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EX-31.2 - EXHIBIT 31.2 - NET TALK.COM, INC.v240832_ex31-2.htm
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EX-32.1 - EXHIBIT 32.1 - NET TALK.COM, INC.v240832_ex32-1.htm
EX-32.2 - EXHIBIT 32.2 - NET TALK.COM, INC.v240832_ex32-2.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

x       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2011

OR

¨       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission file number:  000-53668

NET TALK.COM, INC.
(Exact name of registrant as specified in its charter)

Florida
 
20 – 4830633
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
     
1100 NW 163rd Drive, Miami, FL
 
33169 – 5816
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code:  (305) 621 1200

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Title of each class
 
Name of each exchange on which registered
Common stock, $0.001 par value per share
 
OTCBB
Redeemable preferred stock, $0.001 par value per share
   

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨           No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes ¨           No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x                       No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨
 
Accelerated filer ¨
     
Non-accelerated filer  ¨  (Do not check if a smaller reporting company)
 
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨           No x

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant, computed by reference to price at which the common equity was sold, or the average bid and asked price of such common stock as of September 30, 2010, the last business day of the registrant’s most recently completed fiscal quarter,  was $0.25 .  For purposes of this computation, the registrant has excluded the market value of all shares of its common stock reported as being beneficially owned by executive officers and directors and holders of more than 10% of the common stock on a fully diluted basis of the registrant; such exclusion shall not, however,  be deemed to constitute an admission that any such person is an “affiliate” of the registrant.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

Class
 
Outstanding at December 22, 2011
Common stock, $0.001 par value per share
 
39,464,892
Redeemable preferred stock, $0.001 par value per share
 
500 shares
 
 
 

 

Net Talk.com, Inc.

Form 10-K

For the fiscal year ended September 30, 2011

Table of contents
Page
     
Part I
   
     
Item 1.
Business
4
Item 1A.
Risk factors
9
Item 2.
Properties
10
Item 3.
Legal proceedings
10
Item 4.
Submission of matters to a vote of security holders, executives and directors
10
     
Part II
   
     
Item 5.
Market for registrant’s common equity, related stockholders matters and  issuer purchases of equity securities
11
     
Item 6.
Selected financial data
13
   
 
Item 7.
Management discussion and analysis of financial condition and operation
13
Item 7A.
Quantitative and qualitative disclosure about market risk
18
Item 8.
Financial statements and supplementary data
18
Item 9.
Changes in and disagreements with accountants on accounting and financial disclosure
18
Item 9A.
Controls and procedures
18
Item 9B.
Other information
20
     
Part III
   
     
Item 10.
Directors, executive officers and corporate governance
21
Item 11.
Executive compensation
24
Item 12.
Security ownership of certain owners and management and related stockholder matter
26
Item 13.
Certain relationships and related transactions, and directors independence
27
Item 14.
Principal accountant fees and services
27
     
Part IV
   
     
Item 15.
Exhibits, financial statement schedules
28
 
Signatures
29
 
Financial statements
30

 
 

 
 
Forward Looking Statements

Certain statements contained in this annual report on Form 10-K and other written material and oral statements made from time to time by us do not relate to historical or current facts.  As such, they are referred to as “forward-looking statements,” which are intended to convey our expectations or predictions regarding the occurrence of possible future events or the existence of trends and factors that may impact our future plans and operating results. These forward-looking statements are derived, in part, from various assumptions and analyses we have made in the context of our current business plan and information currently available to us and in light of our experience and perceptions of historical trends, current conditions and expected future developments and other factors we believe to be appropriate in the circumstances. You can generally identify forward-looking statements through words and phrases such as “ seek, ” “ anticipate, ” “ believe, ” “ estimate, ” “ expect, ” “ intend, ” “ plan, ” “ budget, ” “ project, ” “ may be, ” “ may continue, ” “ may likely result, ” and similar expressions. When reading any forward looking statement, you should remain mindful that actual results or developments may vary substantially from those expected as expressed in or implied by that statement for a number of reasons or factors, such as those relating to:

·€€
our ability to develop sales and marketing capabilities;

·€€
the accuracy of our estimates and projections;

·€€
our ability to fund our short-term and long-term financing needs;

·€€
changes in our business plan and corporate strategies; and other risks and uncertainties discussed in greater detail in the sections of this prospectus, including the section captioned “Plan of Operation”.

Each forward-looking statement should be read in context with, and with an understanding of, the various other disclosures concerning our Company and our business made elsewhere in this prospectus, as well as other public reports filed with the SEC. You should not place undue reliance on any forward-looking statement as a prediction of actual results or developments. We are not obligated to update or revise any forward-looking statement contained in this report to reflect new events or circumstances unless and to the extent required by applicable law.

 
 

 
 
Part I

Item 1.  Business

Company and Business

We are a telephone company, which provides, sells and supplies commercial and residential telecommunication services, including services utilizing voice over internet protocol (“VoIP”) technology, session initiation protocol (“SIP”) technology, wireless fidelity technology, wireless maximum technology, marine satellite services technology and other similar type technologies. Our main products are the “DUO” and the “DUO WIFI”.  The DUO WIFI is expected to roll out to customers during February 2012.  Both of these products are analog telephone adapters that provide connectivity for analog telephones and faxes to home, home office or corporate local area networks (“LAN”).  The DUO WIFI allows users to use these services without an Ethernet cable plugged into the device.  We no longer offer the TK 6000 for sale to customers.

Our DUO and DUO WIFI and their related services are cost effective solution for individuals, small businesses and telecommuters connecting to any analog telephone, fax or private branch exchange (“PBX”).  Our DUO and DUO WIFI provide a USB port, one Ethernet port and one analog telephone port.  The DUO WIFI additionally provides a wireless chip so that users can connect to the device over WIFI hotspots.  A full suite of internet protocol features is available to maximize universal connectivity. In addition, analog telephones attached to our  DUO and DUO WIFI are able to use advanced calling features such as call forwarding, caller ID, 3-way calling, call holding, call retrieval and call transfer.

History and Overview

We are a Florida corporation, incorporated on May 1, 2006 under the name Discover Screens, Inc. (“Discover Screens”).

Prior to September 10, 2008, we were known as Discover Screens, a company dedicated to providing advertising through interactive, audiovisual, information and advertising portals located in high-traffic indoor venues. Our name and business operations changed in a series of transactions beginning in December of 2007.

On September 10, 2008, we changed our name from Discover Screens, Inc. to Net Talk.com, Inc.

On September 10, 2008, we acquired certain tangible and intangible assets, formerly owned by Interlink Global Corporation (“Interlink”), directly from Interlink’s creditor who had seized the assets pursuant to a Security and Collateral Agreement.

Our Strategy

We continue to improve and enhance the following factors in building and expanding our customer base:
 
·€€
Deployment and distribution of our main products the DUO and DUO WIFI devices.

·€€
We offer our customers an attractive and innovative value proposition: a portable telephone replacement with multiple and unique features that differentiates our services from the competition.
 
·€€
Innovative, high technology and low cost technology platform.  We believe our innovative software and network technology platform provides us with a competitive advantage over our competition and allows us to maintain a low cost infrastructure relative to our competitors.

Plan of Operation

We provide, sell and supply commercial and residential telecommunication services, including services utilizing voice over internet protocol (“VoIP”) technology, session initiation protocol (“SIP”) technology, wireless fidelity technology, wireless maximum technology, marine satellite services technology and other similar type technologies. We are developing our business infrastructure and new products and services.

 
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Our Products

At this time, our main products are the DUO and DUO WIFI. Our DUO and DUO WIFI are designed to provide specifications unique to each customer’s existing equipment. They allow the customer full mobile flexibility by being able to take internet interface anywhere the customer has an internet connection. Our DUO and DUO WIFI both have the following features:

A Universal Serial Bus (“USB”) connection allowing the interconnection of our DUO and DUO WIFI to any host computer.

In addition to the USB power source option, our DUO and DUO WIFI have an external power supply allowing the phone to independently power itself when not connected to a host computer;

Unlike most VoIP telephone systems, our DUO and DUO WIFI both have standalone feature allowing them to be plugged directly into a standard internet connection.

Our DUO and DUO WIFI are compact, space-efficient products.

Our DUO and DUO WIFI both have interface components so that the customer can purchase multiple units that can communicate with each other allowing simultaneous ringing from multiple locations.

Our products are portable and allow our customers to make and receive phone calls with a telephone anywhere a broadband internet connection is available.  We transmit the calls using Voice over Internet Protocol “VOIP” technology, which converts voice signals into digital data transmissions over the internet.

Our Services

Our business is to provide products and services that utilize Voice Over Internet Protocol, which we refer to as “VoIP.” VoIP is a technology that allows the consumer to make telephone calls over a broadband internet connection instead of using a regular (or analog) telephone line. VoIP works by converting the user’s voice into a digital signal that travels over the internet until it reaches its destination. If the user is calling a regular telephone line number, the signal is converted back into a voice signal once it reaches the end user. Our business model is to develop and commercialize software technology solutions for cost effective, real-time communications over the internet and related services.

Patents – Domestic and International

Our products are currently under US patent pending as well as International patent pending in over 123 countries.

Marketing

We have developed direct sales channels, as represented by web sites and toll free numbers.  Our direct sales channels are supported by highly integrated advertising campaigns across multiple media such as infomercials, television and other media channels.   Our website is www.nettalk.com, our telephone number is 305-621-1200 and our fax number is 305-621-1201.

Our primary source of revenue is the sale and distribution of our NetTalk DUO.  We will be offering our DUO WIFI to customers starting in February of 2012.  We also generate revenue from the sale of accessories to our product and international long distance monthly charges that are billed to our customers.

Advertising

Our goal is to position ourselves as a premier supplier of choice for VoIP services. Our current business strategy is to focus our advertising dollars on our home market in South Florida.  Our advertising will consist of mass marketing campaigns focusing on television infomercials for the South Florida market and other states including cable television channels..

Customers

Our customers are made up of retail, residential and small businesses. We anticipate that future services will appeal to our existing customers and hope that our additional phone products and services will provide a complete phone package experience to our customers.

Our target audience is individual consumers and small businesses looking to lower their current cost of telecommunications. We are also reaching a large audience with our websites. We hope that consumers will find our websites by doing an internet search for VoIP service providers. We also use other means of advertising such as direct to consumer sales, ecommerce and retail marketing coops with retail customers.

 
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Geographic Markets

Our primary geographic market is our home market of South Florida. Our target audiences are individual consumers and small businesses looking to lower their current cost of telecommunications.  We also expect to reach a large audience with our websites. We hope that consumers will find our websites by doing an internet search for VoIP service providers. We will also use other means of advertising such as direct to consumer sales, ecommerce and coop marketing with retail stores.

We have been granted and or are applying for Competitive Local Exchange Carrier (“CLEC”) Licenses in forty three states, as follows:

Alabama
Hawaii
Massachusetts
New York
Utah
Arizona
Idaho
Michigan
North Carolina
Vermont
Arkansas
Illinois
Minnesota
North Dakota
Washington, D.C.
California
Indiana
Missouri
Ohio
Washington
Colorado
Iowa
Montana
Oregon
West Virginia
Connecticut
Kansas
Nebraska
Pennsylvania
Wisconsin
Delaware
Kentucky
Nevada
South Carolina
Wyoming
Florida
Maine
New Jersey
South Dakota
 
Georgia
Maryland
New Mexico
Texas
 

It is our intent to focus our expansion on the geographic markets in which we have been granted CLEC Licenses. We also intend to expand our market place to reach customers worldwide.

The Industry

In the past decade, the use of the internet for all purposes has exploded.  VoIP is a technology that enables communications over the internet through the compression of voice, video and/or other media into data packets that can be efficiently transmitted over data networks and then converted back into the original media at the other end of the transmission. Since the introduction of the first VoIP technology in the mid 1990s, the quality and clarity of VoIP connections have continued to evolve and improve.   Perhaps the biggest jump in VoIP quality came with the introduction of SIP, or Session Initiation Protocol. SIP is a text-based protocol suitable for integrated voice-data applications. Today SIP is the predominant industry standard for establishing multimedia communications over the Internet. As the clarity and quality of VoIP services have increased, so has the acceptance of VoIP by consumers.

As a result of the potential cost savings and added feature availability of VoIP, consumers, industry leaders and traditional telecommunication service providers see VoIP as the future of telecommunications.  Factors that have been contributing to the boom in VoIP use include: (a) increased consumer demand for lower cost telephone services; (b) increased demand for long distance services as the market place becomes increasingly global; (c) improved reliability and quality of VoIP due to technological advances; and (d) innovations that allow services for VoIP users that are not available in traditional telephone services. These factor, and others, have resulted in various service providers and consumers exploring VoIP alternatives to traditional analog phone services.

Our Competition

The communications industry is highly competitive and significantly affected by regulatory changes, technology evolution, marketing strategies, and pricing decisions of the larger industry participants.  The market for our services is evolving rapidly and is subject to shifting customer demands and the introduction of new products and services. Our current and potential competitors come from different market sectors and vary in size and scope with respect to the products and services that they offer or intend to offer in the future.

One of our competitors in the domestic market is traditional telephone service providers that are increasingly adding advanced service features to traditional telephone services. Domestic telephone providers have the advantage of having strong name recognition, large research and development budgets and existing service and market networks.

In addition, numerous vendors sell products and services using VoIP technology. Our competitors use innovations such as Analogue Terminal Adapters, or ATAs, to connect an analogue telephone to a VoIP network. Sometimes referred to as VoIP Gateways, these devices are widely advertised and sold. Sales are conducted by many different methods, including internet and infomercial sales, and barriers to entry into the business are low.

We also face competition from alternative communication methods such as internet, fax providers and voice mail service providers.

Many of our competitors may be better established, larger and better financed than us, and are able to use their visibility and substantial marketing resources to attract customers. In particular, many of our competitors are large, established network service providers that are able to market and distribute enhanced communication services within their already large base of subscribers. As a result, these competitors maybe able to adapt more quickly to new or emerging technologies  and changes in customer requirements.  They may also be able to devote greater resources to the promotion and sale of their products.  Moreover, we may not have sufficient resources to undertake the continuing research and development necessary to remain competitive.

 
6

 
 
We differentiate our services from those offered by our competitors by offering exceptional customer service and lower cost alternatives. We have worked hard to control the development costs associated with the DUO WIFI.   We have done this by choosing phone components and component vendors that are economical but do not compromise on quality. We have developed and marketed our own products and services, rather than simply reselling another manufacturer’s innovations. Finally, our DUO and DUO WIFI products are standalone phone products that do not require the user to first invest in a computer. For these reasons, we know that our DUO and DUO WIFI product is a lower cost alternative to similar telephone products currently being marketed (because we are engaged in the same cost saving measures for the services we offer).  We are able to offer those services at a competitive price.

Our products and services are user friendly and convenient for our customers; for example, our packaging includes detailed, user friendly instructions and diagrams to allow for easy installation and activation. We have distinguished ourselves from our main competitors through the level of customer service offered to our consumers following their purchase or our products or services. Currently, our competitors only offer customer service through an email query program. This does not allow the customer to receive rapid, real-time problem solving assistance in the event our competitor’s product or service fails. In contrast, we established a customer service online forum where our users can post their questions and read other users’ responses. The forum has key word or key phrase search option so that our customers can easily find a solution to the problem they are experiencing. Our forum is moderated by one of our development engineers to ensure that all questions are being properly addressed and issues resolved.  We also offer a pay-per-use live customer support hotline. By paying a fee, either per minute or per call, our customers are able to reach a support specialist to get a direct answer to their questions.  This allows us to provide superior customer service, while still keeping our costs low.

Government Regulation

As a telecommunications supplier, we are subject to extensive government regulation. The majority of our government regulation comes from the Federal Communications Commission (the “FCC”).

Telecommunications is an area of rapid regulatory change. Changes in the laws and regulations and new interpretations of existing laws and regulations may affect permissible activities, the relative costs associated with doing business and amounts paid to us for our services. We cannot predict the future of federal, state and local regulations or legislation, including FCC regulations.

Federal Communications Commission (“FCC”) regulation

The FCC is an independent United States government agency. The FCC was established by the Communications Act of 1934 and is charged with regulating interstate and international communications by radio, television, wire, satellite and cable. The FCC’s jurisdiction covers all fifty states, the District of Columbia and U.S. possessions.

The FCC works to create an environment promoting competition and innovation to benefit communications customers. Where necessary, the FCC has acted to ensure VoIP providers comply with important public safety requirements and public policy goals.

Interconnected VoIP providers must comply with the Commission’s Telecommunications Relay Services (TRS) requirements, including contributing to the TRS Fund used to support the provision of telecommunications services to persons with speech or hearing disabilities, and offering 711 abbreviated dialing for access to relay services. Interconnected VoIP providers and equipment manufacturers also must ensure that, consistent with Section 255 of the Communication Act, their services are available to and usable by individuals with disabilities, if such access is readily achievable.

Finally, the FCC now requires interconnected VoIP providers and telephone companies that obtain numbers from them to comply with Local Number Portability (LNP) rules. These rules allow telephone, and now VoIP, subscribers that change providers to keep the subscribers telephone numbers provided that they stay in the same geographic area. VoIP providers must also contribute to funds established to share LNP and numbering administrative costs among all telecommunications providers benefiting from these services.

The FCC monitors and investigates complaints against VoIP providers and, if necessary, can bring enforcement actions against VoIP providers that do not comply with applicable regulations.

Federal CALEA
 
On August 5, 2005, the Federal Communication Commission (the FCC) released an Order extending the obligation of the Communication Assistance for Law Enforcement Act (“CALEA”) to interconnect VOIP providers.  Under CALEA , telecommunication carriers must assist law enforcement in executing electronic surveillance, which includes the capability of providing call content and call indentifying information to local enforcement agencies, or LEA, pursuant to a court order or other lawful authorization.
 
The FCC required all interconnect VOIP providers to become CALEA compliant by May 14, 2007. To date, we are fully compliant with CALEA.

 
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State Telecommunication Regulation

We are also registered with the Florida Public Utilities Commission as a Competitive Local Exchange Carrier (“CLEC”) and Interexchange (“IXC”) Carrier.

In Florida, a “competitive local exchange carrier” is defined as any company, other than an incumbent local exchange company, certificated by the Public Service Commission to provide local exchange telecommunication services in the state of Florida on or after July 1, 1995. CLEC companies providing services in Florida after July 1, 1995, must be certificated by the Florida Public Service Commission, and competitive local exchange companies are required to file a price list specifying their rates and charges for basic local telecommunication services.

Florida, as well as other states, also regulates providers of Interexchange Telecommunications (“IXC”). The Florida Public Service Commission includes the following as examples of IXC providers: (1) operator service providers; (2) resellers; (3) switchless re-billers; (4) multi-location discount aggregators; (5) prepaid debit card providers; and (5) facilities based interexchange carriers. Section 364.02(13) of the Florida Statutes requires IXCs to provide current contact information and a tariff to the Florida Public Service Commission.

We have been granted and or are applying for Competitive Local Exchange Carrier (“CLEC”) Licenses in forty three states, as follows:
 
Alabama
Hawaii
Massachusetts
New York
Utah
Arizona
Idaho
Michigan
North Carolina
Vermont
Arkansas
Illinois
Minnesota
North Dakota
Washington, D.C.
California
Indiana
Missouri
Ohio
Washington
Colorado
Iowa
Montana
Oregon
West Virginia
Connecticut
Kansas
Nebraska
Pennsylvania
Wisconsin
Delaware
Kentucky
Nevada
South Carolina
Wyoming
Florida
Maine
New Jersey
South Dakota
 
Georgia
Maryland
New Mexico
Texas
 

The law relating to regulation of VoIP technology is in a flux. In recent court cases, other VoIP providers have challenged whether state regulations can be applied to VoIP technology or whether such regulation has been preempted by the Telecommunications Act of 1996 and other Federal laws. At least one of our competitors has successfully fought the application of state laws to VoIP technology. However, to be cautious, we will continue to obtain a competitive local exchange carrier license from each state in which we conduct business. An added advantage of obtaining a CLEC license from each state is that we can obtain an operational carrier number from the North American Numbering Plan Administration. The operational carrier number will allow us to assign our customers telephone numbers in the area code in which they reside.

Employees

We employ 52 full-time and no part-time employees, none of our employees is subject to a collective bargaining agreement, and we consider our employee relations to be satisfactory.

 Intellectual Property

We regard our domain names, patents, trademarks, copyrights, trade dress, trade secrets, proprietary technologies and similar intellectual property as critical to our success, and we rely on patent, trademark and copyright law, trade-secret protection, and confidentiality and/or license agreements with our employees, customers, partners, and others to protect our proprietary rights.

We have filed multiple patent applications with the United States Patent and Trademark Office for the technology associated with our products. We also have software under development by our employees, subcontractors and consultants.

The status of any patent involves complex legal and factual questions, and the breadth of claims allowed is uncertain. Accordingly, we cannot assure you that any patent application filed by us will result in a patent being issued or that our issued patents, and any patents that may be issued in the future, will afford adequate protection against competitors with similar technology. We similarly face the risk that any patents issued to us might be infringed or designed around by others.

Patents – Domestic and International

Our products are currently under US patent pending as well as International patent pending in over 123 countries.

 
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Research and Development

We expense research and development expenses, as these costs are incurred. We account for our offering-related software development costs as costs incurred internally in creating a computer software product and are charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model.  At this time, our main product the DUO is being sold in the market place.  The DUO WIFI will be sold to customers starting in February 2012.   Therefore, research and development cost reported in our financial statements relates development of the DUO WIFI and pre – marketing costs and are expensed accordingly.

On July 14, 2010 we revealed our newest product the net TALK DUO (“DUO”).

Our DUO offers our customers free nationwide calls to any landline or mobile phone in the U.S. and Canada from anywhere in the world, as well as low-cost international rates.  It’s also a versatile digital phone service with no monthly fees, no contracts and no computer required.

Our DUO is flexible enough to connect directly to your Internet connection through the router/modem, there is also a convenient option with our DUO to connect to your computer. The sleek design is small enough to fit in the palm of your hand, making it a portable device.

Our DUO reduces the wear and tear on your home or office computer and reduces energy costs, resulting in money savings.  Our fax-friendly DUO, offers fax (incoming and outgoing), a unique feature not offered, to our knowledge, by similar digital phone services.

The portability of this small device is also great for international travelers who want to place free nationwide calls to the U.S. and Canada, or who are looking for a low-cost solution for international rates. Calls to other netTALK customers are always free.

We are presently working on other new products and anticipate future deployment the later part of this year and over the next year.

Item 1 A. Risk factors

This Annual Report on Form 10 K contains forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Reference is made in particular to the description of our plans and objectives for future operations, assumptions underlying such plans and objectives and other forward-looking statements included in this section, “Item 1 Business,” “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in other places in this Annual Report. Such statements may be identified by the use of forward-looking terminology such as “may”, “will”, “expect”, “believe”, “estimate”, “anticipate”, “intend”, “continue”, or similar terms, variations of such terms or the negative of such terms. Such statements are based on management’s current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. Factors that could cause such results to differ materially from those described in the forward-looking statements include those set forth below.

Risks Relating to Our Business:

WE HAVE A HISTORY OF LOSSES WHICH MAY CONTINUE, WHICH MAY NEGATIVELY IMPACT OUR ABILITY TO ACHIEVE OUR BUSINESS OBJECTIVES.

We incurred net losses of $26,176,565 and $6,306,963 for the years ended September 30, 2011 and 2010, respectively. We cannot assure you that we can achieve or sustain profitability on a quarterly or annual basis in the future. Our operations are subject to the risks and competition inherent in the establishment of a business enterprise.

There can be no assurance that future operations will be profitable. Revenues and profits, if any, will depend upon various factors, including whether we will be able to continue expansion of our revenue. We may not achieve our business objectives and the failure to achieve such goals would have an adverse impact on us.

OUR BUSINESS MAY BE AFFECTED BY FACTORS OUTSIDE OF OUR CONTROL.

Our ability to increase sales, and to profitably distribute and sell our products and services, is subject to a number of risks, including changes in our business relationships with our principal distributors, competitive risks such as the entrance of additional competitors into our markets, pricing and technological competition, risks associated with the development and marketing of new products and services in order to remain competitive and risks associated with changing economic conditions and government regulation.

 
9

 

Item 2. Properties

Description of properties

Our principal executive offices are located at 1100 NW 163rd Drive, Miami, Florida 33169.  Our offices consist of approximately 3,500 square feet. Our lease was extended on June 1st, 2011 for a term of 1 year, terminating on May 31, 2012.  The facility is suitable for our purposes and is expected to accommodate our needs until we move all company operations to our newly purchased building.

On August 8, 2011 we purchased an existing building located in Miami, Florida to be used as our corporate offices and operational center. The building, a 21,675 square foot free standing structure, was purchased for $2,700,000 from Core Development Holdings Corporation, which entity has no relationship to the Company.

Interconnection Leasing Agreements

The Company will be entering into lease arrangements to provide interconnection services in multiple states.  “Interconnection services” is defined in the Telecommunications Act of 1996 (the “Telecommunications Act”) as the linking of two telecommunication systems so that users of either system may utilize the system components of the other. Pursuant to the FCC rules implementing the Telecommunications Act, we negotiate interconnection agreements with incumbent local exchange carriers to obtain access to facilities. Facilities leasing occurs where one network service provider leases the facilities of another network service provider to provide services to end users. We currently have executed two interconnection leasing agreements and are negotiating an interconnection leasing agreement with other major hosting/bandwidth companies. Our current interconnection leasing agreements are with multiple carriers. The agreements relate to facilities located or to be located in the following states:
 
Alabama
Hawaii
Massachusetts
New York
Utah
Arizona
Idaho
Michigan
North Carolina
Vermont
Arkansas
Illinois
Minnesota
North Dakota
Washington, D.C.
California
Indiana
Missouri
Ohio
Washington
Colorado
Iowa
Montana
Oregon
West Virginia
Connecticut
Kansas
Nebraska
Pennsylvania
Wisconsin
Delaware
Kentucky
Nevada
South Carolina
Wyoming
Florida
Maine
New Jersey
South Dakota
 
Georgia
Maryland
New Mexico
Texas
 

The agreements will grant us interconnection leasing rights in all thirty five states in which we have obtained or are pursuing a CLEC license. If we enter new markets, we expect to establish interconnection agreements with incumbent local exchange carriers on an individual state basis, as the need arises.

Item 3.  Legal Proceedings

None.

Item 4.  Submission of Matters to a Vote of Security Holders

None.

 
10

 
 
Part II

Item 5.  Market for registrant’s common equity, related stockholder matters and issuer purchases of equity

Our common stock has been quoted on the OTC Bulletin Board under the symbol “NTLK” since September 15, 2009. The following table sets forth, for the periods indicated, the high and low bid prices of our common stock.  These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.

   
Fiscal Year 2011
 
   
High
   
Low
 
First Quarter
  $ 0.30     $ 0.21  
Second Quarter
  $ 1.50     $ 0.30  
Third Quarter
  $ 1.05     $ 0.56  
Fourth Quarter
  $ 0.70     $ 0.36  

Holders

As of September 30, 2011, there were 95 registered holders or persons otherwise entitled to hold our common stock.  The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various security brokers, dealers, and registered clearing agencies. The transfer agent of our common stock is Fidelity Transfer.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table sets forth certain information about the common stock that may be issued upon the exercise of options under the equity compensation plans as of September 30, 2011.

EQUITY COMPENSATION PLAN INFORMATION

Plan category
 
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
   
Weighted average
exercise price of
outstanding options,
warrants and rights
   
Number of securities
remaining available for
future issuance under equity
compensation plans
(excluding securities
reflected in column (a)
 
   
(a)
   
(b)
   
(c)
 
Equity compensation plans approved by security holders
    -0-       -0-       -0-  
                         
Equity compensation plans not approved by security holders
    -0-       -0-       -0-  
                         
Total
    -0-       -0-       -0-  

2010 Stock Option Plan

On November 15, 2009, Net Talk.com, Inc. (the “Company”) adopted the 2010 Stock Option Plan (the "Plan") which is intended to is to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate persons who make (or are expected to make) important contributions to the Company by providing such persons with equity ownership opportunities and performance-based incentives and thereby better aligning the interests of such persons with those of the Company’s shareholders. All of the Company’s employees, officers, and directors, and those Company’s consultants and advisors (i) that are natural persons and (ii) who provides bona fide services to the Company not connected to a capital raising transaction or the promotion or creation of a market for the company’s securities, are eligible to be granted options or restricted stock awards under the Plan. The maximum aggregate number of shares of the Company’s common stock that may be issued under the Plan is 10,000,000 shares of the Company’s common stock.

On July 26, 2010, May 23, 2011 and July 26, 2011, we issued 3,709,500, 3,890,000 and 2,400,500 shares of common stock to our employees as part of our 2010 Stock Option Plan, respectively.  The shares are compensatory in nature and are fully vested.  We have valued the shares at $0.03, $0.01 and $0.01 per share for the July 26, 2010, May 23, 2011 and July 26, 2011 issuances consistent with the fair value at the time of issuance including and adjusted for ownership restrictions.

 
11

 
 
July 26, 2010 Issuance
           
             
The shares were issued to officers and employees, as follows:
           
   
Shares
   
Expense
 
Anastasios Kyriakides, CEO and President
    1,900,000     $ 57,000  
Kenneth Hosfeld, EVP
    400,000       12,000  
Guillermo Rodriguez, CFO
    400,000       12,000  
Leo Manzewitsch, Former CTO
    400,000       12,000  
Sub – total (officers)
    3,100,000       93,000  
all other employees
    609,500       18,285  
Total
    3,709,500     $ 111,285  
                 
May 23, 2011 Issuance
               
                 
The shares were issued to officers and employees, as follows:
               
   
Shares
   
Expense
 
Anastasios Kyriakides, CEO and President
    1,716,500     $ 12,874  
Kenneth Hosfeld, EVP
    255,000       1,913  
Guillermo Rodriguez, CFO
    500,000       3,750  
Leo Manzewitsch, Former CTO
    500,000       3,750  
Dr. George Gabb, Director
    50,000       375  
Sub – total (officers)
    3,021,500       22,662  
all other employees
    868,500       6,513  
Total
    3,890,000     $ 29,175  

July 26, 2011 Issuance
           
             
The shares were issued to officers and employees, as follows:
           
   
Shares
   
Expense
 
Anastasios Kyriakides, CEO and President
    1,200,000     $ 9,000  
Kenneth Hosfeld, EVP
    200,000       1,500  
Guillermo Rodriguez, CFO
    200,000       1,500  
Leo Manzewitsch, Former CTO
    200,000       1,500  
Dr. George Gabb, Director
    25,000       188  
Sub – total (officers)
    1,825,000       13,688  
all other employees
    575,500       4,316  
Total
    2,400,500     $ 18,004  

Summary of 2010 Stock Option Plan:

Distribution on July 26, 2010
3,709,500
 common stock shares
Distribution on May 23, 2011
3,890,000
 common stock shares
Distribution on July 26, 2011
2,400,500
 common stock shares
  10,000,000
 common stock shares

We have issued all approved common shares under our 2010 Stock Option Plan.

2011 Stock Option Plan

On June 15, 2011, Net Talk.com, Inc. (the “Company”) adopted the 2011 Stock Option Plan (the "Plan") which is intended to is to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate persons who make (or are expected to make) important contributions to the Company by providing such persons with equity ownership opportunities and performance-based incentives and thereby better aligning the interests of such persons with those of the Company’s shareholders. All of the Company’s employees, officers, and directors, and those Company’s consultants and advisors (i) that are natural persons and (ii) who provides bona fide services to the Company not connected to a capital raising transaction or the promotion or creation of a market for the company’s securities, are eligible to be granted options or restricted stock awards under the Plan. The maximum aggregate number of shares of the Company’s common stock that may be issued under the Plan is 30,000,000 shares of the Company’s common stock.

 
12

 

Recent Sales of Unregistered Securities

Unless otherwise noted, the issuances noted below are all considered exempt from registration by reason of     Section 4(2) of the Securities Act of 1933, as amended.

Item 6. Selected financial data.

As a smaller reporting company, we are not required to include disclosure, pursuant to this item.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion and analysis of our financial condition and results of operations contains forward-looking   statements that involve risks and uncertainties. We have based these forward-looking statements on our current expectations and projections of future events. However, our actual results could differ materially from those discussed herein as a result of the risks that we face, including but not limited to those risks stated in ”Risk Factors," or faulty assumptions on our part. In addition, the following discussion should be read in conjunction with the audited financial statements and the related notes thereto included elsewhere in this Annual Report.

Background

Prior to September 10, 2008, we were engaged in the development of advertising services and strategies. On September 10, 2008, our management and Board of Directors committed to the discontinuance and disposal of our advertising business. We disposed of this asset to be able to concentrate our efforts exclusively on the deployment of our VOIP products.

Liquidity and Capital Resources

We have prepared our financial statements as a going concern.  During the years ended September 30, 2011 and 2010, we generated net losses of $26,176,565 and $6,306,963, respectively. We used cash in our operations in the amounts of $7,100,648 and $2,878,544 during the years ended September 30, 2011 and 2010, respectively.

As of September 30, 2011, we had cash on hand of $3,583,449.
 
Statement of cash flow data:
   
 
 
 
September 30, 2011
   
September 30, 2010
 
             
Net cash provided (used) in operating activities
  $ (7,100,648 )   $ (2,878,544 )
Net cash provided (used) in investing activities
  $ (747,587 )   $ (2,054,170 )
Net cash provided (used) in financing activities
  $ 10,410,000     $ 4,943,700  

Our largest operating expenditures currently consist of the following items: $26,050 per month on leasing our corporate office space and network operational center (NOC) and includes our base rent and associated utility expenses and $200,000 per month on payroll.

Our current long term business plan contemplates acquiring the ongoing business of related companies, either through asset acquisitions, consolidations or mergers.

Borrowing Arrangements

Long-term and short term debt

The carrying values of our long term and short term debt consisted of the following as of September 30, 2011 and 2010:
 
   
2011
   
2010
 
             
$3,500,000 face value 10% debenture, due June 30, 2012 (short-term)
  $ 1,695,404     $ -  
$5,266,130 face value 12% debenture, due July 1, 2013
    2,564,290       -  
$2,000,000 face value 12% notes, due July 1, 2013
    802,730          
$3,146,000 face value 12% convertible debenture, due June 30, 2011
    -       3,146,000  
$587,166 face value 12% convertible debenture, due July 20, 2011
    -       587,166  
$1,265,607 face value 12% convertible debenture, due September 30, 2011
    -       1,265,607  
Total
  $ 5,062,424     $ 4,998,773  

 
13

 
 
Conversion of Convertible Debentures:

On June 30, 2011, the holders of our 12% secured convertible debentures converted the debentures with a total face value of $4,998,773 for an aggregate of 19,995,092 shares of common stock, which was in accordance with the contractual conversion price of $0.25.

The outstanding short and long term debt is secured by a lien of all our assets.

The following constitute events of default under the secured long-term debt held by Vicis Capital Master Fund: (i) failure to pay any interest or principal payment when due; (ii) failure to observe any covenant contained in the secured debenture or the purchase agreement that we executed in connection with the issuance of the secured debenture; (iii) the occurrence of an event of default by us under any other material agreement or lease; (iv) entry of a judgment against us in excess of $150,000; and (v) the appointment of a receiver, the filing of bankruptcy by us, or if we otherwise become insolvent. Additionally, if we seek to prepay the secured debentures, we must pay a prepayment penalty equal to 110% of the then outstanding principal, plus all other amounts due.

The secured debentures contain negative covenants that prohibit us from taking certain corporate actions without the prior written consent of the holder of the secured debentures, Vicis Capital Master Fund. We cannot take the following actions without Vicis Capital Master Funds’ consent while the secured debentures remain outstanding:   (i) incur any additional indebtedness or allow any lien to be filed against our assets, except in certain limited instances; (ii) amend our articles of incorporation or bylaws in a manner that adversely effects the holder of our secured debentures; (iii) repay, repurchase or otherwise acquire more than a de minimis number of shares of our common stock or common stock equivalents from any security holder, except in certain limited instances; (iv) enter into any transactions with our executive officers, directors or affiliates; (v) increase our executive officers’ salary or bonus more than 15% from what was paid in the previous year; or (vi) pay cash dividends or distributions on any of our equity security. We are currently in compliance with all restrictive covenants.

Results of Operations

Comparison - fiscal years ended September 30, 2011 and 2010

Revenues: Our operating income amounted to $2,720,465 and $737,498 for the fiscal years ended September 30, 2011 and 2010, respectively.  The increase in revenues relates tosales to several brick and mortar retail customers and increasing sales volume during the year ended December 31, 2011.

Cost of sales: Our cost of sales amounted to $3,098,366 and $1,453,332 for the fiscal years ended September 30, 2011 and 2010, respectively. The increase in cost of sales relates to increased sales primarily driven by sales to our newly acquired retail customers and increasing sales volume during the year ended December 31, 2011.

Advertising:  Our advertising expenses amounted to $1,701,489 and $357,413 for fiscal years ended September 30, 2011 and 2010. The breakdown of our advertising expense is as follows:
 
   
September 30,
 
   
2011
   
2010
 
             
Infomercial/production time
  $ -     $ 18,400  
Media and others
    1,514,992       339,013  
Smartphone
    186,498       -  
Total
  $ 1,701,490     $ 357,413  

Compensation and Benefits: Our compensation and benefits expense amounted to $1,262,994 and $477,576 for fiscal years ended September 30, 2011 and 2010.   This amount represents normal salaries and wages paid to management members and employees.  The increase is due to the addition of employees in our development, engineering and operations departments.  Total employees increased from 35 at September 30, 2010 to 52 at September 30, 2011

Professional Fees: Our professional fees amounted to $235,756 and $255,471 for fiscal years ended September 30, 2011 and 2010, respectively. This amount includes normal payments and accruals for legal, accounting and other professional services related to general business and being a public company.

Depreciation and Amortization: Depreciation and amortization amounted to $356,688 and $363,335 for fiscal years ended September 30, 2011 and 2010.  These amounts represent amortization of our long-lived tangible and intangible assets using the straight-line method and lives commensurate with the assets’ remaining utility. Our long-lived assets, both tangible and intangible, are subject to annual impairment review, or more frequently if circumstances so warrant. During fiscal years ended September 30, 2011 and 2010, we did not calculate or record impairment charges, however, negative trends in our business and our inability to meet our projected future results could give rise to impairment charges in future periods.

 
14

 
 
Research and Development and Software Costs

We expense research and development expenses, as these costs are incurred. We account for our offering-related software development costs as costs incurred internally in creating a computer software product and are charged to   expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model.  At this time our main products, the DUO are being sold in the market place.  Therefore, research and development cost reported in our financial statements relates to pre – marketing cost and are expensed accordingly.

Components of Research and development:
 
September 30, 2011
   
September 30, 2010
 
 
           
Product development and engineering
  $ 405,645     $ 119,933  
Payroll and benefits
    497,724       255,264  
Total
  $ 903,369     $ 375,197  

General, Selling and Administrative Expenses: General, selling and administrative expenses amounted to $1,484,971 for the fiscal year ended September 30, 2011 as compared to $547,075 for the year ended September 30, 2010 and consisted of general corporate expenses.

Our general and administrative expenses are made up of the following items:
 
Items
 
September 30, 2011
   
September 30, 2010
 
 
           
Bad debt
  $ -     $ 21,707  
Insurance
    116,023       73,801  
Software support
    42,883       26,671  
Rent and occupancy
    277,228       175,876  
Taxes and licenses
    77,661       17,538  
Travel
    176,031       85,088  
Distribution, processing and commissions
    434,885       -  
Other
    360,260       146,394  
Total
  $ 1,484,971     $ 547,075  

Loss from operations: Loss from operations amounted to $6,323,169 and $3,091,901 for the fiscal year ended September 30, 2011 and 2010.  The increase in net loss resulted primarily from an increase in payroll and advertising expense to sustain our growth in the retail segment and support awareness of the Company’s products.  Research and development expenses increased as a result of the DUO WIFI and other products expected to roll out during 2012.

Interest Expense: Interest expense amounted to $1,070,522 for the fiscal year ended September 30, 2011 as compared to $1,058,363 for the fiscal year ended September 30, 2010. Such amount represented (i) stipulated interest under our aggregate $4,998,773 face value convertible debentures that were converted to common stock during the year and our secured debentures issued on August 8, 2011, (ii) the related amortization of premiums and discounts  (iii) the amortization of deferred finance costs.  Aggregate premiums continue to be credited to interest expense over the term of the debentures using the effective interest method.

Derivative Income (Expense): Derivative income (expense) amounted to $(17,280,018) for the fiscal year ended September 30, 2011 as compared to derivative income of $1,445,632 for the year ended September 30, 2010. Such amount represents the change in fair value of liability-classified warrants. Derivative financial instruments are carried as liabilities, at fair value, in our financial statements with changes reflected in income. In addition to the liability-classified warrants, we also had certain compound derivative financial instruments related to our $4,998,773 face value convertible debentures that had de minimus values. We are required to adjust our warrant and compound derivatives to fair value at each reporting period. The fair value of our warrant derivative is largely based upon fluctuations in the fair value of our common stock. The fair value of our compound derivative is largely based upon estimates of cash flow arising from the derivative and credit-risk adjusted interest rates. Accordingly, the volatility in these underlying valuation assumptions will have future effects on our earnings.

 Debt extinguished:  Debt extinguished amounted to $1,293,538 for the fiscal year ended September 30, 2011 as compared to $3,617,983 for the fiscal year ended September 30, 2010.  The amount represents loss recognized related to the June 30, 2011 transaction whereupon the investor converted debt into shares of our common stock and was granted inducement warrants to convert such debt; expense was also incurred to settle accrued interest as part of the transaction.  The expense incurred during the Fiscal Year Ended September 30, 2011 related to the issuance of new debentures on February 24, 2010.

Net Loss: Net loss amounted to $26,176,565 for the fiscal year ended September 30, 2011, as compared to a net loss of $6,306,963 for the fiscal year ended September 30, 2010.

 
15

 

Net Loss Per Common Share: Basic loss per common share represents our net loss divided by the weighted average number of common shares outstanding during the period. Diluted loss per common share gives effect to all potentially dilutive securities. We compute the effects on diluted loss per common share arising from warrants and options using the treasury stock method. Applying this method, 80,942,305 and 20,000,000 shares indexed to warrants and convertible preferred stock, respectively were excluded from our computation because the effect was anti-dilutive. We computed the effects on diluted loss per common share arising from convertible securities using the if-converted method. The effects, if anti-dilutive are excluded.

Contractual obligations

Our principal executive offices are located at 1100 NW 163rd Drive, Miami, Florida 33169.  Our offices consist of approximately 3,500 square feet. Our lease was extended on June 1st, 2011 for a term of 1 year, terminating on May 31, 2012.  The facility is suitable for our purposes and is expected to accommodate our needs until we move all company operations to our newly purchased building. Rent and associated occupancy expenses for the fiscal year ended September 30, 2011 and 2010 was $277,228 and $175,876, respectively.

Off-Balance Sheet Arrangements

None

Critical Accounting Policies and estimates

Our accounting policies are discussed and summarized in Note 1 to our financial statements.  The following describes our critical accounting policies and estimates.

Critical Accounting Policies

The financial information contained in our comparative results of operations and liquidity disclosures has been derived from our financial statements. The preparation of those financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and notes. The following significant estimates were made in the preparation of our financial statements and should be considered when reading our Management’s Discussion and Analysis:
 
·
Impairment of Long-lived Assets: Our telecommunications equipment, other property and intangible assets are material to our financial statements. Further, they are subject to the potential negative effects arising from technological obsolescence. We evaluate our tangible and definite-lived intangible assets for impairment annually or more frequently in the presence of circumstances or trends that may be indicators of impairment. Our evaluation is a two step process. The first step is to compare our undiscounted cash flows, as projected over the remaining useful lives of the assets, to their respective carrying values. In the event that the carrying values are not recovered by future undiscounted cash flows, as a second step, we compare the carrying values to the related fair values and, if lower, record an impairment adjustment. For purposes of fair value, we generally use replacement costs for tangible fixed assets and discounted cash flows, using risk-adjusted discount rates, for intangible assets. These estimates are made by competent employees, using the best available information, under the direct supervision of our management.

·
Intangible assets: Our intangible assets require us to make subjective estimates about our future operations and cash flows so that we can evaluate the recoverability of such assets. These estimates consider available information and market indicators including our operational history, our expected contract performance, and changes in the industries that we serve.

·
Share-based payment arrangements: We currently intend to issue share-indexed payments in future periods to employees and non-employees. There are many valuation techniques, such as Black-Scholes-Merton valuation model that we may use to value share-indexed contracts, such as warrants and options. All such techniques will require certain assumptions that require us to develop forward-looking information as well as historical trends. For purposes of historical trends, we may need to look to peer groups of companies and the selection of such groups of companies is highly subjective.

·
Common stock valuation: Estimating the fair value of our common stock is necessary in the preparation of computations related to acquisition, share-based payment and financing transactions. We believe that the most appropriate and reliable basis for common stock value is trading market prices in an active market.
 
 
16

 
·
Derivative Financial Instruments: We generally do not use derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. However, we have entered into certain other financial instruments and contracts, such as our secured convertible debenture and warrant financing arrangements that are either (i) not afforded equity classification, (ii) embody risks not clearly and closely related to host contracts, or (iii) may be net-cash settled by the counterparty. We are required to carried as derivative liabilities, at fair value, in our financial statements.  The fair value of share-indexed derivatives will be significantly influenced by the fair value of our common stock (see Common Stock Valuation, above). Certain other elements of forward-type derivatives are significantly influenced by credit-adjusted interest rates used in cash-flow analysis. Since we are required to carry derivative financial instruments at fair value and make adjustments through earnings, our future profitability will reflect the influences arising from changes in our stock price, changes in interest rates,  and changes in our credit standing.

Revenue recognition

We derive revenue from (i) product sales and (ii) telecom services. All revenues are recognized in accordance with ASC 605, Revenue Recognition and SAB 104 as follows:  when evidence of an arrangement exists, in the case of products, when the product is shipped to a customer, or in the case of telecom services, when the service is used by the consumer, when the fee is fixed or determinable and finally when we have concluded that amounts are collectible from the customers. Shipping costs billed to customers are included as a component of product sales. The associated cost of shipping is included as a component of cost of product sales.

Operating revenue consist of customer equipment sales of our main product the NetTalk DUO (“DUO”), telecommunication service revenues, shipping and handling revenues.

On July 14, 2010 we revealed our newest product the net TALK DUO (“DUO”).

Our DUO offers our customers free nationwide calls to any landline or mobile phone in the U.S. and Canada from anywhere in the world, as well as low-cost international rates.  It’s also a versatile digital phone service with no monthly fees, no contracts and no computer required.

Our DUO is flexible enough to connect directly to your Internet connection through the router/modem, there is also a convenient option with our DUO to connect to your computer. The sleek design is small enough to fit in the palm of your hand, making it a portable device.

Our DUO reduces the wear and tear on your home or office computer and reduces energy costs, resulting in money savings. Our fax-friendly DUO, offers fax (incoming and outgoing), a unique feature not offered, to our knowledge, by similar digital phone services.

The portability of this small device is also great for international travelers who want to place free nationwide calls to the U.S. and Canada, or who are looking for a low-cost solution for international rates. Calls to other netTALK customers are always free.

Our DUO provides for revenue recognition from the sale of the device and from the sale of telephone service. The initial year of telephone service is included on the sale price at time of sale and billed subsequently thereafter. Therefore, revenue recognition on our DUO is fully recognized at the time of our customer equipment sale, the one year telephone service is amortized over 12 month cycle.  Subsequent renewals of the annual telephone service are amortized over the corresponding 12 months cycle.

International calls are billed as earned from our customers.  International calls are prepaid and customers account is debited as minutes are used and earned.

Inventory

Inventory consists of the cost of customer equipment and is stated at the lower of cost or market.

At the present time we do not provide for inventory allowance.  As we continue to sell our product we will evaluate the need for such an allowance.
 
 
September 30,
 
Inventory
 
2011
   
2010
 
Productive material and supplies
  $ 1,109,743     $ 454,231  
Finished products
    801,905       114,329  
Total
  $ 1,911,648     $ 568,560  

During the year ended September 30, 2011 and 2010, in accordance with our lower of cost or market analyses we did not recorded any lower of cost or market adjustments to our finished goods inventories.

 
17

 

 
Of our $801,905 of finished goods inventory, $151,564 of it is held on consignment at one of our distributors.
Income taxes

We recognized deferred taxes for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts using tax rates in effect for the year since the differences are expected to reverse.  We have recorded a valuation allowance on the assumption that we will not have any future taxable income.

Net operating loss carry-forwards

As of September 30, 2011, we had net operating loss carry-forwards for US federal and state tax purposes expiring at various times from thru 2024.

Recent accounting pronouncements

In May 2011, the FASB issued an update that amends the guidance provided in ASC Topic 820, Fair Value Measurement, by clarifying some existing concepts, eliminating wording differences between GAAP and International Financial Reporting Standards (“IFRS”), and in some limited cases, changing some principles to achieve convergence between GAAP and IFRS. The update results in a consistent definition of fair value, establishes common requirements for the measurement of and disclosure about fair value between GAAP and IFRS, and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This update becomes effective in the second quarter of fiscal 2012. We do not expect the adoption of this update to have a material impact on our consolidated financial statements.
 
In June 2009, the Financial Accounting Standards Board (“FASB”) issued the FASB Accounting Standards Codification (“Codification”). The Codification is the single source for all authoritative Generally Accepted Accounting Principles (“GAAP”) recognized by the FASB to be applied for financial statements issued for periods ending after September 15, 2009. The Codification does not change GAAP and did not have a material impact on the Company’s financial statements.

Accounting Changes

Effective on October 1, 2009, we adopted Emerging Issues Task Force Consensus No. 07-05 Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock  (“EITF 07-05”). EITF 07-05 amended previous guidance related to the determination of whether equity-linked contracts, such as our convertible debentures, meet the exclusion to bifurcation and derivative classification of the respective embedded conversion feature. Under EITF 07-05, the embedded conversion option was no longer exempt from bifurcation and derivative classification because the conversion option was subject to adjustments that are not allowable under the new standard. We have accounted for the change as a change in accounting principle where the cumulative effect, which amounted to $872,320, as a charge to our opening additional paid in capital on October 1, 2009.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and, as such, are not required to provide the information under this item.

Item 8. Financial Statement and Supplementary Data

The financial statements begin on Page F-1.

Item 9. Changes In and  Disagreements With Accountants On Accounting and Financial Disclosure

None.

Item 9A(T). Controls and Procedures

Disclosure controls

We maintain “disclosure controls and procedures,” as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 
18

 

As of September 30, 2011, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective in ensuring that information required to be disclosed by us in our periodic reports is recorded, processed, summarized and reported, within the time periods specified for each report and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

In connection with the assessment described above, management identified the following control deficiencies that represent material weaknesses at September 30, 2011:

 
·
Due to the Company’s limited resources, the Company has insufficient personnel resources and technical accounting and reporting expertise to properly address all of the accounting matters inherent in the Company’s financial transactions.  The Company does not have a formal audit committee, and the Board does not have a financial expert, thus the Company lacks the board oversight role within the financial reporting process.

 
The Company’s small size and “one-person” office prohibits the segregation of duties and the timely review of accounts payable, expense reporting and inventory management and banking information.

Our Chief Executive Officer and Chief Financial Officer are in the process of determining how best to change our current system and implement a more effective system to insure that information required to be disclosed in this annual report on Form 10-K has been recorded, processed, summarized and reported accurately.  Our management acknowledges the existence of this problem, and intends to developed procedures to address them to the extent possible given limitations in financial and manpower resources.   While management is working on a plan, no assurance can be made at this point that the implementation of such controls and procedures will be completed in a timely manner or that they will be adequate once implemented.

Management report on internal control over financial reporting

Our management is responsible for establishing and maintaining adequate internal control over financing reporting for our company.  Internal control over financial reporting is defined in Rule 13a – 15(f) and 15d – 15(f) of the Securities and Exchange Act of 1934 as a process designed by or under the supervision of our principal executive and principal financial officer and effected by board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

·
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and disposition of assets of the company;

·
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

·
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations, internal control over financial reporting may not detect or prevent misstatements.  Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our management assessed the effectiveness of our internal control over financial reporting as of September 30, 2011. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in internal control – integrated framework. Based on our assessment, management concluded that as of September 30, 2011, our internal control over financial reporting is not effective based on those criteria.

 
19

 

 
In connection with the assessment described above, management identified the following control deficiencies that represent material weaknesses at September 30, 2011:

 
·
Due to the Company’s limited resources, the Company has insufficient personnel resources and technical accounting and reporting expertise to properly address all of the accounting matters inherent in the Company’s financial transactions.  The Company does not have a formal audit committee, and the Board does not have a financial expert, thus the Company lacks the board oversight role within the financial reporting process.

 
·
The Company’s small size and “one-person” office prohibits the segregation of duties and the timely review of accounts payable, expense reporting and inventory management and banking information.

Our Chief Executive Officer and Chief Financial Officer are in the process of determining how best to change our current system and implement a more effective system to insure that information required to be disclosed in this annual report on Form 10-K has been recorded, processed, summarized and reported accurately.  Our management acknowledges the existence of this problem, and intends to developed procedures to address them to the extent possible given limitations in financial and manpower resources.   While management is working on a plan, no assurance can be made at this point that the implementation of such controls and procedures will be completed in a timely manner or that they will be adequate once implemented.  Failure to develop adequate internal control and hiring of qualified accounting personnel may result in a “material weakness” in the Company’s internal control relating to the above activities.

This annual report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission.

Changes in Internal Controls.

During the year ended September 30, 2011, there were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (f) of Rule 13a-15 or Rule 15d-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Item 9 B.  Other Information

None

 
20

 

Part III

Item 10. Directors, executive officers and corporate governance

The following table sets forth certain information with respect to each of our directors, executive officers and key employees as of September 30, 2011. Their ages, positions, dates of initial election or appointment, and the expiration of their terms are as follows:
 
Name
Age
Position
Period served
       
Anastasios Kyriakides
63
Director, Chief Executive Officer, Secretary
Sept. 2008 to present
       
Kenneth A. Hosfeld
60
Director, Vice President Carriers
Sept. 2008 to present
       
Guillermo Rodriguez
63
Director, Chief Financial Officer
Sept. 2008 to present
       
Dr. Dr. George Gabb,
43
Director, Information Technology
May 2011 to present

Unless expressly indicated in the above table, each director and officer will serve in these capacities until their successors are duly elected, qualified and seated in accordance with the Company’s Articles of Incorporation and Bylaws.

Departure of Directors and Certain Officers

On September 12, 2011, Leo Manzewitsch resigned as Chief Technical Officer and Director of NetTalk.com, Inc.  To the best of our knowledge, no Executive Officer of the Company is aware of any disagreements between the Company and Leo Manzewitsch and the he did not furnish the Company with any written correspondence concerning the circumstances surrounding his resignation.

Background of Executive Officers and Directors

Anastasios Kyriakides, Director, Chief Executive Officer, Secretary. Mr. Kyriakides has served as a member of the Company’s board of directors and as the Company’s Chief Executive Officer and Secretary since September 2008. Mr. Kyriakides received a Bachelor of Science in business from Florida International University in 1975. In 1977, he received a degree in investment banking from the American Institute of Banking. From 1979 until present, Mr. Kyriakides has consulted for numerous companies in the areas of shipping, travel, banking and electronics. Mr. Kyriakides began his career in the electronics development field when, in 1979, he founded and served as Chairman of Lexicon Corporation, producer of the LK300, the first hand held electronic language translator which translated words and phrases into 12 different languages. Lexicon was publicly traded on the NASDAQ, under the symbol LEXI, until it was ultimately acquired by Nixdorf Computers of Germany. Mr. Kyriakides was also the founder of Delcor Industries, established in 1980 in Hollywood, Florida. Delcor was an electronics manufacturing facility employing over 150 employees to assemble OEM products for various electronics companies including IBM mainframe and Gable Division. In 1983, Mr. Kyriakides founded the Mylex Corporation to develop and produce the world’s first hand-held optical scanner and VGA card for personal computers. As the President and Chairman, Mr. Kyriakides guided Mylex from its beginning as a private company to its becoming a public company traded on the NASDAQ under the stock symbol MYLX until it was acquired as a wholly owned subsidiary of IBM (NYSE: IBM). In 1983, Mr. Kyriakides was the founder and Chairman of Tower Bank NA, a full service commercial bank, with three offices, headquartered in Dade County, Florida. Mr. Kyriakides also has extensive experience in the cruise line and travel industries. His cruise ship career started with Carnival Cruise line out of the Port of Miami, and continued to a successful start up with Tropicana Cruises; one of the first gaming ships out of the Port of Miami. Mr. Kyriakides founded Regency Cruise Line in 1984, as the world’s first publicly traded company in passenger shipping, and served as its Chairman and Secretary until 1987. Mr. Kyriakides also organized the successful start-up of Seawind Cruise Line. In his three years with Seawind Cruise Line, Mr. Kyriakides served as its founder, chairman, chief executive officer and secretary.

From 1994 to 1996, Mr. Kyriakides served as the Chairman of Montgomery Ward Travel, a company created to provide full travel services to eight million Montgomery Ward customers and credit card holders. Immediately prior to joining the Company, Mr. Kyriakides served as Chief Executive Officer of Interlink Global Corporation from 1994 until September, 2008. Interlink Global Corporation provided telecommunications applications utilizing hardware and software that enables its domestic and worldwide users to access the internet as a transmission medium for placing telephone calls.

 
21

 

Kenneth Hosfeld, Director, Executive Vice President. Mr. Hosfeld was appointed to serve on the Company’s board of directors in September 2008. Mr. Hosfeld has over twenty-two years of international sales, marketing, and business management experience in the telecommunications industry. Most recently, Mr. Hosfeld served as a member of the board of directors and the executive vice president for Interlink Global Corporation (OTC: ILKG), a provider of private and public telecommunication network and internet services. Prior to joining Interlink, Mr. Hosfeld co-founded NetExpress. He has also served as the Regional Director of Brazil, the Andinos, and the Caribbean for Tellabs, Inc., a global supplier to the dynamic telecommunications industry that designs, manufactures, markets and services voice, data a video transportation tools and networks. While with Tellabs, Mr. Hosfeld secured that company’s first “turn-key” contract which involved a complete, fully managed network deployment including all products and services and project financing. He also opened Tellabs’ offices in Brazil and regularly exceeded revenue targets. Prior to that, Kenneth was Vice President of Nera Latin America, a subsidiary of Nera Telecommunications (formerly ABB), a telecommunications and IT solutions provider for microwave, satellite, wireless broadband access, networking and broadcasting. Mr. Hosfeld had full production and logistic responsibility for the Latin American region, including responsibilities for opening offices throughout Latin America including such countries as Brazil, Colombia, Mexico, and Venezuela, While with the company, Mr. Hosfeld was also able to penetrate the Mexican and Chilean markets. Prior to his work with Nera Latin America, Mr. Hosfeld was responsible for similar product sales in Africa and in China. Mr. Hosfeld speaks over six languages including fluent Spanish and Portuguese. Immediately prior to joining the Company, Mr. Hosfeld served as Executive Vice President of Interlink Global Corporation from 1994 until September, 2008. Interlink Global Corporation provided telecommunications applications utilizing hardware and software that enables its domestic and worldwide users to access the internet as a transmission medium for placing telephone calls.

Guillermo Rodriguez, Director, Chief Financial Officer. Mr. Rodriguez was appointed to the Company’s board of directors in September 2008. Mr. Rodriguez was a certified public accountant. He earned his Bachelor’s Degree with a major in accounting and business administration from the University of Miami in Coral Gables, Florida. Mr. Rodriguez earned his Masters of Business Administration from Nova Southeastern University in Davie, Florida. He has extensive accounting and financial reporting experience in banking, real estate brokering, property management and the telecommunications industry. Prior to joining the Company in September 2008, Mr. Rodriguez worked for Interlink Global Corporation from 2005 until September 2008 and as controller and financial officer for Land Cellular Corporation from 2003 until 2005. Prior to that, Mr. Rodriguez served as controller and financial officer for Bremer Real Estate, CSW Associates and Consolidated Bank, N.A. Mr. Rodriguez also worked as an auditor and investigator for the Federal Deposit Insurance Corporation (FDIC). Mr. Rodriguez is fluent in Spanish.
 
Dr. George Gabb, Director.
 
Mr. Gabb has over 18 years of experience within the education field.  Currently he oversees the Computer Information Systems department at Miami Dade College North Campus (“MDC”), covering a wide variety of programming languages.  Mr. Gabb has been with MDC since 1998 and has a total of 18 years of experience within the education field. Prior to his stay at MDC, he held a variety of Director-level academic IT-related positions. In addition to his academic background, Mr. Gabb is a member of the Florida Bar. He holds a B.S. in Psychology, M.S. in Computer Information Systems, and a J.D. from Nova Southeastern University.

Significant employees

Other than the executive officers named above, the Company does not have any “significant employees.”

Family relationship

None.

Involvement in legal proceedings

No officer, director, promoter or significant employee has been involved in the last five years in any of the following:
 
·
Any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time;
·
Any conviction in a criminal proceeding or being subject to a pending criminal proceeding (excluding traffic violations and other minor offenses);
·
Being subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoying, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities; and
·
Being found by a court of competent jurisdiction (in a civil action), the Commission or the Commodity Futures Trading Commission to have violated or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.
 
 
22

 

Committees

Our business, property and affairs are managed by or under the direction of the board of directors. Members of the board are kept informed of our business through discussion with the chief executive and financial officers and other officers, by reviewing materials provided to them and by participating at meetings of the board and its committees. We presently do not have any committees of our board of directors, however, our board of directors intends to establish various committees at some point in the near future.

Employment Agreements

On May 6, 2009, the Company entered into an Employment Agreement with Anastasios N. Kyriakides (the “Kyriakides Employment Agreement”) pursuant to which Mr. Kyriakides agreed to continue his service as President and Chief Executive Officer of the Company through May 5, 2012.  On May 16, 2011, the employment agreement was amended to extend Mr. Kyriakides current service period for a three year period, ending May 16, 2014 with an automatic two year renewal, increase his salary to $250,000 starting January 1, 2012 and include a change of control clause which requires a cash payment of $1,500,000 if a change in control within the Company occurs.

Under the pre-revised Kyriakides Employment Agreement, Mr. Kyriakides’ base salary was $150,000 per annum, subject to annual increases at the discretion of the Board of Directors. Still applicable from the pre-revised agreement are the following:Mr. Kyriakides is (a) eligible for an annual performance based cash bonus up to a maximum annual award of $112,500 to be determined based upon profitability of the Company, (b) eligible to receive a onetime award on May 5, 2012 of shares of common stock having a maximum value of up to $168,750 to be determined based upon profitability of the Company during the 3 year period ending on May 5, 2012, (c) entitled to receive health benefits and life insurance coverage, (d) entitled to receive a monthly car allowance not to exceed $500 a month, (e) eligible to receive other stock grants and/or options to purchase shares of the Company’s common stock in amounts and upon terms as determined by the Company’s Board of Directors from time to time The Kyriakides Employment Agreement may be terminated by the Board of Directors at any time for cause, provided that Mr. Kyriakides receives notice of such termination and fails to cure the alleged breach. Upon termination by the Company without cause or resignation by Mr. Kyriakides for good reason, Mr. Kyriakides is entitled to receive his base salary, as severance, for a 12 month period.

On May 16, 2011, we executed an Amended Employment Agreement with Mr. Kyriakides our Chief Executive Officer and President as follows:

Salary set at $199,000 per year and $250,000 starting on January 1, 2012.

Three year term with automatic renewal of two years.

Change of control cash payment set at $1,500,000

Currently, with the exception of Mr. Kyriakides Employment Agreement, all other employment with the Company is at will and may be terminated by either the employee or the Company at any time. We require each of our three executive officers to execute a Confidentiality and Non-Competition Agreement.

Compliance with Section 16(a) of the Exchange Act

Section 16(a) of the Securities Exchange Act of 1934 requires our directors and executive officers and persons who beneficially own more than ten percent of a registered class of our equity securities to file with the SEC initial reports of ownership and reports of change in ownership of common stock and other equity securities of our company. Officers, directors and greater than ten percent stockholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to us under Rule 16a-3(e) during the fiscal year ended September 30, 2011, and Forms 5 and amendments thereto furnished to us with respect to the fiscal year ended September 30, 2011, we believe that during the year ended September 30, 2011, our executive officers, directors and all persons who own more than ten percent of a registered class of our equity securities have complied with all Section 16(a) filing requirements.

Code of Ethics

We have adopted a Code of Ethics for our officers, directors and employees. A copy of the Code of Ethics is attached to our Form 10-K for the fiscal year ended September 30, 2010 filed on December 15, 2010 as Exhibit 14.

 
23

 

Item 11. Executive compensation

Compensation of our executive officers

The following table contains compensation information for our executive officers for the fiscal years ended September 30, 2011 and September 30, 2010. No other officer received compensation greater than $100,000 for either fiscal year. All of the information included in this table reflects compensation earned by the individuals for services rendered to our Company and all references in the following tables to stock awards relate to awards of common stock granted by us.
 
Name and Position
 
Year
 
Salary
   
Common Stock Awards
   
Total
 
Anastasios Kyriakides, Director,
 
2011
  $ 190,000 (2)   $ 21,874 (10)   $ 211,874  
Chief Executive Officer (1)
 
2010
  $ 178,791 (2)   $ 57,000 (4)   $ 235,791  
Kenneth Hosfeld, Director,
 
2011
  $ 96,0000 (8)   $ 3,413 (11)   $ 99,413  
Executive Vice President (7)
 
2010
  $ 96,000 (8)   $ 12,000 (9)   $ 108,000  
Guillermo Rodriguez, Director,
 
2011
  $ 85,000 (5)   $ 5,250 (12)   $ 90,250  
Chief Financial Officer (4)
 
2010
  $ 81,200 (5)   $ 12,000 (6)   $ 93,200  

 
(1)
Mr. Kyriakides was appointed to serve as our Chief Executive Officer on September 10, 2008. All amounts reflected in this table are from the date of Mr. Kyriakides appointment to the end of fiscal years.

 
(2)
Mr. Kyriakides annual salary increased to $199,000 during the fiscal year ended September 30, 2011 and increases to $250,000 at January 1, 2012 per his amended employment agreement dated May 16, 2011.

 
(3)
The Board of Directors granted Mr. Kyriakides a stock grant of 1,900,000 shares on July 26, 2010. The stock was valued at $0.03 per share including adjustment for ownership restriction

 
(4)
Mr. Rodriguez was appointed to serve as Chief Financial Officer on September 30, 2008. All amounts reflected in this table are from the date of Mr. Rodriguez appointment to the end of fiscal years.

 
(5)
Mr. Rodriguez annual salary was increased to $85,000.00 during the fiscal year ended September 30, 2011.

 
(6)
The Board of Directors granted Mr. Rodriguez a stock grant of 400,000 shares on July 26, 2010. The stock was valued at $0.03 per share including adjustment for ownership restriction.

 
(7)
Mr. Hosfeld was appointed to serve as our Executive Vice President on September 30, 2008. All amounts reflected in this table are from the date of Mr. Hosfeld appointment to the end of fiscal years.

 
(8)
Mr. Hosfeld annual salary is $96,000.00.

 
(9)
The Board of Directors granted Mr. Hosfeld a stock grant of 400,000 shares on July 26, 2010. The stock was valued at $0.03 per share including adjustment for ownership restriction.

 
(10)
The Board of Directors granted Mr. Kyriakides a stock grant of 1,716,500 and 1,200,000 of the Company’s common stock on May 23 and July 26, 2011, respectively.  The stock was valued at $0.01 per share including adjustment for ownership restriction.

 
(11)
The Board of Directors granted Mr. Hosfeld a stock grant of 255,000 and 200,000 of the Company’s common stock on May 23 and July 26, 2011, respectively.  The stock was valued at $0.01 per share including adjustment for ownership restriction

 
(12)
The Board of Directors granted Mr. Rodriguez a stock grant of 500,000 and 200,000 of the Company’s common stock on May 23 and July 26, 2011, respectively.  The stock was valued at $0.01 per share including adjustment for ownership restriction

 
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Overview

The following is a discussion of our program for compensating our named executive officers and directors. Currently, we do not have a compensation committee, and as such, our board of directors is responsible for determining the compensation of our named executive officers. The primary goal of our executive compensation policy is to attract and retain the most talented and loyal executives possible. Our intent is to ensure that our executives are compensated effectively in a manner consistent with our strategy and competitive practice and to align executive compensation with the achievement of our short and long term business objectives.

 Our board of directors considers a variety of factors in determining compensation of executives including the executive’s background, training and prior work experience.

Elements of executive compensation

Our compensation program for the named executive officers consists primarily of base salary. There is no bonus plan, retirement plan, long-term incentive plan or other such plans. The base salary we provide is intended to equitably compensate the named executive officers based upon their level of responsibility, complexity and implementation of our business plan.

2010 Stock Option Plan

On November 15, 2009, Net Talk.com, Inc. (the “Company”) adopted the 2010 Stock Option Plan (the "Plan") which is intended to is to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate persons who make (or are expected to make) important contributions to the Company by providing such persons with equity ownership opportunities and performance-based incentives and thereby better aligning the interests of such persons with those of the Company’s shareholders. All of the Company’s employees, officers, and directors, and those Company’s consultants and advisors (i) that are natural persons and (ii) who provides bona fide services to the Company not connected to a capital raising transaction or the promotion or creation of a market for the company’s securities, are eligible to be granted options or restricted stock awards under the Plan. The maximum aggregate number of shares of the Company’s common stock that may be issued under the Plan is 10,000,000 shares of the Company’s common stock.

2010 Stock option plan (Share-based payments employees):

On July 26, 2010, May 23, 2011 and July 26, 2011 we issued 3,709,500, 3,890,000 and 2,400,000 shares of common stock to our employees as part of our 2010 Stock Option Plan.  We have issued all approved common shares under our 2010 Stock Option Plan.
The shares are compensatory in nature and are fully vested.  We have valued the shares at $0.03, $0.01 and $0.01, respectively per share consistent with fair value at the time of issuance including and adjusted for ownership restrictions.

The shares were issued to officers and employees, as follows:
           
   
Shares
   
Expense
 
Anastasios Kyriakides, CEO and President
    1,900,000     $ 57,000  
Kenneth Hosfeld, EVP
    400,000       12,000  
Guillermo Rodriguez, CFO
    400,000       12,000  
Leo Manzewitsch, CTO
    400,000       12,000  
Sub – total (officers)
    3,100,000       93,000  
all other employees
    609,500       18,285  
Total
    3,709,500     $ 111,285  
                 
May 23, 2011 Issuance
               
                 
The shares were issued to officers and employees, as follows:
               
   
Shares
   
Expense
 
Anastasios Kyriakides, CEO and President
    1,716,500     $ 12,874  
Kenneth Hosfeld, EVP
    255,000       1,913  
Guillermo Rodriguez, CFO
    500,000       3,750  
Leo Manzewitsch, Former CTO
    500,000       3,750  
Dr. George Gabb, Director
    50,000       375  
Sub – total (officers)
    3,021,500       22,662  
all other employees
    868,500       6,513  
Total
    3,890,000     $ 29,175  
 
 
25

 

 
July 26, 2011 Issuance
           
             
The shares were issued to officers and employees, as follows:
           
   
Shares
   
Expense
 
Anastasios Kyriakides, CEO and President
    1,200,000     $ 9,000  
Kenneth Hosfeld, EVP
    200,000       1,500  
Guillermo Rodriguez, CFO
    200,000       1,500  
Leo Manzewitsch, Former CTO
    200,000       1,500  
Dr. George Gabb, Director
    25,000       188  
Sub – total (officers)
    1,825,000       13,688  
all other employees
    575,500       4,316  
Total
    2,400,500     $ 18,004  

We have issued all approved common shares under our 2010 Stock Option Plan.

2011 Stock Option Plan

On June 15, 2011, Net Talk.com, Inc. (the “Company”) adopted the 2011 Stock Option Plan (the "Plan") which is intended to is to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate persons who make (or are expected to make) important contributions to the Company by providing such persons with equity ownership opportunities and performance-based incentives and thereby better aligning the interests of such persons with those of the Company’s shareholders. All of the Company’s employees, officers, and directors, and those Company’s consultants and advisors (i) that are natural persons and (ii) who provides bona fide services to the Company not connected to a capital raising transaction or the promotion or creation of a market for the company’s securities, are eligible to be granted options or restricted stock awards under the Plan. The maximum aggregate number of shares of the Company’s common stock that may be issued under the Plan is 30,000,000 shares of the Company’s common stock.

Compensation of Directors

None of the Company’s directors have received any additional cash or equity remuneration since inception for their services as Directors except for Dr. George Gabb, one of the Company’s Board of Directors, who received 75,000 shares of stock valued at $563 during the fiscal year ended September 30, 2011.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The following table sets forth certain information, as of September 30, 2011 with respect to the beneficial ownership of the outstanding common stock by (i) any holder of more than five (5%) percent; (ii) each of our executive officers and directors; and (iii) our directors and executive officers as a group. Except as otherwise indicated, each of the stockholders listed below has sole voting and investment power over the shares beneficially owned.
 
Title
 
Name of beneficiary
 
Amount and nature of owner
(2)
   
Percent
 
 
 
 
           
Common stock
 
Anastasios Kyriakides
    6,980,900 (3)     5.8 0 %
Common stock
 
Kenneth A. Hosfeld
    1,955,000       1.4 %
Common stock
 
Guillermo Rodriguez
    2,200,000       1.5 %
Common stock
 
Dr. George Gabb
    75,000       .01 %
Executive officers and directors (4 persons)
        11,210,900       8.71 %
Common stock
 
Vicis Capital Master Fund
    116,859,612 (4)     83.23 %
Total Common stock  of officers, directors and beneficial owners
    128,070,512       91.94 %

(1)
Unless otherwise indicated, the address of each shareholder is 1100 NW 163rd Drive, Miami, Florida 33169. Vicis Capital Master Fund is located in New York, NY.
 
 
26

 
(2)
Beneficial ownership of shares is determined under Rule 13d-3(d)(1) of the Exchange Act and generally includes any shares over which a person exercises sole or shared voting or investment power and the number of shares that can be acquired within sixty (60) days upon exercise of an option or conversion of warrants and debentures. Common stock subject to these convertible securities are deemed to be outstanding for the purpose of computing   the ownership percentage of the person holding such convertible security, but are not deemed to be outstanding  for the purpose of computing the ownership percentage of any other person. Applicable percentage of ownership is based on 140,407,197 of fully diluted shares of Net Talk.com, Inc. common stock being issued and outstanding as of September 30, 2011.

(3)
Includes: (a) 6,926,500 shares of common stock owned by Kyriakides Investments, LLC. and  (b) 54,400 shares of common stock issuable upon exercise of a Series A Common Stock Purchase Warrant,  which may be exercised, at the option of the holder, at an exercise price of $0.25 per share

(4)
Includes:  19,995,092 shares of common stock, 20,000,000 shares of common stock issuable upon conversion of 12% Redeemable preferred stock. It also includes 76,864,520 shares of common stock issuable upon exercise of Common Stock Purchase WarrantS, which may be exercised, at the option of the holder, at an exercise price of $0.50 per share.

Item 13. Certain relationships and related transactions, and director independence

There were no transactions since the beginning of our last fiscal year, and there are no proposed transactions, that involve amounts in excess of $120,000 to which we were or are to become a party in which any director, executive officer, beneficial owner of more than five (5%) percent of our common stock, or members of their immediate families had, or is to have, a direct or indirect material interest.

Item 14.  Principal Accountant Fees and Services

The Company's board of directors reviews and approves audit and permissible non-audit services performed by its independent accountants, as well as the fees charged for such services. In its review of non-audit service fees and its appointment of  Meeks International, LLC. as the Company's independent accountants, the board of directors considered whether the provision of such services is compatible with maintaining independence. All of the services provided and fees charged by Meeks International, LLC. were approved by the board of directors.

Audit Fees

The aggregate fees billed for professional services for the audit of the annual financial statements of the Company and the reviews of the financial statements included in the Company's quarterly reports on Form 10-Q for 2011 and 2010 were $47,800 and $54,598, respectively, net of expenses.

Audit-Related Fees

There were no other fees billed by during the last two fiscal years for assurance and related services that were reasonably related to the performance of the audit or review of the Company's financial statements and not reported under "Audit Fees" above.

Tax Fees

There were no fees paid for tax or consulting services for fiscal years ended September 30, 2011 or 2010.

All Other Fees

There were no other fees billed during the last two fiscal years for products and services provided.

 
27

 
 
Part IV
 
Item 15. Exhibits, financial statement schedules

Exhibit No.
 
Description
31.1
 
Certification of Principal Executive Officer pursuant to 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
 
Certification of Principal Financial Officer pursuant to 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
 
Certification of the Principal Executive Officer pursuant to U.S.C. Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 
32.2
 
Certification of the Principal Financial Officer pursuant to U.S.C. Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002

 
28

 

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
NET TALK.COM, INC.
   
Date:  December 22,  2011
By: /s/ Anastasios Kyriakides
 
Anastasios Kyriakides
 
Chief Executive Officer (Principal Executive Officer)
   
Date:  December 22,  2011
By: /s/ Guillermo Rodriguez
 
Guillermo Rodriguez
 
Chief Financial Officer (Principal Financial Officer and
Principal Accounting Officer)

POWER OF ATTORNEY

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.    Each person whose signature appears below hereby authorizes Anastasios Kyriakides or either of them acting in the absence of the other as his or her true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution for him or her and in his or her name, place and stead, in any and all capacities to sign any and all amendments to this report, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission.

Name
 
Position
     
   
Chief Executive Officer (Principal Executive Officer)
Anastasios Kyriakides
 
and Director
     
   
Chief Financial Officer (Principal Financial Officer
Guillermo Rodriguez
 
and Principal Accounting Officer) and Director
     
   
Executive Vice President and Director
Kenneth Hosfeld
  
 

 
29

 

Index to financial statements
Page
   
Report of Independent Registered Public Accountant
31
Balance sheets as of September 30, 2011and 2010
32
Statements of operations for the years ended September 30, 2011 and 2010
33
Statements of cash flows for the years ended September 30, 2011 and 2010
34
Statements of stockholders’ deficit for the years ended September 30, 2011 and 2010
35
Notes to financial statements
36
 
 
30

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

NetTalk.com, Inc.
Miami, Florida

We have audited the accompanying balance sheet of NetTalk.com, Inc as of September 30, 2011 and 2010 and the related statement of operations, stockholders’ deficit, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of NetTalk.com, Inc. as of September 30, 2011 and 2010, and the results of their operations, changes in their stockholders’ deficit and their cash flows for the years ended September 30, 2011 and 2010, in conformity with accounting principles generally accepted in the United States of America.
 
/s/ Meeks International, LLC
Tampa, Florida
December 21, 2011

 
31

 
Net Talk.com, Inc.
Balance Sheets

   
September 30,
   
September 30,
 
   
2011
   
2010
 
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 3,583,449     $ 1,021,684  
Restricted cash
    140,420       2,017,655  
Accounts receivable, net of allowance for bad debts of $0 and $22,749, respectively
    696,341       39  
Inventory
    1,911,648       568,560  
Prepaid expenses
    4,820       238,651  
Note receivable
    52,000       -  
Total current assets
    6,388,678       3,846,589  
                 
Building, telecommunications equipment, land and other property, net
    2,995,223       578,618  
Intangible assets, net
    149,137       366,361  
Other assets
    39,754       23,000  
Total assets
  $ 9,572,792     $ 4,814,568  
                 
Liabilities, redeemable preferred stock and stockholders' deficit
               
Current liabilities:
               
Accounts payable
  $ 1,201,331     $ 534,725  
Accrued dividends
    554,767       93,000  
Accrued expenses
    304,263       58,515  
Deferred revenue
    1,022,890       92,906  
Short term debt
    1,695,404       -  
Current portion of senior secured convertible debentures
    -       4,998,773  
Current portion of derivative liabilities
    -       5,905,622  
Total current liabilities
    4,778,665       11,683,541  
                 
Senior debenture
    3,367,020       -  
Total liabilities
    8,145,675       11,683,541  
                 
                 
Redeemable preferred stock, $.001 par value, 10,000,000 shares authrorized, 500 and 300 issued and outstanding as of September 30, 2011 and 2010, respectively
    11,727,701       224,968  
                 
Stockholders' deficit:
               
Common stock, $.001 par value, 300,000,000 authorized, 39,464,892 and 13,429,300 issued and outstanding as of September 30, 2011 and 2010, respectively
    39,465       13,430  
Preferred stock to be issued at future dates
    -       2,000,000  
Additional paid in capital
    28,258,375       3,314,488  
Accumulated deficit
    (38,598,424 )     (12,421,859 )
Total stockholders' deficit
    (10,300,584 )     (7,093,941 )
                 
Total liabilities, redeemable preferred stock and stockholders' deficit
  $ 9,572,792     $ 4,814,568  

The accompanying notes are an integral part of the financial statements

 
32

 

Net Talk.com, Inc.
Statements of Operations

   
Year Ended
 
   
September 30,
 
   
2011
   
2010
 
             
Revenues
  $ 2,720,465     $ 737,498  
Cost of sales
    3,098,366       1,453,332  
Gross margin
    (377,901 )     (715,834 )
                 
Advertising and marketing
    1,701,490       357,413  
Compensation and benefits
    1,262,994       477,576  
Professional fees
    235,756       255,471  
Depreciation and amortization
    356,688       363,335  
Research and development
    903,369       375,197  
General and administrative expenses
    1,484,971       547,075  
Total operating expenses
    5,945,268       2,376,067  
                 
Loss from operations
    (6,323,169 )     (3,091,901 )
                 
Other income (expenses):
               
Interest expense
    (1,070,522 )     (1,058,363 )
Derivative income (expense)
    (17,280,018 )     1,445,632  
Debt extinguished
    (1,293,538 )     (3,617,983 )
Interest income
    4,160       15,652  
Gain (loss) on sale of assets
    (213,478 )     -  
      (19,853,396 )     (3,215,062 )
                 
Net loss
    (26,176,565 )     (6,306,963 )
                 
Reconciliation of net loss to loss applicable to common stockholders:
               
Accretion of preferred stock
    (923,778 )     (93,000 )
Preferred stock dividends
    (586,667 )     -  
                 
Loss applicable to common stockholders
  $ (27,687,010 )   $ (6,399,963 )
                 
Loss per common shares:
               
Basic and diluted earnings per common share
  $ (1.40 )   $ (0.60 )
                 
Weighted average shares:
               
Basic and diluted
    19,792,214       10,654,797  

The accompanying notes are an integral part of the financial statements

 
33

 

Net Talk.com, Inc.
Statements of Cash Flows

   
Year Ended
 
   
September 30,
 
   
2011
   
2010
 
Cash flow from operating activities:
           
Net loss
  $ (26,176,565 )   $ (6,306,963 )
Adjustments to reconcile net loss to net cash (used) in operations:
               
Depreciation
    139,464       124,709  
Amortization
    217,224       238,627  
Amortization of finance costs
    -       72,341  
Amortization of debt discount
    331,605       479,404  
Bad debt expense
    -       21,708  
Warranty expense
    -       3,650  
Derivative fair value adjustments
    17,280,018       (1,445,632 )
Issuance of common stock for services
    -       111,286  
Extinguishment of debt
    1,293,538       3,617,983  
Stock based compensation
    47,927       -  
Cancellation of shares for services
    (271,288 )     -  
Changes in assets and liabilities:
               
Accounts receivables
    (696,302 )     25,610  
Prepaid expenses and other assets
    233,831       (233,644 )
Inventories
    (1,343,088 )     (450,848 )
Deferred revenues
    929,984       82,864  
Accounts payable
    666,604       269,814  
Accrued expenses
    246,399       510,547  
Net cash (used) in operating activities
    (7,100,648 )     (2,878,544 )
Cash flow used in investing activities:
               
Restricted cash
    1,877,235       (2,017,655 )
Acquisition of corporate offices and operations center and  fixed assets
    (2,608,069 )     (38,012 )
Decrease in deposits
    (16,753 )     1,497  
Net cash (used) in investing activities:
    (747,587 )     (2,054,170 )
Cash flow from financing activities:
               
Isssuance of senior debentures
    10,500,000       -  
Issuance of preferred stock and warrants
    -       5,000,000  
Cash paid for dividends on preferred stock
    (90,000 )     -  
Payment on loans from officers
    -       (56,300 )
Net cash provided from financing activities
    10,410,000       4,943,700  
Net increase in cash
    2,561,765       10,986  
Cash and equivalents, beginning
    1,021,684       1,010,698  
Cash and equivalents, ending
    3,583,449       1,021,684  
              -  
Supplemental disclosures:
               
Cash paid for interest
  $ 149,953     $ -  
Cash paid for income taxes
  $ -     $ -  
Cash paid for preferred stock dividends
  $ 90,000     $ 125,000  

The accompanying notes are an integral part of the financial statements

 
34

 

NetTalk.com, Inc.
Statement of Stockholders' Deficit

    
Preferred Stock
   
Common Stock
   
Additional Paid
   
Accumulated
   
Total
 
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Deficit
   
Equity
 
                                            
Balance at September 30, 2009
    -       -       9,719,800       9,720       3,458,825       (5,242,577 )     (1,774,032 )
Stock based compensation
    -       -       3,709,500       3,710       107,575       -       111,285  
Preferred stock to be issued at a future date
    4,000       2,000,000       -       -       -       -       2,000,000  
Issuance of preferred shares
    -       -       -       -       (251,912 )     (689,319 )     (941,231 )
Preferred stock dividends
    -       -       -       -       -       (183,000 )     (183,000 )
Net loss
    -       -       -       -       -       (6,306,963 )     (6,306,963 )
Balance at September 30, 2010
    4,000       2,000,000       13,429,300       13,430       3,314,488       (12,421,859 )     (7,093,941 )
                                                         
Cancellation of common shares for services
    -       -       (1,000,000 )     (1,000 )     (249,000 )     -       (250,000 )
Accretion of preferred stock
    -       -       -       -       (2,782,132 )     -       (2,782,132 )
Reclass of preferred stock to mezzanine and derivative liabilities
    (4,000 )     (2,000,000 )                                     (2,000,000 )
Preferred stock dividends
    -       -       -       -       (586,667 )     -       (586,667 )
Settlement shares
                    750,000       750       366,750               367,500  
Reclassification of warrants from liability to equity
    -       -       -       -       6,963,800       -       6,963,800  
Conversion of convertible notes to common stock
    -       -       19,995,092       19,995       13,776,618       -       13,796,613  
Inducement warrants to convert debt to equity
    -       -       -       -       390,800       -       390,800  
Modification of Mezzanine preferred stock and compound embedded derivatives treated as an extinguishment
    -       -       -       -       553,391       -       553,391  
Settlement of accrued interest
    -       -       -       -       416,014       -       416,014  
Warrants issued with debt financings
    -       -       -       -       6,053,418       -       6,053,418  
Stock issuance related to 2010 stock option plan
    -       -       6,290,500       6,290       40,895       -       47,185  
Net loss
    -       -       -       -       -       (26,176,565 )     (26,176,565 )
Balance at September 30, 2011
    -       -       39,464,892       39,465       28,258,375       (38,598,424 )     (10,300,584 )
 
The accompanying notes are an integral part of the financial statements
 
 
35

 

NET TALK.COM, INC.
Notes to Financial Statements
Year ended September 30, 2011 and 2010

Note 1 – Nature of operations and basis of presentation

Net Talk.com, Inc. (“Nettalk” or the “Company”) was incorporated on May 1, 2006 under the laws of the State of Florida. We are a telephone company, who provides, sells and supplies commercial and residential telecommunication services, including services utilizing voice over internet protocol (“VoIP”) technology, session initiation protocol (“SIP”) technology, wireless fidelity technology, wireless maximum technology, marine satellite services technology and other similar type technologies. Our main products are the DUO and DUO WIFI, both analog telephone adapters that provides connectivity for analog telephones and faxes to home, home office or corporate local area networks (“LAN”). The DUO WIFI can connect to an internet hotspot without the use of an Ethernet cable.  Our DUO and DUO WIFI and their related services are a cost effective solution for individuals, small businesses and telecommuters connecting to any analog telephone, fax or private branch exchange (“PBX”).  Our DUO and DUO WIFI provide one USB port, one Ethernet port and one analog telephone port. The DUO WIFI offers an additional wireless chip that allows it to connect to internet hotspots without the use of an Ethernet cable. A full suite of internet protocol features is available to maximize universal connectivity. In addition, analog telephones attached to our DUO and DUO WIFI are able to use advanced calling features such as call forwarding, caller ID, 3-way calling, call holding, call retrieval and call transfer.

Note 2 – Liquidity and management’s plans:
 
The preparation of financial statements in accordance with generally accepted accounting principles contemplates that operations will be sustained for a reasonable period. However, we have incurred operating losses of $6,238,169 and $3,091,901 during the years ended September 30, 2011 and 2010, respectively. In addition, during these periods, we used cash of $7,100,648 and $2,878,544 during the years ended September 30, 2011 and 2010, respectively, in support of our operating activities. As of September 30, 2010, we have cash on hand of $3,583,449 and total working capital of $1,796,204. Since our inception, we have been substantially dependent upon funds raised through the issuance of senior secured convertible debentures and the sale of preferred and common stock and warrants to sustain our operating and investing activities. The concerns regarding our liquidity have been alleviated as explained in our management’s plans in the following paragraphs of this footnote.
 
Our management began implementing strategic plans designed and developed with the intention of alleviating ongoing operating losses. The principal focus of these plans is an intensified emphasis on the redesign of our consumer products and services. We believe that the planned model will provide more predictable revenue streams as well as current and long-term profitability by providing for next-version, next-generation and follow-on opportunities to our branded products and services.
 
The Company received $10,500,000 from the issuance of senior secured convertible debentures during the year ended September 31, 2011 and $5,000,000 in funding from the sale of preferred stock and warrants and similar transactions during the year ended September 30, 2010. Notwithstanding this additional funding, our ability to continue as a going concern for a reasonable period is dependent upon us receiving funding from our primary funding source and achieving our management’s plans for the Company’s reorganization and, ultimately, generating profitable operations from those restructured operations. We cannot give any assurances regarding the success of management’s plans. Our consolidated financial statements do not include adjustments relating to the recoverability of recorded assets or liabilities that might be necessary should we be unable to continue as a going concern.
 
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 our management to make estimates and assumptions that affect the amounts reported in the financial statements and footnotes. Significant estimates inherent in the preparation of our financial statements include developing fair value measurements upon which to base our accounting for acquisitions of intangible assets and issuances of financial instruments, including our common stock. Our estimates also include developing useful lives for our tangible and intangible assets and cash flow projections upon which we determine the existence of, or the measurements for, impairments. In all instances, estimates are made by competent employees under the supervision of management, based upon the current circumstances and the best information available.

Risk and Uncertainties

Our future results of operations and financial condition will be impacted by the following factors, among others: dependence on the worldwide telecommunication markets characterized by intense competition and rapidly changing technology, on third-party manufacturers and subcontractors, on third-party distributors in certain markets, on the successful development and marketing of new products in new and existing markets. Generally, we are unable to predict the future status of these areas of risk and uncertainty.
 
 
36

 
 
Revenue recognition
 
We derive revenue from (i) product sales and (ii) telecom services. All revenues are recognized in accordance with ASC 605, Revenue Recognition and SAB 104 as follows:  when evidence of an arrangement exists, in the case of products, when the product is shipped to a customer, or in the case of telecom services, when the service is used by the consumer, when the fee is fixed or determinable and finally when we have concluded that amounts are collectible from the customers. Shipping costs billed to customers are included as a component of product sales. The associated cost of shipping is included as a component of cost of product sales.

Operating revenue consist of customer equipment sales of our main product the NetTalk DUO (“DUO”), telecommunication service revenues and shipping and handling revenues.
  
On July 14, 2010 we revealed our newest product the net TALK DUO (“DUO”).
 
Our DUO offers our customers free nationwide calls to any landline or mobile phone in the U.S. and Canada from anywhere in the world, as well as low-cost international rates.  It’s also a versatile digital phone service with no monthly fees, no contracts and no computer required.
 
Our DUO is flexible enough to connect directly to your Internet connection through the router/modem, there is also a convenient option with our DUO to connect to your computer. The sleek design is small enough to fit in the palm of your hand, making it a portable device.
 
Our DUO reduces the wear and tear on your home or office computer and reduces energy costs, resulting in money savings. Our fax-friendly DUO, offers fax (incoming and outgoing), a unique feature not offered, to our knowledge, by similar digital phone services.
 
The portability of this small device is also great for international travelers who want to place free nationwide calls to the U.S. and Canada, or who are looking for a low-cost solution for international rates. Calls to other netTALK customers are always free.
 
Our DUO provides for revenue recognition from the sale of the device and from the sale of telephone service. The initial year of telephone service is included on the sale price at time of sale and billed subsequently thereafter. Therefore, revenue recognition on our DUO is fully recognized at the time of our customer equipment sale, the one year telephone service is amortized over 12 month cycle.  Subsequent renewals of the annual telephone service are amortized over the corresponding 12 months cycle.
 
International calls are billed as earned from our customers.  International calls are prepaid and customers account is debited as minutes are used and earned.
 
Cash and Cash Equivalents

We consider all highly liquid cash balances and debt instruments with an original maturity of three months or less to be cash equivalents. We maintain cash balances only in domestic bank accounts, which at times, may exceed federally insured limits.
 
Inventory

Inventories are recorded at cost or market, whichever is lower.

Inventory
 
2011
   
2010
 
             
Productive material and supplies
 
$
1,109,743
   
$
454,231
 
Finished products
   
801,905
     
114,329
 
Total
 
$
1,911,648
   
$
568,560
 

During the year ended September 30, 2011 and 2010, in accordance with our lower of cost or market analyses we did not recorded any lower of cost or market adjustments to our finished goods inventories.
 
Of our $801,904 of finished goods inventory, $151,564 of it is held on consignment at one of our distributors.

Telecommunications Equipment and Other Property
 
Property, equipment and telecommunication equipment includes acquired assets which consist of network equipment, computer hardware, furniture and software. All of our equipments are stated at cost with depreciation calculated using the straight line method over the estimated useful lives of related assets, which ranges from three to five years.  The cost associated with  major improvements are capitalized while the cost of maintenance and repairs is charged to operating expenses.
 
 
37

 
 
Intangible Assets

Our intangible assets were recorded at our acquisition cost, which encompassed estimates of their respective and their relative fair values, as well as estimates of the fair value of consideration that we issued. We amortize our intangible assets using the straight-line method over lives that are predicated on contractual terms or over periods we believe the assets will have utility.

Impairments and Disposals

We evaluate our tangible and definite-lived intangible assets for impairment annually or more frequently in the presence of circumstances or trends that may be indicators of impairment. Our evaluation is a two step process. The first step is to compare our undiscounted cash flows, as projected over the remaining useful lives of the assets, to their respective carrying values. In the event that the carrying values are not recovered by future undiscounted cash flows, as a second step, we compare the carrying values to the related fair values and, if lower, record an impairment adjustment. For purposes of fair value, we generally use replacement costs for tangible fixed assets and discounted cash flows, using risk-adjusted discount rates for intangible assets.

Research and Development and Software Costs

We expense research and development costs, as these costs are incurred. We account for our offering-related software development costs as costs incurred internally in creating a computer software product and are charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model. Thereafter, all software production costs shall be capitalized and subsequently reported at the lower of unamortized cost or net realizable value. Capitalized costs are amortized based on current and future revenue for each product with an annual minimum equal to the straight-line amortization over the remaining estimated economic life of the product.   At this time our main product the NetTalk DUO is being sold in the market place through both Ecommerce and Brick and Mortar retail establishments.  We plan on rolling out our DUO WIFI in February of 2012. Therefore, research and development cost reported in our financial statements relates to pre – marketing costs of our DUO WIFI and other products we are currently working on and preparing for release in the market place. Research and development costs are expensed accordingly.

   
September 30,
 
Components of Research and development:
 
2011
   
2010
 
Product development and engineering
 
$
405,645
   
$
119,933
 
Payroll and benefits
   
497,724
     
255,264
 
Total
 
$
903,369
   
$
375,197
 
 
Reclassifications

Certain reclassifications have been made to prior years financial statements in order to conform to the current year’s presentation.  The reclassification had no impact on net earnings previously reported.
 
 Share-Based Payment Arrangements
 
In June 2008, the FASB issued authoritative guidance on the treatment of participating securities in the calculation of earnings per shares (“EPS”).  This guidance addresses whether instruments granted in share – based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing EPS under the two - class method.  This guidance was effective for fiscal years beginning on December 15, 2008.  Adoption of this guidance did not have a material impact on our results of operations and financial position, or on basic or diluted EPS.

We apply the grant date fair value method to our share – based payment arrangements with employees  and consultants.  Share – based compensation cost to employees is measured at the grant date fair value based on the value of the award and is recognized over the service period.  Share – based payments to non – employees are recorded at fair value on the measurement date and reflected in expense over the service period.

2010 Stock Option Plan

On November 15, 2009, Net Talk.com, Inc. (the “Company”) adopted the 2010 Stock Option Plan (the "Plan") which is intended to is to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate persons who make (or are expected to make) important contributions to the Company by providing such persons with equity ownership opportunities and performance-based incentives and thereby better aligning the interests of such persons with those of the Company’s shareholders. All of the Company’s employees, officers, and directors, and those Company’s consultants and advisors (i) that are natural persons and (ii) who provides bona fide services to the Company not connected to a capital raising transaction or the promotion or creation of a market for the company’s securities, are eligible to be granted options or restricted stock awards under the Plan. The maximum aggregate number of shares of the Company’s common stock that may be issued under the Plan is 10,000,000 shares of the Company’s common stock.
 
 
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2010 Stock option plan (Share-based payments employees):

On July 26, 2010, May 23, 2011 and July 26, 2011 we issued 3,709,500, 3,890,000 and 2,400,500 shares of common stock to our employees as part of our 2010 Stock Option Plan.  We have issued all approved common shares under our 2010 Stock Option Plan.
The shares are compensatory in nature and are fully vested.  We have valued the shares at $0.03, $0.01 and $0.01, respectively per share consistent with fair value at the time of issuance including and adjusted for ownership restrictions.

July 26, 2011 Issuance

The shares were issued to officers and employees, as follows:

   
Shares
   
Expense
 
Anastasios Kyriakides, CEO and President
    1,900,000     $ 57,000  
Kenneth Hosfeld, EVP
    400,000       12,000  
Guillermo Rodriguez, CFO
    400,000       12,000  
Leo Manzewitsch, Former CTO
    400,000       12,000  
Sub – total (officers)
    3,100,000       93,000  
all other employees
    609,500       18,285  
Total
    3,709,500     $ 111,285  

May 23, 2011 Issuance

The shares were issued to officers and employees, as follows:

   
Shares
   
Expense
 
Anastasios Kyriakides, CEO and President
    1,716,500     $ 12,874  
Kenneth Hosfeld, EVP
    255,000       1,913  
Guillermo Rodriguez, CFO
    500,000       3,750  
Leo Manzewitsch, Former CTO
    500,000       3,750  
Dr. George Gabb, Director
    50,000       375  
Sub – total (officers)
    3,021,500       22,662  
all other employees
    868,500       6,513  
Total
    3,890,000     $ 29,175  

July 26, 2011 Issuance

The shares were issued to officers and employees, as follows:

   
Shares
   
Expense
 
Anastasios Kyriakides, CEO and President
    1,200,000     $   9,000  
Kenneth Hosfeld, EVP
    200,000       1,500  
Guillermo Rodriguez, CFO
    200,000       1,500  
Leo Manzewitsch, Former CTO
    200,000       1,500  
Dr. George Gabb, Director
    25,000       188  
Sub – total (officers)
    1,825,000       13,688  
all other employees
    575,500       4,316  
Total
    2,400,500     $ 18,004  

We have issued all approved common shares under our 2010 Stock Option Plan.

2011 Stock Option Plan

On June 15, 2011, Net Talk.com, Inc. (the “Company”) adopted the 2011 Stock Option Plan (the "Plan") which is intended to is to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate persons who make (or are expected to make) important contributions to the Company by providing such persons with equity ownership opportunities and performance-based incentives and thereby better aligning the interests of such persons with those of the Company’s shareholders. All of the Company’s employees, officers, and directors, and those Company’s consultants and advisors (i) that are natural persons and (ii) who provides bona fide services to the Company not connected to a capital raising transaction or the promotion or creation of a market for the company’s securities, are eligible to be granted options or restricted stock awards under the Plan. The maximum aggregate number of shares of the Company’s common stock that may be issued under the Plan is 30,000,000 shares of the Company’s common stock.
 
 
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Financial Instruments

Financial instruments, as defined in the Accounting Standards Codification (“ASC”) 825 Financial Instruments, consist of cash, evidence of ownership in an entity, and contracts that both (i) impose on one entity a contractual obligation to deliver cash or another financial instrument to a second entity, or to exchange other financial instruments on potentially unfavorable terms with the second entity, and (ii) conveys to that second entity a contractual right (a) to receive cash or another financial instrument from the first entity, or (b) to exchange other financial instruments on potentially favorable terms with the first entity. Accordingly, our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, secured convertible debentures, and derivative financial instruments.

We carry cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities at historical costs since their respective estimated fair values approximate carrying values due to their current nature. We also carry convertible debentures and redeemable preferred stock at historical cost.

Derivative financial instruments, as defined in ASC 815-10-15-83 Derivatives and Hedging, consist of financial instruments or other contracts that contain a notional amount and one or more underlying (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare instances, assets.

Redeemable Preferred Stock

Redeemable preferred stock (and other redeemable financial instrument we may enter into) is initially evaluated for possible classification as liabilities under ASC 480 Distinguishing Liabilities from Equity. Redeemable preferred stock classified as liabilities is recorded and carried at fair value. Redeemable preferred stock that does not, in its entirety, require liability classification is evaluated for embedded features that may require bifurcation and separate classification as derivative liabilities under ASC 815. In all instances, the classification of the redeemable preferred stock host contract that does not require liability classification is evaluated for equity classification or mezzanine classification based upon the nature of the redemption features. Generally, any feature that could require cash redemption for matters not within our control, irrespective of probability of the event occurring, requires classification outside of stockholders’ equity. See Note 7 for further disclosures about our redeemable preferred stock.
 
Loss per common share

Basic loss per common share represents our loss applicable to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted loss per common share gives effect to all potentially dilutive securities. We compute the effects on diluted loss per common share arising from warrants and options using the treasury stock method or, in the case of liability classified warrants, the reverse treasury stock method. We compute the effects on diluted loss per common share arising from convertible securities using the if-converted method. The effects, if anti-dilutive are excluded.

Accounting Changes

Effective on October 1, 2009, we adopted Emerging Issues Task Force Consensus No. 07-05 Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock  (“EITF 07-05”). EITF 07-05 amended previous guidance related to the determination of whether equity-linked contracts, such as our convertible debentures, meet the exclusion to bifurcation and derivative classification of the respective embedded conversion feature. Under EITF 07-05, the embedded conversion option was no longer exempt from bifurcation and derivative classification because the conversion option was subject to adjustments that are not allowable under the new standard. We have accounted for the change as a change in accounting principle where the cumulative effect, which amounted to $872,320, as a charge to our opening additional paid in capital on October 1, 2009.

Note 4 – Building, Telecommunications Equipment, Land and Other Property:

Telecommunications equipment and other property consist of the following:
       
September 30,
 
   
Life
   
2011
   
2010
 
   
Telecommunication equipment
 
7
   
$
286,531
   
$
674,362
 
Computer equipment
 
5
     
121,944
     
107,092
 
Building
 
35
     
2,448,364
     
-      
 
Office equipment and furnishing
 
7
     
29,914
     
23,760
 
Purchased software
 
3
     
25,787
     
20,655
 
Land
 
NA
     
270,000
     
-      
 
Sub – total
         
3,182,540
     
825,869
 
Less: accumulated depreciation
         
(187,317
)
   
(247,251
)
Total
       
$
2,995,223
   
$
578,618
 
 
 
40

 
 
Our telecommunications equipment is deployed in our Network Operations Center (“NOC”) as is most of the computer equipment. Other computer and office equipment and furnishings are deployed at our corporate offices, which we lease under an operating lease. Depreciation of the above assets amounted to $139,464 and $124,709 for the fiscal years ended September 30, 2011 and 2010, respectively.

Note 5 - Intangible Assets:

Intangible assets consist of following:
 
Life
   
September 30,
 
         
2011