Check whether the issuer is not required to file reports pursuant to Section 13
or 15(d) of the Exchange Act. [ ]
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No _____
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of the issuer's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB [X ].
Indicate by check mark whether the registrant is a shell company (defined in
Rule 12b-2 of the Exchange Act). Yes ___No [X]
The aggregate market value of the voting equity held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on September
24, 2007 as reported on the Over-the-Counter Bulletin Board (OTCBB) was
approximately $0.05. Shares of Common Stock held by each executive officer and
director and by each person who owns 5% or more of the outstanding Common Stock
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliates status is not necessarily a conclusive determination
for other purposes.
As of September 24, 2007, the Registrant had outstanding 34,109,713 shares of
Common Stock.
Documents incorporated by reference - incorporated by reference to our Proxy
Statement to be filed..
A copy of the Company's Annual Report on Form-10KSB for the year ended June 30,
2007, as filed with the Securities and Exchange Commission, is available without
charge to interested stockholders upon a written request to:
Mr. Peter Castle
Attn: Annual Report
NetWolves Corporation
4805 Independence Parkway
Suite 101
Tampa, FL 33634-7527
PART I
This Annual Report on Form 10-KSB, the exhibits hereto and the information
incorporated by reference herein contain "forward looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act") and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), and such forward looking statements involve risks
and uncertainties. When used in this report, the words "expects", "anticipates",
"estimates", "believes", "intends", "may", "will", "should", "plans",
"predicts", "potential", "continue", "feels", "projects" and similar expressions
are intended to identify forward looking statements. Such statements are subject
to risks and uncertainties that could cause actual results to differ materially
from those projected. These risks and uncertainties include those discussed
below under "Risk Factors" and those discussed in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" or incorporated by
reference herein. NetWolves Corporation undertakes no obligation to publicly
release any revisions to these forward looking statements to reflect the
occurrence of events or circumstances after the date this Report is filed with
the Securities and Exchange Commission or to reflect the occurrence of
unanticipated events.
ITEM 1. DESCRIPTION OF BUSINESS
Background
NetWolves, LLC was an Ohio limited liability company formed on February 13,
1998, which was merged into Watchdog Patrols, Inc. ("Watchdog") on June 17,
1998. Watchdog, the legal surviving entity of the merger, was incorporated under
the laws of the State of New York on January 5, 1970. As a result of the merger
and subsequent sale of Watchdog's existing business, Watchdog changed its name
to NetWolves.
In 2002, NetWolves acquired Norstan Network Services, a provider of
comprehensive network management services, as a wholly owned subsidiary. As a
result of the acquisition and business of Norstan, NetWolves (or its
subsidiaries) became a FCC-licensed carrier. Most of the Debtors' operations are
performed through Norstan as the primary operating company.
On May 21, 2007 (the "Petition Date"), NetWolves filed for protection under
Title 11 of the Bankruptcy Code in the United States Bankruptcy Court for the
Middle District of Florida, Tampa Division.
Overview
NetWolves Corporation ("NetWolves" or the "Company") is a global
telecommunications and Internet managed services providers offering
single-source network solutions that provides multi-carrier and multi-vendor
implementation to over 1,000 customers worldwide. The Company's principal
activity is to design, manage and deliver products and services allowing people
and networks to access the Internet and telecommunications networks, efficiently
and cost effectively. In addition to the prevailing networking equipment,
NetWolves also offers our patented system technology to organizations with
complex requirements, that our plug `n' play perimeter office security platforms
and secure remote monitoring and management ("SRM2 TM") system ideally solve.
Additionally, NetWolves' advanced, centralized, reporting offers the ability for
corporate executives to view, via the Internet, both statistical and performance
based metrics for their network.
We operate primarily in three distinct segments. The Voice Services segment
provides voice services including switched and dedicated outbound, switched and
dedicated toll-free inbound, calling and debit cards, and conference calling.
The Managed Services segment, provides network and security technology and a
variety of recurring managed data services. The Equipment and Consulting
segment, is primarily engaged in the design, development and support of
information delivery hardware products and software as well as providing
consulting services on an as needs basis.
We have achieved an offering of managed products and services that meet the
necessary requirements for organizations to contract with a single source to
attain the benefits and flexibility of a wide variety of public data network.
Additionally, we provide a variety of technologies including our patented
technology to provide a high level of security through an integrated approach to
management, monitoring and interoperability for small and medium remote
enterprise locations (locations with less than 500 network users). We have a
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Managed Services Offering (MSO) that provides complete system solutions to
organizations needing cost-effective network security features such as firewall,
virtual private networking, routing, content filtering, email, etc., with
Internet-based expansion capabilities. Our patented system technology enables
organizations to achieve corporate Information technology (IT) initiatives
through the deployment of easily installable perimeter office security
platforms, coupled with SRM2 TM system. SRM2 TM provides centralized management
capabilities for hundreds or thousands of remote locations without risking
networking integrity because it has no requirement to open an administrative
port on the remote device, which is common network vulnerability.
Managed Service Charges
The NetWolves' managed service offering, coupled with third party or proprietary
security platforms, provide sophisticated, yet easy-to-administer systems for
securely connecting people and offices to the Internet by combining a wide range
of functionality and communications choices. This functionality includes
Internet access, firewall security, web access control, and IP routing, caching
server and file sharing in an integrated system and network managed solution.
NetWolves offers a variety of access methods to the Internet including North
American T1/56K, MPLS, European E1 standards, DSL, cable, EVDO, or wireless
broadband and satellite.
Keeping data secure is one of the main functions of our integrated approach.
Companies significantly reduce private data network costs by installing VPN
(virtual private network) applications and utilizing the Internet to maintain
data privacy, which is accomplished through the use of a protocol and security
procedures, sending encrypted data over the Internet. The primary benefit of the
VPN is providing the client communication services at significantly reduced
costs by utilizing public data network rather than private data network.
Businesses have implemented a similar process called client or remote VPN,
allowing employees to communicate with their company's network at any time from
outside the workplace, using a laptop or desktop computer and client VPN
software. This cost-effective solution makes businesses more productive by
giving remote users secure access to corporate resources.
With our Intelligent Fail-over solution, we have the ability to continuously
monitor application level performance, as well as monitor performance levels of
the VPN tunnel that pass through the primary interface by conducting scheduled
interval tests. If the primary interface fails or the VPN tunnel does not meet
established performance criteria, the network will automatically fail over to a
secondary interface and permit the data to reach its intended destination,
securely and reliably using Routing Information Protocol ("RIP"), Open Shortest
Path First ("OSPF") or Border Gateway Protocol ("BGP") protocols.
Typically, using a web browser, a user attempting to access information on the
Internet performs a Domain Name System (DNS) lookup. DNS is the Internet service
that converts understandable web site names (for example www.netwolves.com) into
computer readable web site numbers or IP addresses (IP numbers are meaningful
only to those who need to know them and not to the average web user). By
integrating a DNS caching server directly into our technology offering, Internet
traffic is reduced and web site address look-up time is faster, therefore
increasing the overall performance of the system.
A Dynamic Host Configuration Protocol (DHCP) server integrated into our
solutions allows for easy management when adding computers to the existing
company network. It saves time and allows network administrators to work more
efficiently, eliminating the need for a person to travel to a remote location to
configure a new computer with an IP address.
Features of NetWolves Security Suite
Our security products and services offer the following standard features:
-- Securely connects any number of users in a small geographic area (LAN)
simultaneous to the Internet through a dedicated connection.
-- Hierarchical caching, which are rules that tell a computer to look for the
data stored locally before accessing the Internet for data, gives more
efficient web viewing and greater ability to transfer data from one file to
another.
-- Any number of users can send and receive e-mail individually, while sharing
one Internet service provider account.
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-- A firewall protects the LAN from Internet-borne attacks.
-- An advanced network address translation module allows the creation of
powerful address translation rules for greater firewall flexibility.
-- Files that store events for review at a later date ensure appropriate use
of Internet resources.
--- Scalability allows Internet usage to grow as a company expands.
-- Can be used as a stand-alone firewall to protect the resources of a private
network from users outside on a public network.
-- Easily managed internal and external proxy services.
-- Web access control allows the network administrator to effectively block or
deny access to the Internet and specific web sites.
-- The Virtual Private Networking (VPN) module provides a process for
encrypting data for secure transmission over public networks and supports
Internet Key Exchange (IKE) and IPSec (a security protocol).
-- Our SSL VPN leverages the power and protection afforded by the Secure
Socket Layer protocol to access vital resource applications on a company's
protected network. SSL technology is standard with today's popular web
browsers, including Netscape Navigator, Microsoft Internet Explorer and
Mozilla Firefox. NetWolves uses two-factor authentication for accessing
important tools and applications. This method provides for strong
authentication by requiring a simple key chain USB device and unique login
password.
- Intelligent Failover with virtual redundant router protocol (VRRP)
establishes a wide area network (WAN) connection on a secondary device
slave if WAN connection on a primary device is lost or fails to meet
minimum VPN performance criteria.
-- NetMetrics provides a means for measuring two performance parameters: the
time required to load a single web page from the Internet, and the time it
takes to send an email to a specified account and receive a reply from that
same account. Net Metrics also provides the monitoring mechanism within
Intelligent Failover.
Firewall and Security Functions
We believe that security is an essential element of any Internet connectivity
solution. For this reason, our security platforms includes high-end firewall
security protection, without requiring the purchase of additional components.
Our platforms are designed to protect a company's private data and systems from
outside intruders with its firewall security system, incorporating three
separate firewall technologies:
-- Stateful packet filters verify that all incoming data packets coming from
the Internet have been requested by an authorized user on the LAN.
-- Proxy applications prevent unauthorized Internet applications from
accessing the LAN.
-- Network Address Translation ("NAT"), which is a conversion of public
addresses to and from private addresses, makes the network invisible to
outside Internet users by hiding the internal network's addresses of each
sender or receiver of information.
-- All packets of data entering the network from the Internet are first
checked for validity against a series of stateful packet filters. Data is
then forwarded to proxy applications that further inspect the contents of
the packets for potential security violations. If the data is determined to
be valid by both the stateful packet filters and proxy applications, it is
allowed to enter the secure LAN.
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Secure Remote Management and Monitoring Services ("SRM2 TM")
Under our SRM2 TM umbrella, product architecture planners believe that Managed
Security Services (MSS) will play an even more important role in future security
plans. Since a customer base already exists within our Platforms, the
security-monitoring infrastructure will significantly reduce costs and provide
effective and economical network managed security services to our clients.
SRM2 TM is comprised of the following product subsystems:
-- SRM2 TM Monitoring and Notification provides monitoring, notification,
paging and alarming capabilities of remote WolfPac Security Platforms. In
addition, the firewall status, VPN tunnel status and Administrative
Interface configuration status of all remote end points are monitored and
logged.
-- SRM2 TM Management and Configuration manages and configures remote end
points individually or by groups, including complete operating system
upgrades. Remote end points are capable of failover to an alternate SRM2 TM
server in the event that the primary server is inaccessible. This service
also allows user access to specific information about remote Platforms
(individually or by groups) via a monitoring console. Specific information
includes firewall status, the number of active VPN connections, traffic
statistics, intrusion detection data, activity logs, and administrative
Interface configuration data.
-- SRM2 TM VPN provides the network manager with the ability to connect
separate business locations, using the IP infrastructure rather than
through private mediums such as leased lines.
-- Security Policy Management is the process by which the client's security
policy is created, defined, or redefined to reflect security management
processes enabled by advent of our products and services. This policy
reflects particularly the rules governing remote end point security and the
processes guiding how security platforms are managed and configured to
ensure specified protections.
-- Firewall Policy Management is the process by which the client's firewall
security policy is created to reflect the methods by which NetWolves
firewall platforms are to be utilized to ensure network protection. This
policy sets forth the rules governing remote end point security and the
processes guiding how the firewall platform is utilized to manage and
configure the client network.
Data services
Data services consist of IP dedicated and dial-up services, broadband services
(including DSL, cable and satellite), frame relay and private line.
Our methodology includes completing a thorough needs assessment to understand
the current infrastructure and future requirements of the prospective customer.
Upon completion of the assessment, we design a custom, unique and flexible
solution utilizing multi-carrier alternatives under one contract, one invoice
and support structure. Its account teams, strategic industry relationships and
robust information and billing system allow us to deliver a single source
solution utilizing the best of what is available to solve the customer's
communication and network needs.
Voice Services
We provide multiple source long distance services and related consulting and
professional services . Voice services consist of voice over Internet protocol
(VoIP), switched and dedicated inbound/outbound long distance, travel cards,
conference calling data services consisting of IP dedicated and dial-up
services.
Competition
Current and potential competitors in our markets include, but are not limited
to, the following, all of whom sell world-wide or have a presence in most of the
major markets; Verizon, AT&T, Qwest and Sprint. Many of these companies have
substantially greater financial and marketing resources, research and
development staffs and distribution methods than us. There can be no assurance
4
that our current and potential competitors will not develop service offerings
that may or may not be perceived to be more effective or responsive to
technological change than ours, or that current or future products will not be
rendered obsolete by such developments. Furthermore, increased competition could
result in price reductions, reduced margins or loss of market share, any of
which could have a material adverse effect on our business operating results and
financial condition.
We compete at the Fortune 2000 level specifically focusing on companies with
multiple locations with complex voice and data needs. Our primary advantage over
our competition is that we have an extensive service offering to manage large,
complex corporate networks, and yet stay agile and able to change our solutions
as the market and the customers needs change, as we are not exclusive to a
single network or technology. Most organizations in our market space are
facilities based having a large investment in technology with a high carrying
cost.
Customers/Suppliers
We currently work with more than 1,000 customers, ranging from start-up
organizations to large well-established corporations. For the years ended June
30, 2007 and June 30, 2006, approximately 0% and 11% of sales were made to Swift
Transportation, respectively. Our agreement with Swift Transportation terminated
on June 30, 2005.
Business Partners
Our business partners include the following companies:
-- Sprint
-- Covad
-- Spacenet
-- Verizon
-- AT&T
-- Qwest
-- NCR
-- TBI
-- Telcom Brokers Inc.
-- Timer Warner Co.
-- X-4
-- Comcast
A major portion of our revenues during the year ended June 30, 2007 were derived
from telecommunications services. We depend on two major suppliers, Sprint and
Verizon, for a substantial part of the telecommunications services the Company
provides to its customers. These services from Sprint and Verizon accounted for
approximately 31% and 23% for fiscal 2007, respectively and for approximately
42% and 28% respectively for fiscal 2006. As a result, the loss of services
from either of these suppliers could cause disruptions and delays to our
customers, resulting in a loss of customers, business volume and substantially
decreasing our revenues.
Licensing and Intellectual Property
We consider certain features of our products, including their methodology and
technology, to be proprietary. We rely on a combination of trade secret,
copyright, patent and trademark laws, contractual provisions and certain
technology and security measures to protect our proprietary intellectual
property. We generally enter into confidentiality agreements with our employees,
consultants, business partners and major customers. We own copyrighted works of
authorship in computer programs, including, but not limited to, portions of the
FoxOS (operating system), products related to FoxOS, and various proprietary
enhancements to publicly available open source system software; as well as
traditional media, including, but not limited to, marketing materials,
documentation and white papers.
On May 22, 2007, we were issued a United States Patent covering our system and
method for the secure management and monitoring of remote network devices.
NetWolves' SRM2 TM system was developed to eliminate security issues associated
with the widely used Simple Network Management Protocol (SNMP) used by many
network management systems such as HP Openview (TM). Unencrypted communications
and open ports are two of the leading avenues of network security vulnerability
and attack. NetWolves SRM2 TM system is a remote monitoring and management
system using secure encrypted communications between the monitoring system and
the remote systems/devices being monitored. NetWolves SRM2 TM technology
requires no open holes in a company's firewall, on either the monitoring system
or the remote systems being monitored.
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Notwithstanding our efforts to protect our proprietary rights, existing trade
secret, copyright, and trademark laws afford only limited protection. Despite
our efforts to protect our proprietary rights and other intellectual property,
unauthorized parties may attempt to copy aspects of our products, obtain and use
information that we regard as proprietary or misappropriate our copyrights,
trademarks, trade dress and similar proprietary rights. In addition, the laws of
some foreign countries do not protect proprietary rights to as great an extent
as do the laws of the United States. Our means of protecting our proprietary
rights may not be adequate. In addition, our competitors might independently
develop similar technology or duplicate our products or circumvent any patents
or our other intellectual property rights.
We do not intend to sell or transfer title of our products to our clients,
though this structure may change as we expand our operations. We intend to
license products pursuant to licensing and services agreements for which
extended payment terms may be offered. In the case of extended payment term
agreements, the customer is contractually bound to equal monthly fixed payments.
In the case of extended payment term agreements, service may be bundled for the
length of the payment term. Thereafter, in both instances, the customer may
purchase service annually.
In connection with the acquisition of Norstan Network Services Inc. (NNSI), we
obtained Certificates of Public Convenience and Necessity, which enable NNSI to
resell long distance services within the state obtained. NNSI is subject to
regulation from the Public Utility Commissions in each specific state.
Sales and Marketing
Our marketing and sales strategy has been created with the forethought to ensure
we have diversified areas for growth as well as maximizing the use of our
capital resources. This approach allows us to minimize the risk of external
market factors on our short and long-term success. Management executes this
strategy in the following approach:
Direct Sales:
This is our longest standing approach with a four-year trend of demonstrated
success. We utilize a sales team that focuses on identifying target customers
who spend $2,000-$25,000 in monthly recurring services. This team leverages
existing relationships and forge new relationships with primarily multi-location
customers. A good example of this type of customer is a leading distributor of
diverse energy products where we currently manage their entire host or
headquarters infrastructure, and associated network, as well as their remote
sites. This type of customer is realizing the many benefits of our single source
solutions including: Managed VPN, Firewall, and Monitoring. Their managed
solution consists of over 25 sub-vendors providing services under a single
managed services agreement and one point of contact for all their requirements.
Additionally, we delivered significant savings while increasing capability and
redundancy.
Channel Sales:
This approach is our fastest growing. Within two years of launching this
strategy, we have developed a presence in what is known as the "Channel Market".
This market consists of an extensive network of sub-agents, agents and master
agents, who utilize their extensive industry experience to bring value and
solutions to end user customers. The benefits of this market are that with a
modest capital investment and low overhead expense, we gain access to a seasoned
sales force numbering in the thousands. In the last two years we have secured
relationships with two of the largest master agents in the country, which has
played a critical role in our growth and the establishment of NetWolves as a
recognized brand.
Enterprise Sales:
This is our largest opportunity approach. With three years of trial and error,
we have developed a methodology to partner with successful organizations whose
core model is under margin and competitive pressure and are in need of
additional value added services. By utilizing our diverse offering to fill in
the "gaps" of their core service, we help them become more competitive and in
return, they provide us cost effective access to their existing customers
numbering in the tens of thousands. An example of this is a proprietary based
solutions provider that services thousands of retail locations, which utilize us
6
for certain managed services. We utilized them in several of our key customers
solutions and jointly, we deliver services to a customer with approximately
eight hundred locations.
Merger and Acquisitions:
During the last several years we have successfully been able to acquire several
customer lists at what we believe to be a reasonable purchase price. These
organizations did not have the critical mass to weather recent market
conditions. However, by layering those assets on to our infrastructure, we are
using their margin to the overall success of the company. With consolidation in
the industry continuing and our demonstrated success with this approach, we are
well positioned to capitalize on these opportunities upon emerging from
reorganization.
Engineering and development
Our engineering and development group is comprised of engineers who specialize
in different areas of security and product development. NetWolves' team has
experience in a variety of industries, including information security, designing
networking protocols, building interfaces, designing databases, and computer
telephony. Their expertise is used in the maintenance and enhancement of our
core solutions.
Engineering and development expenses were approximately $170,000 and $510,000
for the years ended June 30, 2007 and 2006, respectively. The Company did not
capitalize any internally developed software costs during the years ended June
30, 2007 and 2006.
Employees
As of June 30, 2007, we had 49 employees, of which 41 were full-time (1 of whom
is covered by an employment agreement). Approximately 2 of these employees are
involved in engineering and development, 24 in sales and marketing, 9 in finance
and 6 in general administration and operations. In addition, we have retained
independent contractors on a consulting basis who support engineering, marketing
and administrative functions. To date, we believe we have been successful in
attracting and retaining skilled and motivated individuals. Our success will
depend in large part upon our continued ability to attract and retain qualified
employees. We have never experienced a work stoppage and our employees are not
covered by a collective bargaining agreement. We believe that we have good
relations with our employees.
RISK FACTORS
You should carefully consider the factors described below and other information
contained in this report. The risks and uncertainties described below are not
the only ones we face. Additional risks and uncertainties not presently known to
us, which we currently deem immaterial or which are similar to those faced by
other companies in our industry or business in general, may also impair our
business operations. If any of the following risks actually occurs, our
business, financial condition or results of operations could be materially and
adversely affected. In such case, the trading price of our common stock could
decline, and you may lose all or part of your investment. This report also
contains forward-looking statements that involve risks and uncertainties. Please
refer to "Forward-Looking Statements" included elsewhere in this report.
Risk Related to Chapter 11 Reorganization
Our continuation as a going concern is dependent upon the approval by our
creditors of a plan of reorganization, which we intend to propose under Chapter
11 of the United States Bankruptcy code.
On May 21, 2007, we voluntarily filed a plan petitioning for relief under
Chapter 11 of the United States Bankruptcy Code. At the time, our outstanding
indebtedness together with contingent liabilities and claims, required us to
reorganize and work out our indebtedness in order to continue as a going
concern. Since the filing date, we have entered into agreements with our various
vendors and other third parties, which have enabled us to continue operations.
In order to continue as a going concern, we are required to submit a plan or
agreement to our creditors for their approval whereby our outstanding debt will
be either compromised, in part, or paid. Our continuation as a going concern is
dependent on the submission and approval of a plan, which satisfactorily enables
us to repay this indebtedness from additional financing and internally generated
funds.
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No representations can be made that financing will be available on terms
satisfactory to our creditors or us or that a satisfactory plan will be
approved. Unless approved, our restructuring plan under Chapter 11 could be
converted into a Chapter 7 liquidation proceeding, in which event, we would be
forced to cease operations and liquidate our assets.
Financial Risks
We have incurred losses since inception and may never be profitable, which could
result in a further decline in the value of our common stock and the loss of
your investment.
We sustained net losses of $4,035,105 and $3,761,741 for our fiscal years ended
June 30, 2007 and 2006, respectively. We continue to sustain losses during the
current fiscal year, and we may not achieve profitability in the future. As of
June 30, 2007, we had a working capital deficiency of $4,987,795. We recognized
revenues of $17,408,061 and $21,836,709 for our fiscal years ended June 30, 2007
and 2006, respectively. Subsequently, we have been successful in stabilizing the
significant loss of customers and we have further reduced operating costs.
However, we expect that operating losses may continue. Accordingly, these
conditions raise substantial doubt about the Company's ability to continue as a
going concern.
Risks Related to Our Business
We will not achieve profitability if we cannot compete successfully for sales of
our internet security products and services.
Success of our managed network services business depends upon our ability to
gain market share for our services. Our target markets are the small to medium
sized companies that demand both a connection to the Internet and to their
business partners, and enterprise customers, such as multi-branch retailers and
educational institutions. If we fail to penetrate our target markets and/or book
substantial sales of our products, our operations and prospects will suffer.
Gaining market acceptance will depend, in part, upon our ability to demonstrate
the advantages of our Managed Services over technology offered by other
companies. See "Risk Related to Our Industry - If we are unable to compete
successfully in the markets for managed network services business and
telecommunications services, we may not increase our revenues or achieve
profitability."
The loss of our main suppliers of telecommunications services could have a
substantial, negative effect on our revenues.
A major portion of our revenues during the year ended June 30, 2007 was derived
from telecommunications services. We depend on two major suppliers, Sprint and
Verizon, for a substantial part of the telecommunications services the Company
provides to its customers. Theses services from Sprint and Verizon accounted for
approximately 31% and 23% for fiscal 2007, respectively and for approximately
42% and 28% respectively for fiscal 2006. As a result, the loss of services from
either of these suppliers could cause disruptions and delays to our customers,
resulting in a loss of customers, business volume and substantially decreasing
our revenues.
Our managed network services business is complex and may contain undetected
errors or result in failures that could inhibit or delay our growth and increase
our operating costs.
Our managed network services business is quite complex and may contain
undetected errors or bugs or experience failures. In particular, the Internet
network environment is characterized by a wide variety of standard and
non-standard configurations and errors, failures and bugs in third party
platforms and applications that make pre-release testing for programming or
compatibility errors very difficult, time-consuming and expensive. Furthermore,
we believe no amount of testing can guarantee that errors, failures or bugs will
not be found in new products or releases which we ship commercially. Product
failures, if they occur, could result in our having to replace all affected
products without being able to book revenue for the replacements, or we may be
required to refund the purchase price of defective products. Any of these
errors, bugs or failures discovered after commercial release could require
significant expenditures of capital and resources, and cause interruptions,
delays or cessation of service to our customers, and result in:
-- adverse publicity and damage to our reputation;
-- loss of customers;
8
-- loss or delay in revenues;
-- diversion of development efforts;
-- increased service and warranty costs;
-- costly litigation; and
-- diversion of management's attention and depletion of financial and
other resources.
We may have to defend lawsuits or pay damages in connection with any alleged or
actual failure , which occurred after the petition date, of our managed network
services business or telecommunications services, which could significantly
increase our operating costs and have a material adverse effect on our results
of operations and financial condition.
Because we provide and monitor network security and protect confidential and
potentially valuable information from transmission errors, viruses and security
breaches, we could face claims by customers or third parties for product
liability, tort or breach of warranty. Anyone who circumvents our security
systems could misappropriate confidential information or other property of our
customers or interrupt their operations. In this event, we could be forced to
defend lawsuits by customers and third parties. In addition, we may face
liability for breaches caused by faulty installation of our products. Although
we attempt to reduce the risk of losses from claims through contractual warranty
disclaimers and limitations on liability, these provisions may be unenforceable.
Some courts have held that limitations on liability in standard software or
computer contracts are unenforceable under certain conditions. Defending
lawsuits, regardless of the merits, is generally costly. As a result, any
lawsuits brought against us alleging failures of our security solutions products
or services could significantly increase our operating costs and have a material
adverse effect on our results of operations and financial condition.
Any breach of network security could injure the reputation of our managed
service business, reduce our customer base and adversely affect our revenues.
The success of our managed network services business depends, in part, on our
ability to provide effective Internet security. Any breach of network security
in one of our end user's Internet security systems, whether or not the breach
results from any malfunction or defect in our products or services, could damage
our reputation. This, in turn, could result in our loss of actual or potential
customers and distribution partners. Because techniques used by computer hackers
to access or disrupt networks change often and are usually not recognized until
used against a target, we may not anticipate these techniques and protecting our
customers against them. Companies such as ours, in the business of providing
network security, may themselves be more likely to be the targets of attacks by
hackers. If we are unable to protect our internal systems or those of our end
users against penetration by hackers, our reputation may suffer, we may lose
actual or prospective customers and our revenues may be adversely affected.
Failure to manage our operations if they expand could impair our future growth.
If we are able to expand our operations, particularly those of our managed
services business, the expansion will place significant strain on our
management, financial controls, operating systems, personnel and other
resources. Our ability to manage future growth, should it occur, will depend to
a large extent upon several factors, including our ability to do the following,
particularly in relation to our managed network services business:
-- build and train our sales force;
-- establish and maintain relationships with end users;
-- develop customer support systems;
-- develop expanded internal management and financial controls
adequate to keep pace with growth in personnel and sales, if
they occur;
-- successfully leverage the potential for sales of products and services
of each business segment to customers of the other segment.
If we are able to grow our business but do not manage our growth successfully,
we may experience increased operating expenses, loss of end users, distributors
or suppliers and declining or slowed growth of revenues.
Our ability to compete may be damaged and our revenues may be reduced if we are
unable to protect our intellectual property rights adequately.
9
Our success depends upon maintaining the confidentiality and proprietary nature
of our software and other intellectual property rights, particularly in relation
to our managed network services business. To protect these rights, we rely
principally on a combination of:
-- contractual arrangements providing for non-disclosure and prohibitions on
use;
-- patents;
-- trade secret, copyright and trademark laws; and
-- certain technical measures.
Our policy is to enter into confidentiality, technology ownership and/or license
agreements, as applicable, with our technical employees, as well as with
distributors and customers, and to limit access to and distribution of our
software, documentation and other proprietary information. In addition, we do
not license or release our source code, except in connection with source code
escrow arrangements and applicable restricted source code license agreements for
any source code appropriately released from escrow.
Patent, trade secret, copyright and trademark laws provide limited protection.
Trade secret, copyright and trademark laws, in combination with the steps we
take to protect our proprietary rights, may not adequately prevent
misappropriation of those rights. We may be required to bring proceedings in the
United States Patent and Trademark office or other legal action to enforce our
patents, trademarks or copyrights. We may find it necessary to litigate to
protect our trade secrets and know-how. Any legal actions would be costly,
timing consuming, and would divert the attention of management and technical
personnel.
The protections provided by laws protecting intellectual property rights do not
prevent our competitors from developing, independently, products similar or
superior to our products and technologies. In addition, effective protection of
copyrights, trade secrets, trademarks, and other proprietary rights may be
unavailable or limited in certain foreign countries.
Our inability or failure to protect our proprietary technology could damage our
ability to compete, particularly in the managed network services business,
reduce our revenues and damage our prospects for achieving growth and
profitability.
If our products incorporate technology that infringes the proprietary rights of
third parties and we do not secure licenses from them, we could be liable for
substantial damages that would cause a material reduction in revenues and impair
our prospects for achieving growth and profitability.
In furtherance of the development of our services or products, we may need to
acquire licenses for intellectual property to avoid infringement of third party
rights or claims of infringement. These licenses may not be available on
commercially reasonable terms, if at all. Claims for infringement if made, could
damage our business prospects, our results of operations and financial
condition, whether or not the claims have merit, by:
-- consuming substantial time and financial resources required to defend
against them;
-- diverting the attention of management from growing our business and
managing operations;
-- resulting in costly litigation; and
-- disrupting product sales and shipments.
If any third party prevails in an action against us for infringement of its
proprietary rights, we could be required to pay damages and either enter into
costly licensing arrangements or redesign our products so as to exclude the
infringing technology. As a result, we would incur substantial costs, delays in
the product development, sales and shipments of our products and our revenues
may decline substantially and we may never be able to achieve the growth
required for us to achieve profitability.
Potential acquisitions may involve financial and operational risks to our
business.
In the normal course of our business, we evaluate prospective acquisitions of
businesses, products and technologies that could complement or expand our
business. In connection with any acquisition, we cannot predict whether we will:
-- identify suitable acquisition candidates;
-- negotiate successfully the terms of the acquisition;
-- secure adequate financing;
10
-- obtain a proper and adequate valuation of the business or assets to be
acquired;
-- integrate an acquired business, product or technology successfully into
our existing business or products; or
-- retain key personnel previously associated with the acquired businesses.
In addition, we may compete for acquisitions with companies that have
significantly greater resources than we do. Negotiating potential acquisitions
and integrating acquired businesses could divert the time and resources of
management and skilled technical personnel.
We may finance future mergers or acquisitions with cash from operations,
significant additional indebtedness or additional equity financings involving
issuance of a significant number of shares of common or preferred stock. We
cannot provide assurance that we will be able to generate cash from operations
or obtain additional financing from external sources or that such financing, if
available, will be on terms acceptable to us. If we incur substantial debt to
finance an acquisition it could significantly increase our leverage and involve
restrictive covenants which may limit our operations. The issuance of additional
stock to finance acquisitions may dilute our earnings and result in substantial
dilution to our shareholders.
Failure to attract and retain management and other personnel may damage our
operations and financial results and cause our stock price to decline.
We depend to a significant degree on the skills, experience and efforts of our
executive officers and other key management, technical, finance, sales and other
personnel. Our failure to attract, integrate, motivate and retain existing or
additional personnel could disrupt or otherwise harm our operations and
financial results. The loss of services of any of our key employees, an
inability to attract or retain qualified personnel in the future, or delays in
hiring additional personnel could delay the development of our business and have
a negative impact on our operating results and financial condition.
Risks Related to Our Industry
Slower growth in demand for managed network services business and related
products and services may harm our revenues and prospects for achieving growth
and profitability.
The markets for our products and services depend on economic conditions
affecting the broader network security, telecommunications services and related
markets. Downturns in any of these markets may cause end users to delay or
cancel orders for our products and services. Customers may experience financial
difficulties, cease or scale back operations, or reverse prior decisions to
budget for orders of our products and services. As a result, we could experience
longer sales cycles, delays in payment and collection, and pressures from our
markets to reduce our prices. Any reduction in prices would cause us to realize
lower revenues and margins. If capital spending in our markets nevertheless
declines, we may not be able to increase revenues or achieve profitability
without increasing market share from competitors. See "If we are unable to
compete successfully in the markets for managed network services business and
telecommunications services, we may not increase revenues or achieve
profitability."
If we are unable to compete successfully in the markets for managed network
services business and telecommunications services, we may not increase revenues
or achieve profitability.
The markets for managed network services are highly competitive, and management
expects competition to intensify in the future. Many of our competitors have:
-- longer operating and product installation histories;
-- significantly greater financial and technical, marketing and product
development resources;
-- greater name recognition;
-- greater range of products and services;
-- a larger installed base of customers; and
-- greater ability to cross-sell products and services.
Each of these factors represents a significant competitive advantage over us.
Companies with greater resources have significant competitive advantages as to
pricing and the ability to offer enhanced products and services. Competitors
11
with greater financial and other resources to devote to research, development
and marketing are able to respond more quickly to new or emerging technologies
and changes in customer requirements, including demand for products and services
incorporating the most current technology and value-added features. In addition,
there are few substantial barriers to entry, so that we anticipate growing
competition from new market entrants as well as existing competitors.
Our competitors in the markets for managed network services and
telecommunications services primarily include:
-- carriers such as Verizon, AT&T, Qwest and Sprint.
If we are unable to compete successfully in either business segment, our
revenues and profit margins will diminish and we may never achieve
profitability.
Government regulations could have a negative effect on our revenues.
Any additional government regulation of imports or exports could adversely
affect our international and domestic sales. The United States and various
foreign governments have imposed controls, export license requirements and
restrictions on the import or export of some technologies, especially encryption
technology. From time to time, government agencies have proposed further
regulation of encryption technology. Additional regulation of encryption
technology could add to the expense of product development and enhancements.
Because foreign competitors are subject to less stringent controls on the export
of encryption technology, they may have a competitive advantage over us in both
foreign and domestic Internet security markets.
Other Risks
Continued volatility in our stock price could adversely affect your investment.
The market price of our common stock has been and may continue to be volatile.
From January 1, 2001 through September 24, 2007, the closing bid price of our
common stock has varied from a high of $6.00 to a low of $0.04 per share. As
reported on the Over-the-Counter Bulletin Pink Sheets (OTCBB) our closing bid
price on September 24, 2007 was $0.05. If our future operating results are below
the expectations of stock market analysts and investors, our stock price may
further decline. Public announcement of our financial results, business
developments and a plan of reorganization in bankruptcy may have a significant
impact on the market price of our common stock. For example, each of the
following could have the effect of temporarily or permanently reducing the
market price of our common stock:
-- the terms and conditions of our plan of reorganization in bankruptcy
insofar as it relates to our common stock
-- shortfalls in revenues or cash flows from operations;
-- delays in development or roll-out of any of our product and services; and
-- announcements by one or more competitors of new product introductions,
acquisitions or technological innovations.
Declines in our stock price for any reason, as well as broad-based market
fluctuations or fluctuations related to our financial results or other
developments, may adversely affect your ability to sell your shares at a price
equal to or above the price at which you purchased them.
Future sales of a large number of shares of our common stock may cause our stock
price to decline.
At September 24, 2007, 34,109,713 shares of our common stock were outstanding
and 8,563,621 shares are issuable upon conversion of outstanding preferred
stock. Of these shares, approximately 12,000,000 shares are transferable without
restriction under the Securities Act of 1933. Another approximately 2,000,000
shares are eligible for resale subject to the restrictions on volume, manner of
sale and other conditions of Rule 144 promulgated under the Securities Act.
Approximately 12,422,885 shares are issuable upon exercise of outstanding stock
options and warrants. Sales of large amounts of these shares in the public
market could depress the market price of the common stock and impair our ability
12
to raise capital through offerings of our equity securities. Resale of shares of
common stock that may be received by holders of outstanding options and warrants
or convertible preferred stock may also dilute substantially the net tangible
book value of your shares of common stock. Additionally, revocation of part or
all of the outstanding shares of common stock pursuant to Chapter 11 or 7
proceedings of bankruptcy code may result in a total loss of your investment.
Compliance with the Sarbanes-Oxley Act of 2002 will require substantial
financial and management resources and may result in additional expenses, which
as a smaller public company many be disproportionately high.
Section 404 of the Sarbanes-Oxley Act of 2002 requires that we evaluate and
report on our system of internal controls as of June 30, 2008 and requires that
we have such system of internal controls audited beginning with our Annual
Report on 10-KSB for the year ending June 30, 2009. If we fail to maintain the
adequacy of our internal controls, we could be subject to regulatory scrutiny,
civil or criminal penalties and/or stockholder litigation. Any inability to
provide reliable financial reports could harm our business. Section 404 of the
Sarbanes-Oxley Act of 2002 also requires that our independent registered public
accounting firm report on management's evaluation of our system of internal
controls. The development of the internal controls of any such entity to achieve
compliance with the Sarbanes-Oxley Act may increase the time and costs necessary
to complete any such acquisition. Furthermore, any failure to implement required
new or improved controls, or difficulties encountered in the implementation of
adequate controls over our financial processes and reporting in the future,
could harm our operating results or cause us to fail to meet our reporting
obligations. Inferior internal controls could also cause investors to lose
confidence in our reported financial information, which could have a negative
effect on the trading price of our stock.
Provisions of New York law, our certificate of incorporation and bylaws, and
employment agreements with management may deter or prevent a takeover, even in
situations where you could sell your shares at a premium over the market price.
Some provisions of New York law, our certificate of incorporation and bylaws,
and employment agreements with certain executive officers may discourage
attempts to acquire control of us through a merger, tender offer or proxy
contest targeting us, including transactions in which shareholders might be
offered a premium for their shares. These provisions may limit your ability as a
shareholder to approve a transaction that you may believe to be in your best
interest. These provisions include:
-- Classified Board of Directors. Our certificate of incorporation provides
for a board which is divided into three classes so not all of the directors
are subject to election at the same time. As a result, someone who wishes
to take control of our company by electing a majority of the board of
directors must do so over a two-year period.
-- Employment Contracts. The Company has an employment agreement with one
member of its executive management team. The employment agreement provides
for certain payments following death or disability, for certain fringe
benefits such as reimbursement for reasonable expenses and participation in
medical plans, and for accelerated payments in the event of change of
control of the Company. Change of control for this purpose is defined as
the acquisition of 30% or more of our voting power or consummation of a
merger, consolidation, reorganization or sale of all or substantially all
of our assets without board approval; or the change in a majority of our
directors without approval by the incumbent board. Termination for change
of control under these agreements will result in the acceleration of
compensation payments through the term of the agreements and the immediate
vesting of any unvested options. Notwithstanding the foregoing, the Company
intends to reject this agreement through the bankruptcy proceedings as not
to invoke the change of control provision.
-- New York anti-takeover statute. New York law restricts business
combinations with shareholders who acquire 15% or more of a company's
common stock without the consent of our board of directors.
ITEM 2. DESCRIPTION OF PROPERTY
The Company currently maintains leased facilities in the locations listed
below.
13
CURRENT
ANNUAL
SQUARE TERM OF LEASE
FUNCTION LOCATION FEET LEASE COSTS
------------------------ -------------------------------- ---- ----- -----
NetWolves Corporation - Corporate 4850 Independence Parkway, Suite 101 17,316 1/31/11 $ 346,244
Headquarters Tampa, FL 33634
NetWolves Global Services 200 Garden City Plaza, Suite 200 1,855 3/31/10 $ 51,832
- Regional Sales Office Garden City, NY 11530
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We believe that our New York facility is adequate to meet our current business
requirements and that suitable facilities for expansion will be available, if
necessary, to accommodate further physical expansion of corporate operations and
for additional sales and support offices. Additionally, we believe that our
Florida facility has significant excess capacity, and management has undertaken
efforts to work with the landlord to sublet excess space or surrender the entire
space and relocate to more efficient and cost effective space.
ITEM 3. LEGAL PROCEEDINGS
Litigation
a) On April 24, 2006, the Company's subsidiary NetWolves ECCI Corp (the
"Subsidiary") filed an action in the Florida Circuit Court, Hillsborough
County against Education Communications Consortia Inc. ("ECCI"). The action
arises from ECCI's breach of the October 1, 2004 Asset Purchase Agreement
between the parties (the "Agreement") by failing to pay $70,273 pursuant to
a reconciliation of billings, receivable and costs in accordance with the
terms of the Agreement.
On April 27, 2006, ECCI served the Company and Subsidiary with an action in
the Circuit Court of Kanawha County, West Virginia, alleging, inter alia
that the Subsidiary had failed to pay the $200,000 first installment of a
promissory note ("the Note") and has anticipatorily breached payment of the
remaining balance. As a consequence, ECCI alleges that the entire $800,000
note, together with interest and costs, is joint and severally due and
payable by the Subsidiary and by the Company, as guarantor. ECCI asserts
additional claims against the Company in the aggregate sum of approximately
$121,000 based on alleged reimbursable costs incurred by ECCI.
The Company and Subsidiary believe that ECCI's action is without merit and
therefore no accrual has been made. Among other things, it is the Company's
position that the Agreement provided as a condition precedent to any
installment payment that ECCI achieve annual gross revenue of at least
$2,000,000; and that ECCI failed to achieve this amount. However, there can
be no assurances that the Company will be successful.
b) At a meeting of the Board of Directors held on December 4, 2006, the
Company accepted the resignation of Walter M. Groteke as Chairman, Chief
Executive Officer and a director of the Company, effective immediately. At
the same time, Michael R. Rocque, a director of the Company, was appointed
as its Acting Chief Executive Officer.
The action was the result of a series of events commencing with a
resolution approved by the Board of Directors on October 27, 2006 to
separate the positions of Chairman and Chief Executive Officer, both
positions being held by Walter M. Groteke, subject to finding a suitable
candidate, if any, for the position of Chief Executive Officer. As
previously reported, a committee was appointed to search for candidates for
the position of Chief Executive Officer. At the same time Scott Foote,
formerly Vice President, was appointed as the Company's Acting President to
be involved in day-to-day operations.
In response to these resolutions, Mr. Groteke through his counsel, informed
the Company on November 16, 2006, by written notice as required by his
employment agreement, that Mr. Groteke was resigning from the Company for
"good reason," as defined in the employment agreement; that the letter
constituted his 15-day formal notice, making his resignation effective
December 1, 2006; and that Mr. Groteke was demanding all compensation and
benefits set forth in the agreement through June 30, 2010, the remainder of
its term.
14
On November 21, 2006, the Company through its counsel responded to the
November 16th letter by denying that Mr. Groteke had any basis for his
claims, stating among other things, that Mr. Groteke remained Chairman and
CEO with all of his responsibilities inherent in these positions. By letter
dated November 28, 2006, Mr. Groteke's counsel affirmed his prior position.
At the December 4, 2006 Board of Directors meeting, the Board of Directors
formally accepted his resignation. The acceptance was based on his
voluntary resignation and not for the reasons set forth by his counsel.
On December 6, 2006, in the Hillsborough County Circuit Court of the State
of Florida, Mr. Groteke served the Company with an action seeking
declaratory relief and a judgment for his full compensation and benefits
under the employment agreement, on the grounds previously set forth.
It is the Company's position that Mr. Groteke voluntarily resigned and is no
longer entitled to the compensation set forth under his employment agreement
c) On May 21, 2007, NetWolves and some of its subsidiaries filed for
protection under Title 11 of the Bankruptcy Code in the United States
Bankruptcy Court for the Middle District of Florida, Tampa Division. These
actions against us were stayed pursuant to the Bankruptcy Code's automatic
stay provisions. We believe we have strong defenses to these lawsuits and
intend to contest them vigorously. However, because these lawsuits are
premature, we are unable to provide an evaluation of the final outcome of
the litigation. On August 17, 2007 the above referenced actions were moved
to the federal court advisory proceedings subject to the bankruptcy codes.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTORS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The information required by this item is incorporated by reference to our
definitive proxy statement to be filed pursuant to Regulation 14A of the
Securities Exchange Act of 1934 (the "Proxy Statement").
ITEM 10. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the
Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated herein by reference to the
Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to the
Proxy Statement.
ITEM 13. EXHIBITS
Exhibits
3.1 Certificate of Incorporation, as amended (e)
3.2 By-Laws. (a)
4.1 Specimen common stock certificate(a)
4.2 Form of warrant to investment banking firm. (a)
4.3 Form of warrant to employees.(a)
10.1 1998 Stock Option Plan(a)
10.2 2000 Stock Option Plan (b)
21
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10.3 2001 Stock Option Plan (c)
10.4 2002 Stock Option Plan (d)
10.5 2003 Stock Option/Stock Issuance Plan.(f)
10.6 2006 Stock Plan (h)
10.7 Form of Indemnification Agreement(a)
10.8 Employment Agreement between NetWolves Corporation and Peter C. Castle
dated July 1, 2004. (g)
10.9 Office Lease Agreement between Registrant and BRST Fountain Square
L.L.C. dated September 29, 2000. (e)
10.10 Office Lease Amendment between Registrant and DA Colonial L.L.C. dated
August 12, 2005.(g)
10.11 Form of Securities Purchase Agreement dated as of March 1, 2006 (i)
10.12 Form of Securities Purchase Agreement dated as of May 12, 2006 (j)
21 Subsidiaries of the Registrant
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Percentage
Name State of Incorporation owned by Company
---- ---------------------- -----------------
NNS, Inc. Delaware 100%
Norstan Network Services, Inc. Minnesota 100%
TSG Global Education, Inc. Delaware 100%
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23.1 Consent of Marcum & Kliegman LLP
31 CEO and CFO Certifications Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32 CEO and CFO Certifications Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
-------------------------------------------------------------------------
(a) Previously filed as exhibits to Report on Form 10, as amended.
(b) Previously filed as an exhibit to Report on Form 10-K for the fiscal
year ended June 30, 2000.
(c) Previously filed as an exhibit to Report on Form 10-K for the fiscal
year ended June 30, 2001.
(d) Previously filed as an exhibit to Report on Form 10-K for the fiscal
year ended June 30, 2002.
(e) Previously filed as an exhibit to Amendment No. 1 to Registration
Statement on Form S-3/A File No. 333-100734.
(f) Previously filed as an exhibit to the Proxy Statement for the Annual
Meeting of Shareholders held on June 9, 2003
(g) Previously filed as an exhibit to Report on Form 10-KSB for the
fiscal year ended June 30, 2005.
(h) Previously filed as an exhibit to the Proxy Statement for the Annual
Meeting of Shareholders held on April 17, 2006.
(i) Previously filed as an exhibit to the Current Report on Form 8-K filed
on March 27, 2006.
(j) Previously filed as an exhibit to Report on Form 10-KSB for the fiscal
year ended June 30, 2006.
|
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Our financial statements for the fiscal years ended June 30, 2007 and June 30,
2006 were audited by Marcum & Kliegman LLP.
Audit Fees
Audit Fees includes fees for professional services provided in connection with
the audits of our financial statements, consents, and audit services provided in
connection with other statutory or regulatory filings. All such services were
pre-approved by the Audit Committee
For fiscal 2007 and 2006, Marcum & Kliegman LLP's audit fees were approximately
$239,477 and $145,000, respectively.
Audit Related Fees
Marcum & Kliegman LLP did not render any audit related services in fiscal 2007
and 2006.
All Other Fees
Marcum & Kliegman LLP did not render any other services during fiscal 2007 and
2006.
Tax Fees
Marcum & Kliegman LLP did not render any tax services in fiscal 2007 and 2006.
22
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on the
NetWolves Corporation
By: /s/ Scott Foote
-------------------------
Scott Foote
Chief Executive Officer and President
|
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on by the following persons in the capacities indicated:
/s/ Scott Foote
--------------------------- Chief Executive Officer, President and Director
Scott Foote
Peter C. Castle
------------------------- Chief Financial Officer, Vice President-Finance,
Director, Treasurer and Secretary
/s/ Fassil Gabremariam
------------------------- Director
Fassil Gabremariam
------------------------ Director
Gerald A. Gagliardi
/s/ Michael R. Rocque
------------------------ Director
Michael R. Rocque
|
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ......................................... F-1
CONSOLIDATED BALANCE SHEETS
June 30, 2007 and 2006....................................................................... F-2 - F-3
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended June 30, 2007 and 2006................................................... F4 - F-5
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY
For the years ended June 30, 2007 and 2006................................................... F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended June 30, 2007 and 2006................................................... F-8 - F-9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ...................................................... F-10 - F-29
|
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Audit Committee of the Board of Directors and Shareholders of NetWolves
Corporation:
We have audited the accompanying consolidated balance sheets of NetWolves
Corporation (a New York corporation) and subsidiaries (debtor-in-possession) as
of June 30, 2007 and 2006, and the related consolidated statements of
operations, shareholders' (deficit) equity and cash flows for the years then
ended. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
NetWolves Corporation and subsidiaries at June 30, 2007 and 2006, and the
consolidated results of its operations and its cash flows for the years then
ended in conformity with generally accepted accounting principles (United
States).
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, on May 21, 2007, the Company filed voluntary
petitions for relief under Chapter 11 of the United States Bankruptcy Code in
order to reorganize and work out its debt arrangements. In addition, as shown in
the consolidated financial statements, the Company incurred a net loss of
$4,035,105 during the year ended June 30, 2007, and, as of that date, had a
working capital deficiency of $4,987,795 and shareholders' deficiency of
$516,863. These conditions raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are also described in Note 2 to the consolidated financial statements. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Marcum & Kliegman LLP
Marcum & Kliegman LLP
Melville, New York
September 27, 2007
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F-1
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS
June 30,
---------------------------------------
2007 2006
------------------ -------------------
ASSETS
Current assets
Cash and cash equivalents $ 1,027,465 $ 2,016,156
Accounts receivable, net of allowance for doubtful accounts of 1,745,159 2,825,679
$0 and $1,146,044 at June 30, 2007 and 2006,respectively
Inventories, net 74,279 302,562
Prepaid expenses 494,149 320,860
------------------ -------------------
Total current assets 3,341,052 5,465,257
Property and equipment, net 79,557 148,620
Identifiable intangible assets, net 438,550 1,192,043
Goodwill and other indefinite lived intangible assets 3,801,973 3,793,072
Other assets
150,852 125,170
------------------ -------------------
Total Assets
$ 7,811,984 $ 10,724,162
================== ===================
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F-2
The accompanying notes are an integral part of these consolidated financial
statements.
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS
June 30,
------------------------------------
2007 2006
------------------ ----------------
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current liabilities
Liabilities subject to compromise-pre-petition
Current portion of long-term debt $ 1,207,987 $ 100,000
Account payable and accrued expenses $ 4,906,309 $ -
------------------ ----------------
Total Current Liabilities Subject to Compromise-Pre-Petition $ 6,114,296 $ 100,000
------------------ ----------------
Liabilities not subject to compromise-post petition
Account payable and accrued expenses
1,121,971 5,755,385
Deferred revenue 1,092,580 538,267
------------------ ----------------
Total Current Liabilities Not Subject to Compromise-Post-Petition 2,214,551 6,293,652
------------------ ----------------
Long-term debt subject to compromise
- 1,118,750
------------------ ----------------
Total liabilities 8,328,847 7,512,402
------------------ ----------------
Shareholders' (deficit) equity
Series A convertible preferred stock, $.0033 par value; $6,718,296 and
$5,997,188 liquidation preference on June 30, 2007 and 2006,
respectively; 1,000,000 authorized; 199,903 and 178,186 shares issued
and outstanding on June 30, 2007 and 2006, respectively $ 2,418,644 $ 2,092,885
Series B convertible preferred stock, $.0033 par value; $6,778,360 and
$6,480,169 liquidation preference on June 30, 2007 and 2006,
respectively; 500,000 shares authorized; 201,886 and 192,921 shares
issued and outstanding on June 30, 2007 and 2006, respectively 2,519,689 2,501,209
Series C convertible preferred stock, $.0033 par value; $1,862,015 and
$1,578,771 liquidation preference on June 30, 2007 and 2006,
respectively; 100,000 shares authorized; 12,962 shares issued and
outstanding on June 30, 2007 and 2006 205,361 205,361
Preferred stock, $.0033 par value; 400,000 shares authorized; no shares
issued and outstanding -
Common stock, $.0033 par value; 65,000,000 shares authorized; 34,309,713
and 33,134,097 shares issued and outstanding on June 30, 2007 and
2006, respectively 113,223 109,344
Additional paid-in capital 79,528,489 79,570,125
Accumulated deficit (85,302,269) (81,267,164)
------------------ ----------------
Total shareholders' (deficit) equity (516,863) 3,211,760
------------------ ----------------
$ 7,811,984 $ 10,724,162
================== =================
|
F-3
The accompanying notes are an integral part of these consolidated financial
statements.
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the year ended June 30,
----------------------------------------
2007 2006
------------------ -------------------
Revenue
Voice services $ 8,793,564 $ 13,725,882
Managed service charges 8,587,575 8,011,342
Equipment and consulting 26,922 99,485
------------------ -------------------
17,408,061 21,836,709
------------------ -------------------
Cost of revenue
Voice services 6,210,133 9,398,137
Managed service charges 5,758,272 4,874,779
Equipment and consulting
- 28,628
------------------ -------------------
11,986,405 14,301,544
------------------ -------------------
Operating expenses
General and administrative 4,628,585 5,584,897
Engineering and development 170,439 510,140
Sales and marketing 3,529,940 4,714,248
Depreciation and amortization 819,003 876,892
------------------ -------------------
9,147,967 11,686,177
------------------ -------------------
Loss before other income (expense)
and income taxes (3,708,311) (4,151,012)
------------------ -------------------
Other income (expense)
Other income - 448,605
Interest income 9,225 24,433
Interest expense (196,889)
(47,950)
Reorganization costs (138,370) -
------------------ -------------------
(326,034) 425,088
------------------ -------------------
Loss before income taxes (4,034,345) (3,725,924)
Provision for income taxes 760 35,817
------------------ -------------------
Net loss $ (4,035,105) $ (3,761,741)
================== ===================
|
F-4
The accompanying notes are an integral part of these consolidated financial
statements.
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the year ended June 30,
----------------------------------------
2007 2006
------------------ -------------------
Basic and diluted net loss per share
Net loss $ (4,035,105) $ (3,761,741)
Dividends on convertible preferred stock (762,799) (826,304)
------------------ -------------------
Net loss attributable to common shareholders $ (4,797,904) $ (4,588,045)
================= ===================
Basic and diluted net loss per share $ (0.14) $ (0.15)
------------------ -------------------
Weighted average common shares
outstanding, basic and diluted 34,309,713 31,144,024
================= ===================
|
F-5
The accompanying notes are an integral part of these consolidated financial
statements.
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S (DEFICIT) EQUITY
Series A Series B Series C
convertible convertible convertible
Common stock preferred stock preferred stock preferred stock
Shares Amount Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------ ------ ------
Balance, June 30, 2005 29,824,205 $ 98,420 160,719 $1,830,979 207,219 $2,729,977 16,028 $ 365,269
Conversion of convertible preferred stock 1,194,892 3,943 (4,695) (70,535) (42,308) (676,928) (4,345) (236,648)
Conversion of debt to common stock 840,000 2,772
Dividends declared/accrued
Common stock issued for services 150,000 496
Options issued for services
Stock based compensation expense
Dividends paid on preferred stock 22,162 332,441 28,010 448,160 1,279 76,740
Common stock issued in connection 1,125,000 3,713
with Securities Purchase Agreement
Legal services in connection with Securities
Purchase Agreement
Nasdaq fees
Net loss year ended June 30, 2006
------------ ----------- -------- ---------- ------- ---------- ------ ---------
Balance, June 30, 2006 33,134,097 $109,344 178,186 $2,092,885 192,921 $2,501,209 12,962 $ 205,361
========== ======= ======== ========== ======= ========== ====== =========
Conversion of convertible preferred stock 275,616 909 (3) (45) (13,778) (345,456)
Dividends declared/accrued
Common stock issued for services 700,000 2,310
Dividends paid on preferred stock
Stock based compensation expense 21,720 325,804 22,743 363,936
Common stock issued in connection
with Securities Purchase Agreement 200,000 660
Net loss, year ended June 30, 2007
Balance, June 30, 2007 34,309,713 $113,223 199,903 $2,418,644 201,886 $2,519,689 12,962 $ 205,361
========== ======= ======== ========== ======== ========== ====== =========
The accompanying notes are an integral
part of these consolidated financial statements.
|
F-6
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S (DEFICIT) EQUITY
Additional Total
paid-in Accumulated shareholders'
capital deficit equity
---------- ------------ --------------
Balance, June 1, 2005 $ 79,037,423 $(77,505,423)$6,556,645
Conversion of convertible preferred stock 980,168 -
Conversion of debt to common stock 207,228 210,000
Dividends declared/accrued (826,304) (826,304)
Common stock issued for services 49,756 50,252
Options issued for services 84,900 84,900
Stock based compensation expense 43,000 43,000
Dividends paid on preferred stock 857,341
Common stock issued in connection
with Securities Purchase Agreement 52,538 56,251
Legal services in connection with Securities
Purchase Agreement (17,800) (17,800)
Nasdaq fees (40,784) (40,784)
Net loss year ended June 30, 2006 (3,761,741) (3,761,741)
------------ ------------- -----------
Balance, June 30, 2006 $ 79,570,125 $(81,267,164) $3,211,760
============ ============= ===========
Conversion of convertible preferred stock 344,592 -
Dividends declared/accrued (762,799) (762,799)
Common stock issued for services 109,690 112,000
Dividends paid on preferred stock 699,740
Stock based compensation expense 255,667 255,667
Common stock issued in connection
with Securities Purchase Agreement 11,214 11,874
Net loss, year ended June 30, 2007 (4,035,105) (4,035,105)
Balance, June 30, 2007 $79,528,489 $(85,302,269) $ (516,863)
============ ============= ===========
The accompanying notes are an integral
part of these consolidated financial statements.
|
F-6
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the year ended June 30,
2007 2006
---------------- --------------
Cash flows from operating activities
Net loss $ (4,035,105) $ (3,761,741)
Adjustments to reconcile net loss to net cash used
in operating acivities
Depreciation 65,510 123,397
Amortization 753,493 753,493
Amortization of debt discount 1,110 -
Loss on disposal of property and equipment 3,553 4,949
Non-cash charge to operations with respect to common stock,
options and warrants issued for services 367,667 178,152
Bad debt expense 813,577 862,955
Other income - (477,705)
Impairment Charge 173,313 -
Changes in operating assets and liabilities
Restricted cash - 25,958
Accounts receivable 266,944 518,025
Inventories 54,970 166,143
Prepaid expenses (173,289) (13,171)
Other assets (25,682) (5,926)
Pre-petition accounts payable and accrued expenses
subject to compromise 4,833,251 (664,567)
Post-petition accounts payable and accrued expenses (4,633,414) -
Deferred revenue 554,312 (154,663)
---------------- --------------
Net cash used in operating activities
(979,790) (2,444,701)
---------------- --------------
Cash flows from investing activities
Payment on existing customer list (100,000) (100,000)
Patent costs paid (8,901) (9,385)
Purchases of property and equipment - (31,492)
---------------- --------------
Net cash used in investing activities (108,901) (140,877)
================ ==============
F-7
The accompanying notes are an integral part of these financial statements
|
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the year ended June 30,
-------------------------------------
2007 2006
---------------- --------------
Cash flows from financing activities
NASDAQ listing fees - (40,784)
Proceeds from securities purchase agreement 100,000 1,125,000
Financing costs paid - (17,800)
Advances from shareholder - 210,000
---------------- --------------
Net cash provided by (used in) financing
activities 100,000 1,276,416
---------------- --------------
Net decrease in cash and cash equivalents (988,691) (1,309,162)
Cash and cash equivalents, beginning of year 2,016,156 3,325,318
---------------- --------------
Cash and cash equivalents, end of year $ 1,027,465 $ 2,016,156
=============== ==============
Cash paid for taxes $ 68,125 $ 70,376
=============== ==============
Cash paid for interest $ 164,582 $ 41,450
=============== ==============
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES
Dividends accrued on convertible preferred stock $ 762,799 $ 826,304
=============== ==============
Dividends paid in kind on convertible preferred stock $ 689,740 $ 857,341
=============== ==============
Conversion of preferred stock to common stock $ 345,501 $ 984,111
=============== ==============
Purchase price adjustment-reduction of long term $ - $ 800,000
=============== ==============
Conversion of debt to common stock $ - $ 210,000
=============== ==============
Common stock issued in connection to securities
purchase agreement $ 5,000 $ -
=============== ==============
Debt discount on notes payable $ 6873 $ -
=============== ==============
|
F-8
The accompanying notes are an integral part of these financial statements
1. The Company
The consolidated financial statements include the accounts of NetWolves
Corporation and its subsidiaries, NetWolves Technologies Corporation
("NWT"), Norstan Network Services, Inc., d/b/a NetWolves Network Services
("NNS") and TSG Global Education Web, Inc. ("TSG") (collectively
"NetWolves" or the "Company").
NetWolves Corporation ("NetWolves" or the "Company") is a global
telecommunications and Internet managed services providers offering
single-source network solutions that provides multi-carrier and
multi-vendor implementation to over 1,000 customers worldwide. The
Company's principal activity is to design, manage and deliver products and
services allowing people and networks to access the Internet and
telecommunications networks, efficiently and cost effectively. In addition
to the prevailing networking equipment, NetWolves also offers our patented
system technology to organizations with complex requirements, that our plug
`n' play perimeter office security platforms and secure remote monitoring
and management ("SRM2 TM") system ideally solve. Additionally, NetWolves'
advanced, centralized, reporting offers the ability for corporate
executives to view, via the Internet, both statistical and performance
based metrics for their global network.
We operate primarily in three distinct segments. The Voice Services
segment, which operates worldwide, provides voice services including
switched and dedicated outbound, switched and dedicated toll-free inbound,
calling and debit cards, and conference calling. The Managed Services
Charges segment, which operates worldwide, provides network and security
technology and a variety of recurring managed data services. The Equipment
and Consulting segment, which operates worldwide, is primarily engaged in
the design, development and support of information delivery hardware
products and software as well as providing consulting services on an as
needs basis.
2 Bankruptcy, Management's Plans and Going Concern
On May 21, 2007 the Company (also referred to as the "Debtor") filed
voluntary petitions for relief under Chapter 11 of the United States
Bankruptcy Code in the United States Bankruptcy Court. (the "Bankruptcy
Court") in order to facilitate the restructuring of the Debtor's debt,
trade liabilities and other obligations. Throughout the Bankruptcy
proceedings, the Debtors will continue to operate their business and manage
their properties as "debtors-in-possession" pursuant to the Bankruptcy
Code. In general, as debtors-in-possession, the Debtor is authorized under
Chapter 11 to continue to operate as an ongoing business, but may not
engage in transactions outside the ordinary course of business without the
prior approval of the Bankruptcy Court.
Under the Bankruptcy Code, the filing of a bankruptcy petition
automatically stays most actions against the Debtors, including actions to
collect pre-petition indebtedness or to exercise control of the property of
the Debtors' estate. Absent an order of the Bankruptcy Court, substantially
all pre-petition liabilities will be addressed under a plan of
reorganization. The Bankruptcy Court established October 1, 2007 for both
non-governmental agencies and governmental agencies as the bar date for
filing proofs of claims.
Under the Bankruptcy Code, the Debtors may assume or reject certain
pre-petition executory contracts and unexpired leases, including leases of
real property, subject to the approval of the Bankruptcy Court and certain
other conditions. Rejection of an unexpired lease or executory contract is
treated as a pre-petition breach of the lease or contract, generally
resulting in damages being treated as pre-petition unsecured claims.
Counterparties to these rejected contracts or unexpired leases may file
proofs of claim against the Debtors' estate for damages, if any, relating
to such rejections.
The United States Trustee for the Middle District of Florida, Tampa
Division (the "Trustee") appointed an official committee of unsecured
creditors (the "Creditors' Committee"). The Creditors' Committee and its
legal representatives have a right to be heard on all matters that come
before the Bankruptcy Court. The Debtors are in the process of reconciling
creditors' proofs of claim filed with the Bankruptcy Court that differ in
amount from the Debtors' records. Certain creditors have filed claims
substantially in excess of amounts reflected in the Debtors' records. Based
F-9
on ongoing analyses of claims filed, the nature of such differences has
been identified as being attributable to duplicate claims for the same
obligation filed with several, and in certain cases all the Debtors;
damages sought in legal suits; certain contingent liabilities arising from
contracts and other claims filed against the Debtors; creditors claiming
compensation and/or damages for completed and partially completed contracts
and purchase orders; and other disputed items. In addition, claims have
been filed which do not state a specific claim amount or as to which a
specific claim amount is not readily determinable.
After completion of reconciliations, any remaining differences may be
resolved by negotiated agreement between the Debtors and the claimant or by
the Bankruptcy Court as part of the Chapter 11 Case. Consequently, the
amounts included in the consolidated balance sheet at June 30, 2007 as
liabilities that are subject to compromise under reorganization proceedings
may be subject to adjustment. The Debtors have made appropriate provision
for all claims of creditors it believes are valid; however, at this time,
the Debtors cannot make a prediction as to the aggregate amount of claims
allowed or the ultimate treatment of such allowed claims.
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates continuity of operations,
realization of assets, and liquidation of liabilities in the ordinary
course of business, and do not reflect adjustments that might result if the
Company were unable to continue as a going concern. The Company has
incurred net losses for each of the last two years. As of June 30, 2007,
the Company had a working capital deficiency of $4,987,795 and
shareholders' deficiency of $516,863 and during the year ended June 30,
2007, also had a net loss of $4,035,105. Realization of the Company's
assets, however, is dependent on the continued operations of the Company
and the future success of such operations. There can be no assurances that
the Company will be able to reverse its operating losses or cash flow
deficiencies, or that the Company will emerge from Chapter 11 bankruptcy.
These factors raise substantial doubt about the Company's ability to
continue as a going concern.
The Financial Statements have also been prepared in accordance with the
American Institute of Certified Public Accountants ("AICPA") Statement of
Position 90-7, "Financial Reporting by Entities in Reorganization under the
Bankruptcy Code" ("SOP 90-7"). Accordingly, all pre-bankruptcy petition
("pre-petition") liabilities believed to be subject to compromise have been
segregated in the Consolidated Balance Sheets (the "Balance Sheets") and
classified as "liabilities subject to compromise" at the estimated amount
of allowable claims under the Chapter 11 Cases. Liabilities not believed to
be subject to compromise in the bankruptcy proceedings are separately
classified as "current" and "non-current," as appropriate. Expenses
(including professional fees), realized gains and losses, and provisions
for losses resulting from the reorganization are reported separately as
"Reorganization Items." Also, interest expense is reported only to the
extent that it is to be paid during the Chapter 11 Cases. Cash used for
reorganization items is $28,370 for the year ended June 30, 2007.
Historically, the Company has experienced significant recurring net
operating losses as well as negative cash flows from operations. The
Company's main source of liquidity has been equity and debt financing,
which has been used to fund continuing losses from operating activities.
Based on the Company's cash position of approximately $1.0 million, and
further taking into account ongoing costs related to the Chapter 11
bankruptcy proceedings, as well as the ultimate disposition of pre-petition
claims of creditors pursuant to an approved plan of reorganization, the
Company believes that they may not have sufficient cash to meet the
Company's funding requirements through June 30, 2008. The Company's ability
to raise additional capital to fund operations also may have been impaired
by the Chapter 11 reorganization proceeding. The Company will continue its
cost reduction efforts as well as seek additional financing to satisfy its
final approved plan of reorganization. However, based upon the issues
discussed herein, there can be no assurances that the Company will be able
to raise additional capital on desirable terms or at all, reverse its
operating loss or cash flow deficiency, or that the Company will be able to
satisfy its future obligations. These factors raise substantial doubt about
the Company's ability to continue as a going concern which may require
further restructuring, or a sale or liquidation of the Company and could
cause significant dilution or a total loss to its shareholders. The
financial statements do not include any adjustment relating to the
recoverability of the recorded assets or the classification of liabilities
that may be necessary should the Company be unable to continue as a going
concern.
3 Significant accounting policies
Principles of consolidation and basis of presentation
The consolidated financial statements include the accounts of NetWolves
Corporation and its subsidiaries. All significant intercompany transactions
and balances have been eliminated in consolidation. The consolidated
financial statements have been presented in accordance with Statement of
Position ("SOP") 90-7 "Financial Reporting by Entities in Reorganization
under the Bankruptcy Code".
F-10
Cash and cash equivalents
The Company considers highly liquid investments in debt securities with
original maturities of three months or less to be cash equivalents.
Allowance for doubtful accounts
The Company provides allowances for doubtful accounts for estimated losses
from the inability of customers to satisfy their accounts as originally
contemplated at the time of sale and charges actual losses to the allowance
when incurred. The calculation for these allowances is based on detailed
review of certain individual customer accounts, historical satisfaction
rates and the Company's estimation of the overall economic conditions
affecting the Company's customer base. If the financial condition of the
Company's customers were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowances may be required in
conjunction with the Company's May 21, 2007 Chapter 11 bankruptcy filing.
All questionable accounts previously sent to agency were deemed
uncollectible and written down at June 30, 2007. The Company believes all
other amounts are fully collectible and require no reserve.
Inventories
Inventories consist of raw materials and finished goods. Inventories are
valued at the lower of cost or net realizable value using the first-in,
first-out method. Additionally, raw material and finished goods amounted to
$160,476 and $87,116, respectively, at June 30, 2007 and $203,100 and
$99,462, respectively, at June 30, 2006. At June 30, 2007 the Company had a
reserve for slow-moving inventories of $173,313.
Prepaid expenses
Prepaid expenses consist primarily of prepaid insurance and licensing fees
and are being ratably amortized over their respective contract periods.
Property and equipment
Property and equipment are stated at cost. Depreciation is provided on
furniture and fixtures and machinery and equipment over their estimated
lives, ranging from 3 to 7 years, using the straight-line method. Leasehold
improvements are amortized over the lesser of the term of the respective
lease or the useful lives of the related assets. Expenditures for
maintenance and repairs are charged directly to the appropriate operating
accounts at the time the expense is incurred. Expenditures determined to
represent additions and betterments are capitalized and amortized over the
lesser of their useful lives or the useful lives of the related assets.
Internally developed software
Costs associated with the development of software products are generally
capitalized once technological feasibility is established in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed". Software costs are amortized using the greater of the
ratio of current revenue to total projected revenue for a product or the
straight-line method over its estimated useful life and amortization begins
when products become available for general customer release. Costs incurred
prior to establishment of technological feasibility are expensed as
incurred and reflected as engineering and development costs in the
accompanying consolidated statements of operations. The Company incurred
approximately $170,000 and $510,000 in research and development costs for
the years ended June 30, 2007 and 2006, respectively. The Company did not
capitalize any internally developed software costs during the years ended
June 30, 2007 and 2006. Accumulated amortization at June 30, 2007 and 2006
was approximately $2,109,000.
F-11
Goodwill and purchased intangible assets
The Company accounts for goodwill in accordance with SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets". These statements established accounting and reporting standards
for acquired goodwill and other intangible assets. Specifically, the
standards address how acquired intangible assets should be accounted for
both at the time of acquisition and after they have been recognized in the
financial statements. In accordance with SFAS No. 142, purchased goodwill,
must be evaluated for impairment on an annual basis. Those intangible
assets that are classified as goodwill or as other intangibles with
indefinite lives are not amortized.
Impairment testing for goodwill is performed in two steps: (i) the Company
determines impairment by comparing the fair value of a reporting unit with
its carrying value, and (ii) if there is an impairment, the Company
measures the amount of impairment loss by comparing the implied fair value
of goodwill with the carrying amount of that goodwill. The Company has
performed its annual impairment evaluation required by this standard and
determined that no impairment exist with respect to goodwill. Included in
goodwill and other indefinite lived intangible assets is goodwill of
$3,515,698, licenses of $203,000 and patents of $83,275 ($74,374 at June
30, 2006). Identifiable intangible assets consist of software, customer
list and non-compete agreements and are being amortized over their
estimated lives ranging from 2 to 5 years, using the straight line method.
Amortization of $753,493 is included in the depreciation and amortization
expenses in the accompanying consolidated statements of operations for the
years ended June 30, 2007 and 2006.
Product warranties
The Company offers warranties on the sales of certain of its products and
records an accrual for estimated future claims. Such accruals are based
upon historical experience and management's estimate of the level of future
claims.
Revenue recognition
The Company records revenue in accordance with Statement of Position 97-2
"Software Revenue Recognition" ("SOP 97-2"), issued by the American
Institute of Certified Public Accountants (as modified by Statement of
Position 98-9) and SEC Staff Accounting Bulletin 104 "Revenue Recognition"
("SAB 104") regarding revenue recognition in financial statements. SOP 97-2
provides additional guidance with respect to multiple element arrangements;
returns, exchanges, and platform transfer rights; resellers; services;
funded software development arrangements and contract accounting.
Revenues generated from the resale of voice services are recognized as
services are provided and are included within Voice Services revenue in the
accompanying consolidated statements of operations.
Revenues generated from the sale of recurring services within the Managed
Service Charges ("MSC") segment are recognized as services are provided.
Revenue from the sale of hardware, where the Company's software is not
essential, is recognized within Equipment and Consulting revenue at the
time of delivery of hardware products to the customer, when the fee is
fixed and determinable, collectibility is probable and a contract signed by
both parties has been obtained. Maintenance or monitoring revenue that is
bundled with an initial license fee is deferred and recognized ratably
within MSC revenue over the maintenance or monitoring period in the
accompanying consolidated statements of operations. Amounts deferred for
maintenance or monitoring are based on the fair value of equivalent
maintenance or monitoring services sold separately. The Company has
established vendor specific objective evidence ("VSOE") on all undelivered
elements of its software arrangements, which consists of maintenance,
monitoring and, at times, training and consulting. The Company recognizes
revenue under the residual method. The Company's consulting projects are
short-term in nature and are recorded as revenue in Equipment and
Consulting revenues in the accompanying consolidated statements of
operations when services are provided.
Revenue for shipping and handling are included within Equipment and
Consulting revenue and the related costs are included in cost of revenue in
the accompanying consolidated statements of operations.
F-12
Stock-based compensation
Effective July 1, 2006, we adopted the fair value recognition provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123 (revised
2004), "Share-based Payments", ("SFAS(R)") using the
modified-prospective-transition method. As a result, our net loss before
taxes for the year ended June 30, 2007 was $230,528 ($0.01 per share),
greater than if we had continued to account for share-based compensation
under the Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees ("APB 25"). As of June 30, 2007 there was
60,000 of total unrecognized compensation related to stock options granted
which is expected to be recognized over an approximate 1.50 years. The
stock based compensation expense is included in general and administrative
expense in the accompanying condensed consolidated statement of operations.
Prior to July 1, 2006, our stock-based employee compensation plans were
accounted for under the recognition and measurement provisions of APB 25,
and related Interpretations, as permitted by FASB Statement No. 123. We did
not recognize stock-based compensation cost in its statement of operations
for periods prior to July 1, 2006 as all options granted had an exercise
price equal to or greater than the market value of the underlying common
stock on the date of grant. However, compensation expense was recognized
for certain options granted to non-employees of the Company based upon fair
value.
As was permitted under SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amended SFAS No. 123, the
Company elected to continue to follow the intrinsic value method in
accounting for its stock-based employee compensation arrangements as
defined by APB 25, and related interpretations including FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation," an interpretation of APB 25. No stock-based employee
compensation cost is reflected in operations, as all options granted under
those plans had an exercise price equal to or greater than the market value
of the underlying common stock on the date of grant. The following table
illustrates the effect on net loss and net loss per share as if the Company
had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation:
For the year ended
------------------
June 30,
--------
2006
----
Net loss attributable to common shareholders,
as reported $ (3,761,741)
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects
Pro forma net loss $ (608,237)
-------------
Basic and diluted net loss per share $ (4,369,978)
==============
As reported $ (0.15)
Pro forma $ (0.14)
|
Income taxes
In accordance with SFAS No. 109 "Accounting for Income Taxes", the Company
accounts for income taxes using the liability method which requires the
determination of deferred tax assets and liabilities based on the
differences between the financial and tax bases of assets and liabilities
using enacted tax rates in effect for the year in which differences are
expected to reverse. The net deferred tax asset is offset by a valuation
allowance, if, based on the weight of available evidence, it is more likely
than not that some portion or all of the net deferred tax asset will not be
realized. The Company and its subsidiaries file a consolidated Federal
income tax return.
F-13
Basic and diluted net loss per share
The Company displays loss per share in accordance with SFAS No. 128,
"Earnings Per Share" ("SFAS 128"). SFAS 128 requires dual presentation of
basic and diluted earnings per share. Basic earnings per share includes no
dilution and is computed by dividing net income (loss) available to common
shareholders by the weighted average number of common shares outstanding
for the period. The diluted loss per share does not include the impact of
potential shares to be issued upon exercise of convertible preferred stock,
options and warrants aggregating approximately 21.0 million and 19.6
million common shares at June 30, 2007 and 2006 respectively, because the
Company had a net loss attributable to common shareholders and, therefore,
the effect would be anti-dilutive.
Use of estimates
In preparing consolidated financial statements in conformity with
accounting principles generally accepted in the United States, management
makes estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosures of contingent assets and liabilities at the
date of the consolidated financial statements, as well as the reported
amounts of revenue and expenses during the reporting period. Estimates have
been made by management in several areas, including, but not limited to,
revenue recognition, allowances for doubtful accounts, the realizability of
deferred tax assets, goodwill and other intangible assets and stock based
compensation. Management bases its estimates on historical experience and
on various other assumptions that it believes to be reasonable under the
circumstances. Actual results may differ materially from these estimates
under different assumptions or conditions.
Concentrations and fair value of financial instruments
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash investments and
marketable securities. The fair value of financial instruments approximates
their recorded values.
The Company's cash investments are held at primarily one financial
institution in excess of the maximum amount insured by the FDIC as of June
30, 2007 and 2006.
Reclassifications
Certain reclassifications have been made to the 2006 consolidated financial
statements in order to have them conform to the current period's
classifications.
Summary of recent accounting pronouncements
In September 2005, the FASB ratified the EITF's Issue No. 05-8, "Income Tax
Consequences of Issuing Convertible Debt with a Beneficial Conversion
Feature" ("EITF 05-8"), which discusses whether the issuance of convertible
debt with a beneficial conversion feature results in a basis difference
arising from the intrinsic value of the beneficial conversion feature on
the commitment date (which is recorded in the shareholders' equity for book
purposes, but as a liability for income tax purposes) and, if so, whether
that basis difference is a temporary difference under FASB Statement No.
109, "Accounting for Income Taxes." The statement will be effective for
accounting modifications of debt instrument beginning in the first interim
or annual reporting period beginning after December 15, 2005. The adoption
of EITF 05-8 did not have a material impact on the Company's consolidated
financial position or results of operations.
In October 2005, the FASB issued FSP FAS 123(R)-2, "Practical Accommodation
to the Application Grant Date as Defined in FASB Statement No. 123(R)",
which provides clarification of the concept of mutual understanding between
employer and employee with respect to the grant date of a share-based
payment award. This FSP provides that a mutual understanding of the key
terms and conditions of an award shall be presumed to exist on the date the
award is approved by management if the recipient does not have the ability
to negotiate the key terms and conditions of the award and those key terms
and conditions will be communicated to the individual recipient within a
relatively short time period after the date of approval. This guidance was
applicable upon the initial adoption of SFAS 123(R). The adoption of this
F-14
pronouncement did not have an impact on the Company's consolidated
financial position, results of operations, or cash flows.
In November 2005, the FASB issued Staff Position No. FAS 123 (R)-3,
"Transition Election Related to Accounting for the Tax Effects of
Share-Based Payment Awards," FAS 123(R) provides that companies may elect
to use a specified alternative method to calculate the historical pool of
excess tax benefits available to absorb tax deficiencies recognized upon
adoption of SFAS No. 123 (R). The option to use the alternative method is
available regardless of whether SFAS No. 123 (R) was adopted using the
modified prospective or modified retrospective application transition
method, and whether it has the ability to calculate its pool of excess tax
benefits in accordance with the guidance in paragraph 81 of SFAS No. 123
(R). This method only applies to awards that are fully vested and
outstanding upon adoption of SFAS No. 123 (R). FAS 123 (R)- 3 became
effective after November 10, 2005. The adoption of SFAS No. 123 (R)-3 did
not have a material impact on the Company's consolidated financial position
or results of operations.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments" ("SFAS No. 155") an amendment to SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities" and SFAS No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". This statement resolves issues addressed
in Statement 133 Implementation Issue No. D1, "Application of Statement 133
to Beneficial Interests in Securitized Financial Assets." This statement is
effective for all financial instruments acquired or issued after the
beginning of the Company's first fiscal year that begins after September
15, 2006 with early adoption permitted. The Company does not expect the
adoption of SFAS No. 155 to have a material impact on its consolidated
financial statements.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets" - ("SFAS No. 156") an amendment of SFAS No. 140. This
Statement requires that all separately recognized servicing assets and
servicing liabilities be initially measured at fair value, if practicable.
This statement should be adopted as of the beginning of its first fiscal
year that begins after September 15, 2006 with early adoption permitted.
The Company does not expect the adoption of SFAS No. 156 to have a material
impact on its consolidated financial statements.
In June 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes- an interpretation of FASB Statement No. 109"
("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise's financial statements in accordance with SFAS
No. 109. This Interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return. This Interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. FIN 48 is effective for fiscal years beginning
after December 15, 2006. The Company is currently evaluating the impact of
adopting FIN 48 on its future results of operations and financial
condition.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS No. 157"). SFAS No. 157 clarifies the principle that fair value
should be based on the assumptions market participants would use when
pricing an asset or liability and establishes a fair value hierarchy that
prioritizes the information used to develop those assumptions. SFAS No. 157
requires fair value measurements to be separately disclosed by level within
the fair value hierarchy. SFAS No. 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. The Company is currently
evaluating the impact of adopting SFAS No. 157 on its future results of
operations and financial condition.
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 108, "Considering the Effects of Prior Year
Misstatements When Quantifying Misstatements in Current Year Financial
Statements". SAB No. 108 provides interpretive guidance on the
consideration of the effects of prior year misstatements in quantifying
current year misstatements for the purpose of assessing materiality. SAB
No. 108 is effective for fiscal years ending after November 15, 2006. The
Company does not expect the adoption of SAB No. 108 to have a material
impact on its consolidated financial statements.
F-15
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities-including an amendment of FASB
Statement No. 115. This Statement permits entities to choose to measure
many financial instruments and certain other items at fair value. The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex
hedge accounting provisions. The fair value option established by this
Statement permits all entities to choose to measure eligible items at fair
value at specified election dates. A business entity shall report
unrealized gains and losses on items for which the fair value option has
been elected in earnings (or another performance indicator if the business
entity does not report earnings) at each subsequent reporting date. A
not-for-profit organization shall report unrealized gains and losses in its
statement of activities or similar statement. This statement applies to all
entities, including not-for-profit organizations. Most of the provisions of
this Statement apply only to entities that elect the fair value option.
However, the amendment to FASB Statement No. 115, Accounting for Certain
Investments in Debt and Equity Securities, applies to all entities with
available-for-sale and trading securities. Some requirements apply
differently to entities that do not report net income. This Statement is
effective as of the beginning of an entity's first fiscal year that begins
after November 15, 2007. The Company does not expect the adoption of SFAS
No. 159 to have a material impact on its consolidated financial statements.
In June 2006, the EITF reached a consensus on Issue No. 06-3 ("EITF 06-3"),
" Disclosure Requirements for Taxes Assessed by a Governmental Authority on
Revenue-Producing Transactions." The consensus allows companies to choose
between two acceptable alternatives based on their accounting policies for
transactions in which the company collects taxes on behalf of a
governmental authority, such as sales taxes. Under the gross method, taxes
collected are accounted for as a component of sales revenue with an
offsetting expense. Conversely, the net method allows a reduction to sales
revenue. If such taxes are reported gross and are significant, companies
should disclose the amount of those taxes. The guidance should be applied
to financial reports through retrospective application for all periods
presented, if amounts are significant, for interim and annual reporting
beginning after December 15, 2006 with early adoption is permitted. The
adoption of EITF 06-3 did not have a material effect on our consolidated
financial statements.
In December 2006, the FASB issued FASB Staff Position ("FSP") EITF 00-19-2
"Accounting for Registration Payment Arrangements" ("FSP EITF 00-19-2")
which specifies that the contingent obligation to make future payments or
otherwise transfer consideration under a registration payment arrangement
should be separately recognized and measured in accordance with SFAS No. 5,
"Accounting for Contingencies." Adoption of FSP EITF 00-19-02 is required
for fiscal years beginning after December 15, 2006. We do not expect the
adoption of FSP EITF 00-19-2 to have a material impact on our consolidated
financial position, results of operations or cash flows.
F-16
4 Property and equipment, net
Property and equipment consist of the following:
June 30,
-------------------------------
2007 2006
-------------- -------------
Machinery and equipment $734,594 $787,201
Furniture and fixtures 234,765 234,764
Leasehold improvements 141,909 141,909
-------------- -------------
1,111,268 1,163,874
Less: accumulated depreciation and amortization (1,031,711) (1,015,254)
-------------- -------------
Property and equipment, net $ 79,557 $ 148,620
============== =============
|
Depreciation expense on property and equipment was $65,510 and $123,397 for
fiscal years 2007 and 2006, respectively.
5 Identifiable Intangible Assets
Identifiable intangible assets consist of the following:
June 30,
------------------------------------
2007 2006
---------------- -----------------
Software $ 1,462,029 $ 1,462,029
Customer List 2,947,755 2,947,755
Non-Compete 200,000 200,000
---------------- -----------------
Total 4,609,784 4,609,784
Less: Accumulated
Amortization 4,171,234 3,417,741
---------------- -----------------
Identifiable Intangible Assets, net $ 438,550 $ 1,192,043
================ =================
|
Amortization expense for the years ended June 30, 2007 and 2006 amount to
$753,493 and $753,493, respectively.
On October 1, 2004, the Company acquired a customer list from Education
Communications Consortia, Inc. ("ECCI") for a total purchase price of
$1,444,277, including $144,277 in acquisition costs, of which $500,000 was
paid in cash on the date of closing. The remaining $800,000 was originally
recorded as a note payable due in four annual installments of $200,000
commencing November 30, 2005, bearing interest of 4% per annum. The payment
of each of the four annual installments is contingent upon achieving annual
revenue of $2 million for each twelve month period ending September 30,
2005 to 2008. The purchase price, including the entire contingent
liability, was originally recorded as an intangible asset, as it was
initially believed that payment was assured beyond a reasonable doubt, and
was amortized over its expected useful life of 5 years.
In September 2005, the Company determined that gross revenues derived from
the ECCI customer list did not reach the annual revenue of $2 million as
required by the purchase agreement and also no longer believes that the
balance of the payments are assured beyond a reasonable doubt. Accordingly,
the Company has recorded a decrease in the customer list in the amount of
$800,000 and a corresponding decrease in notes payable. As a result, the
Company has reversed previously recorded amortization expense and accrued
interest totaling $144,002, which is reflected as other income in the
F-17
accompanying condensed consolidated statements of operations. The
adjustment will also have the effect of reducing future amortization
expense by $160,000 per annum.
In September 2005, the Company determined that gross revenues derived from
the ECCI customer list did not reach the annual revenue of $2 million as
required by the purchase agreement and no longer believes that the
remaining $400,000 of the performance payment is assured beyond a
reasonable doubt.
In April 2005, the Company acquired a customer list and entered into a
non-compete agreement for $200,000 and $200,000 respectively. The customer
list has an estimated useful of 5 years and the non-compete will be
amortized over 27 months. The Company made cash payments of $150,000 with
three additional annual payments commencing July 31, 2005 in the amounts of
$100,000, $100,000 and $50,000 (see Note 6).
Future amortization expense for the above intangible assets are as follows:
For the year ended
------------------
June 30, Amount
-------- ------
2008 185,184
2009 181,700
2010 71,666
Thereafter -
-------------
Total $ 438,550
=============
|
6 Accounts payable and accrued expenses
Accounts payable and accrued expenses consist of the following:
Pre-Petition
June 30,
-------------------------------------
2007 2006
----------------- ------------
Pre-petition trade accounts payable and other accrued
operating expenses subject to compromise $ 4,027,516 $ -
Sales and excise tax payable 54,754 -
Dividends payable 563,874 -
Compensated absences 65,856 -
Other liabilities 194,309 -
Bonuses and commissions payable - -
Accrued taxes
- -
- -
----------------- ------------
$ 4,906,309 $ -
================== ============
|
F-18
Post-Petition
June 30,
-------------------------------------
2007 2006
----------------- ------------
Post-petition trade accounts payable and other accrued
operating expenses not subject to compromise $ 756,977 $3,271,042
Sales and excise tax payable 13,226 132,409
Dividends payable - 490,819
Compensated absences 33,059 356,361
Other liabilities 270,474 372,826
Bonuses and commissions payable 48,074 16,974
Accrued taxes 161 159
----------------- -------------
$ 1,121,971 $5,755,385
================= -------------
|
7 Long Term Debt
Long Term debt at June 30, 2007 consists of the following:
June 30 June 30,
2007 2006
---------------- --------------
Note payable - 13 month note, 18% annual interest rate,
paid monthly. In addition, the Company is required to
maintain certain covenants. This note was due March 2007
but has been extended to January 1, 2008. Collateralized
by substantially all assets of the Company. $ 403,750 $ 403,750
Note payable - 18 month note, 18% annual interest rate
paid monthly. In addition, the Company is required to
maintain certain covenants. This note was due November
2007, with the exception of $95,000, has been extended to
January 1, 2008. Collateralized by substantially all
assets of the Company. 665,000 665,000
Note payable - 1 remaining contingent payment in the
amount of $50,000 due July 31, 2007. Payments contingent
on achieving targeted revenues
(See Note 7). 50,000 150,000
Note Payable - 18-month note net of debt discount of
$5,763, 10% annual interest rate paid monthly. In
addition, the Company is required to maintain certain -
covenants. Collateralized by substantially all assets of
the Company. 89,237
---------------- --------------
Total Long-Term Debt 1,207,987 1,218,750
Less: Current Maturities (1,207,987) (100,000)
---------------- --------------
Long-Term Debt, Less Current Maturities $ - $ 1,118,750
================ ==============
|
NetWolves' voluntary petition to reorganize under Chapter 11 of the
Bankruptcy Code has resulted in a default under the covenants of the
above-discussed notes. As a result, the full-face amount of the notes, plus
accrued interest, in the amount of $1,243,918 was due at June 30, 2007.
Notwithstanding the aforementioned, the default has been stayed by the
Chapter 11 bankruptcy proceeding pending the approval of a plan of
reorganization.
F-19
8 Shareholders' equity
Common stock issuances and option issuances
Management determined the fair value of all common stock issuances based on
each respective issuance's quoted market price at the measurement date. For
shares of common stock issued to consultants, the measurement dates used
were the vesting dates of the common stock.
For the year ended June 30, 2006, the Company issued 3,309,982 shares of
its common stock as follows:
o The Company received a non-interest bearing advance from a shareholder
in the amount of $210,000 during the quarter ended September 30, 2005,
with no scheduled repayment terms. During the quarter ended December
31, 2005 this short term debt was repaid with the issuances of 840,000
shares of restricted common stock, with no registration rights.
o During December 2005, the Company entered into an agreement with a
consultant. In return for services, the Company issued 75,000 shares
with a value of $30,001 of the Company's common stock.
o During January 2006, the Company entered into an agreement with a
consultant. In return for services, the Company issued 75,000 shares
with a value of $20,251of the Company's common stock.
o During March 2006, the Company entered into a securities purchase
agreement whereas the Company sold 18% senior secured promissory notes
in the principal amount of up to $950,000 and up to 1,000,000 shares
of the Company's common stock, at a price of $0.05 per share or 100
shares for each $95.00 of principal amount of notes sold. As a result
of this debt financing agreement the Company issued 425,000 shares of
the Company's common stock for $21,251 with registration rights.
o In May 2006, the Company entered into an additional securities
purchase agreement wherein the Company sold 18% senior secured
promissory notes in the principal amount of $665,000 and 700,000
shares of the Company's common stock at a price of $0.05 per share or
100 shares for each $95.00 of principal amount of notes sold. The
notes bear interest at the rate of 18% and provide for a maturity date
eighteen months from the closing date. As a result of this debt
financing agreement the Company issued 700,000 shares of the Company's
common stock for $35,000 with registration rights.
o During June 2006, the Company entered into an agreement with a
consultant. In return for services, the Company granted options to
purchase 950,000 shares which vest immediately and have a value of
$66,500.
o During June 2006, the Company entered into an agreement with a
consultant. In return for services, the Company granted options to
purchase 200,000 shares which vest immediately and have a value of
$16,000.
o During June 2006, the Company entered into an agreement with a
consultant. In return for services, the Company granted options to
purchase 40,000 shares which vest immediately and have a value of
$2,400.
o During the year ended June 30, 2006, investors had converted 4,695
shares of Series A Convertible Preferred Stock ("Series A Preferred
Stock"), 42,308 shares of Series B Convertible Preferred Stock
("Series B Preferred Stock") and 4,345 shares of Series C Convertible
Preferred Stock ("Series C Preferred Stock") resulting in issuances of
1,194,892 shares of common stock.
For the year ended June 30, 2007, the Company issued 700,000 shares of its
commons stock as follows:
F-20
o During December 2006, at a meeting of the compensation committee, the
Company authorized the issuance of 2,307,500 options with a fair value
of $290,325 and 700,000 shares of common stock with a fair value of
$112,000 under its existing stock option/stock issuance plans. This
represents an aggregate of 1,825,000 options with a fair value of
$237,250 issued to its executives and directors and 482,500 options
with a fair value of $53,075 issued to its employees and consultants.
The options have an exercise price of $.16 and a vesting period that
ranges from immediately to twenty-four months. The closing price of
the Company's common stock on December 12, the last trading day before
authorization of the issuance was $0.16.
o During the year ended June 30, 2007, investors had converted 3 shares
of Series A Preferred Stock and 13,778 shares of Series B Preferred
Stock resulting in issuances of 275,616 shares of common stock.
As of June 30, 2007, approximately 8,563,621 shares of the Company's common
stock are issuable upon conversion of preferred stock.
During the year ended June 30, 2007, investors had converted 3 shares of
Series A Preferred Stock, and 13,778 shares of Series B Preferred Stock.
There were no conversions of Series C Preferred Stock resulting in
issuances of 275,616 shares of common stock.
Series A Convertible Preferred Stock
On July 16, 2002 the Company amended its Certificate of Incorporation, as
authorized by its Board of Directors, by designating 1,000,000 shares of
its 2,000,000 shares of preferred stock as Series A Convertible Preferred
Stock, par value $.0033 per share.
The Company issued 269,462 shares of its Series A Preferred Stock for total
cash consideration of $4,041,972 during fiscal 2003. The shares were issued
in connection with a private offering of the Company's securities pursuant
to which shareholders also received warrants to purchase shares of the
Company's common stock. Five warrants were issued for each share of Series
A Preferred Stock. The warrants, which were valued at $779,427, have an
exercise price equal to $1.65 per share and are exercisable for five years
from the issuance date.
Cumulative dividends on the Series A Preferred Stock accrue at a rate of
12% per annum and will be payable annually at the Company's option in cash
or Series A Preferred Stock. Cumulative preferred dividends accrued on the
Series A Preferred Stock were $360,602 and $325,804 at June 30, 2007 and
2006, respectively. Each share of the Series A Preferred Stock was
originally convertible at the holders' option into 10 shares of common
F-21
stock. Pursuant to the anti-dilution provision of the Series A Preferred
Stock, each share of Series A Preferred Stock is now convertible into 18.75
shares of common stock. Each share of Series A Preferred Stock will have
ten votes and will vote as a single class with holders of the Company's
common stock.
In July 2006 and 2005 stock dividends totaling 21,720 and 22,162 shares,
respectively were paid in Series A Preferred Stock to Series A Preferred
Stock investors representing accrued dividends through June 30, 2006 and
2005, respectively.
Series B Convertible Preferred Stock
On October 30, 2002, the Company amended its Certificate of Incorporation,
as authorized by its Board of Directors, by designating 500,000 shares of
its 2,000,000 shares of preferred stock as Series B Convertible Preferred
Stock, par value $.0033 per share.
The Company issued 290,963 shares of its Series B Preferred Stock for total
cash consideration of $4,655,300 during fiscal 2003. The shares were issued
in connection with a private offering of the Company's securities pursuant
to which shareholders also received warrants to purchase shares of the
Company's common stock. Five warrants were issued for each share of Series
B Preferred Stock. The warrants, which were valued at $701,430, have an
exercise price equal to $1.25 per share and are exercisable for five years
from the issuance date.
Cumulative dividends on the Series B Preferred Stock accrue at a rate of
12% per annum and will be payable annually at the Company's option in cash
or Series B Preferred Stock. Cumulative preferred dividends accrued on the
Series B Preferred Stock were $159,004 and $153,349 at June 30, 2007 and
2006, respectively. Each share of the Series B Preferred Stock is
convertible at the holders' option into 20 shares of common stock. Each
share of Series B Preferred Stock will have ten votes and will vote as a
single class with holders of the Company's common stock.
On February 1, 2007 and 2006 stock dividends totaling 22,746 and 28,010
shares, respectively were paid in Series B Preferred Stock to Series B
Preferred Stock investors representing accrued dividends through January
31, 2007 and 2006, respectively.
Series C Convertible Preferred Stock
The Company amended its Certificate of Incorporation, as authorized by its
Board of Directors, by designating 100,000 shares of its 2,000,000 shares
of preferred stock as Series C Convertible Preferred Stock, par value
$.0033 per share.
The shares were issued in connection with a private offering of the
Company's securities pursuant to which shareholders also received warrants
to purchase shares of the Company's common stock at an exercise price equal
to $1.50 per share. Six warrants were issued for each share of Series C
Preferred Stock. The warrants, which were valued at $616,012, have an
exercise price equal to $1.50 per share and are exercisable for five years
from the issuance date. As a result of the issuance of Series C Preferred
Stock, the Company recorded a beneficial conversion of $3,106,724.
Cumulative dividends on the Series C Preferred Stock accrue at a rate of 9%
per annum and will be payable annually at the Company's option in cash or
Series C Preferred Stock. Cumulative preferred dividends accrued on the
Series C Preferred Stock were $13,007 and $11,666 at June 30, 2007 and
2006, respectively. Each share of the Series C Preferred Stock is
convertible at the holders' option into 60 shares of common stock. Each
share of Series C Preferred Stock will have fifteen votes and will vote as
a single class with holders of the Company's common stock.
On May 1, 2006 stock dividends totaling 1,279 shares were paid in Series C
Preferred Stock to Series C Preferred Stock investors represent accrued
dividends through August 30, 2006.
F-22
Stock option plans
The Company's Stock Option Plans (the "Plans"), authorize the Board of
Directors to grant nonstatutory stock options to employees and directors to
purchase up to a total of 9,932,500 shares of the Company's common stock.
Generally, options granted under the Plans vest ratably over three years.
If any award under the Plans terminates, expires unexercised, or is
canceled, the shares of common stock that would otherwise have been
issuable pursuant thereto will be available for issuance pursuant to the
grant of new awards.
Approximate
Maximum net cumulative
allowable issuances Maximum
Plans Date adopted issuances June 30, 2007 term in years
------------------- ------------------- ----------------- ----------------- -------------
1998 Plan June 1998 282,500 102,500 10
2000 Plan July 2000 1,500,000 739,500 10
2001 Plan February 2001 1,750,000 2,157,500 10
2002 Plan June 2002 3,000,000 1,415,650 10
2003 Plan June 2003 2,400,000 2,154,050 10
2006 Plan April 2006 1,000,000 315,500 10
----------------- ------------------
9,932,500 6,884,700
================= ======== =========
|
A summary of the Company's stock options is presented below:
Weighted-Average Aggregate Intrinsic
Stock Options Exercise Price Value
------------------------------------------------------------------
Outstanding, June 30, 2006 5,104,200 $ 0.75 -
Granted 2,607,500 $ 0.16 -
Exercised - $ - -
Cancelled/forfeited $ 1.26 -
------------------
(827,000)
Outstanding, June 30, 2007 6,884,700 $ 0.46 $ -
================== ===========
Exercisable, June 30, 2007 6,371,036 $ 0.49 $ -
================== ===========
|
The following table summarizes information about stock options outstanding
at June 30, 2007:
Options Options
outstanding at exercisable at
June 30, 2007 June 30, 2007
------------- -------------
Weighted
average Weighted Weighted
remaining average average
Range of Number of contractual exercise Number of exercise
exercise prices shares life price Shares price
--------------- ------ ---- ----- ------ -----
$ 0.00-$ 0.50 5,213,000 4.15 0.16 4,699,336 0.17
$ 0.51-$ 1.00 1,010,700 2.86 0.99 1,010,700 1.00
$ 1.01-$ 1.50 552,000 0.77 1.19 552,000 1.19
$ 1.51-$ 2.00 6,500 1.31 1.88 6,500 1.88
$ 2.01-$12.00 102,500 1.60 6.90 102,500 6.90
------- ---------
6,884,700 6,371,036
========= =========
|
There was no aggregate intrinsic value for stock options outstanding or
exercisable at June 30, 2007.
F-23
The following table summarizes unvested stock option information as of June
30, 2007:
Weighted
Average
Grant Date Fair
Shares Value
------------- ---------------
Non-vested stock options, July 1, 2006 - -
Granted 2,607,500 $ 0.12
Vested (2,093,836) 0.12
Forfeited - -
------------- ---------------
Non vested stock options, June 30, 2007 513,664 $ 0.12
============= ===============
|
The weighted average fair value of options granted during the year ended
June 30, 2007 is $0.12.
9 Segment Information
The Company reports segments in accordance with SFAS No. 131 "Disclosures
about Segments of an Enterprise and Related Information" ("SFAS 131"). The
Company's management evaluates its operations in three reportable business
segments: Voice Services, Managed Service Charges and Equipment and
Consulting. These three segments reflect management's approach to operating
and directing the businesses and aligns financial and managerial reporting.
The Voice Services segment provides voice services including switched and
dedicated outbound, switched and dedicated toll-free inbound, dedicated T1
access loops, calling and debit cards, and conference calling. The Managed
Service Charges segment, which operates worldwide, provides network and
security technology and a variety of recurring managed data services. The
Equipment and Consulting segment, which operates worldwide, is primarily
engaged in the design, development, marketing and support of information
delivery hardware products and software as well as providing consulting
services on an as needed basis for certain existing or potential customers.
For the year ended June 30,
--------------------------
2007 2006
---------------- --------------
Revenue
Voice Services $ 8,793,564 $ 13,725,882
Managed Service Charges 8,587,575 8,011,342
Equipment and Consulting 26,922 99,485
---------------- --------------
Total $ 17,408,061 $ 21,836,709
================ ==============
Cost of revenue
Voice Services $ 6,210,133 $ 9,398,137
Managed Service Charges 5,758,272 4,874,779
Equipment and Consulting
- 28,628
---------------- --------------
Total $ 11,968,405 $ 14,301,544
================ ==============
Operating loss
Voice Services $ (2,038,306) $ (2,615,138)
Managed Service Charges (1,996,799) (1,535,874)
Equipment and Consulting - -
---------------- --------------
Total $ (4,035,105) $ (4,151,012)
================ ==============
|
F-24
Revenue and cost of revenue are allocated to each segment on a specific
identification method, operating expenses are allocated to each segment on
a pro rata basis, based upon revenue. The Company is not disclosing total
assets for each reportable segment because this information is not reviewed
by the chief operating decision maker.
All of the Company's sales occur in the United States and are shipped
primarily from the Company's facilities in the United States. There were no
sales into any one foreign country in excess of 10% of total net sales.
10 Income taxes
The provision for income taxes consists of the following:
For the year ended June 30,
----------------------------
2007 2006
--------------- -----------
Current - Federal and States $ 760 $ 35,817
Deferred - Federal and States - -
--------------- -----------
Provision for income taxes $ 760 $ 35,817
============== ===========
|
The following table summarizes the significant differences between the
Federal statutory tax rate and the Company's effective tax rate for
financial reporting purposes:
For the year ended June 30,
---------------------------
2007 2006
------------- ----------
Federal statutory tax rate (34%) (34%)
State and local taxes net of Federal
Tax effect (6.7) (2.3)
Permanent differences 0.7 0.6
Valuation allowance on deferred tax
Asset 40.0 36.7
------------- ----------
Effective tax rate _ 1.0%
============= ==========
|
The tax effects of temporary differences and carryforwards that give rise
to deferred tax assets or liabilities are summarized as follows:
F-25
June 30,
----------------------------------------
2007 2006
----------------- --------------
Non deductible reserves and other $ 531,015 $ 852,237
Intangible assets
(166,637) (464,736)
Net operating loss carryforward 21,595,603 19,817,847
Valuation allowance on net deferred tax asset (21,959,981) (20,205,348)
----------------- --------------
Deferred tax asset, net $ - $ -
================= ==============
|
Due to the history of net operating losses for income tax purposes, the
Company has provided for full valuation allowances on the net deferred tax
asset due to it being more likely than not that the deferred tax asset will
not be utilized.
At June 30, 2007, the Company has net tax operating loss carryforwards of
approximately $54 million. A portion or all of these losses may be subject
to Section 382 of the Internal Revenue Code and therefore not available to
offset future income tax liabilities. The carryforward losses expire
through 2027 and have not been recognized in the accompanying consolidated
financial statements as a result of a valuation allowance against the
deferred tax asset.
11 Related party transactions
During the years ended June 30, 2007 and 2006, the Company paid
approximately $245,000 and $140,000, respectively, for legal services to
law firms in which an employee/shareholder is affiliated.
During December 2006, at a meeting of the compensation committee, the
Company authorized the issuance of 700,000 shares of common stock under its
existing stock option/stock issuance plans to related parties.
The Company received a non-interest bearing advance from a shareholder in
the amount of $210,000 during the quarter ended September 30, 2005, with no
scheduled repayment terms.
During the quarter ended December 31, 2005 this short term debt was repaid
with the issuances of 840,000 shares of restricted common stock, with no
registration rights.
12 Significant agreements
For the years ended June 30, 2007 and June 30, 2006, approximately 0% and
11% of sales were made to Swift Transportation, respectively.
Sprint Communications Company L.P.
The Company has two agreements with Sprint Communications Company L.P.
("Sprint") to supply telecommunication services to the Company. The
agreement for switched services has a term of 28 months and the agreement
for the data and private line services has a term of 24 months. The Company
currently has a commitment to purchase a minimum of telecommunication
services monthly from Sprint, which expires November 2008. The remaining
minimum monthly commitment is as follows:
F-26
Monthly
Months Commitment
--------- ----------
53 - 64 (November 2007) 650,000
65 - 76 (November 2008) 750,000
|
The Company made purchases from Sprint that aggregated approximately 31%
and 42% of the total cost of revenue for the years ended June 30, 2007 and
2006, respectively. The Company currently has a commitment to purchase a
minimum of $650,000 of telecommunication services monthly from Sprint.
In addition, the Company made purchases from MCI that aggregated
approximately 23% and 28% and Qwest that aggregated approximately 13% and
8% of the total cost of revenue for the years ended June 30, 2007 and 2006,
respectively.
13 Commitments and contingencies
Leases
The Company has entered into several leases for office space and office
equipment. At June 30, 2007, the approximate future minimum annual lease
payments, are summarized as follows:
Fiscal year ending June 30,
2008 411,225
2009 425,121
2010 426,246
2011 233,918
-----------
$ 1,496,510
===========
|
Total rent expense for the years ended June 30, 2007 and 2006 was $407,700
and $423,252, respectively.
Employment agreements
The Company has an employment agreement with one member of its executive
management team. The employment agreement provides for certain payments
following death or disability, for certain fringe benefits such as
reimbursement for reasonable expenses and participation in medical plans,
and for accelerated payments in the event of change of control of the
Company. The specific terms are as follows:
o The agreement with the Chief Financial Officer is for a term of
three years, subject to two additional one-year extensions, at an
annual salary of $150,000. On July 1, 2004, a new agreement was
entered into for a term of five years, terminating on July 1,
2009 and subject to additional one-year extensions, at an annual
salary of $175,000.
o As part of the plan to reduce certain expenses of the Company the
Chief Financial Officer voluntarily accepted a pay reduction of
50% of his current pay. This amount is net of an existing 15%
deferment and commenced February 1, 2007. This reduction was
reinstated to its original amount by the consent of the Company's
Board of Directors as of June 30, 2007.
Litigation
a) On April 24, 2006, the Company's subsidiary NetWolves ECCI Corp
(the "Subsidiary") filed an action in the Florida Circuit Court,
Hillsborough County against Education Communications Consortia
Inc. ("ECCI"). The action arises from ECCI's breach of the
October 1, 2004 Asset Purchase Agreement between the parties (the
F-27
"Agreement") by failing to pay $70,273 pursuant to a
reconciliation of billings, receivable and costs in accordance
with the terms of the Agreement.
On April 27, 2006, ECCI served the Company and Subsidiary with an
action in the Circuit Court of Kanawha County, West Virginia,
alleging, inter alia that the Subsidiary had failed to pay the
$200,000 first installment of a promissory note ("the Note") and
has anticipatorily breached payment of the remaining balance. As
a consequence, ECCI alleges that the entire $800,000 note,
together with interest and costs, is joint and severally due and
payable by the Subsidiary and by the Company, as guarantor. ECCI
asserts additional claims against the Company in the aggregate
sum of approximately $121,000 based on alleged reimbursable costs
incurred by ECCI.
The Company and Subsidiary believe that ECCI's action is without
merit and therefore no accrual has been made. Among other things,
it is the Company's position that the Agreement provided as a
condition precedent to any installment payment that ECCI achieve
annual gross revenue of at least $2,000,000; and that ECCI failed
to achieve this amount. However, there can be no assurances that
the Company will be successful.
The actions against NetWolves were stayed pursuant to the
Bankruptcy Code's automatic stay provisions on May 21, 2007 when
NetWolves filed for reorganization under Chapter 11 of the
Bankruptcy Code. The Company believes it has strong defenses to
these lawsuits and intends to contest them vigorously. However,
because these lawsuits are at an early stage, the Company is
unable to provide an evaluation of the ultimate outcome of the
litigation.
b) At a meeting of the Board of Directors held on December 4, 2006,
the Company accepted the resignation of Walter M. Groteke as
Chairman, Chief Executive Officer and a director of the Company,
effective immediately. At the same time, Michael R. Rocque, a
director of the Company, was appointed as its Acting Chief
Executive Officer.
The action was the result of a series of events commencing with a
resolution approved by the Board of Directors on October 27, 2006
to separate the positions of Chairman and Chief Executive
Officer, both positions being held by Walter M. Groteke, subject
to finding a suitable candidate, if any, for the position of
Chief Executive Officer. As previously reported, a committee was
appointed to search for candidates for the position of Chief
Executive Officer. At the same time Scott Foote, formerly Vice
President was appointed as the Company's Acting President to be
involved in day-to-day operations.
In response to these resolutions, Mr. Groteke through his
counsel, informed the Company on November 16, 2006, by written
notice as required by his employment agreement, that Mr. Groteke
was resigning from the Company for "good reason," as defined in
the employment agreement; that the letter constituted his 15-day
formal notice, making his resignation effective December 1, 2006;
and that Mr. Groteke was demanding all compensation and benefits
set forth in the agreement through June 30, 2010, the remainder
of its term.
On November 21, 2006, the Company through its counsel responded
to the November 16th letter by denying that Mr. Groteke had any
basis for his claims, stating among other things, that Mr.
Groteke remained Chairman and CEO with all of his
responsibilities inherent in these positions. By letter dated
November 28, 2006, Mr. Groteke's counsel affirmed his prior
position.
At the December 4, 2006 Board of Directors meeting, the Board of
Directors formally accepted his resignation. The acceptance was
based on his voluntary resignation and not for the reasons set
forth by his counsel.
F-28
On December 6, 2006, in the Hillsborough County Circuit Court of
the State of Florida, Mr. Groteke served the Company with an
action seeking declaratory relief and a judgment for his full
compensation and benefits under the employment agreement, on the
grounds previously set forth.
It is the Company's position that Mr. Groteke voluntarily
resigned and is no longer entitled to the compensation set forth
under his employment agreement.
c) On May 21, 2007, NetWolves filed for protection under Title 11 of
the Bankruptcy Code in the United States Bankruptcy Court for the
Middle District of Florida, Tampa Division.
d) The actions against NetWolves were stayed pursuant to the
Bankruptcy Code's automatic stay provisions on May 21, 2007 when
NetWolves filed for reorganization under Chapter 11 of the
Bankruptcy Code. The Company believes it has strong defenses to
these lawsuits and intends to contest them vigorously. However,
because these lawsuits are premature, are unable to provide an
evaluation of the final outcome of the litigation. . On August
17, 2007 the above referenced actions were removed to the federal
court advisory proceedings subject to the bankruptcy codes.
Benefit plans
The Company has established a 401(k) defined contribution plan.
Employees 21 years or older with at least six months of service
are eligible to participate in the plan. Participants may elect
to contribute, on a tax-deferred basis, up to 15% of their
compensation, not to exceed the maximum amount allowed by law.
The Company did not make any contributions to the plan for the
years ended June 30, 2007 and 2006.
F-29