EXHIBIT 99.1
GLOWPOINT, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
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Report of Independent Registered Public Accounting Firm........................................ 2
Consolidated Balance Sheet as of December 31, 2004............................................. 3
Consolidated Statement of Operations for the year ended December 31, 2004...................... 4
Consolidated Statement of Stockholders' Equity for the year ended December 31, 2004............ 5
Consolidated Statement of Cash Flows for the year ended December 31, 2004...................... 6
Notes to Consolidated Financial Statements..................................................... 7
1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and the
Stockholders of Glowpoint, Inc.
We have audited the accompanying consolidated balance sheet of Glowpoint, Inc.
and subsidiaries (the "Company") as of December 31, 2004 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit 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. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Glowpoint, Inc. as
of December 31, 2004 and the consolidated results of its operations and its
consolidated cash flows for the year then ended in conformity with accounting
principles generally accepted in the United States of America.
As described in Note 3, the financial statements as of December 31, 2004 and for
the year then ended, which were previously audited by the predecessor auditors,
have been restated.
Eisner LLP
New York, New York
March 15, 2006
2
GLOWPOINT, INC.
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2004
(IN THOUSANDS, EXCEPT PAR VALUE)
(RESTATED-NOTE 3)
ASSETS
Current assets:
Cash and cash equivalents .................................................... $ 4,497
Escrowed cash ................................................................ 337
Accounts receivable, net of allowance for doubtful accounts of $305 .......... 1,872
Receivable from Gores Technology Group ....................................... 2,371
Prepaid expenses and other current assets .................................... 554
---------
Total current assets ....................................................... 9,631
Property and equipment-net ................................................... 5,103
Other assets ................................................................. 258
---------
Total assets ............................................................. $ 14,992
=========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................. $ 2,984
Accrued expenses ............................................................. 2,421
Derivative financial instrument .............................................. 367
Deferred revenue ............................................................. 265
Capital lease obligations .................................................... 35
---------
Total current liabilities .................................................. 6,072
Derivative financial instrument, less current portion ........................... 932
---------
Total liabilities .......................................................... 7,004
Preferred stock, $.0001 par value; 5,000 shares authorized, 0.203667 Series
B shares issued (stated value of $4,888;liquidation value of $5,257;
cumulative 8% dividends increasing to 12% in July 2005) ...................... 4,888
Commitments and contingencies (Note 12)
Stockholders' equity:
Common stock, $.0001 par value; 100,000 authorized; 37,855 shares issued;
37,815 shares outstanding .................................................. 4
Additional paid-in capital ................................................... 148,879
Accumulated deficit .......................................................... (144,367)
Deferred compensation ........................................................ (1,176)
---------
3,340
Less: Treasury Stock, 40 shares at cost .................................... (240)
---------
Total stockholders' equity ................................................. 3,100
---------
Total liabilities and stockholders' equity ............................... $ 14,992
=========
See accompanying notes to consolidated financial statements.
3
GLOWPOINT, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 2004
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(RESTATED-NOTE 3)
Revenue ......................................................... $ 15,867
Cost of revenue ................................................. 16,019
--------
Gross margin (loss) ............................................. (152)
--------
Operating expenses
Research and development ..................................... 1,078
Sales and marketing .......................................... 3,265
General and administrative ................................... 11,774
--------
Total operating expenses ........................................ 16,117
--------
Loss from operations ............................................ (16,269)
--------
Other (income) expense
Amortization of deferred financing costs ..................... 448
Interest income .............................................. (92)
Interest expense ............................................. 63
Gain on marketable equity securities ......................... (132)
Other income ................................................. (5,000)
Amortization of discount on subordinated debentures .......... 2,650
Increase in derivative financial instrument .................. 134
Loss on exchange of debt ..................................... 743
--------
Total other (income) expense, net ............................... (1,186)
--------
Net loss ........................................................ (15,083)
Preferred stock dividends ....................................... (369)
--------
Net loss attributable to common stockholders .................... $(15,452)
========
Net loss attributable to common stockholders per share:
Basic and diluted ............................................ $ (.42)
========
Weighted average number of common shares outstanding:
Basic and diluted ............................................ 36,362
========
See accompanying notes to consolidated financial statements.
4
GLOWPOINT, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
DECEMBER 31,2004
(IN THOUSANDS)
(RESTATED-NOTE 3)
COMMON STOCK ADDITIONAL
----------------- PAID-IN ACCUMULATED COMPREHENSIVE DEFERRED TREASURY
SHARES AMOUNT CAPITAL DEFICIT INCOME (LOSS) COMPENSATION STOCK TOTAL
-------- ------ ----------- ------------ ------------- ------------ -------- -------
Balance at January 1, 2004 30,515 $ 3 $ 135,730 $ (128,915) $ 78 $ (1,498) $ (240) $ 5,158
Net loss (15,083) (15,083)
Reversal of unrealized loss
upon sale of marketable
securities (78) (78)
-------
Comprehensive loss (15,161)
-------
Deferred compensation related
to the issuance of restricted
stock 190 511 (511) --
Amortization of deferred
compensation 699 699
Forfeiture of restricted stock (40) (134) 134 --
Modification of stock options
resulting in compensation 67 67
Issuance of stock options for
consulting services 32 32
Exercise of stock options 782 570 570
Exchange of subordinated
debentures for preferred
stock, common stock and
modification of warrants 250 743 743
Issuance of common stock and
warrants in connection with
private placement 6,100 1 11,315 11,316
Issuance of shares in lieu of
interest on subordinated
debentures 18 45 45
Preferred stock dividends (369) (369)
------ -------- ---------- ---------- -------- --------- ------ -------
Balance at December 31, 2004 37,815 $ 4 $ 148,879 $ (144,367) $ - $ (1,176) $ (240) $ 3,100
====== ======== ========== ========== ======== ========= ====== =======
See accompanying notes to consolidated financial statements.
5
GLOWPOINT, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2004
(IN THOUSANDS)
(RESTATED-NOTE 3)
Cash flows from operating activities:
Net loss ................................................................. $(15,083)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization .......................................... 2,236
Amortization of deferred financing costs ............................... 448
Amortization of discount on subordinated debentures .................... 2,650
Equity-based compensation .............................................. 798
Common stock issued for interest on subordinated debentures ............ 45
Loss on exchange of debt ............................................... 743
Other expense recognized for the increase in the estimated fair
value of the derivative liability .................................... 134
Other .................................................................. (78)
Increase (decrease) in cash attributable to changes in assets and
liabilities, net of effects of acquisitions:
Escrowed cash ........................................................ (2)
Accounts receivable .................................................. 496
Receivable from Gores Technology Group ............................... (5,539)
Prepaid expenses and other current assets ............................ 415
Other assets ......................................................... (193)
Accounts payable ..................................................... 616
Accrued expenses ..................................................... 756
Accrued equity-based compensation .................................... 82
Deferred revenue ..................................................... 46
--------
Net cash used in operating activities .............................. (11,430)
--------
Cash flows from investing activities:
Purchases of furniture, equipment and leasehold improvements ............. (1,097)
--------
Net cash used in investing activities .............................. (1,097)
--------
Cash flows from financing activities:
Proceeds from issuance of common stock and warrants ...................... 11,316
Proceeds attributed to derivative financial instrument ................... 1,164
Exercise of stock options ................................................ 570
Payments on capital lease obligations .................................... (131)
--------
Net cash provided by financing activities .......................... 12,919
--------
Increase in cash and cash equivalents ...................................... 392
Cash and cash equivalents at beginning of year .............................. 4,105
--------
Cash and cash equivalents at end of year .................................... $ 4,497
========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest ................................................................. $
Noncash investing and financing activities:
Deferred compensation and additional paid-in capital recorded for the
issuance of restricted common stock ...................................... $ 511
Reduction in deferred compensation and additional paid-in capital for
the forfeiture of restricted common stock ................................ 134
Issuance of Series B convertible preferred stock in exchange for
convertible debentures ................................................... 4,888
Dividends on Series B preferred stock ....................................... 369
See accompanying notes to consolidated financial statement
6
NOTE 1--THE BUSINESS
Glowpoint provides comprehensive video communications services. Prior to
2004, Glowpoint, then known as Wire One Technologies, Inc., sold its video
solutions (VS) equipment sales business to Gores Technology Group ("Gores") and
accordingly, the accompanying financial statements do not include such
operations (see Note 4). Our services include IP-based and ISDN-based
videoconferencing services, which are provided principally on a subscription
basis, and managed bridging conferencing services for multi-point video and
audio communications among three or more participants. We also provide IP-based
broadcasting and event services.
On April 20, 2004, we entered into an agreement with Tandberg, Inc., a
wholly owned subsidiary of Tandberg ASA (OSLO: TAA.OL), a global provider of
visual communications solutions. As part of the agreement, we acquired for $1.00
certain assets and the customer base of Tandberg owned Network Systems LLC.
Network Systems customers, primarily ISDN-based video users, obtained immediate
access to our video bridging and webcasting services. As part of the agreement,
Tandberg's corporate use of IP video communications and other telecommunications
services, formerly purchased through Network Systems, is being provided
exclusively by us under a multi-year agreement. In addition, we assumed
contractual commitments with AT&T, MCI and Sprint from Network Systems, which
were subsequently consolidated into new agreements with these carriers. For
accounting purposes, such commitments did not result in any additional asset or
liability recognition. Tandberg named the GlowPoint Certified Program as a
recognized external testing partner for its hardware and software products. The
transaction was accounted for following purchase accounting under Statement of
Financial Accounting Standards ("SFAS") No. 141, "Business Combinations". The
fair value of tangible assets acquired and liabilities assumed were nominal.
Accordingly, we did not record any value of intangible assets acquired. Results
of operations of the acquired business are included in the accompanying
financial statements from April 20, 2004, the date of acquisition. The following
proforma information gives effect to the acquisition as if it had occurred on
January 1, 2004.
($ in thousands, except per share amounts)
Total revenue $ 16, 798
Gross profit $ 37
Net loss $ (14,803)
Net loss per share, basic and diluted $ (0.42)
Our consolidated financial statements have been prepared assuming that we
will continue as a going concern. We incurred a loss from operations of $16.3
million and experienced negative cash flows from operating activities of $11.4
million for the year ended December 31, 2004. At December 31, 2004, we had cash
and cash equivalents of $4.5 million, working capital of $3.6 million and an
accumulated deficit of approximately $144.4 million. We raised capital in 2005,
but continue to sustain losses and negative operating cash flows. In 2006 we
commenced a restructuring of the current business (see Note 18) and are working
on raising capital to fund such operations. However, there are no assurances
that additional capital will be obtained. We believe that our available capital
as of December 31, 2004 along with our operating activities will enable us to
continue as a going concern through December 31, 2005.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Glowpoint
and our wholly owned subsidiaries, AllComm Products Corporation ("APC"), and VTC
Resources, Inc. ("VTC"). All material inter-company balances and transactions
have been eliminated in consolidation.
7
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Use of Estimates
Preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities 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 amounts could differ
from the estimates made. We periodically evaluate estimates used in the
preparation of the financial statements for continued reasonableness.
Appropriate adjustments, if any, to the estimates used are made prospectively
based upon such periodic evaluation. The significant areas of estimation include
determining the allowance for bad debts, accrued sales tax, the estimated life
of customer relationships, the estimated lives of property and equipment and the
fair value of derivative financial instruments.
Changes to our allowance for bad debts during the year ended December
31, 2004 are summarized as follows:
Balance at beginning of year........................... $ 190,000
Charged to expense..................................... 412,000
Deductions............................................. (297,000)
---------
Balance at end of year................................. $ 305,000
---------
Revenue Recognition
We recognize service revenue related to the Glowpoint network subscriber
service and the multi-point video and audio bridging services as service is
provided. Customer activation fees are deferred and recognized over the
twenty-four month estimated life of our customer relationship, because the value
of such activations are closely related to the subsequent delivery of our
services. We recognize revenue derived from other sources when services are
provided or events occur.
Cash and Cash Equivalents
We consider all highly liquid debt instruments with an original maturity
of three months or less when purchased to be cash equivalents.
In September 2003, as a condition to closing the sale of our video
solutions equipment sales business, we set aside $335,000 in an interest-bearing
escrow account. These funds, including interest thereon, were restricted as to
their use until certain calculations required by the asset purchase agreement
were agreed between the parties or determined by independent accountants. The
$335,000 is included in escrowed cash on the restated consolidated balance sheet
at December 31, 2004. Subsequently, we announced that we had entered into a
settlement agreement with Gores under which Gores released to us the $335,000,
including the interest thereon, that was escrowed.
Concentration of Credit Risk
Financial instruments that potentially subject us to significant
concentrations of credit risk consist principally of cash and cash equivalents,
and trade accounts receivable. We place our cash and cash equivalents primarily
in commercial checking accounts and money market funds. Commercial bank balances
may from time to time exceed federal insurance limits; money market funds are
uninsured.
We perform ongoing credit evaluations of our customers. We record an
allowance for doubtful accounts based on specifically identified amounts that
are believed to be uncollectible. We also record additional allowances based on
certain percentages of our aged receivables, which are determined based on
historical experience and an assessment of the general financial conditions
affecting our customer base. If our actual collections experience changes,
revisions to our allowance may be required. After all attempts to collect a
receivable have failed, the receivable is written off against the allowance.
Property and Equipment
Property and equipment are stated at cost. Furniture and office,
computer, videoconferencing, bridging and network equipment are depreciated over
the estimated useful lives of the related assets, which range from three to six
years. Leasehold improvements are amortized over the shorter of either the
asset's useful life or the related lease term. Depreciation is computed on the
straight-line method for financial reporting purposes. Property and equipment
include fixed assets subject to capital leases which are depreciated over the
life of the respective asset.
8
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Long-Lived Assets
We evaluate impairment losses on long-lived assets used in operations,
primarily fixed assets, when events and circumstances indicate that the carrying
value of the assets might not be recoverable in accordance with SFAS No. 144
"Accounting for the Impairment or Disposal of Long-lived Assets". For purposes
of evaluating the recoverability of long-lived assets, the undiscounted cash
flows estimated to be generated by those assets would be compared to the
carrying amounts of those assets. If and when the carrying values of the assets
exceed their fair values, the related assets will be written down to fair value.
Income Taxes
We use the liability method to determine our income tax expense or
benefit. Deferred tax assets and liabilities are computed based on temporary
differences between the financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates that are expected to be
in effect when the differences are expected to reverse. Any resulting net
deferred tax assets are evaluated for recoverability and, accordingly, a
valuation allowance may be established.
Earnings (Loss) Per Share
Basic loss per share is calculated by dividing net loss attributable to
common stockholders by the weighted-average number of common shares outstanding
during the period. Diluted loss per share for 2004 is the same as basic loss per
share. A total of 12,592,000 potential common shares for outstanding options and
warrants and 2,059,000 shares issuable upon conversion of our Series B preferred
stock (see Note 18) have been excluded from the calculation of diluted loss per
share because the effects would be anti-dilutive.
Stock-Based Compensation
We periodically grant stock options to employees and directors in
accordance with the provisions of our stock option plans, with the exercise
price of the stock options being set at the closing market price of the common
stock on the date of grant. We account for our employee stock-based compensation
plans under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations, and, accordingly,
account for employee stock-based compensation utilizing the intrinsic value
method. Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation", establishes a fair value based method
of accounting for stock-based compensation plans. We have adopted the disclosure
only alternative under SFAS No. 123 and SFAS No. 148 "Accounting For Stock Based
Compensation-Transition and Disclosure", which requires disclosure of the pro
forma effects on our net loss attributable to common stockholders and the
related per share amounts as if the fair value based method had been adopted as
well as certain other information.
Stock options or warrants issued in return for services rendered by
non-employees are accounted for using the fair value based method. The following
table illustrates the effect on net loss attributable to common shareholders and
net loss per share for the year ended December 31, 2004 if the fair value based
method had been applied to all awards:
9
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(IN
THOUSANDS,
EXCEPT PER
SHARE AMOUNTS)
Net loss attributable to common stockholders, as reported..... $ (15,452)
Add: stock-based employee compensation expense included in
reported net loss.......................................... 766
Deduct: stock-based employee compensation expense determined
under the fair value based method.......................... (1,788)
-----------
Pro forma net loss............................................ $ (16,474)
-----------
Net loss per share:
Basic and diluted - as reported............................... $ (0.42)
Basic and diluted - pro forma................................. $ (0.45)
The weighted average grant date fair value of options granted during 2004
under the Black-Scholes option pricing model was $1.05 per option. The fair
value of each option granted in 2004 is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
Risk fees interest rates...................................... 3.54%
Expected option lives......................................... 5 years
Expected volatility........................................... 113.20%
Expected dividend yields...................................... None
Fair Value of Financial Instruments
Financial instruments reported in our consolidated balance sheet consist
of cash, accounts receivable and accounts payable, the carrying value of which
approximated fair value at December 31, 2004 due to their short-term nature.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment",
which addresses the accounting for transactions in which a company receives
employee services in exchange for (a) equity instruments of the company or (b)
incurs liabilities that are based on the fair value of the company's equity
instruments or that may be settled by the issuance of such equity instruments.
It eliminates the ability to account for share based compensation transactions
using APB Opinion No. 25 and generally requires that such transactions be
accounted for using a fair value based method. Pro forma disclosure will no
longer be an alternative. Compensation cost will be recognized over the service
period, which would normally be the vesting period of the share-based payment.
The Company has adopted SFAS No. 123R effective January 1, 2006 following the
modified prospective method. The impact of adopting SFAS 123R cannot be
predicted at this time because it will depend on the levels of share-based
payments in the future.
In December 2004, the FASB issued SFAS No. 153, "Exchange of Nonmonetary
Assets", an amendment of APB Opinion No. 29, "Accounting for Nonmonetary
Transactions". SFAS No. 153 is based on the principle that exchange of
nonmonetary assets should be measured based on the fair market value of the
assets exchanged. SFAS No. 153 eliminates the exception of nonmonetary exchanges
of similar productive assets and replaces it with a general exception for
exchanges of nonmonetary assets that do not have commercial substance. SFAS 153
is effective for nonmonetary asset exchanges in fiscal periods beginning after
June 15, 2005. We do not believe that the adoption of SFAS No. 153 will have a
material impact on our consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154 Accounting Changes and Error
Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3 ("SFAS
154"). This Statement replaces APB Opinion No. 20, "Accounting Changes", and
FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial
Statements", and changes the requirements for the accounting for and reporting
of a change in accounting principle. This statement is effective for fiscal
periods beginning after December 15, 2005 and is not expected to have a
significant impact on our financial statements.
10
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In February 2006, the FASB issued SFAS 155, "Accounting for Certain Hybrid
Financial Instruments". SFAS 155 amends SFAS 133 and SFAS 140, and addresses
issues raised in SFAS 133 Implementation Issue No. D1, "Application of Statement
133 to Beneficial Interests in Securitized Financial Assets." SFAS 155 is
effective for all financial instruments acquired or issued after the beginning
of an entity's first fiscal year that begins after September 15, 2006. We are
currently evaluating the implications of SFAS 155 on our financial statements.
NOTE 3-- RESTATEMENTS
We have identified errors in previously reported consolidated financial
statements and have restated our unaudited condensed consolidated financial
statements as of March 31, 2004, June 30, 2004, September 30, 2004 and for the
three months ended March 31, 2004, the three and six months ended June 30, 2004,
the three and nine months ended September 30, 2004 and the three months ended
December 31, 2004. We have also restated our audited financial statements as of
December 31, 2004 and for the year then ended. We have experienced difficulties
in our efforts to restate periods prior to 2004, including an inability to
quantify inventory amounts. We sold our VS equipment business prior to 2004 and
as a result we no longer held inventory as of December 31, 2004. These
restatements relate principally to the following matters (the items described
below will not aggregate the total amount of the restatement):
Balance Sheet
Cash - Cash was reduced by $89,000 as of December 31, 2004 to reflect a
proper cutoff of deposits made on the first business day of 2005.
Accounts receivable, net of allowance for doubtful accounts - Accounts
receivable was reduced by $891,000 as of December 31, 2004. Pre-billed
subscription revenues for January 2005 of $790,000 which was previously included
in accounts receivable has been reversed against the corresponding deferred
revenue included in current liabilities. Additionally, accounts receivable was
increased by $89,000 to reflect a proper cutoff of deposits on the first
business day of 2005 and the allowance for doubtful accounts was increased by
$208,000.
Receivable from Gores Technology Group-net - The account receivable due
from Gores of $2,750,000 was reduced by $379,000 to reflect the net amount of
various transactions between the two companies subsequent to the sale of our VS
equipment business to Gores. As described in Note 4, our restated financial
statements for the year ended December 31, 2004 reflect the sale of the VS
equipment business prior to 2004.
Other current assets - Other current assets was reduced by $385,000. A
monthly telecommunications invoice in the amount of $217,000 which was
previously erroneously reflected as a prepaid expense has been charged to
expense in 2004. Deferred installation costs associated with deferred activation
revenues was overstated by $109,000, prepaid commissions of $75,000 were charged
to expense and $78,000 of disputed sales tax that was recorded as a receivable
was determined to be uncollectible and written-off. These decreases were
partially offset by an adjustment to record as an asset $147,000 for the portion
of a telecommunications invoice related to 2005.
Property and equipment-net - Property and equipment-net was reduced by
$7,488,000 principally reflecting cost of revenue that was improperly
capitalized prior to and during 2004, net of the related adjustment to
accumulated depreciation. Property and equipment previously included purchases
of videoconferencing equipment that represented the cost of sales associated
with our VS equipment business prior to 2004. Property and equipment also
previously included telecommunication charges that represented the cost of
service revenue, including approximately $2.2 million that was improperly
reclassified during 2004. Additionally, during 2004, we had improperly increased
the estimated life of our network equipment.
11
NOTE 3-- RESTATEMENTS (CONTINUED)
Goodwill - Goodwill of $2,548,000 associated with the purchase of a
business by Wire One in 2001 was deemed to have become impaired prior to January
1, 2004, because we determined prior to 2004 that we would not pursue the
development of such asset.
Accounts payable and accrued expenses - Accounts payable and accrued
expenses were increased by $1,087,000, the majority of which relates to
telecommunications carrier invoices that were not previously reflected as of
December 31, 2004 and accrued sales tax.
Derivative financial instrument - We have restated our financial
statements to reflect the estimated fair value of a derivative liability for the
liquidated damages provisions of the registration rights agreement associated
with our February 2004 financing. We estimated that $1,164,000 of the proceeds
associated with the financing was attributable to the derivative financial
instrument and that the estimated fair value of the derivative financial
instrument at December 31, 2004 was $1,298,000 (see Note 10).
Deferred revenue - Deferred revenue was decreased by $753,000,
reflecting principally the reclassification of pre-billed revenue for January
2005 that was netted against the corresponding account receivable.
Deferred income taxes - We previously reflected a $212,000 deferred
income tax liability associated with goodwill. Because the restated financial
statements reflect a write-off of the goodwill prior to 2004, we have eliminated
the associated deferred income tax liability.
Additional paid-in capital - Additional paid-in capital as previously
reported of $157,323,000 was reduced by $8,444,000. We reduced additional
paid-in capital by $1,489,000 to properly apply the guidance of EITF 00-27,
"Application of Issue No. 98-5 to Certain Convertible Instruments" in accounting
for the discount on convertible debentures associated with warrants and a
beneficial conversion premium and the related financing costs (see Note 9). We
have reduced the loss on the exchange of the convertible debentures for Series B
convertible preferred stock, restricted stock and an adjustment to the exercise
price of warrants in January 2004 by $611,000. The restated loss on exchange of
$743,000 reflects the market value of the 250,000 shares of restricted stock and
the incremental fair value of the warrants resulting from the modification (see
Note 10). We had previously recorded $611,000 of additional paid-in capital,
which was included in the loss on exchange, for the excess of the market value
of the shares of common stock issuable upon the conversion of the Series B
convertible preferred stock over the face amount of the convertible debentures.
However, at the time of the exchange, the convertible debentures were
convertible into the same number of shares of common stock as the Series B
convertible preferred stock and, accordingly, additional paid-in capital at
December 31, 2004 and the loss on exchange have been reduced. We reduced
additional paid-in capital for the reclassification of $4,888,000 of Series B
convertible preferred stock to mezzanine. Additionally, we determined that
$1,164,000 of the proceeds of our February 2004 financing were attributable to a
derivative financial instrument and we reduced additional paid-in capital. Other
adjustments further reduced additional paid-in capital by $312,000 and related
principally to the allocation of financing costs and option modifications.
Accumulated deficit - Our accumulated deficit at December 31, 2004 has
been increased by $9,307,000, which reflects an increase of $11,967,000 as of
January 1, 2004 and a decrease in our net loss for the year ended December 31,
2004 of $2,600,000. The most significant adjustments to our accumulated deficit
as of January 1, 2004 relate to the improper capitalization of cost of revenue
as property and equipment and improper accounting for the sale of our VS
equipment business to Gores. The significant restatements to the net loss for
the year ended December 31, 2004 are described below.
Statement of Operations
Revenue - Revenue for the year ended December 31, 2004 was reduced by
$128,000. We have deferred the recognition of revenue associated with
installations services from 2002 and 2003 over a 24 month period (the estimated
average life of a subscription based customer). Previously, we recognized
installation revenue at the time such services were completed. This change had
the impact of increasing 2004 revenue by $160,000. This increase was offset by a
reduction in revenue of $94,000 associated with sales tax charged to customers
that was erroneously classified as revenue; a reduction of $128,000 related to
billing errors that were subsequently corrected, but erroneously reclassified
from previously reported revenue and charged to the allowance for doubtful
accounts and a reduction of $45,000 related to an insurance claim payment to us
that was erroneously classified as revenue.
12
NOTE 3-- RESTATEMENTS (CONTINUED)
Cost of revenue - Cost of revenue was increased by $3,177,000. For the
year ended December 31, 2004, approximately $2,216,000 was erroneously
capitalized as property and equipment rather than being charged to cost of
revenue. In addition, we recomputed the amount of our network costs allocated to
cost of revenue, research and development, sales and marketing and general and
administrative expenses to properly reflect costs associated with the various
departments that used the internal network, which resulted in an increase to
cost of revenue of $297,000 Cost of revenue has been increased by $160,000 for
costs associated with the increase in installation revenue and adjustments to
the deferral of 2004 installation fees. Depreciation expense of $343,000
previously allocated to sales and marketing and general and administrative
expenses has been reclassified to cost of revenues associated with bridging
services. Additionally, we recomputed the amount of certain circuit costs that
were allocated to Gores and previously charged to the sale of the VS equipment
business and have decreased the amount allocated during 2004 by $373,000 and
increased cost of revenue. Cost of revenue was decreased by $173,000 to apply
credits from telecommunication carriers to the appropriate period.
Sales and marketing - Sales and marketing expenses, previously referred
to as selling, were reduced by $4,784,000 for the year ended December 31, 2004.
We have reclassified to general and administrative expenses $3,656,000 that was
previously classified as selling expenses, which relate principally to customer
service, engineering and certain other operating expenses. In addition, we had
previously allocated $1,055,000 of network costs to selling expenses during
2004. We have determined that only $238,000 of such costs are attributable to
sales and marketing expenses and $817,000 has been reclassified principally to
costs of revenue and general and administrative expenses. Sales commission
expense has been reduced for $124,000 that should have been expensed prior to
2004 has been reclassified to 2003. Such expenses should have been recognized in
the period incurred. Additionally, sales and marketing expense has been reduced
by $204,000 relating to an improper accrual of sales commissions.
General and administrative - General and administrative expenses were
increased by $3,303,000. We have reclassified to general and administrative
expenses $4,064,000 that was previously classified as selling ($3,656,000) and
research and development ($408,000), which relate principally to customer
service, engineering and certain other operating expenses. Depreciation expense
was reduced by $1,938,000 reflecting the previously discussed reduction of fixed
assets and a reclassification of depreciation expense related to bridging
revenue. The re-allocation of network costs from sales and marketing expenses
resulted in an increase in general and administrative expenses of $472,000. An
accrual for severance expense in 2004 for $133,000 has been eliminated since the
individual had not been terminated. General and administrative expense was
increased by $388,000 to reflect arbitration expenses of $180,000 and additional
legal expense of $208,000 incurred with regard to such arbitration, which had
previously been charged to the loss on the sale of the VS equipment business to
Gores. We recognized $300,000 of expense related to sales tax. Additionally, bad
debt expense was decreased by $107,000, including $128,000 that was reclassified
as a reduction in revenue. Various additional adjustments resulted in an
aggregate increase to general and administrative expenses of $257,000.
Research and development - Research and development expenses were
decreased by $355,000, principally due to a reclassification of $408,000 to
general and administrative expenses.
Other (income) expense - Other income was increased by $678,000. As a
result of correcting the accounting for the issuance of the subordinated
convertible debentures we reduced the amortization of the related discount by
$500,000 and recognized amortization of deferred financing costs of $448,000. We
had previously overstated the discount by $1,489,000, which was partially offset
by overstating amortization by $989,000 as of January 1, 2004, due to the
overstatement of the discount and by following the straight line method of
amortizing the discount rather than the effective yield method. As a result of
correcting the accounting for the exchange of the subordinated convertible
debentures for Series B convertible preferred stock, warrants and a modification
to warrants, we reduced the loss on the exchange of debt by $611,000. We had
previously recognized a loss on the exchange of $1,354,000, which included the
excess of the fair value of the common stock underlying the Series B convertible
preferred stock ($5,499,000) over the face amount of the subordinated
convertible debentures ($4,888,000) in the loss on exchange. However, the
subordinated convertible debentures were convertible into the same number of
shares of common stock as the Series B convertible preferred stock and,
accordingly, had the same fair value. The loss on the exchange has been reduced
to $743,000, representing the fair value of the shares of common stock and the
incremental fair value from the warrant modification, which were included in the
exchange. Additionally, we recorded other expense of $134,000 associated with
the increase in the estimated fair value of the derivative liability associated
with registration rights.
13
NOTE 3-- RESTATEMENTS (CONTINUED)
Income tax provision - We previously reflected a $212,000 income tax
provision associated with goodwill. Because the restated financial statements
reflect a write-off of the goodwill prior to 2004, we have reversed the
associated income tax provision.
Sale of our VS equipment sales business - We previously reflected a
loss of $2,908,000 during the year ended December 31, 2004 on the sale of our VS
equipment business to Gores. For the reasons described in Note 4, we have
restated the accompanying financial statements to give accounting recognition to
this transaction at its closing prior to 2004, except for $379,000 arising
subsequent to the transaction, which will be recognized upon settlement in 2005.
Accordingly, our restated financial statements do not reflect any gain or loss
on the sale of our VS equipment business during the year ended December 31,
2004.
Statement of Cash Flows - Net cash used in operating activities as
previously reported of $9.1 million has been increased by $2.3 million to $11.4
million. Net cash used in investing activities as previously reported of $3.4
million has been reduced by $2.3 million to $1.1 million. Net cash provided by
financing activities as previously reported of $12.9 million has not materially
changed. The changes reflect the items described above.
The following tables summarize the account balances that have been restated
(dollars in thousands):
Previously As Previously As Previously As Previously As
Reported Restated Reported Restated Reported Restated Reported Restated
------------------------------------------------------------------------------------------------
Balance sheets: March 31, 2004 June 30, 2004 September 30, 2004 December 31, 2004
(unaudited) (unaudited) (unaudited)
------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 13,313 $ 13,313 $ 10,366 $ 10,366 $ 7,280 $ 7,214 $ 4,586 $ 4,497
Escrowed cash 336 336 336 336 336 337 337 337
Accounts receivable, net 2,600 1,685 3,213 2,293 3,081 2,179 2,763 1,872
Receivable from Gores (1) 0 0 0 0 0 0 2,750 2,371
Other current assets 1,370 1,017 2,068 1,088 1,699 619 939 554
------------------------------------------------------------------------------------------------
Total current assets 17,618 16,351 15,984 14,083 12,398 10,349 11,375 9,631
Property and equipment-net 13,074 6,008 12,932 5,708 12,753 5,425 12,591 5,103
Goodwill-net 2,548 0 2,548 0 2,548 0 2,548 0
Other assets 274 274 326 280 314 285 296 258
------------------------------------------------------------------------------------------------
Total assets $ 33,514 $ 22,633 $ 31,790 $ 20,071 $ 28,013 $ 16,059 $ 26,810 $ 14,992
================================================================================================
LIABILITIES
Accounts payable $1,707 $ 1,707 $ 2,133 $ 1,562 $ 1,919 $ 1,919 $ 2,833 $ 2,984
Accrued expenses 1,161 1,132 1,584 2,309 1,484 1,845 1,486 2,421
Derivative 0 0 0 0 0 147 0 367
Payable to Gores 0 3,227 0 2,776 0 2,768 0 0
Deferred revenue 796 245 887 238 947 236 1,018 265
Capital lease obligations 127 127 101 102 68 69 35 35
---------------------------------------------------------------------------------------------
Total current liabilities 3,792 6,438 4,707 6,987 4,419 6,984 5,373 6,072
Deferred income taxes 0 0 0 0 0 0 212 0
Derivative, less current portion 0 1,177 0 1,207 0 1,105 0 932
---------------------------------------------------------------------------------------------
Total liabilities 3,792 7,615 4,707 8,194 4,419 8,089 5,584 7,004
Preferred stock 0 4,888 0 4,888 0 4,888 0 4,888
STOCKHOLDERS' EQUITY
Common stock 4 4 4 4 4 4 4 4
Additional paid-in capital 156,799 148,418 157,295 148,959 157,290 148,954 157,323 148,879
Accumulated deficit (125,036) (136,516) (128,267) (140,220) (131,922) (144,177) (134,530) (144,367)
Comprehensive income 0 161 0 116 0 0 0 0
Deferred compensation (1,804) (1,697) (1,709) (1,630) (1,538) (1,459) (1,331) (1,176)
Treasury stock (240) (240) (240) (240) (240) (240) (240) (240)
---------------------------------------------------------------------------------------------
Total stockholders' equity 29,722 10,130 27,083 6,989 23,594 3,082 21,226 3,100
---------------------------------------------------------------------------------------------
Total liabilities and $ 33,514 $ 22,633 $ 31,790 $ 20,071 $ 28,013 $ 16,059 $ 26,810 $ 14,992
stockholders' equity
=============================================================================================
(1) included in other current assets as previously reported as of March 31,
2004, June 30, 2004 and September 30, 2004.
14
Previously As Previously As Previously As Previously As
Reported Restated Reported Restated Reported Restated Reported Restated
----------------------------------------------------------------------------------------------
Statements of Operations: Three months ended Three months ended Three months ended Three months ended
March 31, 2004 June 30, 2004 September 30, 2004 December 31, 2004
(unaudited) (unaudited) (unaudited) (unaudited)
----------------------------------------------------------------------------------------------
Revenue $ 3,225 $ 3,186 $ 4,126 $ 4,179 $ 4,385 $ 4,383 $ 4,259 $ 4,119
Cost of revenue 2,740 3,539 3,295 4,072 3,435 4,240 3,372 4,168
----------------------------------------------------------------------------------------------
Gross margin (loss) 485 (353) 831 107 950 143 887 (49)
----------------------------------------------------------------------------------------------
Research and development 327 241 337 240 364 313 405 284
Sales and marketing 1,835 556 1,912 703 2,117 931 2,186 1,075
General and administrative 1,882 2,482 1,830 2,760 1,958 2,870 2,800 3,662
----------------------------------------------------------------------------------------------
Total operating expenses 4,044 3,279 4,079 3,703 4,440 4,114 5,392 5,021
----------------------------------------------------------------------------------------------
Loss from operations (3,559) (3,632) (3,248) (3,596) (3,490) (3,971) (4,505) (5,070)
Other (income) expenses 4,655 3,894 (176) 11 23 (113) (5,011) (4,978)
Income tax provision 0 0 0 0 0 0 212 0
----------------------------------------------------------------------------------------------
Income (loss) from continuing (8,214) (7,526) (3,072) (3,607) (3,513) (3,858) 294 (92)
Operations
Discontinued operations 0 0 (61) 0 (43) 0 (2,803) 0
----------------------------------------------------------------------------------------------
Net (loss) (8,214) (7,526) (3,133) (3,607) (3,556) (3,858) (2,509) (92)
Preferred stock dividends (74) (74) (98) (97) (99) (99) (99) (99)
----------------------------------------------------------------------------------------------
Net (loss)attributable to common
Stockholders $ (8,288) $(7,600) $ (3,231) $(3,704) $ (3,655) $(3,957) $ (2,608) $ (191)
==============================================================================================
Net loss per share - basic and
Diluted $ (0.25) $ (0.23) $ (0.09) $ (0.10) $ (0.10) $ (0.10) $ (0.07) $(0.01)
==============================================================================================
15
NOTE 3-- RESTATEMENTS(CONTINUED)
Six months ended Nine months ended Year ended
June 30, 2004 September 30, 2004 December 31, 2004
(unaudited) (unaudited)
------------------------------------------------------------------------
Revenue $ 7,351 $ 7,365 $11,736 $ 11,748 $15,995 $ 15,867
Cost of revenue 6,035 7,611 9,470 11,851 12,842 16,019
------------------------------------------------------------------------
Gross margin (loss) 1,316 (246) 2,266 (103) 3,153 (152)
------------------------------------------------------------------------
Research and development 663 481 1,028 794 1,433 1,078
Sales and marketing 3,746 1,259 5,864 2,190 8,050 3,265
General and administrative 3,712 5,242 5,671 8,112 8,471 11,774
------------------------------------------------------------------------
Total operating expenses 8,122 6,982 12,562 11,096 17,954 16,117
------------------------------------------------------------------------
Loss from operations (6,806) (7,228) (10,296) (11,199) (14,801) (16,269)
Other (income) expenses 4,480 3,905 4,503 3,792 (508) (1,186)
Income tax provision 0 0 0 0 212 0
------------------------------------------------------------------------
Loss from continuing operations (11,286) (11,133) (14,799) (14,991) (14,505) (15,083)
Discontinued operations (61) 0 (105) 0 (2,908) 0
------------------------------------------------------------------------
Net (loss) (11,347) (11,133) (14,904) (14,991) (17,413) (15,083)
------------------------------------------------------------------------
Preferred stock dividends (172) (171) (270) (270) (369) (369)
------------------------------------------------------------------------
Net (loss) attributable to $ (11,519) $(11,304) $(15,174) $(15,261) $(17,782) $(15,452)
common stockholders
========================================================================
Net loss per share - basic and
Diluted $ (0.33) $ (0.32) $ (0.42) $(0.43) $ (0.49) $ (0.42)
========================================================================
NOTE 4--SALE OF VS BUSINESS
In September 2003, we completed the sale of all of the assets of our VS
business to Gores pursuant to the terms of an asset purchase agreement dated as
of June 10, 2003. The total consideration payable to us under the agreement was
up to $24 million, consisting of $21 million in cash, of which $19 million was
payable as of closing ($335,000 was placed in an escrow account) and $2 million
was held back by Gores to cover potential purchase price adjustments, an
unsecured $1 million promissory note maturing on December 31, 2004 and bearing
an interest rate of 5% per annum and up to $2 million in earn-out payments based
on performance of the assets over the two years following the closing. As
partial consideration for the purchase of assets, Gores also assumed certain
liabilities related to the VS segment, including (1) all liabilities to be paid
or performed after the closing date that arose from or out of the performance or
non-performance by Gores after the closing date of any contracts included in the
assets or entered into after June 10, 2003 and (2) our accounts payable,
customer deposits, deferred revenue and accrued liabilities related to the VS
segment.
Pursuant to the agreement, Gores agreed that, for a period of three years
commencing on the closing date, it would not, directly or indirectly, acquire or
own any equity interest in certain of our competitors identified in the
agreement. The agreement further provided that Gores could acquire an identified
competitor upon payment to us of a one-time fee of $5 million. During 2004 Gores
acquired V-SPAN, Inc., which was one of the identified competitors. Accordingly,
other income for the year ended December 31, 2004 includes $5 million pursuant
to the agreement with Gores as their acquisition of V-SPAN closed in November
2004.
16
NOTE 4--SALE OF VS BUSINESS (CONTINUED)
Following the closing of the sale to Gores, we were unable to reach
agreement with Gores on the amount, if any, of the adjustment to be made to the
purchase price, which was based on the net assets, as defined, of the VS
business sold to Gores as of June 30, 2003. Consequently, we entered into
arbitration with Gores in July 2004, with PriceWaterhouseCoopers as the
arbitrator. On January 12, 2005, we announced that PriceWaterhouseCoopers had
rendered its decision. The arbitrator concluded that the net assets of the VS
business sold to Gores should be reduced by $4.3 million.
On March 7, 2005, we announced that we had entered into a settlement
agreement with Gores, resolving the outstanding disputes between the companies
relating to the sale of the assets of the VS business, various payables between
the companies and Gores' acquisition of V-SPAN. Pursuant to the agreement, Gores
paid us $2.75 million and released the $335,000, including interest thereon that
was escrowed at the closing of the asset sale. We dismissed our lawsuit against
Gores relating to the V-SPAN acquisition. We will not receive any payments under
the earnout provision in the agreement.
We originally accounted for the arbitrator's ruling and settlement
agreement with Gores as settlements of a contingency which became known prior to
the issuance of the December 31, 2004 financial statements. Therefore, although
the sale to Gores closed during 2003, we deferred recognition of the related
gain or loss and reported a loss of $2,908,000 during the year ended December
31, 2004. The arbitrator's adjustment of $4,340,000 related to the correction of
specific financial reporting errors that should have adjusted prior period
financial statements rather than being charged to the gain on the sale of the VS
business.
The ultimate settlement of amounts due to/from Gores that arose
subsequent to the transaction closing date and unrelated to the sale
transaction, including $363,000 of revenue that we recognized in 2004, were
previously included in the determination of the loss on the sale. The restated
financial statements exclude these amounts from the gain on the sale and a gain
or loss from the settlement of these items will be recognized in 2005 when the
settlement was reached with Gores.
In addition, we have become aware of several other accounting errors
whereby items unrelated to the sale of the VS segment to Gores were
inappropriately charged to the loss on the sale. We have determined that the
matters addressed in the arbitrator ruling and the other corrections represent
accounting errors. Accordingly, the accompanying restated financial statements
reflect these items as corrections of errors prior to 2004 and the gain or loss
on the transaction is accounted for upon the closing in 2003. Additionally, the
accompanying financial statements reflect a receivable from Gores of $2,750,000
relating to the sale and the payment due from Gores in connection with their
acquisition of V-SPAN, net of $379,000 due to Gores from items arising
subsequent to the sale transaction. Pursuant to the settlement agreement with
Gores in 2005, each party was released from amounts due to the other beyond the
payment by Gores of $2,750,000 and the release of the escrow cash to us.
Accordingly, we will recognize a $379,000 gain on settlement in 2005.
NOTE 5--PREPAID EXPENSES AND OTHER CURRENT ASSETS
Other current assets consist of the following at December 31, 2004:
(IN THOUSANDS)
Prepaid installation costs............................. 66
Prepaid maintenance contracts.......................... 108
Prepaid insurance...................................... 70
Other current assets................................... 310
---------------
$ 554
===============
17
NOTE 6--PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31, 2004:
ESTIMATED
(IN USEFUL
THOUSANDS) LIFE
Leasehold improvements........................ $ 115 5 Years
Office furniture and equipment................ 352 5 Years
Computer equipment and software............... 1,757 3 Years
Videoconferencing equipment................... 74 3 Years
Bridging equipment............................ 1,546 5 Years
Network equipment............................. 7,078 5 Years
----------------
10,922
Accumulated depreciation (5,819)
----------------
$ 5,103
================
Depreciation expense was $2,236,000 for the year ended December 31, 2004,
which includes depreciation expense of $47,000 for 2004 on fixed assets subject
to capital leases. The equipment under capital leases as of December 31, 2004
had a cost of $258,000, accumulated depreciation of $80,000 and a net book value
of $178,000.
NOTE 7--ACCRUED EXPENSES
Accrued expenses consist of the following at December 31, 2004:
(IN THOUSANDS)
-------------
Accrued compensation.......................................... $ 723
Accrued dividends............................................. 368
Accrued taxes................................................. 539
Other accrued expenses........................................ 791
-----------
$ 2,421
===========
NOTE 8--BANK LOAN PAYABLE AND LONG-TERM DEBT
Bank Loan Payable
In February 2004, we terminated a working capital credit facility with
JPMorgan Chase. As a result of the termination of this credit facility, we wrote
off $85,000 of unamortized deferred financing costs to expense in the first
quarter of 2004.
NOTE 9--SUBORDINATED DEBENTURES
In December 2002, we raised net proceeds of $4.2 million in a private
placement of $4,888,000 principal amount of 8% convertible debentures. The
debentures were convertible into 2,036,677 shares of common stock at $2.40 per
share. The debentures were to mature in February 2004, or 90 days following the
expiration (in May 2005) or earlier termination of the credit facility,
whichever was later. We had the option of paying interest quarterly on the
debentures in the form of either cash or shares of our common stock. Investors
in the private placement also received five-year warrants to purchase 814,668
shares of common stock at an exercise price of $3.25 per share. The warrants are
subject to certain anti-dilution adjustments. As of December 31, 2004 the
exercise price of these warrants was $2.64, which has been further adjusted to
$2.47 in connection with a March 2005 financing. We also issued to our placement
agent warrants to purchase 40,733 shares of common stock at an exercise price of
$0.001 per share with an expiration date of January 31, 2008.
We allocated the proceeds received to the debentures and the related
warrants based on the relative fair value method. The fair value of the
debentures was determined based on the market value of the 2,036,677 common
shares into which the debentures were convertible and the fair value of the
warrants was determined using the Black Scholes pricing model. Of the proceeds,
$1,292,000 was allocated to the warrants and was recorded as debt discount and
additional paid-in capital and $3,596,000 was allocated to the debentures. Based
on the market value of the common shares issuable upon conversion, as compared
to the proceeds allocated to the debentures, further debt discount and
additional paid-in capital of $2,107,000 was recorded for the beneficial
conversion feature. The aggregate discount of $3,399,000 has been amortized over
the term to maturity following the effective yield method.
18
NOTE 9--SUBORDINATED DEBENTURES (CONTINUED)
In January 2004, in exchange for the cancellation and termination of the
debentures and forfeiture of any and all rights of collection, claim or demand
under the debentures, we agreed to give the holders of the debentures: (i) an
aggregate of 203.667 shares of series B convertible preferred stock; (ii) an
aggregate of 250,000 shares of restricted common stock; and (iii) a reduction of
the exercise price of the warrants issued pursuant to the original purchase
agreement from $3.25 to $2.75. As a result of this exchange, the unamortized
discount on subordinated debentures was written off to expense, resulting in
amortization of discount of $2,650,000 for the year ended December 31, 2004.
We incurred costs of $609,000 in connection with the financing, which
were allocated to the warrants and the convertible debentures based on their
relative fair values. The portion allocated to the warrants was recorded as a
reduction to additional paid-in capital and the portion allocated to the
convertible debentures was recorded as deferred financing costs, which have been
amortized consistently with the debt discount. Upon the exchange in January
2004, the unamortized deferred financing costs were written off to expense,
resulting in amortization of financing costs of $363,000 for the year ended
December 31, 2004.
NOTE 10--STOCKHOLDERS' EQUITY
Common Stock
In February 2004, we raised net proceeds of $12.4 million in a private
placement of 6,100,000 shares of our common stock at $2.25 per share. Investors
in the private placement were also issued 1,830,000 common stock purchase
warrants at an exercise price of $2.75 per share. The warrants expire five and a
half years after the closing date. The warrants are subject to certain
anti-dilution protection. The exercise price of the warrants was adjusted to
$2.56 as a result of a March 2005 financing. We also issued to our placement
agent five-year warrants to purchase 427,000 shares of common stock at an
exercise price of $2.71 per share with an estimated fair value of $895,000.
The registration rights agreement associated with the February 2004
financing provides for liquidated damages of 3% of the aggregate purchase price
for the first month and 1.5% for each subsequent month if we failed to register
such shares of common stock, including the shares of common stock underlying the
warrants, or maintain the effectiveness of such registration. We account for the
registration rights agreement as a separate freestanding instrument and account
for the liquidated damages provision as a derivative liability subject to SFAS
No. 133. The estimated fair value of the derivative liability is based on
estimates of the probability and costs expected to be incurred and such
estimates are revalued at each balance sheet date with changes in value recorded
as other income or expense. Approximately $1,164,000 of the proceeds of the
financing were attributed to the estimated fair value of the derivative
liability. As of December 31, 2004, we estimated the fair value of the
derivative liability to be $1,298,000 and recognized other expense of $134,000
for the year ended December 31, 2004.
Preferred Stock
Our Certificate of Incorporation authorizes the issuance of up to
5,000,000 shares of preferred stock. Except for the 2,450 shares of Series A
preferred stock issued prior to 2004 (all of which were converted into common
stock prior to 2004) and the 203.667 shares of Series B preferred stock issued
in January 2004, the rights and privileges of the preferred stock have not yet
been designated.
In January 2004, in exchange for the cancellation and termination of
debentures with an aggregate face value of $4,888,000 and forfeiture of any and
all rights of collection, claim or demand under the notes, we issued to the
holders of the debentures: (i) an aggregate of 203.667 shares of Series B
preferred stock with an aggregate stated value of $4,888,000; (ii) an aggregate
of 250,000 shares of restricted common stock; and (iii) a reduction of the
exercise price of the warrants issued pursuant to the original purchase
agreement from $3.25 to $2.75.
The Series B preferred stock ranks senior to our common stock and
subordinate to any indebtedness we may have outstanding. The Series B preferred
stockholders are entitled to receive dividends at the rate of eight percent (8%)
of the stated value per share of $24,000 per share per year through July 21,
2005, increasing to twelve percent (12%) on July 22, 2005, payable annually at
our option in cash or shares of common stock. We must obtain the
19
NOTE 10--STOCKHOLDERS' EQUITY (CONTINUED)
affirmative vote of the holders of at least 75% of the outstanding shares of
Series B preferred stock in order to issue any securities ranking senior to or
on a parity with the Series B preferred stock. Other than as described in the
preceding sentence or as required by Delaware law, the Series B preferred stock
has no voting rights. If we liquidate, dissolve or wind up our affairs, the
holders of the Series B preferred stock are entitled to receive a liquidation
preference equal to the stated value per share plus accrued and unpaid
dividends. The Series B preferred stock is convertible into our common stock at
the conversion price of $2.40 per share of common stock. Upon a change of
control, the holders of the Series B preferred stock can require that we redeem
their shares at the stated value per share plus accrued and unpaid dividends. We
also have the option to redeem the outstanding shares of Series B preferred
stock at a price per share equal to 110% of the stated value plus accrued and
unpaid dividends. The fair value of the Series B preferred shares issued in the
exchange was equal to the fair value of the convertible debentures because the
same number of shares of common stock are issuable upon conversion by the
holders. We recognized a loss on the exchange of $743,000, reflecting the fair
value of the 250,000 shares of restricted common stock and the incremental fair
value of the warrants resulting from the modification to the exercise price.
As a result of the February 2004 financing, the conversion price of the
Series B preferred stock was reduced to approximately $2.374. Accordingly, as of
December 31, 2004, the Series B preferred shares outstanding were convertible
into approximately 2,059,000 shares of common stock. As a result of a March 2005
financing, the conversion price was further adjusted to $2.242.
NOTE 11--STOCK OPTIONS AND WARRANTS
Glowpoint 2000 Stock Incentive Plan
Pursuant to the Glowpoint 2000 Stock Incentive Plan (the "2000 Plan"), as
amended, 4,400,000 shares of common stock have been reserved for issuance
thereunder. The 2000 Plan permits the grant of incentive stock options ("ISOs")
to employees or employees of our subsidiaries. Non-qualified stock options
("NQSOs") may be granted to employees, directors and consultants. As of December
31, 2004, options to purchase a total of 3,140,000 shares were outstanding and
854,000 shares remained available for future issuance under the 2000 Plan.
The exercise price of the awards is established by the administrator of
the plan and, in the case of ISOs issued to employees who are less than 10%
stockholders, the per share exercise price must be equal to at least 100% of the
fair market value of a share of the common stock on the date of grant or not
less than 110% of the fair market value of the shares in the case of an employee
who is a 10% stockholder. The administrator of the plan determines the terms and
provisions of each award granted under the 2000 Plan, including the vesting
schedule, repurchase provisions, rights of first refusal, forfeiture provisions,
form of payment, payment contingencies and satisfaction of any performance
criteria.
1996 Stock Option Plan
Under the 1996 Stock Option Plan (the "1996 Plan"), as amended, 2,475,000
shares of common stock have been reserved for issuance thereunder. The 1996 Plan
provides for the granting of options to officers, directors, employees and
advisors. The exercise price of incentive stock options ("ISOs") issued to
employees who are less than 10% stockholders shall not be less than the fair
market value of the underlying shares on the date of grant or not less than 110%
of the fair market value of the shares in the case of an employee who is a 10%
stockholder. The exercise price of stock options shall not be less than the par
value of the shares to which the option relates. Options are not exercisable for
a period of one year from the date of grant. Under the 1996 Plan, no individual
will be granted ISOs corresponding to shares with an aggregate exercise price in
excess of $100,000 in any calendar year less the aggregate exercise price of
shares under other stock options granted to that individual that vest in such
calendar year. The 1996 Plan will terminate in 2006. No options were granted
under the 1996 Plan in 2004. As of December 31, 2004, options to purchase a
total of 67,000 shares were outstanding and no shares remained available for
future issuance under the 1996 Plan.
20
NOTE 11--STOCK OPTIONS AND WARRANTS (CONTINUED)
VTI Stock Option Plans
Under stock option plans assumed with a merger prior to 2004, options to
purchase a total of 223,000 shares of our common stock were outstanding as of
December 31, 2004. The plans will terminate in 2009. No options were granted
under these Plans in 2004 and as of December 31, 2004 no shares remained
available for future issuance.
We have also issued stock options outside of our qualified plans. At
December 31, 2004, the total of these options outstanding was 1,533,000.
A summary of options issued under our plans and other options outstanding
as of December 31, 2004, is presented below:
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
OPTIONS PRICE
-------------- ------------
Options outstanding, January 1, 2004................................ 5,793,000 $ 3.12
Granted............................................................. 1,491,000 1.30
Exercised........................................................... (782,000) 0.73
Forfeited........................................................... (1,539,000) 3.90
-------------- ------------
Options outstanding, December 31, 2004.............................. 4,963,000 $ 2.71
============== ============
Shares of common stock available for future grant under company
plans............................................................ 854,000
==============
Additional information as of December 31, 2004 with respect to all
outstanding options is as follows:
OUTSTANDING EXERCISABLE
------------------------------------------ --------------------------
WEIGHTED
AVERAGE
REMAINING WEIGHTED WEIGHTED
CONTRACTUAL AVERAGE AVERAGE
RANGE OF NUMBER OF LIFE (IN EXERCISE NUMBER OF EXERCISE
PRICE OPTIONS YEARS) PRICE OPTIONS PRICE
- ------------------------------------------ ------------ -------------- ------------- ------------- ------------
$ 0.57 - $1.13........................... 323,000 7.75 $1.09 285,000 $1.03
1.19 - 2.55............................ 1,647,000 8.67 1.43 430,000 $1.83
2.63 - 3.97............................ 2,615,000 4.68 3.34 2,405,000 $3.33
4.12 - 5.50............................ 294,000 5.96 4.97 261,000 $5.03
5.76 - 9.85............................ 84,000 0.23 $6.82 84,000 $6.82
-------------- -------------
$ 0.57 - 9.85............................ 4,963,000 6.23 $2.71 3,465,000 $3.17
============== =============
21
NOTE 11--STOCK OPTIONS AND WARRANTS (CONTINUED)
We have elected to use the intrinsic value-based method of APB Opinion
No. 25 to account for awards under our employee stock-based compensation plans.
Accordingly, no compensation cost has been recognized in the accompanying
financial statements for stock options issued to employees because the exercise
price of each option equals or exceeds the fair value of the underlying common
stock as of the grant date for each stock option.
Equity-based expenses recognized in our statement of operations totaled
$925,000 in 2004. We recorded amortization of deferred compensation from the
issuance of restricted stock of $699,000 and recognized $67,000 related to the
extension of certain options. In addition, we recorded consulting expense of
$114,000 ($32,000 for options that vested during 2004) related to the issuance
of stock options and interest expense of $45,000 related to shares of common
stock issued to subordinated debenture holders in lieu of cash interest
payments.
During the year ended December 31, 2004, we received $570,000 from the
exercise of stock options.
At December 31, 2004, we had outstanding warrants which can be exercised
for 7,486,000+ shares of common stock. For the 2,257,000 warrants that were
issued in 2004, the weighted average grant date fair value as determined by the
Black-Scholes option pricing model was $1.95.
Additional information as of December 31, 2004 with respect to all
outstanding warrants is as follows:
WEIGHTED
AVERAGE
REMAINING WEIGHTED
CONTRACTUAL AVERAGE
RANGE OF NUMBER LIFE (IN EXERCISE
PRICE OUTSTANDING YEARS) PRICE
- ----------------------------------------------------------------------- ------------- -------------- --------------
$0.001................................................................ 3,000 2.96 $ 0.001
1.00 - 2.43......................................................... 604,000 2.22 2.06
2.71 - 2.75......................................................... 3,072,000 3.82 2.72
4.41 - 6.24......................................................... 2,041,000 1.46 5.04
8.69 - 9.23......................................................... 1,747,000 1.23 8.46
------------- ------ ----------
$0.001 - 9.23......................................................... 7,467,000 2.44 $ 4.64
============= ====== ==========
Principally all of the warrants are subject to anti-dilution adjustments.
NOTE 12--COMMITMENTS AND CONTINGENCIES
Employment Agreements
We have entered into employment agreements with our President and Chief
Executive Officer ("CEO"), our Executive Vice President and Chief financial
Officer ("CFO") and our Executive Vice President and Chief Technology Officer
("CTO") which provide for:
CEO--We entered into an agreement with the CEO having a three-year term
commencing October 15, 2003. Under the agreement, the CEO will receive a defined
annual base salary for each year of employment, annual incentive compensation in
an amount equivalent to fifty percent (50%) of his then annual base salary
subject to the achievement of goals and metrics established by the CEO and the
Compensation Committee of the board of directors, with such goals and metrics
being updated on an annual basis. The agreement provided for an award of 360,000
shares of restricted common stock, the fair value of which was determined to be
$1,116,000. Compensation expense will be recorded evenly over the life of the
employment agreement. Compensation expense of $372,000 was recorded during the
year ended December 31, 2004. Under the agreement, we must secure and pay the
premium on a $2,000,000 life insurance policy payable to the CEO's designated
beneficiary. Either we or the CEO may terminate his employment at any time, for
any reason or no reason at all; however, if the CEO is terminated without cause
or resigns for good reason or if he dies, he is entitled to one year of his then
annual base salary, one year of his then annual incentive compensation, and one
year of accelerated vesting on the restricted stock granted under the employment
agreement. If the CEO's employment is terminated with cause or if he voluntarily
resigns, he is entitled to his base salary and other benefits through the last
day actually worked.
22
NOTE 12--COMMITMENTS AND CONTINGENCIES (CONTINUED)
Executive Vice President and Chief Financial Officer--We entered into an
agreement with the CFO having a three-year term commencing December 7, 2004.
Under the agreement, the CFO is entitled to annual base salary, annual incentive
compensation in an amount equivalent to forty percent (40%) of his then annual
base salary subject to the achievement of goals and metrics established by the
President and CEO with such goals and metrics being updated on an annual basis
and a grant of an option to purchase 125,000 shares of common stock under the
2000 Plan, vesting in three equal annual installments. Either we or the CFO may
terminate his employment at any time, for any reason or no reason at all;
however, if the CFO is terminated without cause or resigns for good reason or if
he dies, he is entitled to six months of his then annual base salary, as well as
the pro-rated amount of incentive compensation due as of the effective date of
termination and one year of accelerated vesting of the stock options granted
under the employment agreement. If the CFO's employment is terminated with cause
or if he voluntarily resigns, he is entitled to his base salary and other
benefits through the last day actually worked.
Executive Vice President and Chief Technology Officer--We entered into
an agreement with the CTO having a three-year term commencing January 1, 2001,
which has been subsequently amended numerous times to reflect agreed upon annual
base salary, incentive compensation and other stock option grants. Under the
current three year agreement, the CTO is entitled to an annual base salary in
each year, an ability to earn annual incentive compensation in an amount
equivalent to forty percent (40%) of his then annual base salary, subject to the
achievement of goals and metrics established by the CEO, with such goals and
metrics being updated on an annual basis. , In addition, the CTO's agreement
stipulates that if we enter into a sale agreement during the term of the
agreement and the CTO realizes less than $200,000 from the exercise of all
outstanding options, then he is entitled to a bonus in an amount equal to the
difference between $200,000 and the amount realized. The agreement also provides
for a grant of an option to purchase 100,000 shares of common stock under the
2000 Plan, with 25% vesting immediately and the remaining options vesting in
three equal annual installments at the anniversary date of the agreement. Either
we or the CTO may terminate his employment at any time, for any reason or no
reason at all; however, if the CTO is terminated without cause or resigns for
good reason or if he dies, he is entitled to one year of his then annual base
salary and one year of accelerated vesting of the stock options granted under
the amended employment agreement. If the CTO's employment is terminated with
cause or if he voluntarily resigns, he is entitled to his base salary and other
benefits through the last day actually worked.
Operating Leases
We lease several facilities under operating leases expiring through 2005.
Certain leases require us to pay increases in real estate taxes, operating costs
and repairs over certain base year amounts. Lease payments for the years ended
December 31, 2004 were approximately $304,000. These amounts are inclusive of
rent expense that was related to our discontinued VS and AV operations.
Future minimum rental commitments under all non-cancelable leases as of
December 31, 2004 aggregated $243,000 for the year ending December 31, 2005 (see
Note 18)
Capital Lease Obligations
We lease certain equipment under non-cancelable lease agreements. These
leases are accounted for as capital leases. Future minimum lease payments under
capital lease obligations at December 31, 2004 of $35,000 are due during 2005.
NOTE 13--INCOME TAXES
We had no tax provision for the year ended December 31, 2004. Our
effective tax rate differs from the statutory federal tax rate as shown in the
following table:
(IN THOUSANDS)
U.S. federal income taxes at the statutory rate............... $ (5,121)
State taxes, net of federal effects........................... (904)
Beneficial conversion feature................................. 1,066
Nondeductible loss on exchange of debt........................ 297
Change in valuation allowance................................. 4,072
Adjustments to prior years' options and other charges......... 582
Other......................................................... 8
------------
$ --
============
23
NOTE 13--INCOME TAXES (CONTINUED)
The tax effect of the temporary differences that give rise to significant
portions of the deferred tax assets and liabilities as of December 31, 2004 is
presented below:
(IN THOUSANDS)
Deferred tax assets:
Tax benefit of operating loss carry forwards.......... $ 35,922
Reserves and allowances............................... 401
Accrued expenses...................................... 670
Goodwill.............................................. 807
Equity-based compensation............................. 1,223
Unrealized loss on derivative financial instrument.... 54
Other................................................. 8
------------
Total deferred tax assets................................ 39,085
------------
Deferred tax liabilities:
Fixed assets.......................................... 121
------------
Sub-total................................................ 38,964
Valuation allowance...................................... (38,964)
------------
Net deferred tax liabilities............................. $ --
============
We and our subsidiaries file federal returns on a consolidated basis and
separate state tax returns. At December 31, 2004, we have net operating loss
(NOL) carry-forwards of approximately $93 million each for federal and state
income tax purposes, respectively, which expire in various amounts through 2024.
The utilization of a portion of our NOL is limited each year as a result of an
"ownership change" (as defined by Section 382 of the Internal Revenue Code of
1986, as amended). Our NOL's may be subject to further limitation due to past
and future issuances of stock. We provide a full valuation allowance, which
increased by $4,072,000 during 2004, against our deferred tax assets due to the
uncertainly about the realization of such assets. Management expects to maintain
the valuation allowance on our tax benefits until profitability is sustained
over a long enough period for us to conclude that it is more likely than not
that a portion or all of our deferred tax assets will be realized.
NOTE 14--401(k) PLAN
We have adopted a 401(k) retirement plan under Section 401(k) of the
Internal Revenue Code. The 401(k) plan covered substantially all employees who
met minimum age and service requirements. The plan was non-contributory on our
part. Effective with the merger with VTI, we assumed the 401(k) Plan of VTI,
combined its assets with those of the existing plan and began making
contributions to the plan. Employer contributions to the 401(k) plan for the
years ended December 31, 2004 were approximately $26,000.
NOTE 15--RELATED PARTIES
We receive financial and tax services from an accounting firm in which
one of our directors is a partner. For the year ended December 31, 2004, we
incurred fees for these services of approximately $23,000.
NOTE 16--RESTATED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of our unaudited restated quarterly results of
operations for 2004 (See Note 3).
1st Quarter
Net revenues......................................$ 3,186
Gross margin...................................... (353)
Loss from operations.............................. (3,682)
Net loss.......................................... (7,526)
Net loss attributable to common stockholders...... (7,600)
Net loss per share - basic and diluted............ (0.23)
24
NOTE 16--RESTATED QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
2nd Quarter
Net revenues......................................$ 4,179
Gross margin...................................... 107
Loss from operations.............................. (3,596)
Net loss.......................................... (3,607)
Net loss attributable to common stockholders...... (3,704)
Net loss per share - basic and diluted............ (0.10)
3rd Quarter
Net revenues......................................$ 4,383
Gross margin...................................... 143
Loss from operations.............................. (3,971)
Net loss.......................................... (3,858)
Net loss attributable to common stockholders...... (3,956)
Net loss per share - basic and diluted............ (0.10)
4th Quarter
Net revenues......................................$ 4,119
Gross margin...................................... (49)
Loss from operations.............................. (5,070)
Net loss.......................................... (92)
Net loss attributable to common stockholders...... (191)
Net loss per share - basic and diluted............ (0.01)
Net loss per share is computed independently for each of the quarters
presented. Therefore, the sum of the quarterly net loss per share figure in 2004
does not equal the total computed for that year.
NOTE 17--SUBSEQUENT EVENTS
In March 2005, we entered into a common stock purchase agreement with
several unrelated institutional investors in connection with the offering of (i)
an aggregate of 6,766,667 shares of our common stock and (ii) warrants to
purchase up to an aggregate of 2,706,667 shares of our common stock. We received
proceeds from the sale of these shares and warrants equal to approximately
$10.15 million, less our expenses relating to the sale, which were approximately
$760,500, a portion of which represents investment advisory fees totaling
$710,500 to Burnham Hill Partners, our financial advisor. The warrants that were
issued are exercisable for a five-year term and have an exercise price of $2.40
per share. The warrants may be exercised by cash payment of the exercise price
or by "cashless exercise."
In March 2005, 83.333 shares of our outstanding Series B convertible
preferred stock were exchanged for 1,333,328 shares of our common stock and
warrants to purchase 533,331 shares of our common stock.
In April, 2005, we amended our operating lease for our Hillside, NJ
office to extend the term of the lease through April 2007. At such time, we also
increased the square feet under lease. Payments due under the amended lease
aggregate $197,000, $218,000 and $73,000 for the years ending December 31, 2005,
2006 and 2007, respectively, excluding operating cost.
25
NOTE 17--SUBSEQUENT EVENTS (CONTINUED)
In March 2006, we implemented a corporate restructuring plan designed
to reduce ongoing operating, sales and general and administrative costs. As part
of the strategic initiative, we made management changes, including the promotion
of Michael Brandofino to Chief Operating Officer with principal responsibility
for the implementation and management of the restructuring plan. We also
announced that Gerard Dorsey, executive vice president and chief financial
officer since December 2004, will be leaving Glowpoint in April 2006 to pursue
other opportunities. He will transition his responsibilities to Edward Heinen,
Glowpoint's vice president and controller, who will become acting Chief
Financial Officer upon Mr. Dorsey's departure.
26