Item 1. Business
Company and Business
We are a telephone company, who provides, sells and supplies commercial and residential telecommunication services, including services utilizing voice over internet protocol (“VoIP”) technology, session initiation protocol (“SIP”) technology, wireless fidelity technology, wireless maximum technology, marine satellite services technology and other similar type technologies. Our main products are the “TK 6000” and the “DUO”, an analog telephone adapter that provides connectivity for analog telephones and faxes to home, home office or corporate local area networks (“LAN”).
Our TK 6000 and DUO and their related services are a cost effective solution for individuals, small businesses and telecommuters connecting to any analog telephone, fax or private branch exchange (“PBX”). Our TK 6000 and DUO provides aUSB port, one Ethernet port and one analog telephone port. A full suite of internet protocol features is available to maximize universal connectivity. In addition, analog telephones attached to our TK 6000 and DUO are able to use advanced calling features such as call forwarding, caller ID, 3-way calling, call holding, call retrieval and call transfer.
History and Overview
We are a Florida corporation, incorporated on May 1, 2006 under the name Discover Screens, Inc. (“Discover Screens”).
Prior to September 10, 2008, we were known as Discover Screens, a company dedicated to providing advertising through interactive, audiovisual, information and advertising portals located in high-traffic indoor venues. Our name and business operations changed in a series of transactions beginning in December of 2007.
On September 10, 2008, we changed our name from Discover Screens, Inc. to Net Talk.com, Inc.
On September 10, 2008, we acquired certain tangible and intangible assets, formerly owned by Interlink Global Corporation (“Interlink”), directly from Interlink’s creditor who had seized the assets pursuant to a Security and Collateral Agreement.
Our Strategy
We continue to improve and enhance the following factors in building and expanding our customer base:
●
Deployment and distribution of our main products TK 6000 and DUO devices.
●
Attractive and innovative value proposition. We offer our customers an attractive and innovative e value proposition: a portable telephone replacement with multiple and unique features that differentiates our services from the competition.
●
Innovative, high technology and low cost technology platform. We believe our innovative software and network technology platform provides us with a competitive advantage over our competition and allows us to maintain a low cost infrastructure relative to our competitors.
Plan of Operation
We provide, sell and supply commercial and residential telecommunication services, including services utilizing voice over internet protocol (“VoIP”) technology, session initiation protocol (“SIP”) technology, wireless fidelity technology, wireless maximum technology, marine satellite services technology and other similar type technologies. We are developing our business infrastructure and new products and services.
Our Products
At this time, our main products are the TK 6000 and DUO. Our TK 6000 and DUO are designed to provide specifications unique to each customer’s existing equipment. It allows the customer full mobile flexibility by being able to take internet interface anywhere the customer has an internet connection. Our TK 6000and DUO both have the following features:
A Universal Serial Bus (“USB”) connection allowing the interconnection of ourTK 6000 and DUO to any host computer.
In addition to the USB power source option, our TK 6000 and DUO has an external power supply allowing the phone to independently power itself when not connected to a host computer;
Unlike most VoIP telephone systems, our TK 6000 and DUO both have standalone feature allowing them to be plugged directly into a standard internet connection.
Our TK 6000 and DUO are compact, space-efficient products.
Our TK 6000 and DUO both have interface component so that the customer can purchase multiple units that can communicate with each other allowing simultaneous ringing from multiple locations.
Our products are portable and allows our customers to make and receive phone calls with a telephone anywhere broadband internet connection is available. We transmit the calls using Voice over Internet Protocol “VOIP” technology, which converts voice signals into digital data transmissions over the internet.
Our Services
Our business is to provide products and services that utilize Voice Over Internet Protocol, which we refer to as “VoIP.” VoIP is a technology that allows the consumer to make telephone calls over a broadband internet connection instead of using a regular (or analog) telephone line. VoIP works by converting the user’s voice into a digital signal that travels over the internet until it reaches its destination. If the user is calling a regular telephone line number, the signal is converted back into a voice signal once it reaches the end user. Our business model is to develop and commercialize software technology solutions for cost effective, real-time communications over the internet and related services.
Services provided or to be provided:
Text to phone reminder service. We are currently developing a service that will allow VoIP to synchronize with the customer’s data base schedule management system (such as Microsoft Office Outlook © ). Our goal is to develop a service that will call the customer at a pre-designated time to provide an audio reminder of that day’s agenda to the customer. By offering this service at a low price point of less than five dollars per month we hope to appeal to a broad customer base. This software is currently under development.
Free conference server. This product is currently available to all our customers.
Future Voice Message Delivery. This service allows the user to record a voice message which will be delivered to a recipient at a later date and time specified by the user.
Speech to text services for the hearing impaired. This is a standalone service that will allow the hearing impaired to receive real time conversion of incoming voice signals into text displayed on an incorporated display panel.
Patents - Domestic and International
Our products are currently under US patent pending as well as International patent pending in over 123 countries.
Marketing
We have developed direct sales channels, as represented by web sites and toll free numbers. Our direct sales channels are supported by highly integrated advertising campaigns across multiple media such as infomercials, television and other media channels. Our website is www.nettalk.com, our telephone number is 305 621 1200 and our fax number is 305 621 1201.
Our primary source of revenue is the sale and distribution of our TK 6000 and DUO products. We also generate revenue from the sale of accessories to our product and international long distance monthly charges that are billed to our customers.
Advertising
Our goal is to position ourselves as a premier supplier of choice for VoIP services. Our current business strategy is to focus our advertising dollars on our home market in South Florida. Our advertising will consist of mass marketing campaigns focusing on television infomercials for the South Florida market and other states including cable television channels..
Customers
Our customers are made up of residential and small businesses. We anticipate that future services will appeal to our existing customers and hope that our additional phone products and services will provide a complete phone package experience to our customers.
Our target audience is individual consumers and small businesses looking to lower their current cost of telecommunications. We are also reaching a large audience with our websites. We hope that consumers will find our websites by doing an internet search for VoIP service providers. We also use other means of advertising such as direct to consumer sales, ecommerce and wholesale sales to retail stores.
Geographic Markets
Our primary geographic market is our home market of South Florida. Our target audience are individual consumers and small businesses looking to lower their current cost of telecommunications. We also expect to reach a large audience with our websites. We hope that consumers will find our websites by doing an internet search for VoIP service providers. We will also use other means of advertising such as direct to consumer sales, ecommerce and wholesale sales to retail stores.
We have been granted and or are applying for Competitive Local Exchange Carrier (“CLEC”) Licenses in thirty states, as follows:
Alabama
Idaho
Minnesota
North Carolina
Utah
Arizona
Illinois
Montana
North Dakota
Vermont
Arkansas
Indiana
Nebraska
Ohio
Washington DC
California
Kansas
New Jersey
Oregon
Washington
Florida
Kentucky
New York
South Dakota
West Virginia
Georgia
Massachusetts
New Mexico
Texas
Wisconsin
It is our intent to focus our expansion on the geographic markets in which we have been granted CLEC Licenses. We also intend to expand our market place to reach customers worldwide.
The Industry
In the past decade, the use of the internet for all purposes has exploded. VoIP is a technology that enables communications over the internet through the compression of voice, video and/or other media into data packets that can be efficiently transmitted over data networks and then converted back into the original media at the other end of the transmission. Since the introduction of the first VoIP technology in the mid 1990s, the quality and clarity of VoIP connections have continued to evolve and improve. Perhaps the biggest jump in VoIP quality came with the introduction of SIP, or Session Initiation Protocol. SIP is a text-based protocol suitable for integrated voice-data applications. Today SIP is the predominant industry standard for establishing multimedia communications over the Internet. As the clarity and quality of VoIP services have increased, so has the acceptance of VoIP by consumers.
As a result of the potential cost savings and added feature availability of VoIP, consumers, industry leaders and traditional telecommunication service providers see VoIP as the future of telecommunications. Factors that have been contributing to the boom in VoIP use include: (a) increased consumer demand for lower cost telephone services; (b) increased demand for long distance services as the market place becomes increasingly global; (c) improved reliability and quality of VoIP due to technological advances; and (d) innovations that allow services for VoIP users that are not available in traditional telephone services. These factor, and others, have resulted in various service providers and consumers exploring VoIP alternatives to traditional analog phone services.
Our Competition
The communications industry is highly competitive and significantly affected by regulatory changes, technology evolution, marketing strategies, and pricing decisions of the larger industry participants. The market for our services is evolving rapidly and is subject to shifting customer demands and the introduction of new products and services. Our current and potential competitors come from different market sectors and vary in size and scope with respect to the products and services that they offer or intend to offer in the future.
One of our competitor in the domestic market is traditional telephone service providers that are increasingly adding advanced service features to traditional telephone services. Domestic telephone providers have the advantage of having strong name recognition, large research and development budgets and existing service and market networks.
In addition, numerous vendors sell products and services using VoIP technology. Our competitors use innovations such as Analogue Terminal Adapters, or ATAs, to connect an analogue telephone to a VoIP network. Sometimes referred to as VoIP Gateways, these devices are widely advertised and sold. Sales are conducted by many different methods, including internet and infomercial sales, and barriers to entry into the business are low.
We also face competition from alternative communication methods such as internet, fax providers and voice mail service providers.
Many of our competitors may be better established, larger and better financed than us, and are able to use their visibility and substantial marketing resources to attract customers. In particular, many of our competitors are large, established network service providers that are able to market and distribute enhanced communication services within their already large base of subscribers. As a result, these competitors maybe able to adapt more quickly to new or emerging technologies and changes in customer requirements. They may also be able to devote greater resources to the promotion and sale of their products. Moreover, we may not have sufficient resources to undertake the continuing research and development necessary to remain competitive.
We differentiate our services from those offered by our competitors by offering exceptional customer service and lower cost alternatives. We have worked hard to control the development costs associated with the TK 6000. We have done this by choosing phone components and component vendors that are economical but do not compromise on quality. We have developed and marketed our own products and services, rather than simply reselling another manufacturer’s innovations. Finally, our TK 6000 product is a standalone phone product that does not require the user to first invest in a computer. For these reasons, we know that our TK 6000 product is a lower cost alternative to similar telephone products currently being marketed. Because we are engaged in the same cost saving measures for the services we offer, we are able to offer those services at a competitive price.
Our products and services are user friendly and convenient for our customers. For example, our packaging includes detailed, user friendly instructions and diagrams to allow for easy installation and activation. We have distinguished ourselves from our main competitors through the level of customer service offered to our consumers following their purchase or our products or services. Currently, our competitors only offer customer service through an email query program. This does not allow the customer to receive rapid, real-time problem solving assistance in the event our competitor’s product or service fails. In contrast, we established a customer service online forum where our users can post their questions and read other users’ responses. The forum has key word or key phrase search option so that our customers can easily find a solution to the problem they are experiencing. Our forum is moderated by one of our development engineers to ensure that all questions are being properly addressed and issues resolved. We also offer a pay-per-use live customer support hotline. By paying a fee, either per minute or per call, our customers are able to reach a support specialist to get a direct answer to their questions. This allows us to provide superior customer service, while still keeping our costs low.
Government Regulation
As a telecommunications supplier, we are subject to extensive government regulation. The majority of our government regulation comes from the Federal Communications Commission (the “FCC”).
Telecommunications is an area of rapid regulatory change. Changes in the laws and regulations and new interpretations of existing laws and regulations may affect permissible activities, the relative costs associated with doing business and amounts paid to us for our services. We cannot predict the future of federal, state and local regulations or legislation, including FCC regulations.
Federal Communications Commission (“FCC”) regulation
The FCC is an independent United States government agency. The FCC was established by the Communications Act of 1934 and is charged with regulating interstate and international communications by radio, television, wire, satellite and cable. The FCC’s jurisdiction covers all fifty states, the District of Columbia and U.S. possessions.
The FCC works to create an environment promoting competition and innovation to benefit communications customers. Where necessary, the FCC has acted to ensure VoIP providers comply with important public safety requirements and public policy goals.
Interconnected VoIP providers must comply with the Commission’s Telecommunications Relay Services (TRS) requirements, including contributing to the TRS Fund used to support the provision of telecommunications services to persons with speech or hearing disabilities, and offering 711 abbreviated dialing for access to relay services. Interconnected VoIP providers and equipment manufacturers also must ensure that, consistent with Section 255 of the Communication Act, their services are available to and usable by individuals with disabilities, if such access is readily achievable.
Finally, the FCC now requires interconnected VoIP providers and telephone companies that obtain numbers from them to comply with Local Number Portability (LNP) rules. These rules allow telephone, and now VoIP, subscribers that change providers to keep the subscribers telephone numbers provided that they stay in the same geographic area. VoIP providers must also contribute to funds established to share LNP and numbering administrative costs among all telecommunications providers benefiting from these services.
The FCC monitors and investigates complaints against VoIP providers and, if necessary, can bring enforcement actions against VoIP providers that do not comply with applicable regulations.
State Telecommunication Regulation
We are also registered with the Florida Public Utilities Commission as a Competitive Local Exchange Carrier (“CLEC”) and Interexchange (“IXC”) Carrier.
In Florida, a “competitive local exchange carrier” is defined as any company, other than an incumbent local exchange company, certificated by the Public Service Commission to provide local exchange telecommunication services in the state of Florida on or after July 1, 1995. CLEC companies providing services in Florida after July 1, 1995, must be certificated by the Florida Public Service Commission, and competitive local exchange companies are required to file a price list specifying their rates and charges for basic local telecommunication services.
Florida, as well as other states, also regulates providers of Interexchange Telecommunications (“IXC”). The Florida Public Service Commission includes the following as examples of IXC providers: (1) operator service providers; (2) resellers; (3) switchless re-billers; (4) multi-location discount aggregators; (5) prepaid debit card providers; and (5) facilities based interexchange carriers. Section 364.02(13) of the Florida Statutes requires IXCs to provide current contact information and a tariff to the Florida Public Service Commission.
We have been granted and or are applying for Competitive Local Exchange Carrier (“CLEC”) Licenses in thirty states, as follows:
Alabama
Idaho
Minnesota
North Carolina
Utah
Arizona
Illinois
Montana
North Dakota
Vermont
Arkansas
Indiana
Nebraska
Ohio
Washington DC
California
Kansas
New Jersey
Oregon
Washington
Florida
Kentucky
New York
South Dakota
West Virginia
Georgia
Massachusetts
New Mexico
Texas
Wisconsin
The law relating to regulation of VoIP technology is in a flux. In recent court cases, other VoIP providers have challenged whether state regulations can be applied to VoIP technology or whether such regulation has been preempted by the Telecommunications Act of 1996 and other Federal laws. At least one of our competitors has successfully fought the application of state laws to VoIP technology. However, to be cautious, we will continue to obtain a competitive local exchange carrier license from each state in which we conduct business. An added advantage of obtaining a CLEC license from each state is that we can obtain an operational carrier number from the North American Numbering Plan Administration. The operational carrier number will allow us to assign our customers telephone numbers in the area code in which they reside.
Employees
We employ 35 full-time and no part-time employees, none of our employees is subject to a collective bargaining agreement, and we consider our employee relations to be satisfactory.
Intellectual Property
We regard our domain names, patents, trademarks, copyrights, trade dress, trade secrets, proprietary technologies and similar intellectual property as critical to our success, and we rely on patent, trademark and copyright law, trade-secret protection, and confidentiality and/or license agreements with our employees, customers, partners, and others to protect our proprietary rights.
We have filed multiple patent applications with the United States Patent and Trademark Office for the technology associated with our products. We also have software under development by our employees, subcontractors and consultants.
The status of any patent involves complex legal and factual questions, and the breadth of claims allowed is uncertain. Accordingly, we cannot assure you that any patent application filed by us will result in a patent being issued or that our issued patents, and any patents that may be issued in the future, will afford adequate protection against competitors with similar technology. We similarly face the risk that any patents issued to us might be infringed or designed around by others.
Patents - Domestic and International
Our products are currently under US patent pending as well as International patent pending in over 123 countries.
Research and Development
We expense research and development expenses, as these costs are incurred. We account for our offering-related software development costs as costs incurred internally in creating a computer software product and are charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model. At this time our main products the TK6000 and DUO are being sold in the market place. Therefore, research and development cost reported in our financial statements relates to pre - marketing cost and are expensed accordingly.
On July 14, 2010 we revealed our newest product the net TALK DUO (“DUO”).
Our DUO offers our customers free nationwide calls to any landline or mobile phone in the U.S. and Canada from anywhere in the world, as well as low-cost international rates. It’s also a versatile digital phone service with no monthly fees, no contracts and no computer required.
Our DUO is flexible enough to connect directly to your Internet connection through the router/modem, there is also a convenient option with our DUO to connect to your computer. The sleek design is small enough to fit in the palm of your hand, making it a portable device.
Our DUO reduces the wear and tear on your home or office computer and reduces energy costs, resulting in money savings. Our fax-friendly DUO, offers fax (incoming and outgoing), a unique feature not offered, to our knowledge, by similar digital phone services.
The portability of this small device is also great for international travelers who want to place free nationwide calls to the U.S. and Canada, or who are looking for a low-cost solution for international rates. Calls to other netTALK customers are always free.
We are presently working on other new products and anticipate future deployment the later part of this year and over the next year.
Item 1 A.
Item 1 A. Risk factors
This Annual Report on Form 10 K contains forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Reference is made in particular to the description of our plans and objectives for future operations, assumptions underlying such plans and objectives and other forward-looking statements included in this section, “Item 1 Business,” “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in other places in this Annual Report. Such statements may be identified by the use of forward-looking terminology such as “may”, “will”, “expect”, “believe”, “estimate”, “anticipate”, “intend”, “continue”, or similar terms, variations of such terms or the negative of such terms. Such statements are based on management’s current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. Factors that could cause such results to differ materially from those described in the forward-looking statements include those set forth below.
Risks Relating to Our Business:
WE HAVE A HISTORY OF LOSSES WHICH MAY CONTINUE, WHICH MAY NEGATIVELY IMPACT OUR ABILITY TO ACHIEVE OUR BUSINESS OBJECTIVES.
We incurred net losses of $6,306,963 and $2,737,817 for the years ended September 30, 2010 and 2009, respectively. We cannot assure you that we can achieve or sustain profitability on a quarterly or annual basis in the future. Our operations are subject to the risks and competition inherent in the establishment of a business enterprise.
There can be no assurance that future operations will be profitable. Revenues and profits, if any, will depend upon various factors, including whether we will be able to continue expansion of our revenue. We may not achieve our business objectives and the failure to achieve such goals would have an adverse impact on us.
OUR BUSINESS MAY BE AFFECTED BY FACTORS OUTSIDE OF OUR CONTROL.
Our ability to increase sales, and to profitably distribute and sell our products and services, is subject to a number of risks, including changes in our business relationships with our principal distributors, competitive risks such as the entrance of additional competitors into our markets, pricing and technological competition, risks associated with the development and marketing of new products and services in order to remain competitive and risks associated with changing economic conditions and government regulation.
Item 2.
Item 2. Properties
Description of properties
Our principal executive offices are located at 1100 NW 163rd Drive, Miami, Florida 33169. Our offices consist of approximately 3,500 square feet. Our lease terminated on August 31, 2010 and we are presently under negotiations with our landlord to renew the lease agreement or purchase the entire facility. The facility is suitable for our purposes and is expected to accommodate our needs for the foreseeable future.
Interconnection Leasing Agreements
The Company will be entering into lease arrangements to provide interconnection services in multiple states. “Interconnection services” is defined in the Telecommunications Act of 1996 (the “Telecommunications Act”) as the linking of two telecommunication systems so that users of either system may utilize the system components of the other. Pursuant to the FCC rules implementing the Telecommunications Act, we negotiate interconnection agreements with incumbent local exchange carriers to obtain access to facilities. Facilities leasing occurs where one network service provider leases the facilities of another network service provider to provide services to end users. We currently have executed two interconnection leasing agreements and are negotiating an interconnection leasing agreement with other major hosting/bandwidth companies. Our current interconnection leasing agreements are with multiple carriers. The agreements relate to facilities located or to be located in the following states:
Alabama
Idaho
Minnesota
North Carolina
Utah
Arizona
Illinois
Montana
North Dakota
Vermont
Arkansas
Indiana
Nebraska
Ohio
Washington DC
California
Kansas
New Jersey
Oregon
Washington
Florida
Kentucky
New York
South Dakota
West Virginia
Georgia
Massachusetts
New Mexico
Texas
Wisconsin
The agreements will grant us interconnection leasing rights in all thirty five states in which we have obtained or are pursuing a CLEC license. If we enter new markets, we expect to establish interconnection agreements with incumbent local exchange carriers on an individual state basis, as the need arises.
Item 3.
Item 3. Legal Proceedings
On September 29, 2010, Midtown Partners and Co., LLC ("Midtown") filed, in the Circuit Court of Hillsborough County, Florida (Case No. 101981) an action against us alleging an unpaid commission in the amount of $400,000 plus warrants in connection with the sales of securities by us. We believe Midtown's allegations are without merit . We intend to mount a vigorous defense. The matter is in its earliest stage; we have filed our response to the complaint, denying the allegations therein, raising affirmative defenses and making a counterclaim based on Midtown's breach of contract.
Item 4.
Item 4. Submission Of Matters To a Vote of Security Holders
None.
Part II
Item 5.
Item 5. Market for registrant’s common equity, related stockholder matters and issuer purchases of equity
Our common stock has been quoted on the OTC Bulletin Board under the symbol “NTLK ” since September 15, 2009 . The following table sets forth, for the periods indicated, the high and low bid prices of our common stock. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
Holders
As of September 30, 2010, there were 74 registered holders or persons otherwise entitled to hold our common stock. The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various security brokers, dealers, and registered clearing agencies. The transfer agent of our common stock is Fidelity Transfer.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth certain information about the common stock that may be issued upon the exercise of options under the equity compensation plans as of September 30, 2009.
EQUITY COMPENSATION PLAN INFORMATION
Plan category
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
Weighted average
exercise price of
outstanding options,
warrants and rights
Number of securities
remaining available for
future issuance under equity
compensation plans
(excluding securities
reflected in column (a)
(a)
(b)
(c)
Equity compensation plans
approved by security holders
Equity compensation plans not
approved by security holders
Total
2010 Stock Option Plan
On November 15, 2009, Net Talk.com, Inc. (the “Company”) adopted the 2010 Stock Option Plan (the "Plan") which is intended to is to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate persons who make (or are expected to make) important contributions to the Company by providing such persons with equity ownership opportunities and performance-based incentives and thereby better aligning the interests of such persons with those of the Company’s shareholders. All of the Company’s employees, officers, and directors, and those Company’s consultants and advisors (i) that are natural persons and (ii) who provides bona fide services to the Company not connected to a capital raising transaction or the promotion or creation of a market for the company’s securities, are eligible to be granted options or restricted stock awards under the Plan. The maximum aggregate number of shares of the Company’s common stock that may be issued under the Plan is 10,000,000 shares of the Company’s common stock.
2010 Stock option plan (Share-based payments employees):
On July 26, 2010, we issued 3,709,500 shares of common stock to our employees as part of our 2010 Stock Option Plan. The shares are compensatory in nature and are fully vested. We have valued the shares at $0.03 per share consistent with fair value at the time of issuance including and adjusted for ownership restrictions.
Recent Sales of Unregistered Securities
Unless otherwise noted, the issuances noted below are all considered exempt from registration by reason of Section 4(2) of the Securities Act of 1933, as amended.
Item 6.
Item 6. Selected financial data.
As a smaller reporting company, we are not required to include disclosure, pursuant to this item.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis of our financial condition and results of operations contains forward-looking statements that involve risks and uncertainties. We have based these forward-looking statements on our current expectations and projections of future events. However, our actual results could differ materially from those discussed herein as a result of the risks that we face, including but not limited to those risks stated in "Risk Factors," or faulty assumptions on our part. In addition, the following discussion should be read in conjunction with the audited financial statements and the related notes thereto included elsewhere in this Annual Report.
Background
Prior to September 10, 2008, we were engaged in the development of advertising services and strategies. On September 10, 2008, our management and Board of Directors committed to the discontinuance and disposal of our advertising business. We disposed of this asset to be able to concentrate our efforts exclusively on the deployment of our TK6000 and DUO products.
Liquidity and Capital Resources
We have prepared our financial statements as a going concern. During the year ended September 30, 2010 and 2009, we generated net losses of $6306,963 and $2,737,817, respectively. We used cash in our operations in the amounts of $2,878,544 during year ended September 30, 2010 and $1,715,260 for the period ended September 30, 2009.
As of September 30, 2010, we had cash on hand of $1,021,684.
Our largest operating expenditures currently consist of the following items: $18,500 per month on leasing our corporate office space and network operational center (NOC) and includes our base rent and associated utility expenses and $109,200 per month on payroll.
Our current long term business plan contemplates acquiring the ongoing business of related companies, either through asset acquisitions, consolidations or mergers.
Borrowing Arrangements
Secured Convertible Debentures
The carrying values of our 12% secured convertible debentures consist of the following as of September 30, 2010 and 2009:
Each debenture bears interest on the principal amount outstanding and unpaid from time to time at a rate of 12% per annum from the date of issuance until paid in full. The debentures convert into shares of our common stock at the option of the holder at $0.25 per share. The debentures are secured by a lien in all our assets.
The following constitute events of default under the secured debentures held by Vicis Capital Master Fund: (i) failure to pay any interest or principal payment when due; (ii) failure to observe any covenant contained in the secured debenture or the purchase agreement that we executed in connection with the issuance of the secured debenture; (iii) the occurrence of an event of default by us under any other material agreement or lease; (iv) entry of a judgment against us in excess of $150,000; and (v) the appointment of a receiver, the filing of bankruptcy by us, or if we otherwise become insolvent. Additionally, if we seek to prepay the secured debentures, we must pay a prepayment penalty equal to 110% of the then outstanding principal, plus all other amounts due.
The debentures contain full ratchet anti-dilution price protection. The secured debentures contain negative covenants that prohibit us from taking certain corporate actions without the prior written consent of the holder of the secured debentures, Vicis Capital Master Fund. We cannot take the following actions without Vicis Capital Master Funds’ consent while the secured debentures remain outstanding: (i) incur any additional indebtedness or allow any lien to be filed against our assets, except in certain limited instances; (ii) amend our articles of incorporation or bylaws in a manner that adversely effects the holder of our secured debentures; (iii) repay, repurchase or otherwise acquire more than a de minimis number of shares of our common stock or common stock equivalents from any security holder, except in certain limited instances; (iv) enter into any transactions with our executive officers, directors or affiliates; (v) increase our executive officers’ salary or bonus more than 15% from what was paid in the previous year; or (vi) pay cash dividends or distributions on any of our equity security. We are currently in compliance with all restrictive covenants.
Results of Operations
Comparison - fiscal years ended September 30, 2010 and 2009
Revenues: Our operating income amounted to $737,498 for the fiscal year ended September 30, 2010 as compared to $115,571 for comparable period 2009. The increase in revenues relates to establishing our operating architecture and commencing revenue producing activities.
Cost of sales: Our cost of sales amounted to $1,453,332 for the fiscal year ended September 30, 2010 as compared to $118,563 for comparable period 2009. The increase in cost of sales relates to establishing our operating architectural and commencing revenue producing activities.
Advertising: Our advertising expenses amounted to $357,413 for fiscal year ended September 30, 2010 as compared to $444,249 for comparable period 2009. The breakdown of our advertising expense is as follows:
Compensation and Benefits: Our compensation and benefits expense amounted to $477,576 for fiscal year ended September 30, 2010 as compared to $446,807 for the period ended September 30, 2009. This amount represents normal salaries and wages paid to management members and employees.
Professional Fees: Our professional fees amounted to $255,471 for the fiscal year ended September 30, 2010 as compared to $294,425 for the period ended September 30, 2009. This amount includes normal payments and accruals for legal, accounting and other professional services.
Depreciation and Amortization: Depreciation and amortization amounted to $363,335 for the fiscal year ended September 30, 2010 as compared to $358,244 for the period ended September 30, 2009. These amounts represent amortization of our long-lived tangible and intangible assets using straight-line methods and lives commensurate with the assets’ remaining utility. Our long-lived assets, both tangible and intangible, are subject to annual impairment review, or more frequently if circumstances so warrant. During the fiscal year ended September 30, 2010, we did not calculate or record impairment charges. However, negative trends in our business and our inability to meet our projected future results could give rise to impairment charges in future periods.
Research and Development and Software Costs
We expense research and development expenses, as these costs are incurred. We account for our offering-related software development costs as costs incurred internally in creating a computer software product and are charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model. At this time our main products TK6000 and DUO are being sold in the market place. Therefore, research and development cost reported in our financial statements relates to pre - marketing cost and are expensed accordingly.
General and Administrative Expenses. General and administrative expenses amounted to $547,074 for the fiscal year ended September 30, 2010 as compared to $383,659 for the period ended September 30, 2009 and consisted of general corporate expenses.
Our general and administrative expenses are made up of the following items:
Interest Expense: Interest expense amounted to $1,058,363 for the fiscal year ended September 30, 2010 as compared to $533,171 for the period ended September 30, 2009. Such amount represented (i) stipulated interest under our aggregate $4,998,773 face value convertible debentures, (ii) the related amortization of premiums and discounts (iii) the amortization of deferred finance costs. Aggregate premiums continue to be credited to interest expense over the term of the debentures using the effective interest method.
Derivative Income : Derivative income amounted to $1,445,632 for the fiscal year ended September 30, 2010 as compared to $128,646 for the period ended September 30, 2009. Such amount represents the change in fair value of liability-classified warrants. Derivative financial instruments are carried as liabilities, at fair value, in our financial statements with changes reflected in income. In addition to the liability-classified warrants, we also have certain compound derivative financial instruments related to our $4,998,773 face value convertible debentures that had de minimus values. We are required to adjust our warrant and compound derivatives to fair value at each reporting period. The fair value of our warrant derivative is largely based upon fluctuations in the fair value of our common stock. The fair value of our compound derivative is largely based upon estimates of cash flow arising from the derivative and credit-risk adjusted interest rates. Accordingly, the volatility in these underlying valuation assumptions will have future effects on our earnings.
Debt extinguished: Debt extinguished amounted to $3,617,983 for the fiscal year ended September 30, 2010 as compared to $0 for the period ended September 30, 2009. The amount represents loss recognized on the issuance of new debentures on February 24, 2010.
Net Loss. The net loss amounted to $6,306,963for the fiscal year ended September 30, 2010, as compared to a net loss of $2,737,817 for the period ended September 30, 2009.
Net Loss Per Common Share: Basic loss per common share represents our net loss divided by the weighted average number of common shares outstanding during the period. Diluted loss per common share gives effect to all potentially dilutive securities. We compute the effects on diluted loss per common share arising from warrants and options using the treasury stock method. Applying this method, xxx shares indexed to warrants were excluded from our computation because the effect was anti-dilutive. We computed the effects on diluted loss per common share arising from convertible securities using the if-converted method. The effects, if anti-dilutive are excluded. Applying this method, 16,800,000 shares indexed to our convertible debentures were excluded from our computation because the effect was anti-dilutive.
Quarterly results of operations
The following table presents our quarterly statement of operations. We derived the information from our unaudited financial statements which we believe have been prepared on the same basis as our audited financial statements. The operating results in any quarter are not necessarily indicative of the results that may be expected for any future period.
Contractual obligations
Our principal executive offices are located at 1100 NW 163rd Drive, Miami, Florida 33169. Our offices consist of approximately 2,500 square feet. Our lease terminated on August 31, 2010 and we are presently under negotiations with our landlord to renew the lease agreement for additional term of 2 years.
We lease our principal office space under an operating lease agreement, presently under negotiations. Rent and associated occupancy expenses for the fiscal year ended September 30, 2010 was $175,876 and for the period ended September 30, 2009 was $165,716.
Our principal executive offices are located at 1100 NW 163rd Drive, Miami, Florida 33169. Our offices consist of approximately 3,500 square feet. Our lease terminated on August 31, 2010 and we are presently under negotiations with our landlord to renew the lease agreement or purchase the entire facility. The facility is suitable for our purposes and is expected to accommodate our needs for the foreseeable future.
Off-Balance Sheet Arrangements
None
Critical Accounting Policies and estimates
Our accounting policies are discussed and summarized in Note 1 to our financial statements. The following describes our critical accounting policies and estimates.
Critical Accounting Policies
The financial information contained in our comparative results of operations and liquidity disclosures has been derived from our financial statements. The preparation of those financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and notes. The following significant estimates were made in the preparation of our financial statements and should be considered when reading our Management’s Discussion and Analysis:
●
Impairment of Long-lived Assets: Our telecommunications equipment, other property and intangible assets are material to our financial statements. Further, they are subject to the potential negative effects arising from technological obsolescence. We evaluate our tangible and definite-lived intangible assets for impairment annually or more frequently in the presence of circumstances or trends that may be indicators of impairment. Our evaluation is a two step process. The first step is to compare our undiscounted cash flows, as projected over the remaining useful lives of the assets, to their respective carrying values. In the event that the carrying values are not recovered by future undiscounted cash flows, as a second step, we compare the carrying values to the related fair values and, if lower, record an impairment adjustment. For purposes of fair value, we generally use replacement costs for tangible fixed assets and discounted cash flows, using risk-adjusted discount rates, for intangible assets. These estimates are made by competent employees, using the best available information, under the direct supervision of our management.
●
Intangible assets: Our intangible assets require us to make subjective estimates about our future operations and cash flows so that we can evaluate the recoverability of such assets. These estimates consider available information and market indicators including our operational history, our expected contract performance, and changes in the industries that we serve.
●
Share-based payment arrangements: We currently intend to issue share-indexed payments in future periods to employees and non-employees. There are many valuation techniques, such as Black-Scholes-Merton valuation model that we may use to value share-indexed contracts, such as warrants and options. All such techniques will require certain assumptions that require us to develop forward-looking information as well as historical trends. For purposes of historical trends, we may need to look to peer groups of companies and the selection of such groups of companies is highly subjective.
●
Common stock valuation: Estimating the fair value of our common stock is necessary in the preparation of computations related to acquisition, share-based payment and financing transactions. We believe that the most appropriate and reliable basis for common stock value is trading market prices in an active market.
●
Derivative Financial Instruments: We generally do not use derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. However, we have entered into certain other financial instruments and contracts, such as our secured convertible debenture and warrant financing arrangements that are either (i) not afforded equity classification, (ii) embody risks not clearly and closely related to host contracts, or (iii) may be net-cash settled by the counterparty. We are required to carried as derivative liabilities, at fair value, in our financial statements. The fair value of share-indexed derivatives will be significantly influenced by the fair value of our common stock (see Common Stock Valuation, above). Certain other elements of forward-type derivatives are significantly influenced by credit-adjusted interest rates used in cash-flow analysis. Since we are required to carry derivative financial instruments at fair value and make adjustments through earnings, our future profitability will reflect the influences arising from changes in our stock price, changes in interest rates, and changes in our credit standing.
Revenue recognition
Operating revenue consist of customer equipment sales of our main product TK6000, telecommunication service revenues, shipping and handling revenues.
Our operating revenues are generated from the sale of customer equipment of our main products, our TK6000 and DUO. We also derive service revenues from per minute fees for international calls. Revenue from the sale of our TK6000 is fully recognized at the time of our customer equipment sale. Our TK6000 provides for life time service (over the life of the device/equipment). Our TK6000 is able to operate within our network/platform or over any other network/platform. There is no need for income allocation between our TK6000 and life time service provided. The full intrinsic value of the sale is allocated to the device. Therefore, we recognized 100% of revenue at time of customer equipment sale and do no allocate any income to life time service provided. Shipping and handling is also recognized at time of sale.
On July 14, 2010 we revealed our newest product the net TALK DUO (“DUO”).
Our DUO offers our customers free nationwide calls to any landline or mobile phone in the U.S. and Canada from anywhere in the world, as well as low-cost international rates. It’s also a versatile digital phone service with no monthly fees, no contracts and no computer required.
Our DUO is flexible enough to connect directly to your Internet connection through the router/modem, there is also a convenient option with our DUO to connect to your computer. The sleek design is small enough to fit in the palm of your hand, making it a portable device.
Our DUO reduces the wear and tear on your home or office computer and reduces energy costs, resulting in money savings. Our fax-friendly DUO, offers fax (incoming and outgoing), a unique feature not offered, to our knowledge, by similar digital phone services.
The portability of this small device is also great for international travelers who want to place free nationwide calls to the U.S. and Canada, or who are looking for a low-cost solution for international rates. Calls to other netTALK customers are always free.
Our DUO provides for revenue recognition from the sale of the device and from the sale of telephone service. The initial year of telephone service is included on the sale price at time of sale and billed subsequently thereafter. Therefore, revenue recognition on our DUO is fully recognized at the time of our customer equipment sale, the one year telephone service is amortized over 12 month cycle. Subsequent renewals of the annual telephone service is amortized over the corresponding 12 months cycle.
International calls are billed as earned from our customers. International calls are prepaid and customers account is debited as minutes are used and earned.
Inventory
Inventory consists of the cost of customer equipment and is stated at the lower of cost or market.
At the present time we do not provide for inventory allowance. As we continue to sell our product we will evaluate the need for such an allowance.
During the year ended September 30, 2010 and 2009, in accordance with our lower of cost or market analyses we did not recorded any lower of cost or market adjustments to our finished goods inventories.
Income taxes
We recognized deferred taxes for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts using tax rates in effect for the year since the differences are expected to reverse. We have recorded a valuation allowance on the assumption that we will not have any future taxable income.
Net operating loss carry-forwards
As of September 30, 2010, we had net operating loss carry-forwards for US federal and state tax purposes expiring at various times from year 2023.
Recent accounting pronouncements
Accounting Changes
Effective on October 1, 2009, we adopted Emerging Issues Task Force Consensus No. 07-05 Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock (“EITF 07-05”). EITF 07-05 amended previous guidance related to the determination of whether equity-linked contracts, such as our convertible debentures, meet the exclusion to bifurcation and derivative classification of the respective embedded conversion feature. Under EITF 07-05, the embedded conversion option was no longer exempt from bifurcation and derivative classification because the conversion option was subject to adjustments that are not allowable under the new standard. We have accounted for the change as a change in accounting principle where the cumulative effect, which amounted to $872,320, as a charge to our opening additional paid in capital on October 1, 2009.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and, as such, are not required to provide the information under this item.
Item 8.
Item 8. Financial Statement and Supplementary Data
The financial statements begin on Page.
Item 9.
Item 9. Changes In and Disagreements With Accountants On Accounting and Financial Disclosure
None.
Item 9A(T).
Item 9A(T). Controls and Procedures
Disclosure controls
We maintain “disclosure controls and procedures,” as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
As of September 30, 2010, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective in ensuring that information required to be disclosed by us in our periodic reports is recorded, processed, summarized and reported, within the time periods specified for each report and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
In connection with the assessment described above, management identified the following control deficiencies that represent material weaknesses at September 30, 2010:
·
Due to the Company’s limited resources, the Company has insufficient personnel resources and technical accounting and reporting expertise to properly address all of the accounting matters inherent in the Company’s financial transactions. The Company does not have a formal audit committee, and the Board does not have a financial expert, thus the Company lacks the board oversight role within the financial reporting process.
·
The Company’s small size and “one-person” office prohibits the segregation of duties and the timely review of accounts payable, expense reporting and inventory management and banking information.
Our Chief Executive Officer and Chief Financial Officer are in the process of determining how best to change our current system and implement a more effective system to insure that information required to be disclosed in this annual report on Form 10-K has been recorded, processed, summarized and reported accurately. Our management acknowledges the existence of this problem, and intends to developed procedures to address them to the extent possible given limitations in financial and manpower resources. While management is working on a plan, no assurance can be made at this point that the implementation of such controls and procedures will be completed in a timely manner or that they will be adequate once implemented.
Management report on internal control over financial reporting
Our management is responsible for establishing and maintaining adequate internal control over financing reporting for our company. Internal control over financial reporting is defined in Rule 13a - 15(f) and 15d - 15(f) of the Securities and Exchange Act of 1934 as a process designed by or under the supervision of our principal executive and principal financial officer and effected by board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
●
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and disposition of assets of the company;
●
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
●
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations, internal control over financial reporting may not detect or prevent misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of September 30, 2010. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in internal control - integrated framework. Based on our assessment, management concluded that as of September 30, 2010, our internal control over financial reporting is not effective based on those criteria.
In connection with the assessment described above, management identified the following control deficiencies that represent material weaknesses at September 30, 2010:
·
Due to the Company’s limited resources, the Company has insufficient personnel resources and technical accounting and reporting expertise to properly address all of the accounting matters inherent in the Company’s financial transactions. The Company does not have a formal audit committee, and the Board does not have a financial expert, thus the Company lacks the board oversight role within the financial reporting process.
·
The Company’s small size and “one-person” office prohibits the segregation of duties and the timely review of accounts payable, expense reporting and inventory management and banking information.
Our Chief Executive Officer and Chief Financial Officer are in the process of determining how best to change our current system and implement a more effective system to insure that information required to be disclosed in this annual report on Form 10-K has been recorded, processed, summarized and reported accurately. Our management acknowledges the existence of this problem, and intends to developed procedures to address them to the extent possible given limitations in financial and manpower resources. While management is working on a plan, no assurance can be made at this point that the implementation of such controls and procedures will be completed in a timely manner or that they will be adequate once implemented. Failure to develop adequate internal control and hiring of qualified accounting personnel may result in a “material weakness” in the Company’s internal control relating to the above activities.
This annual report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission.
Changes in Internal Controls.
During the three months ended September 30, 2010, there were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (f) of Rule 13a-15 or Rule 15d-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9 B.
Item 9 B. Other Information
On September 29, 2010, Midtown Partners and Co., LLC ("Midtown") filed, in the Circuit Court of Hillsborough County, Florida (Case No. 101981) an action against us alleging an unpaid commission in the amount of $400,000 plus warrants in connection with the sales of securities by us. We believe Midtown's allegations are without merit . We intend to mount a vigorous defense. The matter is in its earliest stage; we have filed our response to the complaint, denying the allegations therein, raising affirmative defenses and making a counterclaim based on Midtown's breach of contract.
On October, 28, we filed Form 8 K reporting the issuance of Redeemable preferred stock and release of our pledge account balance.
On October 28, 2010, the account balance of our Restricted cash was released to our operating account, increasing our working capital accordingly.
On November 19, we filed Form 10 Q/A reporting amended manufacturing agreement previously filed.
Part III
Item 10.
Item 10. Directors, executive officers and corporate governance
The following table sets forth certain information with respect to each of our directors, executive officers and key employees as of September 30, 2010. Their ages, positions, dates of initial election or appointment, and the expiration of their terms are as follows:
Name
Age
Position
Period served
Anastasios Kyriakides
Director, Chief Executive Officer, Secretary
Sept. 2008 to present
Kenneth A. Hosfeld
Director, Executive Vice President
Sept. 2008 to present
Guillermo Rodriguez
Director, Chief Financial Officer
Sept. 2008 to present
Leo Manzewitsch
Director, Chief Technical Officer
Sept. 2008 to present
Unless expressly indicated in the above table, each director and officer will serve in these capacities until their successors are duly elected, qualified and seated in accordance with the Company’s Articles of Incorporation and Bylaws.
Background of Executive Officers and Directors
Anastasios Kyriakides, Director, Chief Executive Officer, Secretary. Mr. Kyriakides has served as a member of the Company’s board of directors and as the Company’s Chief Executive Officer and Secretary since September 2008. Mr. Kyriakides received a Bachelor of Science in business from Florida International University in 1975. In 1977, he received a degree in investment banking from the American Institute of Banking. From 1979 until present, Mr. Kyriakides has consulted for numerous companies in the areas of shipping, travel, banking and electronics. Mr. Kyriakides began his career in the electronics development field when, in 1979, he founded and served as Chairman of Lexicon Corporation, producer of the LK300, the first hand held electronic language translator which translated words and phrases into 12 different languages. Lexicon was publicly traded on the NASDAQ, under the symbol LEXI, until it was ultimately acquired by Nixdorf Computers of Germany. Mr. Kyriakides was also the founder of Delcor Industries, established in 1980 in Hollywood, Florida. Delcor was an electronics manufacturing facility employing over 150 employees to assemble OEM products for various electronics companies including IBM mainframe and Gable Division. In 1983, Mr. Kyriakides founded the Mylex Corporation to develop and produce the world’s first hand-held optical scanner and VGA card for personal computers. As the President and Chairman, Mr. Kyriakides guided Mylex from its beginning as a private company to its becoming a public company traded on the NASDAQ under the stock symbol MYLX until it was acquired as a wholly owned subsidiary of IBM (NYSE: IBM). In 1983, Mr. Kyriakides was the founder and Chairman of Tower Bank NA, a full service commercial bank, with three offices, headquartered in Dade County, Florida. Mr. Kyriakides also has extensive experience in the cruise line and travel industries. His cruise ship career started with Carnival Cruise line out of the Port of Miami, and continued to a successful start up with Tropicana Cruises; one of the first gaming ships out of the Port of Miami. Mr. Kyriakides founded Regency Cruise Line in 1984, as the world’s first publicly traded company in passenger shipping, and served as its Chairman and Secretary until 1987. Mr. Kyriakides also organized the successful start-up of Seawind Cruise Line. In his three years with Seawind Cruise Line, Mr. Kyriakides served as its founder, chairman, chief executive officer and secretary.
From 1994 to 1996, Mr. Kyriakides served as the Chairman of Montgomery Ward Travel, a company created to provide full travel services to eight million Montgomery Ward customers and credit card holders. Immediately prior to joining the Company, Mr. Kyriakides served as Chief Executive Officer of Interlink Global Corporation from 1994 until September, 2008. Interlink Global Corporation provided telecommunications applications utilizing hardware and software that enables its domestic and worldwide users to access the internet as a transmission medium for placing telephone calls.
Kenneth Hosfeld, Director, Executive Vice President. Mr. Hosfeld was appointed to serve on the Company’s board of directors in September 2008. Mr. Hosfeld has over twenty-two years of international sales, marketing, and business management experience in the telecommunications industry. Most recently, Mr. Hosfeld served as a member of the board of directors and the executive vice president for Interlink Global Corporation (OTC: ILKG), a provider of private and public telecommunication network and internet services. Prior to joining Interlink, Mr. Hosfeld co-founded NetExpress. He has also served as the Regional Director of Brazil, the Andinos, and the Caribbean for Tellabs, Inc., a global supplier to the dynamic telecommunications industry that designs, manufactures, markets and services voice, data a video transportation tools and networks. While with Tellabs, Mr. Hosfeld secured that company’s first “turn-key” contract which involved a complete, fully managed network deployment including all products and services and project financing. He also opened Tellabs’ offices in Brazil and regularly exceeded revenue targets. Prior to that, Kenneth was Vice President of Nera Latin America, a subsidiary of Nera Telecommunications (formerly ABB), a telecommunications and IT solutions provider for microwave, satellite, wireless broadband access, networking and broadcasting. Mr. Hosfeld had full production and logistic responsibility for the Latin American region, including responsibilities for opening offices throughout Latin America including such countries as Brazil, Colombia, Mexico, and Venezuela, While with the company, Mr. Hosfeld was also able to penetrate the Mexican and Chilean markets. Prior to his work with Nera Latin America, Mr. Hosfeld was responsible for similar product sales in Africa and in China. Mr. Hosfeld speaks over six languages including fluent Spanish and Portuguese. Immediately prior to joining the Company, Mr. Hosfeld served as Executive Vice President of Interlink Global Corporation from 1994 until September, 2008. Interlink Global Corporation provided telecommunications applications utilizing hardware and software that enables its domestic and worldwide users to access the internet as a transmission medium for placing telephone calls.
Guillermo Rodriguez, Director, Chief Financial Officer. Mr. Rodriguez was appointed to the Company’s board of directors in September 2008. Mr. Rodriguez was a certified public accountant. He earned his Bachelor’s Degree with a major in accounting and business administration from the University of Miami in Coral Gables, Florida. Mr. Rodriguez earned his Masters of Business Administration from Nova Southeastern University in Davie, Florida. He has extensive accounting and financial reporting experience in banking, real estate brokering, property management and the telecommunications industry. Prior to joining the Company in September 2008, Mr. Rodriguez worked for Interlink Global Corporation from 2005 until September 2008 and as controller and financial officer for Land Cellular Corporation from 2003 until 2005. Prior to that, Mr. Rodriguez served as controller and financial officer for Bremer Real Estate, CSW Associates and Consolidated Bank, N.A. Mr. Rodriguez also worked as an auditor and investigator for the Federal Deposit Insurance Corporation (FDIC). Mr. Rodriguez is fluent in Spanish.
Leo Manzewitsch, Director, Chief Technology Officer. Mr. Manzewitsch’ has over eighteen years of experience in the telecommunications industry. He received his Masters in Electronics Engineering from the University of Buenos Aires, Argentina in 1991 and a degree in mechanics from the Argentinean National School of Technical Education, Buenos Aires in 1981. Before joining the Company as a director and the Chief Technology Officer in September 2008, Mr. Manzewitsch’ held positions in sales support management with UT Starcom, a global leader in internet protocol television, IPTV solutions, IPTV products, VoIP, mobile internet and internet television. Mr. Hosfeld has also worked as the Business Development Manager for STRATEKGY Telecom Solutions. Mr. Manzewitsch’ has also held various positions at NEC Corporation, which provides IT network integrated solutions and semiconductor solutions, including new product engineer and manager of new product marketing. From 2000 until 2006, Mr. Manzewitsch’ served as the Marketing Manager for Tellabs International in their South American market. In 2006, Mr. Manzewitsch’ joined Interlink Global Corporation, where he served as the Chief Technology Officer until he joined the Company in September, 2008. Mr. Manzewitsch’ is fluent in Spanish.
Significant employees
Other than the executive officers named above, the Company does not have any “significant employees.”
Family relationship
None.
Involvement in legal proceedings
No officer, director, promoter or significant employee has been involved in the last five years in any of the following:
●
Any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time;
●
Any conviction in a criminal proceeding or being subject to a pending criminal proceeding (excluding traffic violations and other minor offenses);
●
Being subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoying, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities; and
●
Being found by a court of competent jurisdiction (in a civil action), the Commission or the Commodity Futures Trading Commission to have violated or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.
Committees
Our business, property and affairs are managed by or under the direction of the board of directors. Members of the board are kept informed of our business through discussion with the chief executive and financial officers and other officers, by reviewing materials provided to them and by participating at meetings of the board and its committees. We presently do not have any committees of our board of directors, however, our board of directors intends to establish various committees at some point in the near future.
Employment Agreements
On May 6, 2009, the Company entered into an Employment Agreement with Anastasios N. Kyriakides (the “Kyriakides Employment Agreement”) pursuant to which Mr. Kyriakides agreed to continue his service as President and Chief Executive Officer of the Company through May 5, 2012.
Under the Kyriakides Employment Agreement, Mr. Kyriakides’ base salary is $150,000 per annum, subject to annual increases at the discretion of the Board of Directors. In addition, under the Kyriakides Employment Agreement, Mr. Kyriakides is (a) eligible for an annual performance based cash bonus up to a maximum annual award of $112,500 to be determined based upon profitability of the Company, (b) eligible to receive a onetime award on May 5, 2012 of shares of common stock having a maximum value of up to $168,750 to be determined based upon profitability of the Company during the 3 year period ending on May 5, 2012, (c) entitled to receive health benefits and life insurance coverage, (d) entitled to receive a monthly car allowance not to exceed $500 a month, (e) eligible to receive other stock grants and/or options to purchase shares of the Company’s common stock in amounts and upon terms as determined by the Company’s Board of Directors from time to time The Kyriakides Employment Agreement may be terminated by the Board of Directors at any time for cause, provided that Mr. Kyriakides receives notice of such termination and fails to cure the alleged breach. Upon termination by the Company without cause or resignation by Mr. Kyriakides for good reason, Mr. Kyriakides is entitled to receive his base salary, as severance, for a 12 month period.
Currently, with the exception of Mr. Kyriakides Employment Agreement, all other employment with the Company is at will and may be terminated by either the employee or the Company at any time. We require each of our executive officers to execute a Confidentiality and Non-Competition Agreement.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires our directors and executive officers and persons who beneficially own more than ten percent of a registered class of our equity securities to file with the SEC initial reports of ownership and reports of change in ownership of common stock and other equity securities of our company. Officers, directors and greater than ten percent stockholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to us under Rule 16a-3(e) during the fiscal year ended September 30, 2009, and Forms 5 and amendments thereto furnished to us with respect to the fiscal year ended September 30, 2009, we believe that during the year ended September 30, 2009, our executive officers, directors and all persons who own more than ten percent of a registered class of our equity securities have complied with all Section 16(a) filing requirements, except for the changes on holdings of beneficial owners, as set forth below: Anastasios Kyriakides, Guillermo Rodriguez, Kenneth Hosfeld and Leo Manzewitsch each filed their Form 3 4 days late. Ronald J. Rule, Jr. filed his Form 3 11 days late.
Code of Ethics
We have adopted a Code of Ethics for our officers, directors and employees. A copy of the Code of Ethics is attached here to as Exhibit 14.1 to this Annual Report on Form 10-K.
Item 11.
Item 11. Executive compensation
Compensation of our executive officers
The following table contains compensation information for our executive officers for the fiscal years ended September 30, 2010 and September 30, 2009. No other officer received compensation greater than $100,000 for either fiscal year. All of the information included in this table reflects compensation earned by the individuals for services rendered to our Company and all references in the following tables to stock awards relate to awards of common stock granted by us.
(1)
Mr. Kyriakides was appointed to serve as our Chief Executive Officer on September 10, 2008.
All amounts reflected in this table are from the date of Mr. Kyriakides appointment to the end of fiscal years.
(2)
Mr. Kyriakides annual salary is $190,000.00.
(3)
The Board of Directors granted Mr. Kyriakides a stock grant of 1,900,000 shares on July 26, 2010.
The stock was valued at $0.03 per share including adjustment for ownership restriction.
(4)
Mr. Rodriguez was appointed to serve as Chief Financial Officer on September 30, 2008.
All amounts reflected in this table are from the date of Mr. Rodriguez appointment to the end of fiscal years.
(5)
Mr. Rodriguez annual salary is $85,000.00.
(6)
The Board of Directors granted Mr. Rodriguez a stock grant of 400,000 shares on July 26, 2010.
The stock was valued at $0.03 per share including adjustment for ownership restriction.
(7)
Mr. Hosfeld was appointed to serve as our Executive Vice President on September 30, 2008.
All amounts reflected in this table are from the date of Mr. Hosfeld appointment to the end of fiscal years.
(8)
Mr. Hosfeld annual salary is $96,000.00.
(9)
The Board of Directors granted Mr. Hosfeld a stock grant of 400,000 shares on July 26, 2010.
The stock was valued at $0.03 per share including adjustment for ownership restriction.
(10)
Mr. Manzewitsch was appointed to serve as our Chief Technology Officer on September 30, 2008.
All amounts reflected in this table are from the date of Mr. Manzewitsch appointment to the end of fiscal years.
(11)
Mr. Manzewitsch annual salary is $96,000.00.
(12)
The Board of Directors granted Mr. Manzewitsch a stock grant of 400,000 shares on July 26, 2010.
The stock was valued at $0.03 per share including adjustment for ownership restriction.
(13)
Mr. Kyriakides was appointed to serve as Marketing Director on September 30, 2008.
(14)
Mr. Kyriakides annual salary is $85,000.00.
(15)
The Board of Directors granted Mr. Kyriakides a stock grant of 400,000 shares on July 26, 2010.
The stock was valued at $0.03 per share including adjustment for ownership restriction.
Overview
The following is a discussion of our program for compensating our named executive officers and directors. Currently, we do not have a compensation committee, and as such, our board of directors is responsible for determining the compensation of our named executive officers. The primary goal of our executive compensation policy is to attract and retain the most talented and loyal executives possible. Our intent is to ensure that our executives are compensated effectively in a manner consistent with our strategy and competitive practice and to align executive compensation with the achievement of our short and long term business objectives.
Our board of directors considers a variety of factors in determining compensation of executives including the executive’s background, training and prior work experience.
Elements of executive compensation
Our compensation program for the named executive officers consists primarily of base salary. There is no bonus plan, retirement plan, long-term incentive plan or other such plans. The base salary we provide is intended to equitably compensate the named executive officers based upon their level of responsibility, complexity and implementation of our business plan.
2010 Stock Option Plan
On November 15, 2009, Net Talk.com, Inc. (the “Company”) adopted the 2010 Stock Option Plan (the "Plan") which is intended to is to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate persons who make (or are expected to make) important contributions to the Company by providing such persons with equity ownership opportunities and performance-based incentives and thereby better aligning the interests of such persons with those of the Company’s shareholders. All of the Company’s employees, officers, and directors, and those Company’s consultants and advisors (i) that are natural persons and (ii) who provides bona fide services to the Company not connected to a capital raising transaction or the promotion or creation of a market for the company’s securities, are eligible to be granted options or restricted stock awards under the Plan. The maximum aggregate number of shares of the Company’s common stock that may be issued under the Plan is 10,000,000 shares of the Company’s common stock.
2010 Stock option plan (Share-based payments employees):
On July 26, 2010, we issued 3,709,500 shares of common stock to our employees as part of our 2010 Stock Option Plan. The shares are compensatory in nature and are fully vested. We have valued the shares at $0.03 per share consistent with fair value at the time of issuance including and adjusted for ownership restrictions.
Compensation of Directors
None of the Company’s directors have received any cash or equity remuneration since inception.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth certain information, as of September 30, 2010 with respect to the beneficial ownership of the outstanding common stock by (i) any holder of more than five (5%) percent; (ii) each of our executive officers and directors; and (iii) our directors and executive officers as a group. Except as otherwise indicated, each of the stockholders listed below has sole voting and investment power over the shares beneficially owned.
(1)
Unless otherwise indicated, the address of each shareholder is 1100 NW 163rd Drive, Miami, Florida 33169.
(2)
Beneficial ownership of shares is determined under Rule 13d-3(d)(1) of the Exchange Act and generally includes any shares over which a person exercises sole or shared voting or investment power and the number of shares that can be acquired within sixty (60) days upon exercise of an option or conversion of warrants and debentures. Common stock subject to these convertible securities are deemed to be outstanding for the purpose of computing the ownership percentage of the person holding such convertible security, but are not deemed to be outstanding for the purpose of computing the ownership percentage of any other person. Applicable percentage of ownership is based on 79,484,104 of fully diluted shares of Net Talk.com, Inc. common stock being issued and outstanding as of September 30, 2010.
(3)
Includes: (a) 4,010,000 shares of common stock owned by Kyriakides Investments, LLC. and (b) 54,400 shares of common stock issuable upon exercise of a Series A Common Stock Purchase Warrant, which may be exercised, at the option of the holder, at an exercise price of $0.25 per share
(4)
Includes: 19,995,092 shares of common stock issuable upon conversion of 12% Senior Secured Convertible Debentures held by Vicis Capital Master Fund in the aggregate principal amount of $4,998,773 and it also includes 16,800,000 shares of common stock issuable upon conversion of 12% Redeemable preferred stock. It also includes 12,00,000 shares of common stock issuable upon exercise of a Series D 1 and D 2 Common Stock Purchase Warrant, which may be exercised, at the option of the holder, at an exercise price of $0.50 per share and 12,000,000 shares of common stock issuable upon exercise of a Series D 3 Common Stock Purchase Warrant, which may be exercised, at the option of the holder, at an exercise price of $0.50 per share. The 12% Senior Secured Convertible Debentures impose a contractual limitation on the holder’s ability to convert such debenture into common stock. This limitation prevents such holder from beneficially owning more than 4.99% of Net Talk.com, Inc.’s common stock.
Item 13.
Item 13. Certain relationships and related transactions, and director independence
There were no transactions since the beginning of our last fiscal year, and there are no proposed transactions, that involve amounts in excess of $120,000 to which we were or are to become a party in which any director, executive officer, beneficial owner of more than five (5%) percent of our common stock, or members of their immediate families had, or is to have, a direct or indirect material interest.
Item 14.
Item 14. Principal Accountant Fees and Services
The Company's board of directors reviews and approves audit and permissible non-audit services performed by its independent accountants, as well as the fees charged for such services. In its review of non-audit service fees and its appointment of Meeks International, LLC. as the Company's independent accountants, the board of directors considered whether the provision of such services is compatible with maintaining independence. All of the services provided and fees charged by Meeks International, LLC. were approved by the board of directors.
Audit Fees
The aggregate fees billed for professional services for the audit of the annual financial statements of the Company and the reviews of the financial statements included in the Company's quarterly reports on Form 10-Q for 2010 and 2009 were $54,598 and $77,701, respectively, net of expenses.
Audit-Related Fees
There were no other fees billed by during the last two fiscal years for assurance and related services that were reasonably related to the performance of the audit or review of the Company's financial statements and not reported under "Audit Fees" above.
Tax Fees
There were no fees paid for tax or consulting services for fiscal year ended September 30, 2010 or 2009.
All Other Fees
There were no other fees billed during the last two fiscal years for products and services provided.
Part IV
Item 15.
Item 15. Exhibits, financial statement schedules
Exhibit No. Description
31.1
Certification of Principal Executive Officer pursuant to 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Principal Financial Officer pursuant to 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of the Principal Executive Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of the Principal Financial Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1
On October, 28, we filed Form 8 K reporting the issuance of Redeemable preferred stock and release of our pledge account balance.
99.2
On November 19, we filed Form 10 Q/A reporting amended manufacturing agreement previously filed.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NET TALK.COM, INC.
Date: December 15, 2010
By: /s/ Anastasios Kyriakides
Anastasios Kyriakides
Chief Executive Officer (Principal Executive Officer)
Date: December 15, 2010
By: /s/ Guillermo Rodriguez
Guillermo Rodriguez
Chief Financial Officer (Principal Financial Officer and
Principal Accounting Officer)
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Each person whose signature appears below hereby authorizes Anastasios Kyriakides or either of them acting in the absence of the other as his or her true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution for him or her and in his or her name, place and stead, in any and all capacities to sign any and all amendments to this report, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission.
Name
Position
Date
_________________________
Anastasios Kyriakides
Chief Executive Officer (Principal Executive Officer)
and Director
December 15, 2010
_________________________
Guillermo Rodriguez
Chief Financial Officer (Principal Financial Officer
and Principal Accounting Officer) and Director
December 15, 2010
_________________________
Kenneth Hosfeld
Executive Vice President and Director
December 15, 2010
_________________________
Leo Manzewitsch
Chief Technical Officer and Director
December 15, 2010
Page
Report of Independent Registered Public Accountant firm Meeks International, LLC.
Balance sheets as of September 30, 2010
Statements of operations for the years ended September 30, 2010 and 2009
Statements of cash flows for the years ended September 30, 2010 and 2009
Statements of stockholders equity (deficit) for the years ended September 30, 2010 and 2000
Notes to financial statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
NetTalk.com, Inc.
Miami, Florida
We have audited the accompanying balance sheet of NetTalk.com, Inc as of September 30, 2010 and 2009 and the related statement of operations, stockholders’ deficit, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of NetTalk.com, Inc. as of September 30, 2010 and 2009, and the results of their operations, changes in their stockholders’ deficit and their cash flows for the years ended September 30, 2010 and 2009, in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern.
Meeks International, LLC.
Tampa, Florida
November 30, 2010
NET TALK.COM, INC.
Notes to Financial Statements
Year ended September 30, 2010 and 2009
Note 1 - Nature of operations and basis of presentation
Net Talk.com, Inc. (“Nettalk” or the “Company”) was incorporated on May 1, 2006 under the laws of the State of Florida. We are a telephone company, who provides, sells and supplies commercial and residential telecommunication services, including services utilizing voice over internet protocol (“VoIP”) technology, session initiation protocol (“SIP”) technology, wireless fidelity technology, wireless maximum technology, marine satellite services technology and other similar type technologies. Our main products are the TK 6000 and the DUO, an analog telephone adapters that provides connectivity for analog telephones and faxes to home, home office or corporate local area networks (“LAN”). Our TK 6000 and DUO and their related services are a cost effective solution for individuals, small businesses and telecommuters connecting to any analog telephone, fax or private branch exchange (“PBX”). Our TK 6000 and DUO provides one USB port, one Ethernet port and one analog telephone port. A full suite of internet protocol features is available to maximize universal connectivity. In addition, analog telephones attached to our TK 6000 and DUO are able to use advanced calling features such as call forwarding, caller ID, 3-way calling, call holding, call retrieval and call transfer.
Subsequent events
We have evaluated subsequent events that occurred after our fiscal year ended September 30, 2010 through November 30, 2010.
Note 2 - Summary of Significant Accounting Policies:
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make estimates and assumptions that affect the amounts reported in the financial statements and footnotes. Significant estimates inherent in the preparation of our financial statements include developing fair value measurements upon which to base our accounting for acquisitions of intangible assets and issuances of financial instruments, including our common stock. Our estimates also include developing useful lives for our tangible and intangible assets and cash flow projections upon which we determine the existence of, or the measurements for, impairments. In all instances, estimates are made by competent employees under the supervision of management, based upon the current circumstances and the best information available.
Risk and Uncertainties
Our future results of operations and financial condition will be impacted by the following factors, among others: dependence on the worldwide telecommunication markets characterized by intense competition and rapidly changing technology, on third-party manufacturers and subcontractors, on third-party distributors in certain markets, on the successful development and marketing of new products in new and existing markets. Generally, we are unable to predict the future status of these areas of risk and uncertainty.
Revenue recognition
Operating revenue consist of customer equipment sales of our main product TK6000, telecommunication service revenues, shipping and handling revenues.
Our operating revenues are generated from the sale of customer equipment of our main products, our TK6000 and DUO. We also derive service revenues from per minute fees for international calls. Revenue from the sale of our TK6000 is fully recognized at the time of our customer equipment sale. Our TK6000 provides for life time service (over the life of the device/equipment). Our TK6000 is able to operate within our network/platform or over any other network/platform. There is no need for income allocation between our TK6000 and life time service provided. The full intrinsic value of the sale is allocated to the device. Therefore, we recognized 100% of revenue at time of customer equipment sale and do no allocate any income to life time service provided. Shipping and handling is also recognized at time of sale.
On July 14, 2010 we revealed our newest product the net TALK DUO (“DUO”).
Our DUO offers our customers free nationwide calls to any landline or mobile phone in the U.S. and Canada from anywhere in the world, as well as low-cost international rates. It’s also a versatile digital phone service with no monthly fees, no contracts and no computer required.
Our DUO is flexible enough to connect directly to your Internet connection through the router/modem, there is also a convenient option with our DUO to connect to your computer. The sleek design is small enough to fit in the palm of your hand, making it a portable device.
Our DUO reduces the wear and tear on your home or office computer and reduces energy costs, resulting in money savings. Our fax-friendly DUO, offers fax (incoming and outgoing), a unique feature not offered, to our knowledge, by similar digital phone services.
The portability of this small device is also great for international travelers who want to place free nationwide calls to the U.S. and Canada, or who are looking for a low-cost solution for international rates. Calls to other netTALK customers are always free.
Our DUO provides for revenue recognition from the sale of the device and from the sale of telephone service. The initial year of telephone service is included on the sale price at time of sale and billed subsequently thereafter. Therefore, revenue recognition on our DUO is fully recognized at the time of our customer equipment sale, the one year telephone service is amortized over 12 month cycle. Subsequent renewals of the annual telephone service is amortized over the corresponding 12 months cycle.
International calls are billed as earned from our customers. International calls are prepaid and customers account is debited as minutes are used and earned.
Cash and Cash Equivalents
We consider all highly liquid cash balances and debt instruments with an original maturity of three months or less to be cash equivalents. We maintain cash balances only in domestic bank accounts, which at times, may exceed federally insured limits.
Inventory
Inventories are recorded at cost or market, whichever is lower.
During the year ended September 30, 2010 and 2009, in accordance with our lower of cost or market analyses we did not record lower of cost or market adjustments to our finished goods inventories.
Telecommunications Equipment and Other Property
Property, equipment and telecommunication equipment includes acquired assets which consist of network equipment, computer hardware, furniture and software. All of our equipments are stated at cost with depreciation calculated using the straight line method over the estimated useful lives of related assets, which ranges from three to five years. The cost associated with major improvements are capitalized while the cost of maintenance and repairs is charged to operating expenses.
Intangible Assets
Our intangible assets were recorded at our acquisition cost, which encompassed estimates of their respective and their relative fair values, as well as estimates of the fair value of consideration that we issued. We amortize our intangible assets using the straight-line method over lives that are predicated on contractual terms or over periods we believe the assets will have utility.
Impairments and Disposals
We evaluate our tangible and definite-lived intangible assets for impairment annually or more frequently in the presence of circumstances or trends that may be indicators of impairment. Our evaluation is a two step process. The first step is to compare our undiscounted cash flows, as projected over the remaining useful lives of the assets, to their respective carrying values. In the event that the carrying values are not recovered by future undiscounted cash flows, as a second step, we compare the carrying values to the related fair values and, if lower, record an impairment adjustment. For purposes of fair value, we generally use replacement costs for tangible fixed assets and discounted cash flows, using risk-adjusted discount rates for intangible assets.
Research and Development and Software Costs
We expense research and development costs, as these costs are incurred. We account for our offering-related software development costs as costs incurred internally in creating a computer software product and are charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model. Thereafter, all software production costs shall be capitalized and subsequently reported at the lower of unamortized cost or net realizable value. Capitalized costs are amortized based on current and future revenue for each product with an annual minimum equal to the straight-line amortization over the remaining estimated economic life of the product. At this time our main products the TK6000 and DUO are being sold in the market place. Therefore, research and development cost reported in our financial statements relates to pre - marketing costs and are expensed accordingly.
Reclassifications
Certain reclassifications have been made to prior years financial statements in order to conform to the current year’s presentation. The reclassification had no impact on net earnings previously reported.
Share-Based Payment Arrangements
In June 2008, the FASB issued authoritative guidance on the treatment of participating securities in the calculation of earnings per shares (“EPS”). This guidance addresses whether instruments granted in share - based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing EPS under the two - class method. This guidance was effective for fiscal years beginning on or after December 15, 2008. Adoption of this guidance did not have a material impact on our results of operations and financial position, or on basic or diluted EPS.
We apply the grant date fair value method to our share - based payment arrangements with employees and consultants. Share - based compensation cost to employees is measured at the grant date fair value based on the value of the award and is recognized over the service period. Share - based payments to non - employees are recorded at fair value on the measurement date and reflected in expense over the service period.
2010 Stock Option Plan
On November 15, 2009, Net Talk.com, Inc. (the “Company”) adopted the 2010 Stock Option Plan (the "Plan") which is intended to is to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate persons who make (or are expected to make) important contributions to the Company by providing such persons with equity ownership opportunities and performance-based incentives and thereby better aligning the interests of such persons with those of the Company’s shareholders. All of the Company’s employees, officers, and directors, and those Company’s consultants and advisors (i) that are natural persons and (ii) who provides bona fide services to the Company not connected to a capital raising transaction or the promotion or creation of a market for the company’s securities, are eligible to be granted options or restricted stock awards under the Plan. The maximum aggregate number of shares of the Company’s common stock that may be issued under the Plan is 10,000,000 shares of the Company’s common stock.
2010 Stock option plan (Share-based payments employees):
On July 26, 2010, we issued 3,709,500 shares of common stock to our employees as part of our 2010 Stock Option Plan. The shares are compensatory in nature and are fully vested. We have valued the shares at $0.03 per share consistent with fair value at the time of issuance including and adjusted for ownership restrictions.
Financial Instruments
Financial instruments, as defined in the Accounting Standards Codification (“ASC”) 825 Financial Instruments, consist of cash, evidence of ownership in an entity, and contracts that both (i) impose on one entity a contractual obligation to deliver cash or another financial instrument to a second entity, or to exchange other financial instruments on potentially unfavorable terms with the second entity, and (ii) conveys to that second entity a contractual right (a) to receive cash or another financial instrument from the first entity, or (b) to exchange other financial instruments on potentially favorable terms with the first entity. Accordingly, our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, secured convertible debentures, and derivative financial instruments.
We carry cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities at historical costs since their respective estimated fair values approximate carrying values due to their current nature. We also carry convertible debentures and redeemable preferred stock at historical cost. However, the fair values of debt and akin-to-debt financial instruments are estimated for disclosure purposes. As of September 30, 2010, estimated fair values and respective carrying values of our Secured Convertible Debentures and Series A Convertible Preferred Stock are as follows:
The fair values of the Secured Convertible Debentures and Series A Convertible Preferred Stock were determined based upon their respective discounted cash flow, using observable market rates, plus the fair value of the embedded conversion options. Observable market rates ranged from 7.52% for one-year and 7.85% for two years and were derived from publicly available surveys of corporate bond curves for issuers with similar risk characteristics as ours.
Derivative financial instruments, as defined in ASC 815-10-15-83 Derivatives and Hedging, consist of financial instruments or other contracts that contain a notional amount and one or more underlying (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare instances, assets.
We generally do not use derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. However, we have entered into certain other financial instruments and contracts, such as our secured convertible debenture and warrant financing arrangements that are either (i) not afforded equity classification, (ii) embody risks not clearly and closely related to host contracts, or (iii) may be net-cash settled by the counterparty. As required by ASC 815, these instruments are required to be carried as derivative liabilities, at fair value, in our financial statements. See Note 7 for additional information about derivative financial instruments.
Redeemable Preferred Stock
Redeemable preferred stock (and other redeemable financial instrument we may enter into) is initially evaluated for possible classification as liabilities under Statements of Financial Accounting Standards No. 150 Financial Instruments with Characteristics of Both Liabilities and Equity. Redeemable preferred stock classified as liabilities is recorded and carried at fair value. Redeemable preferred stock that does not, in its entirety, require liability classification is evaluated for embedded features that may require bifurcation and separate classification as derivative liabilities under Statement 133. In all instances, the classification of the redeemable preferred stock host contract that does not require liability classification is evaluated for equity classification or mezzanine classification based upon the nature of the redemption features. Generally, any feature that could require cash redemption for matters not within our control, irrespective of probability of the event occurring, requires classification outside of stockholders’ equity. See Note 6 for further disclosures about our redeemable preferred stock.
Loss per common share
Basic loss per common share represents our loss applicable to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted loss per common share gives effect to all potentially dilutive securities. We compute the effects on diluted loss per common share arising from warrants and options using the treasury stock method or, in the case of liability classified warrants, the reverse treasury stock method. We compute the effects on diluted loss per common share arising from convertible securities using the if-converted method. The effects, if anti-dilutive are excluded.
Accounting Changes
Effective on October 1, 2009, we adopted Emerging Issues Task Force Consensus No. 07-05 Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock (“EITF 07-05”). EITF 07-05 amended previous guidance related to the determination of whether equity-linked contracts, such as our convertible debentures, meet the exclusion to bifurcation and derivative classification of the respective embedded conversion feature. Under EITF 07-05, the embedded conversion option was no longer exempt from bifurcation and derivative classification because the conversion option was subject to adjustments that are not allowable under the new standard. We have accounted for the change as a change in accounting principle where the cumulative effect, which amounted to $872,320, as a charge to our opening additional paid in capital on October 1, 2009.
Note 3 - Telecommunications Equipment and Other Property:
Our telecommunications equipment is deployed in our Network Operations Center (“NOC”) as is most of the computer equipment. Other computer and office equipment and furnishings are deployed at our corporate offices, which we lease under an operating lease. Depreciation of the above assets amounted to $124,709 during the fiscal year ended September 30, 2010 and $119,464 during year ended September 30, 2009.
Note 4 - Intangible Assets:
Amortization of the above intangible assets amounted to $238,627 and $238,780 for year ended September 30, 2010 and 2009, respectively. The weighted average amortization period for the amortizable intangible assets is 3.0 years.
Estimated future amortization of intangible assets for each year ending after September 30, 2010, is as follows:
Note 5 - Secured Convertible Debentures
The carrying values of our 12% secured convertible debentures consist of the following as of September 30, 2010 and 2009:
Our convertible debentures as of September 30, 2010 were issued on February 24, 2010 in connection with an exchange agreement with our creditors that provided for, among other things, the consolidation of our previous secured convertible debt instruments, with maturities listed in the table above, and included the capitalization of $798,773 of accrued interest. The newly issued convertible debentures bear interest at 12%, which is payable at the earlier of the maturity date or the date that the debentures are converted, if ever. Such interest is payable at the Company’s option in cash or common stock at $0.25 per common share. The principal amount of the debentures is convertible into common stock at $0.25. Accordingly, the convertible debentures are indexed to 19,995,092 shares of our common stock. Each of the principal and debt conversion rates are subject to adjustment for recapitalization events or sales of equity or equity-linked contracts with a price or conversion price less than the contractual conversion price. The convertible debentures are secured by substantially all of our assets and are either callable or subject to a default interest rate, at the creditor’s option, if we default on the debentures. The significant events that could trigger a default include our failure to service the debentures, bankruptcy and the filing of significant judgments against us. The debentures also preclude merger and similar transactions, incurring additional debt, our payment of dividends on our equity securities and limit the compensation that we may pay to our officers.
Our accounting for the aforementioned exchange transaction required us to consider whether the exchange resulted in a substantial modification to the original convertible debentures based upon either cash flows or the fair value of the embedded conversion feature, wherein substantial is generally defined as a change greater than 10%. In all instances, our calculations indicated that the exchange of convertible debentures resulted in changes that were substantial to either cash flows, the embedded conversion option, or both. As a result, we were required to extinguish the prior debt instruments and reestablish the new convertible debentures at fair value, with the difference reflected in our expenses. The following table reflects the components of our extinguishment calculations on February 24, 2010:
The fair values of the Secured Convertible Debentures were determined based upon their respective discounted cash flow, using observable market rates, plus the fair value of the embedded conversion options. Observable market rates on the exchange date ranged from 7.91% for one-year and 8.47% for two years and were derived from publicly available surveys of corporate bond curves for issuers with similar risk characteristics as ours. The fair value of our compound embedded derivatives were determined using the Monte Carlo Simulations model. See Note 8. The compound embedded derivatives were adjusted to fair value on the exchange date, immediately before the exchange transaction, which amount is included in our derivative income (expense).
The fair value of the new convertible debentures was allocated to the debt balance, the compound embedded derivative and paid-in capital. Paid-in capital arises in this transaction, because the allocation resulted in premiums which, under accounting principles, are considered equity components. The following table summarizes the allocation on the exchange date:
Our accounting for the original debenture financings is as follows:
2008 Convertible Debenture Financing
On September 10, 2008, we issued a $1,000,000 face value, 12% secured convertible debenture (T-1), due September 10, 2010 and Series B warrants indexed to 4,000,000 shares of our common stock in exchange for the Interlink Asset Group, discussed in Note 3. Also on September 30, 2008, we issued a $500,000 face value 12% secured convertible debenture (T-2), due September 10, 2010 and Series B warrants indexed to 2,000,000 shares of our common stock for net cash proceeds of $472,800. The warrants have a term of five years. These financial instruments were issued to the same creditor under contracts that are substantially similar, unless otherwise mentioned in the following discussion.
The principal amount of the debentures is payable on September 10, 2010 and the interest is payable quarterly, on a calendar quarter basis. While the debenture is outstanding, the investor has the option to convert the principal balance, and not the interest, into shares of our common stock at a conversion price of $0.25 per common share. The terms of the conversion option provide for anti-dilution protections for traditional restructurings of our equity, such as stock-splits and reorganizations, if any, and for sales of our common stock, or issuances of common-indexed financial instruments, at amounts below the otherwise fixed conversion price. Further, the terms of the convertible debenture provide for certain redemption features. If, in the event of certain defaults on the terms of the debentures, some of which are indexed to equity risks, we are required at the investors option to pay the higher of (i) 110% of the principal balance, plus accrued interest or (ii) the if-converted value of the underlying common stock, using the 110% default amount, plus accrued interest. If this default redemption is not exercised by the investor, we would incur a default interest rate of 18% and the investor would have rights to our assets under the related Security Agreement. We may redeem the convertible debentures at anytime at 110% of the principal amount, plus accrued interest.
Because the two hybrid debt contracts were issued as compensation for the Interlink Asset Group, we concluded that they should be combined for accounting purposes, the accounting resulted in no beneficial conversion feature.
2009 Convertible Debenture Financings
We entered into several Securities Purchase Agreements with Debt Opportunity Fund, LLP (“DOF”) during the year ended September 30, 2009.
-
On January 30, 2009 we issued (a) 12% Senior Secured Convertible Debentures in the aggregate principal amount of $600,000 with a maturity date of January 30, 2011, convertible into shares of common stock at a conversion price of $0.25; and (b) Series C Warrants to purchase 2,400,000 shares of our common stock at an exercise price of $0.50 for net cash proceeds of $507,900. The warrants have a term of five years.
-
On February 6, 2009 we issued (a) 12% Senior Secured Convertible Debentures in the aggregate principal amount of $500,000 with a maturity date of January 30, 2011, convertible into shares of common stock at a conversion price of $0.25; and (b) Series C Warrants to purchase 2,000,000 shares of our common stock at an exercise price of $0.50 for net cash proceeds of $443,250. The warrants have a term of five years.
-
On July 20, 2009, we issued (a) 12% Senior Secured Convertible Debentures in the aggregate principal amount of $500,000 with a maturity date of July 20, 2011, convertible into shares of common stock at a conversion price of $0.25; and (b) Series C Warrants to purchase 2,000,000 shares of our common stock at an exercise price of $0.50 for net cash proceeds of $446,250. The warrants have a term of five years.
-
On September 25, 2009, we issued (a) 12% Senior Secured Convertible Debentures in the aggregate principal amount of $1,100,000 with a maturity date of July 20, 2011, convertible into shares of common stock at a conversion price of $0.25; and (b) Series C Warrants to purchase 4,400,000 shares of our common stock at an exercise price of $0.25 for net cash proceeds of $1,000,000. The warrants have a term of five years.
Each debenture bears interest at a rate of 12% per annum from the date of issuance until paid in full. Interest is calculated on the basis of a 360-day year and paid for the actual number of days elapsed, and accrues and is payable quarterly or upon conversion (as to the principal amount then being converted). The debentures convert into shares of our common stock at the option of the holder at $0.25 per share (which conversion price is subject to adjustment under certain circumstances). The debentures are secured by a lien in all of the assets of the Company. Further, the terms of the convertible debentures provide for default redemption features similar to those described above.
Midtown Partners & Co., LLC (“Midtown Partners”), an NASD registered broker dealer, acted as the placement agent for the Company in connection with the January 30, July 20, and September 25, 2009 Convertible Debt Offerings (“2009 Convertible Debt Offerings”). We paid Midtown Partners cash commissions equal to $198,000 and we issued Series BD Common Stock Purchase Warrants to Midtown Partners entitling Midtown Partners to purchase 1,720,000 shares of the Company’s common stock at an initial exercise price of $0.50 per share and 440,000 shares of the Company’s common stock at an initial exercise price $0.25 per share. Since the Series BD warrants offered full ratchet anti-dilution protection, any previously issued and outstanding warrants with a conversion price greater than $0.25 automatically had their conversion price ratchet down to $0.25 as subsequent issuances were made with a conversion price of $0.25.
On September 22, 2009 we voided and reissued warrants in connection with our financing transactions. The cancellation and reissuance of warrants was treated as a modification under ASC 470-50 Modifications and Extinguishments although the change in cash flow was <10% so extinguishment accounting was not applicable.
Cancelled and re-issued warrants were as follows:
Original Warrants
Indexed
Shares
Strike
Price
Reissued
Warrants
Indexed
Shares
Strike
Price
C-1 warrants
2,400,000
$0.50
C-3 warrants
2,400,000
$0.50
C-2 warrants
2,000,000
$0.50
C-4 warrants
2,000,000
$0.50
BD-1 warrants
480,000
$0.50
BD-4 warrants
240,000
$0.25
BD-5 warrants
240,000
$0.50
BD-2 warrants
400,000
$0.50
BD-6 warrants
200,000
$0.25
BD-7 warrants
200,000
$0.50
BD-3 warrants
200,000
$0.50
BD-8 warrants
200,000
$0.25
BD-4 warrants
200,000
$0.50
BD-9 warrants
200,000
$0.50
Accounting for the Financing Arrangements:
We have evaluated the terms and conditions of the secured convertible debentures under the guidance of ASC 815, Derivatives and Hedging. We have determined that, while the anti-dilution protections preclude treatment of the embedded conversion option as conventional, the conversion option is exempt from classification as a derivative because it otherwise achieves the conditions for equity classification (if freestanding) provided in ASC 815. We have further determined that the default redemption features described above are not exempt for treatment as derivative financial instruments, because they are not clearly and closely related in terms of risk to the host debt agreement. On the inception date of the arrangements through June 30, 2010, we determined that the fair value of these compound derivatives is de minus. However, we are required to re-evaluate this value at each reporting date and record changes in its fair value, if any, in income. For purposes of determining the fair value of the compound derivative, we have evaluated multiple, probability-weighted cash flow scenarios. These cash flow scenarios include, and will continue to include fair value information about our common stock. Accordingly, fluctuations in our common stock value will significantly influence the future outcomes from applying this technique.
Since, as discussed above, the embedded conversion options did not require treatment as derivative financial instruments; however, we were required to evaluate the feature as embodying a beneficial conversion feature under ASC 470-20, Debt with Conversion and Other Options. A beneficial conversion feature (“BCF”) is present when the fair value of the underlying common share exceeds the effective conversion price of the conversion option. The effective conversion price is calculated as the basis in the financing arrangement allocated to the hybrid convertible debt agreement, divided by the number of shares into which the instrument is indexed. Because the two hybrid debt contracts dated September 10, 2008 were issued as compensation for the Interlink Asset Group and as further discussed in Note 3 we concluded that they should be combined for accounting purposes and the accounting resulted in no beneficial conversion feature. The financings issued in 2009 were found to have a BCF which gives effect to the (i) the trading market price on the contract dates and (ii) the effective conversion price of each issuance after allocation of proceeds to all financial instruments sold based upon their relative fair values. Notwithstanding, the BCF was limited to the value ascribed to the remaining hybrid contract (using the relative fair value approach). Accordingly, the BCF allocated to paid-in capital from the 2009 financings amounted to $872,320 for the year ended September 30, 2009.
We evaluated the terms and conditions of the Series B, Series C and Series BD warrants under the guidance of ASC 480, Distinguishing Liabilities from Equity (“ASC 480”). The warrants embody a fundamental change-in-control redemption privilege wherein the holder may redeem the warrants in the event of a change in control for a share of assets or consideration received in such a contingent event. This redemption feature places the warrants within the scope of ASC 480-10, as put warrants and, accordingly, they are classified in liabilities and measured at inception and on an ongoing basis at fair value. Fair value of the warrants was measured using the Black-Scholes-Merton valuation technique and in applying this technique we were required to develop certain subjective assumptions which are listed in more detail below.
Premiums on the secured convertible debentures arose from initial recognition at fair value, which is higher than face value. Discounts arose from initial recognition at fair value, which is lower than face value. Premiums and discounts are amortized through credits and debits to interest expense over the term of the debt agreement. Amortization of debt (discount) premiums amounts to $479,403 and $2,640 for the nine months ended June 30, 2010 and 2009, respectively.
Direct financing costs were allocated to the financial instruments issued (hybrid debt and warrants) based upon their relative fair values. Amounts related to the hybrid debt are recorded as deferred finance costs and amortized through charges to interest expense over the term of the arrangement using the effective interest method. Amounts related to the warrants were charged directly to income because the warrants were classified in liabilities, rather than equity, as described above. Direct financing costs are amortized through charges to interest expense over the term of the debt agreement.
On September 24, 2009, we obtained an extension of the interest payments due June 30, 2009 and September 30, 2009 to June 30, 2010 and September 30, 2010, respectively. The change in cash flow from this modification was analyzed to determine if it was greater than 10% which would give rise to extinguishment accounting. In each case, the change in cash flows was less than 10% so extinguishment accounting was not applicable.
On February 24, 2010, we exchanged the convertible debentures for newly issued convertible debentures as discussed in the beginning of this footnote.
Note 6 - Redeemable Preferred Stock
On February 24, 2010, we designated 500 shares of our authorized preferred stock as Series A Convertible Preferred Stock; par value $0.001 per share, stated value $10,000 per share (“Preferred Stock”). The Preferred Stock is redeemable for cash on June 30, 2011 at the stated value, plus accrued and unpaid dividends. Dividends accrue, whether or not declared, at a rate of 12% of the stated value. The Preferred Stock is convertible into common stock at the holder’s option at $0.25 based upon the stated value. Such conversion rate is subject to adjustment for traditional reorganizations and recapitalization and in the event that we sell common stock or other equity-linked instruments below the conversion price. Holders of the Preferred Stock are entitled to a preference equal to the stated value, plus accrued and unpaid dividends. While the Preferred Stock is outstanding, holders vote the number of indexed common shares.
Our accounting for the Preferred Stock and warrant financing transaction required us to evaluate the classification of the embedded conversion feature and the warrants. As a prerequisite to establishing the classification of the embedded conversion option, we were required to determine the nature of the hybrid Preferred Stock contract based upon its risks as either a debt-type or equity-type contract. The presence of the mandatory cash redemption and the requirement to accrue dividends were persuasive evidence that the Preferred Stock was more akin to a debt than an equity contract, with insufficient evidence to the contrary (e.g. voting privilege). Given that the embedded conversion feature, when evaluated as embodied in a debt-type contract, did not meet the definition for an instrument indexed to a company’s own stock, the embedded conversion feature required bifurcation and classification in liabilities, at fair value. Similarly, the warrants did not meet the definition for an instrument indexed to a company’s own stock, resulting in their classification in liabilities, at fair value.
The following table reflects the allocation of the purchase price on the financing date:
Warrants were valued using the Black-Scholes-Merton valuation technique. Significant assumptions were as follows: Market value of underlying, using the trading market of $0.58; expected term, using the contractual term of 5.0 years; market volatility, using a peer group of 90.20%; and, risk free rate, using the yield on zero coupon government instruments of 2.40%. The compound embedded derivative was valued using the Monte Carlo Simulations (“MCS”) technique. The MSC technique is a generally accepted valuation technique for valuing embedded conversion features in hybrid convertible notes, because it is an open-ended valuation model that embodies all significant assumption types, and ranges of assumption inputs that management of the Company believe would likely be considered in connection with the arms-length negotiation related to the transference of the instrument by market participants. However, there may be other circumstances or considerations, other than those addressed herein, that relate to both internal and external factors that would be considered by market participants as it relates specifically to the Company and the subject financial instruments.
Given its redeemable nature, we are required to classify our Preferred Stock outside of stockholders’ equity. Further, the inception date carrying value is subject to accretion to its ultimate redemption value over the term to redemption, using the effective method. During the period from its issuance to September 30, 2010, we accreted $224,969, which was reflected as a charge to paid-in capital in the absence of accumulated earnings. We also accrued $218,000 during the same period which amount represents the cumulative dividends that we are required to pay whether or not they are declared.
Note 7 - Derivative Financial Instruments
The components of our derivative liabilities consisted of the following at September 30, 2010 and 2009:
The following table reflects the activity in our derivative liability balances from October 1, 2009 to September 30, 2010:
The following table reflects the activity in our derivative liability balances from October 1, 2008 to September 30, 2009:
The following table summarizes the effects on our income (loss) associated with changes in the fair values of our derivative financial instruments:
Fair Value Considerations
We adopted the provisions of ASC 820 Fair Value Measurements and Disclosures (“ASC 820”) with respect to our financial instruments. As required by of ASC 820, assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to their fair value measurement. Our derivative financial instruments which are required to be measured at fair value on a recurring basis under of ASC 815 as of September 30, 2010 are all measured at fair value using Level 3 inputs. Level 3 inputs are unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The warrants are valued using the Black-Scholes-Merton (“BSM”) valuation methodology because that model embodies all of the relevant assumptions that address the features underlying these instruments. Significant assumptions were as follows as of September 30, 2010:
September 30, 2010
Series
D
Warrants
BD
Warrants
BD
Warrants
Contractual strike price
$0.50
$0.25
$0.50
Adjusted strike price
$0.43
$0.23
$0.43
Volatility
107.90%
111.48%--116.72%
111.48%--116.72%
Term to expiration
4.40
3.33-4.00
3.33-4.00
Risk-free rate
1.27%
0.64%--1.27%
0.64%--1.27%
Dividends
--
--
--
Assumptions at September 30, 2009 related to warrants by class were as follows:
September 30, 2009
Series
B
Warrants
Series
C-3
Warrants
Series
C-4
Warrants
Series
C-5
Warrants
Series
C-6
Warrants
Series
BD
Warrants
Adjusted Strike price
$0.25
$0.25
$0.25
$0.25
$0.25
$0.25
Volatility
93%
92%
92%
89%
89%
89%-93%
Expected term (years)
3.95
4.34
4.36
4.81
5.00
3.95-5.00
Risk-free rate
2.31%
2.31%
2.31%
2.31%
2.31%
2.31%
Dividends
--
--
--
--
--
--
We did not have a historical trading history sufficient to develop an internal volatility rate for use in BSM. As a result, we have used a peer approach wherein the historical trading volatilities of certain companies with similar characteristics as ours and who had a sufficient trading history were used as an estimate of our volatility. In developing this model, no one company was weighted more heavily.
Note 8 - Stockholders’ Deficit:
Share-based payments (employees):
On July 26, 2010, we issued 3,709,500 shares of common stock to our employees as part of our 2010 Stock Option Plan. The shares are compensatory in nature and are fully vested. We have valued the shares at $0.03 per share consistent with fair value at the time of issuance including and adjusted for ownership restrictions.
Note 9 - Commitment and Contingencies:
Leases
Our principal executive offices are located at 1100 NW 163rd Drive, Miami, Florida 33169. Our offices consist of approximately 2,500 square feet. Our lease terminated on August 31, 2010 and we are presently under negotiations with our landlord to renew the lease agreement for additional term of 2 years. This facility is suitable for our purposes and is expected to accommodate our needs for the foreseeable future.
Rent and associated occupancy expenses for year ended September 30, 2010 and 2009 was $175,876 and $165,716, respectively.
Employment arrangements
We have entered into an employment agreement with our Chief Executive Officer, Anastasios Kyriakides and in consideration of his services to us, we have agreed to pay him a base salary of $150,000 plus certain bonuses and awards if the Company achieves certain profitability levels and adopts certain incentive compensation plans. As of September 30, 2009, none of these incentive arrangements and plans had been realized. The agreement is effective through September 30, 2013.
Note 10 - Related Parties: NONE
Note 11 - Income taxes:
Deferred tax assets and (liabilities) reflects the net tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Significant components of our deferred tax assets are as follows, as of September 30, 2010 and 2009:
Our valuation allowance increased $1,560,860 and $1,076,640 during the year ended September 30, 2010 and 2009, respectively.
Based on our prior earnings and sufficiency of income to be utilized in carry back years and future taxable income, it is more likely than not that these net deferred tax assets will not be utilized. Therefore, a valuation allowance has been set up to reduce deferred tax assets to zero. As of September 30, 2010, we have net operating loss carry forward amounting to $7,720,329 that are available, subject to limitations, to offset future taxable income through 2025. All prior tax years, subject to limitations, remain subject to examination by Federal and state taxing authorities.
Note 12 - Subsequent Events:
On September 29, 2010, Midtown Partners and Co., LLC ("Midtown") filed, in the Circuit Court of Hillsborough County, Florida (Case No. 101981) an action against us alleging an unpaid commission in the amount of $400,000 plus warrants in connection with the sales of securities by us. We believe Midtown's allegations are without merit . We intend to mount a vigorous defense. The matter is in its earliest stage; we have filed our response to the complaint, denying the allegations therein, raising affirmative defenses and making a counterclaim based on Midtown's breach of contract.
On October, 28, we filed Form 8 K reporting the issuance of Redeemable preferred stock and release of our pledge account balance.
On November 19, we filed Form 10 Q/A reporting amended manufacturing agreement previously filed.