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EX-32.1 - EXHIBIT 32.1 - NET TALK.COM, INC.v386460_ex32-1.htm
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EX-31.2 - EXHIBIT 31.2 - NET TALK.COM, INC.v386460_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - NET TALK.COM, INC.v386460_ex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

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

 

For the quarter ended June 30, 2014

 

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 incorporation or organization)   (I.R.S. employer identification no.)
     
1080 NW 163rd Drive, Miami Gardens, FL   33169
(Address of principal executive offices)   (Zip code)

 

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

 

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 þ No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

 

Indicate by check mark whether the registrant is a large 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. (Check one):

 

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company þ

 

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

The Registrant had 77,694,391 shares of Common Stock, par value $0.001 per share, outstanding as of August 12, 2014.

 

 
 

 

NET TALK.COM, INC.

FORM 10-Q QUARTERLY REPORT

QUARTER ENDED JUNE 30, 2014

INDEX

 

      Page
Part I - FINANCIAL INFORMATION  
       
Item 1   Financial Statements 3
       
    Balance Sheets at June 30, 2014 (Unaudited) and December 31, 2013 (Audited) 3
       
    Statements of Operations for the Three and Six Months Ended June 30, 2014 and 2013 (Unaudited) 4
       
    Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013 (Unaudited) 5
       
    Notes to Financial Statements 6
       
Item 2   MANAGEMENT'S DISCUSSION AND FINANCIAL ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 17
       
Item 3   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 29
       
Item 4   CONTROLS AND PROCEDURES 29
       
Part II   OTHER INFORMATION  
       
Item 1   LEGAL PROCEEDINGS 30
       
Item 1A   RISK FACTORS 31
       
Item 2   UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS 31
       
Item 3   DEFAULTS UPON SENIOR SECURITIES 31
       
Item 4   MINE SAFETY DISCLOSURES 31
       
Item 5   OTHER INFORMATION 31
       
Item 6   EXHIBITS 32

  

2
 

 

NET TALK.COM, INC.

Balance Sheets

 

   June 30,   December 31, 
   2014   2013 
   (Unaudited)     
Assets          
Current assets:          
Cash and cash equivalents  $368,209   $76,791 
Restricted cash   115,530    183,930 
Accounts receivable, net   186,836    175,157 
Inventory   1,032,540    1,126,300 
Prepaid expenses and other assets   268,750    91,842 
Total current assets   1,971,866    1,654,020 
           
Building, equipment and land, net   2,679,667    2,794,148 
Intangible assets, net   91,500    116,770 
Development costs   301,658      
Other assets   27,253    27,253 
Total assets  $5,071,944   $4,592,191 
           
Liabilities, redeemable preferred stock and stockholders' deficit          
Current liabilities:          
Accounts payable  $1,608,477   $2,434,952 
Accrued expenses   1,087,415    773,905 
Due to officer/shareholder   338,413    87,583 
Deferred revenue   2,047,279    1,857,407 
Mortgage payable   1,400,000    1,400,000 
Current portion of promissory notes   3,000,000       
Total current liabilities   9,481,584    6,553,847 
           
Long term debt   2,941,155    4,529,278 
Total liabilities   12,422,739    11,083,125 
           
Stockholders' deficit:          
Common stock, $.001 par value, 300,000,000 authorized, 77,694,391 and 41,324,221 issued and outstanding as of June 30, 2014 and December 31, 2013   77,703    41,333 
Additional paid in capital   55,104,058    55,009,280 
Accumulated deficit   (62,532,556)   (61,541,547)
Total stockholders' deficit   (7,350,795)   (6,490,934)
           
Total liabilities and stockholders' deficit  $5,071,944   $4,592,191 

 

The accompanying notes are an integral part of the financial statements

 

3
 

 

NET TALK.COM, INC.

Statements of Operations

(Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2014   2013   2014   2013 
                 
Net revenues  $1,276,611   $1,442,832   $2,452,490   $2,996,098 
                     
Cost of revenues   771,176    1,231,051    1,524,631    2,580,635 
                     
Gross profit   505,435    211,781    927,859    415,463 
                     
Operating expenses   764,693    1,211,251    1,686,958    2,648,853 
                     
Operating loss   (259,257)   (999,470)   (759,098)   (2,233,390)
                     
Other income (expenses):                    
Interest expense   (120,702)   (353,015)   (231,912)   (724,954)
Other income   -    102,237    -    102,238 
                     
    (120,702)   (250,778)   (231,912)   (622,716)
                     
Net loss  $(379,960)  $(1,250,248)  $(991,011)  $(2,856,106)
                     
Basic and diluted earnings per common share  $(0.005)  $(0.02)  $(0.02)  $(0.05)

 

The accompanying notes are an integral part of the financial statements

  

4
 

 

NET TALK.COM, INC.

Statements of Cash Flows

(Unaudited)

 

   Six Months Ended June 30, 
   2014   2013 
Cash flow used in operating activities:          
Net loss  $(991,011)  $(2,856,106)
Adjustments to reconcile net loss to net cash used in operations:          
Depreciation and amortization   139,751    154,982 
Amortization of debt discount   -    464,874 
Issuance of common stock   131,148    - 
Recognition of deferred revenue   (1,931,535)   (2,335,470)
Exercise of net share settled warrants   -    126,955 
Changes in assets and liabilities:          
Accounts receivables   (11,679)   385,007 
Prepaid expenses and other assets   (176,908)   98,910 
Inventories   93,760    277,145 
Deferred revenues   2,121,407    2,065,349 
Accounts payable   (826,475)   207,840 
Accrued liabilities   313,511    500,310 
Net cash used in operating activities   (1,138,031)   (910,204)
Cash flow used in investing activities:          
Restricted cash   68,399    (271)
Purchase of property and equipment   -    (8,447)
Development costs   (301,658)     
Investment in intangible assets   -    (21,457)
Net cash used in investing activities:   (233,259)   (30,175)
Cash flow from financing activities:          
Proceeds from promissory and demand notes   1,411,877    641,272 
Proceeds from mortgage payable   -    400,000 
Payments of demand notes   -    (92,185)
Proceeds from shareholder   250,830    - 
Net cash provided by financing activities   1,662,707    949,087 
Net increase in cash   291,418    8,708 
Cash and cash equivalents, beginning   76,791    96,347 
Cash and cash equivalents, ending  $368,209   $105,055 
Supplemental disclosures:          
Cash paid for interest  $84,000   $84,000 

 

The accompanying notes are an integral part of the financial statements

 

5
 

 

NET TALK.COM, INC.

Notes to Unaudited Financial Statements

 

Note 1 – Description of Business and Basis of Presentation

 

Description of Business

 

NET TALK.COM, INC. (“NetTalk” or the “Company”) was incorporated on May 1, 2006 under the laws of the State of Florida, under the name Discover Screens Inc. On September 10, 2008 the Company changed its name to NetTalk.com, Inc. We are a telephone company, who provides 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; DUO II and DUOWIFI, analog telephone adapters that provide connectivity for analog telephones and faxes to home, home office or corporate local area networks (“LAN”). Our DUO products 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 products provide one USB port, one Ethernet port and one analog telephone port. A full suite of internet protocol features is available to maximize universal connectivity. In addition, analog telephones attached to our DUO products are able to use advanced calling features such as call forwarding, caller ID, 3-way calling, call holding, call retrieval, and call transfer.

 

Basis of Presentation

 

The accompanying unaudited interim financial statements are presented in U.S. dollars in conformity with accounting principles generally accepted in the United States (“GAAP”) and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC) for reporting of interim financial information. Pursuant to such rules and regulations, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. However, the unaudited condensed financial information includes all adjustments which are, in the opinion of management, necessary to fairly present the financial position and the results of operations for the interim periods presented. The operating results for the three and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for future fiscal quarters of 2014, for the year ending December 31, 2014 or for future periods. The significant accounting principles used in the preparation of these unaudited interim financial statements are the same as those used in the preparation of the annual audited financial statements. These statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 and other Company filings with the Securities and Exchange Commission.

 

Note 2 - Going Concern and Liquidity

 

We have never sustained profits and our losses could continue. Without sufficient additional capital to repay our indebtedness as it matures, we may be required to significantly scale back our operations, significantly reduce our headcount, seek protection under the provisions of the U.S. Bankruptcy Code, and/or discontinue many of our activities which could negatively affect our business and prospects. Our current efforts to raise capital may not be successful on terms favorable to the Company, or at all.

 

We recorded net losses of $379,960 and $991,011 for the three and six months ended June 30, 2014, compared to net losses of $1,250,248 and $2,856,106 for the three and six months ended June 30, 2013, respectively. As of June 30, 2014, we were indebted for $5,941,155, after deducting applicable discount, in promissory notes and $1,400,000 in a mortgage payable.

 

Our current cash resources, together with anticipated cash flows from operating activities, may not be sufficient to fund our operations, including interest and principal payments due in 2014. In light of these circumstances, we are seeking additional capital through public or private debt or equity financing. However, there are no assurances that those efforts will be successful or that additional capital will be available on terms that do not adversely affect our existing stockholders or restrict our operations, if it is available at all.

 

6
 

 

Also, any equity financing would likely be substantially dilutive to our stockholders, particularly in light of the prices at which our common stock has been recently trading. In addition, if we raise additional funds through the sale of equity securities, new investors could have rights senior to our existing stockholders. The terms of any future financings may restrict our ability to raise additional capital, which could delay or prevent the further development or marketing of our products and services. Our need to raise capital before the repayment of our debt becomes due may require us to accept terms that may harm our business or be disadvantageous to our current stockholders.

 

The accompanying financial statements have been prepared and are presented assuming the Company’s ability to continue as a going concern. The Company has incurred significant recurring losses from operations and is dependent on outside sources of funding for continuation of its operations. Our independent registered public accounting firm issued its report dated May 7, 2014, in connection with the audit of our financial statements as of December 31, 2013, that included an emphasis paragraph describing the existence of conditions that raise substantial doubt about our ability to continue as a going concern.

 

The accompanying financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result from the outcome of this uncertainty.

 

In order to address the need to satisfy its continuing obligations and realize its long term strategy, management has been reviewing various strategic alternatives and has taken several steps and is considering additional actions to improve its operating and financial results, which may be sufficient to provide the Company with the ability to continue as a going concern, including the following:

 

·As a result of the redemption and debt restructuring agreement (“Redemption Agreement”) with Vicis Capital Master Fund, we restructured the Company’s debt on December 31, 2013 resulting in the extinguishment of $13,662,615 of debt, $436,234 of accrued interest, $1,601,116 accrued dividends, cancelled 19,995,092 shares of common stock and cancelled common stock purchase warrants exercisable for 76,864,250 shares of the Company’s common stock.
   
·We identified key vendors and developed strategic alliances whereby the Company has reduced it cost of providing telecom service and extended the due dates of certain promissory notes to March 1, 2016.
   
·We have implemented more stringent credit and collection procedures and controls in an attempt to reduce days outstanding of trade accounts receivable and improve working capital.
   
·We eliminated 26 employees and reduced costs during 2013 by $1,164,000.
   
·The Company entered into an engagement agreement with a New York based registered broker/dealer whereby the broker/dealer will represent the Company as its placement agent and financial advisor in connection with raising equity and/or debt financing.

 

7
 

 

In addition, we are seeking financing from other sources, including refinancing the mortgage on the building, the possibility of an infusion of equity to generate additional funds for operations, including the retention of an investment banker to seek funding and evaluate other strategic alternatives. There is no assurance that the above actions will allow the Company to continue as a going concern.

 

Based upon the steps outlined above being successful, cash on hand and the maintenance of our strategic alliance with a key vendor may provide sufficient cash to meet current obligations for our operations to allow the Company to continue as a going concern.

 

There can be no assurance that the actions will be successful or any such new financing or equity infusion will be available or that we could obtain any such arrangements on terms suitable to us. The financial statements do not include any adjustments that might result from the outcome of the uncertainty.

 

Note 3 - Summary of Accounting Policies

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires our management to make estimates and assumptions that affect the amounts reported in the financial statements and footnotes. These estimates and assumptions are evaluated and revised periodically. 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, allowance for billing adjustments, and doubtful accounts and allocation of prices between device and telecom services. In all instances, estimates are made by competent employees under the supervision of management, based upon the current circumstances and the best information available. Actual results could differ significantly from these estimates and assumptions, and the differences could be material.

 

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 in domestic and Canadian bank accounts; the balances in our domestic accounts may at times exceed the FDIC limits. Management believes cash and cash equivalent balances are not exposed to significant credit risk due to the financial position of the depository institutions in which these deposits are held.

 

Inventory

 

Inventories are stated at the lower of cost or market. Cost is determined using the first-in first-out method. Obsolete inventory is reserved for as determined.

 

Fair Value of Financial Instruments

 

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of valuation hierarchy are defined as follows:

 

Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

 

Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

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. The carrying amounts of debt obligations approximate their fair values as the terms are comparable to terms currently offered by local lending institutions for arrangements with similar terms to industry peers with comparable credit characteristics.

 

8
 

 

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 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.

 

Property and Equipment

 

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

 

Intangible Assets

 

Our intangible assets were recorded at 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.

 

Revenue Recognition

 

Revenue is generated from product sales, telecom services, shipping and handling charges and leasing cell tower and co-location rack space in our operations center. 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 amounts are collectible from the customers.

 

Revenue is recognized for a device sale when the customer is invoiced for retail sales and when the customer completes the transaction for internet sales. Revenue for telecom service is recognized prorata monthly as the service is used and revenue for 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.

 

Deferred Revenue

 

Our DUO products provides for revenue recognition from the sale of the device and from the sale of telephone service. The initial period of telephone service is included in the sale price at time of sale and billed subsequently thereafter. Therefore, revenue recognition on our DUO products are fully recognized at the time of our customer equipment sale, and the telephone service is amortized over the period of the service provided.  Subsequent renewals of the telephone service are amortized over the corresponding period of service.

 

Call plans including basic, domestic, international and pay as you go are prepaid and are recognized as revenue pro-ratably over the period of the Call Plan.

 

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. In performing our review, we estimate the future net cash flows from the assets and compare this amount to the carrying value. If this review indicates the carrying value may not be recoverable, impairment losses are measured and recognized based on the difference between the estimated discounted cash flows and over the remaining life of the assets and the assets carrying value.

 

9
 

 

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 development costs shall be capitalized and subsequently reported at the lower of unamortized cost or net realizable value. Development costs will be 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. As of June 30, 2014, the Company has capitalized $301,658 for software development costs.

 

Reclassification

 

Certain reclassifications have been made to prior years financial statements in order to conform to the current quarter’s presentation.

 

Share-Based Payment Arrangements

 

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, is 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.

 

NetTalk stock option plans are intended to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate key individuals by providing such persons with equity ownership opportunities and performance-based incentives, 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 provide 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 Plans.

 

Certain Risks and Concentration

 

Our primary manufacturer accounted for approximately 23% and 20% of our cost of revenues for the six months ended June 30, 2014 and 2013. Our primary telecom service provider, which is owned by the current president of the Company, accounted for approximately 36% of our cost of revenues for the six months ended June 30, 2014. For the six months ended June 30, 2013 our primary telecom service provider, which was not owned by the current president, accounted for approximately 35% of our cost of revenues.

 

One of our customers presently operates under a consignment agreement. Under this agreement, we sell and ship merchandise to this customer and recognize revenues as we collect payments from the customer which assures our collectability.

 

Loss per common share

 

Basic earnings (loss) per share is calculated by dividing net income (loss) attributable to the Company available to common stockholders by the weighted average number of common shares outstanding for the three months and six months ended June 30, 2014 and 2013. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. In accordance with ASC 260, the effect of potentially dilutive securities is not considered during periods of loss or if the effect is anti-dilutive. 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. If required, we compute the effects on diluted loss per common share arising from convertible securities using the if-converted method.

 

10
 

 

Income Taxes

 

We record our income taxes using the asset and liability method. Under this method, the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis are reflected as tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences reverse. Changes in these deferred tax assets and liabilities are reflected in the provision for income taxes. However, we are required to evaluate the recoverability of net deferred tax assets. If it is more likely than not that some portion of a net deferred tax asset will not be realized, a valuation allowance is recognized with a charge to the provision for income taxes.

 

Recent accounting pronouncements

 

In February 2013, the Financial Accounting Standards Board issued ASU No. 2013-02, Reporting Amounts Reclassified Out of Accumulated Other Comprehensive Income ("ASU 2013-02"). ASU 2013-02 requires an entity to present, either on the face of the statement where net income is presented or in the notes to the financial statements, significant amounts reclassified out of accumulated other comprehensive income (loss) by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. Amounts that are not required to be reclassified in their entirety to net income must be cross-referenced to other disclosures that provide additional detail. This guidance was effective on a prospective basis for the annual and interim reporting periods for the Company beginning January 1, 2013. The Company's adoption of this standard did not have a significant impact on its financial statements. The Company's accumulated other comprehensive loss is comprised of one item pertaining to the Company's unrealized gains and losses on marketable securities. Reclassification of the gains or losses occurs when the specific investments are sold.

 

Note 4 – Accounts Receivable

 

Trade accounts receivable consisted of the following at:

 

   June 30,   December 31, 
   2014   2013 
         
Accounts receivable, gross  $227,581   $304,501 
Allowance for returns and doubtful accounts   (40,745)   (129,344)
Total  $186,836   $175,157 

 

Note 5 – Inventory

 

Inventory consisted of the following at:

 

   June 30,   December 31, 
   2014   2013 
         
Raw materials  $661,902   $721,914 
Finished goods   370,638    404,386 
Total  $1,032,540   $1,126,300 

 

Of our total finished goods inventory, at June 30, 2014 and December 31, 2013, $85,054 and $113,305, respectively, is held on consignment at one of our distributors.

 

During the six months ended June 30, 2014 and 2013, there were no write-downs of obsolete inventory.

 

11
 

 

Note 6 – Property and equipment

 

Building, equipment and land consisted of the following at:

 

   Estimated  June 30,   December 31, 
   Useful Life  2014   2013 
            
Telecommunication equipment  7  $356,154   $356,154 
Computer equipment  5   169,754    169,754 
Building  35   2,448,364    2,448,364 
Building improvements  10   86,442    86,442 
Office equipment and furnishing  7   48,212    48,212 
Purchased software  3   34,147    34,147 
Land      270,000    270,000 
       3,413,073    3,413,073 
Less: accumulated depreciation      (733,406)   (618,925)
Property and equipment, net     $2,679,667   $2,794,148 

 

Our property and equipment is located in our network operations center and corporate offices which are housed in the same building. Depreciation expense for the three and six months ended June 30, 2014 was $57,240 and $114,481, respectively. Depreciation expense for the three and six months ended June 30, 2013 was $59,808 and $119,560, respectively.

 

Note 7 - Intangible Assets

 

Intangible assets consisted of the following at:

 

   Estimated  June 30,   December 31, 
   Useful Life  2014   2013 
Trademarks - national and international  5  $332,708   $332,708 
Employment agreements  3   225,084    225,084 
Knowhow and specialty skills  3   212,254    212,254 
Workforce  3   54,000    54,000 
Patents  20   93,747    93,747 
Finance cost  2   83,280    83,280 
       1,001,073    1,001,073 
Less: accumulated amortization      (909,573)   (884,303)
Intangible assets, net     $91,500   $116,770 

 

Amortization expense for the three and six months ended June 30, 2014 was $24,195 and $25,270, respectively. Amortization expense for the three and six months ended June 30, 2013 was $17,711 and $35,442, respectively.

 

Note 8 – Debt Restructuring, Promissory Notes and Mortgage Payable

 

Debt Restructuring

 

The Company executed a redemption and debt restructuring agreement with Vicis Capital Master Fund ("Vicis") to, among other things, extend the term of our Vicis loans to June 30, 2014 with two additional one year extensions if accrued interest is paid in full, and reduce the overall loans with Vicis from approximately $17,000,000 to $3,000,000. The restated loan accrues interest at six percent (6%) per annum. In addition, pursuant to the redemption and restructuring agreement, all shares and derivative securities held by Vicis including the series A convertible redeemable preferred stock, 19,995,092 shares of the Company’s common stock, and common stock purchase warrants exercisable for 76,864,250 shares of common stock have been returned to the Company and cancelled. The holders received no additional consideration to effect the modification.

 

The approximately $14,000,000 extinguishment of debt was recorded as an equity transaction and the cancelled securities have been reflected as a reduction of the related shares of preferred and common stock and other securities as of December 31, 2013. The result was a decrease to common stock of $19,995 and an increase to additional paid-in capital of $14,098,847 from the extinguishment of debt, $5,000,000 from the write-off of preferred stock and $1,601,116 from the write-off of preferred stock dividends.

 

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Phoenix Vitae Holdings, LLC (“PV”), which is owned by the CEO of the Company, purchased the 6%, $3,000,000 secured promissory note from Vicis Capital Master Fund July 7, 2014. PV extended the interest payment date for the initial interest payment from June 30, 2014 to September 1, 2014.  However, at that time, all interest accrued through that date will be due and payable in full in immediately available funds, with no grace period.  If such payment is not made on or before such date, or if no agreement between PV and the Company has been reached with regard to further extension, the full principal amount of the Note will then also be immediately due and payable in full, per its terms, and PV reserves all rights related thereto as set forth in the Note or otherwise.

 

Demand, Promissory and Convertible Notes

 

Debt consisted of the following at:

 

   June 30,   December 31, 
   2014   2013 
         
$3,000,000, 6% secured promissory note, due September 1, 2014  $3,000,000   $3,000,000 
$300,000, 5% secured convertible note, due December 1, 2013   -    300,000 
$200,000, 5% secured convertible note, due January 15, 2014   -    200,000 
$2,766,155, 5% secured promissory note, due March 1, 2016   2,766,155    - 
$175,000, 6% promissory note, due June 30, 2017   175,000    175,000 
$1,400,000, 12% mortgage payable, due November 29, 2014   1,400,000    1,400,000 
$854,278, demand notes, due on demand   -    854,278 
   $7,341,155   $5,929,278 

 

On March 11, 2014, the Company executed a secured promissory note with Telestrata LLC (“Telestrata”), a Colorado limited liability for $4,071,940. Interest accrues at 5% and the note and interest are payable March 1, 2016 subject to accelerated repayment terms as defined in the promissory note agreement. The principal balance of the note has increased $500,000 as provided by the promissory note agreement. As of June 30, 2014, the Company received $250,000 of additional cash payments and $250,000 of additional indirect cash payments for telecom service received from an affiliate of Telestrata. This affiliate is owned by the President of the Company. These amounts were added to the original principal balance resulting in a new principal balance of $2,766,155.

 

Reconciliation of Teletrata promissory note at:

 

   June 30,   December 31, 
   2014   2013 
Secured promissory note due to Telestrata  $4,071,940   $4,071,940 
Less promissory note discount   (1,805,785)   (1,805,785)
Plus additional cash payment   250,000    200,000 
Plus additional indirect cash payment for telecom service   250,000    57,396 
Total  $2,766,155   $2,523,551 

 

On May 31, and July 15, 2013, the Company issued to Samer Bishay, the current president of the Company and a related party, two 5% secured convertible promissory notes with face values of $300,000 and $200,000, respectively. These notes were due on December 1, 2013 and January 15, 2014, respectively, and were convertible into shares of the Company’s common stock at a rate of $0.08 per share, for a total of 3,750,000 and 2,500,000 common shares, respectively. These notes had a second priority security interest, junior in priority only to the holder of the first priority interest, to all real property of the Company and any and all cash proceeds and/or noncash proceeds of any of the foregoing, including, without limitation, insurance proceeds, and all supporting obligations and the security therefor or for any right to payment. On March 11, 2014, these notes were converted into the promissory note due to Telestrata as discussed above.

 

During the third and fourth quarters of 2013, the Company received $521,000, for working capital from a now related party. On March 11, 2014, these demand notes were converted into the promissory note due to Telestrata as discussed above.

 

During the first and second quarters of 2013, the Company received advances of $175,000 from a third party. These advances are evidenced by a promissory note that accrues interest at 6% per year and matures June 30, 2017.

 

During the first, second and third quarters of 2013, amounts totaling $137,185 was advanced to the Company as a short term loan from the CEO. As of December 31, 2013, all loans have been repaid by the Company and the Company owed the CEO $87,583 in back-pay.

 

In the first quarter of 2014, the CEO loaned the Company and the Company repaid $100,000 and the Company accrued the CEO’s cut in compensation of $18,750 and repaid back-pay of $29,250. In the second quarter of 2014, the CEO loaned the Company and the Company repaid $300,000 and the Company accrued the CEO’s cut in compensation of $18,750 and repaid back-pay of $58,333. The amount due to the CEO at June 30, 2014 is $338,413

 

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Mortgage Payable

 

On November 29, 2012, we borrowed $1,000,000 from a lender and in exchange, the Company issued a 12% promissory note and a mortgage and security agreement. The 12% promissory note, among other matters, accrues interest at 12% per annum, is payable in full on November 29, 2014, and is secured by our corporate office building, located at 1080 NW 163rd Drive, Miami Gardens, FL 33169.

 

On January 11, 2013, we received an additional advance of $400,000 pursuant to its existing lending facility with 1080 NW 163rd Drive, LLC. The additional advance of $400,000 was endorsed by a promissory note which was consolidated with the initial advance of $1,000,000 from the mortgage on 1080 NW 163rd Drive, LLC. The consolidated promissory mortgage note has an aggregate principal balance of $1,400,000, accrues interest at 12% per annum, is payable in full on November 29, 2014, and is secured by our corporate office building, located at 1080 NW 163rd Drive, Miami Gardens, FL 33169.

 

Note 9 – Revenue and Cost of Revenues

 

Revenues and cost of revenues consisted of the following at:

 

   Three Months End June 30,   Six Months End June 30, 
   2014   2013   2014   2013 
Revenues:                    
Sales of devices  $175,766   $529,994   $343,559   $847,595 
Renewals and access charges   1,050,483    840,902    2,018,074    1,978,198 
Other   50,362    71,936    90,857    170,305 
Total   1,276,611    1,442,832    2,452,490    2,996,098 
                     
Cost of revenues:                    
Cost of sales of devices   276,696    306,053    560,368    809,676 
Cost of renewals and access charges   494,480    826,124    964,263    1,569,012 
Other        98,874         201,947 
Total   771,176    1,231,051    1,524,631    2,580,635 
                     
Gross profit  $505,435   $211,781   $927,859   $415,463 

 

Note 10 - Share-Based Payment Arrangements

 

On July 25, 2012, the Company adopted the 2012 Stock Option Plan (the ”Plan”). The maximum number of shares of the Company’s common stock that may be issued under the Plan is 20,000,000. The Plan is intended to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate individuals who make (or are expected to make) important contributions to the Company by providing such individuals with equity ownership opportunities and performance-based incentives, thereby better aligning the interests of such persons with those of the Company’s shareholders.

 

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All of the Company’s employees, officers, and directors, and those Company’s consultants and advisors (i) that are natural persons and (ii) who provide 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 shares are compensatory in nature and are fully vested upon issuance. We have valued the shares consistent with fair value at the time of issuance including and adjusted for ownership restrictions. The Company issued 10,929,000 share of common stock in the first quarter of 2014 to management and employees. The expense related to these shares was $131,148 and were debited in compensation expenses, additional paid in capital was credited for $120,219 and common stock was credited for $10,929. Also, the Company issued a common stock purchase warrant entitling management to purchase shares of common stock of the Company equal to 20% of the then outstanding shares of common stock of netTALK.

 

Note 11 - Issuance of Common Stock and Warrants

 

Pursuant to the stock and warrant purchase agreement effective March 11, 2014 (the “Stock Agreement”), Telestrata acquired (a) 25,441,170 shares of the Company’s common stock and (b) a common stock purchase warrant entitling Telestrata to purchase shares of common stock of the Company equal to 20% of the then outstanding shares of common stock of netTALK. Concerning the acquisition of the shares and warrants, Telestrata agreed to fund and/ or refinance as follows: (a) $500,000 in the form of the conversion and cancellation of two promissory notes issued to Samer Bishay in May and July 2013, (b) $837,373 in loans to the Company received in the third and fourth quarters of 2013, (c) the satisfaction by Telestrata of $2,734,566 of liabilities of the Company and (d) $500,000 of future cash payments and indirect cash payments for telecom services to be received from an affiliate of Telestrata. As described in Note 8 above, the Company is obligated to repay all such amounts advanced by Telestrata; provided, the Company is entitled to reduce the principal by up to a maximum of $1,805,785 if the Company makes timely principal and interest payments as required by the promissory note. The Company was also able to restructure the past due principal owed to its largest creditor as a result of obtaining this new debt capital provided by Telestrata. The debt restructuring is also described in Note 8 above.

 

Note 12 – Conversion of Warrants to Common Shares

 

For the nine months ended September 30, 2013, 4,231,832 warrants were converted into 1,057,958 common shares of netTALK. The share price of netTALK common stock on the day of conversion was $0.12; resulting in a charge of $126,955 included within general and administrative expenses in the Statements of Operations.

 

Note 13 - Related Party Transactions

 

During the first, second and third quarters of 2013, amounts totaling $137,185 was advanced to the Company as a short term loan from the CEO. As of December 31, 2013, all loans have been repaid by the Company and the Company owed the CEO $87,583 in back-pay.

 

In the first quarter of 2014, the CEO loaned the Company and the Company repaid $100,000 and the Company accrued the CEO’s cut in compensation of $18,750 and repaid back-pay of $29,250. In the second quarter of 2014, the CEO loaned the Company $300,000 and the Company accrued the CEO’s cut in compensation of $18,750 and repaid back-pay of $58,333. The amount due to the CEO at June 30, 2014 is $338,413

 

The Company’s president owns 100% as a vendor that provides a significant portion of our telecom service. Also, the President owns a significant portion of Telestrata who purchased an interest in the Company on March 11, 2014. See notes 8 and 11 for further discussion.

 

The Chief Operating Officer is related to the CEO and was promoted to COO January 1, 2014 by the Board of Directors.

 

Phoenix Vitae Holdings, LLC (“PV”), which is owned by the CEO of the Company, purchased the 6%, $3,000,000 secured promissory note from Vicis Capital Master Fund July 7, 2014. PV extended the interest payment date for the initial interest payment from June 30, 2014 to September 1, 2014.  However, at that time, all interest accrued through that date will be due and payable in full in immediately available funds, with no grace period.  If such payment is not made on or before such date, or if no agreement between PV and the Company has been reached with regard to further extension, the full principal amount of the Note will then also be immediately due and payable in full, per its terms, and PV reserves all rights related thereto as set forth in the Note or otherwise.

 

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Note 14 – Subsequent Events

 

July 7, 2014, Phoenix Vitae Holdings, LLC (“PV”), which is owned by the CEO of the Company, purchased the 6%, $3,000,000 secured promissory note from Vicis Capital Master Fund. PV extended the interest payment date for the initial interest payment from June 30, 2014 to September 1, 2014.  However, at that time, all interest accrued through that date will be due and payable in full in immediately available funds, with no grace period.  If such payment is not made on or before such date, or if no agreement between PV and the Company has been reached with regard to further extension, the full principal amount of the Note will then also be immediately due and payable in full, per its terms, and PV reserves all rights related thereto as set forth in the Note or otherwise.

 

The loan from the CEO of $300,000 was repaid to the Company in July 2014.

 

Note 15 – Commitments and Legal Proceedings

 

Employment Agreements

 

On January 2, 2014, the Company entered into employment agreements with the Chief Executive Officer, Executive Vice President, Chief Financial Officer, Chief Operating Officer and Chief Technical Officer according to the following terms: Stated salary for 2014 and 2015, a term of 2 to 5 years and a change in control payment, as defined in the agreements. Aggregate minimum annual payment is $655,000.

 

Commitments

 

The Company entered into an engagement agreement with a New York based registered broker/dealer whereby the broker/dealer will represent the Company as its placement agent and financial advisor in connection with raising equity and or debt financing.

 

Legal Proceedings

 

On April 4, 2012, MagicJack Vocaltec Ltd. filed a complaint in United States District Court for the Southern District of Florida, Civil Action No.: 9:12-cv-80360-DMM, against the Company, alleging patent infringement, seeking injunctive relief and damages as a result of the alleged patent infringement. The Company answered the complaint, denying all of its material allegations, asserting a number of affirmative defenses, and seeking counterclaims for declaratory relief. The Company’s patent counsel has provided an opinion that the NetTalk DUO does not infringe their patent. MagicJack Vocaltec Ltd. and NetTalk filed a Joint Stipulation and motion for the dismissal. Effective November 2012, the federal court has dismissed the entire case with prejudice, including all claims, counterclaims, defenses and causes of action.

 

On September 21, 2012, NetTalk.com, Inc. filed a complaint in United States District Court For the Southern District of Florida, Civil Action No.: 9:12-cv-81022-CIV-MIDDLEBROOK/BRANNON, against MAGICJACK VOCALTECLTD, MAGIJACK HOLDINGS CORPORATION f/k/a YMAX HOLDINGS CORPORATION and DANIEL BORISLOW. In the complaint we allege patent infringement by the defendants and are seeking injunctive relief and two hundred million dollars ($200,000,000) in damages as a result of the alleged patent infringement by defendants. There can be no assurances as to the outcome of this litigation.

 

As a result of this action, MAGICJACK/ VOCALTEC LTC filed a document with the United States Patent Office (“USPTO”) requesting reexamination of netTALK patent 8,243,722. The USPTO granted the reexamination petition and the claim against MAGICJACK/VOVALTEC LTD was stayed pending the outcome of the USPTO reexamination.

 

In December 2013, netTALK received a USPTO Notice of Intent to Issue Ex Parte Reexamination Certificate (“NIRC”) for netTALK’s U.S. Patent Number 8,243,722. 

 

In January 2014, netTALK petitioned the courts to restart the aforementioned lawsuit against MAGICJACK VOCALTECLTD, MAGIJACK HOLDINGS CORPORATION f/k/a YMAX HOLDINGS CORPORATION and DANIEL BORISLOW.

 

On February 27, 2014, netTALK received the reexamination certificate which restated that all three claims of the ‘722 Patent are deemed allowable by the USPTO.  The three claims of the ‘722 Patent were minimally amended during the proceeding.

 

On September 14, 2012, a supplier to the Company, Arrow Electronics, Inc. (“Arrow”), filed a complaint in the United States District Court for the Southern District of Florida, Case No.: 1:12-cv-23366-FAM, alleging breach of contract by the Company and seeking damages of not less than $473,319 due to such alleged breach.  The Company and Arrow Electronics, Inc. entered into a settlement agreement providing for the payment of past due amounts. A final order was entered into on December 12, 2012 dismissing the litigation. As of June 30, 2014, the Company owes Arrow approximately $48,790 which is recorded in accounts payable. The Company will continue making installment payments until the obligation is paid in full.

 

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On November 26, 2012, a supplier to the Client, Broadvox, LLC (“Broadvox”), filed a complaint in the Court of Common Pleas, Cuyahoga County, Ohio, Case No.: CV-12-796095, alleging breach of contract by the Company and seeking damages of not less than $111,701 due to such alleged breach.  The Company and Broadvox entered into a settlement agreement providing for the payment of all past due amounts. The settlement was paid in full on October 29, 2013.

 

On June 30, 2012, a Statement of Claim was served by DACS Marketing & Sponsorship Inc. (“DACS”) on NetTalk.com Inc. The claim was for $125,834 for amounts DACS claims is owing to it pursuant to its agreement as well as $126,000 for general damages for breach of contract. A Statement of Defense was delivered on behalf of the Company on August 31, 2012, denying all claims. On November 28, 2013, the Company and DACS entered into a settlement agreement providing for $60,000 in 4 monthly equal installments. The obligation was paid in full on February 7, 2014.

 

On or about September 1, 2013, ADP Total Source filed a lawsuit against the Company. The claim is for an amount not exceeding $90,776 for general damages for alleged breach of contract. The Company settled with ADP on December 23, 2013 and the obligation was paid in full on May 23, 2014.

 

On February 24, 2013, a Statement of Claim was served by Sears Canada Inc. on the Company. The claim is for $24,131 for amounts Sears claims is owed to it pursuant to its agreement under the “Universal Terms and Conditions for Sears Canada Suppliers”. We have settled with Sears Canada for $24,131 and are currently making monthly installment of $2,464 until the obligation is paid in full. The balance due at June 30, 2014 is $14,784 which is recorded in accounts payable.

 

On March 20, 2014 a claim was filed by Billsoft, Case No. 14CV01827. The claim states the Company indebted to Billsoft in the amount of $16,776 pursuant the terms of said Contract including $1,192 for attorney and court fees incurred by Billsoft for a total of $17,969. The Company has reached a settlement agreement on April 24, 2014 to make $1,000 monthly payments until the obligation is paid in full. The balance due at June 30, 2014 is $15,969 which is recorded in accounts payable.

 

On July 30, 2014, the Company was serve with a complaint from Active Media Services, Inc. that was filed in the United States District Court, Southern District of New York, Case No.: 14 CV 5915, alleging breach of contract by the Company and seeking damages of approximately $374,803 plus interest and collection costs due. As of the filing date of this 10-Q, the Company is evaluating whether a loss is probable or if there is a reasonable possibility that a loss may had been incurred and whether an accrual is necessary.

 

On July 30, 2014, the Company was serve with a complaint from QVC, Inc. that was filed in the United States District Court, for the Eastern District of Pennsylvania, Case No.: 2:14-cv-04406-LS, alleging breach of contract by the Company and seeking damages of no less than $95,798 which has been recorded in accounts payable as of June 30, 2014.

 

We are aggressively defending all of the lawsuits and claims described above. While we do not believe these aforementioned claims will have a material adverse effect on our financial position, given the uncertainty and unpredictability of litigation there can be no assurance of no material adverse effect. The Company is engaged in other legal actions and claims arising in the ordinary course of business, none of which are believed to be material to the Company.

  

Note 16 – Patent Protection Costs

 

Assets are probable future economic benefits obtained as a result of past transactions or events. Legal fees and other costs incurred for successfully defending a patent from infringement are considered deferred legal costs in the sense that they are part of the cost of retaining and obtaining the future economic benefit of the patent as per Statement of Accounting Concept No. 6. If defense of the patent lawsuit is successful, costs may be capitalized to the extent of an evident increase in the value of the patent per TIS Section 2260.

 

Management believes it is probable that the patent will be successfully defended which will increase the patents value as a result of defending the suit. Thus, legal fees incurred defending our patent have been recorded in other assets. As of June 30, 2014 and December 31, 2013, legal fees recorded as other assets are $185,971 and $0, respectively.

 

Item 2 – Management Discussion and Analysis of Financial Conditions and Results of Operations

 

Our Management’s discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements included elsewhere in this Quarterly Report and the audited financial statements for the year ended December 31, 2013, included in our Annual Report on Form 10-K. This Quarterly Report contains, in addition to unaudited historical information, forward-looking statements, which involve risk and uncertainties. The words “believe,” “expect,” “estimate,” “may,” “will,” “could,” “plan,” or “continue” and similar expressions are intended to identify forward-looking statements. Our actual results could differ significantly from the results discussed in such forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those discussed under the headings “Risk Factors” in our 2013 Annual Report on Form 10-K and this Quarterly Report on Form 10-Q, if any. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to (and we expressly disclaim any obligation to) revise or update any forward-looking statement, whether as a result of new information, subsequent events, or otherwise (except as may be required by law), in order to reflect any event or circumstance which may arise after the date of this Quarterly Report on Form 10-Q.

 

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Cautionary Statement about Forward Looking Statements

 

Certain statements contained in this Form 10-Q 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.

 

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 Form 10-Q, 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.

 

Going Concern and Liquidity

 

We have not sustained profits and our losses could continue. Without sufficient additional capital to repay our indebtedness as it matures, we may be required to significantly scale back our operations, significantly reduce our headcount, seek protection under the provisions of the U.S. Bankruptcy Code, and/or discontinue many of our activities which could negatively affect our business and prospects. Our current efforts to raise capital may not be successful on terms favorable to the Company, or at all.

 

We recorded net losses of $379,960 and $991,011 for the three and six months ended June 30, 2014, compared to net losses of $1,250,248 and $2,856,106 for the three and six months ended June 30, 2013, respectively. As of June 30, 2014, we were indebted for $5,941,155, after deducting applicable discount, in promissory notes and $1,400,000 in a mortgage payable.

 

Our current cash resources, together with anticipated cash flows from operating activities, may not be sufficient to fund our operations, including interest and principal payments, in 2014. In light of these circumstances, we are seeking additional capital through public or private debt or equity financing. However, there are no assurances that those efforts will be successful or that additional capital will be available on terms that do not adversely affect our existing stockholders or restrict our operations, if it is available at all.

 

Also, any equity financing would likely be substantially dilutive to our stockholders, particularly in light of the prices at which our common stock has been recently trading. In addition, if we raise additional funds through the sale of equity securities, new investors could have rights senior to our existing stockholders. The terms of any future financings may restrict our ability to raise additional capital, which could delay or prevent the further development or marketing of our products and services. Our need to raise capital before the repayment of our debt becomes due may require us to accept terms that may harm our business or be disadvantageous to our current stockholders.

 

The accompanying financial statements have been prepared and are presented assuming the Company’s ability to continue as a going concern. The Company has incurred significant recurring losses from operations and is dependent on outside sources of funding for continuation of its operations. Our independent registered public accounting firm issued its report dated May 7, 2014, in connection with the audit of our financial statements as of December 31, 2013, that included an emphasis paragraph describing the existence of conditions that raise substantial doubt about our ability to continue as a going concern.

 

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The accompanying financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result from the outcome of this uncertainty.

 

In order to address the need to satisfy its continuing obligations and realize its long term strategy, management has been reviewing various strategic alternatives and has taken several steps and is considering additional actions to improve its operating and financial results, which may be sufficient to provide the Company with the ability to continue as a going concern, including the following:

 

·As a result of the Redemption Agreement, we restructured the Company’s debt on December 31, 2013 resulting in the extinguishment of $13,662,615 of debt, $436,234 of accrued interest, $1,601,116 accrued dividends, cancelled 19,995,092 shares of common stock and cancelled common stock purchase warrants exercisable for 76,864,250 shares of the Company’s common stock, effective December 31, 2013.

 

·We identified key vendors and developed strategic alliances whereby the Company has reduced it cost of providing telecom service and extended the due dates of certain promissory notes to March 1, 2016.

 

·We have implemented more stringent credit and collection procedures and controls in an attempt to reduce days outstanding of trade accounts receivable and improve working capital.

 

·We eliminated 26 employees and reduced costs during 2013 by $1,164,000.

 

·The Company entered into an engagement agreement with a New York based registered broker/dealer whereby the broker/dealer will represent the Company as its placement agent and financial advisor in connection with raising equity and/or debt financing.

 

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In addition, we are seeking financing from other sources, including refinancing the mortgage on the building, the possibility of an infusion of equity to generate additional funds for operations, including the retention of an investment banker to seek funding and evaluate other strategic alternatives. There is no assurance that the above actions will allow the Company to continue as a going concern.

 

Based upon the steps outlined above being successful, cash on hand and the maintenance of our strategic alliance with a key vendor may provide sufficient cash to meet current obligations for our operations to allow the Company to continue as a going concern.

 

There can be no assurance that the actions will be successful or any such new financing or equity infusion will be available or that we could obtain any such arrangements on terms suitable to us.

 

General and Recent Developments

 

The Company executed a Redemption Agreement with Vicis Capital Master Fund ("Vicis") to, among other things, extend the term of our loans to June 30, 2014 with two additional one year extensions, and reduce the overall loan with Vicis from approximately seventeen million dollars ($17,000,000) to three million dollars ($3,000,000). The restated loan accrues interest at six percent (6%) per annum.

 

In addition, pursuant to the Redemptions Agreement, all shares and derivative securities held by Vicis were cancelled including the series A convertible redeemable preferred stock, 19,995,092 shares of the Company’s common stock, and common stock purchase warrants exercisable for 76,864,250 shares of common stock. These securities have been returned to the Company and have been cancelled. The holders received no additional consideration to effect the modification.

 

Phoenix Vitae Holdings, LLC (“PV”), which is owned by the CEO of the Company, purchased the 6%, $3,000,000 secured promissory note from Vicis Capital Master Fund July 7, 2014. PV extended the interest payment date for the initial interest payment from June 30, 2014 to September 1, 2014.  However, at that time, all interest accrued through that date will be due and payable in full in immediately available funds, with no grace period.  If such payment is not made on or before such date, or if no agreement between PV and the Company has been reached with regard to further extension, the full principal amount of the Note will then also be immediately due and payable in full, per its terms, and PV reserves all rights related thereto as set forth in the Note or otherwise.

 

Effective March 11, 2014, netTALK and Telestrata LLC (“Telestrata”), a Colorado limited liability company executed a restricted stock and warrant purchase agreement, pursuant to which, in part, Telestrata purchased: (a) 25,441,170 shares of the Company’s common stock and (b) a common stock purchase warrant entitling Telestrata to purchase shares of common stock of the Company equal to 20% of the then outstanding shares of common stock of netTALK.

 

Subject to repayment obligations of the Company as provided below, Telestrata received credit of $4,571,939 to acquire shares and warrants as follows: (a) $500,000 in the form of the conversion and cancellation of two promissory notes issued to Samer Bishay in May and July 2013, (b) $837,373 in loans to the Company received in the third and fourth quarters of 2013 and (c) the satisfaction by Telestrata of $2,734,566 of liabilities of the Company.

 

On March 11, 2014, the Company executed a secured promissory note with Telestrata LLC (“Telestrata”), a Colorado limited liability company for $4,071,940. Interest accrues at 5% and the note and interest are payable March 1, 2016 subject to accelerated repayment terms as defined in the promissory note agreement. The principle balance of the note can increase based on additional advances, as defined in the promissory note agreement. As of June 30, 2014, the Company received $250,000 of additional cash payments and approximately $250,000 of additional indirect cash payments for telecom service received from an affiliate of Telestrata. This affiliate is owned by the President of the Company. These amounts were added to the original principal balance resulting in a new principal balance of $2,766,155 including the discount of up to $1,805,785. The promissory note provides for a discount of up to a maximum of $1,805,785 if the Company makes timely principal and interest payments as required by the promissory note.

 

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Company and Business

 

We are a telephone company that provides 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”; “DUO II” and the “DUO WIFI”. The DUO WIFI and DUO II are presently sold and distributed to our customers. 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.

 

Our DUO, DOU II 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, DUO II 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, DUO II 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 NetTalk.com, Inc. and 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.

 

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 leveraging our patented technology to allow the customer to connect to the internet using a variety of interfaces.

 

A Universal Serial Bus (“USB”) connection allowing the interconnection of our DUO or 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 without the use of a computer.

 

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

 

The DUO WIFI also includes the ability to connect to the internet using a standard WiFi connection.

 

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 VoIP technology to allow our 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 under US patent number 8,243,722 and five additional patents have been submitted to the USPTO in the area of telecommunication and television technology.

 

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.

 

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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 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 identifying 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.

 

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 or are applying for Competitive Local Exchange Carrier (“CLEC”) Licenses in  twenty-six states, as follows:

 

California Indiana Maine Ohio Wisconsin
Connecticut Iowa Missouri Pennsylvania Wyoming
Florida Kentucky Nebraska Texas  
Georgia Louisiana New Jersey Utah  
Idaho Massachusetts New York Washington  
Illinois Maryland North Carolina West Virginia  

 

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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.

 

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 DUO, DUO WIFI and DUO II products. 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 residential and small businesses. We anticipate that future services will appeal to our existing customers and 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 expect 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 wholesale sales to retail stores.

 

Geographic Markets

 

Our primary geographic market is the United States and Canada. Our target audience is 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 expect 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 wholesale sales to retail stores.

 

Critical Accounting Policies

 

Our accounting policies are discussed and summarized in Note 3 to our financial statements.  The following describes our critical accounting policies.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires our management to make estimates and assumptions that affect the amounts reported in the financial statements, disclosures and contingencies. These estimates and assumptions are evaluated and revised routinely as required.

 

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, allowance for billing adjustments and doubtful accounts and allocation of prices between devices and telecom services.

 

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Our estimates and assumptions are based on experience, historical trends identified by management, telecommunications industry trends and the overall economic condition in the United States and abroad. Actual results could differ significantly from these estimates and assumptions, and the differences could be material.

 

Fair Value of Financial Instruments

 

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of valuation hierarchy are defined as follows:

 

Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

 

Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

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. The carrying amounts of debt obligations approximate their fair values as the terms are comparable to terms currently offered by local lending institutions for arrangements with similar terms to industry peers with comparable credit characteristics.

 

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.

 

Revenue Recognition

 

Revenue is generated from product sales, telecom services, shipping, handling charges and leasing cell tower and co-location rack space in our operations center. 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 amounts are collectible from the customers.

 

Revenue is recognized for a device sale when the customer is invoiced for retail sales and when the customer completes the transaction for internet sales. Revenue for telecom service is recognized prorata monthly as the service is used and revenue for 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.

 

Deferred Revenue

 

Our DUO products 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 in the sale price at time of sale and billed subsequently thereafter. Therefore, revenue recognition on our devices are fully recognized at the time of our customer equipment sale, and the telephone service is amortized over the life of the service plan.  Subsequent renewals of the telephone service are amortized over the life of the service plan.

 

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Call plans including basic, domestic, international and pay as you go are prepaid and are recognized as revenue pro-ratably over the period of the Call Plan.

 

Results of Operations

 

Three months ended June 30, 2014 Compared to Three Months Ended June 30, 2013

 

Revenues: Net revenues were $1,276,611 and $1,442,832 for the three months ended June 30, 2014 and 2013, respectively. The decrease in revenues is primarily due to a decrease in devices sold offset, in part, by an increase in telecom renewals.

 

Cost of revenues: Cost of revenues were $771,176 and $1,231,051 for the three months ended June 30, 2014 and 2013, respectively. The decrease in cost of revenues is primarily due to a reduction in costs resulting from the reduction in the number of devices sold plus a reduction in telecom service charges per subscriber.

 

Gross margin: Gross profits were $505,435 and $211,781 for the three months ended June 30, 2014 and 2013, respectively. The increase is due primarily to a reduction in the cost of telecom service charges per subscriber.

 

Operating expenses: Operating expenses were $764,693 compared to $1,211,251 for the three months ended June 30, 2014 and 2013, respectively. The decrease in operating expenses was primarily due to management’s cost cutting plan necessary to conserve working capital in order to maintain liquidity. Also, the Company began capitalizing development costs in the first quarter of 2014 as described below.

 

   Three Months Ended June 30,   Three Months Ended June 30, 
   2014   2013   $ Change   % Change 
Advertising   43,939    59,200    (15,261)   -26%
Compensation & Benefits   241,467    311,244    (69,777)   -22%
Professional fees   45,562    97,239    (51,677)   -53%
Depreciation & Amortization   81,435    77,519    3,916    5%
Research & Development   89,722    215,067    (125,345)   -58%
General & Administrative   262,567    450,982    (188,415)   -42%
Total operating expenses   764,693    1,211,251    (446,558)     

 

Research and Development: We expense research and development costs as they are incurred. We account for our 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 completion of a working model. We capitalize costs for internally developed software in accordance with FASB ASC 350-40, “Internal-Use Software”. We capitalized software costs of approximately $152,000 and $0 at June 30, 2014 and 2013, respectively. These products are not available for general release to customers and thus, are not being amortized.

 

General and Administrative Expenses: General and administrative expenses were $262,567 and $450,982 for the three months ended June 30, 2014 and 2013, respectively. The decrease in general and administrative expenses is also primarily due to management’s cost cutting plan necessary to conserve working capital in order to maintain liquidity. These reductions are offset by an increase in travel expense in order to raise capital.

 

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   Three Months Ended June 30,   Three Months Ended June 30, 
   2014   2013   $ Change   % Change 
Insurance   41,750    44,558    (2,808)   -6%
Taxes and licenses   8,187    60,280    (52,093)   -86%
Travel   22,693    4,255    18,438    433%
Commissions   47,366    77,080    (29,714)   -39%
Other   142,571    264,809    (122,238)   -46%
Total G&A expenses   262,567    450,982    (188,415)     

 

Loss from Operations: Losses from operations were $259,257 and $999,470 for the three months ended June 30, 2014 and 2013, respectively. The significant decrease in losses was due primarily to increased gross profit margin from the reduction in telecom service charges and the reduction of operating expenses.

 

Interest Expense: Interest expense was $120,702 and $353,015 for the three months ended June 30, 2014 and 2013, respectively. The decrease in interest expense was primarily due to the reduction in debt related to the restructuring in the fourth quarter of 2013.

 

Net Loss: Net loss was $379,960 and $1,250,248 for the three months ended June 30, 2014 and 2013, respectively.

 

Net loss Per Common Share: Net loss per common share was $0.01 and $0.02 for the three months ended June 30, 2014 and 2013, respectively.

 

Six months ended June 30, 2014 Compared to Six Months Ended June 30, 2013

 

Revenues: Net revenues were $2,452,490 and $2,996,098 for the six months ended June 30, 2014 and 2013, respectively. The decrease in revenues is primarily due to a reduction in sales of devices offset, in part, by an increase in telecom renewals.

 

Cost of revenues: Cost of revenues were $1,524,631 and $2,580,635 for the six months ended June 30, 2014 and 2013, respectively. The decrease in cost of revenues is primarily due to a reduction in costs resulting from the reduction in the number of devices sold plus a reduction in telecom service charges per subscriber.

 

Gross margin: Gross profits were $927,859 and $415,463 for the six months ended June 30, 2014 and 2013, respectively. The increase is due primarily to a reduction in the cost of telecom service charges per subscriber

 

Operating expenses: Operating expenses were $1,686,958 compared to $2,648,853 for the six months ended June 30, 2014 and 2013, respectively. The decrease in operating expenses was primarily due to management’s cost cutting plan necessary to conserve working capital in order to maintain liquidity. Also, the Company began capitalizing development costs in the first quarter of 2014 as described below. These reductions are offset by the significant increase in professional fees to defend our patents.

 

   Six Months Ended June 30,   Six Months Ended June 30, 
   2014   2013   $ Change   % Change 
Advertising   107,986    152,312    (44,326)   -29%
Compensation & Benefits   608,841    685,668    (76,827)   -11%
Professional fees   137,961    211,424    (73,463)   -35%
Depreciation & Amortization   139,752    154,982    (15,230)   -10%
Research & Development   186,003    511,069    (325,066)   -64%
General & Administrative   506,414    933,398    (426,984)   -46%
Total operating expenses   1,686,958    2,648,853    (961,895)     

 

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Research and Development and Software Development Costs: We expense research and development costs as they are incurred. We account for our 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 completion of a working model. We capitalize costs for internally developed software in accordance with FASB ASC 350-40, “Internal-Use Software”. We capitalized software costs of approximately $302,000 and $0 at June 30, 2014 and 2013, respectively. These products are not available for general release to customers and thus, are not being amortized.

 

General and Administrative Expenses: General and administrative expenses were $506,414 and $933,398 for the six months ended June 30, 2014 and 2013, respectively. The decrease in general and administrative expenses is also primarily due to management’s cost cutting plan necessary to conserve working capital in order to maintain liquidity. These reductions are offset, in part, by an increase in travel expense in order to raise capital.

 

   Six Months Ended June 30,   Six Months Ended June 30, 
   2014   2013   $ Change   % Change 
Insurance   82,064    128,722    (46,658)   -36%
Taxes and licenses   12,458    85,550    (73,092)   -85%
Travel   37,190    17,540    19,650    112%
Commissions   99,499    195,047    (95,548)   -49%
Other   275,203    506,539    (231,336)   -46%
Total G&A expenses   506,414    933,398    (426,984)     

 

Loss from Operations: Losses from operations were $759,098 and $2,233,390 for the six months ended June 30, 2014 and 2013, respectively. The significant decrease in losses was due primarily to increased profitability by selling more telecom service and the reduction of operating expenses.

 

Interest Expense: Interest expense was $231,912 and $724,954 for the six months ended June 30, 2014 and 2013, respectively. The decrease in interest expense was primarily due to the reduction in debt related to the restructuring in the fourth quarter of 2014.

 

Net Loss: Net loss was $991,011 and $2,856,106 for the six months ended June 30, 2014 and 2013, respectively.

 

Net loss Per Common Share: Net loss per common share was $0.02 and $0.05 for the six months ended June 30, 2014 and 2013, respectively.

 

Liquidity and Capital Resources

 

Our principal source of liquidity are our cash and cash equivalent balances, cash flow from operations, and access to financial markets. Our current cash resources, together with anticipated cash flows from operating activities, may not be sufficient to fund our operations, including interest and principal payments due in 2014.

 

As of June 30, 2014, our cash and cash equivalents were $368,209 compared to $76,791 at December 31, 2013. As of June 30, 2014 we had negative working capital of $7,509,718 compared to $4,899,828 at December 31, 2013. The is due primarily to the increase in the current portion of long term debt partially offset by the reduction in accounts payable related to the Telestrata transaction which converted approximately $930,000 from accounts payable to note payable to Telestrata.

 

Net cash used in operating activities for the six months ended June 30, 2014 was $1,138,031 compared to net cash used in operations of $910,204 for the same period of 2013. The increase in cash used in operating activities was due primarily to the reduction in accounts payable.

 

Net cash used in investing activities for the six months ended June 30, 2014 was $233,259 compared to net cash used in investing activities of $30,175 for the same period of 2013. The increase in cash used in investing activities was due primarily to the increase in investment in development costs from the prior year.

 

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Net cash provided by financing activities for the six months ended June 30, 2014 was $1,662,707 compared to net cash provided by financing activities of $949,087 for the same period of 2013. The increase in cash provided by investing activities was due primarily to cash proceeds from promissory notes in excess of prior year and loans from a shareholder.

 

Certain Risks and Concentration

 

Our primary manufacturer accounted for approximately 23% and 20% of our cost of revenues for the six months ended June 30, 2014 and 2013. Our primary telecom service provider, which is owned by the current president of the Company, accounted for approximately 36% of our cost of revenues for the six months ended June 30, 2014. Our primary telecom service provider, which was not owned by the current president, accounted for approximately 35% of our cost of revenues for the six months ended June 30, 2013.

 

One of our customers presently operates under a consignment agreement. Under this agreement, we sell and ship merchandise to our customer and recognize revenues as we collect payments from the customer which assures our collectability.

 

Off-Balance Sheet Arrangements

 

We did not have any off-balance sheet arrangements as of June 30, 2014.

 

Item 3 Quantitative and Qualitative Disclosures about Market Risk

 

Not applicable. 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 4 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.

 

As of June 30, 2014, 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 June 30 2014:

 

Due to the limited resources, we have insufficient personnel resources and technical accounting and reporting expertise to properly address all of the accounting matters inherent in our financial transactions. We do not have a formal audit committee and the Board of Directors does not have a financial expert, thus we lack the Board oversight role within the financial reporting process.

 

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Our small accounting department prohibits the segregation of duties and the timely review of accounts payable, expense reporting, 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 will be 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.

 

Changes in Internal Controls.

 

During the six months ended June 30, 2014, 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.

 

PART II             OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

Legal Proceedings

 

On April 4, 2012, MagicJack Vocaltec Ltd. filed a complaint in United States District Court for the Southern District of Florida, Civil Action No.: 9:12-cv-80360-DMM, against the Company, alleging patent infringement, seeking injunctive relief and damages as a result of the alleged patent infringement. The Company answered the complaint, denying all of its material allegations, asserting a number of affirmative defenses, and seeking counterclaims for declaratory relief. The Company’s patent counsel has provided an opinion that the NetTalk DUO does not infringe their patent. MagicJack Vocaltec Ltd. and NetTalk filed a Joint Stipulation and motion for the dismissal. Effective November 2012, the federal court has dismissed the entire case with prejudice, including all claims, counterclaims, defenses and causes of action.

 

On September 21, 2012, NetTalk.com, Inc. filed a complaint in United States District Court for the Southern District of Florida, Civil Action No.: 9:12-cv-81022-CIV-MIDDLEBROOK/BRANNON, against MAGICJACK VOCALTECLTD, MAGIJACK HOLDINGS CORPORATION f/k/a YMAX HOLDINGS CORPORATION and DANIEL BORISLOW. In the complaint we allege patent infringement by the defendants and are seeking injunctive relief and two hundred million dollars ($200,000,000) in damages as a result of the alleged patent infringement by defendants. There can be no assurances as to the outcome of this litigation.

 

As a result of this action, MAGICJACK/ VOCALTEC LTC filed a document with the United States Patent Office (“USPTO”) requesting reexamination of netTALK patent 8,243,722. The USPTO granted the reexamination petition and the claim against MAGICJACK/VOVALTEC LTD was stayed pending the outcome of the USPTO reexamination.

 

In December 2013, netTALK received a USPTO Notice of Intent to Issue Ex Parte Reexamination Certificate (“NIRC”) for netTALK’s U.S. Patent Number 8,243,722. 

 

In January 2014, netTALK petitioned the courts to restart the aforementioned lawsuit against MAGICJACK VOCALTECLTD, MAGIJACK HOLDINGS CORPORATION f/k/a YMAX HOLDINGS CORPORATION and DANIEL BORISLOW.

 

On February 27, 2014, netTALK received the reexamination certificate which restated that all three claims of the ‘722 Patent are deemed allowable by the USPTO.  The three claims of the ‘722 Patent were minimally amended during the proceeding.

 

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On September 14, 2012, a supplier to the Company, Arrow Electronics, Inc. (“Arrow”), filed a complaint in the United States District Court for the Southern District of Florida, Case No.: 1:12-cv-23366-FAM, alleging breach of contract by the Company and seeking damages of not less than $473,319 due to such alleged breach.  The Company and Arrow Electronics, Inc. entered into a settlement agreement providing for the payment of past due amounts. A final order was entered into on December 12, 2012 dismissing the litigation. As of June 30, 2014, the Company owes Arrow approximately $48,790 which is recorded in accounts payable. The Company will continue making installment payments until the obligation is paid in full.

 

On November 26, 2012, a supplier to the Client, Broadvox, LLC (“Broadvox”), filed a complaint in the Court of Common Pleas, Cuyahoga County, Ohio, Case No.: CV-12-796095, alleging breach of contract by the Company and seeking damages of not less than $111,701 due to such alleged breach.  The Company and Broadvox entered into a settlement agreement providing for the payment of all past due amounts. The settlement was paid in full October 29, 2013.

 

On June 30, 2012, a Statement of Claim was served by DACS Marketing & Sponsorship Inc. (“DACS”) on NetTalk.com Inc. The claim was for $125,834 for amounts DACS claims is owing to it pursuant to its agreement as well as $126,000 for general damages for breach of contract. A Statement of Defense was delivered on behalf of the Company on August 31, 2012, denying all claims. On November 28, 2013, the Company and DACS entered into a settlement agreement providing for $60,000 in 4 monthly equal installments. The obligation was paid in full on February 7, 2014.

 

On or about September 1, 2013, ADP Total Source filed a lawsuit against the Company. The claim is for an amount not exceeding $90,776 for general damages for alleged breach of contract. The Company settled with ADP on December 23,2013 and the obligation was paid in full May 23, 2014.

 

On February 24, 2013, a Statement of Claim was served by Sears Canada Inc. on the Company. The claim is for $24,131 for amounts Sears claims is owed to it pursuant to its agreement under the “Universal Terms and Conditions for Sears Canada Suppliers”. We have settled with Sears Canada for $24,131 and are currently making monthly installment of $2,464 until the obligation is satisfied. The balance due at June 30, 2014 is $14,784 which is recorded in accounts payable.

 

On March 20, 2014 a claim was filed by Billsoft, Case No. 14CV01827. The claim states the Company indebted to Billsoft in the amount of $16,776 pursuant the terms of said Contract including $1,192 for attorney and court fees incurred by Billsoft for a total of $17,968. The Company has reached a settlement agreement on April 24, 2014 to make $1,000 monthly payments until the debt is satisfied. The balance due at June 30, 2014 is $15,969 which is recorded in accounts payable.

 

On July 30, 2014, the Company was serve with a complaint from Active Media Services, Inc. that was filed in the United States District Court, Southern District of New York, Case No.: 14 CV 5915, alleging breach of contract by the Company and seeking damages of approximately $374,803 plus interest and collection costs due. As of the filing date of this 10-Q, the Company is evaluating whether a loss is probable or if there is a reasonable possibility that a loss may had been incurred and whether an accrual is necessary.

 

On July 30, 2014, the Company was serve with a complaint from QVC, Inc. that was filed in the United States District Court, for the Eastern District of Pennsylvania, Case No.: 2:14-cv-04406-LS, alleging breach of contract by the Company and seeking damages of no less than $95,798 which has been recorded in accounts payable as of June 30, 2014. 

 

We are aggressively defending all of the lawsuits and claims described above. While we do not believe these aforementioned claims will have a material adverse effect on our financial position, given the uncertainty and unpredictability of litigation there can be no assurance of no material adverse effect. The Company is engaged in other legal actions and claims arising in the ordinary course of business, none of which are believed to be material to the Company.

 

Item 1A.   Risk Factors

 

For the quarter ended June 30, 2014, there are no material changes to the risk factors set forth in “Item 1A, Risk Factors” of our Annual Report on Form 10-K.

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

The Company issued 10,929,000 shares of common stock to management and employees under the 2012 Stock Option Plan on March 7, 2014.

 

Item 3.  Defaults upon Senior Securities

 

None.

 

Item 4.  Mine Safety Disclosures

 

Not Applicable.

 

Item 5.  Other Information.

 

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CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

NetTalk.com, Inc. changed independent accountants in September 2013 from Thomas, Howell, Ferguson, CPA's to Zachary Salum Auditors P.A. Information regarding the change in independent accountants was reported in NetTalk.com, Inc. Current Report on Form 8-K dated September 23, 2013. There were no disagreements or any reportable events subject to Item 304(b) requiring disclosure.

 

Item 6. Exhibits

 

Exhibit No.   Description
3.01   Articles of Incorporation of Net Talk.com Inc. (1)
3.02   Articles of Amendment to the Articles of Incorporation of Net Talk.com Inc. (1)
3.03   Articles of Amendment to the Articles of Incorporation of Net Talk.com Inc. (1)
3.04   Articles of Amendment to the Articles of Incorporation of Net Talk.com Inc. (1)
3.05   Bylaws of Net Talk.com
10.01   Redemption and Debt Restructuring Agreement (2)
10.02   Fourth Amended and Restated Agreement (2)
10.03    6% Secured Promissory Note (2)
10.04   Restricted Stock and Warrant Purchase Agreement (3)
10.05   Registration Rights Agreement (3)
10.06   Secured Promissory Note (3)
10.07   Employment Agreements (4)
31.01   Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 18, 2014. (5)
31.02   Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 18, 2014. (5)
32.01   Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated August 18, 2014. (5)
32.02   Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated August 18, 2014. (5)
101.   INS XBRL Instance Document (5)
101.   SCH XBRL Taxonomy Extension Scheme Document (5)
101.   CAL XBRL Taxonomy Extension Calculation Linkbase Document (5)
101.   LAB XBRL Taxonomy Extension Label Linkbase Document (5)
101.   PRE XBRL Taxonomy Extension Presentation Linkbase Document (5)

 

(1) Filed as an exhibit to the Company’s Form S-1 which was filed with the Commission on February 2, 2009, and incorporated herein by reference.

(2) Previously filed as an exhibit to the Form 8-K, filed with the SEC on January 27, 2014 and incorporated herein by reference.

(3) Previously filed as an exhibit to the Form 8-K, filed with the SEC on March 24, 2014 and incorporated herein by reference.

(4) Previously filed as an exhibit to the Form 10-K, filed with the SEC on May 7, 2014 and incorporated herein by reference.

(5) Filed herewith.

 

Pursuant to Rule 406T of Regulation S-T, these Interactive Data Files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to the liability under the sections.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

      NetTalk.com, Inc.
       
Date: August 18, 2014   By /s/ Anastasios Kyriakides
    Anastasios Kyriakides
    Chief Executive Officer (Principal Executive Officer)

 

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