ITEM 1. FINANCIAL STATEMENTS

 

Notes to Consolidated Financial Statements

NOTE A - ORGANIZATION AND DESCRIPTION OF BUSINESS

VoIP, Inc. (the "Company") was incorporated on August 3, 1998 under its original name of Millennia Tea Masters under the laws of the State of Texas. In February 2004 the Company exchanged 12,500,000 shares for the common stock of two start-up telecommunication businesses, eGlobalphone, Inc. and VoIP Solutions, Inc. The Company changed its name to VoIP, Inc. in April 2004 and acquired VCG Technologies, Inc. d/b/a DT Net Technologies (“DTNet”), a hardware supplier, and VoIP Americas, Inc. (“VoIP Americas”), in June and September, respectively, of 2004. The Company decided to exit its former tea business in December 2004 and focus its efforts and resources in the Voice over Internet Protocol (“VoIP”) telecommunications industry. In May 2005 the Company acquired Caerus, Inc. (“Caerus”), a VoIP carrier and service provider. In October 2005 the Company purchased substantially all of the VoIP assets of WQN Inc.'s (“WQN”) business.

The Company is an emerging global provider of advanced communications services utilizing VoIP technology. VoIP telephony is the real time transmission of voice communications in the form of digitized "packets" of information over the Internet or a private network, similar to the way in which e-mail and other data is transmitted. VoIP services are expected to allow consumers and businesses to communicate in the future at dramatically reduced costs compared to traditional telephony networks.

The Company owns its network and its technology and offers the ability to provide complete product and service solutions, including wholesale carrier services for call routing and termination, outsourced customer service and hardware fulfillment. The Company is a certified Competitive Local Exchange Carrier (“CLEC”) and Interexchange Carrier (“IXC”). The Company offers a portfolio of advanced telecommunications technologies, enhanced service solutions, and broadband products. Current and targeted customers include regional bell operating companies (“RBOCs”), CLECs, IXCs, wireless carriers, resellers, internet service providers, cable multiple system operators and other providers of telephony services.

The Company's operations consist of three segments: Telecommunication Services, Hardware Sales and Calling Card Sales.

 

The financial information presented herein should be read in conjunction with the consolidated financial statements for the year ended December 31, 2005. The accompanying consolidated financial statements for the three months ended March 31, 2006 and 2005 are unaudited but, in the opinion of management, include all adjustments (which are of normal and recurring in nature) necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. Interim results are not necessarily indicative of results for a full year. Therefore, the results of operations for the three months ended March 31, 2006 are not necessarily indicative of operating results to be expected for the full year or future interim periods.

 

Significant accounting policies are detailed in the Company's annual report on Form 10-KSB for the year ended December 31, 2005.

All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 2005 financial statements to conform to the 2006 presentation.

NOTE B - BUSINESS SEGMENT INFORMATION

The Company has three reportable segments: telecommunication services, hardware sales, and calling card sales. The telecommunications services segment terminates wholesale and retail, local and long distance calls. Such termination is either on the Company’s network or through other telecommunication service providers. This segment is also in the early stages of implementing wholesale VoIP services. The hardware sales segment supplies broadband components and VoIP hardware to broadband service providers. The calling card segment sells prepaid telephone calling cards purchased from other carriers through a network of private distributors located primarily in southern California.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies as detailed in the Company's annual report on Form 10-KSB for the year ended December 31, 2005. Information about operations by business segment, as of and for the three months ended March 31, 2006 and 2005 (except listed 2005 balance sheet amounts, which are as of December 31, 2005), is as follows: 

 

6

---

 

											Corporate
		Telecommunication			Hardware			Calling			and
		Services			Sales			Cards			Eliminations			Consolidated
2006
Revenues		$	4,632,547		$	434,851		$	5,294,148		$	-		$	10,361,546
Interest and expense			325,360			-			-			1,179,088			1,504,448
Depreciation and amortization			1,498,965			5,436			-			25,687			1,530,088
Net loss			(4,446,688	)		(1,145,043	)		(26,593	)		(8,188,710	)		(13,807,034	)
Capital expenditures			110,321			-			-			-			110,321
Identifiable assets			11,421,916			446,919			1,566,541			2,812,814			16,248,190
Goodwill			23,351,473			198,000			-			-			23,549,473
Other intangible assets, net			13,888,900			-			-			305,000			14,193,900
2005
Revenues		$	843,935		$	558,534		$	-		$	-		$	1,402,469
Interest expense			-			-			-			14,278			14,278
Depreciation and amortization			30,000			1,312			-			16,668			47,980
Net income (loss)			(632,721	)		2,531			-			(925,208	)		(1,555,398	)
Capital expenditures			9,693			917			-			38,742			49,352
Identifiable assets			11,979,115			562,576			1,448,236			2,958,716			16,948,643
Goodwill			23,306,341			1,037,101			-			-			24,343,442
Other intangible assets, net			14,792,930			-			-			305,000			15,097,930

 

NOTE C - LIQUIDITY AND CAPITAL RESOURCES

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplates continuation of the Company as a going concern. The Company has incurred operating losses and negative cash flows from operations since inception of its business in 2004 and has been dependent on issuances of debt and equity instruments to fund its operations and capital expenditures. The Company’s independent auditors have added an explanatory paragraph to their opinion on the Company’s consolidated financial statements for the year ended December 31, 2005, based on substantial doubt about the Company’s ability to continue as a going concern.

At March 31, 2006, the Company's contractual obligations for debt, leases and capital expenditures totaled approximately $16.3 million. Included in this amount is approximately $4.0 million due on a loan from a lending institution. The Company was not in compliance with certain covenants under the loan agreement for this debt. However, the lender has not declared a default.

See Note H for a description of the Company’s convertible notes issued in January and February 2006. As explained below, the subscription agreements for these notes contain provisions that could impact the Company’s future capital raising efforts and its capital structure:

·

As required by the subscription agreements, in February 2006, the Company filed a registration statement (the “Notes Registration Statement”) to register 200% of the shares issuable upon conversion of these notes and all of the shares issuable upon exercise of the warrants issued in connection with the notes. Until the Notes Registration Statement is declared effective by the Securities and Exchange Commission the Company is liable, beginning in late April 2006, for liquidated damages each month at a rate of 1.5% of the outstanding principal of the notes until the Notes Registration Statement is declared effective.

·

Unless consent is obtained from the note holders, the Company may not file any new registration statements or amend any existing registrations until the sooner of (i) 60 days following the effective date of the Notes Registration Statement or (ii) all the notes have been converted into shares of the Company’s common stock and such shares of common stock and the shares of common stock issuable upon exercise of the warrants have been sold by the note holders.

·	Until the Notes Registration Statement has been effective for 365 days, the note holders must be given the right of first refusal with respect to any proposed sale of the Company’s common stock or debt obligations.

·

Unless consent is obtained from the note holders, for so long as 20% or more of the principal amount of the notes, the warrants or the common stock issued or issuable for the notes remains outstanding, the Company may not issue any new shares of common stock, convertible securities or warrants at a price per share, conversion price per share or exercise price per share that is lower than those prices in effect for the notes and warrants without issuing the note holders sufficient additional shares or warrants at prices such that their warrant exercise price or per share price on average is equal to that for the proposed securities to be issued.

 

 

7

---

 

·	In April 2006, the Company was in violation of certain requirements of these debt facilities. However, the note holders have not declared the notes in default. As such, the full amount of the notes at March 31, 2006 has been classified as current.

The Company will need to continue to raise additional debt or equity capital to provide the funds necessary to restructure or repay its $4.0 million loan, meet its other contractual commitments, and continue its operations. The Company is actively seeking to raise this additional capital but may not be successful in obtaining further debt or equity financing. The accompanying financial statements do not include any adjustments relating to the recoverability and classification of asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

The Company’s authorized shares of stock consist of 100,000,000 shares of common stock. As of March 31, 2006, 68,878,266 common shares were issued and outstanding, approximately 41,000,000 million additional shares are contingently issuable upon the exercise of stock options and warrants, or conversion of convertible securities. A proxy statement will be filed in connection with the Company’s annual meeting of shareholders, at which a proposal will be submitted to increase the authorized shares of capital stock to 250,000,000 shares of common stock and 25,000,000 shares of preferred stock. If such proposal is not approved, the Company may be unable to satisfy the contractual obligations it has undertaken to issue future shares of common stock.

 

NOTE D - PROPERTY AND EQUIPMENT, NET

Property and equipment consisted of the following:

		March 31,			December 31,
		2006			2005
Equipment		$	10,526,740		$	9,381,372
Furniture & Fixtures			178,082			216,402
Software			723,122			1,667,864
Vehicles			15,269			15,269
Leasehold improvements			151,835			248,952
Total			11,595,048			11,529,859
Less accumulated depreciation			(2,000,410	)		(1,374,352	)
Total		$	9,594,638		$	10,155,507

Payments Due by Period

 

The following table illustrates our outstanding debt, purchase obligations, and related payment projections as of March 31, 2006:

 

					Less than
Contractual Obligations		Total			1 Year			1-3 Years			3-5 Years
Convertible notes (principal)		$	16,945,378		$	16,945,378		$	-		$	-
Loan payable			3,980,200			3,980,200			-			-
Unsecured advances			286,675			286,675			-
Due to related parties			349,637			349,637			-			-
Other liabilities			269,106			74,323			129,037			65,746
Subtotal			21,830,996			21,636,213			129,037			65,746
Purchase obligations			426,750			426,750			-			-
Operating leases			538,602			295,578			243,024			-
Total		$	22,796,348		$	22,358,541		$	372,061		$	65,746

ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

In conjunction with the January and February, 2006 convertible note issuances discussed in NOTE H to our consolidated financial statements, we determined that we had insufficient authorized common shares to satisfy the related warrants to purchase 8,508,594 million shares of the Company’s common stock. Therefore, under Emerging Issues Task Force Issue 00-19, the $3,526,077 value of these warrants at their issuance dates was classified as a liability on our consolidated balance sheet, and their value was marked-to-market at March 31, 2006, resulting in a $1,281,278 increase in the liability, and a corresponding charge to earnings for the three months ended March 31, 2006. Until we have sufficient authorized common shares to satisfy these warrant obligations, we will be subject to future noncash mark-to-market exposure to the extent that the estimated market value of these warrants changes in the future, which are in turn primarily dependent on the Company’s common stock market price per share. As a hypothetical example, a $0.50 per share increase or decrease in the market price of the Company’s common stock at March 31, 2006 would have increased or decreased the estimated average market value of these warrants by $0.38 or $.30 per warrant, respectively, resulting in hypothetical mark-to-market adjustments that would have further increased the Company’s consolidated net loss for the three months ended March 31 2006 by $3,190,723, or decreased that loss by $2,552,579, respectively.

We are not exposed to significant interest rate or foreign currency exchange rate risk.

 

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15(b) under the Exchange Act, as of the end of the period covered by this Quarterly Report, our management conducted an evaluation with the participation of our Chief Executive Officer and Chief Financial Officer (collectively, the “Certifying Officers”) regarding the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) under the Exchange Act). Our management, with the participation of the Certifying Officers, also conducted an evaluation of our Company’s internal control over financial reporting and identified three control deficiencies, which in combination resulted in a material weakness.

 

22

---

A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects our ability to initiate, authorize, record, process or report external financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement our annual or interim financial statements that is more than inconsequential will not be prevented or detected. A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected, as of March 31, 2006. The control deficiencies identified by our management and the Certifying Officers, which in combination resulted in a material weakness, were (a)  misstatements in amounts reported for a consolidated subsidiary, (b) insufficient personnel resources with appropriate accounting expertise, and (c) a lack of independent verification of amounts billed to certain customers.

Based on this evaluation and in accordance with the requirements of Auditing Standard No. 2 of the Public Company Accounting Oversight Board, our Certifying Officers conclude that our disclosure controls and procedures were ineffective as of March 31, 2006.

 

Our management, including the Certifying Officers, does not expect that our disclosure controls and procedures will prevent all errors and all improper conduct. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute assurance that the objectives of the control system are met. Further, a design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of improper conduct, if any, have been detected. These inherent limitations include the realities that judgments and decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more persons, or by management override of the control. Further, the design of any system of controls is also based in part upon 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. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations and a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that:

 

·

pertain to the maintenance of records that, in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;

 

·

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and, that receipts and expenditures of the Company are being made only in accordance with authorization of management and directors of the Company; and

    

·

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

Our management, including the Certifying Officers, assessed the effectiveness of our internal control over financial reporting as of March 31, 2006, and have concluded that we had the following control deficiencies as of March 31, 2006 that, when combined, resulted in a material weakness:

 

(a)

In March 2006, during their review and analysis of 2005 results and financial condition in connection with the preparation of the 2005 financial statements and the 2005 Annual Report on Form 10-KSB, our senior financial management discovered certain overstatements of the revenues and expenses reported, and understatement of net loss, for our consolidated subsidiary DTNet. Based upon an assessment of the impact of the adjustments to our financial results arising from this matter, we restated the financial information presented in our Form 10-KSB/A for the year ended December 31, 2004. Adjustments to reduce (i) the overstatements of revenues; (ii) the overstatement of cost of goods sold; and (iii) the understatement of net loss, aggregated $791,200, $498,123, and $462,618, respectively, for the year ended December 31, 2004, and $604,678, $499,840, and $48,101, for the year ended December 31, 2005, respectively.

(b)

The amounts invoiced to our wholesale telecommunications customers are calculated by our engineering department.  This billing process is overseen solely by the head of that department, our Chief Technology Officer.  We do not presently employ a separate revenue assurance process whereby these bills would be recalculated and independently verified by a department other than engineering.  Our management with the participation of the Certifying Officers determined that the potential magnitude of a misstatement arising due to this deficiency is more than inconsequential to the annual and/or interim financial statements.

 

23

---

 

(c)

We do not have sufficient personnel resources at corporate headquarters with appropriate accounting expertise or experience in financial reporting for public companies. Our management with the participation of the Certifying Officers determined that the potential magnitude of a misstatement arising from this deficiency is more than inconsequential to the annual and/or interim financial statements.

 

Management has concluded that the above deficiencies when combined together have resulted in a material weakness in its internal control of financial reporting because the quantitative effect of any errors resulting from these deficiencies when taken together could result in a material misstatement of our interim and annual financial reports. Based on this evaluation and in accordance with the requirements of Auditing Standard No. 2 of the Public Company Accounting Oversight Board, the Certifying Officers concluded that we did not maintain effective internal control over financial reporting as of March 31, 2006 based on the criteria in the Internal Control - Integrated Framework.

 

Remediation Steps to Address Control Deficiencies

We are in the process of addressing the identified material weakness by remediating the control deficiencies in our internal control over financial reporting which comprise this material weakness as follows:

(a)

In March 2006, our Board of Directors (the “Board”) retained counsel to conduct a thorough investigation of the accounting misstatements of our DTNet subsidiary. Such counsel, in turn, retained an independent forensic accounting firm to assist its investigation. Based on this investigation our Board and management have concluded that these intentional overstatements of revenues, expenses and receivables were limited to the unauthorized actions of two individuals. One of these individuals was employed at corporate headquarters and the other was employed at DTNet’s headquarters. The individual employed at corporate headquarters resigned shortly after the initiation of the investigation, and we terminated the employment of the other individual immediately following the receipt of the preliminary findings of the investigation in early April 2006. We changed the individual responsible for the day-to-day management of DTNet, relocated its accounting to our corporate offices and increased our analysis of this subsidiary’s transactions. In April 2006, we sold this subsidiary to our former Chief Operating Officer.

(b)

We continue to seek to improve our in-house accounting resources. During the fourth quarter of 2005 we hired a new CFO with significant accounting and public company experience. During the first quarter of 2006 we did not hire any new accounting personnel. However, we significantly supplemented our internal accounting resources during these three months by using independent accounting and financial consulting firms. We expect to continue to use such third parties until such time as we are able to hire sufficient in-house accounting expertise. In April 2006 we promoted the former Finance Director of one of our recently acquired subsidiaries to the position of Corporate Controller. This individual has significant financial experience (including five years with the audit department of the accounting firm of KPMG Peat Marwick), has served as the CFO and/or controller of various companies (including a public registrant), and is a Certified Public Accountant.

 

(c)

We are in the process of designing a revenue assurance process for the billing of our wholesale telecommunications customers to provide independent recalculation and verification of amounts billed. We anticipate implementing this methodology by the end of the third quarter of 2006.

 

Changes in Control Over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation of such internal control that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

24

---

 

ITEM 1. LEGAL PROCEEDINGS

 

ITEM 5. OTHER INFORMATION

None