NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Interim financial information
The summary financial information contained herein is unaudited; however,
in the opinion of management, all adjustments (consisting only of normal
recurring accruals) necessary for a fair presentation of such financial
information have been included. These financial statements, including the
condensed consolidated balance sheet as of June 30, 2007, which has been
derived from audited financial statements, are presented in accordance with
the requirements of Form 10-QSB and consequently may not include all
disclosures normally required by generally accepted accounting principles
or those normally made in the Company's Annual Report on Form 10-KSB. The
accompanying condensed consolidated financial statements and related notes
should be read in conjunction with the Company's Annual Report on Form
10-KSB for the fiscal year ended June 30, 2007. The results of operations
for the three and six months ended December 31, 2007 are not necessarily
indicative of the results to be expected for the full year.
2. Bankruptcy, Management's Plan and Going Concern
On May 21, 2007 NetWolves Corporation ("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 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.
5
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 Condensed 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 Costs." Also, interest expense is
reported only to the extent that it is to be paid during the Chapter 11
Cases. Contractual interest in total debt is as disclosed in Note 9. Cash
used for reorganization items was approximately $298,000 and $404,000 for
the three and six months ended December 31, 2007.
Upon confirmation of all amounts owed, 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 condensed consolidated balance sheets at December
31, 2007 and 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 under the Plan.
On October 29, 2007, the Company filed a Joint Plan of Reorganization of
Debtors and related Disclosure Statement with the Bankruptcy Court.
On January 17, 2008, the Company filed a First Amended Joint Plan of
Reorganization of Debtors and related Disclosure Statement with the
Bankruptcy Court.
The accompanying condensed 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
December 31, 2007, the Company had a working capital deficiency of
$5,798,268 and shareholders' deficiency of $1,272,990. 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 emerge from Chapter 11 bankruptcy.
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 $500,000, 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 it may not have sufficient cash to meet the Company's funding
requirements through December 31, 2008, without raising additional capital.
The Company's ability to raise additional capital to fund operations also
may have been impaired by the Chapter 11 reorganization proceeding. The
Company plans to continue its cost reduction efforts as well as seek
additional financing to satisfy a plan of reorganization by the Company's
creditors. 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, in order 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
6
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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. 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 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. 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.
The Company operates primarily in two 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 Charges segment provides network
and security technology and a variety of recurring managed data services
giving its customers a single source solution.
4. Reclassifications
Certain reclassifications have been made to the December 31, 2006 condensed
consolidated statement of operations and cash flows in order to have them
conform to the current period's classifications. These reclassifications
have no effect on previously reported net loss.
5. Income Taxes
The Company has adopted the provisions of Financial Accounting Standards
Board ("FASB") Interpretation No. 48, "Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109 ("FIN 48"), on July 1,
2007. FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise's financial statements in accordance with SFAS
No. 109, "Accounting for Income Taxes," and prescribes a recognition
threshold and measurement process for financial statement recognition and
measurement of a tax classification, interest and penalties, accounting in
interim period, disclosure and transition.
The Company has identified its Federal tax return and its state tax return
in New York as "major" tax jurisdictions, as defined. Based on the
Company's evaluation, it has been concluded that there are no significant
uncertain tax positions requiring recognition in the Company's financial
statements. The Company's evaluation was performed for tax years ended June
30, 2004 through June 30, 2007, the only periods subject to examination.
The Company believes that its income tax positions and deductions would be
sustained on audit and does not anticipate any adjustments that would
result in a material change to its financial position. In addition, the
Company did not record a cumulative effect adjustment related to the
adoption of FIN 48.
The Company's policy for recording interest and penalties associated with
audits is to record such items as a component of income before income
taxes. Penalties are recorded in other expense and interest paid or
7
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
received is recorded in interest expense or interest income, respectively,
in the statement of operations. There were no amounts accrued for penalties
or interest as of or during the three and six months ended December 31,
2007. The Company does not expect its unrecognized tax benefit position to
change during the next twelve months. Management is currently unaware of
any issues under review that could result in significant payments, accruals
or material deviations from its position.
The Company is no longer subject to U.S. Federal income tax examinations by
the Internal Revenue Service and most state and local authorities for
fiscal tax years ending prior to June 30, 2004 (certain state authorities
may subject the Company to examination up to the period ending June 30,
2003). The Company does, however, have prior year net operating loss, which
will remain open for examination.
6. Summary of Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles, and
expands disclosures about fair value measurements. It codifies the
definitions of fair value included in other authoritative literature;
clarifies and, in some cases, expands on the guidance for implementing fair
value measurements; and increases the level of disclosure required for fair
value measurements. Although SFAS 157 applies to (and amends) the
provisions of existing authoritative literature, it does not, of itself,
require any new fair value measurements, nor does it establish valuation
standards. SFAS 157 is effective for financial statements issued for fiscal
years beginning after November 15, 2007, and interim periods within those
fiscal years. The Company will evaluate the impact of adopting SFAS 157 but
does not expect that it will have a material impact on the Company's
consolidated financial position, results of operations or cash flows.
In December 2006, the FASB issued "FASB Staff Position ("FSP") EITF
00-19-2, "Accounting for Registration Payment Arrangements". This FSP
specifies that the contingent obligation to make future payments or
otherwise transfer consideration under a registration payment arrangement,
whether issued as a separate agreement or included as a provision of a
financial instrument or other agreement, should be separately recognized
and measured in accordance with FASB Statement No. 5, "Accounting for
Contingencies". This FSP further clarifies that a financial instrument
subject to a registration payment arrangement should be accounted for in
accordance with other applicable GAAP without regard to the contingent
obligation to transfer consideration pursuant to the registration payment
arrangement. This FSP amends various authoritative literature notably FASB
Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities", FASB Statement No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity", and FASB
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others".
This FSP is effective immediately for registration payment arrangements and
the financial instruments subject to those arrangements that are entered
into or modified subsequent to December 21, 2006. For registration payment
arrangements and financial instruments subject to those arrangements that
were entered into prior to December 21, 2006, the guidance in the FSP is
effective for financial statements issued for fiscal years beginning after
December 15, 2006, and interim periods within those fiscal years. The
adoption of this pronouncement did not have a material impact on the
Company's financial position, results of operations, or cash flows.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" ("SFAS 159"). Under the
provisions of SFAS 159, companies may choose to account for eligible
financial instruments, warranties and insurance contracts at fair value on
a contract-by-contract basis. Changes in fair value will be recognized in
earnings each reporting period. SFAS 159 is effective for financial
8
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. The Company is required to and
plans to adopt the provisions of SFAS 159 beginning in the first quarter of
fiscal 2008. The Company is currently assessing the impact of the adoption
of SFAS 159.
In December 2007, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141R, "Business
Combinations" ("SFAS 141R"), which replaces SFAS No. 141, "Business
Combinations." SFAS 141R establishes principles and requirements for
determining how an enterprise recognizes and measures the fair value of
certain assets and liabilities acquired in a business combination,
including noncontrolling interests, contingent consideration, and certain
acquired contingencies. SFAS 141R also requires acquisition-related
transaction expenses and restructuring costs be expensed as incurred rather
than capitalized as a component of the business combination. SFAS 141R will
be applicable prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. SFAS 141R would have an
impact on accounting for any businesses acquired after the effective date
of this pronouncement.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests
in Consolidated Financial Statements - An Amendment of ARB No. 51" ("SFAS
160"). SFAS 160 establishes accounting and reporting standards for the
noncontrolling interest in a subsidiary (previously referred to as minority
interests). SFAS 160 also requires that a retained noncontrolling interest
upon the deconsolidation of a subsidiary be initially measured at its fair
value. Upon adoption of SFAS 160, the Company would be required to report
any noncontrolling interests as a separate component of stockholders'
deficit. The Company would also be required to present any net income
allocable to noncontrolling interests and net income attributable to the
stockholders of the Company separately in its condensed consolidated
statement of operations. SFAS 160 is effective for fiscal years, and
interim periods within those fiscal years, beginning on or after December
15, 2008. SFAS 160 requires retroactive adoption of the presentation and
disclosure requirements for existing minority interests. All other
requirements of SFAS 160 shall be applied prospectively. SFAS 160 would
have an impact on the presentation and disclosure of the noncontrolling
interests of any non wholly owned businesses acquired in the future.
7. 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
$144,303 and $82,012, respectively, at December 31, 2007 and $160,476 and
$87,116, respectively, at June 30, 2007. At December 31, 3007 and June 30,
2007 the Company had a reserve for slow-moving inventories of $173,313.
8. Accounts payable and accrued expenses
Accounts payable and accrued expenses consist of the following:
Pre-Petition
-----------------------------------------
December 31, June 30,
2007 2007
--------------------- -------------------
Pre-petition trade accounts payable and other accrued $4,275,784 $4,027,516
operating expenses subject to compromise
Sales and excise tax payable 54,754 54,754
Dividends payable 615,688 563,874
Compensated absences 65,856 65,856
Other liabilities 194,309 194,309
--------------------- -------------------
$5,206,391 $4,906,309
===================== ===================
|
9
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Post-Petition
--------------------------------------------
December 31, June 30,
2007 2007
--------------------- ----------------------
Post-petition trade accounts payable and other accrued operating $862,891 $ 756,977
expenses not subject to compromise
Sales and excise tax payable 78,492 13,226
Compensated absences 43,568 33,059
Other liabilities 168,094 270,474
Bonuses and commissions payable 48,074 48,074
Accrued taxes -- 161
--------------------- ----------------------
$ 1,201,119 $1,121,971
==================== ======================
|
9. Long Term Debt
Long Term debt consists of the following:
December 31, June 30
2007 2007
----------------------------------------------
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. 50,000 50,000
---------------------- ----------------------
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 89,237
---------------------- ----------------------
Total long-term Debt 1,207,987 1,207,987
Less: Current Maturities (1,207,987) (1,207,987)
---------------------- ----------------------
Long-Term Debt, Less Current Maturities $ -- $ --
====================== ======================
|
The Company's voluntary petition to reorganize under Chapter 11 of the
Bankruptcy Code has resulted in 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
10
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
10. Related party transactions
During the three months ended December 31, 2007 and 2006, the Company paid
approximately $45,000 and $52,000, respectively, for legal services to law
firms in which an employee/stockholder is affiliated.
During the six months ended December 31, 2007 and 2006, the Company paid
approximately $90,000 and $88,000, respectively, for legal services to law
firms in which an employee/stockholder is affiliated.
11. Shareholders' equity
Preferred stock
On February 1, 2007 stock dividends totaling 22,746 shares with a value of
$363,936 were paid in Series B Preferred Stock to Series B investors
representing accrued dividends through January 31, 2007.
On May 1, 2007 stock dividends totaling 1,169 shares with a value of
$70,140 were paid in Series C Preferred Stock to Series C Preferred Stock
investors representing accrued dividends through April 30, 2007.
On July 1, 2007 stock dividends totaling 23,984 shares with a value of $
359,760 were paid in Series A Preferred Stock to Series A Preferred Stock
investors representing accrued dividends through June 30, 2007.
For the six months ended December 31, 2007, there were no conversions of
Preferred Stock.
Dividends on the Series A, B and C Preferred Stock accrue at a rate of 12%,
12% and 9% per annum, respectively. Aggregate dividends accrued for the
three and six months ended December 31, 2007 were $217,115 and $481,713,
respectively. Aggregate dividends accrued for the three and six months
ended December 31, 2006 were $198,284 and $387,136.
Options
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 December 31, 2007 term in years
--------------------- ----------------------- ------------------- -------------------------- -----------------------
1998 Plan June 1998 282,500 72,500 10
2000 Plan July 2000 1,500,000 750,000 10
2001 Plan February 2001 1,750,000 1,675,000 10
2002 Plan June 2002 3,000,000 1,394,650 10
2003 Plan June 2003 2,400,000 2,153,450 10
2006 Plan April 2006 1,000,000 315,500 10
--------- ---------
9,932,500 6,361,100
========= =========
|
11
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A summary of the Company's stock options is presented below:
Weighted-Average Aggregate Intrinsic
Stock Options Exercise Price Value
--------------------------------------------------------------------------
Outstanding, July 1, 2007 6,884,700 $ 0.46 $ --
Granted -- -- --
Exercised -- -- --
Cancelled/forfeited (523,600) $ 1.60 --
--------- --------- --------
Outstanding, December 31, 2007 6,361,100 $ 0.37 $ --
========= ======== ========
Exercisable, December 31, 2007 6,025,764 $ 0.38 $ --
========= ======== ========
|
The following table summarizes information about stock options outstanding
at December 31, 2007:
Options outstanding at Options exercisable at
December 31, 2007 December 31, 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 3.65 0.16 4,877,664 0.17
$ 0.51-$ 1.00 517,100 4.63 0.99 517,100 1.00
$ 1.01-$ 1.50 552,000 0.27 1.19 552,000 1.19
$ 1.51-$ 2.00 6,500 0.81 1.88 6,500 1.88
$ 2.01-$ 12.00 72,500 1.01 5.00 72,500 5.00
--------- ---------
6,361,100 6,025,764
========= =========
|
12. Securities purchase agreement
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, $ 0.0033 par value per share at a price of $0.05
per share or 100 shares for each $95.00 of principal amount of notes sold.
On March 21, 2006 the Company issued $403,750 principal amount of senior
secured notes. The notes bear interest at the rate of 18% and provide for a
maturity date thirteen months from the closing date. As a result of this
debt financing agreement the Company issued 425,000 shares of the Company's
common stock for $21,250 with registration rights during the quarter ended
September 30, 2006.
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.
12
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
During the quarter ended March 31, 2007 the Company sold one 10% secured
subordinated promissory note in the amount of $100,000 with an 18 month
maturity date. As a result, the Company issued 200,000 shares of the
Company's common stock for $5,000.
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 May 21, 2007.
Notwithstanding the aforementioned, the default has been stayed by the
Chapter 11 bankruptcy proceeding pending the approval of a plan of
reorganization.
13. 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 two reportable business
segments: Voice Services and Managed Service Charges. These two segments
reflect management's approach to operating and directing the businesses and
align 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 provides network and security technology and a
variety of recurring managed data services.
For the Three Months Ended For the Six Months Ended
December 31, December 31,
--------------------------------- ---------------------------------
2007 2006 2007 2006
---------------- ---------------- ---------------- ----------------
Revenue
Voice services $2,017,532 2,183,082 $4,104,566 $4,776,461
Managed service charges 2,145,054 2,158,531 4,217,800 4,215,809
------------ ------------ ----------- ------------
4,162,586 4,341,613 8,322,366 8,992,270
------------ ------------ ----------- ------------
Cost of Revenue
Voice services 1,334,897 1,455,075 2,685,918 3,153,272
Managed service charges 1,421,511 1,373,157 2,716,006 2,663,289
------------ ------------ ----------- ------------
2,756,408 2,828,232 5,401,924 5,816,561
------------ ------------ ----------- ------------
Operating loss
Voice Services (25,004) (517,695) $ (157,622) $(885,563)
Managed Service Charges (26,584) (511,873) (161,970) (781,618)
------------ ------------ ----------- ------------
Total $ (51,588) $(1,029,568) $ (319,592) $(1,667,181)
============ =========== =========== ============
|
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.
13
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
14. Significant agreements
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. The minimum monthly commitment is $750,000
and expires in November 2008.
The Company made purchases from Sprint that aggregated approximately 29%
and 34% of the total cost of revenue for the six months ended December 31,
2007 and 2006, respectively. For the three months ended December 31, 2007
and 2006, the Company made purchases from Sprint that aggregated
approximately 28% and 31% of the total cost of revenue, respectively. The
Company currently has a commitment to purchase a minimum of $750,000 of
telecommunication services monthly from Sprint.
In addition, the Company made purchases from Verizon that aggregated
approximately 23% and 26% and Qwest that aggregated approximately 13% and
11% of the total cost of revenue for the six months ended December 31, 2007
and 2006, respectively. For the three months ended December 31, 2007 and
2006, the Company made purchases from Verizon of 22% and 22% and Qwest 14%
and 11%, respectively.
15. Commitments and contingencies
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:
On July 1, 2004, an agreement was entered into with the Chief Financial
Officer 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.
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 "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
14
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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, Scott Foote, 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.
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.
15
NETWOLVES CORPORATION AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The actions referenced above 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 in the discovery phase, the Company is 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.
Leases
The Company entered into a lease surrender agreement at the same time
entering into a lease assignment agreement, which commenced on October
1, 2007 and expiring on May 31, 2009. Monthly rent is approximately
$5,000 per month. On October 12, 2007, the Company vacated the
premises and successfully relocated their Tampa office.
The approximate future minimum annual lease payments, for the new
office space is summarized as follows:
Fiscal Year
Ending June 30, Amount
----------------------------------- ------------------
2008 $ 43,557
2009 58,076
---------
Total $101,633
=========
|
16. Subsequent Event
On January 17, 2008, the Company filed a First Amended Joint Plan of
Reorganization of Debtors and related Disclosure Statement with the
Bankruptcy Court.