UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended September 30, 2006
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number: 001-12155
One IP Voice, Inc.
(Exact name of registrant as specified in its charter)
Delaware 06-1205743
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
22 Prestige Park Circle
East Hartford, CT 06108
(Address of principal executive offices) (Zip Code)
(860) 610-6000
(Registrant's telephone number)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [x]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of October 30, 2006, the registrant had 4,483,539 shares of its $0.001 par
value Common Stock outstanding.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Page
----
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
Consolidated Balance Sheets - September 30, 2006 and December 31, 2005 3
Consolidated Statements of Operations - Three and Nine Months Ended
September 30, 2006 and 2005 4
Consolidated Statement of Changes in Stockholders' Deficiency -
Nine Months Ended September 30, 2006 5
Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2006 and 2005 6
Notes to Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 31
ITEM 4. CONTROLS AND PROCEDURES 31
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 31
ITEM 1A. RISK FACTORS 32
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 32
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 32
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 32
ITEM 5. OTHER INFORMATION 33
ITEM 6. EXHIBITS 33
SIGNATURES 34
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ONE IP VOICE, INC.
(f/k/a Farmstead Telephone Group, Inc.)
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
(In thousands) 2006 2005
----------------------------------------------------------------------------------------------------------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 325 $ 222
Accounts receivable, net 2,297 3,125
Inventories, net 924 723
Other current assets 126 281
----------------------------------------------------------------------------------------------------------------
Total Current Assets 3,672 4,351
Property and equipment, net 742 615
Deferred financing costs 458 535
Other assets 328 103
----------------------------------------------------------------------------------------------------------------
Total Assets $ 5,200 $ 5,604
----------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable $ 3,863 $ 3,105
Accrued expenses and other current liabilities 610 539
Current portion of convertible debt, net of unamortized discount (Note 4) 1,176 860
Derivative financial instruments (Note 5) 435 385
Current portion of long-term debt (Note 3) 59 30
----------------------------------------------------------------------------------------------------------------
Total Current Liabilities 6,143 4,919
Postretirement benefit obligation 825 719
Convertible debt, net of unamortized discount (Note 4) 1 8
Derivative financial instruments (Note 5) 1,874 406
Long-term debt (Note 3) 102 49
----------------------------------------------------------------------------------------------------------------
Total Liabilities 8,945 6,101
----------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Redeemable convertible preferred stock, Series A (Note 7) 200 -
Stockholders' Deficiency:
Common stock, $0.001 par value; 30,000,000 shares authorized; 4,308,219 and
3,817,132 shares issued and outstanding at September 30, 2006 and December
31, 2005, respectively 4 4
Common stock to be issued (Note 15) 56 -
Additional paid-in capital 13,388 13,249
Accumulated deficit (17,383) (13,734)
Accumulated other comprehensive loss (10) (16)
----------------------------------------------------------------------------------------------------------------
Total Stockholders' Deficiency (3,945) (497)
----------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Deficiency $ 5,200 $ 5,604
================================================================================================================
See accompanying notes to consolidated financial statements.
3
ONE IP VOICE, INC.
(f/k/a Farmstead Telephone Group, Inc.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three For the Nine
Months Ended Months Ended
September 30, September 30,
------------------- -------------------
(In thousands, except loss per share amounts) 2006 2005 2006 2005
-------------------------------------------------------------------------------------------------
Revenues:
Equipment $ 2,324 $ 3,890 $ 8,270 $ 9,578
Services and other revenue 597 917 2,320 2,121
-------------------------------------------------------------------------------------------------
Total revenues 2,921 4,807 10,590 11,699
Cost of Revenues:
Equipment 1,815 2,887 6,150 6,901
Services and other revenue 478 573 1,669 1,128
Other cost of revenues 147 108 334 341
-------------------------------------------------------------------------------------------------
Total cost of revenues 2,440 3,568 8,153 8,370
-------------------------------------------------------------------------------------------------
Gross profit 481 1,239 2,437 3,329
Selling, general and administrative expenses 2,902 1,885 8,277 5,033
-------------------------------------------------------------------------------------------------
Operating loss (2,421) (646) (5,840) (1,704)
-------------------------------------------------------------------------------------------------
Other income (expense):
Interest expense (76) (55) (221) (111)
Derivative instrument income (expense) (Note 1) 740 (1,949) 2,403 (1,662)
Other income 5 3 20 7
-------------------------------------------------------------------------------------------------
Total other income (expense) 669 (2,001) 2,202 (1,766)
-------------------------------------------------------------------------------------------------
Loss before income taxes (1,752) (2,647) (3,638) (3,470)
Provision for income taxes 1 1 11 8
-------------------------------------------------------------------------------------------------
Net loss (1,753) (2,648) (3,649) (3,478)
Accretion of discount on preferred stock (23) - (49) -
-------------------------------------------------------------------------------------------------
Net loss attributable to common stockholders $(1,776) $(2,648) $(3,698) $(3,478)
=================================================================================================
Net loss per common share:
Basic and diluted $ (.42) $ (.75) $ (.92) $ (1.02)
Weighted average common shares outstanding:
Basic and diluted 4,204 3,511 4,022 3,398
=================================================================================================
See accompanying notes to consolidated financial statements.
4
ONE IP VOICE, INC.
(f/k/a Farmstead Telephone Group, Inc.)
CONSOLIDATED STATEMENT OF CHANGES IN
STOCKHOLDERS' DEFICIENCY
(UNAUDITED)
For the Nine Months Ended September 30, 2006
Common Accumulated
Stock Additional Accum- Other Com-
Common Stock to be Paid-in ulated prehensive
Shares Amount Issued Capital Deficit Loss Total
---------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2005 3,817 $4 $ - $13,249 $(13,734) $(16) $ (497)
Net loss - - - - (3,649) - (3,649)
Amortization of pension liability
adjustment - - - - - 6 6
-------
Comprehensive loss (3,643)
Stock-based compensation - - - 330 - - 330
Common stock issued under stock
option and stock purchase plans 43 - - 52 - - 52
Shares issued upon conversion of
Laurus debt 388 - - 298 - - 298
Value of Warrants issued to
investors for notes payable - - - 852 - - 852
Costs and expenses in connection
with issuance of convertible
note and Series A preferred
stock - - - (507) - - (507)
Value of warrants for preferred
and common stock issued to
placement agent in connection
with issuance of convertible
note and Series A preferred stock - - - (710) - - (710)
Excess of fair value of Series A
investor warrants over
allocated proceeds - - - (203) - - (203)
Common stock issued in connection
with purchase of assets 50 - - 61 - - 61
Common stock issued to consultant
for services 10 - - 15 - - 15
Common stock to be issued to
placement agent - - 56 - - - 56
Accretion of discount on Series A
preferred stock - - - (49) - - (49)
---------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2006 4,308 $4 $56 $13,388 $ 17,383 $(10) $(3,945)
===========================================================================================================================
See accompanying notes to consolidated financial statements.
5
ONE IP VOICE, INC.
(f/k/a Farmstead Telephone Group, Inc.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Months Ended September 30, 2006 and 2005
(In thousands) 2006 2005
--------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net loss $(3,649) $(3,478)
Adjustments to reconcile net loss to net cash used in
operating activities:
Provision for doubtful accounts receivable 27 27
Provision for losses on inventories 36 30
Depreciation and amortization of property and equipment 166 81
Amortization of deferred financing costs 77 47
Amortization of discounts on convertible notes 64 43
Amortization of acquired customer contracts 9 -
(Gain) loss on derivative instruments (2,403) 1,662
Stock-based compensation expense 330 -
Value of common stock issued for services 15 -
Decrease in accumulated other comprehensive loss 6 6
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 801 (2,172)
(Increase) decrease in inventories (237) 252
Decrease in other assets 87 270
Increase in accounts payable 758 2,013
Increase in accrued expenses and other current liabilities 71 166
Increase in postretirement benefit obligation 106 95
--------------------------------------------------------------------------------------------
Net cash used in operating activities (3,736) (958)
--------------------------------------------------------------------------------------------
Cash flows from investing activities:
Cash paid in asset acquisition (15) -
Purchases of property and equipment (215) (320)
--------------------------------------------------------------------------------------------
Net cash used in investing activities (230) (320)
--------------------------------------------------------------------------------------------
Cash flows from financing activities:
Repayment of BACC revolving loan advances - (179)
Borrowings under Laurus revolving loan facility 144 1,618
Proceeds from issuance of convertible note, net 913 -
Proceeds from issuance of Series A preferred stock, net 2,991 -
Deferred financing costs - (272)
Repayment of long-term debt and capital lease obligations (31) (17)
Proceeds from exercise of stock options and employee
stock purchases 52 97
--------------------------------------------------------------------------------------------
Net cash provided by financing activities 4,069 1,247
--------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 103 (31)
Cash and cash equivalents at beginning of period 222 217
--------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 325 $ 186
============================================================================================
6
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 115 $ 46
Income taxes 2 2
Supplemental disclosure of non-cash financing and
investing activities:
Purchase of equipment under capital lease 59 56
Net assets acquired from Rhyne 76 -
Fair value of shares issued for net assets acquired from Rhyne 61 -
Common stock issued upon Laurus minimum borrowing
note conversions 298 732
Discount on warrants issued to Laurus - 335
Warrants issued to investors in connection with convertible notes 852 -
Preferred shares issued on conversion of convertible note 628 -
Warrants issued to placement agent in connection with
issuance of convertible notes and preferred shares 710 -
Fair value of Series A preferred shares and warrants issued
to investors 3,460 -
Discounts on issuance of convertible debt - 1,094
See accompanying notes to consolidated financial statements.
ONE IP VOICE, INC.
(f/k/a Farmstead Telephone Group, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION, BUSINESS OPERATIONS, AND SIGNIFICANT ACCOUNTING
POLICIES
Basis of Presentation
The consolidated financial statements presented herein consist of the
accounts of One IP Voice, Inc., formerly known as Farmstead Telephone Group,
Inc., and its wholly-owned subsidiaries. The accompanying consolidated
financial statements as of September 30, 2006 and for the three and nine months
ended September 30, 2006 and 2005 have been prepared in accordance with
accounting principles generally accepted in the United States of America and
the rules and regulations of the Securities and Exchange Commission for interim
financial statements. The consolidated financial statements contemplate
continuation of the Company as a going concern and the realization of assets
and the satisfaction of liabilities in the normal course of business. The
carrying amounts of assets and liabilities presented in the consolidated
financial statements do not purport to represent realizable or settlement
values. In the Company's opinion, the unaudited interim consolidated financial
statements and accompanying notes reflect all adjustments, consisting of normal
recurring adjustments that are necessary for a fair statement of results for
the interim periods presented. The results of operations for the interim
periods are not necessarily indicative of the results to be experienced for the
entire fiscal year. This Form 10-Q should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2005.
Corporate Name Change: Effective July 19, 2006 Farmstead Telephone Group, Inc.
changed its corporate name to "One IP Voice, Inc.". Concurrently, the Company's
wholly-owned subsidiary, One IP Voice, Inc., changed its corporate name to
"OIPV Corp.". In the discussions that follow, the business conducted by One IP
Voice, Inc. is also referred to as the
7
"Telecommunications equipment business", or the "legacy business"; the business
conducted by OIPV Corp. is also referred to as the "IP telephony business".
Use of Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, revenues and expenses and related
disclosures in the consolidated financial statements. Actual results could
differ from those estimates. Estimates are used in accounting for the
allowances for uncollectible receivables, inventory obsolescence, depreciation,
taxes and contingencies, among others. Estimates are also used in determining
product sales returns, which are reflected as reductions to revenues. Estimates
are also made with regard to the identification and valuation of derivative
instruments, the amortization periods for debt issuance costs, and the
amortization of discounts on convertible securities arising from bifurcated
derivative instruments. Estimates and assumptions are reviewed periodically and
the effects of revisions are reflected in the consolidated financial statements
in the period they are determined to be necessary.
Derivative Financial Instruments
The identification of, and accounting for, derivative instruments is
complex. Derivative financial instruments are initially measured at their fair
value. For derivative financial instruments that are accounted for as
liabilities, the derivative instrument is initially recorded at its fair value
and is then revalued at each reporting date, with changes in the fair value
reported as charges or credits to income. We determine the fair value of these
instruments using the Black-Scholes option pricing model. That model requires
assumptions related to the remaining term of the instruments and risk-free
rates of return, our current common stock price and expected dividend yield,
and the expected volatility of our common stock price over the life of the
conversion option. We estimate the future volatility of our common stock price
based on several factors, including the history of our stock price and the
experience of other entities considered comparable to us. The identification
of, and accounting for, derivative instruments and the assumptions used to
value them can significantly affect our financial position and results of
operations. Derivative instrument liabilities are classified in the balance
sheet as current or non-current based on whether or not net-cash settlement of
the derivative instrument could be required within 12 months of the balance
sheet date.
During the three and nine months ended September 30, 2006, we recorded
derivative instrument income of $740,000 and $2,403,000 respectively, as
compared to derivative instrument expense of $(1,949,000) and $(1,662,000) for
the respective three and nine months ended September 30, 2005. The recording of
derivative instrument income during 2006 resulted from the decline in the
calculated fair market value of derivative instrument liabilities, primarily
attributable to a decline in the market value of the Company's common stock.
The recording of derivative instrument expense during 2005 resulted from the
increase in the calculated fair market value of derivative instrument
liabilities, primarily attributable to an increase in the market value of the
Company's common stock. These "mark-to-market" adjustments are non-cash, with
no impact on liquidity.
Business Operations and Going Concern Issues
As presented in the accompanying consolidated financial statements, the
Company incurred operating losses of $2,421,000 and $5,840,000 for the three
and nine months ended September 30, 2006, as compared to operating losses of
$646,000 and $1,704,000 for the three and nine months ended September 30, 2005.
Approximately $1,248,000 and $3,465,000 of the operating losses reported for
the three and nine months ended September 30, 2006, and $243,000 and $486,000
of the operating losses reported for the three and nine months ended September
30, 2005 were attributable to the operations of the Company's wholly-owned
subsidiary, OIPV Corp. ("OIPV"). In May 2005, OIPV was formed to provide
carrier-based VoIP telephony solutions along with network services. Its primary
target market is the small-to-medium sized business ("SMB") market, which the
Company and independent sources believe is the fastest growing segment of the
telecommunications systems business. OIPV's product offerings include Hosted IP
Centrex and IP Trunking services, bundled with private OIPV "last mile"
connectivity on a national basis, long distance calling, On Net calling, local
area calling, 911 capabilities and Wide Area Network ("WAN") voice and data
connectivity. In January 2006, the Company launched the national marketing of
OIPV's products and services; however revenues generated to date have been
insufficient to cover its operating costs, and operating losses are expected to
continue into 2007. During the last three months of 2005 and the first nine
months of operations in 2006, OIPV completed the installation and
interoperability testing of its feature server in Denver as well as the
installation of its test lab and network operations center. In addition, during
2006 it has additionally accomplished the following:
8
o Signed a wholesale agreement with an additional tier 1 carrier that
expands our coverage and lowers PSTN costs thereby improving
margins. Negotiations are underway with additional carriers to
further that process;
o Signed an agreement with the leading e911 provider to give us
increased flexibility to tailor carrier offerings for each customer
and still provide mandated service;
o Signed distribution agreements with several organizations that give
us endorsed access to over 400 independent dealers and 1200 agents
to market our offerings;
o Sold, provisioned and billed installations in 11 states;
o Signed over 100 independent business partners that provide over 300
sales personnel representing our products.
Staff build-out continues in Denver to develop and deploy additional
offerings demanded in this emerging market.
The remaining operating losses are attributable to the Company's legacy
telecommunications equipment business which has been negatively impacted by
declining revenues and profit margins. Management is currently optimistic that
this division's fourth quarter revenues will improve over current levels.
Management is currently seeking an acquisition or merger opportunity as a means
to significantly grow this division's revenues and return it to profitability
through consolidation economies in operating costs. As of September 30, 2006,
the Company had a negative net worth of $3,945,000 and a working capital
deficiency of $2,471,000 ($2,036,000 excluding non-cash derivative instrument
liabilities). The Company continues to experience negative cash flows from
operations, which were anticipated by management in its continuing buildout of
OIPV's IP telephony business and plan to become a major player in an emerging
growth marketplace. As a result, the Company continues to be dependent upon its
revolving credit facility and raising cash from private and public placements
of debt and equity in order to fund its business and business development
plans. These conditions raise substantial uncertainties about the Company's
ability to continue as a going concern. The Company's continuation as a going
concern is dependent on its ability to meet its obligations, to obtain
additional financing as, and when, required, to generate sufficient operating
revenue and ultimately to attain profitability.
Management's plans for the Company include raising additional capital by
the end of the current year through the issuance of debt and equity securities,
implementing cost reduction measures, negotiating payment arrangements with key
suppliers, seeking an acquisition or merger for its legacy telecommunications
business division, and continuing the buildout of OIPV's IP telephony business.
On September 11, 2006, the Company reached an agreement with its
principal Avaya product supplier, under which the supplier agreed to forbear on
the collection of past due accounts payable totaling approximately $1.5 million
("Forbearance Amount") until the first occurrence of the closing and funding of
a follow-on offering of securities or December 1, 2006. In connection with this
agreement, the Company received a new credit limit of $250,000 to support
ongoing purchase requirements. The Forbearance Amount represented 39% of the
Company's accounts payable at September 30, 2006.
As of September 30, 2006 the Company's borrowing availability under the
revolving loan portion of the Laurus credit facility was $296,000. As further
described in Note 14, on October 17, 2006, the Company and Laurus executed and
entered into an Amendment and Forbearance Agreement, and related documents,
pursuant to which among other things Laurus was issued a Secured Demand Note
for a principal amount of up to $1,000,000 (the "New Note"). On October 18,
2006, the Company was advanced $500,000 under the New Note. Further advances
under the New Note, up to an additional $500,000, are contingent upon the
Company obtaining additional financing from other sources. The Amendment and
Forbearance Agreement includes requirements that the Company raise a minimum of
$750,000 in bridge financing by December 1, 2006, and delivers to Laurus by
December 25, 2006 a fully executed term sheet setting forth the terms,
conditions and pricing of the Company's proposed follow-on securities offering.
On September 7, 2006, the Company engaged the services of C.P. Baker
Securities, Inc., to assist the Company in securing up to $3 million in bridge
financing. On September 15, 2006, the Company engaged the services of Stonegate
Securities, Inc. to act as placement agent on a follow-on offering of
securities of at least $10 million. No assurances can be given, however that we
will be able to raise sufficient amounts of cash on a timely basis or, if so,
whether the terms of any such transaction will be advantageous to us. In the
event that we are successful in negotiating an agreement with one or more
investors, it is likely that we will be required to issue a significant number
of shares of Common Stock, or other securities
9
convertible or exercisable into shares of Common Stock, which would result in
very significant dilution to our present stockholders. In the event that we are
unable to meet the above-described December 1, 2006 commitments with our key
supplier and Laurus, we would need to renegotiate said agreements. A default
condition under these agreements could result in a demand for repayment, which
the Company wouldn't be able to satisfy out of its currently available cash
resources.
For additional discussion on the Company's financing plans, operating
results and financial condition, refer to Note 14 - Subsequent Events, and Item
2 - Management's Discussion and Analysis of Financial Condition and Results of
Operations, contained herein.
2. SUPPLEMENTARY FINANCIAL INFORMATION
Balance Sheet Information
September 30, December 31,
(In thousands) 2006 2005
-------------------------------------------------------------------------------------
ACCOUNTS RECEIVABLE, NET: (1)
Trade accounts receivable $ 2,127 $ 2,815
Less: allowance for doubtful accounts (95) (75)
------- -------
Trade accounts receivable, net 2,032 2,740
Other receivables 265 385
------- -------
Accounts receivable, net $ 2,297 $ 3,125
======= =======
INVENTORIES, NET: (2)
Finished goods and spare parts $ 868 $ 1,136
Work in process 176 202
Rental equipment 8 12
------- -------
1,052 1,350
Less: reserves for excess and obsolete inventories (128) (627)
------- -------
Inventories, net $ 924 $ 723
======= =======
PROPERTY AND EQUIPMENT, NET:
Computer and office equipment $ 1,173 $ 1,065
IP network equipment and licenses 472 391
Furniture and fixtures 303 288
Leasehold improvements 171 171
Capitalized software development costs 98 98
Automobiles 78 50
Leased property and equipment under capital lease 115 56
------- -------
2,410 2,119
Less: accumulated depreciation and amortization (1,668) (1,504)
------- -------
Property and equipment, net $ 742 $ 615
======= =======
ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES:
Salaries, commissions and benefits $ 359 $ 296
Legal fees and expenses 107 104
State and local taxes 18 36
Customer deposits and unearned revenue 42 30
Employee Stock Purchase Plan deposits 2 28
Other 82 45
------- -------
Accrued expenses and other current liabilities $ 610 $ 539
======= =======
(1) Other receivables primarily consist of commissions, rebates and other dealer
incentives due from Avaya and are recorded in the consolidated financial
statements when earned.
10
(2) Work in process consists of used equipment requiring repair or refurbishing.
The amounts shown in this table for December 31, 2005 for finished goods and
spare parts, and for the reserves for excess and obsolete inventories reflect a
correction of a typographical error in the consolidated financial statements
included in the Form 10-K for the year ended December 31, 2005. The amounts
originally reported were $947 and ($438), respectively. This correction had no
effect on the net reported value.
3. DEBT OBLIGATIONS
September 30, December 31,
(In thousands) 2006 2005
--------------------------------------------------------------------
Installment purchase note $34 $40
Payment obligation to Rhyne 49 -
Obligations under capital lease 78 39
--------------------------------------------------------------------
161 79
Less: current portion (59) (30)
--------------------------------------------------------------------
Long-term debt obligations $102 $49
====================================================================
Installment Purchase Note:
The Company is financing an automobile through a $50,056, 3.75% note
payable to a finance company. The note is payable in 38 monthly installments of
$799, with a final payment of $24,236 on January 7, 2008.
Payment obligation to Rhyne:
In connection with an Asset Purchase Agreement entered into on July 3,
2006 with Rhyne Communications, Inc., Rhyne Capital Corporation ("RCC") and Mr.
Henry Delgado (the sole owner of these companies) (collectively "Rhyne"), the
Company agreed to assume the installment note payment obligations remaining on
four vehicles owned by Rhyne, and utilized by the Company. The notes have
remaining terms ranging from 9-36 months as of September 30, 2006.
Obligations under Capital Lease:
The Company leases computer equipment and furniture under capital lease
obligations, with payment terms ranging from 24 to 36 months. The agreements
contain a $1.00 purchase option at the end of the lease term. The effective
interest rate on the lease obligations range from 10.4 to 13%.
4. CONVERTIBLE DEBT
September 30, December 31,
(In thousands) 2006 2005
-------------------------------------------------------------------------------------
Borrowing under secured revolving credit facility
note, including accrued interest $ 1,553 $1,409
Secured convertible Minimum Borrowing Note 19 423
Less: unamortized discount attributable to the
revolving credit facility note (377) (549)
Less: unamortized discount attributable to the
Minimum Borrowing Note (18) (415)
-------------------------------------------------------------------------------------
Convertible debt, net of unamortized discounts 1,177 868
Less: current portion (1,176) (860)
-------------------------------------------------------------------------------------
Convertible debt, net of unamortized discounts $ 1 $ 8
=====================================================================================
On August 15, 2006 the Company and the Laurus Master Fund. LTD.
("Laurus") executed an Amendment to the Secured Convertible Minimum Borrowing
Note Series B dated September 2, 2005 (the "Note") issued to Laurus. The
Amendment reduced the fixed conversion price on $160,000 of principal on the
Note from $1.27 to $0.80. Conversion of the $160,000 Note principal at the
reduced fixed conversion price of $0.80 will result in the issuance of 74,016
more shares of common stock than would have been issued under the previous
conversion price of $1.27. The purpose of the reduction was to increase the
Company's borrowing availability under its revolving credit facility through
the conversion of the Note principal from debt to equity. During 2006, $404,000
of debt under the existing Minimum Borrowing Note was converted to 387,500
shares of common stock.
11
On October 17, 2006 the Company obtained additional financing from Laurus
and further amended certain terms and conditions of its lending agreements. See
Note 14 for further information. As of September 30, 2006, the amount of
available borrowings under the revolving portion of the credit facility,
pursuant to borrowing formulas, was as follows (in thousands):
Available borrowings supported by collateral base $ 1,868
Less: amount borrowed under revolving credit facility (1,553)
Less: amount borrowed under the Minimum Borrowing Note (19)
-------
Available to borrow as of September 30, 2006 $ 296
=======
The average and highest amounts borrowed under the Laurus revolving credit
facility during the three months ended September 30, 2006 were approximately
$1,600,000 and $2,073,000, respectively. The average and highest amounts
borrowed under the Laurus revolving credit facility during the nine months ended
September 30, 2006 were approximately $1,479,000 and $2,073,000, respectively.
Future required principal repayments under the Minimum Borrowing Note as of
September 30, 2006 are: 2006 - $0; 2007 - $0; and 2008 - $19,000.
5. DERIVATIVE FINANCIAL INSTRUMENTS
The following derivative liabilities related to warrants and embedded derivative
instruments were outstanding as of September 30, 2006 and December 31, 2005 (in
thousands):
Value -
Exercise Issue Value- Value -
Instrument: Price date 9/90/06 12/31/05
----------------------------------------------------------------------------------------------------------------
Laurus Minimum Borrowing Note (Note 4) $1.27(1) $ 323 $ 4 $ 135
Laurus Revolving Note (Note 4) 1.27(1) 388 435 385
58,970 shares of Series A preferred stock issued in
connection with convertible note (Notes 7 and 8) - 628 256 -
200,456 shares of Series A preferred stock issued in
private placement (Note 7) - 2,340 870 -
----------------------------------------------------------------------------------------------------------------
Fair value of bifurcated embedded derivative instrument
liabilities 1,565 520
500,000 common stock warrants issued to Laurus 1.82(1) 335 156 271
150,000 common stock warrants issued to placement agent in
connection with convertible note (Note 8) 1.27 197 69 -
1,002,280 common stock warrants issued in private
placement (Note 7) 2.125 1,120 340 -
30,067 preferred stock warrants issued to placement agent
in private placement (Note 7) 17.00 345 128 -
150,335 common stock warrants issued to placement agent in
private placement (Note 7) 2.125 222 51 -
----------------------------------------------------------------------------------------------------------------
Total derivative financial instruments 2,309 791
Less: amount attributable to the Revolving Note, reported
in current liabilities (435) (385)
----------------------------------------------------------------------------------------------------------------
Derivative financial instruments recorded in non-current
liabilities $1,874 $ 406
================================================================================================================
12
(1) In connection with the Amendment and Forbearance Agreement entered into
with Laurus on October 17, 2006, the exercise price was reset to $0.60.
The Company uses the Black-Scholes option pricing model to value warrants,
and the embedded conversion option components of any bifurcated embedded
derivative instruments that are recorded as derivative liabilities. In valuing
(i) the Laurus warrants and the embedded conversion option components of
Laurus's bifurcated embedded derivative instruments; and (ii) the warrants to
acquire common stock issued to the Series A investors and the placement agent,
at the time they were issued and at each quarter ending date, we used the
following assumptions: market price of our common stock on the date of
valuation; an expected dividend yield of 0%; an expected life equal to either
the remaining period to the expiration date of the warrants or maturity date of
the convertible debt instruments; implied volatility of 65%; and a risk-free
rate of return based on constant maturity rates published by the U.S. Federal
Reserve, applicable to the remaining life of the instruments. In valuing the
shares of Series A preferred stock issued to investors, as well as the warrants
to acquire preferred stock issued to the placement agent, in addition to using
the same dividend yield, volatility and rate-of-return assumptions as above, we
initially used an expected life of 4.5 years which considered the fact that
there is a mandatory conversion option once the market price of the Company's
common stock exceeds $5.00 per share for 20 trading days. In valuing these
securities as of September 30, 2006, we changed the expected life assumption to
5.3 years, which reflects the remaining period of time to the beginning of the
contractual redemption period.
6. STOCK-BASED COMPENSATION
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based
Payment," ("SFAS No. 123R"), revising FASB Statement 123, "Accounting for
Stock-Based Compensation" and superseding APB Opinion No. 25, "Accounting for
Stock Issued to Employees" and its related implementation guidance. This
Statement establishes standards for the accounting for transactions in which an
entity exchanges its equity instruments for goods or services, focusing
primarily on transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123 (revised 2004) requires a public
entity to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award
(with limited exceptions). That cost will be recognized over the period during
which an employee is required to provide service in exchange for the award.
Accounting for share-based compensation transactions using the intrinsic method
supplemented by pro forma disclosures will no longer be permissible. This
statement became effective as of the beginning of the first interim or annual
reporting period that began after December 15, 2005.
Effective January 1, 2006, the Company adopted SFAS 123R using the
modified prospective method as permitted under SFAS 123R. Under this transition
method, compensation cost recognized during 2006 includes: (a) compensation cost
for all share-based payments granted prior to, but not yet vested as of December
31, 2005, based on the grant-date fair value estimated in accordance with the
provisions of SFAS 123, and (b) compensation cost for all share-based payments
granted subsequent to December 31, 2005, based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123R. In accordance with the
modified prospective method of adoption, the Company's results of operations and
financial position for prior periods have not been restated.
Stock Option Plans: The Company has outstanding options granted under the
following plans: (i) the Farmstead Telephone Group, Inc. 2002 Stock Option Plan
(the "2002 Plan") and (ii) the Farmstead Telephone Group, Inc. 1992 Stock Option
Plan (the "1992 Plan"). The 1992 Stock Option Plan terminated in May 2002;
however options previously granted under the 1992 Plan may continue to be
exercised in accordance with the terms of the individual grants. The Company
grants options with varying vesting terms, including 100% exercisable after 1
year, 50% per year over 2 years, and 25% or 20% per year over 4 or 5 years. The
vesting terms vary depending upon the circumstances (for example, options
included in an employment offer may be subject to negotiation with the
prospective employee) and are reviewed with the Board of Directors.
The 2002 Plan permits the granting of options to purchase shares of common
stock to employees, directors and consultants of the Company, which shall be
either incentive stock options ("ISOs") as defined under Section 422 of the
Internal Revenue Code, or non-qualified stock options ("NSOs"). ISOs may be
granted at no less than market value at the time of grant, with a maximum term
of ten years except, for a 10% or more stockholder, the exercise price shall not
be less than 110% of market value, with a maximum term of five years. NSOs may
be granted at no less than 50% of market value at the time of grant, with a
maximum term of 10 years. Any option granted pursuant to this Plan which for any
reason fails to qualify as an ISO shall be deemed to have been granted as an
option not qualified under Section 422 of the Code. As of June
13
30, 2006, the maximum number of shares issuable under the 2002 Plan, which
expires April 3, 2012, was 2,300,000. At the Company's Annual Meeting of
Stockholders, held July 13, 2006, the stockholders approved an increase in the
maximum number of shares issuable under the 2002 Plan to 3,300,000.
Employee Stock Purchase Plans - The Company also has an employee stock
purchase plan ("ESPP") that allows eligible employees to purchase, through
payroll deductions, shares of the Company's common stock at a discount from the
fair market value of the common stock at specified dates. Employees may withdraw
from an offering before the purchase date and obtain a refund of the amounts
withheld. In the semi-annual offering period that ended February 2006, the
Company amended the terms of the ESPP such that the discount was reduced from
15% to 5% of the market value of the common stock as of the last day of the
offering period. This change in the plan resulted in the expense related to the
ESPP to be non-compensatory under SFAS 123R. During the nine months ended
September 30, 2006 employees purchased 18,900 shares of common stock for
$33,642.
Under SFAS 123R, the Company recognized $151,000 and $330,000 of
compensation expense during the three and nine months ended September 30, 2006,
which was charged to SG&A expense. The following table details the effect on net
loss and loss per share had stock-based compensation expense been recorded for
the three and nine months ended September 30, 2005 based on the fair-value
method under SFAS 123, "Accounting for Stock-based Compensation" (in thousands,
except per share amounts).
Three Months Nine Months
Ended Ended
September 30, September 30,
2005 2005
-----------------------------------------------------------------------------------------
Net income (loss), as reported $(2,648) $(3,478)
Add: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (202) (441)
-----------------------------------------------------------------------------------------
Pro forma net income (loss) $(2,850) $(3,919)
Pro forma net income (loss) per share:
Basic $ (.81) $ (1.15)
Diluted $ (.81) $ (1.15)
=========================================================================================
Grant-Date Fair Value
---------------------
The Company uses the Black-Scholes option pricing model to calculate the
grant-date fair value of an award. The fair values of options granted were
calculated using the following estimated weighted average assumptions:
Nine Months Ended
September 30,
--------------------
2006 2005
---- ----
Risk-free rate of return 4.8% 4.1%
Expected life of award (years) 3.8 3.5
Expected dividend yield of stock 0% 0%
Expected volatility of stock 65% 55%
Weighted-average fair value $.48 $.80
Risk-free interest rate - the Company uses the constant maturity rates on U.S.
Treasury securities published by the U. S. Federal Reserve for a period that is
commensurate with the expected term assumption.
Expected term - the Company estimates the expected term of its option grants
through a review of its historical employee exercise behavior and through
consultation with an independent third-party advisor with the requisite
expertise in stock option valuations who also considered the Company's history
of stock price appreciation/decline and studies on employee exercise behavior.
Expected dividend yield - the Company assumes a 0% yield since it has never
declared a dividend on its common stock and is currently prohibited from doing
so without the consent of its lender.
14
Expected volatility - the Company estimates volatility by considering both
historical volatility and implied (future) volatility in consultation with an
independent third-party advisor with expertise in this area. In determining
implied volatility, the Company and advisor consider such factors as the
thinly-traded nature of the Company's stock over significant time-spans, and a
review of volatility in the Company's industry sector. The Company currently
believes that the use of implied volatility results in a more accurate estimate
of the grant-date fair value of employee stock options because it more
appropriately reflects the market's expectations of future volatility.
Historical volatility during the period commensurate with the expected term of
the Company's stock options over the past several years included a period of
time that the Company's stock price experienced unprecedented increases and
subsequent declines. The Company believes that this past stock price volatility
is unlikely to be indicative of future stock price behavior.
Option Plan Activity
--------------------
A summary of the activity under the Company's stock option plans during
the nine months ended September 30, 2006 is as follows (aggregate intrinsic
value in thousands):
Weighted
Weighted average
average remaining Aggregate
Number exercise contractual intrinsic
of shares price term (years) value
---------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 2005 2,684,619 $1.45 5.3 $582
Granted 1,264,000 .91
Exercised (12,250) .65
Canceled (4,500) 1.32
Forfeited (104,000) 1.38
---------------------------------------------------------------------------------------------------------------
Outstanding at September 30, 2006 3,827,869 $1.28 6.1 $686
===============================================================================================================
Exercisable at September 30, 2006 2,661,519 $1.42 4.5 $443
Vested or expected to vest at September 30, 2006 3,797,000 1.28 6.1 680
During the nine months ended September 30, 2006 (i) the weighted-average
grant-date fair value of options granted was $.48; (ii) the total intrinsic
value of options exercised was $14,000; and (iii) the total fair value of
options vested was $345,000. Cash received from stock option exercises during
the nine months ended September 30, 2006 was $7,914.
In September 2006, the Company's Chief Executive Officer received an
option to purchase 1,000,000 shares of common stock at an exercise price equal
to the market value of the Company's common stock on the date of grant. Under
the terms of the grant, (i) 90,900 shares were immediately exercisable; (ii)
227,275 options vest upon the closing of bridge financing of an amount greater
than $1 million; (iii) 545,460 options vest upon the closing of additional
financing of an amount greater than $5 million; and (iv) 136,365 options vest
when the closing price of the Company's common stock is greater than $3.50 per
share for five consecutive trading days.
Warrants:
---------
As of September 30, 2006, there were 900,000 warrants outstanding that
were issued to certain executive officers of the Company, all of which were
fully vested at December 31, 2005. As of September 30, 2006, the warrants had a
weighted-average exercise price of $.67, a weighted-average remaining
contractual term of 3.2 years, and an aggregate intrinsic value of $300,500.
Expense
-------
The Company recognizes expense using the straight-line prorated allocation
method. The amount of stock-based compensation recognized during a period is
based on the value of the portion of the awards that are ultimately expected to
vest. SFAS 123R requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from
those estimates. The term "forfeitures" is distinct from "cancellations" or
"expirations" and represents only the unvested portion of the surrendered
option. The Company has applied an annual forfeiture rate of 4% to all unvested
options as of January 1, 2006. Ultimately, the actual expense recognized over
the vesting period will only be for those shares that vest. As of September 30,
2006, there was $473,000 of total unrecognized compensation cost related to
15
unvested share-based awards. That cost is expected to be recognized into expense
over a weighted-average period of 1.1 years.
7. PREFERRED STOCK
The Company has 2,000,000 shares of $0.001 par value preferred stock
authorized, of which there were 259,426 and 0 Series A shares issued and
outstanding at September 30, 2006 and December 31, 2005, respectively.
September 30, December 31,
(In thousands) 2006 2005
-----------------------------------------------------------------------------------------------------------
Series A redeemable convertible preferred stock ( Note 8) $4,410 $ -
Less: unamortized discount related to warrants issued to investors and
bifurcated embedded derivative instruments (Note 5) (4,210)
-----------------------------------------------------------------------------------------------------------
Carrying amount $ 200 $ -
-----------------------------------------------------------------------------------------------------------
On February 17, 2006, March 17, 2006 and April 17, 2006, the Company sold
an aggregate of 200,456 Units of Series A Preferred Stock to several accredited
investors (the "Investors") at a price of $17.00 per Unit. Each Unit consists of
(i) one share of the Company's Series A Preferred Stock, $.001 par value per
share, and (ii) a Warrant to purchase five shares of the Company's Common Stock,
par value $.001 per share, at an exercise price of $2.125 per share (the Series
A Preferred Stock and the Warrant together "Securities"). The Securities were
not registered under the Securities Act of 1933, as amended, or applicable state
securities laws as of their dates of issuance. The Securities are subject to
restrictions on transferability and resale and may not be transferred or resold
except as permitted under the Securities Act of 1933, as amended, and applicable
state securities laws, pursuant to registration or exemption from those laws.
The proceeds received by the Company, net of $272,634 placement agent fees and
$144,156 expenses incurred by the Company, were $2,991,147.
The following describes certain of the material terms of these
transactions. The description below is not a complete description of the terms
of the financing transaction and is qualified in its entirety by reference to
the agreements entered into in connection therewith which are included as
exhibits to previously filed Current Reports on Form 8-K.
Series A Preferred Stock. Each share of Series A Preferred Stock is
convertible into ten shares of common stock, based upon an initial conversion
price of $1.70 per common share. The conversion price of the Series A Preferred
Stock will be subject to a weighted average adjustment (based on all deemed
outstanding shares of Common Stock and shares of Preferred Stock) and to reduce
dilution in the event that the Company issues additional equity securities
(other than the shares reserved for issuance under or to Laurus Master Fund
Ltd., the Company's 2002 Stock Option Plan, the Company's Employee Stock
Purchase Plan, employees, officers, consultants and directors of the Company,
and under other currently existing options, warrants and obligations to issue
shares) at a purchase price less than the Series A Preferred Stock conversion
price. The Series A Preferred Stock conversion price will also be subject to
proportional adjustment for stock splits, stock dividends, recapitalizations and
the like.
Dividends accrue at an 8% annual rate; however the Company is under no
obligation to pay such accruing dividends except under the following conditions:
(i) the Investors have the right to receive in preference to any dividend on the
Common Stock a cumulative non-compounding dividend at the rate of 8% per annum
of the original Preferred A Per Share Price; (ii) in the event of any
liquidation or winding up of the Company, the Investors shall be entitled to
receive in preference to the holders of the Common Stock an amount equal to two
times the original Preferred A Per Share Price plus any declared but unpaid
dividends; and (iii) in the event of a redemption, as further described below.
The Series A Preferred Stock is subject to mandatory conversion into
shares of common stock upon the earliest to occur of (a) the closing of the sale
of shares of common stock to the public at a price of at least $5.00 per share,
subject to anti-dilution adjustments, which results in at least $10 million of
gross proceeds to the Company; (b) the consent of the majority of the holders of
the then outstanding Series A Preferred Stock; or (c) the date upon which the
closing sale price of the common stock exceeds $5.00 per share for twenty
consecutive trading days. All of the outstanding shares of Series A Preferred
Stock shall be redeemed by the Company at its original issue price of $4,410,427
plus accrued dividends in three annual installments commencing 270 days after
receipt by the Company at any time on or after February 17, 2011 and prior
16
to February 17, 2013, of written notice from the holders of a majority of the
then outstanding shares of Series A Preferred Stock.
The Series A Preferred Stock will vote together with the Common Stock and
not as a separate class except as required by law, however, the holders of the
Series A Preferred Stock, exclusively and as a separate class, will be entitled
to elect one (1) director of the Corporation. Each share of Series A Preferred
Stock shall have a number of votes equal to the number of shares of Common Stock
then issuable upon conversion of such share of Series A Preferred Stock.
Warrant to Purchase Shares of Stock. The Investors received warrants to
purchase up to an aggregate of 1,002,280 shares of the Company's common stock at
an exercise price of $2.125 per share. The warrants expire five years from
issuance. In lieu of exercising the warrant with cash, the Holder may elect to
receive that number of shares of common stock equal to the value of the warrant
(or that portion being exercised) at the time of exercise.
Registration rights. The Company has registered the common stock
underlying the Securities for resale on Form S-1, which was declared effective
by the Securities and Exchange Commission on July 18, 2006.
Because the Series A Preferred Stock is not considered to be "conventional
convertible preferred stock", the embedded conversion option is subject to the
accounting requirements of EITF Issue 00-19. Because of the penalties we may
have to pay under the Investor Rights Agreement, and the fact that the
conversion price can be adjusted in certain circumstances, we are required by
EITF 00-19 to bifurcate the embedded conversion option and account for it as a
derivative instrument liability. This derivative instrument liability was
initially valued, using the Black-Scholes options pricing model, at $10.64 -
$13.59 per preferred share, attributable to three separate closing dates. It is
then adjusted to fair value at the end of each subsequent period, with any
changes in fair value charged or credited to income in the period of change.
Refer to Note 5 for further information on the assumptions used in determining
fair market value of the derivative instruments. The Company allocated the
$2,340,374 fair value of the embedded conversion options and $916,796 of the
$1,119,919 aggregate fair value of the 1,002,280 common stock purchase warrants
issued to the investors in the February, March and April 2006 closings, to the
$3,407,937 gross proceeds received, resulting in the recording of a $3,257,170
discount and an aggregate initial net carrying value of the preferred stock of
$150,767. The net carrying value will be adjusted, through accretion of the
discount, to $3,407,937 using the effective interest method over the 5.75 year
period to the date the holders can redeem the shares for cash. The $203,123
difference between the fair value of the investor warrants and that which was
allocated was immediately charged to additional paid-in capital, resulting from
an excess in the calculated fair market value of the embedded conversion option
and investor warrants in the April 2006 closing over the proceeds received in
that closing.
In connection with the above Series A Preferred Stock transactions, the
Company issued to its placement agent warrants (the "Placement Agent Warrants")
(i) to purchase up to an aggregate of 150,335 shares of the Company's common
stock at an exercise price of $2.125 per share and (ii) to purchase up to an
aggregate of 30,067 shares of the Company's Series A Preferred Stock at an
exercise price of $17.00 per share. The Placement Agent Warrants expire five
years from issuance. In lieu of exercising the warrants with cash, the placement
agent may elect to receive that number of shares of common stock or Series A
Preferred Stock, as applicable, equal to the value of the warrant (or that
portion being exercised) at the time of exercise. The Company also paid the
placement agent a fee of $272,634 representing 8% of the gross proceeds. The
placement agent fees, the $513,423 calculated fair value of the placement agent
warrants and $144,156 of other transaction costs were charged to additional
paid-in capital.
8. CONVERTIBLE NOTES
On February 8, 2006, the Company issued a $1,000,000 Principal Amount
Convertible Promissory Note (the "Sotomar Note") to Sotomar - Empreendimentos
Industriais e Imobiliarios, SA (the "Holder") pursuant to a Convertible Note and
Warrant Purchase Agreement (the "Purchase Agreement"). The proceeds received by
the Company, net of an $80,000 placement agent fee and $6,909 of other expenses,
were $913,091. Under the terms of the Sotomar Note, the outstanding principal,
plus any accrued but unpaid interest thereon, shall automatically convert into
shares of Series A Preferred Stock upon the sale of Series A Preferred Stock and
warrants to purchase Common Stock to accredited investors in a private placement
transaction pursuant to Regulation D (collectively, "Offered Securities") which
produces at least $500,000 of aggregate gross proceeds to the Company (a
"Preferred Offering"). As a result of the February 17, 2006 sale of Series A
Preferred Stock to an accredited investor for $750,000, the Sotomar Note,
together with $2,490 interest accrued thereon, converted into 58,970 shares of
Series A Preferred Stock.
17
In connection with the issuance of the Sotomar Note, the Holder received a
warrant to purchase up to an aggregate 529,134 shares of the Company's common
stock at an exercise price of $1.27 per share. The warrant expires ten years
from issuance. In lieu of exercising the warrant with cash, the Holder may elect
to receive that number of shares of common stock equal to the value of the
warrant (or that portion being exercised) at the time of exercise. The warrants
were valued using the Black-Scholes options pricing model, resulting in an
$834,021 discount against the proceeds of the Sotomar Note. Because the exercise
price and the number of shares are fixed, subject to normal anti-dilution
adjustments, and the Company can deliver unregistered shares, the Company
recorded the $834,021 directly to additional paid-in capital. Because the Series
A Preferred Stock into which the Sotomar Note converted has the same
characteristics as the other issued Series A Preferred Stock, the Company has
bifurcated the embedded conversion option and is accounting for it as a
derivative instrument liability, in the same manner as the other issued Series A
Preferred Stock. Since the value of the embedded conversion option of $627,500
exceeded the net carrying value of the Sotomar Note of $168,469 at the date of
conversion, the Company reduced the initial carrying value of the associated
Series A Preferred Stock to zero and recorded an immediate charge to income of
$459,031. The series A Preferred Stock will be accreted to its redemption value
of $1,002,490 using the effective interest method and an estimated life to
conversion of 5.3 years.
In connection with the Sotomar Note transaction, and pending receipt of
proceeds from the issuance of the Sotomar Note, on January 30, 2006 an affiliate
of the placement agent advanced the Company $400,000 pursuant to a convertible
note with terms similar to the Sotomar Note. The advance was repaid with $1,111
of interest on February 8, 2006. A warrant for the purchase of 22,047 shares of
common stock was issued to the affiliate for providing the advance. The warrant
has a 5 year life and is exercisable at $1.27 per share. Using Black-Scholes the
Company calculated an $18,127 value to the warrant. Because the exercise price
and the number of shares are fixed, subject to normal anti-dilution adjustments,
and the Company can deliver unregistered shares without penalty, the Company
recorded this amount directly to additional paid-in capital. Upon repayment of
the advance, the $18,127 unamortized discount was charged to interest expense.
In connection with the Sotomar Note, the placement agent received an
$80,000 fee and a warrant (the "Placement Agent Warrant") to purchase up to an
aggregate 150,000 shares of the Company's common stock at an exercise price of
$1.27 per share. The Placement Agent Warrant expires five years from issuance.
In lieu of exercising this warrant with cash, the placement agent may elect to
receive that number of shares of common stock equal to the value of the warrant
(or that portion being exercised) at the time of exercise. Because these
warrants are subject to the same registration rights and associated penalties as
described in Note 7, the Company has accounted for the warrant as a derivative
instrument liability. See Notes 1 and 5 for further accounting information.
9. INTEREST EXPENSE
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
(In thousands) 2006 2005 2006 2005
-------------------------------------------------------------------------------------------------
Interest expense on outstanding borrowings $45 $19 $121 $ 44
Amortization of deferred financing costs (1) 15 11 37 23
Amortization of discounts on convertible notes (2) 16 25 63 44
-------------------------------------------------------------------------------------------------
Total interest expense $76 $55 $221 $111
=================================================================================================
(1) Consists of amortization of an imputed discount of $335,000 on warrants
issued to the Laurus Master Fund Ltd. ("Laurus"), and amortization of a
prepaid facility fee of $117,000 in connection with a revolving credit
facility entered into with Laurus on March 31, 2005. These costs are
included in deferred financing costs on the Consolidated Balance Sheet,
and are being amortized to interest expense over the three-year term of
the facility.
(2) Consists of (i) the write-off of a $18,127 discount recorded in valuing
free-standing warrants issued in February 2006 in connection with a
convertible note which was subsequently repaid in February (see Note 8);
and (ii) amortization of discounts imputed in accounting for the Company's
convertible revolving and minimum borrowing notes with Laurus (see
Note 4).
18
10. SEGMENT INFORMATION
Historically, the Company had operated in a single business segment,
selling telecommunications equipment to businesses. During 2005, the Company
formed OIPV and commenced activities related to the development of a new
business segment which provides hosted carrier-based Voice over IP products and
related network services to the small-to-medium business marketplace. The hosted
VoIP business, presented below as the "IP Telephony Services" business segment,
commenced sales operations in January 2006. Summarized financial information for
the Company's reportable business segments for the three and nine months ended
September 30, 2006 and 2005, is presented below. Geographic information is not
presented because the Company does not operate outside of the United States.
Corporate expenses consist primarily of compensation and benefits, costs
associated with corporate governance and compliance, investor relations, and
other shared general expenses not allocated to the business segments. There are
no inter-segment sales.
Business segment information as of and for the three months ended
September 30, 2006 and 2005 is as follows:
Telecom- IP
munication Telephony
(In thousands) Equipment Services Corporate Consol.
--------------------------------------------------------------------------------
2006:
Revenues $2,868 $ 53 $ - $ 2,921
Operating loss (833) (1,248) (340) (2,421)
Depreciation and amortization
of property and equipment 38 23 - 61
Identifiable assets 3,910 776 514 5,200
Capital expenditures 19 51 - 70
2005:
Revenues $4,807 $ - $ - $ 4,807
Operating loss (145) (243) (258) (646)
Depreciation and amortization
of property and equipment 24 1 3 28
Identifiable assets 5,581 326 560 6,467
Capital expenditures 1 301 - 302
Business segment information as of and for the nine months ended
September 30, 2006 and 2005 is as follows:
Telecom- IP
munication Telephony
(In thousands) Equipment Services Corporate Consol.
--------------------------------------------------------------------------------
2006:
Revenues $10,475 $ 115 $ - $10,590
Operating loss (1,446) (3,465) (929) (5,840)
Depreciation and amortization
of property and equipment 88 78 - 166
Identifiable assets 3,910 776 514 5,200
Capital expenditures 78 215 - 293
2005:
Revenues $11,699 $ - $ - $11,699
Operating loss (469) (486) (749) (1,704)
Depreciation and amortization
of property and equipment 69 4 8 81
Identifiable assets 5,581 326 560 6,467
Capital expenditures 75 301 - 376
19
The following table reconciles the totals reported for the operating loss
of the segments to the Company's reported loss before income taxes:
Three months ended Nine months ended
September 30, September 30,
------------------- -------------------
(In thousands) 2006 2005 2006 2005
------------------------------------------------------------------------------------------
Total segment operating losses $(2,081) $ (388) $(4,911) $ (955)
Unallocated amounts:
Corporate expenses (340) (258) (929) (749)
Interest expense (76) (55) (221) (111)
Derivative instrument income (expense) 740 (1,949) 2,403 (1,662)
Other income 5 3 20 7
------------------------------------------------------------------------------------------
Consolidated loss before income taxes $(1,752) $(2,647) $(3,638) $(3,470)
==========================================================================================
11. EMPLOYEE BENEFIT PLAN
The components of the net periodic benefit cost included in the results of
operations for the three and nine months ended September 30, 2006 and 2005 are
as follows:
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
(In thousands) 2006 2005 2006 2005
-------------------------------------------------------------------------------
Service cost $23 $21 $ 67 $ 64
Interest cost 14 12 38 32
Recognized actuarial losses 2 1 6 6
-------------------------------------------------------------------------------
Net expense $39 $34 $111 $102
===============================================================================
12. ACQUISITION
Effective July 3, 2006, the Company entered into an agreement with Rhyne
Communications, Inc. (RCI"), Rhyne Capital Corporation ("RCC") and Mr. Henry
Delgado (the sole owner of RCI and RCC) (collectively "Rhyne") (the "Agreement")
to acquire certain fixed assets, telephone equipment, existing maintenance
contracts, and vehicles. The purchase price consisted of (i) $15,000 cash for
the acquired fixed assets, consisting primarily of computer equipment, office
furniture and equipment; and (ii) 50,000 shares of restricted common stock which
had a market value of $61,000 on the acquisition date. The acquired maintenance
contracts, which have remaining terms of less than one year, have an annualized
contract value of $94,000, of which $33,000 is billable by the Company through
their current renewal dates. The Company additionally agreed to acquire vehicles
currently being financed by Rhyne under installment notes with finance
companies, with remaining terms ranging from 12-59 months, by agreeing to assume
their remaining installment payments, which aggregated $61,717 at the date of
acquisition. The purchase price was allocated as follows (dollars in thousands):
Value of 50,000 shares issued at $1.22 per share $ 61
Cash paid for fixed assets 15
----
Total fair value of purchase price 76
Assets Purchased:
Property & equipment $ 15
Vehicles 60
Customer contracts 55
----
Total Assets Purchased 130
Liabilities Assumed:
Principal amount-installment notes payable $ 54
----
Total Liabilities Assumed 54
20
The Company entered into this Agreement in order to expand its direct
installation and maintenance business. In connection with the Agreement, the
Company entered into a two-year employment agreement with Mr. Delgado, and hired
five former installation technicians of RCI. In addition, the Company agreed to
an assignment of RCI's existing lease contract, pending approval by the
landlord, for office space in Pine Brook, NJ, from which the Company will locate
its installation and maintenance operations. Under the lease, the Company will
be leasing 5,328 square feet of office space under a term expiring March 31,
2011. The monthly rental payments will range from $3,996 to $4,493 over the
lease term. The Company is amortizing the assigned value of the customer
contracts over a two-year period.
13. INCOME (LOSS) PER SHARE
Basic income (loss) per share is computed by dividing the net income
(loss) attributable to the common stockholders (the numerator) by the weighted
average number of shares of common stock outstanding (the denominator) during
the reporting periods. Diluted income (loss) per share is computed by increasing
the denominator by the weighted average number of additional shares that could
have been outstanding from securities convertible into common stock, such as
stock options and warrants (using the "treasury stock" method), and convertible
preferred stock and debt (using the "if-converted" method), unless their effect
on net income (loss) per share is antidilutive. Under the "if-converted" method,
convertible instruments are assumed to have been converted as of the beginning
of the period or when issued, if later, and any proceeds received on conversion
are assumed to have been used to purchase treasury stock at the average market
price for the period. Net income is adjusted to eliminate interest expense and
any gains or losses from derivative instruments during the period.
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
2006 2005 2006 2005
----- ----- ----- -----
Weighted-average securities excluded from the computation
of diluted earnings (loss) per share (1):
Employee stock options and warrants 3,025 1,619 2,838 2,488
Warrants issued to Laurus 500 122 500 335
Laurus convertible debt 743 726 710 434
Series A convertible preferred stock 2,594 - 1,904 -
Warrants for preferred and common shares issued in
private placements 2,154 - 1,110 -
----- ----- ----- -----
9,016 2,467 7,062 3,257
===== ===== ===== =====
(1) These securities have been excluded because (i) their exercise or
conversion prices were higher than the average market price during the
period, or (ii) their inclusion would reduce net loss per share and,
therefore, be anti-dilutive.
14. SUBSEQUENT EVENTS
Financing Transactions:
-----------------------
On October 17, 2006, the Company and the Laurus Master Fund. LTD.
("Laurus") executed and entered into an Amendment and Forbearance Agreement, and
related documents, pursuant to which among other things (a) Laurus was issued a
Secured Demand Note, with interest accruing at prime plus 2%, for a principal
amount of up to $1,000,000 (the "New Note") ) and a Common Stock Purchase
Warrant to purchase up to a certain number of shares of the Company's common
stock at $0.60 per share (the "New Warrant"); (b) the conversion price under the
existing Secured Revolving Note and Secured Convertible Minimum Borrowing Notes
previously issued to Laurus (the "Prior Notes"), as well as the exercise price
for the previously issued Common Stock Purchase Warrant to Laurus dated March
31, 2005 to purchase up to 500,000 shares of Company's common stock (the "Prior
Warrant), were each reduced to $.60 per share; (c) a Master Security Agreement
(the "Master Security Agreement") granting Laurus security interest in all of
the assets of the Company's and its wholly-owned subsidiary, OIPV Corp. (the
"Subsidiary"); (d) two separate Stock Pledge Agreements each pledging all of the
shares of common stock of the Subsidiary issued to the Company pursuant to the
Master Security Agreement and the Security Agreement between the same parties
dated March 31, 2005; and (e) Laurus agreed to forbear from exercising its
rights with respect to certain events of default that may have occurred under
its financing agreements with the Company and
21
OIPV Corp., until the earliest to occur of January 15, 2007 or the occurrence of
a Forbearance Default, as defined in the Amendment and Forbearance Agreement.
On October 18, 2006, the Company was advanced $500,000 under the New Note.
Further advances under the New Note, up to an additional $500,000, are
contingent upon the Company obtaining additional financing from other sources.
In such event, Laurus may make additional advances of funds under the New Note
(the "Additional Advances") in an aggregate amount equal to thirty-seven and
one-half percent (37.5%) of the gross proceeds of such additional external
financing provided, however, in the event the Company does not actually receive
and retain in the aggregate at least 90% of the gross proceeds of such
financing, then the Additional Advances shall not exceed an aggregate amount
equal to thirty-seven and one-half percent (37.5%) of the net proceeds actually
received and retained.
Pursuant to the Amendment and Forbearance Agreement described above, the
New Warrant allows Laurus to purchase the Company's common stock at $0.60 per
share up to a number equal to 8,333.34 shares of Common Stock for each tranche
of $10,000 funded by Laurus to the Company or its designee under the Secured
Demand Note. The New Warrant also contains normal anti-dilution clauses in the
event of stock splits or stock dividends, and provides registration rights with
respect to the underlying equity securities to be equal to the registration
rights of certain future investors in the Company.
This transaction was completed in a private offering pursuant to an
exemption from registration under Section 4(2) of the Securities Act of 1933, as
amended. The New Warrant and its underlying securities were not registered under
the Securities Act of 1933, as amended, or applicable state securities laws. The
New Warrant and its underlying securities are subject to restrictions on
transferability and resale and may not be transferred or resold except as
permitted under the Securities Act of 1933, as amended, and applicable state
securities laws, pursuant to registration or exemption from those laws.
Conversion of the current aggregate principal amounts under the Prior
Notes at the reduced fixed conversion price of $0.60 could result in the
potential issuance of approximately 707,000 more shares of common stock than
would have been issued under the pre-amendment fixed conversion prices.
On November 8, 2006, the Company engaged the services of Wall Street
Consulting, Inc. ("WSG") to act as investor and public relations counsel to the
Company, In connection therewith, WSG will receive a cash fee of $7,500 per
month, plus, for each full twelve month period that the agreement is in effect,
WSG will be granted options to purchase as many shares of Company common stock
as could be purchased for $100,000. Each option grant shall have a term of five
years and an exercise price per share equal to the closing price of the
Company's common stock on the date of grant.
Employment Agreement
--------------------
On October 11, 2006, the Company executed an employment agreement with its
Chief Financial Officer ("CFO") which includes the following: (i) the term of
the agreement is from August 1, 2006 to December 31, 2006; (ii) the CFO's annual
base salary was increased from $150,000 to $175,000; (iii) the grant of an
option to purchase 50,000 shares of common stock at an exercise price equal to
the closing market price of the Company's common stock on the date of grant; and
(iv) a retention bonus of $60,000 conditioned upon continued employment through
December 31, 2006. The agreement also provides severance pay for the CFO during
the term of the agreement under certain circumstances. Should the Company
terminate the agreement without "cause", or in the event of a change in control
of the Company, severance pay will equal three times the CFO's base salary, and
an award of 50,000 stock options. Mr. LaVigne has notified the Company that he
would not accept an extension of his employment agreement beyond its current
term. On November 6, 2006, the Company engaged the services of Mr. Philip
McTague as a consultant to the Company, reporting directly to the Chief
Executive Officer, in order to provide a smooth transition of Mr. LaVigne's
current responsibilities. Upon Mr. LaVigne's departure, Mr. McTague will be
named "acting" CFO. In the capacity of acting CFO he will assume full
responsibility for managing all day to day financial reporting of the company,
management of the finance department employees, cash management and all
Securities and Exchange (SEC) reporting consistent with the requirements of a
CFO of a publicly traded company. He will also assist the Chief Executive
Officer, as directed, in new financing efforts, negotiations with current
creditors and existing borrowing relationships. The term of Mr. McTague's
agreement is for three (3) months with three (3) three month renewals at the
Company's option. On November 9, 2006, the Company's Audit Committee met to
begin the process of identifying a successor to Mr. LaVigne.
22
15. COMMON STOCK TO BE ISSUED
On September 15, 2006, the Company engaged the services of Stonegate
Securities, Inc. ("Stonegate") to act as placement agent on a follow-on offering
of securities of at least $10 million. Under the terms of the agreement,
Stonegate, or its designee, was to receive 50,000 shares of restricted common
stock upon execution of the agreement on September 15, 2006, and an additional
50,000 shares upon commencement of the offering solicitation. These shares have
been valued at $112,000 based upon the market value of the Company's stock price
at the time the terms of the agreement were agreed to. Included in Stockholders'
Deficiency at September 30, 2006 was $56,000 representing the value of 50,000
shares which were earned by Stonegate as of that date. All 100,000 shares were
issued in October 2006.
16. NEW ACCOUNTING PRONOUNCEMENTS
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments--an amendment of FASB Statements No. 133 and 140"
("SFAS 155"). This Statement amends FASB Statements No. 133, "Accounting for
Derivative Instruments and Hedging Activities", and No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities".
This Statement resolves issues addressed in Statement 133 Implementation Issue
No. D1, "Application of Statement 133 to Beneficial Interests in Securitized
Financial Assets." SFAS 155 (a) Permits fair value re-measurement for any hybrid
financial instrument that contains an embedded derivative that otherwise would
require bifurcation; (b) Clarifies which interest-only strips and principal-only
strips are not subject to the requirements of Statement 133; (c) Establishes a
requirement to evaluate interests in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation; (d)
Clarifies that concentrations of credit risk in the form of subordination are
not embedded derivatives; and (e) Amends Statement 140 to eliminate the
prohibition on a qualifying special-purpose entity from holding a derivative
financial instrument that pertains to a beneficial interest other than another
derivative financial instrument. SFAS 155 is effective for all financial
instruments acquired or issued after the beginning of the first fiscal year that
begins after September 15, 2006. The Company is currently reviewing the affect
that adoption of this Statement will have on our financial position or results
of operations.
In May 2005, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 154, "Accounting
Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB
Statement No. 3" ("SFAS 154"). SFAS 154 applies to all voluntary changes in
accounting for, and reporting of, changes in accounting principles. SFAS No. 154
requires retrospective application to prior periods' financial statements of a
voluntary change in accounting principles unless it is not practical to do so.
APB No. 20 previously required that most voluntary changes in accounting
principles be recognized by including in net income of the period of the change
the cumulative effect of changing to the new accounting principle. SFAS No. 154
is effective for accounting changes and corrections of errors made in fiscal
years beginning after December 15, 2005. SFAS 154 will only affect our financial
statements if we change any of our accounting principles. At this time, no such
changes are contemplated.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109" ("FIN
48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized
in an enterprise's financial statements. This Interpretation prescribes a
"more-likely-than-not" recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. This Interpretation also provides guidance
on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. The Company will be required to adopt the
provisions of FIN 48 beginning in fiscal 2008. The Company is currently
assessing the impact of the adoption of FIN 48 on its Consolidated Financial
Statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 prescribes a single definition of fair value as the price
that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. The
Company does not believe the adoption of SFAS 157 will have a material impact on
its financial condition or results of operations. SFAS 157 is effective for the
Company's fiscal year beginning January 1, 2008.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The discussions set forth below and elsewhere in this Quarterly Report on
Form 10-Q contain certain statements, based on current expectations, estimates,
forecasts and projections about the industry in which we operate and
management's beliefs and assumptions, which are not historical facts and are
considered forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 ("the Act"). Forward-looking statements
include, without limitation, any statement that may predict, forecast, indicate,
or imply future results, performance, or achievements, and may contain the words
"believe," "will be," "will continue," "will likely result," "anticipates,"
"seeks to," "estimates," "expects," "intends," "plans," "predicts," "projects,"
and similar words, expressions or phrases of similar meaning. Our actual results
could differ materially from those projected in the forward-looking statements
as a result of certain risks, uncertainties and assumptions, which are difficult
to predict. Many of these risks and uncertainties are described in Part II, Item
1A "Risk Factors". All forward-looking statements included in this document are
based upon information available to us on the date hereof. We undertake no
obligation to update publicly any forward-looking statements, whether as a
result of new information, future events or otherwise. In addition, other
written or oral statements made or incorporated by reference from time to time
by us or our representatives in this report, other reports, filings with the
Securities and Exchange Commission ("SEC"), press releases, conferences, or
otherwise may be forward-looking statements within the meaning of the Act.
RESULTS OF OPERATIONS
Overview
For the three months ended September 30, 2006, we reported a net loss of
$1,753,000 or $(.42) per share, on revenues of $2,921,000. This compares with a
net loss of $2,648,000 or $(.75) per share, on revenues of $4,807,000 reported
for the three months ended September 30, 2005. The net loss in each quarterly
period included non-cash derivative instrument income (expense) of $740,000 and
$(1,949,000), respectively, primarily arising from decreases or (increases) in
the fair market value of the Company's derivative financial instruments during
these periods, as more fully described in Notes 1 and 5 of the Notes to
Consolidated Financial Statements contained herein. The reported results for the
three months ended September 30, 2006 and 2005 reflect operating losses of
$2,421,000 and $646,000, respectively, of which approximately $1,248,000 and
$243,000, respectively, is attributable to the operations of our wholly-owned
subsidiary OIPV Corp. ("OIPV") as further described below.
For the nine months ended September 30, 2006, we reported a net loss of
$3,649,000 or $(.92) per share, on revenues of $10,590,000. This compares with a
net loss of $3,478,000 or $(1.02) per share, on revenues of $11,699,000 reported
for the nine months ended September 30, 2005. The net loss in each period
included non-cash derivative instrument income (expense) of $2,403,000 and
$(1,662,000), respectively, primarily arising from decreases or (increases) in
the fair market value of the Company's derivative financial instruments during
these periods, as more fully described in Notes 1 and 5 of the Notes to
Consolidated Financial Statements contained herein. The reported results for the
nine months ended September 30, 2006 and 2005 reflect operating losses of
$5,840,000 and $1,704,000, respectively, of which approximately $3,465,000 and
$486,000, respectively, is attributable to the operations of OIPV.
As further described in our Annual Report on Form 10-K for the year ended
December 31, 2005, and in Note 1- "Business Operations and Going Concern Issues"
in the accompanying financial statements, we have taken several measures in
attempts to turnaround our operating performance. The turnaround strategy was
principally based upon trying to stabilize our legacy telecommunications
equipment business ("Legacy Business") through building a larger and more highly
qualified sales force and diversifying our product offerings and targeted
customers, increasing our focus on the small-to-medium size business ("SMB")
market along with continuing to serve our base of large, "Enterprise" customers,
while at the same time developing an IP telephony services business in order to
transition the Company's business model to a broader communications solutions
provider. In January 2006, OIPV Corp became operational, offering carrier-based
hosted IP telephony services along with network services nationwide. Its primary
target is also the SMB market. Our efforts have not resulted in increased
revenues in 2006 to date as compared to 2005, and revenue levels are currently
not sufficient to cover the operating costs of each business segment. The
operating losses that we are ncurring in OIPV's IP telephony business segment
have been expected, as we are still in the development stage of this business as
we continue its infrastructure buildout and product development and
revenue-generation activities. This is an emerging growth company in a rapidly
expanding new market, and it will take some additional time to ramp up to
profitability. The operating losses that we are
24
iincurring in the Legacy Business are primarily the result of reduced sales
levels and gross profit margins attributable to increased competitive pressures
in the telecommunications equipment market. Management's plans for the Legacy
Business include seeking an acquisition or merger opportunity as a means to
significantly grow this division's revenues and return it to profitability
through consolidation economies in operating costs.
As a result, the Company continues to be dependent upon its revolving
credit facility and raising cash from private and public placements of debt and
equity in order to fund its business and business development plans. These
conditions raise substantial uncertainties about the Company's ability to
continue as a going concern. The Company's continuation as a going concern is
dependent on its ability to meet its obligations, to obtain additional financing
as, and when, required, to generate sufficient operating revenue and ultimately
to attain profitability.
In order to finance our business turnaround and expansion plans, we
increased our credit lines in March 2005, obtaining a $3 million credit facility
from Laurus Master Fund Ltd., which replaced a $1.7 million credit facility.
During 2006, the Company raised approximately $4 million of additional capital
through offerings of convertible debt and preferred stock to unaffiliated
private investors. This new capital has been used to continue the build out and
national deployment of our IP telephony products and services, and to fund our
2006 operating losses. Significant amounts of additional external financing,
however, will be required in order to sustain current operations and further
develop OIPV's IP telephony business to the operating levels anticipated by
management. For additional information on our financial condition and
management's operating and financing plans, refer to Notes 1 and 14 of the
accompanying Notes to Consolidated Financial Statements, and to the Liquidity
and Capital Resources section which follows.
Additional information on our results of operations and financial
condition for the three and nine ended September 30, 2006 follows below.
Revenues
Three months ended Nine months ended
September 30, September 30,
------------------ -------------------
(In thousands) 2006 2005 2006 2005
-------------------------------------------------------------------------------
Equipment:
End-user equipment sales $2,209 $3,739 $ 7,925 $ 9,273
Equipment sales to resellers 115 151 345 305
-------------------------------------------------------------------------------
Total equipment sales 2,324 3,890 8,270 9,578
-------------------------------------------------------------------------------
Services:
Installations 421 652 1,614 1,311
Other services 24 12 68 60
IP telephony services 50 - 90 -
-------------------------------------------------------------------------------
Total services 495 664 1,772 1,371
Other revenue 102 253 548 750
-------------------------------------------------------------------------------
Total services and other revenue 597 917 2,320 2,121
-------------------------------------------------------------------------------
Consolidated revenues $2,921 $4,807 $10,590 $11,699
-------------------------------------------------------------------------------
Revenues by business segment:
Telecommunications Equipment $2,868 $4,807 $10,475 $11,699
IP Telephony Services 53 - 115 -
-------------------------------------------------------------------------------
Consolidated revenues $2,921 $4,807 $10,590 $11,699
-------------------------------------------------------------------------------
Equipment Sales. End user equipment sales for the three months ended
September 30, 2006 decreased by $1,530,000 or 41% from the comparable 2005
period. The decrease consisted of a $2,291,000 or 85% decrease in systems sales,
partly offset by a $761,000 or 72% increase in parts sales. End user equipment
sales for the nine months ended September 30, 2006 decreased by $1,348,000 or
15% over the comparable 2005 period, as a result of a $2,082,000 decrease in
system sales, partly offset by a $734,000 increase in parts sales. A portion of
the decline in system sales for the three and nine-month periods was
attributable to an unusually large sale to a single customer in 2005, which
accounted for $574,000 and $1,075,000, respectively of the period-over-period
decline. The telecommunications equipment business has become extremely
price-competitive, especially among the larger businesses. Equipment has become
more of a "commodity"
25
business and less of a "value-added" business, and has therefore become more
prone to price-shopping by customers. This situation has affected our sales
levels, and we expect that this business environment will continue. Since March
2005, we have increased our focus on capturing more market share in the
small-to-medium - sized business ("SMB") marketplace in order to generate
incremental equipment sales revenues. Although overall equipment sales revenues
have declined from the prior year levels, we have experienced significant sales
growth in the SMB sector in both the current quarter and nine-month periods as
compared to last year.
Services revenue for the three months ended September 30, 2006 decreased
by $169,000 or 25% from the comparable 2005 period, attributable to a $230,000
decrease in the legacy telecommunications business installation revenues, of
which $168,000 was attributable to a single customer as referred to above,
partly offset by $50,000 of hosted and network service revenues generated by
OIPV, and an $11,000 increase in other provided services. Services revenue for
the nine months ended September 30, 2006 increased by $401,000 or 29% over the
comparable 2005 period, attributable to a $303,000 increase in the Legacy
Business's installation revenues, $90,000 of hosted and network service revenues
generated by OIPV and an $8,000 increase in other provided services. An increase
or decrease in installation revenues, however, does not always coincide with the
reported increase or decrease in system sales since installations may occur in
different periods than the related system sale.
Other revenue for the three months ended September 30, 2006 decreased by
$151,000 or 60% from the comparable 2005 period, primarily attributable to a
$127,000 decrease in commissions earned on Avaya maintenance contract sales.
Other revenue for the nine months ended September 30, 2006 decreased by $202,000
or 27% from the comparable 2005 period, primarily attributable to a $200,000
decrease in commissions earned on Avaya maintenance contract sales. In the sale
of Avaya maintenance contracts, the Company receives a one-time commission, and
all of the equipment service obligations are borne entirely by Avaya.
Cost of Revenues and Gross Profit. Total cost of revenues for the three
months ended September 30, 2006 was $2,440,000, a decrease of $1,128,000 or 32%
from the comparable 2005 period. The gross profit for the three months ended
September 30, 2006 was $481,000, a decrease of $758,000 or 61% from the
comparable 2005 period. As a percentage of revenue, the consolidated gross
profit margin was 16% for the third quarter of 2006, compared to 26% for the
comparable 2005 period. Total cost of revenues for the nine months ended
September 30, 2006 was $8,153,000, a decrease of $217,000 or 3% from the
comparable 2005 period. The gross profit for the nine months ended September 30,
2006 was $2,437,000, a decrease of $892,000 or 27% from the comparable 2005
period. As a percentage of revenue, the consolidated gross profit margin was 23%
for 2006, compared to 28% for the comparable 2005 period.
Gross profit by business segment is as follows (in thousands):
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
2006 2005 2006 2005
----- ------ ------ ------
Telecommunications Equipment:
Gross profit $ 582 $1,239 $2,696 $3,329
Percent of segment revenues 20% 26% 26% 28%
----- ------ ------ ------
IP Telephony Services:
Gross profit (loss) $(101) - $ (259) -
Percent of segment revenues(1) - - - -
----- ------ ------ ------
Consolidated:
Gross profit $ 481 $1,239 $2,437 $3,329
Percent of consolidated revenues 16% 26% 23% 28%
===== ====== ====== ======
(1) The percentage is less than 0% in all periods presented.
The consolidated gross profit margin was adversely impacted by a $101,000
and $259,000 negative gross profit recorded by the IP Telephony Services
business segment ("OPIV") during the three and nine months ended September 30,
2006, respectively. OIPV, which commenced sales operations in January 2006, has
not currently generated sufficient revenues to cover its network operating
costs.
Gross Profit Margins on Equipment Sales. For the three months ended
September 30, 2006, the consolidated gross profit margin on equipment sales was
22% compared to 26% in 2005. For the nine months ended September 30, 2006, the
26
gross profit margin on equipment sales was 26% compared to 28% in 2005. The
decrease in both periods was attributable to lower profit margins on end user
parts sales, partly offset by higher margins on systems sales. Profit margins on
system sales were higher than last year due in part to increased sales to the
SMB marketplace at higher average profit margins than we generate from sales to
large, "Enterprise level" companies. The telecommunications equipment business
has become extremely price-competitive, especially among the larger businesses.
Equipment has become more of a "commodity" business and less of a "value-added"
business, and has therefore become more prone to price-shopping by customers,
which has had a negative impact on profit margins. We expect that this business
environment will continue.
Gross Profit Margins on Services Revenue. The consolidated gross profit
margin on services revenue was 2% for the three months ended September 30, 2006
compared with 25% in the comparable 2005 period. The 2006 profit margin included
a 33% profit margin generated by the Legacy Business, compared to 25% in the
prior year period. The improved current year profit margins generated by the
Legacy Business was attributable to higher margins on installation services,
which was primarily attributable to the implementation of a direct installation
workforce, thereby reducing the Company's use of subcontractors. The
consolidated gross profit margin also included a negative profit margin recorded
by OIPV, which. incurred $101,000 of hosted and network service costs in excess
of its realized revenues during this period, which represented its third quarter
of sales operations.
The consolidated gross profit margin on services revenue was 11% for the
nine months ended September 30, 2006 compared with 34% in the comparable 2005
period. The 2006 profit margin included a 36% profit margin generated by the
Legacy Business, compared to 34% in the prior year period. The improved current
year profit margin generated by the Legacy Business was attributable to higher
margins on installation services, which was primarily attributable to the
implementation of a direct installation workforce, thereby reducing the
Company's use of subcontractors. The consolidated gross profit margin also
included a negative profit margin from OIPV, which incurred $261,000 of hosted
and network service costs in excess of its realized revenues during 2006.
OIPV's hosted and network service costs, which include its network
operations center, facility costs, fees paid to third-party carriers, and
depreciation of its network equipment and licenses, currently provide "excess
capacity", and as such will continue to have a negative impact on the Company's
profit margins until such time as the volume of business generated exceeds these
costs.
Gross Profit Margins on Other Revenues. The gross profit margin on other
revenues was 64% and 78%, respectively during the three and nine months ended
September 30, 2006, compared with 84% and 86% during the comparable prior year
period. Other revenue primarily consists of one-time commissions earned on the
sale of Avaya maintenance contracts which generate a 100% profit margin. The
decrease in gross profit margin in each current period resulted from lower sales
of these maintenance contracts.
Other Cost of Revenues. Other cost of revenues consists of product
handling, purchasing and facility costs and expenses incurred by the Legacy
Business. They represented approximately 5% and 3% of equipment revenues during
the three months ended September 30, 2006 and 2005, respectively, and 4% of
equipment revenues during the nine months ended September 30, 2006 and 2005.
Selling, General and Administrative ("SG&A") Expenses.
Three months ended September 30, 2006:
SG&A expenses for the three months ended September 30, 2006 were
$2,902,000, an increase of $1,017,000 or 54% from the comparable 2005 period.
SG&A expenses for the three months ended September 30, 2006 were 99% of
revenues, compared to 39% of revenues in 2005. Approximately $915,000 of the
increase in SG&A expenses were incurred by, or allocated to, OIPV. The growth in
OIPV's SG&A expenses is primarily attributable to the continued, planned
buildout of OIPV's sales, marketing and operations support infrastructure and
associated facilities costs, as further described below. The remaining $102,000
increase was attributable to the Legacy Business and unallocated corporate
expenses, as further described below.
Sales and marketing expenses accounted for $429,000 of the increase in
SG&A for the three months ended September 30, 2006, of which $505,000 was
incurred by OIPV, attributable to compensation and expenses in the buildout to
date of its sales and marketing team. This was partly offset by a $76,000
decrease in sales and marketing expenses incurred by the
27
Legacy Business, attributable to lower sales commissions. The Company recorded
$31,000 of non-cash stock option expense from the implementation of the
accounting requirements of SFAS 123R, as further described in Note 6 -
Stock-Based Compensation.
General and administrative expenses accounted for $588,000 of the increase
in SG&A for the three months ended September 30, 2006, of which $410,000 of the
increase was directly incurred by, or allocated to, OIPV, related to the
continuing buildout of its operations and administrative support infrastructure
including compensation of management and administrative personnel, office rent
and related expenses associated with its national operations center in Denver,
Colorado, costs associated with the outsourcing of its billing operations,
insurance, business travel and depreciation. The remaining $178,000 increase in
G&A was attributable to the Legacy Business and unallocated corporate expenses,
and primarily consisted of compensation increases and increased legal fees in
connection with the Company's financing activities. The increase in SG&A
includes $121,000 of non-cash stock option expense as referred to above.
Nine months ended September 30, 2006:
SG&A expenses for the nine months ended September 30, 2006 were
$8,277,000, an increase of $3,244,000 or 64% from the comparable 2005 period.
SG&A expenses for the nine months ended September 30, 2006 were 78% of revenues,
compared to 43% of revenues in 2005. Approximately $2,741,000 of the increase in
SG&A expenses were incurred directly by, or allocated to, OIPV. The growth in
OIPV's SG&A expenses is primarily attributable to the continued, planned
buildout of OIPV's sales, marketing and operations support infrastructure and
associated facilities costs, as further described below. The remaining $503,000
increase was attributable to the Legacy Business and unallocated corporate
expenses, as further described below.
Sales and marketing expenses accounted for $1,546,000 of the increase in
SG&A for the nine months ended September 30, 2006, of which $1,332,000 of the
increase was incurred by OIPV, attributable to compensation and expenses in the
buildout to date of its sales and marketing team. The remaining $214,000
increase was incurred by the Legacy Business, primarily attributable to
compensation associated with its sales and sales support team. The increase in
sales and marketing expenses includes $113,000 of non-cash stock option expense.
General and administrative expenses accounted for $1,698,000 of the
increase in SG&A for the nine months ended September 30, 2006, of which
$1,409,000 of the increase was directly incurred by, or allocated to, OIPV,
related to the continuing buildout of its operations and administrative support
infrastructure including compensation of management and administrative
personnel, office rent and related expenses associated with its national
operations center in Denver, Colorado, costs associated with the outsourcing of
its billing operations, insurance, business travel and depreciation. The
remaining $209,000 increase in G&A expenses was attributable to the Legacy
Business and unallocated corporate expenses, and primarily consisted of
increased compensation, and increased legal, accounting and investor relations
fees. The increase in general and administrative expenses includes $222,000 of
non-cash stock option expense as referred to above. Included in general and
administrative expense in 2005 was $84,000 of expense related to the early
termination of the Company's credit facility with BACC.
We expect our SG&A expenses to increase as we continue the infrastructure
development and deployment of OIPV.
Other Income (Expense). Other income (expense) for the three and nine
months ended September 30, 2006 was $669,000 and $2,202,000, respectively,
compared with $(2,001,000) and $(1,766,000), respectively, for 2005. The
principal components of other income (expense) are as follows.
Interest Expense:
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
(In thousands) 2006 2005 2006 2005
---------------------------------------------------------------------------------------------
Interest expense on outstanding borrowings $45 $19 $121 $ 44
Amortization of deferred financing costs 15 11 37 23
Amortization of discounts on convertible notes 16 25 63 44
---------------------------------------------------------------------------------------------
Total interest expense $76 $55 $221 $111
=============================================================================================
28
The increase in interest expense on outstanding borrowings was primarily
attributable to higher average borrowing levels and interest rates under the
Company's credit facilities. Amortization of deferred financing costs consists
of (i) the amortization of a $335,000 imputed discount on warrants issued to
Laurus and (ii) the amortization of a $117,000 prepaid facility fee in
connection with the Laurus revolving credit facility entered into March 31,
2005. These costs are included in deferred financing costs on the Consolidated
Balance Sheet, and are being amortized to interest expense over the three-year
term of the facility. Amortization of discounts on convertible notes primarily
consists of amortization of the imputed discount on the Laurus Minimum Borrowing
Note and Revolving Note (see Note 4). Discounts imputed in accounting for the
Company's convertible notes and warrants issued to the Laurus Master Fund
pursuant to this credit facility, are being amortized to interest expense over
their term using the effective interest method.
Derivative instrument income (expense). The Company recorded derivative
instrument income of $740,000 and $2,403,000 during the three and nine months
ended September 30, 2006, respectively, from a reduction in the calculated fair
market value of derivative instrument liabilities arising from its 2006 private
placements of convertible debt, convertible Series A preferred stock and
associated common and preferred stock warrants, as well as from its Laurus
convertible notes and issued free-standing warrants. The Company recorded
derivative instrument expense of $(1,949,000) and $(1,662,000) during the three
and nine months ended September 30, 2005, respectively, from derivative
instrument liabilities arising from its Laurus convertible notes and issued
free-standing warrants. The recording of derivative instrument expense resulted
from an increase in the calculated fair market value of such derivative
instrument liabilities from their inception to the end of each reporting period
due to increases in the market value of the Company's common stock. These
"mark-to-market" adjustments are non-cash, with no impact on liquidity.
Other income for all periods presented consisted of interest earned on
invested cash.
Provision for Income Taxes. The provision for income taxes represents
estimated minimum state taxes in all reported periods. We maintain a full
valuation allowance against our net deferred tax assets, which consist primarily
of net operating loss and capital loss carryforwards, and timing differences
between the book and tax treatment of inventory and other asset valuations.
Realization of these net deferred tax assets is dependent upon our ability to
generate future taxable income.
LIQUIDITY AND CAPITAL RESOURCES
The Company had a working capital deficiency of $2,471,000 ($2,036,000
excluding non-cash derivative instrument liabilities).at September 30, 2006,
compared o a deficiency of $568,000 ($183,000 excluding non-cash derivative
instrument liabilities) at December 31, 2005. Working capital at September 30,
2006 and December 31, 2005 included a respective $435,000 and a $385,000
non-cash derivative instrument liability related to the Company's convertible
revolving credit facility which was recorded in current liabilities.
Operating activities used $3,736,000 during the nine months ended
September 30, 2006, compared to using $958,000 in the comparable 2005 period.
Net cash used by operating activities in 2006 consisted of a net loss of
$3,649,000 plus non-cash items credited to income aggregating $1,673,000, and
net cash generated by changes in operating assets and liabilities of $1,586,000.
The non-cash items included $2,403,000 of net unrealized gains arising from the
net decrease in value of the Company's derivative instrument liabilities, as
more fully presented in Notes 1 and 5. Net cash generated by changes in
operating assets and liabilities included an $829,000 increase in accounts
payable, accrued expenses and other current liabilities, as the Company extended
its vendor payment cycle to conserve cash, and an $801,000 decrease in accounts
receivable. The operations of OIPV accounted for approximately $3.2 million of
the use of cash from operating activities, primarily attributable to a $3.4
million operating loss for the current nine-month period.
Investing activities used $230,000 during the nine months ended September
30, 2006, compared to $320,000 in 2005. Net cash used by investing activities in
2006 consisted of $215,000 of capital expenditures and $15,000 paid in
connection with the acquisition of certain assets of Rhyne. Net cash used by
investing activities in 2005 consisted of capital expenditures. Capital
expenditures during 2006 were principally for the purchase of network equipment
and software in connection with OIPV's continuing build-out of its IP telephony
platform, and for computer and office equipment. Pursuant to our loan agreement
with Laurus, we may obtain external financing on capital expenditures of up to
$500,000 in any fiscal year period before requiring Laurus's prior approval.
29
Financing activities provided $4,069,000 during the nine months ended
September 30, 2006, principally from net proceeds of $3,904,000 from private
placements of a convertible note and Series A preferred stock. .
The Company continues to experience negative cash flows from operations,
as the Company has not been generating sufficient cash flow to cover the
operating costs of both our Legacy Business and OIPV. We are highly dependent
upon our revolving credit facility with Laurus, and raising cash from private
and public placements of debt and equity securities in order to fund our
business operations. During the nine months ended September 30, 2006, the
Company raised approximately $3.9 million from private placements of a
convertible note and Series A preferred stock, which has since been used for
working capital needs. Significant amounts of additional external financing will
be required in order to sustain current operations and to further develop OIPV's
IP telephony business to the operating levels anticipated by management. At a
Special Meeting of the Stockholders of the Company, held December 16, 2005, the
Company received shareholder approval to conclude one or a series or combination
of private offerings to investors of the Company's Securities, and a secondary
offering to the public of Common Stock, in the range of approximately $6,000,000
to $26,000,000 (exclusive of any securities which may be sold upon exercise of
any over-allotment options).
During the period January through April of 2006, the Company completed
several private placements of convertible debt and equity securities, raising
approximately $3.9 million, for use in its current business and the working
capital requirements of OIPV. Refer to Notes 7 and 8 of the Notes to
Consolidated Financial Statements contained herein, for a description of the
material terms of these financing transactions. To summarize:
o On January 30, 2006, the Company issued a $400,000 Convertible
Promissory Note and a Warrant to purchase 22,047 shares of common stock to an
affiliate of the placement agent, pursuant to a Convertible Promissory Note and
Purchase Agreement. This note was subsequently repaid in full, with interest, on
February 8, 2006.
o On February 8, 2006, the Company issued a $1,000,000 Principal Amount
Convertible Promissory Note (the "Sotomar Note") to Sotomar - Empreendimentos
Industriais e Imobiliarios, SA (the "Holder") pursuant to a Convertible Note and
Warrant Purchase Agreement (the "Purchase Agreement") of even date. The proceeds
received by the Company, net of $80,000 placement agent fees and $6,909 of
expenses, amounted to $913,091. Pursuant to the terms of the Sotomar Note, as a
result of the sale of Units described below, on February 17, 2006 the Sotomar
Note, together with interest accrued thereon, converted into 58,970 shares of
Series A Preferred Stock.
o On February 17, 2006, March 17, 2006 and April 17, 2006 the Company sold
an aggregate of 200,456 Unit shares of Series A Preferred Stock to several
accredited investors (the "Investors") at a price of $17.00 per Unit. Each Unit
consists of (i) one share of the Company's Series A Preferred Stock, $.001 par
value per share, and (ii) a Warrant to purchase five shares of the Company's
Common Stock, par value $.001 per share, at an exercise price of $2.125 per
share (the Series A Preferred Stock and the Warrant together "Securities"). The
proceeds received by the Company, net of $272,634 placement agent fees and
$144,156 expenses incurred by the Company's placement agent, were $2,991,071.
As of September 30, 2006 the Company's borrowing availability under the
revolving loan portion of the Laurus credit facility was $296,000. As further
described in Note 14, on October 17, 2006, the Company and Laurus executed and
entered into an Amendment and Forbearance Agreement, and related documents,
pursuant to which among other things Laurus was issued a Secured Demand Note for
a principal amount of up to $1,000,000 (the "New Note") and a Common Stock
Purchase Warrant to purchase up to a certain number of shares of Company's
common stock at $0.60 per share. On October 18, 2006, the Company was advanced
$500,000 under the New Note. Further advances under the New Note, up to an
additional $500,000, are contingent upon the Company obtaining additional
financing from other sources.
On September 7, 2006, the Company engaged the services of C.P. Baker
Securities, Inc., the securities firm previously used in the above-described
private placements, to assist the Company in securing up to $3 million in bridge
financing. On September 15, 2006, the Company engaged the services of Stonegate
Securities, Inc. ("Stonegate") to act as placement agent on a follow-on offering
of securities of at least $10 million. In connection therewith, Stonegate
received 100,000 shares of common stock in October.
On November 8, 2006, the Company engaged the services of Wall Street
Consulting, Inc. ("WSG") to act as investor and public relations counsel to the
Company, In connection therewith, WSG will receive a cash fee of $7,500 per
month, plus, for each full twelve month period that the agreement is in effect,
WSG will be granted options to purchase as many
30
shares of Company common stock as could be purchased for $100,000. Each option
grant shall have a term of five years and an exercise price per share equal to
the closing price of the Company's common stock on the date of grant.
No assurances can be given that we will continue to be successful in
raising sufficient amounts of cash through securities offerings, since they are
dependent upon, among other factors, the market conditions prevailing during the
offering periods. We cannot give any assurances that we will be able to find any
investors on a timely basis or, if so, whether the terms of any such transaction
will be advantageous to us. In the event that we are successful in negotiating
an agreement with one or more investors, it is likely that we will be required
to issue a significant number of shares of Common Stock, or other securities
convertible or exercisable into shares of Common Stock, which would result in
very significant dilution to our present stockholders. In order to conclude such
additional financing, we may also need to demonstrate improved operating
performance. If the Company is unable to raise sufficient additional funds, it
will have to develop and implement a plan to reduce overhead and conserve cash
until sufficient additional capital is raised. For additional information, refer
to Note 1, "Business Operations and Going Concern Issues".
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion included in Item 7 of our Annual Report on Form 10-K for
the year ended December 31, 2005 under the subheading "Critical Accounting
Policies and Estimates" is still considered current and applicable, and is
hereby incorporated into this Quarterly Report on Form 10-Q.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The discussion included in Item 7A of our Annual Report on Form 10-K for
the year ended December 31, 2005, "Quantitative and Qualitative Disclosures
About Market Risk", is still considered current and applicable, and is hereby
incorporated into this Quarterly Report on Form 10-Q.
ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures. We maintain
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) that
are designed to ensure that information required to be disclosed in our reports
filed under the Exchange Act, is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission's
rules and forms, and that such information is accumulated and communicated to
our management, including our Chief (principal) Executive Officer and Chief
(principal) Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.
An evaluation was conducted by our Chief Executive Officer and Chief
Financial Officer of the effectiveness of the Company's disclosure controls and
procedures as of the end of the period covered by this report. Based on that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective to ensure that
information required to be disclosed in our reports filed under the Exchange
Act, is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms.
(b) Changes in Internal Controls. There have been no changes in our
internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) during the most recently completed fiscal
quarter that materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.
PART II. OTHER INFORMATION.
ITEM 1. LEGAL PROCEEDINGS
None.
31
ITEM 1A. RISK FACTORS
The discussion included in Item 1A of our Annual Report on Form 10-K for
the year ended December 31, 2005 under the subheading "Risk Factors" is still
considered current and applicable, and is hereby incorporated into this
Quarterly Report on Form 10-Q.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The Company hereby incorporates by reference the information contained in
Current Reports on Form 8-K filed with the Securities and Exchange Commission on
the following dates: February 14, 2006, February 24, 2006, March 21, 2006 and
April 21, 2006. In connection with the reported transactions, the Company's
placement agent received aggregate cash fees of $272,634, and warrants to
purchase shares of common stock and Series A preferred stock as described in the
aforementioned Current Reports and in Notes 7 and 8 of the Notes to Consolidated
Financial Statements contained herein.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The proposals voted upon at the Company's Annual Meeting of Stockholders,
held July 13, 2006, along with the voting results, are presented below. The
results include voting rights associated with 193,997 shares of Series A
Preferred Stock present at the annual meeting, each share of which representing
ten common equivalent shares of common stock.
(1) Election of Directors: All nominees were elected: The results of the
balloting were as follows:
Votes Votes
Nominees For Withheld
------------------------ --------- --------
Jean-Marc Stiegemeier 5,321,013 32,385
George J. Taylor, Jr. 5,320,267 33,131
Harold L. Hanson 5,327,383 26,015
Hugh M Taylor 4,879,208 474,190
Joseph J. Kelley 4,878,873 474,525
Ronald P. Pettirossi 5,328,355 25,043
Series A Preferred Stock
Designated Director:
Christopher L. Rafferty 1,939,970(a) 0
(a) represents common equivalent voting shares from the 193,997 Series A
Preferred Stock shares voted for.
(2) Ratification of the appointment of Carlin, Charron & Rosen LLP as
independent auditors of the Company for the year ending December 31,
2006: The proposal was approved with 5,342,701 votes for, 9,694
votes against and 1,003 abstentions.
(3) Approval of an amendment to the Company's 2002 Stock Option Plan to
increase the number of shares of Common Stock available for grants
and awards from 2,300,000 to 3,300,000: The proposal was approved
with 3,233,055 votes for, 365,349 votes against and 2,385
abstentions.
(4) Approval of an amendment to the Company's Certificate of
Incorporation to change the corporate name of the Company from
"Farmstead Telephone Group, Inc." to "One IP Voice, Inc.": The
proposal was approved with 5,302,165 votes for, 46,359 votes against
and 4,874 abstentions.
32
ITEM 5. OTHER INFORMATION
On October 13, 2006 Mr. Nevelle R. Johnson notified the Company of his
resignation from the position of Executive Vice President of the Company. Mr.
Johnson's responsibilities include the re-direction and growth of the Company's
legacy telecommunications equipment business, including management of that
division's direct sales force. Mr. Johnson's resignation shall become effective
on January 11, 2007.
ITEM 6. EXHIBITS:
The following documents are filed as Exhibits to this Quarterly Report on
Form 10-Q:
10.1 Agreement dated September 7, 2006 between One IP Voice, Inc. and
C.P. Baker Securities, Inc.
10.2 Placement Agency Agreement dated September 15, 2006 between One IP
Voice, Inc. and Stonegate Securities, Inc.
10.3 Agreement dated October 11, 2006 between One IP Voice, Inc. and
Robert G. LaVigne
10.4 Consulting agreement dated November 3, 2006 between One IP Voice,
Inc. and Mr. Philip McTague
10.5 Agreement dated November 8, 2006 between One IP Voice, Inc. and Wall
Street Consultants, Inc. Agreement [clean up language]
10.6 Agreement dated September 8, 2006 between One IP Voice, Inc. and
ScanSource, Inc.
31.1 Certification of the Chief Executive Officer, pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer, pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer, pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer, pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ONE IP VOICE, INC.
Dated: November 17, 2006 /s/ Jean-Marc Stiegemeier
----------------------------------------
Jean-Marc Stiegemeier
Chief Executive Officer, President
Dated: November 17, 2006 /s/ Robert G. LaVigne
----------------------------------------
Robert G. LaVigne
Executive Vice President,
Chief Financial Officer
34