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| CNWT.OB > SEC Filings for CNWT.OB > Form 10KSB/A on 30-Sep-2008 | All Recent SEC Filings |
30-Sep-2008
Annual Report
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes that appear in this filing. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences have been included throughout the public filings from the company.
RESTATEMENT OF PREVIOUSLY ISSUED CONSOLIDATED FINANCIAL STATEMENTS
The Company has restated its Consolidated Balance Sheet as of March 31, 2007 and its Consolidated Statements of Operations, Stockholders' Equity (Deficit) and Cash Flows for the years ended March 31, 2007 and 2006 to reflect: (i) a correction in its accounting for its Senior Unsecured Convertible Promissory Notes and detachable warrants issued in private placements during the period from December 2004 to April 2007 (the "PP1 Notes," "PP1 Warrants," "PP2 Notes," and "PP2 Warrants") and (ii) share-based compensation related to employee stock options. The adjustments required by this restatement had no impact on net cash used in operations, net cash used in investing activities or net cash from financing activities.
The impact of the restatement is summarized in the table below:
Adjustments to Consolidated Statements of Operations:
Income (Expense)
Convertible
Promissory Notes Share-based
and Warrants Compensation Total
Year ended March 31, 2007 $ (665,195 ) $ (101,700 ) $ (766,895 )
Year ended March 31, 2006 469,573 - 469,573
Cumulative effect at April 1, 2005 (1,091,046 ) - (1,091,046 )
Total $ (1,286,668 ) $ (101,700 ) $ (1,388,368 )
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Convertible Promissory Notes and Warrants
The Company has concluded that its original accounting for the PP1 Notes and PP1 Warrants issued in fiscal year 2005 and the PP2 Notes and PP2 Warrants issued in fiscal year 2007 and fiscal year 2008 was incorrect and that the necessary adjustments were material for the fiscal year 2007 and 2006 consolidated financial statements.
The Company based its conclusion upon a further review of the documents associated with the Notes and Warrants and considered the following sources as relevant guidance in determining the proper accounting treatment for the Notes and Warrants:
· SFAS 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"),
· APB Opinion 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants ("APB 14"),
· Emerging Issues Task Force (EITF) Issue 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock ("EITF 00-19"),
· EITF 05-2, The Meaning of "Conventional Convertible Debt Instrument" ("EITF 05-2"),
· EITF 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios ("EITF 98-5"),
· EITF 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments ("EITF 00-27"), and
· SEC Staff Accounting Bulletin No. 107 ("SAB 107").
Conversion feature of the Notes
The Company concluded that the Notes meet the definition of "conventional convertible debt" (as defined in EITF 00-19 and affirmed in EITF 05-2). EITF 00-19, paragraph 4 states: "The Task Force observed that, pursuant to paragraphs 11(a) and 12(c) of Statement 133, if an embedded derivative is indexed to the reporting entity's own stock and would be classified in stockholders' equity if it was a freestanding derivative, that embedded derivative is not considered a derivative for purposes of SFAS 133. The Task Force reached a consensus that for purposes of evaluating under SFAS 133 whether an embedded derivative indexed to a company's own stock would be classified in stockholders' equity if freestanding, the requirements of paragraphs 12-32 of this Issue do not apply if the hybrid contract is a conventional convertible debt instrument in which the holder may only realize the value of the conversion option by exercising the option and receiving the entire proceeds in a fixed number of shares or the equivalent amount of cash (at the discretion of the issuer)."
Therefore, the Company has concluded that the conversion feature of the convertible debt did not meet the definition of a derivative under SFAS 133 and did not require separate accounting from the debt instrument.
Valuation of Notes and Warrants and beneficial conversion feature
APB 14 addresses the accounting for convertible debt with a nondetachable (embedded) conversion feature, the terms of which provide for an initial conversion price that is greater than the market value at the date of issuance and a conversion price that does not decrease, except under antidilution protection, but does not explicitly address situations in which the embedded conversion feature is "in-the money" at issuance. The Notes, including any accrued interest, were exercisable into the Company's common stock at less than the closing price of the Company's stock on the dates of issuance, and the Company considered this conversion to be an "embedded beneficial conversion feature."
EITF 98-5 requires "that embedded beneficial conversion features present in convertible securities should be valued separately at issuance." Further, EITF 98-5 states "that the intrinsic value of the beneficial conversion feature may be greater than the proceeds allocated to the convertible instrument," and as such, "that the amount of the discount assigned to the beneficial conversion feature is limited to the amount of the proceeds allocated to the convertible instrument." EITF 00-27 further states "that the effective conversion price based on the proceeds received for or allocated to the convertible instrument should be used to compute the intrinsic value, if any, of the embedded conversion option. As a result of this consensus, an issuer should first allocate the proceeds received in a financing transaction that includes a convertible instrument to the convertible instrument and any other detachable instruments included in the exchange (such as detachable warrants) on a relative fair value basis. Then, the Issue 98-5 model should be applied to the amount allocated to the convertible instrument, and an effective conversion price should be calculated and used to measure the intrinsic value, if any, of the embedded conversion option."
Accordingly, we calculated the fair value of both the convertible Notes and the Warrants and allocated the respective relative fair value percentages of each in determining the initial values of the convertible Notes and the Warrants. Because the Warrants were determined to be derivative liabilities (see conclusion in next section below and in Note 3 to the consolidated financial statements), the Company recorded them at fair value as calculated under the Black-Scholes option pricing model ("BS model"). For Notes and Warrants issuances where the net cash proceeds were greater than the fair value of the Warrants, this difference was allocated to the value of the Notes. The amount assigned to the Warrants represented a debt discount on the Notes, which is amortized over the life of the Notes. For Notes and Warrants issuances where the net cash proceeds were less than the fair value of the Warrants, the Warrants were recorded at fair value and the difference was recorded as a charge to the consolidated Statement of Operations at inception. This second situation occurred with the issuance of the PP1 Notes in December 2004 and resulted in a charge to the Statement of Operations of approximately $230,000; no value was allocated to the Notes, with a full debt discount recorded and amortized over the life of the Notes.
After determining the recorded value of the Warrants and Notes (if any), we calculated the beneficial conversion feature of the Notes, which resulted in an additional debt discount which was amortized over the life of the Notes.
Classification and accounting for Warrants
We evaluated the Warrants as a potential free standing derivative under the criteria in paragraph 11(a) of SFAS 133, which require that a contract (Warrants) issued by a reporting entity be accounted for as a derivative unless it is both (1) indexed to its own stock and (2) classified in stockholders' equity in its statement of financial position. We concluded that the Warrants were indexed to the Company's own stock and should be classified in stockholders' equity and would qualify for the scope exception contained in this paragraph. The Company was required to further review the requirements for equity classification contained in paragraphs 12-32 of EITF 00-19. The Company concluded that it had not met criteria (2) above based on the requirements for equity classification in EITF 00-19. Specifically, both the PP1 and PP2 Notes contain registration rights agreements (the "RR agreements") that stipulate that the Company must register all "registrable securities" (defined as the "shares of Common Stock issuable upon conversion of the Notes and the shares of Common Stock issuable upon exercise of the Warrants") within a time frame (and this was deemed to be outside of the control of the Company). In the event of not filing a registration statement by a specified date or by not having a registration effective by a specified date, the Company was obligated to pay liquidated damages in the amount of 1% of the then current outstanding amount of the Notes plus accrued interest. The Company accrued all required liquidated damages, beginning in FY 2005 with the PP1 Notes. Liquidated damages required under the RR Agreement for the PP1 Notes ceased on September 25, 2005, which was the date that the Company filed its initial registration statement for the PP1 Notes and PP1 Warrants.
Accordingly, the Company concluded that the Warrants did not satisfy the requirement for equity classification and should be classified, recorded and prospectively accounted for as derivative liabilities until it has registered all underlying shares to the Warrants or until such time that the RR agreements are no longer in effect. The prospective accounting requires that the Warrants be remeasured at each balance sheet date based on estimated fair value and any resultant changes in fair value be recorded to the Statement of Operations.
The Company used the BS model for calculating the fair value of all Warrants issued based on the following assumptions:
Warrants issued in PP1 Warrants issued in PP2
Expected volatility 128% 100%-104%
Expected term 5 years 5 years
Risk-free interest rate 3.58% - 4.33% 4.46% - 4.65%
Expected dividend yield 0% 0%
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We estimated volatility primarily based on historical volatility rates through the date of each closing of the PP1 and PP2 offerings. The Warrants have a transferability provision and based on guidance provided in SAB 107 for options issued with such a provision, we used the full, five-year contractual term as the expected term in the initial valuation of the Warrants. For the risk-free interest rate, we used the five year U.S. Treasury zero coupon rate for the initial valuation of the Warrants. Expected volatilities, expected terms and risk-free interest rates were adjusted as of each quarterly period commensurate with the remaining contractual lives of the Warrants on such dates and were used to determine the estimated fair value of the Warrants under the BS model.
Share-based compensation
The Company has concluded that it incorrectly calculated and recorded share-based compensation expense associated with stock options upon the adoption of Statement of Financial Accounting Standards No. 123 (revised) ("SFAS 123R"), "Share-Based Payment," on April 1, 2006. Specifically, the Company did not calculate the fair value of employee stock options issued during the period from February 2004 through October 2004 and did not record any related expense in the Statement of Operations for the year ended March 31, 2007 related to the unrecognized stock option cost as of April 1, 2006. The Company has not issued any additional stock options to employees since October 2004.
Write-off of goodwill
For the fiscal year ended March 31, 2006, the Company, in its prior filings, had reported the write-off of goodwill in the amount of $2,134,821 related to the acquisition of XBridge as a component of "Other income and expense" in the Statement of Operations. This amount has been reclassified as a component of "Operating expenses" to conform with the appropriate classification and presentation under GAAP.
The table below summarizes the effect of the restatement and reclassification adjustments on the Consolidated Statements of Operations:
For the year ended March 31, 2007 For the year ended March 31, 2006
As previously As previously
reported Adjustments As restated reported Adjustments As restated
Gross profit $ 1,619,566 $ - $ 1,619,566 $ 1,251,351 $ - $ 1,251,351
Operating expenses: 2,819,971 101,700 2,921,671 3,575,903 2,134,821 5,710,724
Loss from operations (1,200,405 ) (101,700 ) (1,302,105 ) (2,324,552 ) (2,134,821 ) (4,459,373 )
Other income (expense)
Interest expense, net (84,038 ) - (84,038 ) (112,721 ) - (112,721 )
Write-off of goodwill - - - (2,134,821 ) 2,134,821 -
Amortization of discount on
convertible notes - (146,684 ) (146,684 ) (894,084 ) (894,084 )
Benefit (charge) for change in
estimated fair value of
derivative financial
instruments - Warrants - (518,511 ) (518,511 ) - 1,363,657 1,363,657
Net loss $ (1,284,443 ) $ (766,895 ) $ (2,051,338 ) $ (4,572,094 ) $ 469,573 $ (4,102,521 )
Basic & diluted net loss per share $ (0.16 ) $ (0.09 ) $ (0.25 ) $ (0.72 ) $ 0.07 $ (0.64 )
Weighted average shares
outstanding: basic and diluted 8,190,123 8,190,123 6,393,718 6,393,718
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The table below summarizes the effect of the restatement adjustments on the Consolidated Balance Sheet as of March 31, 2007:
As previously
reported Adjustments As restated
Current assets:
Cash and cash equivalents $ 534,871 $ - $ 534,871
Restricted cash - -
Accounts receivable, net 314,178 314,178
Related party receivables 23,927 23,927
Inventory 75,743 75,743
Prepaid expenses 10,143 10,143
Total current assets 958,862 958,862
Property and equipment, net 122,046 122,046
Intangible assets, net 2,294,993 2,294,993
Total long-term assets 2,417,039 2,417,039
TOTAL ASSETS $ 3,375,901 $ - $ 3,375,901
Current liabilities:
Accounts payable $ 544,796 $ 544,796
Related party payables 24,038 24,038
Accrued liabilities 598,023 598,023
Deferred revenue 465,179 465,179
Convertible promissory notes 144,000 144,000
Line of credit and other current debt 64,509 64,509
Total current liabilities 1,840,545 1,840,545
Convertible promissory notes 1,900,606 1,900,606
Discount on convertible promissory notes (1,663,211 ) (1,663,211 )
Derivative financial instruments, at estimated fair
value - Warrants 2,265,225 2,265,225
Deferred revenue 84,968 84,968
Total long-term liabilities 1,985,574 602,014 2,587,588
Total liabilities 3,826,119 602,014 4,428,133
Stockholders' deficit:
Preferred stock - -
Common stock 8,292 8,292
Additional paid-in capital 8,739,970 786,353 9,526,323
Accumulated deficit (9,198,480 ) (1,388,367 ) (10,586,847 )
Total stockholders' deficit (450,218 ) (602,014 ) (1,052,232 )
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 3,375,901 $ - $ 3,375,901
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The table below summarizes the effect of the restatement adjustments on the Consolidated Statement of Cash Flows for the year ended March 31, 2007:
As previously
reported Adjustments As restated
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,284,443 ) $ (766,895 ) $ (2,051,338 )
Adjustments used to reconcile net loss to net cash
used in
operating activities:
Amortization of discount on convertible
promissory notes - 146,684 146,684
Charge for change in estimated fair value of
derivative
financial instruments - Warrants - 518,511 518,511
Depreciation and amortization 347,086 347,086
Share-based compensation - 101,700 101,700
Changes in operating assets and liabilities:
Accounts receivable (125,149 ) (125,149 )
Related party receivables 9,290 9,290
Inventory (52,616 ) (52,616 )
Prepaid expenses 31,483 31,483
Accounts payable (350,181 ) (350,181 )
Related party payables (35,400 ) (35,400 )
Accrued interest 44,109 44,109
Other accrued liabilities 43,600 43,600
Deferred revenue 320,988 320,988
Net cash used in operating activities (1,051,233 ) - (1,051,233 )
Net cash used investing activities (63,619 ) - (63,619 )
Net cash provided by financing activities 1,588,733 - 1,588,733
Net increase in cash and cash equivalents 473,881 473,881
Cash and cash equivalents at beginning of year 60,990 60,990
Cash and cash equivalents at end of year $ 534,871 $ - $ 534,871
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SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Conversion of convertible promissory notes and related accrued interest to common stock $ 21,965 $ 21,965 Conversion of accounts payable and other accrued liabilities to convertible promissory notes 220,606 220,606 Conversion of other notes payable to common stock 32,595 32,595 Allocation of discount on convertible promissory notes to derivative financial instruments - Warrants - 1,244,591 1,244,591 Discount related to beneficial conversion feature on convertible promissory notes $ - $ 482,934 $ 482,934 |
The table below summarizes the effect of the restatement adjustments on the Consolidated Statement of Cash Flows for the year ended March 31, 2006:
As previously
reported Adjustments As restated
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,572,094 ) $ 469,573 $ (4,102,521 )
Adjustments used to reconcile net loss to net cash
used in
operating activities 3,969,521 - 3,969,521
Amortization of discount on convertible
promissory notes -
outside investors - 894,084 894,084
Benefit for change in estimated fair value of
derivative
financial instruments - Warrants - (1,363,657 ) (1,363,657 )
Net cash used in operating activities $ (602,573 ) $ - $ (602,573 )
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Overview
We provide IP network-based application appliances and services that add features and enhanced functionality to the telecommunications services used by large enterprises, small and mid-sized organizations, both in the commercial and public sector. Our software- and hardware-based solutions are delivered on our open-architecture, component-based platform known as the Cistera ConvergenceServer™, which allows administrators to centrally manage advanced applications for IP telephony environments across large single-site and multi-site private voice/data networks. Because our solutions improve productivity and efficiencies for customers using IP telephony systems, we believe that our convergence solutions complement the efforts of IP telephony solution providers to increase the overall return on investment and value contribution associated with IP telephony systems. This has allowed us to establish cooperative relationships with IP telephony solution providers, as well as large VARs and systems integrators focused on delivering IP telephony systems and services.
Currently, we offer new customers a robust IP-based applications platform pre-loaded with a variety of packaged applications (we refer to them as application engines). We market our software and hardware solutions through a VAR channel, and in some cases directly to Fortune 500 customers. To ensure growth scalability, our VAR channel is being trained to deliver professional services for standard installations, which we believe will allow us to focus on advanced professional services for complex installations.
Our objective is to be the leading provider of IP communications application platforms and advanced IP-based applications for businesses worldwide. To address our market opportunity, our management team is focused on a number of short and long-term challenges including: strengthening and extending our solution offerings; adding new customers and expanding our sales efforts into new territories; deepening our relationships with our existing customers, VARs, and SIs; and encouraging the development of third-party applications on our platform.
In order to increase our revenues and take advantage of our market opportunity, we will need to add substantial numbers of customer installations. We plan to reinvest our earnings for the foreseeable future in the following ways: hiring additional personnel, particularly in sales and engineering; expanding our domestic and international selling and marketing activities; increasing our research and development activities to upgrade and extend our solution offerings and to develop new solutions and technologies; growing our VAR and systems implementation channel; adding to our infrastructure to support our growth; and expanding our operational and financial systems to manage a growing business.
Fiscal Year
Our fiscal year ends on March 31. References to fiscal 2007, for example, refer to the fiscal year ended March 31, 2007.
Sources of Revenues
We derive our revenues from three sources: (1) product revenues, which are comprised of software and hardware solutions; (2) professional services revenues, consisting primarily of installation, configuration, integration, training and VAR support services; and (3) support and maintenance, which is . . .
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