ACCESSLINE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
Note 1 - Description of Business and Basis of Presentation
Description of Business - Accessline Holdings, Inc. and subsidiaries (the Company) is a hosted communications provider of inter-exchange (long-distance) services and, commencing in 2005, voice over internet (VoIP) services. The Company primarily serves business customers including Fortune 500 companies, medium and small sized businesses and telecommunications companies. Using the Company’s hosted enhanced features, customers are able to solve their communication needs by leveraging their existing communications systems avoiding additional capital expenditures. These enhanced features enable customers to add virtual extensions to their in-house PBX (private branch exchange) systems; integration of wire line or wireless phones with existing corporate networks and dial plans; advanced voicemail with access from both the phone and Web; conference calling; call attendant; call forwarding prioritization and screening; pager notification and PBX exchange hosting.
Principles of Consolidation - The consolidated financial statements include the accounts of Accessline Holdings, Inc. and its wholly owned subsidiaries. The only active subsidiary during 2006 and 2005 was Accessline Communications, Inc. All significant intercompany transactions have been eliminated.
Note 2 - Liquidity and Management’s Plan for Continued Existence
The Company’s consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and settlement of liabilities and commitments in the normal course of business for the foreseeable future. As shown in the accompanying financial statements, the Company incurred a $8,912,606 net loss for the year ended December 31, 2006, and as of that date had an accumulated deficit of $126,460,669. These factors could create an uncertainty about the Company’s ability to continue as a going concern.
Management’s plans for continued existence include a focus on improving earnings and operating cash flow. Based on preliminary unaudited 2007 operating results, the Company is working toward reducing operating losses. Management intends to match growth in expenses appropriate to growth in revenues so that profitability can be achieved and maintained. In addition, management will seek to extend the long term debt principal repayment obligations which are currently scheduled to begin in September 2007.
The Company’s future success is dependent upon its ability to achieve profitable operations and generate cash from operating activities, or upon continuing to obtain additional financing. There is no assurance that the Company will be able to generate sufficient cash from operations, through the sale of additional shares of stock, or from additional borrowings.
The Company’s inability to obtain additional cash could have a material adverse effect on its financial position, results of operations and its ability to continue in existence. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
ACCESSLINE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
Note 3 - Summary of Significant Accounting Policies
Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents - The Company considers all highly liquid instruments with a maturity of 90 days or less when purchased to be cash equivalents.
Accounts Receivable - Sales are made to approved customers on an open account basis, subject to established credit limits, and generally, no collateral is required. Accounts receivable are stated at the amount management expects to collect. The Company has recorded an allowance for doubtful accounts of $110,153 and $125,879 at December 31, 2006 and 2005, respectively. This allowance is based on management’s evaluation of outstanding accounts receivable at the end of each period.
Property and Equipment - Property and equipment are stated at cost and consist primarily of software and computer equipment, communications equipment, furniture and fixtures, and leasehold improvements, and are depreciated on a straight-line basis over their estimated useful lives of two to seven years, or, if applicable, the term of the related lease if shorter.
Internally Developed Software - The Company capitalizes payroll and related costs that are directly attributable to the design, coding, and testing of the Company’s software developed for internal use. The Company has capitalized $1,008,709 and $1,692,982 related to the development of internal use software in 2006 and 2005, respectively. Internally developed software costs, which are included in property and equipment, are amortized on a straight-line basis over a useful life of two years. Amortization of these costs was $1,762,668 and $1,713,050 for the years ended December 31, 2006 and 2005, respectively.
Valuation of Long-Lived Assets - The Company periodically evaluates the carrying value of its long-lived assets, including, but not limited to, property and equipment and other assets. The carrying value of a long-lived asset is considered impaired when the undiscounted net cash flow from such asset is estimated to be less than its carrying value. Management does not believe that there were any long-lived assets subject to impairment at December 31, 2006 and 2005.
Restricted Cash - Restricted cash of $120,000 and $265,000 at December 31, 2006 and 2005, respectively, consists of certificates of deposit held as collateral in favor of certain creditors.
Preferred Stock - SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that a Company classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. The financial instruments affected include mandatorily redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets, and certain obligations that can be settled with shares of stock. SFAS No. 150 was effective for all mandatorily redeemable financial instruments with both a fixed redemption date and amount beginning in the year ended December 2005. Accordingly outstanding shares of non-convertible Series A mandatorily redeemable preferred stock are included as a liability in the consolidated balance sheet. Outstanding shares of Series B, Series C and Series D preferred stock are presented as mezzanine equity as their conversion features preclude them from classification as a liability under SFAS No. 150.
Revenue Recognition - Revenues principally consist of: (1) monthly fees from communication services, which include mobility services, PBX enhancements, single number services and unified messaging, voice messaging, and paging; (2) activation fees for new customers; and (3) fees from usage including conference calling and long distance. Monthly fees for communications services and usage are recognized when the service is provided. Commencing with the year ended December 31, 2006, the Company recognizes activation fee revenue at inception for new customers. During 2005, activation fees were deferred and recognized over a 12-month period.
Research and Development Expense - Research and development costs are expensed as incurred.
Income Taxes - The Company records income taxes under Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, under which deferred tax assets, including net operating losses, and liabilities are determined based on temporary differences between the book and tax bases of assets and liabilities. The Company provides a valuation allowance for deferred tax assets that cannot be currently recognized due to the Company’s losses and the uncertainty of future profitability.
ACCESSLINE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
Note 3 - Summary of Significant Accounting Policies (Continued)
Stock-Based Compensation - The Company has a stock-based compensation plan, as described more fully in Note 10. Prior to January 1, 2006, the Company accounted for this plan using the intrinsic value method set forth in Accounting Principles Board Opinion No. 25 (APB No. 25), Accounting for Stock Issued to Employees, and related interpretations, as permitted by Statement of Financial Accounting Standard No. 123 (SFAS No. 123), Accounting for Stock-Based Compensation. No stock-based employee compensation cost was recognized in the statement of operations for the year ended December 31, 2005, as all options granted under the plan at that date had an exercise price equal to the estimated fair value at the grant date. Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (Revised 2004) (SFAS No. 123(R)), Share-Based Payments, using the prospective transition method. Under this transition method, compensation expense recognized for the year ended December 31, 2006 includes only compensation expense for all share-based payments granted subsequent to January 1, 2006 based on the estimated fair value at the grant date in accordance with the provisions of SFAS No. 123(R). All share-based compensation granted prior to January 1, 2006 was previously valued using the minimum-value method and therefore is not included in the share-based compensation expense under the prospective method. For share-based compensation granted subsequent to January 1, 2006, compensation expense, based on the estimated fair value at the grant date, is recognized on a straight-line basis over the vesting period.
Advertising - The Company expenses advertising costs when incurred. Advertising expense during 2006 and 2005 was $1,038,590 and $1,118,406, respectively.
Concentration of Credit Risk - Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and accounts receivable. At times, cash balances exceed federally insured limits. However, cash is held on deposit in major financial institutions and is considered subject to minimum credit risk.
At December 31, 2006 and 2005, one and two customers accounted for approximately 32% and 41% of accounts receivable, respectively. During 2006, one customer accounted for 20% of total revenue. During 2005, two customers accounted for 29% of total revenue.
Fair Values of Financial Instruments - The Company has financial instruments, such as cash and cash equivalents and accounts receivable. The carrying amounts of financial instruments approximate fair value because of the short-term maturity of these instruments.
Certain Significant Risks - The Company operates in a dynamic, high-technology industry and believes that any of the following could have a material effect on the Company’s future financial position or results of operations: changes in the overall demand for the Company’s services; changes in the technology underlying the Company’s services; increased competition; litigation against the Company based on intellectual property, securities, or other claims; compliance with regulatory requirements; availability of necessary components; and the Company’s ability to implement and improve its operational and financial systems and attract and retain employees necessary to support its operations.
Note 4 - Property and Equipment
Property and equipment consists of the following at December 31:
| | | | | | | | Estimated |
| | | 2006 | | | 2005 | | Useful Life |
| Communications equipment | | $ | 16,447,945 | | | $ | 11,486,664 | | 2-5 years |
| Capitalized software | | | | | | | | | |
| development costs | | | 6,043,346 | | | | 9,902,153 | | 2 years |
| Software and computer equipment | | | 2,892,947 | | | | 6,747,301 | | 3-5 years |
| Furniture and fixtures | | | 315,505 | | | | 733,474 | | 5-7 years |
| Leasehold improvements | | | 238,339 | | | | 439,892 | | Life of lease |
| | | | 25,938,082 | | | | 29,309,484 | | |
| Accumulated depreciation | | | (20,903,264 | ) | | | (23,783,544 | ) | |
| | | | | | | | | | |
| | | $ | 5,034,818 | | | $ | 5,525,940 | | |
As of December 31, 2006 and 2005, property and equipment with a cost of $4,240,730 and $2,789,851, respectively, was financed through outstanding capital lease obligations. As of December 31, 2006 and 2005, accumulated amortization for these assets was $1,506,201 and $761,492, respectively.
ACCESSLINE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
Note 5 - Other Assets
Other assets consist of the following at December 31:
| | | 2006 | | | 2005 |
| | | | | | |
| Deferred legal fees | | $ | - | | | $ | 101,474 |
| Deposits | | | 162,100 | | | | 124,535 |
| | | | | | | | |
| | | $ | 162,100 | | | $ | 226,009 |
| | | | | | | | |
Note 6 - Stockholders’ Deficit
In March 2005, the articles of incorporation were amended to increase the number of authorized shares of common stock to 661,000,000 and increase the number of authorized shares of preferred stock to 520,500,000, of which 4,500,000 are designated as Series A preferred stock, 30,500,000 are designated as Series B preferred stock, 26,000,000 are designated as Series C preferred stock, 8,500,000 are designated as Series C-2 preferred stock, and 451,000,000 are designated as Series D preferred stock.
Note 7 - Preferred Stock
Mandatorily Redeemable Preferred Stock - The Company has issued four series of mandatorily redeemable preferred stock (Series A, Series B, Series C and Series D). Information related to these issuances is as follows as of December 31:
| | | | | | | Annual | | | | | | | | |
| | | | | Par | | Dividend | | Shares Issued | | Aggregate Liquidation Value |
Series | | Date | | Value | | (Per Share) | | 2006 | | 2005 | | 2006 | | 2005 |
| A | | September 1998 | | $ 0.001 | | $ 0.0800 | | 4,345,368 | | 4,345,368 | | $ 7,178,750 | | $ 6,831,358 |
| B | | June 1999 | | $ 0.001 | | $ 0.0274 | | 13,138,690 | | 13,138,690 | | 7,208,502 | | 6,848,748 |
| C | | May and June 2000 | | $ 0.001 | | $ 0.1984 | | 11,088,715 | | 11,088,715 | | 42,008,419 | | 39,809,924 |
| D | | April 2002, January 2003, April 2005 | | $ 0.001 | | $ 0.0154 | | 162,467,203 | | 162,467,203 | | 49,227,456 | | 46,727,204 |
| | | | | | | | | 191,039,976 | | 191,039,976 | | $ 105,623,127 | | $ 100,217,234 |
During 2005, the Company issued 1,965 shares of Series D preferred stock to settle a portion of the outstanding convertible notes payable.
Conversion - Each share of Series B, Series C, Series C-2, and Series D preferred stock is convertible at the option of the holder into common stock at any time. The conversion of preferred stock is determined by dividing the original purchase price of $0.3425, $2.48, $0.15446 and $0.15446 for the Series B, Series C, Series C-2 and Series D preferred stock, respectively, by its then conversion price. The original conversion price will be adjusted for failure by the Company to make mandatory redemptions. Unpaid cumulative dividends will be paid in cash for converted shares. Under the terms of the Amended and Restated Certificate of Incorporation, the Series B, Series C, Series C-2 and Series D preferred stock shall be automatically converted into shares of common stock upon the closing of a public offering at a price per share of not less than $0.46338 per share and a net offering price to the Company of not less than $30,000,000. Series A preferred stock does not include conversion features.
ACCESSLINE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
Note 7 - Preferred Stock (Continued)
Dividends - Series A, Series B, Series C, Series C-2 and Series D preferred stock accrue cumulative dividends from their date of issuance at the rate of $0.08 per share per annum for Series A, $0.0274 per share per annum for Series B, $0.1984 per share per annum for Series C, $0.0274 per share per annum for Series C-2 and $0.0154 per share per annum for Series D. Holders of Series D preferred stock shall be entitled to receive dividends in preference to the payment of any dividend on any other Series of preferred stock or common stock. Holders of Series B, Series C and Series C-2 preferred stock shall be entitled to receive dividends in preference to the payment of any dividend on Series A preferred stock or common stock.
Redemption - Series D preferred stock is to be redeemed at a $0.15446 price per share plus all accrued and unpaid dividends on June 23, 2008.
Subject to the prior redemption of all of the Series D preferred stock, the Series B, Series C and Series C-2 preferred stock is to be redeemed at a price per share equal to $0.3425, $2.48 and $0.15446, respectively, plus all accrued and unpaid dividends pursuant to the following schedule:
| | | % of Outstanding |
Date of Redemption | | Shares to Be Redeemed |
| June 23, 2008 | | 33-1/3% |
| June 23, 2009 | | 50% |
| June 23, 2010 | | 100% |
Series A preferred stock shall be redeemed on October 21, 2010, at the price of $1 per share, plus accrued and unpaid dividends, subject to the prior redemption of all Series B, Series C, Series C-2 and Series D preferred stock.
Should the Company fail to redeem the Series B, Series C, Series C-2 and Series D preferred stock, a liquidation event shall have been deemed to occur unless waived. If waived, the holders of shares otherwise to be redeemed shall share ratably in any funds legally available for redemption of such shares, and the remaining shares will be outstanding and entitled to all rights until additional money is available and then shares will be redeemed on a prorated basis.
The difference between the initial carrying value at issuance and the redemption price for Series A, Series B, Series C and Series D preferred stock is accreted each period using the straight-line method, which approximates the amount determined using the effective interest rate method.
Liquidation - In the event of a voluntary or involuntary liquidation, dissolution, or winding up of the Company, the holders of Series D preferred stock will be entitled to be paid out of the assets of the Company available for distribution in preference to other classes of preferred stock and common stock in such amounts that entitle the holder to $0.23169 per share, plus all unpaid cumulative dividends. After full payment to the holders of the Series D preferred stock, the holders of the Series B, Series C and Series C-2 preferred stock will be entitled to be paid out of the assets of the Company available for distribution in preference to Series A and common stock in such amounts that entitle the holder to the greater of $0.3425, $2.48 and $0.30892 per share, respectively, plus all unpaid cumulative dividends or an amount that would have been received had the Series B, Series C and Series C-2 preferred stock been converted to common stock prior to liquidation. Series A preferred stockholders would then receive $1 per share, plus all unpaid cumulative dividends. After payment to the Series A preferred stockholders, if any assets remain available for distribution, the Series D preferred stockholders and the common stockholders are entitled to payment on a pro-rata basis.
ACCESSLINE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
Note 7 - Preferred Stock (Continued)
Voting - Holders of Series A preferred stock do not have voting privileges. Each share of Series B, Series C, Series C-2 and Series D preferred stock have voting rights and powers equivalent to each full share of common stock into which shares of preferred stock would be convertible on the record date for the vote.
Preferred Stock Warrants - As of December 31, 2006, the Company has the following warrants to purchase stock outstanding:
| | | | | | | | | | | Estimated | | |
| | | | | Number | | | Exercise | | | Fair Value | | |
Class | Series | Date | | of Shares | | | Price | | | at Issuance | | Expiration |
| Preferred | D | 3/3/2003 | | | 19,422,503 | | | $ | 0.15446 | | | $ | 1,967,803 | | 3/4/2008 |
| Preferred | D | 12/19/2003 | | | 4,974,978 | | | $ | 0.15446 | | | $ | 505,538 | | 12/20/2008 |
| Preferred | D | 5/7/2004 | | | 3,315,420 | | | $ | 0.15446 | | | $ | 339,935 | | 5/8/2009 |
| Preferred | D | 7/7/2004 | | | 3,363,102 | | | $ | 0.15446 | | | $ | 345,389 | | 7/8/2009 |
| Preferred | D | 9/17/2004 | | | 3,496,051 | | | $ | 0.15446 | | | $ | 402,971 | | 9/18/2011 |
| Preferred | D | 3/18/2005 | | | 98,483,757 | | | $ | 0.15446 | | | $ | 2,732,826 | | 3/19/2010 |
| Preferred | D | 9/15/2005 | | | 1,942,250 | | | $ | 0.15446 | | | $ | 223,873 | | 9/16/2012 |
| Preferred | D | 7/28/2006 | | | 3,884,501 | | | $ | 0.15446 | | | $ | 447,746 | | 7/29/2013 |
Note 8 - Borrowing Arrangements
Orix Venture Finance, LLC Financing - During September 2004, the Company executed a $6,000,000 term debt arrangement with Orix Venture Finance, LLC. This agreement requires monthly interest only payments through October 2006, with interest charged at Prime + 3% or 8%, whichever is greater. Commencing October 2006, principal is due in 30 monthly installments of $200,000, plus accrued interest. The agreement is subject to certain financial covenants and is collateralized by substantially all assets of the Company.
During September 2004, the Company issued warrants in conjunction with this financing arrangement. The warrants were for the purchase of up to 3,496,051 shares of Series D preferred stock at an exercise price of $0.15446 per share. These warrants are exercisable immediately upon grant and expire in September 2011. The warrants automatically convert into common stock warrants upon an initial public offering. In accordance with SFAS No. 123, the fair value of the warrants is estimated on the grant date using a pricing model assuming the following assumptions: risk-free interest rate of 3.725%, volatility of 80%, dividends of $-0-, and an expected life of seven years. The value of these warrants, $402,971, is recognized as interest expense over the term of the agreement. The unamortized balance of the warrants has been reflected as a discount against the long-term debt as of December 31, 2005.
During September 2005, the Company issued additional warrants in conjunction with this financing arrangement. The warrants were for the purchase of up to 1,942,250 shares of Series D preferred stock at an exercise price of $0.15446 per share. These warrants are exercisable immediately upon grant and expire in September 2012. The warrants automatically convert into common stock warrants upon an initial public offering. In accordance with SFAS No. 123, the fair value of the warrants is estimated on the grant date using a pricing model assuming the following assumptions: risk-free interest rate of 3.725%, volatility of 80%, dividends of $-0-, and an expected life of seven years. The value of these warrants, $223,873, is recognized as interest expense over the term of the agreement. The unamortized balance of the warrants has been reflected as a discount against the long-term debt as of December 31, 2005.
As discussed below, during July 2006 the Orix Venture Finance LLC long term debt was refinanced in full by RAM Opportunity Fund I, LLC. Upon execution of the refinance, all deferred loan fees and unamortized warrant value were fully expensed.
ACCESSLINE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
Note 8 - Borrowing Arrangements (Continued)
RAM Opportunity Fund I, LLC Financing - During July 2006, the Company executed an $8,000,000 term debt arrangement with RAM Opportunity Fund I, LLC. Approximately $6,115,000 of this financing was used to repay the Company’s note payable to Orix Venture Finance, LLC, and to remove that bank’s security interest in the Company. This agreement requires monthly interest only payments through August 2007, with interest charged at 12.13%. Commencing September 2007, principal and interest are due in 30 monthly installments of $310,476. The agreement is collateralized by substantially all assets of the Company.
During July 2006, the Company issued warrants in conjunction with this financing arrangement. The warrants were for the purchase of up to 3,884,501 shares of Series D preferred stock at an exercise price of $0.15446 per share. These warrants are exercisable immediately upon grant and expire in July 2013. The warrants automatically convert into common stock warrants upon an initial public offering. In accordance with SFAS No. 123(R), the fair value of the warrants is estimated on the grant date using a pricing model assuming the following assumptions: risk-free interest rate of 3.725%, volatility of 80%, dividends of $-0-, and an expected life of seven years. The value of these warrants, $447,746, is recognized as interest expense over the term of the agreement. The unamortized balance of the warrants has been reflected as a discount against the long-term debt as of December 31, 2006.
The agreement also contains a Success Fee Agreement. The Success Fee Agreement stipulates that with the occurrence of a “Change in Control” event, as defined in the agreement, the Company is to pay RAM Opportunity Fund I, LLC a one time contingent fee of $1,000,000.
Maturities of principal under this agreement are as follows for the years ending December 31:
| 2007 | | $ | 932,456 |
| 2008 | | | 3,033,385 |
| 2009 | | | 3,422,497 |
| 2010 | | | 611,662 |
| | | $ | 8,000,000 |
In December 2006, RAM Opportunity Fund I, LLC transferred all its rights and interests in the financing agreement to BlueCrest Venture Finance Master Fund Limited.
Convertible Notes Payable and Warrants - During 2003, the Company authorized $8,000,000 in convertible notes payable with interest at 8%, of which $6,280,725 were sold to a number of the Company’s major investors. During 2004, the Company sold the remaining $1,719,275 of authorized notes.
During March 2005, the Company rolled the previously $8,000,000 in outstanding convertible notes payable into a new agreement. During this transaction, holders of $169,534 of previously outstanding convertible notes payable elected to receive a cash settlement of their notes payable, rather then roll their notes payable into the new agreement. As part of the new agreement, the Company authorized $9,000,000 in additional convertible notes payable with simple interest at 8%, all of which were sold to its major investors. Unless the notes are previously converted to Series D preferred stock at the option of the note holders, all principal and accrued interest on the notes shall automatically convert into shares of Series D preferred stock on December 31, 2006 at a conversion price of $0.15446 per share. During August 2006, the maturity date of the convertible notes payable was extended to December 31, 2007.
The outstanding convertible notes payable are subordinated to the RAM Opportunity Fund I, LLC financing. In addition, in the event of a liquidation event prior to the maturity date, the convertible note holders shall receive in cancellation and repayment of the notes all outstanding principal and accrued interest together with an amount equal to 75% of the outstanding principal amount of the convertible notes payable.
As of December 31, 2006 and 2005, a total of 129,559,760 of Series D preferred stock warrants have been issued in conjunction with the convertible notes payable financing. The value of these warrants has been recognized as interest expense over the original term of the notes. The remaining warrant balance as of December 31, 2005 is reflected as a discount against convertible notes payable. As of December 31, 2006, the entire value of the warrants has been amortized to interest expense, accordingly there is no discount recorded.
ACCESSLINE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
Note 9 - Income Taxes
The tax effects of temporary differences and net operating loss carryforwards that gave rise to the Company’s deferred tax assets and liabilities at December 31 are as follows:
| | | 2006 | | | 2005 | |
| Nondeductible reserves, accruals, and deferrals | | $ | 282,779 | | | $ | 124,024 | |
| Federal and state net operating loss carryforwards | | | 51,651,634 | | | | 48,728,167 | |
| Federal tax credit carryforwards | | | 505,246 | | | | 505,246 | |
| Deferred tax assets | | | 52,439,659 | | | | 49,357,437 | |
| Less valuation allowance | | | (52,439,659 | ) | | | (49,357,437 | ) |
| | | $ | - | | | $ | - | |
At December 31, 2006, the Company has U.S. net operating loss carryforwards of approximately $146,850,000 and tax credit carryforwards of $505,246, which expire in varying amounts during the years 2007 through 2026. The future utilization of net operating loss carryforwards may be limited due to changes in ownership. Due to the uncertainty of future taxable income as of December 31, 2006 and 2005, a valuation allowance for the full amount of the deferred tax asset has been recorded.
A reconciliation of net loss at the federal statutory rate to actual tax expense at December 31 is as follows:
| | | 2006 | | | 2005 | |
| Federal tax at statutory rate | | | (35.0 | %) | | | (35.0 | %) |
| Change in valuation allowance | | | 35.0 | | | | 35.0 | |
| | | | - | % | | | - | % |
Note 10 - Stock-Based Compensation
Stock Option Plan - In May 1999, the Company adopted a stock option plan (the Plan) which provides for the issuance of incentive and nonqualified common stock options to employees and directors of the Company. As of December 31, 2006 and 2005, the Board of Directors has reserved 94,200,000 shares of common stock to be issued in conjunction with the Plan.
Stock options are granted at exercise prices and vesting schedules determined by the Board of Directors. All options granted to employees have been approved by the Board of Directors, generally with four-year vesting schedules and options exercisable 25% each year on the anniversary of the grant. Stock options expire ten years after the date of grant.
ACCESSLINE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
Note 10 - Stock-Based Compensation (Continued)
The Plan provides for accelerated exercise of options prior to vesting for its officers, Board of Directors, and Advisory Board members. The Company has the right to repurchase unvested shares.
The following summary sets forth the activity under the plan for the years ended December 31, 2006 and 2005:
| | | | Weighted | | |
| | | | Average | | |
| | Number | | Exercise | | Options |
| | of Shares | | Price | | Exercisable |
| | | | | | |
| Balance, December 31, 2004 | | 52,874,482 | | $ | 0.02 | | 18,503,579 |
| Options granted | | 33,606,274 | | $ | 0.02 | | |
| Options exercised | | (34,154 | ) | $ | 0.02 | | |
| Options forfeited | | (5,358,745 | ) | $ | 0.02 | | |
| | | | | | | | |
| Balance, December 31, 2005 | | 81,087,857 | | $ | 0.02 | | 31,356,686 |
| Options granted | | 4,025,000 | | $ | 0.02 | | |
| Options exercised | | (37,485 | ) | $ | 0.02 | | |
| Options forfeited | | (3,638,962 | ) | $ | 0.02 | | |
| | | | | | | | |
| Balance, December 31, 2006 | | 81,436,410 | | $ | 0.02 | | 53,706,980 |
The following table summarizes information about stock options outstanding and exercisable at December 31, 2006:
| | | | | | | Weighted | | | |
| | | | | | | Average | | | |
| | | | | | | Remaining | | | |
Exercise | | | Number | | | Contractual | | | Options |
Price | | | Outstanding | | | Life (In Years) | | | Exercisable |
| | | | | | | | | | |
| $ | 0.02 | | | | 79,093,835 | | | | 7.33 | | | | 51,364,405 |
| $ | 0.04 | | | | 1,425,736 | | | | 2.57 | | | | 1,425,736 |
| $ | 0.05 | | | | 5,950 | | | | 4.91 | | | | 5,950 |
| $ | 0.15 | | | | 671,809 | | | | 2.07 | | | | 671,809 |
| $ | 0.25 | | | | 170,618 | | | | 3.23 | | | | 170,618 |
| $ | 0.83 | | | | 68,462 | | | | 4.06 | | | | 68,462 |
| | | | | | | | | | | | | | |
| | | | | | 81,436,410 | | | | | | �� | | 53,706,980 |
ACCESSLINE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
Note 10 - Stock-Based Compensation (Continued)
The Company estimates the value of its stock options using the calculated value on the grant date, based on the Black-Scholes option pricing model. In determining the estimated fair value of stock options granted, the following key assumptions were used during the years ended December 31:
| | | 2006 | | | 2005 | |
| Expected dividend yield | | | 0 | % | | | 0 | % |
| Expected volatility | | | 65 | % | | | 0 | % |
| Risk-free interest rate | | | 4.75 | % | | | 4 | % |
| Expected life | | 7 years | | | 10 years | |
The Company has not declared any dividends and does not expect to do so in the near future. The risk-free interest rate used in the Black-Scholes valuation method is based on the implied yield currently available in US Treasury securities for maturities with an approximately equivalent term. The expected volatility for options issued subsequent to January 1, 2006 was based on the annualized historical volatility for comparable companies within the Company’s industry. Stock options issued to employees prior to January 1, 2006, were valued using the minimum-value method with a volatility measurement of 0.0%. The expected term of options represents the period that the Company’s stock-based awards are expected to be outstanding and was determined using the short-cut method as defined by SFAS No. 123(R).
Note 11 - Commitments and Contingencies
Lease Commitments - The Company has noncancelable operating and capital leases for corporate facilities and equipment. The leases expire through November 2011 and include certain renewal options. Rent expense under the operating leases totaled $727,488 and $697,273 for the years ended December 31, 2006 and 2005, respectively. Rent expense is provided on a straight-line basis, with any resulting deferral being included in long-term obligations in the consolidated balance sheets.
Future minimum rental payments required under noncancelable operating and capital leases are as follows for the years ending December 31:
| | | Operating | | | Capital |
| | | Leases | | | Leases |
| | | | | | |
| 2007 | | $ | 993,300 | | | $ | 1,293,295 |
| 2008 | | | - | | | | 773,804 |
| 2009 | | | - | | | | 447,351 |
| 2010 | | | - | | | | 132,497 |
| 2011 | | | - | | | | 46,730 |
| | | | | | | | |
| Total minimum lease payments | | $ | 993,300 | | | | 2,693,677 |
| Less amount representing interest | | | | | | | 443,686 |
| Present value of minimum lease payments | | | | | | | 2,249,991 |
| Less current portion | | | | | | | 1,047,047 |
| | | | | | | | |
| | | | | | | $ | 1,202,944 |
ACCESSLINE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
Note 11 - Commitments and Contingencies (Continued)
AudioFAX Settlement - During 2003, the Company received a letter from Intellectual Property Asset Corporate (IPAC), an intellectual property management company, regarding patents issued to their client, AudioFAX, suggesting that a license may be appropriate. The AudioFAX patents relate primarily to fax services. The Company and IPAC negotiated a one-time fully paid license for $1,025,000, which was finalized and executed in September 2004. The present value of the settlement payments of $400,000 and $679,112 is included in other accrued liabilities as of December 31, 2006 and 2005, respectively. The final accrued payment of $400,000 is payable in the first reporting period in which the Company achieves $30,000,000 in revenue.
Incentive Plan - The Company has entered into an incentive plan agreement with key members of management. Under the terms of the Plan, upon the occurrence of a qualifying change in control as defined in the Plan agreement, select members of senior management may be entitled to compensation based on a percentage of the acquisition price. The Company has not recognized any expense for this Plan during the years ended December 31, 2006 and 2005.
Legal Contingency - The Company is party to several legal claims encountered in the normal course of business. Management evaluates all such notices and believes such claims will not have a material adverse effect on the Company’s financial position and results of operations.
Note 12 - Savings Plan
A salary deferral 401(k) savings plan (the savings plan) was put into place in January 1994. All employees are eligible to participate in the savings plan after six months of employment. The savings plan does not provide for employer contributions.
