
as earned and are included in accrued salaries on the accompanying balance
sheets.
The stock option grants and modifications were accounted for in accordance with
APB Opinion No 25 and FASB Interpretation 44 Accounting for Certain Transactions
Involving Stock Compensation-An Interpretation of APB Opinion No 25.
F-20
In connection with the reverse merger consummated July 22, 2004, two of the
Officers/Stockholders each converted $100,000 of amounts due them for accrued
salaries into 80,000 shares of common stock of the Company at $1.25 per share.
At December 31, 2004, accrued but unpaid salaries totaled $1,529,555 (this
amount was reduced to $587,407 after deducting authorized payments of $942,148).
NOTE Q - 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 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 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 the right to
acquire 266,154 shares of Company common stock. These shares are issuable,
66,540 shares upon consummation of the reverse merger, and 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 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. For the period from June 15,
2004 to December 31, 2004, $45,045 has been amortized as a selling expense.
NOTE R - COMMITMENTS
Upon the consummation of the merger, the board of directors of the Company
approved a five-year employment agreement with the President and Chief Executive
Officer, providing for a base annual compensation of $195,000, certain fringe
benefits and bonus compensation and/or stock options as determined by the board
of directors.
NOTE S - SIGNIFICANT CUSTOMERS
For the year ended December 31, 2004 two customers accounted for 60.3% and 39.7%
of net sales, respectively. One of these customers accounted for 100% of net
sales for the year ended December 31, 2003.
F-21