-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Aw5zdPAQEKpyvUqRRGB7eQo4sagx1y7yW6PkCND1haT7wnPzecnT61SYjF7tMdMO T+aLj9/OQ/tWTagPr0Z5EQ== 0001019687-04-001448.txt : 20040629 0001019687-04-001448.hdr.sgml : 20040629 20040629171821 ACCESSION NUMBER: 0001019687-04-001448 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 20040331 FILED AS OF DATE: 20040629 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ILINC COMMUNICATIONS INC CENTRAL INDEX KEY: 0001042291 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING, DATA PROCESSING, ETC. [7370] IRS NUMBER: 760545043 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-13725 FILM NUMBER: 04889347 BUSINESS ADDRESS: STREET 1: 2999 NORTH 44TH STREET STREET 2: SUITE 650 CITY: PHOENIX STATE: AZ ZIP: 85018 BUSINESS PHONE: 6029521200 MAIL ADDRESS: STREET 1: 2999 N 44TH STREET STREET 2: SUITE 650 CITY: PHOENIX STATE: AZ ZIP: 85018 FORMER COMPANY: FORMER CONFORMED NAME: EDT LEARNING INC DATE OF NAME CHANGE: 20010814 FORMER COMPANY: FORMER CONFORMED NAME: E-DENTIST COM INC DATE OF NAME CHANGE: 20001114 FORMER COMPANY: FORMER CONFORMED NAME: PENTEGRA DENTAL GROUP INC DATE OF NAME CHANGE: 19970822 10-K 1 ilinc_10k-033104.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- FORM 10-K For Annual and Transition Reports Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 31, 2004. 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 _________ -------------- ILINC COMMUNICATIONS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 76-0545043 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 2999 N. 44TH STREET, SUITE 650 PHOENIX, ARIZONA 85018 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) (602) 952-1200 -------------- Securities registered pursuant to Section 12(b) of the Act COMMON, $0.001 PAR VALUE PER SHARE Name of Exchange on Which Registered AMERICAN STOCK EXCHANGE Securities registered pursuant to Section 12(g) of the Act NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] ================================================================================ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No (X) The aggregate market value of the registrant's voting and non-voting Common Stock held by non-affiliates of the registrant computed by reference to the price at which the common equity was last sold on the American Stock Exchange as of September 30, 2003, was approximately $10,422,008. The number of shares of Common Stock of the registrant, par value $0.001 per share, outstanding at June 29, 2004 was 24,827,034 net of shares held in treasury. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement relating to the Annual Meeting of Stockholders of the registrant to be held on August 20, 2004 are incorporated by reference into Part III of this Report. ================================================================================ FORM 10-K REPORT INDEX
PART I Item 1. Business................................................................................... 4 Item 2. Properties................................................................................. 9 Item 3. Legal Proceedings.......................................................................... 10 Item 4. Submission of Matters to a Vote of Security Holders........................................ 10 Item 4A. Executive Officers......................................................................... 11 PART II Item 5. Market for Registrant's Common Stock and Related Shareholder Matters....................... 12 Item 6. Selected Financial Data.................................................................... 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 16 Item 7A. Quantitative and Qualitative Disclosures about Market Risk................................. 37 Item 8. Financial Statements and Supplementary Data................................................ 39 Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure....... 73 Item 9A. Controls and Procedures.................................................................... 74 PART III Item 10. Directors and Executive Officers of the Registrant......................................... 74 Item 11. Executive Compensation .................................................................... 74 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters..................................................................... 75 Item 13. Certain Relationships and Related Transactions............................................. 75 Item 14. Controls and Procedures.................................................................... 75 PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................... 76 2
FORWARD - LOOKING STATEMENTS Unless the context requires otherwise, references in this document to "iLinc Communications," "iLinc" the "Company," "we," "us," and "our" refer to iLinc Communications, Inc., (formerly known as EDT Learning, Inc.). Statements contained in this Annual Report on Form 10-K that involve words like "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates" and similar expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. These are statements that relate to future periods and include, but are not limited to, statements as to our ability to: sell our products and services; improve the quality of our software; derive overall benefits of our products and services; introduce new products and versions of our existing products; sustain and increase revenue from existing products; integrate current and emerging technologies into our product offerings; control our expenses including those related to sales and marketing, research and development, and general and administrative expenses; control changes in our customer base; support our customers and provide sufficient technological infrastructure; obtain sales or increase revenues; impact the results of legal proceedings; control and implement changes in our employee headcount; obtain sufficient cash flow; manage liquidity and capital resources; realize positive cash flow from operations; or realize net earnings. Such forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from anticipated results. These risks and uncertainties include, but are not limited to, our dependence on our products or services, market demand for our products and services, our ability to attract and retain customers and channel partners, our ability to expand our technological infrastructure to meet the demand from our customers, our ability to recruit and retain qualified employees, the ability of channel partners to successfully resell our products, the status of the overall economy, the strength of competitive offerings, the pricing pressures created by market forces, and the risks discussed herein (see "Managements Discussion and Analysis of Financial Condition and Results of Operations"). All forward-looking statements included in this report are based on information available to us as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein, to reflect any change in our expectations or in events, conditions or circumstances on which any such statement is based. Readers are urged to carefully review and consider the various disclosures made in this report and in our other reports filed with the SEC that attempt to advise interested parties of certain risks and factors that may affect our business. Our reports are available free of charge as soon as reasonably practicable after we file them with the SEC and may be obtained through our Website located at www.ilinc.com. The Company's trademarks and service marks include iLinc, iLinc Communications, MeetingLinc, LearnLinc, SupportLinc, and ConferenceLinc, graphics associated with that four-product suite of Web collaboration products, Glyphics, EDT Learning, e-Learning Simplified, ThoughtWare, Quisic, and Learning-Edge. We may also refer to trademarks of other corporations and organizations in this report. 3 PART I ITEM 1. BUSINESS COMPANY OVERVIEW We develop and sell software that provides real-time collaboration and training using Web-based tools that we believe increase worker productivity and save money. Our four-product iLinc Suite, led by LearnLinc (which also includes MeetingLinc, ConferenceLinc, and SupportLinc), is an award winning virtual classroom, Web conferencing and collaboration suite of software. With our Web collaboration, conferencing and virtual classroom products, we provide simple, reliable and cost-effective tools for remote presentations, meetings and online events. Our software is based on a proprietary architecture and code that finds its origins as far back as 1994, in what we believe to be the beginnings of the Web collaboration industry. LearnLinc has been translated into six languages, and is currently available in version 7.4. Our customers may choose from several different pricing options for the iLinc suite, and may receive our products on a stand-alone basis or integrated with one or a number of our other award-winning products, depending upon their needs. Customers wishing to collaborate and present, may choose between MeetingLinc, LearnLinc, ConferenceLinc and SupportLinc to deliver live events over the Internet in a one-to-one, one-to-many, or many-to-many communication format. Uses for our four-product suite of Web collaboration software include online business meetings, sales presentations, employee training sessions, product demonstrations and technical support assistance. We sell our software solutions to large and medium-sized corporations inside and outside of the Fortune 1000, targeting certain vertical markets. We market our products using a direct sales force and a distribution channel consisting of referral agents, international and national value-added resellers ("VAR"). We allow customers to choose between purchasing a perpetual license or subscribing to a periodic license of our products, providing for flexibility in pricing and payment methods. Our iLinc revenues are a mixture of high margin perpetual licenses of software and monthly recurring revenues from annual maintenance and support agreements, ASP subscription agreements and other products and services. ABOUT THE ILINC WEB COLLABORATION SUITE The iLinc Suite(TM) is a four product suite of software that addresses the four most common business collaboration needs. LearnLinc(TM) is an Internet-based software that is designed for training and education of remote students. With LearnLinc, instructors and students can collaborate and learn remotely providing an enhanced learning environment that replicates and surpasses traditional instructor-led classes. Instructors can create courses and classes, add varied agenda items, enroll students, deliver live instruction, and deliver content that includes audio, video, and interactive multimedia. In combination with TestLinc(TM), LearnLinc permits users to administer comprehensive tests, organize multiple simultaneous breakout sessions and record, edit, play back and archive entire sessions for future use. MeetingLinc(TM) is an online collaboration software designed to facilitate the sharing of documents, PowerPoint(TM) presentations, graphics and applications between meeting participants without leaving their desks. MeetingLinc allows business professionals, government employees, and educators to communicate more effectively and economically through interactive online meetings using voice-over-IP technology to avoid the expense of travel and long distance charges. MeetingLinc allows remote participants to: give presentations, demonstrate their products and services, annotate on virtual whiteboards, edit documents simultaneously, and take meeting participants on a Web tour. Like all of the Web collaboration products in the suite, MeetingLinc includes integrated voice and video conferencing services. ConferenceLinc(TM) is a presentation software designed to deliver the message in a one-to-many format providing professional management of Web conferencing events. ConferenceLinc manages events such as earning announcements, press briefings, new product announcements, corporate internal mass communications and external marketing events. ConferenceLinc is built on the MeetingLinc software platform and code to combine the best interactive features with an easy to use interface providing meaningful and measurable results to presenters and participants alike. Its design includes features that take the hassle out of planning, and supporting a hosted Web seminar. ConferenceLinc includes automatic email invitations, "one-click join" capabilities, online confirmations, update notifications, and customized attendee registration. With ConferenceLinc, presenters may not only present 4 content, but may also gain audience feedback using real-time polling, live chat, question and answer sessions, and post-event assessments. The entire presentation is easily recordable for viewing offline and review after the show with the recorder capturing the content and the audio, video, and participant feedback. SupportLinc(TM) is an online technical support and customer sales support software designed to give customer service organizations the ability to provide remote hands-on support for products, systems, or software applications. SupportLinc manages the support call volume and enhances the effectiveness of traditional telephone-based customer support systems. SupportLinc's custom interface is designed to be simple to use so as to improve the interaction and level of support for both customers and their technical support agents. Our Web collaboration suite of products may be sold as a customer-hosted installation (instead of a concurrent user license), allowing the customer to purchase the entire suite for organization-wide use on an unlimited connection basis. The enterprise edition provides for unlimited use for an unlimited number of users, and includes our entire four-product suite of Web collaboration products. Corporations, educational institutions and governments may purchase or lease any one product or a combination of the products to suit their individual needs. Because our Web collaboration products are available for license as an iLinc hosted ASP solution or as a customer hosted behind-the-firewall solution, customers can choose the model that works best for their budget and IT capabilities. If a customer purchases a perpetual license for the product, it also may purchase a customer support and maintenance agreement, varying in term from one to five years and typically costing 15% to 18% of the license fee for the product. AUDIO CONFERENCING Through its acquisition of Glyphics Communications in June 2004, the Company now also delivers comprehensive audio conferencing solutions that help businesses provide virtual meetings, corporate events, distance learning programs, and daily conference calls. Our audio conferencing offering includes a wide array of services and products that include the following: o AUDIO ON-DEMAND (NO RESERVATIONS NEEDED): With pre-established calling accounts for each user, you can create or participate in conference calls with no advance notice, 24/7; o RESERVED AUTOMATED: The solution for recurring calls, each participant has a permanent number and passcode; o OPERATOR ASSISTED: For important calls, this service includes an iLinc conference operator to host, monitor, and coordinate the call; and, o ONLINE SEMINARS: Support online Web presentation with high-quality audio from iLinc. Customers may purchase our audio conferencing products and services without an annual contract commitment on a monthly recurring usage basis, and often subscribe for a fixed per minute rate. OTHER PRODUCTS AND SERVICES In addition to the iLinc Suite of products and services, we offer to our customers an array of e-Learning and training products and services. o TECHNOLOGY: We offer training software products that like iLinc, promote online collaboration with products that integrate with our LearnLinc software. These include TestLinc - an assessment and quizzing tool that allows for formal testing and evaluation of students, and i-Canvas(TM) - a training content development software that allows non-technical training professionals to create Web-based training courses without programming. i-Canvas is sold on an individual user perpetual license basis. o SERVICES: We also offer custom content development services through a subcontractor relationship with Interactive Alchemy, an entity which is primarily comprised of former employees of 5 iLinc and which resides in iLinc's corporate office in Phoenix. Custom content services are bid on a project-by-project basis. o CONTENT: We also offer a library of online courses focused upon the training of executives on essential business topics. Our off-the-shelf online library of content includes an online mini-MBA program co-developed with the Tuck School of Business at Dartmouth College. Customers subscribe for a period of time per course, with the license providing for access over typically one year from the date the students first access of the course. MARKETING Marketing has outlined a plan that incorporates public relations, tradeshows, Web events, Web marketing initiatives and direct marketing (mail and email) efforts specifically at the target verticals - messaged in campaigns that speak to the needs of these industries. The goals of this strategy are to increase our market share in the selected markets, target marketing dollars more efficiently, sell away from the competition, align sales, marketing, and product development and creating customer value to prevent future displacement threats. DIRECT SALES The direct sales team is organized by geographic territory and is broken down into distinct groups - corporate sales sells to organizations with fewer than 3,000 employees; major accounts sales sells in a team environment with the regional accounts sales. These two sales teams focus on large target account sales and organizations with 3000 or more employees; and event services sales focuses on large "high-touch" professionally-managed events. All of these groups focus all of their outbound activity with our specific vertical markets: financial services, high technology, and professional service organizations. We believe that the target vertical markets have a commonality of meeting four criteria: we have an established customer base in the market; our product feature set is specifically appropriate to the needs of the market; analysts have identified a need within that market for increasing use of Web conferencing; and we believe that we have the potential to capture a portion of the share of such markets. INDIRECT SALES iLinc has formed relationships with several organizations that market and sell our products and services through their sales distribution channels. The relationships can be categorized into referral partners which strictly refer business for a small percentage of the contract sale and value added resellers (VAR) that actively sell the products and provide product support. As of March 31, 2004, we had 60 organizations selling our products, on a non-exclusive basis, with 32 of those partners providing indirect sales in North America, including the United States, Canada and Mexico, and have 28 partners providing indirect sales in 12 countries outside North America, including the United Kingdom, Spain, Italy, Israel, Germany, Australia, Costa Rica, Columbia and Japan. Referral partners execute referral agreements providing for the payment of a fee upon the closing of a sale, with a distribution agreement typically having a one-year renewable term. Our value added resellers execute agreements to resell our products to their customers through direct sales and in some cases through integration of our products into their products or service offerings. Our distribution agreements typically have terms of one to three years and are automatically renewed for an additional like term unless either party terminates the agreement for breach or other financial reasons. In most of these agreements, the distribution partner licenses the product from us and resells the product to its customers. Under those agreements, we record only the amount paid to us by the distributor as revenue, and recognize revenue when all revenue recognition criteria have been met. Our national and international VAR network focuses on sales of iLinc and i-Canvas on an integrated or stand-alone basis. These VARs are focused in markets such as the domestic education and government markets, as well as international markets, where we do not compete. CUSTOMERS Our corporate customer list includes those inside and outside of the Fortune 1000 with notable customers in financial services such as Aetna, Guardian Life Insurance, JP Morgan Chase, Travelers Insurance, and Wells Fargo; high tech with customers such as California Software, Qualcomm, Sabre, and Xerox, and professional services organizations such as EDS, Greenburg Traurig and McKinsey Consulting. We also have a significant number of higher educational 6 organizations including The State University of New York, Kent State University, Tulane and 23 other major universities that use our products. Our reach includes customers both within the United States, Canada, Mexico, and outside North America in 13 other countries. AWARDS We are proud of the recognition received by the Company from industry leading experts, software associations, and training organizations. Together with our predecessors, we have been honored with more than 55 awards from notable authorities such as The American Society for Training and Development ("ASTD"), Brandon Hall Magazine, and New Media Magazine. The list of awards includes four National Telly Awards; six Software Service Provider of the Year Awards and two Gold Medals from e-Learning authority Brandon Hall, and most notably two first-place awards by a vote of e-Learning professionals LearnLinc was the winner of first place in the Synchronous Software Shootout held at Online Learning's conference in the fall of 2002, being voted number one in the head-to-head competition, besting industry leaders WebEx and PlaceWare (purchased by Microsoft and now Microsoft Live Meeting); and i-Canvas was the winner of first place in the Software Simulation Shootout held at Online Learning's conference in 2001, being voted number one in the head-to-head competition, defeating products from industry leaders Click2Learn and Macromedia. TECHNOLOGY & INTELLECTUAL PROPERTY Our existing technology and intellectual property were originally developed by organizations that we have acquired including the assets of Learning-Edge, ThoughtWare, Quisic, Mentergy and Glyphics. For our ASP customers, we host our software and provide Internet connectivity from our dedicated servers in Los Angeles, California; Phoenix, Arizona; Springville, Utah; and Troy, New York. We run a network infrastructure on-premises both in our Phoenix and Troy offices and through leased data centers in Los Angeles and Springville. Our ASP data network is redundant in design and is secure from unauthorized access. Our Web collaboration software products are client/server applications that operate in a Windows environment. Our ASP product operates in a Linux environment using an Oracle database. RESEARCH & DEVELOPMENT The Company invested a substantial portion of its working capital and resources in the continued development of its e-Learning software and technologies. We employ full-time engineers, programmers and developers, that are located in Troy, New York and Phoenix, Arizona, who are constantly focused on developing new features and enhancements to our existing software offering and expanding that offering with new products and services. The primary focus of our research and development efforts are on improving the functionality and performance of the iLinc suite as well as developing new features that meet changing market demands. In the 2003 fiscal year, we invested over $3.2 million in direct and indirect research and development activities, and have invested over $2.7 million for the 2004 fiscal year. We expect to continue to make significant investments in research and development for the next several years. CUSTOMER SERVICE We offer technical and customer support through a customer support team that has been together for over ten years. We offer differing levels of support depending upon the maintenance and support agreement executed by the customer that includes telephone support through a toll-free number from 8:30 a.m. until 8:30 p.m. Eastern Time and an email request system. We also offer access to self-help information that includes a database of frequently asked questions, quick reference and advanced end-user guides, online tutorials, and access to a real-time searchable knowledge database. Most of our requests for technical support are questions concerning general product functionality with some assistance with technical computer and firewall issues. Our response times vary depending upon the issue, but the vast majority of our customer support questions are addressed during the initial technical support call. Customer issues and support tickets are tracked within our CRM database for use by our technical support teams and customers searching the knowledge database. 7 COMPETITION We believe that our current Web conferencing software has specific and unique characteristics that match the needs of our target vertical markets. The Company intends to leverage these strengths as well as direct product development efforts to continue to enhance the software to meet the specific needs of these markets. We believe that by targeting an integrated development and marketing approach to these verticals, iLinc can demonstrate enough value as a tool that supplements the collaboration needs for our vertical markets to discourage displacement of the product - even if the capability was to be heavily discounted by a competitor. With our emphasis being our Web collaboration four-product suite, we face competition from various Web conferencing and collaboration software companies including WebEx, PlaceWare (purchased by Microsoft and now called Microsoft Live Meeting) and Centra, as well as providers of similar software such as IBM, and Oracle. The Web collaboration, virtual classroom and Web conferencing industry continue to change and evolve rapidly, and we expect continued consolidation within the industry. Many of our current and potential competitors have longer operating histories, significantly greater financial, technical and other resources and greater name recognition than we have. We have identified what we believe to be the principal competitive factors in our markets, including ease of use; breadth of features; quality and reliability of products; pricing; security; indirect channel sales and the effectiveness of a direct sales force; ability to develop and support software; and limitations presented by the use of the public Internet. Although we believe our products compete favorably, we may not be able to maintain a competitive position against current and potential competitors, especially those with greater financial resources. ACQUISITIONS As a part of our external growth strategy, we acquired the Web conferencing and several e-Learning companies providing the Company with expertise, tangible and intangible assets, technology, customer base, recurring revenues, and a global VAR network. October 2001 - Learning-Edge, Inc. ("Learning-Edge"), a Phoenix based provider of custom content development services. We acquired from Learning-Edge substantially all of its assets, which included an existing customer base, and an award winning Content Development Tool (i-Canvas). January 2002 - ThoughtWare Technologies, Inc. ("ThoughtWare"), a Memphis based provider of workforce management software. We acquired from ThoughtWare a small recurring revenue base, and HR workforce performance software that supports human capital development (Learning Tracker; People Search; Performance Coach and Career Planner). June 2002 - Quisic Corporation ("Quisic"), a Los Angeles based provider of custom content development services and e-Learning software. We acquired from Quisic certain assets primarily consisting of approximately 130 hours off-the-shelf library of online courses (including the 75 hour Tuck Business School at Dartmouth with content focused on accounting, finance, management, and marketing). November 2002 - Mentergy, Inc. ("Mentergy"), a provider of virtual classroom software. We acquired from Mentergy all assets associated with LearnLinc and TestLinc software, an existing customer base, a VAR network and a recurring maintenance revenue stream. June 2004 - Glyphics Communications, Inc., ("Glyphics") a provider of comprehensive audio conferencing products and services. On June 3, 2004, the Company executed an agreement to acquire substantially all of the assets of and assume certain liabilities of Glyphics Communications, Inc., a Utah based private company. The acquisition had a stated effective date of June 1, 2004 and was fully consummated on June 14, 2004. The purchase price, which is expected to total $5.568 million, is based on a multiple of the Glyphics' 2003 estimated annual audited net audio conferencing business revenues. The purchase price will be paid with the assumption of approximately $2.114 million in specific liabilities, with the balance paid using the Company's common stock at the fixed price of $1.05 per share, or an estimated 3.524 million shares. The actual purchase price to be paid, and the resulting number of shares to be issued will be based upon the audited results that are expected to be obtained within sixty days of the closing date. Twenty percent of the consideration due is being held in escrow. Amounts held in escrow will be available to the Company to satisfy contingent claims and seller's indemnification obligations. Amounts held in 8 escrow also may be returned to the Company in the event that audio conferencing revenue performance measures required to be obtained by the Company during the 2004 calendar year are not met. EMPLOYEES As of March 31, 2004, we employed 48 full time persons, with the majority of those located at our corporate offices in Phoenix, Arizona. Our employee base consists of 7 employees performing general and administrative functions, 28 employees performing sales, marketing functions and customer support, 11 employees performing product research and development functions, and two employees performing IT functions. None of our employees is represented by collective bargaining agreements. As part of the Glyphics acquisition that occurred subsequent to the fiscal 2004 year end, the Company also, as of June 1, 2004, employs 34 full-time and 5 part-time employees at the Springville, UT facility. This employee base consists of one employee performing general and administrative functions, 6 employees performing sales functions, 28 employees performing audio conferencing support functions, and 4 employees performing IT functions. None of the employees are represented by collective bargaining agreements. DENTAL PRACTICE MANAGEMENT BUSINESS TREATED AS DISCONTINUED OPERATIONS The Company began its operations in March of 1998, with the simultaneous roll-up of 50 dental practices (an "Affiliated Practice") and an initial public offering. The Company's initial goals were to provide training and practice enhancement services nationwide to our Affiliated Practices using our proprietary Web-based learning management and financial reporting system. Beginning in April of 2000, the Company modified its affiliated service agreements and commensurate with that change the Company recorded certain charges against earnings during the fiscal year ended March 31, 2002 and March 31, 2001. The Company modified its business plan moving away from its dental practice management business during the third quarter of its fiscal year ended March 31, 2002. Effective January 1, 2004, the Company is no longer engaged in the dental practice management business and has reflected such business segment as a discontinued operation. ITEM 2. PROPERTIES We maintain corporate headquarters in Phoenix, Arizona and have occupied that 14,000 square foot Class A facility since the Company's inception in 1998. The Phoenix lease began in 1998 and has a term of ten years. The Phoenix offices can accommodate up to 85 employees and is fully equipped with up to date computer equipment and server facilities. The Phoenix lease requires a monthly rent and operating expenses of approximately $30,000. We also maintain a 2,500 square foot Class B facility in Troy, New York costing $4,800 per month with an emphasis in that location on research and development, and technical support. As a part of the ThoughtWare acquisition, we leased facilities in Memphis, Tennessee consisting of 2,700 square feet with a three-year term costing $4,400 per month. Those Memphis operations were consolidated into Phoenix operations and we are currently seeking to vacate those premises with the assumption of the lease by a sub-tenant. Our subsidiary, TW Acquisition Subsidiary, Inc., is obligated under an operating lease in Carlsbad, California consisting of 3,300 square feet with a three-year remaining term costing approximately $8,000 per month and the space has been sub-leased for the remaining term for approximately $7,200 per month. As a part of the discontinued dental practice management services segment we leased facilities in Houston, Texas on behalf of one of our Affiliated Practices consisting of 1,500 square feet with a ten-year term costing $2,800 per month. The Affiliated Practice vacated the premises without notice to us even though he had assumed the lease. We are currently seeking reimbursement for any and all amounts owed on this lease from the Affiliated Practice and are seeking to terminate the lease with the current landlord. 9 As a part of the Glyphics acquisition that occurred subsequent to the 2004 fiscal year end, the Company also, as of June 1, 2004, maintains offices in Springville, Utah, occupying Class A facility in two adjacent buildings. The first building houses its administrative and IT functions, with 10,000 square feet of space, with the second housing the operator complex and sales organizations with 6,122 square feet. The Springville lease began in 2003 and has a term of five years. The Springville offices can accommodate up to 100 employees and is fully equipped with up to date computer equipment. The facility also provides a fully redundant co-location and server facility for all audio conferencing activities. The Springville lease requires a monthly rental of approximately $10,700. ITEM 3. LEGAL PROCEEDINGS On June 14, 2002, the Company acquired the assets of Quisic Corporation. Subsequently, on November 4, 2002, two former employees of Quisic Corporation (their CEO and CIO), filed a lawsuit in the Superior Court of the State of California styled George B. Weathersby, et. al. vs. Quisic Corporation, et. al. claiming damages against Quisic and the Board of Directors of Quisic arising from their employment termination by the Quisic Board. The Company was also added as a third party defendant with an allegation of successor liability, but only to the extent that Quisic Corporation is found liable, and then only to the extent the plaintiffs prove their successor liability claim against the Company. The Company only acquired certain assets of Quisic Corporation in an asset purchase transaction. Based upon the facts and circumstances known, the Company believes that the plaintiffs' claims are without merit, and furthermore, that the Company is not the successor of Quisic, and therefore the Company intends to vigorously defend this aspect of the lawsuit. While in the opinion of management, resolution of these matters is not expected to have a material adverse effect on the Company's financial position, results of operations or cash flows, the ultimate outcome of any litigation is uncertain. Were an unfavorable outcome to occur that awarded to the Plaintiffs against defendant Quisic large sums, and then the court determined that the Company is a successor to Quisic, then the impact is likely to be material to the Company. Subsequent to the defendants' answers being filed, the court ordered that an arbitration of the merits be held, but the date of that arbitration has not been set. On June 11, 2003, Kepner-Tregoe, Inc. filed suit in the Supreme Court of the State of New York, County of New York, styled, Kepner-Tregoe, Inc. vs. Internal & External Communications, Inc., et. al., against Quisic Corporation and the Board of Directors of Quisic seeking to collect an arbitration award against Internal & External Communications, Inc. (a subsidiary of Quisic). The Company was also added as a third party defendant with an allegation of successor liability, but only to the extent that Quisic Corporation is found liable, and then only to the extent the plaintiffs prove their successor liability claim against the Company. The Company only acquired certain assets of Quisic Corporation in an asset purchase transaction. As a part of the Quisic acquisition transaction consideration, the Company placed into escrow 500,000 shares of its common stock that was to secure a revenue performance requirement. That revenue performance target was not achieved and the Company demanded the return of the shares of common stock. The shareholders of Quisic do not dispute the right of the Company to obtain those shares. However, since the claims of the plaintiffs assert potential rights to those shares, they were instead tendered to the registry of the trial court pending resolution of the party's respective claims. Those 500,000 shares are not counted as shares outstanding nor as treasury shares as the performance contingency associated with those shares was not met. The Company believes that it is not the successor of Quisic, and therefore the Company intends to vigorously defend this aspect of the lawsuit. While in the opinion of management, resolution of these matters is not expected to have a material adverse effect on the Company's financial position, results of operations or cash flows, the ultimate outcome of any litigation is uncertain. Were an unfavorable outcome to occur that awarded to the Plaintiffs against defendant Quisic large sums, and then the court determined that the Company is a successor to Quisic, then the impact is likely to be material to the Company. Subsequent to the defendants' answers being filed, the Quisic defendants sought an order dismissing the plaintiff's claims and that order is still pending. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At a Special Meeting of Stockholders that was held February 5, 2004, a proposal by proxy was submitted to a vote of stockholders that would approve the Certificate of Amendment to the Company's Restated Certificate of Incorporation that would (a) increase the number of shares of common stock that the Company will have authority to issue from Forty Million (40,000,000) to One Hundred Million (100,000,000) shares and (b) change the name of the Company to "iLinc Communications, Inc." The proposal passed with 12,079,459 voting in favor of the proposal and 316,816 voting against the proposal. With affirmative vote of a majority of the outstanding shares of the Company's common stock, the proposal passed and the Company accordingly filed an amendment to its Restated 10 Certificate of Incorporation that became effective on February 5, 2004. A copy of the Certificate of Amendment to the Company's Restated Certificate of Incorporation is attached hereto as an Exhibit. ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information concerning the executive officers of the Company (ages are as of March 31, 2004): James M. Powers, Jr. 48 Chairman, President and Chief Executive Officer James L. Dunn, Jr. 42 Senior Vice President, General Counsel, and Interim Chief Financial Officer Nathan Cocozza 31 Senior Vice President of Sales JAMES M. POWERS, JR. CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER Dr. James Powers, Jr. has served as Chairman, President and CEO of the Company since December 1998. Dr. Powers led the Company through its initial growth and acquisition phase and subsequent transformation to an integrated communications company providing Web, audio, video and voice-over IP solutions. Dr. Powers joined the Company through the merger with Liberty Dental Alliance, Inc., a Nashville based company where he was the founder, Chairman and President from 1997 to 1998. Dr. Powers was a founder and Chairman of Clearidge, Inc., a privately held bottled water company in Nashville, Tennessee from 1993 to 1999, where he led Clearidge through 13 acquisitions over three years to become one of the largest, independent bottlers in the Southeast, before selling the company to Suntory Water Group, Inc. Dr. Powers also is a founder and Director of Barnhill's Buffet, Inc., a privately held chain of 48 restaurants in the Southeast with over $100 million in annual revenue. He received his Bachelor of Science Degree from University of Memphis, a Doctor of Dental Surgery Degree from The University of Tennessee, and his MBA from the Vanderbilt University's Owen Graduate School of Management. JAMES L. DUNN, JR. SENIOR VICE PRESIDENT, GENERAL COUNSEL, AND INTERIM CHIEF FINANCIAL OFFICER James L. Dunn, Jr., is a co-founder of the Company and has been an integral part of the senior management team since the Company's initial public offering in 1998. Mr. Dunn is responsible for all merger and acquisition activities. He successfully managed the acquisition of over 100 Affiliated Practices and three dental practice management companies that doubled the Company's annual revenues within the first 12 months of operations. Mr. Dunn was instrumental in the reorganization of the Company leading to its current Web conferencing focus and managed the acquisition of five companies in the past 30 months. He assumed the role of General Counsel in March 2000 and is also responsible for all legal affairs of the Company. He also assumed the role of interim CFO in February of 2004. Mr. Dunn is an attorney licensed in the State of Texas and is a CPA as well. He received his law degree from Southern Methodist University School of Law and his Bachelor's Degree in Business Administration-Accounting from Texas A & M University. NATHAN COCOZZA SENIOR VICE PRESIDENT OF SALES Nathan Cocozza joined the Company in early January of 2004 as Senior Vice President of Sales. Mr. Cocozza has had extensive sales experience specifically in the Web conferencing, audio conferencing, and Web collaboration industry. He was previously the vice president of strategic development for PlaceWare where he was responsible for their growth in their major accounts department from five to 50 people, obtaining contracts from organizations representing over 50% of the Fortune 100, and a major factor in PlaceWare's overall growth in revenue to over $50 million annually. PlaceWare was a leading provider of Web conferencing services that began in 1997 and ultimately was purchased by Microsoft for reportedly $200 million. Mr. Cocozza subsequently served as vice president of North American Web sales for Genesys Conferencing (NasdaqNM:GNSY), where he was responsible for the launch of the Genesys Web collaboration services in the United States. Genesys, a French-based company, provides primarily audio conferencing as well as integrated Web conferencing services in 20 countries. 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS MARKET INFORMATION, HOLDERS AND DIVIDENDS The Company's Common Stock has been traded on the American Stock Exchange system under the symbol "ILC" since February 6, 2004. Prior to that, the Company's Common Stock was traded on the American Stock Exchange system under the symbol "EDT". The following table sets forth the range of the reported high and low sales prices of the Company's Common Stock for the years ended March 31, 2004 and 2003: 2004 HIGH LOW ---- ------- ------- First Quarter................................... $0.41 $0.25 Second Quarter.................................. $0.81 $0.32 Third Quarter................................... $1.09 $0.61 Fourth Quarter.................................. $1.23 $0.80 2003 HIGH LOW ---- ------- ------- First Quarter .................................. $1.40 $0.76 Second Quarter.................................. $0.90 $0.33 Third Quarter................................... $0.57 $0.25 Fourth Quarter.................................. $0.57 $0.25 As of June 17, 2004, the closing price of our Common Stock was $0.99 per share and there were approximately 344 holders of record, as shown on the records of the transfer agent and registrar of Common Stock. The number of record holders does not bear any relationship to the number of beneficial owners of the Common Stock. The Company has not paid any cash dividends on its Common Stock in the past and does not plan to pay any cash dividends on its Common Stock in the foreseeable future. The Company's Board of Directors intends, for the foreseeable future, to retain earnings to finance the continued operation and expansion of the Company's business. EQUITY COMPENSATION PLANS The table below provides information relating to our equity compensation plans as of March 31, 2004:
Number of Securities Remaining Available for Future Issuance Under Number of Securities to Weighted-Average Compensation Plans be Issued Upon Exercise Exercise Price of (Excluding Securities Of Outstanding Options, Outstanding Options, Reflected in First Plan Category Warrants and Rights Warrants and Rights Column) - ------------------------------------------------------------------------------------------------------------------ Equity compensation plans approved by security holders 2,282,855 $1.43 736,937 Equity compensation plans approved by security holders 450,000 $8.50 -- Equity compensation plans not approved by security holders -- -- -- -------------------------- -------------------------- Total 2,732,855 736,937 ========================== ==========================
12 In December 2001, the Company, under the initiative of the Compensation Committee with the approval of the Board of Directors, issued its chief executive officer an incentive stock grant under the 1997 Stock Compensation Plan of 450,000 restricted shares of the Company's common stock as a means to retain and incentivize the chief executive officer. The shares 100% vest after 10 years from the date of grant. The shares were valued at $405,000 based on the closing price of the stock on the date of grant, which is recorded as compensation expense ratably over the vesting period. The vesting of the incentive shares accelerates based on the Company's share price as follows:
PERFORMANCE CRITERIA SHARES VESTED ------------------------------------------------------------------ -------------- Share price trades for $4.50 per share for 20 consecutive days 150,000 shares Share price trades for $8.50 per share for 20 consecutive days 150,000 shares Share price trades for $12.50 per share for 20 consecutive days 150,000 shares
SALES OF UNREGISTERED SECURITIES Set forth below are the securities we issued in private placement transactions which at the time were not registered under the Securities Act of 1933, as amended (the "Securities Act"). Further included is the consideration, if any, we received for such securities and information relating to the section of the Securities Act, or rule of the Securities and Exchange Commission, under which exemption from registration was claimed. In September 2003, the Company completed its private placement of convertible preferred stock with detachable warrants. The Company sold 30 units at $50,000 each and raised a total of $1,500,000. Each unit consisted of 5,000 shares of convertible preferred stock, par value $0.001 and a warrant to purchase 25,000 shares of common stock. The convertible preferred stock is convertible into the Company's common stock at a price of $0.50 per share (subject to adjustment in certain events, with a floor of $0.30), and the warrants are immediately exercisable at a price of $1.50 per share with a three-year term. Accordingly, each share of preferred stock is convertible into 20 shares of common stock and retains a $10 liquidation preference. The Company will pay an 8% dividend to holders of the convertible preferred stock, and the dividend is cumulative. The convertible preferred stock is non-voting and non-participating. The shares of convertible preferred stock will not be registered under the Securities Act of 1933, as amended, and were offered in a private placement providing exemption from registration. The placement agent was paid a commission of $150,000 or 10% of the gross proceeds plus $45,000, which represented a 3% non-accountable expense fee and received a warrant to purchase 3 units at the same terms of the original units. In addition, the Company paid $17,000 in legal and accounting fees bringing the net proceeds raised to $1,288,000. The Company used the net proceeds for general working capital, to expand its sales and marketing activities and to retire certain acquisition related liabilities. The cash proceeds of the private placement of convertible preferred stock was allocated pro-rata between the relative fair values of the preferred stock and warrants at issuance using the Black Scholes valuation model for valuing the warrants. After allocating the proceeds between the preferred stock and warrant, an effective conversion price was calculated for the convertible preferred stock to determine the beneficial conversion discount for each share. The aggregate value of the warrants and the beneficial conversion discount of $247,000 are considered a deemed dividend in the calculation of loss per share. Subsequent to year-end, a holder of 2,500 shares of preferred stock converted the shares to 50,000 shares of common stock and one holder of 20,000 shares converted to 400,000 shares of common stock. The underlying common stock that would be issued upon conversion of the preferred stock and upon exercise of the associated warrants have been registered with the SEC and may be sold pursuant to a resale prospectus dated May 24, 2004. In February of 2004, the Company completed a private placement offering raising capital of $500,000 that was used for general corporate purposes. Under the terms of the offering, the Company issued unsecured subordinated convertible notes that have a term of 24 months (subject to adjustment in certain events), and the notes are subordinated to any present or future senior indebtedness. The notes bear interest at the rate of 8% per annum for the first twelve months and then 10% for the second twelve months (subject to a retroactive adjustment to 15% if the underlying shares into which the notes are convertible have not been registered by July 31, 2004) and require quarterly payments of interest only, with the principal due at maturity on February 12, 2006. The holders of the notes may convert the outstanding principal into shares of the Company's common stock at the fixed price of $0.70 per share (subject to adjustments for dilution, as defined). At the issue date, the Company calculated a beneficial conversion feature of the notes to be $214,286, which is being amortized as interest expense over the 2-year life of the debt. The holders of the notes 13 retain certain demand and piggy-back registration rights. Subsequent to year end, holders with a principal balance totaling $500,000 converted their notes into 714,285 shares of the Company's common stock. The underlying common stock that would be issued upon conversion of the notes have been registered with the SEC and may be sold pursuant to a resale prospectus dated May 24, 2004. In April of 2004, the Company completed a private placement offering raising capital of $4.25 million that provided the Company $3.8 million of net proceeds. Under the terms of this offering, the Company issued $3,187,500 in unsecured senior notes and 1,634,550 shares of Common Stock of the Company. The senior notes were issued as a series of notes pursuant to a unit purchase and agency agreement. The senior notes are unsecured, non-convertible, and the purchasers received no warrants. The placement agent received a commission equal to 10% of the gross proceeds together with a warrant for the purchase of 163,455 shares of the Company's common stock at a price equal to 120% of the price paid by investors. The senior notes bear interest at a rate of 10% per annum, and accrued interest is due and payable on a quarterly basis beginning July 15, 2004, with principal due at maturity on July 15, 2007. The senior notes are redeemable by the Company at 100% of the principal value at any time after July 15, 2005. The senior notes are unsecured obligations of the Company but are senior in right of payment to all existing and future indebtedness of the Company. Individuals and entities participating in this offering have the right to demand registration of the common stock issued therefrom upon written notice to the Company and also have piggy-back registration rights should the company file a registration statement before the shares are otherwise registered. The issuance of these securities was made in reliance upon the exemptions from registration set forth in Section 4(2) of the Securities Act and Regulation D under the Securities Act. ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected financial data of the Company (now trading as AMEX:ILC) that has been derived from the audited consolidated financial statements. Effective January 1, 2004, the Company discontinued its dental practice management services. The Company has restated its historical results to reflect that business segment as a discontinued operation. The Company began its current Web conferencing operations during the fiscal year ended March 31, 2002. The selected financial data should also be read in conjunction with the Company's consolidated financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this report. 14
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED MARCH 31, MARCH 31, MARCH 31, MARCH 31, MARCH 31, STATEMENT OF OPERATIONS DATA: 2004 2003(*) 2002(*) 2001(*) 2000(*) ---------- ---------- ---------- ---------- ---------- Revenues Licenses ....................................... $ 2,241 $ 447 $ 92 $ -- $ -- Service and maintenance ........................ 3,665 3,629 2,590 -- -- ---------- ---------- ---------- ---------- ---------- Total revenue ................................ 5,906 4,076 2,682 -- -- Operating expenses ............................... 7,293 6,748 3,446 -- -- ---------- ---------- ---------- ---------- ---------- Loss from operations ............................. (1,387) (2,672) (764) -- -- ---------- ---------- ---------- ---------- ---------- Loss from continuing operations before income taxes .......................................... (2,293) (3,889) (1,062) -- -- Income tax expense ............................... -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- Loss from continuing operations .................. (2,293) (3,889) (1,062) -- -- Income (loss) from discontinued operations ....... 275 133 6,867 (24,917) (5,360) ---------- ---------- ---------- ---------- ---------- Net income (loss) ................................ (2,018) (3,756) 5,805 (24,917) (5,360) Preferred stock dividends ........................ (75) -- -- -- -- Imputed preferred stock dividends ................ (247) -- -- -- -- ---------- ---------- ---------- ---------- ---------- Income (loss) available to common shareholders ... $ (2,340) $ (3,756) $ 5,805 $ (24,917) $ (5,360) ========== ========== ========== ========== ========== Earnings (loss) per common share - basic and diluted From continuing operations .................... $ (0.16) $ (0.25) $ (0.09) $ -- $ -- From discontinued operations .................. 0.02 0.01 0.58 (2.37) (0.52) ---------- ---------- ---------- ---------- ---------- Net earnings (loss) per common share .......... $ (0.14) $ (0.24) $ 0.49 $ (2.37) $ (0.52) ========== ========== ========== ========== ========== BALANCE SHEET DATA: Cash and cash equivalents ........................ $ 292 $ 409 $ 1,498 $ -- $ -- Working capital (deficit) ........................ (3,113) (2,984) (1,538) -- -- Assets of discontinued operations ................ 301 620 7,350 9,191 37,906 Total assets ..................................... 12,460 12,423 15,587 9,191 37,906 Long-term debt, less current maturities .......... 6,404 7,901 7,361 11,461 14,829 Long-term debt discount .......................... (1,960) (2,038) (2,264) -- -- Liabilities of discontinued operations ........... -- -- -- 15,845 18,899 Total shareholders' equity (deficit) ............. 3,366 2,320 4,666 (6,654) 19,007 - -------------- (*) Effective January 1, 2004, the Company discontinued its dental practice management services. The Company has restated its historical results and selected financial data to reflect its dental segment as a discontinued operation. The Company began its current Web conferencing operations during the fiscal year ended March 31, 2002. 15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K THAT INVOLVE WORDS LIKE "ANTICIPATES," "EXPECTS," "INTENDS," "PLANS," "BELIEVES," "SEEKS," "ESTIMATES" AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, THE SECURITIES ACT OF 1933, AS AMENDED, AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. SUCH FORWARD-LOOKING STATEMENTS INVOLVE CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANTICIPATED RESULTS. THESE RISKS AND UNCERTAINTIES INCLUDE, BUT ARE NOT LIMITED TO, OUR DEPENDENCE ON OUR PRODUCTS OR SERVICES, MARKET DEMAND FOR OUR PRODUCTS AND SERVICES, OUR ABILITY TO ATTRACT AND RETAIN CUSTOMERS AND CHANNEL PARTNERS, OUR ABILITY TO EXPAND OUR TECHNOLOGICAL INFRASTRUCTURE TO MEET THE DEMAND FROM OUR CUSTOMERS, OUR ABILITY TO RECRUIT AND RETAIN QUALIFIED EMPLOYEES, THE ABILITY OF CHANNEL PARTNERS TO SUCCESSFULLY RESELL OUR SERVICES, THE STATUS OF THE OVERALL ECONOMY, THE STRENGTH OF COMPETITIVE OFFERINGS, THE PRICING PRESSURES CREATED BY MARKET FORCES, AND THE OTHER RISKS DISCUSSED HEREIN. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON INFORMATION AVAILABLE TO US AS OF THE DATE HEREOF. WE EXPRESSLY DISCLAIM ANY OBLIGATION OR UNDERTAKING TO RELEASE PUBLICLY ANY UPDATES OR REVISIONS TO ANY FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, TO REFLECT ANY CHANGE IN OUR EXPECTATIONS OR IN EVENTS, CONDITIONS OR CIRCUMSTANCES ON WHICH ANY SUCH STATEMENT IS BASED. OUR REPORTS ARE AVAILABLE FREE OF CHARGE AS SOON AS REASONABLY PRACTICABLE AFTER WE FILE THEM WITH THE SEC AND MAY BE OBTAINED THROUGH OUR WEBSITE. OVERVIEW Headquartered in Phoenix, Arizona, iLinc Communications, Inc., ("We", "Us", "Our" or the "Company") is a provider of Web and audio conferencing software and services for business collaboration. We changed our name to "iLinc Communications, Inc." from EDT Learning, Inc. to reflect not only the breadth of our Web conferencing products and services but also to reflect the integration of audio conferencing, video conferencing, and voice-over-IP technologies. The name change was approved by our stockholders at a special meeting of stockholders on February 5, 2004. Along with the name change, the Company's stock symbol changed to the new symbol of "ILC." PRODUCTS AND SERVICES FLAGSHIP PRODUCT LINE - ILINC SUITE iLinc provides integrated Web and audio conferencing software that addresses common business collaboration needs. The company is named after the flagship product - iLinc, which is a four product suite of software. The iLinc(TM) Suite includes: LearnLinc(TM) - which permits live instructor-led training and education over the Internet to remote students replicating the instructor-led environment; MeetingLinc(TM) - which facilitates more effective and economical communication through online meetings to replace in-person meetings or sales presentations; ConferenceLinc(TM) - which delivers one-to-many presentation capabilities for Web casts or marketing events; and SupportLinc(TM) - - which gives customer service organizations the ability to provide remote, hands-on support for products, systems, or software applications. Our iLinc Web collaboration software suite is available in both a periodic license model (ASP) or a perpetual license model. Since its beginnings in 1994, LearnLinc and MeetingLinc have been installed and operational in large and small organizations throughout the United States and Internationally. LearnLinc(TM), the flagship of our four-product iLinc suite, won first place at the Synchronous e-Learning Shootout held at Online Learning's Conference in the fall of 2002, winning by a vote of training professionals over such other notable companies as WebEx, PlaceWare (now Microsoft Live), and Centra. AUDIO CONFERENCING Through its acquisition of Glyphics that was effective June 1, 2004, the Company now also delivers comprehensive audio conferencing solutions that help businesses provide virtual meetings, corporate events, distance learning programs, and daily conference calls. Its audio conferencing offering includes a wide array of products: 16 o Audio On-Demand (no reservations needed) -- The pre-established calling accounts for each user, you can create or participate in conference calls with no advance notice, 24/7; o Reserved Automated -- The solution for recurring calls, each participant has a permanent number and passcode; o Operator Assisted -- For important calls, this service includes an iLinc conference operator to host, monitor, and coordinate the call; and o Online Seminars -- Support online Web presentation with high-quality audio from iLinc. SUPPLEMENTAL TRAINING PRODUCTS While we have focused on our iLinc suite of products, we also continue to provide various e-Learning and training solutions that help to differentiate the product line from other pure play Web conferencing providers. o TECHNOLOGY: We offer training software products that like iLinc, promote online collaboration with products that integrate with our LearnLinc software. These include TestLinc(TM) - an assessment and quizzing tool that allows for formal testing and evaluation of students, and i-Canvas(TM) - a training content development software that allows non-technical training professionals to create Web-based training courses without programming. i-Canvas is sold on an individual user perpetual license basis. o SERVICES: We also offer custom content generation services through the Interactive Alchemy subcontractor relationship. Custom content services are bid on a project-by-project basis and revenue is recognized on the percentage-of-completed contract method. o CONTENT: We also offer a library of online courses focused upon the training of executives on essential business topics. Our off-the-shelf online library of content includes an online mini-MBA program co-developed with the Tuck School of Business at Dartmouth College. Customers subscribe for a period of time per course, with the license providing for access over typically one year from date the students first access of the course. INDUSTRY TRENDS We see several emerging industry trends in the Web conferencing and audio conferencing industries that we believe make us well positioned to take advantage of the predicted market growth. First, the industries that have embraced Web conferencing to a large degree continue to be the financial services sector, high technology sector and professional services sector. According to a recent report by the analyst group Frost and Sullivan, these two segments represented 52.2% of the total Web conferencing revenues in 2002 and will continue to be the largest single markets for Web conferencing revenue by 2009. Frost & Sullivan has also identified Professional Service agencies as a large adopter of the Web Conferencing from now until 2009. To that end, we now have more than 200 professional service companies that have chosen our Web conferencing solution as their tool of choice, including some of the larger organizations inside the Fortune 1000. A second notable trend is that specific features and licensing options are becoming increasingly important to the financial services sector, high technology and professional service markets. This has created what we believe to be unique opportunities for iLinc. Frost & Sullivan expects that desktop videoconferencing and voice over IP integration will be heavily utilized features among high technology companies in the immediate future and that Web conferencing vendors offering these functionalities within their solution will likely find numerous successes within this vertical market. Unlike many of our competitors, our video and voice over IP can be throttled for high bandwidth users or for low bandwidth users allowing anyone from a dial-up connection to utilize these features. Frost & Sullivan also expects that the financial services vertical market offers significant growth opportunities for those Web conferencing vendors offering a behind the firewall solution. iLinc is the only carrier class Web conferencing solution that offers both a behind the firewall solution installation combined with the strength of its feature set as well as its use of the latest Advanced Encryption Standard (AES) security. Prominent organizations inside the financial services sector of the Fortune 1000 have chosen our solution based upon these features. 17 Third, we expect to see an increase in the demand for a single source for audio and Web conferencing. Frost and Sullivan have noted in a separate report on audio conferencing that the demand for integrated audio, web, and video conferencing solutions continues to surge as end user needs for easy-to-use, single-source solutions swell. Developing and proving a truly converged user environment and experience, including the integration of audio, web and video conferencing technologies is essential. With our acquisition of Glyphic Communications we are now able to provide a single source for deeply integrated Web, audio, video as well as voice over IP. Increasingly, the vendor selection made for Web conferencing determines the selection made for audio conferencing. iLinc has already made significant progress in selling Web conferencing products to the Glyphics customer base as well as selling audio conferencing to the iLinc customer base. We believe that another benefit of the integrated conferencing approach is customer retention. According to the same Frost and Sullivan report, when Web conferencing and audio conferencing are sold together as an integrated package there is a significant increase in retention of the audio conferencing service. We have also found from customer surveys, this to be true and continuing to create incentives for our audio customers to be Web and audio customers to drive this retention. MARKET POSITION - DIFFERENTIATORS We view our position in the market as the appropriate solution for the enterprise-wide buyer in mature markets that have already adopted Web conferencing and collaboration. Our goal is to specialize so that we might reach the needs of target niches and be able to demonstrate specific value to these industries beyond the competition. Our target markets include financial services, high-tech and professional services. Frost and Sullivan noted in a recent report that these markets combined will deliver between 50% to 60% of the total Web conferencing market revenues this year. These vertical markets have been the early adopters of Web and audio conferencing and have become what we term as "mature conferencing buyers". Unlike other industries, the financial services, high technology and professional services markets have great familiarity with Web conferencing products and importantly, they have different needs. A growing number of these organizations have recognized that because the buying decision for Web conferencing has traditionally not been centralized, and in our experience they are using five or more different vendors for Web or audio conferencing services and therefore not realizing the economies of scale that consolidating to one or two vendors could provide. There are also other important considerations revolving around Web conferencing such as security and bandwidth availability that are inducing the buying decision for Web and audio conferencing out of the business units and into the IT department. We believe that our solution uniquely maps to critical IT requirements among these mature buyers in five important distinctions. First, we offer flexible licensing options that allow organizations to pay a one-time license fee to install the software inside of their environment, or organizations can contract with us annually to use our Web and audio conferencing services through an ASP arrangement . We also offer the ability for organizations to purchase perpetual licenses and then, have provided hosting in our co-location facility. We find this flexibility to be an important differentiator for customers making an enterprise-wide decision. As Frost & Sullivan notes, in many instances, Web conferencing is a migratory technology (from ASP to installed software) - new users tend to first utilize Web conferencing ASP services as they offer much more flexibility in terms of usage, ability to utilize multiple solutions, and require less up-front investment, and are less burdensome on enterprise resources. Therefore, a majority of new users that adopt web conferencing prior to 2007, are expected to initially adopt an ASP service-based solution, and then migrate to the purchase of a perpetual license. Second, as noted earlier we provide a completely integrated Web, audio, video and voice-over-IP conferencing solution with what we believe to be a rich-feature set. According to Web conferencing analyst, as the industry moves beyond the boundaries imposed by the term "web conferencing" to more of a rich media communications environment, those vendors that are ahead of the curve in terms of features and functionality will be around for the long-term survival. Vendors offering a "me too" solution are not expected to be active long-term competitors and are expected to disappear in the form of consolidation, acquisitions, or all together exit the market because of shrinking profits. Third, we offer the highest level of data security commercially available. We are the only Web conferencing provider that offers a customer hosted solution with a purchase license option and true point-to-point security with our unique combination of AES and secure socket layer (SSL). All information within a session can be transmitted between meeting attendees securely without any reduction in performance. Fourth, our solution is suitable and scalable for enterprise-wide deployment. The iLinc Suite addresses most common needs for business collaboration within the enterprise. We offer virtual classroom software with our LearnLinc product, software for presentation and sales demonstrations with MeetingLinc, customer support with SupportLinc, and software for Web casts and marketing events with ConferenceLinc. Each of these products share a common 18 interface enabling users of one product to easily understand any of our other products. This reduces the learning curve for Web conferencing enterprise-wide roll out and we believe increases adoption success. Fifth, we provide what we believe to be an exceptional "total cost of ownership" value. Our software and services are very competitively priced and also importantly, the customer's installation of our product is a very short and non-labor intensive process and maintenance of our software requires minimal attention from an IT perspective. We believe that all of these factors make our solution compelling to our target markets, but we also recognize that in order to grow our market share within the financial services, high technology and professional services verticals we need to develop products that address their specific needs. To that end, we have aligned our sales, marketing and product development efforts to build Web and audio conferencing functionality that delivers and addresses specific pains within each of our identified markets. For example, in the Financial Services community, companies are being mandated to secure and document every communication that happens inside and outside of their organization. We currently offer our AES data encryption solution that delivers this needed security and this year we plan to release enhanced communication and document management functionality that will completely fulfill these requirements. In the high tech community, Web conferencing is predominantly used for software or technology demonstrations. We arguably have the best application sharing technology in the industry with the ability to throttle bandwidth up or down to increase speed and performance. In the professional services community, the predominate use for Web conferencing is for training. Our product was originally built for training and we believe that it continues to be the best virtual classroom tool on the market. We believe our focus on gaining market share in our target markets correctly positions us for significant growth over future quarters. Our strategy has also been validated by industry experts in our space some who have noted iLinc as one of the first real time collaboration vendors that understands the need to move up the food chain to IT and wisely focus on three markets. SALES AND MARKETING FOCUS To leverage these advantages, our organization has launched a marketing and sales campaign inside these vertical markets with the goal of achieving growth in market share within the financial services, high tech and professional services markets. Our ability to attract and maintain these specific types of customers has given us a base of existing customers that we hope will enable us to further grow within these sectors and others. As to maintaining the existing customer base, our client services group is frequently praised in survey and online by our customers who also use our competitor's products as competitive. Our emphasis in client service has allowed us to strengthen the existing iLinc customer base while maintaining almost all of the previously existing clients in the 17 months since we acquired the software. The ability to maintain our customer base provides recurring maintenance revenues as well as opportunities for up-sales of our new iLinc products and services within those organizations. We recently added a new Senior Vice President of Sales who brings to us sales experience specifically in senior level sales positions with PlaceWare and Genesys Conferencing. The iLinc sales and marketing team has now grown a staff of 28 including an inside sales team focusing on the small-to-middle business market, a major / regional account team focused on enterprise sales, and an events services sales team that focuses on selling "high-touch " professionally-managed large Web and audio events. 19 RESULTS OF OPERATIONS As of March 31, 2004, we provide integrated Web and audio conferencing software and services with what we believe to be a very robust feature set that includes integrated video and voice over IP. Our name change is reflective of our focus in terms of research, development, sales and marketing on our award-winning suite of Web conferencing and collaboration software known as the iLinc Suite. The iLinc Suite includes: LearnLinc- permits live instructor-led training and education over the Internet to remote students replicating the instructor-led environment; MeetingLinc - facilitates more effective and economical communication through online meetings using voice-over-IP technology to avoid the expense of travel and long-distance charges; ConferenceLinc - delivers your message more consistently in a one-to-many format replicating professionally managed conferencing events; and SupportLinc - gives customer service organizations the ability to provide remote, hands-on support for products, systems, or software applications. The iLinc Suite is available in both an ASP and perpetual license purchase model. Since its beginnings in 1994, LearnLinc and MeetingLinc have been installed and operational in corporate, government, and educational organizations in the United States and internationally. LearnLinc, the flagship of iLinc's four-product iLinc suite, won first place at the Synchronous e-Learning Shootout held at Online Learning's Conference in the fall of 2002, winning by a vote of training professionals over such other notable companies as WebEx, PlaceWare (now Microsoft Live), and Centra. Our iLinc suite of products includes the ability to use integrated voice-over-IP and two-way live video. We have also completely integrated together audio conferencing services into the Web conferencing products. These services supplement the Web product but can also be purchased separately. On October 1, 2001, the Company acquired all of the outstanding capital stock of Learning-Edge, Inc.; an Arizona based private e-learning company. The Company issued 1,950,000 common shares and $1.1 million of debt under the terms of the acquisition agreement. The debt bore interest at rates ranging from 7.5% to 9.0% and was due in two equal installments on October 1, 2003 and on October 1, 2004, respectively. The Company also assumed approximately $2.9 million of Learning-Edge debt as part of this acquisition. The operating results of Learning-Edge are included with the Company as of October 1, 2001. On January 15, 2002, the Company acquired all of the outstanding capital stock of ThoughtWare Technologies, Inc.; a Tennessee based private company. The Company issued 1,550,000 common shares under the terms of the acquisition agreement. The Company also assumed approximately $1.5 million of ThoughtWare debt as part of this acquisition. Since January 2002, operating results of ThoughtWare are included with the Company's results from operations. On March 29, 2003, the Company settled various disputes it had with the former shareholders of ThoughtWare Technologies, Inc. The settlement resulted in 365,000 of the shares issued in connection with the acquisition being returned to the Company. The Company valued the shares using the share price at the date of acquisition and recorded the returned shares as a $507,000 decrease to shareholders' equity and goodwill. On June 14, 2002, the Company acquired certain assets of Quisic Corporation ("Quisic"); a California based private e-Learning company in an asset purchase and common stock purchase transaction that involved the issuance of 2,000,000 common shares to certain shareholders of Quisic together with an additional 500,000 shares that were placed into escrow to secure a revenue performance requirement. That revenue performance target was not achieved and the Company demanded the return of the shares of common stock. The shareholders of Quisic do not dispute the right of the Company to obtain those shares. However, since the claims of the plaintiffs in the Kepner-Tregoe litigation matter assert potential rights to those shares, the shares were instead tendered to the registry of the trial court pending resolution of the party's respective claims (Please refer to Item 3 - Legal Proceedings). Those 500,000 shares are not counted as shares outstanding nor as treasury shares as the performance contingency associated with those shares was not met. The operating results of Quisic have been included in the consolidated operations of the Company commencing June 17, 2002. The purchase agreement requires that the Company pay certain contingent compensation to the seller if during the 5 year period following the closing certain sales to PBS and others occur. Through December 31, 2003, the Company had collected funds subject to this contingent provision, which resulted in required contingent payments totaling $300,000. On December 31, 2003, the seller agreed to convert the entire amount then due instead into 333,333 common shares the Company's common stock at the fair market price of $0.90 per share. During the fourth quarter of fiscal 2004, the Company had invoiced for but not received additional funds subject to this contingent provision, which resulted in accrued contingent payments totaling $50,000 due at March 31, 2004. 20 Effective November 4, 2002, the Company acquired certain assets of Mentergy, Inc. ("Mentergy") that included the LearnLinc Web collaboration and Web conferencing software that is the foundation for the iLinc suite of products (the "LearnLinc Assets"). In exchange for the LearnLinc Assets, the Company paid $500,000, with one half due at closing and the remaining payment due in a note that was due December 13, 2003, assumed scheduled liabilities equal to $462,000 and agreed to provide a royalty earn-out payment due upon sales of the LearnLinc product. The royalty earn-out is equal to 20% for all revenues collected by the Company from the sale or license of LearnLinc software over a three-year period beginning with the closing date, with the first $600,000 of collected revenues not subject to the royalty, and the maximum amount due under the agreement is $5,000,000. The Company accounts for any such amounts to be paid as additional purchase consideration in accordance with EITF No. 95-8 at the time related revenues are recognized. The Company has accrued LearnLinc royalties totaling $367,000 during fiscal year 2004. The operating results are included with the Company's as of November 4, 2002. On June 3, 2004, the Company executed an agreement to acquire substantially all of the assets of and assume certain liabilities of Glyphics Communications, Inc., a Utah based private company. The acquisition had a stated effective date of June 1, 2004 and was fully consummated on June 14, 2004. The purchase price, which is expected to total $5.568 million, is based on a multiple of the Glyphics' 2003 estimated annual audited net audio conferencing business revenues. The purchase price will be paid with the assumption of approximately $2.114 million in specific liabilities, with the balance paid using the Company's common stock at the fixed price of $1.05 per share, or an estimated 3.524 million shares. The actual purchase price to be paid, and the resulting number of shares to be issued will be based upon the audited results that are expected to be obtained within sixty days of the closing date. Twenty percent of the consideration due is being held in escrow. Amounts held in escrow will be available to the Company to satisfy contingent claims and seller's indemnification obligations. Amounts held in escrow also may be returned to the Company in the event that audio conferencing revenue performance measures required to be obtained by the Company during the 2004 calendar year are not met. Individuals and entities participating in this transaction who are shareholders receiving the Company's common stock have the right to demand registration of the common stock issued therefrom upon written notice, one year from the date of the transaction, to the Company and also have piggy-back registration rights should the Company file a registration statement before the shares are otherwise registered. The operations of the Company involve many risks, which, even through a combination of experience, knowledge and careful evaluation, may not be overcome. These risks include the fact that the market for e-learning products and services is in the early stages of development and may not grow to a sufficient size or at a sufficient rate to sustain the Company's business. The Company also faces intense competition from other e-learning providers and may be unable to compete successfully. Many of the Company's existing and potential competitors have longer operating histories and significantly greater financial, technical and other resources and therefore may be able to more quickly respond to changing opportunities or customer requirements. New competitors are also likely to enter this market in the future due to the lack of significant barrier to entry in the market share. See "Additional Risk Factors That May Affect Our Operating Results and The Market Price of Our Common Stock." REVENUES FROM CONTINUING OPERATIONS Total revenues generated from continuing operations for the twelve months ended March 31, 2004 ("fiscal 2004") and March 31, 2003 ("fiscal 2003") were $5.9 million and $4.1 million, respectively, an increase of $1.8 million. License revenues from continuing operations increased $1.8 million from $447,000 in fiscal 2003 to $2.2 million in fiscal 2004 and service and maintenance revenues increased $100,000 from $3.6 million in fiscal 2003 to $3.7 million in fiscal 2004. The increase in revenue is a result of the Company's continuing expansion into the Web conferencing marketplace and concentrated sales and marketing strategies focused promoting the iLinc Suite of products. Total revenues from continuing operations generated for the twelve months ended March 31, 2003 ("fiscal 2003") and March 31, 2002 ("fiscal 2002") were $4.1 million and $2.7 million, respectively, an increase of $1.4 million. The Company recognized $92,000 of license revenue and $2.6 million of service and maintenance revenue in fiscal 2002. OPERATING EXPENSES FROM CONTINUING OPERATIONS Operating expenses from continuing operations consist of research and development, sales and marketing, general and administrative, depreciation and amortization expenses. The Company incurred operating expenses from continuing 21 operations of $7.3 million in fiscal 2004, an increase of $600,000 from $6.7 million in fiscal 2003. This increase is primarily due to an increase in general and administrative costs of $600,000, sales and marketing costs of $200,000 and depreciation and amortization of $200,000. These increases are offset by a decrease in research and development costs of $400,000. Fiscal 2003 operating expenses from continuing operations were $6.7 million, a $3.3 million increase from fiscal 2002 operating expenses of $3.4 million. The increase is primarily due to the Company's strategic change in business and acquisitions of Thoughtware, Learning Edge, Quisic, and Mentergy, and cost increases which incurred as the acquired infrastructure became a part of iLinc's operations. Research and development expenses from continuing operations represent expenses incurred in connection with the provision of e-learning services, development of new products and new product versions and consist primarily of salaries and benefits, communication equipment and supplies. Research and development expenses for fiscal 2004 and fiscal 2003 were $2.8 million and $3.2 million respectively, a decrease of $400,000. Salaries and wages decreased $1.5 million and were partially offset by increased product development costs of $1.1 million, due to the spin-off of the custom content group to Interactive Alchemy in May 2003. Fiscal 2003 research and development expenses from continuing operations were $3.2 million, an increase of $900,000 from fiscal 2002 research and development expenses of $2.3 million. The increase is a result of the Company's acquisition of Quisic and the LearnLinc assets and related compensation and product development expenses. Sales and marketing expenses from continuing operations consist primarily of sales and marketing salaries and benefits, travel, advertising, and other marketing literature. Sales and marketing expenses were $1.8 million and $1.7 million for fiscal 2004 and fiscal 2003, respectively, an increase of $100,000. The increase is primarily from product royalty fees of $94,000 relating to the increased sales of software licenses of the Executive Training Library(TM) courseware and an increase in printing and advertising costs of $34,000 relating to the Company's name change in February 2004. Fiscal 2003 sales and marketing expenses from continuing operations were $1.7 million, an increase of $945,000 from fiscal 2002 sales and marketing expenses of $755,000. The increase is a result of the Company's change in business and addition of sales and marketing personnel focused on promoting the iLinc Suite. General and administrative expenses from continuing operations consist of the corporate expenses of the Company. These corporate expenses include salaries and benefits of executive, finance and administrative personnel, rent, bad debt expense, professional services, travel, office costs and other general corporate expenses. During fiscal 2004 and 2003, general and administrative expenses from continuing operations were $2.2 million and $1.6 million, respectively, an increase of $600,000. General and administrative expenses increased primarily due to the Company's change in strategy and the acquisition of LearnLinc, and was primarily composed of increases in occupancy expenses of $147,000, legal fees of $105,000, compensation and related benefits of $142,000, general insurance of $91,000, telephone of $70,000, office expenses of $72,000, travel and entertainment of $53,000, other professional fees of $47,000 and investor relation expenses of $27,000. These and other increases were partially offset by bad debt recoveries of $284,000. During fiscal 2003 and 2002, general and administrative expenses from continuing operations were $1.6 million and $269,000 respectively, an increase of $1.3 million. General and administrative expenses increased primarily due to the Company's change in business strategy, and were composed of increases in compensation and related benefits of $562,000, occupancy expenses of $289,000, investor relations expenses of $148,000, and accounting fees of $118,000, as a result of the increased allocation of expense to continuing operations and the Quisic and Mentergy acquisitions. Fiscal 2004 and 2003 depreciation and amortization expense relating to continuing operations was $462,000 and $250,000, respectively, an increase of $212,000. The increase is a result of the acquisitions of Quisic and LearnLinc assets and purchases of computer servers and other equipment necessary to facilitate sales and service of our products. In fiscal 2002, depreciation and amortization expense was $99,000. 22 INTEREST EXPENSE FROM CONTINUING OPERATIONS Interest expense from continuing operations remained constant at $1.2 million in fiscal 2004 and fiscal 2003. During fiscal 2004, the Company incurred one-time charges to interest expense resulting from conversions of notes into the Company's common stock totaling $48,500. Interest expense increased $900,000 during fiscal 2003 from $298,000 in fiscal 2002. The increase is primarily a result of the interest associated with the $5.8 million of convertible notes issued in March 2002. INCOME TAX EXPENSE FROM CONTINUING OPERATIONS The Company recorded no tax benefit during fiscal 2004 because it concluded it is not likely it would be able to recognize the tax asset created due to the lack of operating history of its e-Learning business strategy. At March 31, 2004, the Company has a net deferred tax asset of $10.7 million with a corresponding valuation allowance. The Company's tax benefits are scheduled to expire over a period of five to thirteen years. The Company recorded no tax expense during fiscal 2004 and 2003 as a result of the losses it incurred in those years and did not record a tax benefit during fiscal 2002 due to the utilization of its fully reserved net operating loss carry-forward. RESULTS OF DISCONTINUED OPERATIONS Effective January 1, 2004, the Company discontinued its dental practice management services. Results of operations from this segment are presented as discontinued operations for the fiscal years ended March 31, 2004, 2003 and 2002 in accordance with SFAS 146 "ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES". Net income from discontinued operations for fiscal 2004, 2003 and 2002 were $275,000, $133,000, and $6.9 million, respectively. Cash flows provided by discontinued operations was $387,000, $1.6 million and $1.1 million during the fiscal years 2004, 2003 and 2002, respectively. LIQUIDITY AND CAPITAL RESOURCES The Company has a working capital deficiency, has incurred operating losses and has negative cash flows from continued operations. The Company currently does not have existing working capital and does not generate positive cash flows from operations. As a result, we may not have sufficient financial resources to satisfy our obligations as they come due in the near term. These matters, among others, including our limited operating history as a provider of Web conferencing and Web collaboration software have caused our auditors to conclude in their report that there is substantial doubt about the Company's ability to continue as a going concern. Our plan with regard to these matters includes the continued development, marketing and licensing of our iLinc suite of products and services through both internal sales efforts and through external channel partnerships. We plan to expand where appropriate with external growth by acquisition, with those acquisitions including providers of audio conferencing as well as Web conferencing products and services. Although we continue to pursue these plans, there is no assurance that the Company will be successful in obtaining sufficient revenues from its Web collaboration and e-Learning products and services to provide adequate cash flows to sustain our operations. Our continuation as a Company may be dependent on our ability to raise additional equity or debt capital, to continue to increase sales and revenues, to generate positive cash flows from operations and ultimately to achieve profitability. In order to increase its liquidity, the Company intends to restructure or extend existing obligations to reduce cash outflows for debt service, seek, if necessary, additional funding from the placement of debt or equity securities, invest in further marketing and sales efforts that result in the sale of the Company's high margin software products and services. However, there can be no assurance that the Company's plans will be achieved or that the Company will be able to acquire additional sums. At March 31, 2004, the Company had a working capital deficit of $3.1 million. Current assets included $292,000 in cash and $1.1 million in accounts receivable and $100,000 in prepaids and other assets. Current liabilities consisted of $1.1 million of deferred revenue, $1.2 million of current maturities of long-term debt and capital leases and $2.3 million in accounts payable and accrued liabilities. CASH FLOWS FROM CONTINUING OPERATIONS Cash used in operating activities was $1.1 million during fiscal 2004 and $2.1 million during fiscal 2003. Cash used in operating activities during fiscal 2004 was primarily attributable to a net loss of $2.3 million and 23 increases in accounts receivable and other assets of $430,000. These items were partially offset by increases in accounts payable and accrued liabilities of $750,000 and non-cash expenses and revenues totaling $900,000. Cash used in operating activities during fiscal 2003 was $2.1 million and was primarily attributable to a net loss of $3.9 million and an increase in accounts receivable of $177,000. These items were partially offset by increases in accounts payable and accrued liabilities of $922,000 and non-cash expenses and revenues totaling $1.0 million. Cash provided by operating activities was $55,000 during fiscal 2002 primarily due to an increase in accounts payable of $950,000 and non-cash expenses and revenues totaling $588,000. These items were partially offset by a net loss of $1.1 million and an increase in accounts receivable of $400,000. Cash used by investing activities was $400,000, $126,000 and $158,000 in fiscal years 2004, 2003 and 2002, respectively. Cash used by investing activities during fiscal 2004 was primarily due to capital expenditures of $66,000 and acquisitions, net of cash acquired of $370,000. Cash used by investing activities during fiscal 2003 was primarily due to capital expenditure of $64,000 and issuance of note receivable of $100,000. Cash used by investing activities in fiscal 2002 was primarily due to acquisitions, net of cash acquired of $100,000 and capital expenditures of $40,000. Cash provided in financing activities was $926,000 during fiscal 2004. Cash used in financing activities was $500,000 during fiscal 2003 and $500,000 during fiscal 2002. Cash provided in financing activities during fiscal 2004 was primarily due to proceeds from the issuance of preferred stock of $1.5 million and issuance of long-term debt of $500,000. These were partially offset by the repayment of long-term debt of $560,000 and $200,000 in financing costs. Cash used in financing activities during fiscal 2003 was due to the repayment of debt and capital leases of $510,000. Cash used in financing activities during fiscal 2002 was primarily attributable to the repayment of debt and capital leases of $5.5 million and financing costs incurred of $830,000. These uses of cash were partially offset by the proceeds of the Private Placement Offering (the "Offering") of $5.8 million. HISTORICAL ACTIVITIES RELATED TO ACQUISITIONS AND CAPITAL RAISE ACTIVITIES In connection with the Company's IPO in March of 1998, the Company issued $468,000 of notes (the "IPO Notes") to certain shareholders who had provided capital prior to the IPO. Originally, interest accrued at the rate of 6% with the entire amount due on March 30, 2003. Many of the IPO Note holders agreed to have the accrued interest added to the principal balance and extended the maturity date to April 1, 2005 in exchange for quarterly payments of interest and an increase in the interest rate to 10%. The total outstanding principal balance on these IPO Notes is $278,000 as of March 31, 2004. The Company had issued in 1998 as a part of the consideration due to Affiliated Practices certain subordinated promissory notes (the "Series A Notes"). On September 19, 2003, all of the outstanding principal balance of the Series A Notes, in the sum of $849,000, were converted into 1,572,222 shares of the Company's common stock. A conversion price of $0.54 per share was used as the fair price per share which was the preceding twenty trading day average closing price of the Company's common stock. As a result of that conversion, the Company recorded a $252,000 charge associated with the conversion of the Series A Notes due to a difference in the closing price of the Company's common stock on the day of conversion and the twenty trading day average closing price. Holders of the Series A Notes included James M. Powers, Jr., who had received a $76,000 Series A Note as a part of the consideration paid to him from his own Affiliated Practice transaction in 1998. In October 2001, the Company issued $1.1 million of subordinated promissory notes to the shareholders of Learning-Edge, Inc. under the terms of the acquisition agreement (the "Learning-Edge Notes"). The Learning-Edge Notes bear interest at rates ranging from at 7.5% to 9.0% and were due in two equal installments on April 5, 2005 and on October 1, 2005, respectively. The Learning-Edge Notes provided for pre-payment in the event that the Company raised additional capital between $3 and $5 million. The total outstanding principal balance on these notes is $0.9 million as of March 31, 2004. As a result of the capital raise in April of 2004 of $4.25 million, all of the outstanding balance of these notes have been fully extinguished subsequent to March 31, 2004, with cash payments of $333,000 and conversions of $583,000 of notes into 550,633 shares of the Company's common stock. In March 2002, the Company completed a private placement offering (the "Convertible Note Offering") raising capital of $5,775,000 that was used to extinguish an existing line of credit. Under the terms of the Convertible Note Offering, the Company issued unsecured subordinated convertible notes (the "Convertible Notes"). The Convertible Notes bear interest at the rate of 12% per annum and require quarterly interest payments, with the principal due at 24 maturity on March 29, 2012. The holders of the Convertible Note may convert the principal into shares of the Company's common stock at the fixed price of $1.00 per share. The Company may force redemption by conversion of the principal into common stock at the fixed conversion price, if at any time the 20 trading day average closing price of the Company's common stock exceeds $3.00 per share. The notes are subordinated to any present or future senior indebtedness. The placement agent received a commission of $577,500 plus $173,250 as a non-accountable expense reimbursement and received a warrant to purchase units on the same basis as other investors representing ten percent of the gross proceeds at a price of 110% of that paid by investors. As a part of the Convertible Note Offering the Company also issued warrants to purchase 5,775,000 shares of the Company's common stock for an exercise price of $3.00 per share. The Company may force redemption of the warrants if at any time the 20 trading day average closing price of the Company's common stock exceeds $5.50 per share, and the warrants expire on March 29, 2005. The fair value of the warrants was estimated using a Black-Scholes pricing model with the following assumptions: contractual and expected life of three years, volatility of 75%, dividend yield of 0%, and a risk-free rate of 3.87%. A discount to the Convertible Notes of $1,132,000 was recorded using this value, which is being amortized to interest expense over the ten (10) year term of the Convertible Notes. As the carrying value of the notes is less than the conversion value, a beneficial conversion feature of $1,132,000 was calculated and recorded as an additional discount to the notes and is being amortized to interest expense over the ten (10) year term of the Convertible Notes. Upon conversion, any remaining discount associated with the beneficial conversion feature will be expensed in full at the time of conversion. During fiscal 2004 holders with a principal balance totaling $150,000 converted their notes into common shares of the Company. On September 16, 2003, the Company completed its private placement of convertible preferred stock with detachable warrants. The Company sold 30 units at $50,000 each and raised a total of $1,500,000. Each unit consisted of 5,000 shares of convertible preferred stock, par value $0.001 and a warrant to purchase 25,000 shares of common stock. The convertible preferred stock is convertible into the Company's common stock at a price of $0.50 per share (subject to adjustment in certain events, with a floor of $0.30), and the warrants are immediately exercisable at a price of $1.50 per share with a three-year term. Accordingly, each share of preferred stock is convertible into 20 shares of common stock and retains a $10 liquidation preference. The Company pays an 8% dividend to holders of the convertible preferred stock, and the dividend is cumulative. The convertible preferred stock is non-voting and non-participating. The shares of convertible preferred stock will not be registered under the Securities Act of 1933, as amended, and were offered in a private placement providing exemption from registration. The placement agent was paid a commission of $150,000 or 10% of the gross proceeds plus $45,000, which represented a 3% non-accountable expense fee and received a warrant to purchase 3 units at the same terms of the original units. In addition, the Company paid $17,000 in legal and accounting fees bringing the net proceeds raised to $1,288,000. The Company plans on using the net proceeds for general working capital, to expand its sales and marketing activities and to retire certain acquisition related liabilities. The cash proceeds of the private placement of convertible preferred stock was allocated pro-rata between the relative fair values of the preferred stock and warrants at issuance using the Black Scholes valuation model for valuing the warrants. After allocating the proceeds between the preferred stock and warrant, an effective conversion price was calculated for the convertible preferred stock to determine the beneficial conversion discount for each share. The aggregate value of the warrants and the beneficial conversion discount of $247,000 are considered a deemed dividend in the calculation of loss per share. Subsequent to March 31, 2004, holders of 22,500 shares converted to 450,000 shares of common stock. In connection with the acquisition of certain assets from Mentergy, Inc. (and its wholly owned subsidiary LearnLinc Corporation), the Company issued among other consideration a secured promissory note with a principal balance of $250,000 that was due on December 13, 2003 (the "Mentergy Note"). By agreement with Mentergy and its assignees, the Company paid $50,000 in principal amount on the note during December of 2003. The remaining balance of $200,000 was paid in full in February 2004, and Mentergy has released any security interests they had in the Company's assets. In February of 2004, the Company completed a private placement offering raising capital of $500,000 that will be used for general corporate purposes. Under the terms of the offering, the Company issued unsecured subordinated convertible notes that have a term of 24 months (subject to adjustment in certain events), and the notes are subordinated to any present or future senior indebtedness. The notes bear interest at the rate of 8% per annum for the first twelve months and then 10% for the second twelve months (subject to a retroactive adjustment to 15% if the underlying shares into which the notes are convertible have not been registered by July 31, 2004) and require quarterly payments of interest only, with the principal due at maturity on February 12, 2006. The holders of the notes may convert the outstanding principal into shares of the Company's common stock at the fixed price of $0.70 per share (subject to adjustments for dilution, as defined). At the issue date, the Company calculated 25 a beneficial conversion feature of the notes to be $214,286, which will be amortized as interest expense over the 2-year life of the debt. The holders of the notes retain certain demand and piggy-back registration rights. Subsequent to year end, holders with a principal balance totaling $500,000 converted their notes into 714,285 shares of the Company's common stock. ACTIVITIES RELATED TO ACQUISITIONS AND CAPITAL RAISE ACTIVITIES OCCURRING SHORTLY AFTER THE FISCAL YEAR END In April of 2004, the Company completed a private placement offering raising capital of $4,250,000 that provided the Company $3.8 million of net proceeds. Under the terms of this offering, the Company issued $3,187,500 in unsecured senior notes and 1,634,550 shares of Common Stock of the Company. The senior notes were issued as a series of notes pursuant to a unit purchase and agency agreement. The senior notes are unsecured, non-convertible, and the purchasers received no warrants. The placement agent received a commission equal to 10% of the gross proceeds together with a warrant for the purchase of 163,455 shares of the Company's common stock at a price equal to 120% of the price paid by investors. The senior notes bear interest at a rate of 10% per annum and accrued interest is due and payable on a quarterly basis beginning July 15, 2004, with principal due at maturity on July 15, 2007. The senior notes are redeemable by the Company at 100% of the principal value at any time after July 15, 2005. The senior notes are unsecured obligations of the Company but are senior in right of payment to all existing and future indebtedness of the Company. The underlying common stock that would be issued upon conversion of the preferred stock and upon exercise of the associated warrants have been registered with the SEC and may be sold pursuant to a resale prospectus dated May 24, 2004. On June 3, 2004, the Company executed an agreement to acquire substantially all of the assets of and assume certain liabilities of Glyphics Communications, Inc., a Utah based private company that is a provider of comprehensive audio conferencing products and services. The acquisition had a stated effective date of June 1, 2004 and was fully consummated on June 14, 2004. The purchase price, which is expected to total $5.568 million, is based on a multiple of the Glyphics' 2003 estimated annual audited net audio conferencing business revenues. The purchase price will be paid with the assumption of approximately $2.114 million in specific liabilities, with the balance paid using the Company's common stock at the fixed price of $1.05 per share, or an estimated 3.524 million shares. The actual purchase price to be paid, and the resulting number of shares to be issued will be based upon the audited results that are expected to be obtained within sixty days of the closing date. Twenty percent of the consideration due is being held in escrow. Amounts held in escrow will be available to the Company to satisfy contingent claims and seller's indemnification obligations. Amounts held in escrow also may be returned to the Company in the event that audio conferencing revenue performance measures required to be obtained by the Company during the 2004 calendar year are not met. Individuals and entities participating in this transaction who are shareholders receiving the Company's common stock have the right to demand registration of the common stock issued therefrom upon written notice, one year from the date of the transaction, to the Company and also have piggy-back registration rights should the Company file a registration statement before the shares are otherwise registered. The Company has been a reseller of Glyphics' audio conferencing services for over six months and already offers an integrated Web and Audio On-DemandTM product. Glyphics offers a wide array of audio conferencing products that include: Audio On-Demand (no reservations needed) with pre-established calling accounts for each user to create or participate in conference calls with no advance notice, 24/7; Reserved Automated where each participant has a permanent number and passcode for recurring calls; Operator Assisted that includes an iLinc conference operator to host, monitor, and coordinate the call; and Online Seminars that support online Web presentations with high-quality audio from iLinc. The Company plans to continue to pursue the business formerly conducted by the seller on an integrated basis with its existing Web conferencing products. 26 CONTRACTUAL OBLIGATIONS The following schedule details all of the Company's indebtedness and the required payments related to such obligations at March 31, 2004 (IN THOUSANDS):
DUE IN DUE IN YEARS LESS THAN DUE IN DUE IN YEAR FOUR AND DUE AFTER TOTAL ONE YEAR YEAR TWO THREE FIVE FIVE YEARS ----------- ----------- ----------- ----------- ----------- ----------- Long term debt................ $ 7,365 $ 961 $ 779 $ -- $ -- $ 5,625 Capital lease obligations..... 304 289 15 -- -- -- Operating lease obligations... 2,210 743 639 463 177 188 Base salary commitments under employment agreements................. 881 506 375 -- -- -- ----------- ----------- ----------- ----------- ----------- ----------- Total contractual obligations. $ 10,760 $ 2,499 $ 1,808 $ 463 $ 177 $ 5,813 =========== =========== =========== =========== =========== ===========
CRITICAL ACCOUNTING POLICIES AND ESTIMATES The Company's discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The more significant areas requiring use of estimates relate to revenue recognition, accounts receivable and notes receivable valuation reserves, realizability of intangible assets, realizability of deferred income tax assets, and the evaluation of contingencies and litigation. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The results of such estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may materially differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. REVENUE RECOGNITION Our revenues are generally classified into two main categories - license revenue and service and maintenance revenue. License revenue is generated from the sale of our iLinc suite of Web conferencing software on a purchase-model (perpetual license basis) and from the sale of our off-the-shelf courseware, primarily the online Bridge (Mini-MBA) program. The service revenue aspect of our Service and Maintenance revenue is primarily generated from the sale of our iLinc Web conferencing software on a periodic license basis (i.e., ASP or per minute), as well as, all service contracts that might include hosting, and training services. Service and Maintenance revenue also includes all revenue arising from maintenance and upgrade contracts that are sold with our iLinc Web conferencing software purchases. Included in our Service and Maintenance revenue are the revenues associated with our custom content development services. Sales of Software Licenses We earn our revenues from the sale of software licenses and service and maintenance agreements related to those software license sales. We offer our software and services in one of two forms, the first being a purchase model that permits the purchase of a perpetual license, and the second being an ASP or per minute model that permits the purchase of a periodic term license. The iLinc suite of Web conferencing products is sold utilizing both the purchase model and the ASP model with separate revenue recognition policies applicable to each model. With each sale of our products and services, we execute contracts that govern the terms and conditions of each software license sale, hosting agreement, maintenance and support agreement and other services arrangements. 27 In connection with the Company's sales of software licenses, the Company adopted Statement of Position ("SOP") 97-2 as issued by the American Institute of Certified Public Accountants. In accordance with SOP 97-2, the Company recognizes revenue from the sale of software licenses if all of the following conditions are met: First, there is persuasive evidence of an arrangement with the customer; Second, the product has been delivered to the customer; Third, the amount of the fees to be paid by the customer is fixed or determinable; and, Fourth, collection of the fee is probable. Each of these factors, particularly the determination of whether a fee is fixed and determinable and the collectability of the resulting receivable, requires the application of the judgment and the estimates of management. Therefore, significant management judgment is utilized and estimates must be made in connection with the revenue we recognize in any accounting period. We analyze various factors, including a review of the nature of the license or product sold, the terms of specific transaction, the vendor specific objective evidence of the elements required by SOP 97-2, any contingencies that may be present, our historical experience with like transactions or with like products, the creditworthiness of the customer, and other current market and economic conditions. Changes in our judgment based upon these factors and others could impact the timing and amount of revenue that we recognize, and ultimately the results of operations and our financial condition. Therefore, the recognition of revenue is a key component of our results of operations. At the time of the sale of our perpetual software license, we assess whether the fee associated with the transaction is fixed or determinable based on the payment terms associated with the transaction before recording immediate revenue recognition, assuming all other elements of revenue recognition are present. Billings to our customers are generally due within 30 to 90 days, with payment terms up to 120 days available to certain credit worthy customers. We believe that we will have sufficient history of collecting all amounts within these normal payment terms and to conclude that the fee is fixed or determinable at the time of the perpetual license sale. Under certain circumstances, we have offered payment terms greater than 120 days and up to as much as twelve months to certain customers, for sales involving our Web conferencing perpetual license products where license revenue would normally be recognized upon delivery of the product. However, we currently do not believe that we have sufficient history of selling the iLinc Suite of products under perpetual license arrangements with extended payment terms exceeding 120 days, and therefore will record revenue when the payments from the customer are due, rather than immediately upon delivery of the product and collection is probable, assuming all other elements of revenue recognition are present. Beginning in fiscal 2004, we began offering payment terms of 180 days and anticipate continuing using those 180-day payment terms related to sales of our perpetual license products. While we do not at this time believe that we have sufficient history of selling perpetual licenses with 180-day payment terms to determine that such fees are fixed and determinable, we do expect to consider those 180-day payment terms to be normal payment terms for certain well capitalized customers when we have such a history, and accordingly, at that time will include those sales in revenue when the perpetual license sale occurs (again assuming all other aspects of revenue recognition are present). We consider all arrangements with payment terms longer than 180 days not to be fixed or determinable and for arrangements involving the extended payment terms exceeding 180 days, revenue recognition occurs when payments are due and collection is probable, assuming all other elements of revenue recognition are present. In addition, in assessing whether collection is probable or not for a given transaction, and therefore whether we should recognize the revenue, we make estimates regarding the creditworthiness of the customer. Initial creditworthiness is assessed through internal credit check processes, such as credit applications or third party reporting agencies. Creditworthiness for transactions to existing customers primarily relies upon a review of their prior payment history. We do not request collateral or other security from our customers. If we determine that collection of a fee is not reasonably assured, we defer the fee and recognize revenue at the time collection becomes reasonably assured, which is generally upon the receipt of payment or other change in circumstance. Sales of Concurrent Licenses (ASP) and Per Minute Basis Historically, a majority of our license revenue has been generated under the purchase model with revenue recognized based on a one-time sale of a perpetual license. In addition to that purchase model, we also offer a more flexible monthly, fixed-fee subscription pricing model (ASP Model) and a per-minute usage based model. Under our subscription or ASP model, a customer may subscribe to a certain number of concurrent connections or seats for a fixed period, often a year. Under this ASP method, we recognize the revenue associated with these monthly, fixed-fee subscription arrangements each month on a straight line basis over the term of the agreement. Other customers choose to avoid 28 annual commitments and instead use our Web conferencing and audio conferencing products and services based upon a per minute or usage-based pricing model. Per minute customers may also include those customers on an ASP model that incur overage fees for usage in excess of the permitted number of seats or minutes in excess of the minimum commitment. The per minute fees that include overage fees are charged at the end of each month and recorded as revenue at the end of each month as the services are provided. Customers with contractually established minimum per minute fees are assessed the greater of the established minimum or the actual usage at the end of each month. Customers wishing to avoid monthly commitments may use the e-commerce portion of our web site that permits the use our Web conferencing services on a pay-per-use basis, with no monthly minimum, purchasing the services and paying for those services online by credit card. Sales of Maintenance, Hosting and other Related Services The Company offers with each sale of its software products a software maintenance, upgrade and support arrangement. These contracts may be elements in a multiple-element arrangement or may be sold in a stand-alone basis. Revenues from maintenance and support services are recognized ratably on a straight-line basis over the term that the maintenance service is provided. Maintenance contracts typically provide for 12 month terms with maintenance contracts available up to 36 months. Revenues from consulting, training and education services are recognized either as the services are performed, ratably over a subscription period, or upon completing a project milestone if defined in the agreement. These consulting, training and education services, are not considered essential to the functionality of our products as these services do not alter the product capabilities, do not require specialized skills, and are often performed by the customer or our VAR's customers without access to those services. Implementation, consulting, training, translation, and other event type services may also be sold in conjunction with the sale of our software products. Those services are generally recognized as the services are performed or if earlier when all other revenue recognition criteria have been met. Although the Company may provide implementation, training and consulting services on a time and materials basis, a significant portion of these services have been provided on a fixed-fee basis. Should the sale of our software involve an arrangement with multiple elements (for example, the sale of a software license along with the sale of maintenance and support to be delivered over the contract period), we allocate revenue to each component of the arrangement using the residual value method based on the fair value of the undelivered elements. We defer revenue from the arrangement equivalent to the fair value of the undelivered elements and recognize the remaining amount at the time of the delivery of the product or when all other revenue recognition criteria have been met. Fair values for the ongoing maintenance and support obligations are based upon separate sales of renewals of maintenance contracts. Fair value of services, such as training or consulting, is based upon separate sales of these services to other customers. Thus, these types of arrangements require us to make judgments about the fair value of undelivered arrangements. Sales of Custom Content Development Services A component of our service and maintenance revenue is derived from custom content development services. The sale of custom content development services often involves the execution of a master service agreement and corresponding work orders describing the deliverable due, the costs involved, the project milestones and the payments required. For contracts and revenues related exclusively to custom content development services, the Company recognizes revenue and profit as work progresses on custom content service contracts using the percentage-of-completion method. This method relies on estimates of total expected contract revenue and costs as each job progresses throughout the relevant contract period. The Company follows this method since reasonably dependable estimates of the costs applicable to various stages of a custom content service contract can be made. Recognized revenues and profit are subject to revisions as the custom content service contract progresses to completion. Revisions in profit estimates are charged to income in the period in which the facts that give rise to the revision become known. Customers sometimes request modifications to projects in progress which may result in significant revisions to cost estimates and profit recognition, and the Company may not be successful in negotiating additional payments related to the changes in scope of requested services. Should this arise, the provision for any estimated losses on uncompleted custom content service contracts are made in the period in which such losses become evident. There were no such losses at March 31, 2004 for any custom content development services. For arrangements requiring customer acceptance, revenue is deferred until the earlier of the end of the acceptance period or until written notice of acceptance is received from the customer. 29 Sales by VAR's and Agents The Company has engaged organizations within the United States of America and in twelve other countries that market and sell its products and services through their sales distribution channels that are value added resellers (VAR's). The VAR's primarily sell, on a non-exclusive basis, our iLinc suite of Web conferencing products and predominately sell purchase-model perpetual licenses for installation and hosting by the VAR's customer. The Company's VAR contracts have terms of one to two years and are automatically renewed for an additional like term unless either party terminates the agreement for breach or other financial reasons. Each VAR purchases the product from the Company and resells the product to its customers. Under those VAR agreements, the Company records only the amount paid by the VAR as revenue and recognizes revenue when all revenue recognition criteria have been met. The Company also engages organizations that act as mere agents or distributors of its products ("Agents"), without title passing to the Agent and with the Agent only receiving a commission on the consummation of the sale to our customer. The Company records revenue on sales by Agents on a gross basis before commissions due to the Agent and only when all revenue recognition criteria are met as would be with a sale by the Company directly to a customer not involving an agent. Sales Reserves The sales reserve is an estimate for losses on receivables resulting from customer credits, cancellations and terminations and is recorded, if at all, as a reduction in revenue at the time of the sale. Increases to sales reserve are charged to revenue, reducing the revenue otherwise reportable. The sales reserve estimate is based on an analysis of the historical rate of credits, cancellations and terminations. The accuracy of the estimate is dependent on the rate of future credits, cancellations and terminations being consistent with the historical rate. If the rate of actual credits, cancellations and terminations is different than the historical rate, revenue would be different from what was reported. As of March 31, 2004, we did not believe that an accrual for sales reserves was appropriate, but continue to assess the adequacy of the sales reserve account balance on a quarterly basis. Allowance for Doubtful Accounts We record an allowance for doubtful accounts to provide for losses on accounts receivable due to customer credit risk. Increases to the allowance for doubtful accounts are charged to general and administrative expense as bad debt expense. Losses on accounts receivable due to financial distress or failure of the customer are charged to the allowance for doubtful accounts. The allowance estimate is based on an analysis of the historical rate of credit losses. The accuracy of the estimate is dependent on the future rate of credit losses being consistent with the historical rate. If the rate of future credit losses is greater than the historical rate, then the allowance for doubtful accounts may not be sufficient to provide for actual credit losses. The allowance for doubtful accounts for iLinc Web collaboration product sales is, as of March 31, 2004, $24,000 and is based on our historical collection experience. Any adjustments to these accounts are reflected in the income statement for the current period, as an adjustment to revenue in the case of the sales reserve and as a general and administrative expense in the case of the allowance for doubtful accounts. SOFTWARE DEVELOPMENT COSTS The Company accounts for software development costs in accordance with Statements of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," whereby costs for the development of new software products and substantial enhancements to existing software products are expensed as incurred until technological feasibility has been established, at which time any additional costs are capitalized. Technological feasibility is established upon completion of a working model. Costs of maintenance and customer support are charged to expense when related revenue is recognized or when those costs are incurred, whichever occurs first. Software development costs incurred subsequent to the establishment of technological feasibility have not been significant to date, and all software development costs have been charged to research and development expense in the accompanying consolidated statements of operations. INTANGIBLE ASSETS On April 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets" and as a result, the Company's goodwill is no longer amortized. SFAS No. 142 requires that goodwill be tested annually (or more frequently if impairment indicators arise) for impairment. Upon initial 30 application of SFAS No. 142, the Company determined there was no impairment of goodwill. The Company has established the date of March 31 on which to value its goodwill. The Company has made acquisitions of companies having operations or technology in areas within its strategic focus and has recorded goodwill and other intangible assets associated with its acquisitions. Future adverse changes in market conditions or poor operating results of the underlying acquired operations could result in losses or an inability to recover the carrying value of the goodwill and other intangible assets thereby possibly requiring an impairment charge in the future. As of March 31, 2004, the Company has identified no such impairment. Debt issuance costs are amortized using the effective interest rate method over the ten-year term of the related debt obligations. Other intangibles primarily consist of the Quisic and LearnLinc purchase consideration that was allocated to purchased software and customer relationship intangibles. Such other intangible are amortized over their expected benefit period of twenty four to thirty six months. INCOME TAXES The Company utilizes the liability method of accounting for income taxes in accordance with SFAS No. 109 "Accounting for Income Taxes." Under this method, deferred taxes are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted marginal tax rates currently in effect when the differences reverse. The Company has recorded a full valuation allowance to reduce the carrying value of its net deferred tax assets because it has concluded that it is more likely than not that it will not be realized. The Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. In the event the Company was to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase net income in the period such a determination was made. STOCK-BASED COMPENSATION In December 2002, the FASB issued SFAS No. 148, "ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND DISCLOSURE - AN AMENDMENT TO SFAS NO. 123." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method on accounting for stock-based employee compensation. The Company has adopted the disclosure provisions of SFAS No. 123 and accordingly the implementation of SFAS No. 148 did not have a material effect on the Company's consolidated financial position or results of operations. GUARANTEES AND INDEMNIFICATIONS In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation ("FIN") No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others -- an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN 34." The following is a summary of the Company's agreements that the Company has determined are within the scope of FIN No. 45: The Company provides a 90-day warranty for certain of its products. Historically, the Company's performance under the warranty has been minimal, and as such, no warranty accrual has been provided for in the Company's consolidated financial statements. Under its bylaws, the Company has agreed to indemnify its officers and directors for certain events or occurrences arising as a result of the officer's or director's serving in such capacity. The term of the indemnification period is for the officer's or director's lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. However, the Company has a director and officer liability insurance policy that limits its exposure and enables it to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal and has no liabilities recorded for these agreements as of March 31, 2004. 31 The Company enters into indemnification provisions under (i) its agreements with other companies in its ordinary course of business, typically with business partners, contractors, and customers, landlords and (ii) its agreements with investors. Under these provisions the Company generally indemnifies and hold harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company's activities or, in some cases, as a result of the indemnified party's activities under the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of March 31, 2004. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued SFAS No. 143, "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS", which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred with the associated asset retirement costs being capitalized as a part of the carrying amount of the long-lived asset. SFAS No. 143 also includes disclosure requirements that provide a description of asset retirement obligations and reconciliation of changes in the components of those obligations. The statement is effective for fiscal years beginning after June 15, 2002. The implementation of SFAS No. 143 did not have a material impact on the Company's consolidated financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, "IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," which addresses accounting and financial reporting for the impairment or disposal of long-lived assets. This standard was effective for the Company's consolidated financial statements beginning January 1, 2002. The implementation of SFAS No. 144 did not have a material impact on the Company's consolidated financial position or results of operations. In April 2002, the FASB issued SFAS No. 145, "RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL CORRECTIONS." SFAS No. 145 rescinded three previously issued statements and amended SFAS No. 13, "ACCOUNTING FOR LEASES." The statement provides reporting standards for debt extinguishments and provides accounting standards for certain lease modifications that have economic effects similar to sale-leaseback transactions. The statement is effective for certain lease transactions occurring after May 15, 2002 and all other provisions of the statement shall be effective for fiscal years ending after May 15, 2002. The implementation of SFAS No. 145 will effect the classification of extraordinary items presented in the Company's consolidated statements of operations. Such gains will no longer be considered extraordinary in nature and will be reclassified to operations. In June 2002, the FASB issued SFAS No. 146, "ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES," which updates accounting and reporting standards for personnel and operational restructurings. The Company will be required to adopt SFAS No. 146 for exit, disposal or other restructuring activities that are initiated after December 31, 2002, with early application encouraged. The adoption of SFAS No. 146 did not have a material effect on the Company's consolidated financial position or results of operations. In April 2003, SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" was issued. This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement is effective for contracts entered into or modified after June 30, 2003. Adoption of this statement did not have a material impact on the Company's consolidated financial position or results of operations. In May 2003, SFAS No. 150, "ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY" was issued. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003. The adoption of SFAS No. 150 did not have a material impact on the Company's consolidated financial position, results of operations, or cash flows. On December 18, 2003 the SEC issued Staff Accounting Bulletin No. 104, REVENUE RECOGNITION ("SAB 104"), which supersedes SAB 101, Revenue Recognition in Financial Statements. SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, 32 which was superseded as a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." The adoption of SAB 104 did not have a material impact the Company's consolidated financial position or results of operations. In December 2003, the FASB issued Interpretation No. 46 ("FIN 46R") (revised December 2003), "Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51" ("ARB 51"), which addresses how a business enterprise should evaluate whether it has a controlling interest in an entity though means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46 (FIN 46), which was issued in January 2003. Before concluding that it is appropriate to apply ARB 51 voting interest consolidation model to an entity, an enterprise must first determine that the entity is not a variable interest entity (VIE). As of the effective date of FIN 46R, an enterprise must evaluate its involvement with all entities or legal structures created before February 1, 2003, to determine whether consolidation requirements of FIN 46R apply to those entities. There is no grandfathering of existing entities. Public companies must apply either FIN 46 or FIN 46R immediately to entities created after December 15, 2003 and no later than the end of the first reporting period that ends after March 15, 2004 to entities considered to be special purpose entities. The adoption of FIN 46R did not have a material impact on the Company's consolidated financial position or results of operations. 33 ADDITIONAL RISK FACTORS THAT MAY AFFECT OUR OPERATING RESULTS AND THE MARKET PRICE OF OUR COMMON STOCK You should carefully consider the risks described below. The risks and uncertainties described below are not the only ones we face. If any of the following risks actually occur, our business, financial condition or results of operations could be materially and adversely affected. In that case, the trading price of our common stock could be adversely affected. WE HAVE A LIMITED OPERATING HISTORY, WHICH MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS. We have a limited operating history in the Web conferencing e-Learning business. While the organizations that we have acquired have been engaged in the their respective business for over five years, we only recently acquired those assets and have undertaken to integrate their assets into our operations at varying levels. Over the past 30 months, we have made significant changes to our product mix and service mix, our growth strategies, our sales and marketing plans, and other operational matters. As a result, it may be difficult to evaluate an investment in our company. Given our recent investment in technology, we cannot be certain that our business model and future operating performance will yield the results that we intend. In addition, the competitive and rapidly changing nature of the e-Learning and Web conferencing markets makes it difficult for us to predict future results. Our business strategy may be unsuccessful and we may be unable to address the risks we face. WE FACE RISKS INHERENT IN INTERNET-RELATED BUSINESSES AND MAY BE UNSUCCESSFUL IN ADDRESSING THESE RISKS. We face risks frequently encountered by early-stage companies in new and rapidly evolving markets such as e-Learning and Web conferencing. We may fail to adequately address these risks and, as a consequence, our business may suffer. To address these risks among others, we must successfully introduce and attract new customers to our products and services; successfully implement our sales and marketing strategy to generate sufficient sales and revenues to achieve or sustain operations; foster existing relationships with our existing customers to provide for continued or recurring business and cash flow; and, successfully address and establish new products and technologies as new markets develop. As an early-stage company, we may not be able to sufficiently access, address and overcome risks inherent in our business strategy. OUR QUARTERLY OPERATING RESULTS ARE UNCERTAIN AND MAY FLUCTUATE SIGNIFICANTLY. Our operating results have varied significantly from quarter to quarter and are likely to continue to fluctuate as a result of a variety of factors, many of which we cannot control. Factors that may adversely affect our quarterly operating results include: the size and timing of product orders; the mix of revenue from custom services and software products; the market acceptance of our products and services; our ability to develop and market new products in a timely manner and the market acceptance of these new products; the timing of revenues and expenses relating to our product sales; and, the timing of revenue recognition. Expense levels are based, in part, on expectations as to future revenue and to a large extent are fixed in the short term. To the extent we are unable to predict future revenue accurately, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. WE HAVE SIGNIFICANT OPERATING LOSSES, HAVE LIMITED FINANCIAL RESOURCES, AND MAY NOT BECOME PROFITABLE. We have incurred substantial operating losses and have limited financial resources at our disposal. We have and long-term obligations that we will not be able to satisfy without additional debt and/or equity capital and ultimately generating profits and cash flows from our e-Learning and Web conferencing operations. If we are unable to achieve profitability in the near future, we will face increasing demands for capital and liquidity. We may not be successful in raising additional debt or equity capital and may not become profitable in the short term or not at all. As a result, we may not have sufficient financial resources to satisfy our obligations as they come due in the short term. OUR AUDITORS HAVE EXPRESSED SUBSTANTIAL DOUBT AS TO OUR ABILITY TO CONTINUE AS A GOING CONCERN. Our consolidated financial statements have been prepared on a basis which assumes that we will continue as a going concern and which contemplates the realization of our assets and the satisfaction of our liabilities and 34 commitments in the normal course of business. We have a significant working capital deficiency, and have historically suffered substantial recurring losses and negative cash flows from operations. These factors, among others, and the limited operating history as an e-Learning and Web collaboration company have caused our auditors to conclude in their report that there is substantial doubt as to our ability to continue as a going concern. Our plans with regard to these factors include continued development, marketing and licensing of our Web Conferencing and e-Learning products and services through both internal growth and acquisition. Although we continue to pursue these plans, there is no assurance that we will be successful in obtaining sufficient revenues from our products and services to provide adequate cash flows to sustain operations. Our continuation is dependent on our ability to raise additional equity or debt capital, to increase our e-Learning revenues, to generate positive cash flows from operations and to achieve profitability. The consolidated financial statements do not include any adjustments related to the recoverability of assets and classification of liabilities that might result from the outcome of this uncertainty. LISTING QUALIFICATIONS MAY NOT BE MET. The American Stock Exchange's continued listing standards require that the Company maintain stockholder's equity of at least $4.0 million if the Company has losses from continuing operations and/or net losses in three of its four most recent fiscal years. While the Company has sustained losses in three of its four most recent fiscal years, and had less than $4.0 million of stockholder's equity at March 31, 2004, the Company raised approximately $0.9 million in additional equity capital, converted certain other debt to equity and completed an acquisition subsequent to the fiscal year end and therefore has as of the date of this report stockholder's equity in excess of the $4.0 million requirement. If in the future, the Company fails to maintain a sufficient level of stockholder's equity in compliance with those and other listing standards of the American Stock Exchange then the Company would be required to submit a plan to the American Stock Exchange describing how it intended to regain compliance with the requirements. DILUTION TO EXISTING STOCKHOLDERS IS LIKELY TO OCCUR UPON ISSUANCE OF SHARES WE HAVE RESERVED FOR FUTURE ISSUANCE. On March 31, 2004, 19,257,304 shares of our common stock were issued, of which 1,432,412 were held in treasury, and 23,449,805 additional shares of our common stock were reserved for issuance. The issuance of these additional shares will reduce the percentage ownership of existing stockholders in the Company. The following shares were reserved for issuance as of March 31, 2004: o Issued and outstanding stock options to purchase common shares totaling 2,282,855; o Issued and outstanding warrants to purchase common shares totaling 7,647,664; o Issued and outstanding warrant to purchase $577,500 of convertible redeemable subordinated notes with detachable warrants for 577,500 common shares, all of which are exercisable for or convertible into an aggregate 1,155,000 common shares; o Issued and outstanding warrant to purchase 15,000 shares of convertible preferred stock with detachable warrants for 75,500 common shares, all of which are exercisable for or convertible into an aggregate 575,000 common shares; o A restricted stock grant to receive shares totaling approximately 450,000; and o Shares issuable upon the conversion of convertible redeemable subordinated notes and preferred stock totaling a potential aggregate of 11,339,286 common shares. The existence of these reserved shares coupled with other factors, such as the relatively small public float, could adversely affect prevailing market prices for our common stock and our ability to raise capital through an offering of equity securities. THE LOSS OF THE SERVICES OF OUR SENIOR EXECUTIVES AND KEY PERSONNEL WOULD LIKELY CAUSE OUR BUSINESS TO SUFFER. Our success depends to a significant degree on the performance of our senior management team. The loss of any of these individuals could harm our business. We do not maintain key person life insurance for any officers or key employees other than on the life of James M. Powers, Jr., our Chairman, President and CEO, with that policy providing a death benefit to the Company of $1.0 million. Our success also depends on the ability to attract, integrate, motivate and retain additional highly skilled technical, sales and marketing, and professional services personnel. To the extent we are unable to attract and retain a sufficient number of additional skilled personnel, our business will suffer. 35 OUR INTELLECTUAL PROPERTY MAY BECOME SUBJECT TO LEGAL CHALLENGES, UNAUTHORIZED USE OR INFRINGEMENT, ANY OF WHICH COULD DIMINISH THE VALUE OF OUR PRODUCTS AND SERVICES. Our success depends in large part on our proprietary technology. If we fail to successfully enforce our intellectual property rights, the value of these rights, and consequently the value of our products and services to our customers, could diminish substantially. It may be possible for third parties to copy or otherwise obtain and use our intellectual property or trade secrets without our authorization, and it may also be possible for third parties to independently develop substantially equivalent intellectual property. Currently, we do not have patent protection in place related to our products and services. Litigation may be necessary in the future to enforce our intellectual property rights, to protect trade secrets or to determine the validity and scope of the proprietary rights of others. While we have not received any notice of any claim of infringement of any of our intellectual property, from time to time we may receive notice of claims of infringement of other parties' proprietary rights. Such claims could result in costly litigation and could divert management and technical resources. These types of claims could also delay product shipment or require us to develop non-infringing technology or enter into royalty or licensing agreements, which agreements, if required, may not be available on reasonable terms, or at all. COMPETITION IN THE WEB CONFERENCING SERVICES MARKET IS INTENSE AND WE MAY BE UNABLE TO COMPETE SUCCESSFULLY, PARTICULARLY AS A RESULT OF RECENT ANNOUNCEMENTS FROM LARGE SOFTWARE COMPANIES. The market for Web conferencing services is relatively new, rapidly evolving and intensely competitive. Competition in our market will continue to intensify and may force us to reduce our prices, or cause us to experience reduced sales and margins, loss of market share and reduced acceptance of our services. Many of our competitors have larger and more established customer bases, longer operating histories, greater name recognition, broader service offerings, more employees and significantly greater financial, technical, marketing, public relations and distribution resources than we do. We expect that we will face new competition as others enter our market to develop Web conferencing services. These current and future competitors may also offer or develop products or services that perform better than ours. In addition, acquisitions or strategic partnerships involving our current and potential competitors could harm us in a number of ways. FUTURE REGULATIONS COULD BE ENACTED THAT EITHER DIRECTLY RESTRICT OUR BUSINESS OR INDIRECTLY IMPACT OUR BUSINESS BY LIMITING THE GROWTH OF INTERNET-BASED BUSINESS AND SERVICES. As commercial use of the Internet increases, federal, state and foreign agencies could enact laws or adopt regulations covering issues such as user privacy, content and taxation of products and services. If enacted, such laws or regulations could limit the market for our products and services. Although they might not apply to our business directly, we expect that laws or rules regulating personal and consumer information could indirectly affect our business. It is possible that such legislation or regulation could expose companies involved in providing Internet-based services to liability, which could limit the growth of Web use generally and thereby reduce demand for our products and services. Such legislation or regulation could dampen the growth in Web usage and decrease its acceptance as a medium of communications and commerce. WE DEPEND LARGELY ON ONE-TIME SALES TO GROW REVENUES. A high percentage of our revenue is attributable to one-time purchases by our customers rather than long term recurring ASP type contracts. As a result, our inability to continue to obtain new agreements and sales may result in lower than expected revenue, and therefore, harm our ability to achieve or sustain operations or profitability on a consistent basis, which could also cause our stock price to decline. Further, because we face competition from larger better-capitalized companies, we could face increased downward pricing pressure that could cause a decrease in our gross margins. OUR OPERATING RESULTS MAY SUFFER IF WE FAIL TO DEVELOP AND FOSTER OUR VALUE ADDED RESELLER OR DISTRIBUTION RELATIONSHIPS. We have an existing channel and distribution network that provides growing revenues and contributes to our high margin software sales. These distribution partners are not obligated to distribute our services at any particular minimum level. As a result, we cannot accurately predict the amount of revenue we will derive from our distribution partners in the future. The 36 inability of our distribution partners to sell our products to their customers and increase their distribution of our products could result in significant reductions in our revenue, and therefore, harm our ability to achieve or sustain profitability on a consistent basis. SALES IN FOREIGN JURISDICTIONS BY US AND OUR INTERNATIONAL DISTRIBUTOR NETWORK MAY CAUSE COSTS THAT ARE NOT ANTICIPATED. We continue to expand internationally through our value added reseller network and OEM partners. We have limited experience in international operations and may not be able to compete effectively in international markets. We face certain risks inherent in conducting business internationally, such as: o our inability to establish and maintain effective distribution channels and partners; o the varying technology standards from country to country; o our inability to effectively protect our intellectual property rights or the code to our software; o our inexperience with inconsistent regulations and unexpected changes in regulatory requirements in foreign jurisdictions; o language and cultural differences; o fluctuations in currency exchange rates; o our inability to effectively collect accounts receivable; or o our inability to manage sales and other taxes imposed by foreign jurisdictions. THE GROWTH OF OUR BUSINESS SUBSTANTIALLY DEPENDS ON OUR ABILITY TO SUCCESSFULLY DEVELOP AND INTRODUCE NEW SERVICES AND FEATURES IN A TIMELY MANNER. We acquired our Web collaboration, Web conferencing and virtual classroom software in November of 2002. With our focus upon that product suite our growth depends on our ability to continue to develop new features, products and services around the iLinc suite and line of products. We may not successfully identify, develop and market new products and features in a timely and cost-effective manner. If we fail to develop and maintain market acceptance of our existing and new products to offset our continuing development costs, then our net losses will increase and we may not be able to achieve or sustain profitability on a consistent basis. IF WE FAIL TO OFFER COMPETITIVE PRICING, WE MAY NOT BE ABLE TO ATTRACT AND RETAIN CUSTOMERS. Because the Web conferencing market is relatively new and still evolving, the prices for these services are subject to rapid and frequent changes. In many cases, businesses provide their services at significantly reduced rates, for free or on a trial basis in order to win customers. Due to competitive factors and the rapidly changing marketplace, we may be required to significantly reduce our pricing structure, which would negatively affect our revenue, margins and our ability to achieve or sustain profitability on a consistent basis. We have an existing channel and distribution network that provides growing revenues and contributes to our high margin software sales. These distribution partners are not obligated to distribute our services at any particular minimum level. As a result, we cannot accurately predict the amount of revenue we will derive from our distribution partners in the future. Our inability of our distribution partners to sell our products to their customers and increase their distribution of our products could result in significant reductions in our revenue, and therefore, harm our ability to achieve or sustain profitability on a consistent basis. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The following discusses our exposure to market risk related to changes in interest rates, equity prices and foreign currency exchange rates. Market risk generally represents the risk of loss that may result from the potential change in the value of a financial instrument as a result of fluctuations in interest rates and market prices. We have not traded or otherwise bought and sold derivatives nor do we expect to in the future. We also do not invest in market risk sensitive instruments for trading purposes. We provide our products and services to customers in the United States, Europe and elsewhere throughout the world. Sales are predominately made in U.S. Dollars, however, we have sold products that were payable in Euros and Canadian Dollars. A strengthening of the U.S. Dollar could make our products and services less competitive in foreign markets. 37 The primary objective of the Company's investment activity is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, the Company maintains its portfolio of cash equivalents in a variety of money market funds. As of March 31, 2004, the carrying value of our outstanding convertible redeemable subordinated notes was approximately $6.4 million at fixed interest rates of 8% to 12%. In certain circumstances, we may redeem this long-term debt. Our other components of indebtedness bear fixed interest rates of 6% to 10%. Because the interest rates on these instruments are fixed, a hypothetical 10% change in interest rates would not have a material impact on our consolidated financial condition, revenues or operations. Increases in interest rates could, however, increase the interest expense associated with future borrowings, if any. We do not hedge against interest rate increases. 38 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA INDEX TO FINANCIAL STATEMENTS PAGE(S) ------- FINANCIAL STATEMENTS: Report of Independent Registered Public Accounting Firm................... 40 Report of Independent Registered Public Accounting Firm................... 41 Consolidated Balance Sheets at March 31, 2004 and 2003.................... 42 Consolidated Statements of Operations for the years ended March 31, 2004, 2003 and 2002 .................. 43 Consolidated Statements of Shareholders' Equity (Deficit) for the years ended March 31, 2004, 2003 and 2002.................... 44 Consolidated Statements of Cash Flows for the years ended March 31, 2004, 2003 and 2002.................... 45 Notes to Consolidated Financial Statements................................ 46 FINANCIAL STATEMENTS SCHEDULE: Report of Independent Registered Public Accounting Firm................... 79 Report of Independent Registered Public Accounting Firm................... 80 Schedule II - Valuation and Qualifying Accounts for the years ended March 31, 2004, 2003 and 2002.................... 81 All other schedules are omitted because they are not applicable. 39 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders iLinc Communications, Inc. and Subsidiaries We have audited the accompanying consolidated balance sheets of iLinc Communications, Inc. and its subsidiaries (the "Company") as of March 31, 2004 and 2003, and the related consolidated statements of operations, stockholders' equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board of the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of iLinc Communications, Inc. and its subsidiaries as of March 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has a significant working capital deficiency and has suffered substantial recurring losses and negative cash flows from operations. These matters, among others, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are described in Note 2. The long-term continuation of the Company is dependent on the Company's ability to raise additional equity or debt capital, to increase its revenues, to generate positive cash flows from operations and to achieve profitability. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ BDO Seidman, LLP Costa Mesa, California May 21, 2004, except for Note 18, as to which the date is June 21, 2004 40 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To The Board of Directors and Shareholders of iLinc Communications, Inc. and Subsidiaries In our opinion, the accompanying consolidated statements of operations, shareholders' equity (deficit) and cash flows present fairly, in all material respects, the financial position of iLinc Communications, Inc. and its Subsidiaries at March 31, 2002 and the results of their operations and their cash flows for the year ended March 31, 2002 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has experienced recurring negative cash flows from operations and working capital deficits that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ PricewaterhouseCoopers LLP Phoenix, Arizona July 11, 2002 41 ILINC COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, 2004 MARCH 31, 2003 -------------- -------------- ASSETS Current Assets: Cash and cash equivalents .......................................................... $ 292 $ 409 Accounts receivable, net of allowance for doubtful accounts of $24 and $172, respectively ............................................................... 1,097 597 Note receivable .................................................................... 25 25 Prepaid expenses and other current assets .......................................... 108 32 ------------- ------------- Total current assets ........................................................... 1,522 1,063 Property and equipment, net ........................................................ 310 465 Goodwill ........................................................................... 9,190 8,823 Intangible assets, net ............................................................. 1,061 1,346 Note receivable .................................................................... 25 50 Other assets ....................................................................... 51 56 Assets of discontinued operations .................................................. 301 620 ------------- ------------- Total assets ................................................................... $ 12,460 $ 12,423 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long term debt ................................................. $ 961 $ 728 Accounts payable and accrued liabilities .......................................... 2,301 2,040 Current portion of capital lease liabilities ...................................... 289 462 Deferred revenue .................................................................. 1,084 817 ------------- ------------- Total current liabilities ...................................................... 4,635 4,047 Long term debt, less current maturities, net of discount of $1,960 and $2,038, respectively ................................................................... 4,444 5,863 Capital lease liabilities, less current maturities ................................. 15 193 ------------- ------------- Total liabilities .............................................................. 9,094 10,103 ------------- ------------- Commitments and contingencies Shareholders' Equity: Preferred stock, $.001 par value, 10,000,000 shares authorized, 150,000 shares issued and outstanding, liquidation preference of $1,500,000 .................... -- -- Common stock, $.001 par value, 100,000,000 shares authorized, 19,257,304 and 17,018,184 issued, respectively ................................................. 19 17 Additional paid-in capital ........................................................ 36,395 32,854 Accumulated deficit ............................................................... (31,640) (29,300) Less: 1,432,412 and 1,244,713 treasury shares at cost, respectively ............... (1,408) (1,251) ------------- ------------- Total shareholders' equity ..................................................... 3,366 2,320 ------------- ------------- Total liabilities and shareholders' equity ..................................... $ 12,460 $ 12,423 ============= ============= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS. PLEASE REFER TO THE REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS. 42
ILINC COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
YEAR ENDED YEAR ENDED YEAR ENDED MARCH 31, MARCH 31, MARCH 31, 2004 2003 2002 ------------ ------------ ------------ Revenues Licenses ................................................. $ 2,241 $ 447 $ 92 Service and maintenance .................................. 3,665 3,629 2,590 ------------ ------------ ------------ Total revenue ........................................ 5,906 4,076 2,682 ------------ ------------ ------------ Operating expenses Research and development ................................. 2,754 3,236 2,323 Sales and marketing ...................................... 1,840 1,660 755 General and administrative ............................... 2,237 1,602 269 Depreciation and amortization ............................ 462 250 99 ------------ ------------ ------------ Total operating expenses ............................... 7,293 6,748 3,446 ------------ ------------ ------------ Loss from operations ........................................ (1,387) (2,672) (764) ------------ ------------ ------------ Interest expense ............................................ (1,233) (1,228) (298) Interest income and other ................................... 6 11 -- Net gain on settlement of debt and other obligations ........ 349 -- -- Loss on foreign currency translation ........................ (28) -- -- ------------ ------------ ------------ (906) (1,217) (298) ------------ ------------ ------------ Loss from continuing operations before income taxes ......... (2,293) (3,889) (1,062) Income tax expense .......................................... -- -- -- ------------ ------------ ------------ Loss from continuing operations ............................. (2,293) (3,889) (1,062) Income from discontinued operations ......................... 275 133 6,867 ------------ ------------ ------------ Net income (loss) ........................................... (2,018) (3,756) 5,805 Preferred stock dividends ................................... (75) -- -- Imputed preferred stock dividends ........................... (247) -- -- ------------ ------------ ------------ Income (loss) available to common shareholders .............. $ (2,340) $ (3,756) $ 5,805 ============ ============ ============ Earnings (loss) per common share, basic and diluted From continuing operations ............................... $ (0.16) $ (0.25) $ (0.09) From discontinued operations ............................. 0.02 0.01 0.58 ------------ ------------ ------------ Net earnings (loss) per common share ..................... $ (0.14) $ (0.24) $ 0.49 ============ ============ ============ Number of shares used in calculation of earnings (loss) per share basic and diluted: .............................. 16,743 15,710 11,930 ============ ============ ============ THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS. PLEASE REFER TO THE REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS. 43
ILINC COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (IN THOUSANDS)
CONVERTIBLE TOTAL PREFERRED STOCK COMMON STOCK ADDITIONAL SHARE -------------------- --------------------- PAID-IN ACCUMULATED TREASURY HOLDERS' SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT STOCK EQUITY --------- --------- --------- --------- --------- --------- --------- --------- Balances, April 1, 2001 .............. -- $ -- 11,722 $ 12 $ 25,809 $(31,349) $ (1,126) $ (6,654) Issuances of common stock ............ -- -- 3,559 3 3,219 -- -- 3,222 Issuance of warrants ................. -- -- -- -- 44 -- -- 44 Issuance of warrants in connection with convertible redeemable subordinated notes ................. -- -- -- -- 1,132 -- -- 1,132 Beneficial conversion feature associated with convertible redeemable subordinated notes ................. -- -- -- -- 1,132 -- -- 1,132 Shares repurchased ................... -- -- -- -- -- -- (15) (15) Net income ........................... -- -- -- -- -- 5,805 -- 5,805 --------- --------- --------- --------- --------- --------- --------- --------- Balances, March 31, 2002 ............. -- -- 15,281 15 31,336 (25,544) (1,141) 4,666 Options exercise ..................... -- -- 24 -- 20 -- -- 20 Issuance of common stock in connection with Quisic acquisition ................. -- -- 2,000 2 1,838 -- -- 1,840 Escrow shares returned in connection with the ThoughtWare acquisition ............ -- -- (365) -- (507) -- -- (507) Vesting of restricted stock grant ....................... -- -- -- -- 51 -- -- 51 Restoration of shares previously reflected as cancelled ....................... -- -- 65 -- 110 -- (110) -- Other ................................ -- -- 13 -- 6 -- -- 6 Net loss ............................. -- -- -- -- -- (3,756) -- (3,756) --------- --------- --------- --------- --------- --------- --------- --------- Balances, March 31, 2003............ -- -- 17,018 17 32,854 (29,300) (1,251) 2,320 Issuances of common stock ............ -- -- 25 -- 14 -- -- 14 Repricing of warrants ................ -- -- -- -- 12 -- -- 12 Vesting of restricted stock grant ........................ -- -- -- -- 40 -- -- 40 Issuance of convertible preferred stock in private placement (net of expenses of $212) ............... 150 -- -- -- 1,288 -- -- 1,288 Convertible subordinated notes converted to common stock ....................... -- -- 1,572 2 1,099 -- -- 1,101 Convertible redeemable subordinated notes converted to common stock ............................. -- -- 150 -- 150 -- -- 150 Beneficial conversion feature associated with convertible redeemable notes ............................. -- -- -- -- 214 -- -- 214 Debt and accrued liability converted to common stock .......... -- -- 492 -- 456 -- -- 456 Preferred stock dividends ............ -- -- -- -- -- (75) -- (75) Warrant grant ........................ -- -- -- -- 21 -- -- 21 Affiliate Practice terminations ...................... -- -- -- -- -- -- (157) (157) Imputed preferred stock dividends ......................... -- -- -- -- 247 (247) -- -- Net loss ............................. -- -- -- -- -- (2,018) -- (2,018) --------- --------- --------- --------- --------- --------- --------- --------- Balances, March 31, 2004 ............. 150 $ -- 19,257 $ 19 $ 36,395 $(31,640) $ (1,408) $ 3,366 ========= ========= ========= ========= ========= ========= ========= ========= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS. PLEASE REFER TO THE REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS. 44
ILINC COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FOR THE YEAR FOR THE YEAR FOR THE YEAR ENDED ENDED ENDED MARCH 31, MARCH 31, MARCH 31, 2004 2003 2002 ------------ ------------ ------------ Cash flows from continuing operating activities: Loss from continuing operations ................................. $ (2,293) $ (3,889) $ (1,062) Adjustments to reconcile loss from continuing operations to cash provided by (used in) continuing operating activities: Provision for (recovery of) bad debts ........................ (148) 148 24 Depreciation and amortization ................................ 462 250 99 Warrant expense .............................................. 33 -- -- Stock compensation expense ................................... 40 51 44 Net gain on settlement of debt and other obligations ......... (349) -- -- Accretion of debt discount to interest expense ............... 292 226 -- Stock issued for contingent compensation ..................... 300 -- -- Changes in operating assets and liabilities, net of business acquisitions: Accounts receivable .......................................... (352) (177) (361) Prepaid expenses and other current assets .................... (76) 55 (87) Other assets ................................................. 5 (45) (11) Accounts payable and accrued liabilities ..................... 753 922 948 Deferred revenue ............................................. 267 357 461 ------------ ------------ ------------ Net cash provided by (used in) operating activities ....... (1,066) (2,102) 55 ------------ ------------ ------------ Cash flows from investing activities: Capital expenditures ......................................... (66) (64) (40) Acquisitions, net of cash acquired ........................... (367) 35 (118) Deferred acquisitions costs .................................. 44 -- -- Repayment (issuance) of notes receivable ..................... 25 (97) -- ------------ ------------ ------------ Net cash used in investing activities ..................... (364) (126) (158) ------------ ------------ ------------ Cash flows from financing activities: Proceeds from issuance of preferred stock .................... 1,500 -- -- Preferred stock dividends .................................... (75) -- -- Proceeds from issuance of long term debt ..................... 500 -- 5,775 Stock issuance expense ....................................... 14 -- -- Proceeds from exercise of stock options ...................... -- 20 -- Repayment of long-term debt .................................. (559) (393) (5,415) Repayment of capital lease liabilities ....................... (242) (117) (65) Financing costs incurred ..................................... (212) -- (832) ------------ ------------ ------------ Net cash provided by (used in) financing activities ....... 926 (490) (537) ------------ ------------ ------------ Cash flows from continuing operations ........................... (504) (2,718) (640) Cash flows from discontinued operations ......................... 387 1,629 1,087 ------------ ------------ ------------ Net change in cash and cash equivalents ................... (117) (1,089) 447 Cash and cash equivalents, beginning of period .................. 409 1,498 1,051 ------------ ------------ ------------ Cash and cash equivalents, end of period ........................ $ 292 $ 409 $ 1,498 ============ ============ ============ THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS. PLEASE REFER TO THE REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS. 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND NATURE OF OPERATIONS Headquartered in Phoenix, Arizona, iLinc Communications, Inc. ("iLinc" or the "Company") is a leading provider of Web conferencing, audio conferencing and collaboration software and services. The Company's software has become well recognized for providing industry-leading software with one of the most robust set of features and functionality. With over 15 years of combined e-Learning expertise, iLinc provides proven solutions to corporate, government, and education clients alike. As a comprehensive provider of e-Learning software and services, iLinc's products and services are offered either as an integrated suite or sold separately. The Company began operations in March of 1998. Its formation included the simultaneous rollup of fifty private businesses and an initial public offering. The Company's initial goals included providing training enhancement services over the Internet using a browser based system. In 2002, the Company shifted and refined its focus away from its legacy business, settling on its current focus on Web conferencing and audio conferencing and in doing so ultimately changed its name to iLinc Communications, Inc. in February 2004. 2. BASIS OF PRESENTATION The Company's consolidated financial statements have been prepared on a basis which assumes that it will continue as a going concern and which contemplates the realization of its assets and the satisfaction of its liabilities and commitments in the normal course of business. The Company has a significant working capital deficiency, and has historically suffered substantial recurring losses and negative cash flows from operations. These matters, among others, including those discussed above and the limited operating history as Web conferencing and e-Learning company, raise substantial doubt about the Company's ability to continue as a going concern. Management's plan with regard to these matters include continued development, marketing and licensing of its Web conferencing, audio conferencing and e-Learning products and services through both internal growth and acquisition. Although management continues to pursue these plans, there is no assurance that the Company will be successful in obtaining sufficient revenues from its products and services to provide adequate cash flows to sustain operations. The consolidated financial statements do not include any adjustments related to the outcome of this uncertainty. During the year ended March 31, 2004, the Company discontinued its dental practice management services segment. Accordingly, the Company has reflected these operations as discontinued and has restated the prior year consolidated financial statements to conform to such presentation. Discontinued operations is discussed further in Note 3. 3. DISCONTINUED OPERATIONS Effective January 1, 2004, the Company discontinued its dental practice management services. In accordance with SFAS 144 "ACCOUNTING FOR IMPAIRMENT ON DISPOSAL OF LONG-LIVED ASSETS", the Company has restated its historical results to reflect its dental practice management service business segment as a discontinued operation. 46 A summary of the results from discontinued operations for the years ended March 31, 2004, 2003 and 2002 are as follows:
FOR THE YEAR ENDED MARCH 31, 2004 2003 2002 ------------ ------------ ------------ (IN THOUSANDS) Net revenue .................................. $ 128 $ 3,129 $ 6,582 Operating expenses ........................... (87) 3,934 4,682 ------------ ------------ ------------ Income (loss) from operations ................ 215 (805) 1,900 Interest expense ............................. (86) (173) (842) Interest income .............................. 29 197 247 Gain on termination of service agreements with Affiliated Practices .................. 63 914 1,297 Gain on debt forgiveness ..................... 54 -- 4,265 Tax expense .................................. -- -- -- ------------ ------------ ------------ Net income from discontinued operations ...... $ 275 $ 133 $ 6,867 ============ ============ ============
Interest expense of $86,000, $173,000 and $842,000 for fiscal years 2004, 2003 and 2002 were allocated to the discontinued dental practice management services business segment since it relates to specific debts that were incurred in order to provide the dental practice management services. A summary of the assets of our discontinued operations are as follows:
AS OF MARCH 31, 2004 2003 -------- -------- (IN THOUSANDS) Accounts receivable, net ...................... $ -- $ 78 Prepaids and other current assets ............. -- 1 Notes receivable, net ......................... 301 521 Property and equipment, net of accumulated .... -- 20 -------- -------- $ 301 $ 620 ======== ========
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements of the Company include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. The more significant areas requiring use of estimates relate to revenue recognition, accounts receivable and notes receivable valuation reserves, realizability of intangible assets, realizability of deferred income tax assets, and the evaluation of contingencies and litigation. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The results of such estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may materially differ from these estimates under different assumptions or conditions. REVENUE RECOGNITION Our revenues are generally classified into two main categories - license revenue and service and maintenance revenue. License revenue is generated from the sale of our iLinc suite of Web conferencing software on a purchase-model (perpetual license basis) and from the sale of our off-the-shelf courseware, primarily the online Bridge (Mini-MBA) program. The service revenue 47 aspect of our Service and Maintenance revenue is primarily generated from the sale of our iLinc Web conferencing software on a periodic license basis (i.e., ASP or per minute), as well as, all service contracts that might include hosting, and training services. Service and Maintenance revenue also includes all revenue arising from maintenance and upgrade contracts that are sold with our iLinc Web conferencing software purchases. Included in our Service and Maintenance revenue are the revenues associated with our custom content development services. Sales of Software Licenses We earn our revenues from the sale of software licenses and service and maintenance agreements related to those software license sales. We offer our software and services in one of two forms, the first being a purchase model that permits the purchase of a perpetual license, and the second being an ASP or per minute model that permits the purchase of a periodic term license. The iLinc suite of Web conferencing products is sold utilizing both the purchase model and the ASP model with separate revenue recognition policies applicable to each model. With each sale of our products and services, we execute contracts that govern the terms and conditions of each software license sale, hosting agreement, maintenance and support agreement and other services arrangements. In connection with the Company's sales of software licenses, the Company adopted Statement of Position ("SOP") 97-2 as issued by the American Institute of Certified Public Accountants. In accordance with SOP 97-2, the Company recognizes revenue from the sale of software licenses if all of the following conditions are met: First, there is persuasive evidence of an arrangement with the customer; Second, the product has been delivered to the customer; Third, the amount of the fees to be paid by the customer is fixed or determinable; and, Fourth, collection of the fee is probable. Each of these factors, particularly the determination of whether a fee is fixed and determinable and the collectability of the resulting receivable, requires the application of the judgment and the estimates of management. Therefore, significant management judgment is utilized and estimates must be made in connection with the revenue we recognize in any accounting period. We analyze various factors, including a review of the nature of the license or product sold, the terms of specific transaction, the vendor specific objective evidence of the elements required by SOP 97-2, any contingencies that may be present, our historical experience with like transactions or with like products, the creditworthiness of the customer, and other current market and economic conditions. Changes in our judgment based upon these factors and others could impact the timing and amount of revenue that we recognize, and ultimately the results of operations and our financial condition. Therefore, the recognition of revenue is a key component of our results of operations. At the time of the sale of our perpetual software license, we assess whether the fee associated with the transaction is fixed or determinable based on the payment terms associated with the transaction before recording immediate revenue recognition, assuming all other elements of revenue recognition are present. Billings to our customers are generally due within 30 to 90 days, with payment terms up to 120 days available to certain credit worthy customers. We believe that we will have sufficient history of collecting all amounts within these normal payment terms and to conclude that the fee is fixed or determinable at the time of the perpetual license sale. Under certain circumstances, we have offered payment terms greater than 120 days and up to as much as twelve months to certain customers, for sales involving our Web conferencing perpetual license products where license revenue would normally be recognized upon delivery of the product. However, we currently do not believe that we have sufficient history of selling the iLinc Suite of products under perpetual license arrangements with extended payment terms exceeding 120 days, and therefore will record revenue when the payments from the customer are due, rather than immediately upon delivery of the product and collection is probable, assuming all other elements of revenue recognition are present. Beginning in fiscal 2004, we began offering payment terms of 180 days and anticipate continuing using those 180-day payment terms related to sales of our perpetual license products. While we do not at this time believe that we have sufficient history of selling perpetual licenses with 180-day payment terms to determine that such fees are fixed and determinable, we do expect to consider those 180-day payment terms to be normal payment terms for certain well capitalized customers when we have such a history, and accordingly, at that time will include those sales in revenue when the perpetual license sale occurs (again assuming all other aspects of revenue recognition are present). We consider all arrangements with payment terms longer than 180 days not to be fixed or determinable and for arrangements involving the extended payment terms exceeding 180 days, revenue recognition occurs when payments are due and collection is probable, assuming all other elements of revenue recognition are present. 48 In addition, in assessing whether collection is probable or not for a given transaction, and therefore whether we should recognize the revenue, we make estimates regarding the creditworthiness of the customer. Initial creditworthiness is assessed through internal credit check processes, such as credit applications or third party reporting agencies. Creditworthiness for transactions to existing customers primarily relies upon a review of their prior payment history. We do not request collateral or other security from our customers, but access to the software may be prohibited if a customer fails to make the payments required. If we determine that collection of a fee is not reasonably assured, we defer the fee and recognize revenue at the time collection becomes reasonably assured, which is generally upon the receipt of payment or other change in circumstance. Sales of Concurrent Licenses (ASP) and Per Minute Basis Historically, a majority of our license revenue has been generated under the purchase model with revenue recognized based on a one-time sale of a perpetual license. In addition to that purchase model, we also offer a more flexible monthly, fixed-fee subscription pricing model (ASP Model) and a per-minute usage based model. Under our subscription or ASP model, a customer may subscribe to a certain number of concurrent connections or seats for a fixed period, often a year. Under this ASP method, we recognize the revenue associated with these monthly, fixed-fee subscription arrangements each month on a straight line basis over the term of the agreement. Other customers choose to avoid annual commitments and instead use our Web conferencing and audio conferencing products and services based upon a per minute or usage-based pricing model. Per minute customers may also include those customers on an ASP model that incur overage fees for usage in excess of the permitted number of seats or minutes in excess of the minimum commitment. The per minute fees that include overage fees are charged at the end of each month and recorded as revenue at the end of each month as the services are provided. Customers with contractually established minimum per minute fees are assessed the greater of the established minimum or the actual usage at the end of each month. Customers wishing to avoid monthly commitments may use the e-commerce portion of our web site that permits the use our Web conferencing services on a pay-per-use basis, with no monthly minimum, purchasing the services and paying for those services online by credit card. Sales of Maintenance, Hosting and other Related Services The Company offers with each sale of its software products a software maintenance, upgrade and support arrangement. These contracts may be elements in a multiple-element arrangement or may be sold in a stand-alone basis. Revenues from maintenance and support services are recognized ratably on a straight-line basis over the term that the maintenance service is provided. Maintenance contracts typically provide for 12 month terms with maintenance contracts available up to 36 months. Revenues from consulting, training and education services are recognized either as the services are performed, ratably over a subscription period, or upon completing a project milestone if defined in the agreement. These consulting, training and education services, are not considered essential to the functionality of our products as these services do not alter the product capabilities, do not require specialized skills, and are often performed by the customer or our VAR's customers without access to those services. Implementation, consulting, training, translation, and other event type services may also be sold in conjunction with the sale of our software products. Those services are generally recognized as the services are performed or if earlier when all other revenue recognition criteria have been met. Although the Company may provide implementation, training and consulting services on a time and materials basis, a significant portion of these services have been provided on a fixed-fee basis. Should the sale of our software involve an arrangement with multiple elements (for example, the sale of a software license along with the sale of maintenance and support to be delivered over the contract period), we allocate revenue to each component of the arrangement using the residual value method based on the fair value of the undelivered elements. We defer revenue from the arrangement equivalent to the fair value of the undelivered elements and recognize the remaining amount at the time of the delivery of the product or when all other revenue recognition criteria have been met. Fair values for the ongoing maintenance and support obligations are based upon separate sales of renewals of maintenance contracts. Fair value of services, such as training or consulting, is based upon separate sales of these services to other customers. Thus, these types of arrangements require us to make judgments about the fair value of undelivered arrangements. 49 Sales of Custom Content Development Services A component of our service and maintenance revenue is derived from custom content development services. The sale of custom content development services often involves the execution of a master service agreement and corresponding work orders describing the deliverable due, the costs involved, the project milestones and the payments required. For contracts and revenues related exclusively to custom content development services, the Company recognizes revenue and profit as work progresses on custom content service contracts using the percentage-of-completion method. This method relies on estimates of total expected contract revenue and costs as each job progresses throughout the relevant contract period. The Company follows this method since reasonably dependable estimates of the costs applicable to various stages of a custom content service contract can be made. Recognized revenues and profit are subject to revisions as the custom content service contract progresses to completion. Revisions in profit estimates are charged to income in the period in which the facts that give rise to the revision become known. Customers sometimes request modifications to projects in progress which may result in significant revisions to cost estimates and profit recognition, and the Company may not be successful in negotiating additional payments related to the changes in scope of requested services. Should this arise, the provision for any estimated losses on uncompleted custom content service contracts are made in the period in which such losses become evident. There were no such losses at March 31, 2004 for any custom content development services. For arrangements requiring customer acceptance, revenue is deferred until the earlier of the end of the acceptance period or until written notice of acceptance is received from the customer. Sales by VAR's and Agents The Company has engaged organizations within the United States of America and in twelve other countries that market and sell its products and services through their sales distribution channels that are value added resellers (VAR's). The VAR's primarily sell, on a non-exclusive basis, our iLinc suite of Web conferencing products and predominately sell purchase-model perpetual licenses for installation and hosting by the VAR's customer. The Company's VAR contracts have terms of one to two years and are automatically renewed for an additional like term unless either party terminates the agreement for breach or other financial reasons. Each VAR purchases the product from the Company and resells the product to its customers. Under those VAR agreements, the Company records only the amount paid by the VAR as revenue and recognizes revenue when all revenue recognition criteria have been met. The Company also engages organizations that act as mere agents or distributors of its products ("Agents"), without title passing to the Agent and with the Agent only receiving a commission on the consummation of the sale to our customer. The Company records revenue on sales by Agents on a gross basis before commissions due to the Agent and only when all revenue recognition criteria are met as would be with a sale by the Company directly to a customer not involving an agent. Sales Reserves The sales reserve is an estimate for losses on receivables resulting from customer credits, cancellations and terminations and is recorded, if at all, as a reduction in revenue at the time of the sale. Increases to sales reserve are charged to revenue, reducing the revenue otherwise reportable. The sales reserve estimate is based on an analysis of the historical rate of credits, cancellations and terminations. The accuracy of the estimate is dependent on the rate of future credits, cancellations and terminations being consistent with the historical rate. If the rate of actual credits, cancellations and terminations is different than the historical rate, revenue would be different from what was reported. As of March 31, 2004, we did not believe that an accrual for sales reserves was appropriate, but continue to assess the adequacy of the sales reserve account balance on a quarterly basis. Allowance for Doubtful Accounts We record an allowance for doubtful accounts to provide for losses on accounts receivable due to customer credit risk. Increases to the allowance for doubtful accounts are charged to general and administrative expense as bad debt expense. Losses on accounts receivable due to financial distress or failure of the customer are charged to the allowance for doubtful accounts. The allowance estimate is based on an analysis of the historical rate of credit losses. The accuracy of the estimate is dependent on the future rate of credit losses being consistent with the historical rate. If the rate of future credit losses is greater than the historical rate, then the allowance for doubtful accounts may not be sufficient to provide for actual credit losses. 50 The allowance for doubtful accounts for iLinc Web collaboration product sales is $24,000 and $172,000, respectively, as of March 31, 2004 and 2003 and is based on our historical collection experience. Any adjustments to these accounts are reflected in the income statement for the current period, as an adjustment to revenue in the case of the sales reserve and as a general and administrative expense in the case of the allowance for doubtful accounts. SOFTWARE DEVELOPMENT COSTS The Company accounts for software development costs in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," whereby costs for the development of new software products and substantial enhancements to existing software products are expensed as incurred until technological feasibility has been established, at which time any additional costs are capitalized. Technological feasibility is established upon completion of a working model. Costs of maintenance and customer support are charged to expense when related revenue is recognized or when those costs are incurred, whichever occurs first. Software development costs incurred subsequent to the establishment of technological feasibility have not been significant to date, and all software development costs have been charged to research and development expense in the accompanying consolidated statements of operations. CASH AND CASH EQUIVALENTS The Company considers all highly liquid debt investments with remaining maturities of three months or less at the date of acquisition to be cash equivalents. The Company maintains cash balances at various financial institutions. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $100,000. The Company's accounts at these institutions may, at times, exceed the federally insured limits. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful life of the various classes of depreciable assets. During fiscal 2003, the Company changed the estimated useful life on certain classes of its property and equipment to more accurately reflect the change in the Company's business. The following classes of depreciable assets were changed as follows: Furniture & Fixtures from 7 years to 5 years Equipment from 7 years to 5 years Computer Equipment from 5 years to 3 years Leasehold improvements shorter of 5 years or lease term Maintenance and repairs are charged to expense whereas renewals and major replacements are capitalized. Gains and losses from dispositions are included in operations. INTANGIBLE ASSETS On April 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets" and as a result, the Company's goodwill is no longer amortized. SFAS No. 142 requires that goodwill be tested annually (or more frequently if impairment indicators arise) for impairment. Upon initial application of SFAS No. 142, the Company determined there was no impairment of goodwill. The Company has established the date of March 31 on which to conduct its annual impairment test. Had the Company adopted SFAS No. 142 on April 1, 2001, net income would have increased by $91,000 for the year ended March 31, 2002 due to the non-amortization of goodwill. The adoption of this statement would have decreased the basic and diluted loss per share from continuing operations to $0.08 from $0.09 for the year ended March 31, 2002. The Company has made acquisitions of companies having operations or technology in areas within its strategic focus and has recorded goodwill and other intangible assets associated with the acquisitions (see Note 9). Future adverse changes in market conditions or poor operating results of the underlying acquired operations could result in losses or an inability to recover the carrying value of the goodwill and other intangible assets thereby possibly requiring an impairment charge in the future. As of March 31, 2004, the Company, based on a third party full scope valuation, has identified no such impairment. 51 Debt issuance costs, which are included in other intangible assets, are amortized using the effective interest rate method over the ten-year term of the related debt obligations. At March 31, 2004 and 2003, debt issuance costs, net of accumulated amortization, were $726,000 and $771,000, respectively. Amortization of debt issuance costs have been reflected in interest expense in the accompanying consolidated statements of operations and total $104,000, $138,000, and $99,000 for the years ended March 31, 2004, 2003, and 2002, respectively. These intangibles are amortized over their expected lives of 120 months. Other intangibles primarily consist of the Quisic and LearnLinc purchase consideration (see Note 9), which was allocated to purchased software and customer relationship intangibles (see Note 7). Such other intangibles are amortized over their expected benefit period of twenty-four to thirty-six months. LONG-LIVED ASSETS The Company reviews for the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The carrying amount of a long-lived asset is considered impaired when anticipated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. The Company recorded an impairment charge totaling $390,000 for the year ended March 31, 2003, which is included in net income from discontinued operations for fiscal 2003. No such impairment charges were recorded for the years ended March 31, 2004 and 2002. CUSTOMER CONCENTRATIONS Accounts receivable represent license agreements entered into and services rendered by the Company with its customers. The Company performs periodic credit reports before recognizing sales to certain customers, but does not receive collateral related to the receivables. Revenues included one customer with transactions approximating 15% and 21% of net revenues for the years ended March 31, 2004 and 2003, respectively. Revenues from international customers for the years ended March 31, 2004 and 2003 approximated $975,000 and $107,000, respectively. Accounts receivable balances for one customer approximated 24% as a percentage of the total balance outstanding at March 31, 2004 and for two customers approximated 13% each as a percentage of the total balance outstanding at March 31, 2003. INCOME TAXES The Company utilizes the liability method of accounting for income taxes in accordance with SFAS No. 109 "Accounting for Income Taxes." Under this method, deferred taxes are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted marginal tax rates currently in effect when the differences reverse. The Company has recorded a full valuation allowance to reduce the carrying value of its net deferred tax assets because it has concluded that it is more likely than not that it will not be realized due to continuing operating losses. The Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. In the event the Company was to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase net income in the period such a determination was made. STOCK-BASED COMPENSATION In December 2002, the FASB issued SFAS No. 148, "ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND DISCLOSURE - AN AMENDMENT TO SFAS NO. 123." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method on accounting for stock-based employee compensation. The Company has adopted the disclosure provisions of SFAS No. 123 and accordingly the implementation of SFAS No. 148 did not have a material effect on the Company's consolidated financial position or results of operations. 52 The fair value for options granted was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the years ended March 31, 2004, 2003 and 2002:
2004 2003 2002 ---- ---- ---- Risk free interest rate 3.73-4.40% 3.07-4.32% 3.87% Dividend yield 0% 0% 0% Volatility factors of the expected market price of the Company's common stock 70-139% 41% 75% Weighted-average expected life of Options 5-9 years 5-9 years 5-9 years
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS):
2004 2003 2002 ------------- ------------- ------------- Net Income (loss) available to common shareholders, as reported .......... $ (2,340) $ (3,756) $ 5,805 Plus: Stock-based employee compensation expense included in reported net income (loss) .................... -- -- -- Less: Total stock-based employee compensation expense determined using fair value based method ............... (168) (270) (286) ------------- ------------- ------------- Pro forma net income (loss) .......... $ (2,508) $ (4,026) $ 5,519 ============= ============= ============= Earnings (loss) per share Basic and Diluted - as reported ...... $ (0.14) $ (0.24) $ 0.49 ============= ============= ============= Basic and Diluted - pro forma ........ $ (0.15) $ (0.26) $ 0.46 ============= ============= =============
EARNINGS PER SHARE Earnings per share are computed based upon the weighted average number of shares of Common Stock and Common Stock equivalents outstanding during each period. Outstanding options and warrants to purchase 9,930,519, 8,498,617, and 1,945,602 shares of Common Stock at exercise prices above the market value of Common Stock were excluded from the calculation of earnings per share for the years ended March 31, 2004, 2003 and 2002, respectively, because their effect would have been antidilutive. Furthermore, a restricted stock grant of 450,000 shares (see Note 15) and 11,339,286 (2004) and 5,900,777 (2003) shares into which preferred stock (Note 11) and debt (Note 10) are convertible have been excluded from the 2004 and 2003 earnings per share calculation because their effect would have been antidilutive. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of cash and cash equivalents, accounts receivables and accounts payable approximate fair values due to the short-term maturities of these instruments. The carrying amounts of the Company's long-term borrowings and notes receivables (presented in assets both from continuing and discontinued operations) as of March 31, 2004 and 2003, approximate their fair value based on the Company's current incremental borrowing rates for similar type of borrowing arrangements. 53 GUARANTEES AND INDEMNIFICATIONS In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation ("FIN") No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others -- an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN 34." The following is a summary of the Company's agreements that the Company has determined are within the scope of FIN No. 45: The Company provides a 90-day warranty for certain of its products. Historically, the Company's performance under the warranty has been minimal, and as such, no warranty accrual has been provided for in the accompanying consolidated financial statements. Under its bylaws, the Company has agreed to indemnify its officers and directors for certain events or occurrences arising as a result of the officer's or director's serving in such capacity. The term of the indemnification period is for the officer's or director's lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. However, the Company has a director and officer liability insurance policy that limits its exposure and enables it to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal and has no liabilities recorded for these agreements as of March 31, 2004. The Company enters into indemnification provisions under (i) its agreements with other companies in its ordinary course of business, typically with business partners, contractors, and customers, landlords and (ii) its agreements with investors. Under these provisions the Company generally indemnifies and hold harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company's activities or, in some cases, as a result of the indemnified party's activities under the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of March 31, 2004. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued SFAS No. 143, "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS", which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred with the associated asset retirement costs being capitalized as a part of the carrying amount of the long-lived asset. SFAS No. 143 also includes disclosure requirements that provide a description of asset retirement obligations and reconciliation of changes in the components of those obligations. The statement is effective for fiscal years beginning after June 15, 2002. The implementation of SFAS No. 143 did not have a material impact on the Company's consolidated financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, "IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," which addresses accounting and financial reporting for the impairment or disposal of long-lived assets. This standard was effective for the Company's consolidated financial statements beginning January 1, 2002. The implementation of SFAS No. 144 did not have a material impact on the Company's consolidated financial position or results of operations. In April 2002, the FASB issued SFAS No. 145, "RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL CORRECTIONS." SFAS No. 145 rescinded three previously issued statements and amended SFAS No. 13, "ACCOUNTING FOR LEASES." The statement provides reporting standards for debt extinguishments and provides accounting standards for certain lease modifications that have economic effects similar to sale-leaseback transactions. The statement is effective for certain lease transactions occurring after May 15, 2002 and all other provisions of the statement shall be effective for fiscal years ending after May 15, 2002. The implementation of SFAS No. 145 will effect the classification of extraordinary items presented in the Company's consolidated statements of operations. Such gains will no longer be considered extraordinary in nature and will be reclassified to operations. In June 2002, the FASB issued SFAS No. 146, "ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES," which updates accounting and reporting standards for personnel and operational restructurings. The Company will be required to adopt SFAS No. 146 for exit, disposal or other restructuring activities that are initiated after December 31, 2002, with early application 54 encouraged. The adoption of SFAS No. 146 did not have a material effect on the Company's consolidated financial position or results of operations. In April 2003, SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" was issued. This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement is effective for contracts entered into or modified after June 30, 2003. Adoption of this statement did not have a material impact on the Company's consolidated financial position or results of operations. In May 2003, SFAS No. 150, "ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY" was issued. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003. The adoption of SFAS No. 150 did not have a material impact on the Company's consolidated financial position, results of operations, or cash flows. On December 18, 2003 the SEC issued Staff Accounting Bulletin No. 104, REVENUE RECOGNITION ("SAB 104"), which supersedes SAB 101, Revenue Recognition in Financial Statements. SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superseded as a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." The adoption of SAB 104 did not have a material impact the Company's consolidated financial position or results of operations. In December 2003, the FASB issued Interpretation No. 46 ("FIN 46R") (revised December 2003), "Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51" ("ARB 51"), which addresses how a business enterprise should evaluate whether it has a controlling interest in an entity though means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46 (FIN 46), which was issued in January 2003. Before concluding that it is appropriate to apply ARB 51 voting interest consolidation model to an entity, an enterprise must first determine that the entity is not a variable interest entity (VIE). As of the effective date of FIN 46R, an enterprise must evaluate its involvement with all entities or legal structures created before February 1, 2003, to determine whether consolidation requirements of FIN 46R apply to those entities. There is no grandfathering of existing entities. Public companies must apply either FIN 46 or FIN 46R immediately to entities created after December 15, 2003 and no later than the end of the first reporting period that ends after March 15, 2004 to entities considered to be special purpose entities.. The adoption of FIN 46R did not have a material impact on the Company's consolidated financial position or results of operations. RECLASSIFICATIONS Certain prior year balances in the consolidated financial statements have been reclassified to conform to the fiscal 2004 presentation. 5. NOTE RECEIVABLE Note receivable consisted of the following: MARCH 31, ----------------------- 2004 2003 --------- --------- (IN THOUSANDS) Note receivable ........................... $ 50 $ 75 Less: allowance for doubtful accounts ..... -- -- --------- --------- 50 75 Less: note receivable, current ............ (25) (25) --------- --------- $ 25 $ 50 ========= ========= The remaining note receivable bears interest at 6%, with interest payments due monthly and principal payments due in two equal installments on August 1, 2004 and 2005. 55 6. PROPERTY AND EQUIPMENT, NET Property and equipment consisted of the following: MARCH 31, ------------------------- 2004 2003 ---------- ---------- (IN THOUSANDS) Furniture and fixtures ................... $ 253 $ 233 Equipment ................................ 303 373 Computer equipment ....................... 691 644 Leasehold improvements ................... 24 24 ---------- ---------- Total property and equipment .......... 1,271 1,274 Less: accumulated depreciation ........... (961) (809) ---------- ---------- Property and equipment, net ........... $ 310 $ 465 ========== ========== Depreciation expense for the years ended March 31, 2004, 2003 and 2002 was $221,000, $100,000 and $99,000, respectively. 7. GOODWILL AND INTANGIBLE ASSETS, NET Goodwill consisted of the following: MARCH 31, ------------------------- 2004 2003 ---------- ---------- (IN THOUSANDS) Goodwill.................................. $ 9,190 $ 8,823 ========== ========== The changes in the carrying amount of the goodwill for the years ended March 31, 2004 and 2003 (IN THOUSANDS): Balance, March 31, 2002 .................. $ 7,479 Quisic acquisition .................... 1,695 Mentergy acquisition .................. 348 Mentergy acquisition adjustment ....... (20) Learning-Edge acquisition adjustment .. (7) ThoughtWare acquisition adjustment .... (27) ThoughtWare escrow shares acquisition adjustment .......................... (507) Dexpo transfer to intangibles ......... (138) --------- Balance, March 31, 2003 .................. 8,823 Mentergy acquisition, royalty accrual . 367 --------- Balance, March 31, 2004 .................. $ 9,190 ========= 56
MARCH 31, 2004 ------------------------------------------------- GROSS CARRYING ACCUMULATED AMOUNT AMORTIZATION NET ------------- ------------- ------------- (IN THOUSANDS) AMORTIZED INTANGIBLE ASSETS: Deferred offering costs ........ $ 887 $ (161) $ 726 Purchased software ............. 675 (343) 332 Customer relationship .......... 32 (29) 3 ------------- ------------- ------------- $ 1,594 $ (533) $ 1,061 ============= ============= ============= MARCH 31, 2003 ------------------------------------------------- GROSS CARRYING ACCUMULATED AMOUNT AMORTIZATION NET ------------- ------------- ------------- (IN THOUSANDS) AMORTIZED INTANGIBLE ASSETS: Deferred offering costs ........ $ 1,020 $ (249) $ 771 Purchased software ............. 675 (118) 557 Customer relationship .......... 32 (14) 18 ------------- ------------- ------------- $ 1,727 $ (381) $ 1,346 ============= ============= ============= AGGREGATE AMORTIZATION EXPENSE FOR INTANGIBLES (IN THOUSANDS): For the year ended March 31, 2004 $241 For the year ended March 31, 2003 $150 For the year ended March 31, 2002 -- ESTIMATED AMORTIZATION EXPENSE (IN THOUSANDS): Fiscal Year ----------- 2005 $165 2006 113 2007 100 2008 83 2009 83
57 8. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES Accounts payable and accrued liabilities consisted of the following:
MARCH 31, ---------------------- 2004 2003 --------- --------- (IN THOUSANDS) Accounts payable trade ................................ $ 1,000 $ 681 Accrued state sales tax ............................... 40 384 Accrued interest ...................................... 204 310 Amount payable to Quisic shareholders ................. 50 150 Amounts related to acquisitions ....................... 33 73 Amounts payable to third party providers .............. 327 -- Amounts payable to Interactive Alchemy ................ 149 -- Accrued salaries and related benefits ................. 190 160 Deferred rent liability ............................... 80 89 Lease termination liability ........................... 171 101 Other ................................................. 57 92 --------- --------- Total accounts payable and accrued liabilities ..... $ 2,301 $ 2,040 ========= =========
9. BUSINESS COMBINATIONS LEARNING-EDGE, INC. On October 1, 2001, the Company acquired all of the outstanding capital stock of Learning-Edge, Inc.; an Arizona based private e-learning company. The Company issued 1,950,000 common shares and $1.1 million of debt under the terms of the acquisition agreement (see further discussion at Note 10). The Company also assumed approximately $2.9 million of Learning-Edge debt as part of this acquisition. The operating results of Learning-Edge are included with the Company's as of October 1, 2001. The purchase price has been calculated as follows: LEARNING-EDGE -------------- (IN THOUSANDS) Issuance of iLinc common stock valued at $0.51 per share ......................................... $ 995 Issuance of iLinc debt ............................... 1,102 Acquisition costs .................................... 200 --------- Net purchase price, including acquisition costs ... 2,297 Assumed liabilities .................................. 2,946 --------- Total purchase price .............................. $ 5,243 ========= The total purchase price has been allocated to assets acquired and liabilities assumed based upon their estimated fair values in accordance with SFAS No. 141, "Business Combinations". The excess purchase price over the estimated fair value of the tangible assets acquired and liabilities assumed has been assigned to goodwill. Upon completion of an assessment of Learning-Edge's operations, no separately identifiable intangible assets were found to exist. 58 The purchase price was originally allocated as follows:
PURCHASE PRICE ALLOCATION -------------- (IN THOUSANDS) Current assets ............................................ $ 826 Property and equipment .................................... 274 Other long-term assets, including goodwill of $4,133 ...... 4,143 Current liabilities ....................................... (2,867) Long-term obligations, excluding current maturities ....... (1,381) Common stock, net of treasury shares ...................... (2) Capital in excess of par value ............................ (993) -------------- $ -- ==============
THOUGHTWARE TECHNOLOGIES, INC. On January 15, 2002, the Company acquired all of the outstanding capital stock of ThoughtWare Technologies, Inc.; a Tennessee based private company. The Company issued 1,550,000 common shares under the terms of the acquisition agreement. The Company also assumed approximately $1.5 million of ThoughtWare debt as part of this acquisition. The operating results of ThoughtWare are included with the Company's as of January 1, 2002. The purchase price has been calculated as follows: THOUGHTWARE ----------- (IN THOUSANDS) Issuance of iLinc common stock valued at $1.39 per share ......................................... $ 2,155 Acquisition costs .................................... 200 ----------- Net purchase price, including acquisition costs ... 2,355 Assumed liabilities .................................. 1,464 ----------- Total purchase price .............................. $ 3,819 =========== The total purchase price has been allocated to assets acquired and liabilities assumed based upon their estimated fair values in accordance with SFAS No. 141. The excess purchase price over the estimated fair value of the tangible assets acquired and liabilities assumed has been assigned to goodwill. Upon completion of an assessment of ThoughtWare's operations, no separately identifiable intangible assets were found to exist. The purchase price was originally allocated as follows: PURCHASE PRICE ALLOCATION -------------- (IN THOUSANDS) Current assets ........................................ $ 448 Property and equipment ................................ 163 Goodwill .............................................. 3,208 Current liabilities ................................... (1,543) Long-term obligations, excluding current maturities ... (121) Common stock, net of treasury shares .................. (2) Capital in excess of par value ........................ (2,153) ----------- $ -- =========== 59 On March 29, 2003, the Company settled various disputes it had with the former shareholders of ThoughtWare Technologies, Inc. The settlement resulted in 365,000 of the shares issued in connection with the acquisition being returned to the Company. The Company valued the shares using the share price at the date of acquisition and recorded the returned shares as a $507,000 decrease to shareholders' equity and goodwill. QUISIC CORPORATION On June 14, 2002, the Company acquired certain assets of Quisic Corporation ("Quisic"), a California based private Company in exchange for 2,000,000 shares of the Company's common stock and the assumption of $223,000 of liabilities, together with an additional 500,000 shares of the Company common stock that were placed into escrow to secure a revenue performance requirement. That revenue performance target was not achieved and the Company demanded the return of the shares of common stock. The shareholders of Quisic do not dispute the right of the Company to obtain those shares. However, since the claims of the plaintiffs in the Kepner-Tregoe litigation matter assert potential rights to those shares, the shares were instead tendered to the registry of the trial court pending resolution of the party's respective claims (Note 14). Those 500,000 shares are not counted as shares outstanding nor as treasury shares as the performance contingency associated with those shares was not met and accordingly are not reflected in earnings per share. The operating results of Quisic have been included in the consolidated operations of the Company commencing June 17, 2002. The purchase agreement requires that the Company pay certain contingent compensation to the seller if during the 5-year period following the closing certain sales to PBS and others occur. Through December 31, 2003, the Company had collected funds subject to this contingent provision, which resulted in required contingent payments totaling $300,000. On December 31, 2003, the seller agreed to convert the entire amount then due instead into 333,333 common shares our common stock at the fair market price of $0.90 per share. During the fourth quarter of fiscal 2004, the Company had invoiced for but not received additional funds subject to this contingent provision, which resulted in accrued contingent payments totaling $50,000 due at March 31, 2004 (Note 8). The purchase price has been calculated as follows: QUISIC ----------- (IN THOUSANDS) Issuance of iLinc common stock valued at $0.92 per share .......................... $ 1,840 Acquisition costs .................................... 100 ----------- Net purchase price, including acquisition costs ... 1,940 Assumed liabilities .................................. 223 ----------- Total purchase price .............................. $ 2,163 =========== The total purchase price has been allocated to assets acquired and liabilities assumed based upon their estimated fair values in accordance with SFAS No. 141, "Business Combinations". The excess purchase price over the estimated fair value of the tangible and identifiable intangible assets acquired and liabilities assumed has been assigned to goodwill. The purchase price of Quisic has been allocated as follows: PURCHASE PRICE ALLOCATION ---------------- (IN THOUSANDS) Current assets ..................................... $ 186 Property and equipment ............................. 75 Goodwill ........................................... 1,695 Identifiable intangible assets ..................... 207 Current liabilities, including deferred revenue .... (323) Common stock ....................................... (3) Additional paid-in capital ......................... (1,837) -------------- $ -- ============== 60 MENTERGY Effective November 4, 2002, the Company acquired certain assets of LearnLinc Corporation, a wholly owned subsidiary of Mentergy, Inc., in exchange for $500,000 and the assumption of $462,000 of liabilities. In addition, the Company has agreed to pay a royalty of 20% for all cash revenues collected from the sale or license of LearnLinc software over a three-year period. The first $600,000 of sales are not subject to the royalty. The maximum amount due under the Royalty Agreement is $5,000,000. From the date of acquisition through March 31, 2004, the Company has collected $2.4 million in cash from the sale or license of iLinc software. The Company accounts for any such amounts to be paid as additional purchase consideration in accordance with EITF No. 95-8 at the time related revenues are recognized. The Company has accrued LearnLinc royalties totaling $367,000 during fiscal year 2004. The operating results of Mentergy have been included in the consolidated operations of the Company commencing November 4, 2002. The purchase price has been calculated as follows: MENTERGY ------------- (IN THOUSANDS) Issuance of debt and payment of cash ................ $ 500 Acquisition costs ................................... 60 ------------- Net purchase price, including acquisition costs .. 560 Assumed liabilities ................................. 462 ------------- Total purchase price ............................. $ 1,022 ============= The total purchase price has been allocated to assets acquired and liabilities assumed based upon their estimated fair values in accordance with SFAS No. 141, "Business Combinations". The excess purchase price over the estimated fair value of the tangible and identifiable intangible assets acquired and liabilities assumed has been assigned to goodwill. The purchase price of Mentergy has been allocated as follows: PURCHASE PRICE ALLOCATION ---------------- (IN THOUSANDS) Current assets ..................................... $ 124 Property and equipment ............................. 50 Goodwill ........................................... 348 Identifiable intangible assets ..................... 500 Note Payable ....................................... (500) Current liabilities, including deferred revenue .... (522) -------------- $ -- ============== 61 10. LONG-TERM DEBT Long-term debt consisted of the following:
MARCH 31, ----------------------------- 2004 2003 ------------ ------------ (IN THOUSANDS) Convertible redeemable subordinated notes .... $ 5,625 $ 5,775 Convertible redeemable subordinated notes .... 500 -- Convertible subordinated notes, Series A ..... -- 849 Subordinated promissory notes ................ 913 1,072 Shareholders' notes payable .................. 287 430 Notes payable ................................ 40 503 ------------ ------------ 7,365 8,629 Less: Current portion of long-term debt ...... (961) (728) Discount ............................... (882) (1,019) Beneficial conversion feature .......... (1,078) (1,019) ------------ ------------ Long-term debt, net of current portion ....... $ 4,444 $ 5,863 ============ ============
In February of 2004, the Company completed a private placement offering raising capital of $500,000 that was used for general corporate purposes. Under the terms of the offering, the Company issued unsecured subordinated convertible notes that have a term of 24 months (subject to adjustment in certain events), and the notes are subordinated to any present or future senior indebtedness. The notes bear interest at the rate of 8% per annum for the first twelve months and then 10% for the second twelve months (subject to a retroactive adjustment to 15% if the underlying shares into which the notes are convertible have not been registered by July 31, 2004) and require quarterly payments of interest only, with the principal due at maturity on February 12, 2006. The holders of the notes may convert the outstanding principal into shares of the Company's common stock at the fixed price of $0.70 per share (subject to adjustments for dilution, as defined). At the issue date, the Company calculated a beneficial conversion feature of the notes to be $214,286, which is being amortized as interest expense over the 2-year life of the debt. The holders of the notes retain certain demand and piggy-back registration rights. Subsequent to March 31, 2004, holders with a principal balance totaling $500,000 converted their notes into 714,285 common shares of the Company. The underlying common stock issued upon conversion of the notes have been registered with the SEC and may be sold pursuant to a resale prospectus dated May 24, 2004. In connection with the acquisition of certain assets from Mentergy, Inc. (and its wholly owned subsidiary LearnLinc Corporation), the Company issued among other consideration a secured promissory note with a principal balance of $250,000 that was due on December 13, 2003 (the "Mentergy Note"). By agreement with Mentergy and its assignees, the Company paid $50,000 in principal amount on the note during December of 2003. The remaining balance of $200,000 was paid in full in February 2004, and Mentergy has released any security interests they had in the Company's assets. In March 2002, the Company completed a private placement offering (the "Convertible Note Offering") raising capital of $5,775,000 that was used to extinguish an existing line of credit. Under the terms of the Convertible Note Offering, the Company issued unsecured subordinated convertible notes (the "Convertible Notes"). The Convertible Notes bear interest at the rate of 12% per annum and require quarterly interest payments, with the principal due at maturity on March 29, 2012. The holders of the Convertible Note may convert the principal into shares of the Company's common stock at the fixed price of $1.00 per share. The Company may force redemption by conversion of the principal into common stock at the fixed conversion price, if at any time the 20 trading day average closing price of the Company's common stock exceeds $3.00 per share. The notes are subordinated to any present or future senior indebtedness. The placement agent received a commission of $577,500 plus $173,250 as a non-accountable expense reimbursement and received a warrant to purchase units on the same basis as other investors representing ten percent of the gross proceeds at a price of 110% of that paid by investors. As a part of the Convertible Note Offering, the Company also issued warrants to purchase 5,775,000 shares of the Company's common stock for an exercise price of $3.00 per share. The Company may force redemption of the warrants if at any time the 62 20 trading day average closing price of the Company's common stock exceeds $5.50 per share, and the warrants expire on March 29, 2005. The fair value of the warrants was estimated using a Black-Scholes pricing model with the following assumptions: contractual and expected life of three years, volatility of 75%, dividend yield of 0%, and a risk-free rate of 3.87%. A discount to the Convertible Notes of $1,132,000 was recorded using this value, which is being amortized to interest expense over the ten (10) year term of the Convertible Notes. As the carrying value of the notes is less than the conversion value, a beneficial conversion feature of $1,132,000 was calculated and recorded as an additional discount to the notes and is being amortized to interest expense over the ten (10) year term of the Convertible Notes. Upon conversion, any remaining discount associated with the beneficial conversion feature will be expensed in full. During fiscal 2004, holders with a principal balance totaling $150,000 converted their notes into 150,000 common shares of the Company. The underlying common stock that would be issued upon conversion of these notes and upon exercise of the associated warrants have been registered with the SEC and may be sold pursuant to a resale prospectus dated May 24, 2004. In October 2001, the Company issued $1.1 million of subordinated promissory notes to the shareholders of Learning-Edge, Inc. under the terms of the acquisition agreement (the "Learning-Edge Notes"). The Learning-Edge Notes bear interest at rates ranging from at 7.5% to 9.0% and are due in two equal installments on April 1, 2005 and on October 1, 2005, respectively. The terms of the Learning-Edge Notes provided that if the Company raises additional capital equal to or in excess of $3 million, 25% of the principal of the Learning-Edge Notes is to be repaid. For each $500,000 raised above $3 million, the repayment percentage increases by 15%. If more than $5 million is raised, 100% of the principal of the Learning-Edge Notes is to be repaid. The holders of the Learning-Edge Notes waived these accelerated payment provisions in relation to the Convertible Note Offering. As a result of the capital raise in April of 2004 of $4.25 million, all of the outstanding balance of these notes have been fully extinguished subsequent to March 31, 2004 with cash payments of $333,000 and conversions of $583,000 of notes into 550,633 shares of the Company's common stock. The Company had issued in 1998 as a part of the consideration due to Affiliated Practices certain subordinated promissory notes (the "Series A Notes"). On September 19, 2003, all of the outstanding principal balance of the Series A Notes, in the sum of $849,000, were converted into 1,572,222 shares of the Company's common stock. A conversion price of $0.54 per share was used as the fair price per share which was the preceding twenty trading day average closing price of the Company's common stock. As a result of that conversion, the Company recorded a $252,000 charge associated with the conversion of the Series A Notes due to a difference in the closing price of the Company's common stock on the day of conversion and the twenty trading day average closing price. Holders of the Series A Notes included James M. Powers, Jr. who had received a $76,000 Series A Note as a part of the consideration paid to him from his own Affiliated Practice transaction in 1998. In connection with the Company's IPO in March of 1998, the Company issued $468,000 of notes (the "IPO Notes") to certain shareholders who had provided capital prior to the IPO. Originally, interest accrued at the rate of 6% with the entire amount due on March 30, 2003. Many of the IPO Note holders agreed to have the accrued interest added to the principal balance and extended the maturity date to April 1, 2005 in exchange for quarterly payments of interest and an increase in the interest rate to 10%. Several of the holders agreed to accept a discounted sum in full payment of their IPO Note. The new principal balance on these renewed and extended IPO Notes is $278,000 as of March 31, 2004. 63 The aggregate maturities of long-term debt excluding capital leases for each of the next five years subsequent to March 31, 2004 were as follows (IN THOUSANDS): 2005 ...................................... $ 961 2006 ...................................... 779 2007 ...................................... -- 2008 ...................................... -- 2009 ...................................... -- Thereafter ................................ 5,625 --------- $ 7,365 ========= 11. CAPITALIZATION PREFERRED STOCK The Company has the authority to issue ten million shares of preferred stock, par value $.001 per share. On September 16, 2003, the Company completed its private placement of convertible preferred stock with detachable warrants. The Company sold 30 units at $50,000 each and raised a total of $1,500,000. Each unit consisted of 5,000 shares of convertible preferred stock and a warrant to purchase 25,000 shares of common stock. The convertible preferred stock is convertible into the Company's common stock at a price of $0.50 per share (subject to adjustment in certain events, with a floor of $0.30), and the warrants are immediately exercisable at a price of $1.50 per share with a three-year term. Accordingly, each share of preferred stock is convertible into 20 shares of common stock and retains a $10 liquidation preference. The Company pays an 8% dividend to holders of the convertible preferred stock, and the dividend is cumulative. The convertible preferred stock is non-voting and non-participating. The shares of convertible preferred stock will not be registered under the Securities Act of 1933, as amended, and were offered in a private placement providing exemption from registration. The placement agent was paid a commission of $150,000 or 10% of the gross proceeds plus $45,000, which represented a 3% non-accountable expense fee and received a warrant to purchase 3 units at the same terms of the original units. In addition, the Company paid $17,000 in legal and accounting fees bringing the net proceeds raised to $1,288,000. The Company used the net proceeds for general working capital, to expand its sales and marketing activities and to retire certain acquisition related liabilities. The cash proceeds of the private placement of convertible preferred stock was allocated pro-rata between the relative fair values of the preferred stock and warrants at issuance using the Black Scholes valuation model for valuing the warrants. After allocating the proceeds between the preferred stock and warrant, an effective conversion price was calculated for the convertible preferred stock to determine the beneficial conversion discount for each share. The aggregate value of the warrants and the beneficial conversion discount of $247,000 are considered a deemed dividend in the calculation of loss per share. Subsequent to March 31, 2004, holders of 22,500 shares converted to 450,000 shares of common stock. COMMON STOCK As of March 31, 2004, the Company is authorized to issue 100 million shares of common stock. The Company has acquired treasury stock from certain Affiliated Practices for the payment of receivables and purchase of property and equipment. In December 2001, the Company, under the initiative of the Compensation Committee with the approval of the Board of Directors, issued its chief executive officer an incentive stock grant under the 1997 Stock Compensation Plan of 450,000 restricted shares of the Company's common stock as a means to retain and incentivize the chief executive officer. The shares 100% vest after 10 years from the date of grant. The shares were valued at $405,000 based on the closing price of the stock on the date of grant, which is recorded as compensation expense ratably over the vesting period. The vesting of the incentive shares accelerates based on the Company's share price as follows:
PERFORMANCE CRITERIA SHARES VESTED --------------------------------------------------------------------- --------------- Share price trades for $4.50 per share for 20 consecutive days 150,000 shares Share price trades for $8.50 per share for 20 consecutive days 150,000 shares Share price trades for $12.50 per share for 20 consecutive days 150,000 shares
64 In connection with the restricted stock grant, the Company loaned the Chief Executive Officer $179,000 to fund the immediate tax consequences of the grant. The Company recognized a $179,000 charge to income at the date of grant. WARRANTS On November 19, 2003, the Company issued a warrant to purchase 250,000 shares of common stock to an advisor of the Company in exchange for certain advisory and consulting services pursuant to a written advisory agreement that will be provided to the Company over a three-year contractual period. The warrants are exercisable for shares of the Company's common stock at a price of $0.40. The warrant contained a provision that prohibited the delivery of shares even if exercised until after February 5, 2004. The warrants are currently treated as a variable plan grant; accordingly, the warrant will be revalued at each quarter end and the portion related to the cumulative expired services period less prior charges recorded will be recorded as a charge to expense during the period. The warrants were valued using the Black-Scholes model to calculate a fair value of $0.73 per share at March 31, 2004. A portion of the fair value totaling $20,000 was recognized for fiscal 2004. The Company issued warrants to purchase 887,752 shares of the Company's common stock to Bank One, the Company's prior lender, and the Company's legal counsel exercisable at prices ranging from $0.42 to $1.50 per share. The Company valued and expensed these warrants at $44,000 in fiscal 2002. The Company has issued other warrants in conjunction with various debt and equity offerings. Please refer to the summary at Note 13. 12. INCOME TAXES Significant components of the provision for income taxes were as follows (IN THOUSANDS):
YEAR ENDED YEAR ENDED YEAR ENDED MARCH 31, MARCH 31, MARCH 31, 2004 2003 2002 ----------- ----------- ------------ Current tax expense: Federal ..................... $ -- $ -- $ 2,023 State ....................... -- -- 384 ----------- ----------- ------------ Total current ............. -- -- 2,407 ----------- ----------- ------------ Deferred tax expense: Federal ..................... -- -- (2,023) State ....................... -- -- (384) ----------- ----------- ------------ Total deferred ............ -- -- (2,407) ----------- ----------- ------------ Expense for income taxes ....... $ -- $ -- $ -- =========== =========== ============
Significant components of the Company's deferred tax assets (liabilities) were as follows (IN THOUSANDS):
MARCH 31, ------------------------- 2004 2003 ---------- ---------- Deferred tax assets: Reserves for uncollectible accounts ........ $ 98 $ 686 Deferred revenue ........................... 412 271 Accrued expenses ........................... 160 158 Net operating loss carryforward ............ 10,026 8,779 Organizational costs ....................... -- -- Other ...................................... 19 25 ---------- ---------- Total deferred tax assets .................. 10,715 9,919 ---------- ---------- 65 Deferred tax liabilities: Property and equipment ..................... (18) (36) Management services agreement .............. -- -- ---------- ---------- Total deferred tax liabilities ........... (18) (36) ---------- ---------- Net deferred tax asset ........................ 10,697 9,883 Less: valuation allowance .................. (10,697) (9,883) ---------- ---------- Net deferred tax asset ..................... $ -- $ -- ========== ==========
The differences between the statutory federal tax rate and the Company's effective tax rate on continuing operations were as follows (IN THOUSANDS):
YEAR ENDED YEAR ENDED YEAR ENDED MARCH 31, MARCH 31, MARCH 31, 2004 2003 2002 ---------- ---------- ---------- Tax (benefit) at U.S. Statutory rate (34%) ............ $ (780) $ (1,322) $ (361) State income taxes (benefit), net of federal tax ...... (62) (167) 254 Nondeductible expenses and other ...................... (68) (491) 1,530 Change in valuation allowance, net .................... 910 1,980 (1,423) ---------- ---------- ---------- Total tax expense (benefit) ........................ $ -- $ -- $ -- ========== ========== ==========
At March 31, 2004, the Company had federal and State of Arizona net operating loss carry-forwards available to reduce future taxable income of approximately $26 million and $11 million, respectively, which begin to expire in 2018 and 2004, respectively. The Company has certain net operating losses in other states relating to its acquisitions (see Note 9). The Company is currently quantifying such net operating losses and evaluating the Company's ability to use them. The Company recorded a valuation allowance for its entire deferred tax asset because it concluded it is not likely it would be able to realize the tax assets due to the lack of profitable operating history of its implementation of the e-Learning plan. In accordance with Internal Revenue Code Section 382, the annual utilization of net operating loss carry-forwards and credits existing prior to a change in control, as defined, in the Company or a company the Company has acquired may be substantially limited. Accordingly, the utilization of a substantial portion of the Company's net operating loss carry-forwards is limited, such as net operating loss carry-forwards are either related to the acquisition of ThoughtWare Technologies, Learning-Edge, Inc. and other acquired entities, or are related to current operations during which change in control events may have occurred. 13. STOCK OPTION PLANS AND WARRANTS The Company grants stock options under its 1997 Stock Compensation Plan (the "Plan"). The Company recognizes stock-based compensation issued to employees at the intrinsic value between the exercise price of options granted and the fair value of stock for which the options may be exercised. However, pro forma disclosures as if the Company recognized stock-based compensation at the fair value of the options themselves are presented below. Under the Plan, as amended, the Company is authorized to issue 3,500,000 shares of Common Stock pursuant to "Awards" granted to officers and key employees in the form of stock options. There were 2,282,855 and 1,835,865 options granted under the Plan, at March 31, 2004 and 2003, respectively. The Compensation Committee administers the Plan. These stock options have contractual terms of 10 years and have an exercise price no less than the fair market value of the stock at grant date. The options vest at varying rates over a one to five year period. 66 Following is a summary of the status of the Company's stock options as of March 31, 2004 and for the three years then ended:
WEIGHTED NUMBER OF AVERAGE WEIGHTED AVERAGE SHARES UNDERLYING EXERCISE FAIR-VALUE OF OPTIONS PRICES OPTIONS GRANTED ------------------ ------------ ------------------ Outstanding at March 31, 2001................... 1,643,173 $ 2.50 Granted......................................... 515,765 0.65 $ 0.44 ================== Exercised....................................... (6,250) 0.50 Forfeited....................................... (429,750) 2.68 Expired......................................... -- ------------------ ------------ Outstanding at March 31, 2002................... 1,722,938 1.90 Granted......................................... 383,130 0.65 $ 0.37 ================== Exercised....................................... (23,958) 0.81 Forfeited....................................... (246,245) 0.71 Expired......................................... -- -- ------------------ ------------ Outstanding at March 31, 2003................... 1,835,865 1.82 Granted......................................... 632,500 0.67 $ 0.56 ================== Exercised....................................... -- -- Forfeited....................................... (185,510) 2.64 Expired......................................... -- -- ------------------ ------------ Outstanding at March 31, 2004................... 2,282,855 $ 1.43 ================== ============
The following table summarizes information about stock options outstanding at March 31, 2004:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------------ ---------------------------- WEIGHTED WEIGHTED AVERAGE WEIGHTED AVERAGE AVERAGE NUMBER OF EXERCISE REMAINING CONTRACTUAL NUMBER OF EXERCISE SHARES PRICE LIFE (YEARS) SHARES PRICE -------------- ------------- ------------------------- ------------- ------------- $ 0.01 - $ 0.99 1,592,456 $ 0.59 7.92 909,253 $ 0.54 $ 1.00 - $ 1.99 87,125 $ 1.72 6.12 87,125 $ 1.72 $ 2.00 - $ 2.99 430,000 $ 2.22 5.28 378,000 $ 2.25 $ 3.00 - $ 8.50 173,274 $ 6.98 4.08 156,596 $ 7.08 -------------- ------------ 2,282,855 1,530,974 ============== ============
Subsequent to March 31, 2004, the Company granted certain employees stock options to purchase a total of 22,000 shares of common stock at an exercise price of $1.10, and a total of 36,000 shares of common stock at an exercise price of $1.00. Subsequent to the fiscal year end, five former employees of the Company exercised stock options representing 128,000 shares of the Company's common stock, with exercise prices between $0.50 and $0.65 per share. 67 The following table summarizes information about stock purchase warrants outstanding at March 31, 2004:
WARRANTS OUTSTANDING WARRANTS EXERCISABLE ------------------------------------------------------ ---------------------------- WEIGHTED WEIGHTED AVERAGE WEIGHTED AVERAGE AVERAGE NUMBER OF EXERCISE REMAINING CONTRACTUAL NUMBER OF EXERCISE SHARES PRICE LIFE (YEARS) SHARES PRICE -------------- ------------- ------------------------- ------------- ------------- $ 0.40 - $ 0.40 250,000 $ 0.40 2.64 250,000 $ 0.40 $ 0.42 - $ 0.42 543,182 $ 0.42 7.39 393,182 $ 0.42 $ 0.44 - $ 0.44 132,972 $ 0.44 7.45 132,972 $ 0.44 $ 0.50 - $ 0.50 25,000 $ 0.50 1.75 25,000 $ 0.50 $ 1.50 - $ 1.50 921,510 $ 1.50 3.39 171,510 $ 1.50 $ 3.00 - $ 3.00 5,775,000 $ 3.00 0.99 5,775,000 $ 3.00 -------------- ------------ 7,647,664 6,747,664 ============== ============
14. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company leases a portion of its property and equipment under the terms of capital and operating leases. The capital leases bear interest at varying rates ranging from 8.9% to 22.8% and require monthly payments. Assets recorded under capital leases, at March 31, 2004, consisted of the following (IN THOUSANDS): Cost ........................................ $ 351 Less: accumulated amortization .............. (204) ---------- Total ....................................... $ 147 ========== Future minimum lease payments under capital leases and noncancelable operating leases with initial or remaining terms of one or more years consisted of the following at March 31, 2004 (IN THOUSANDS):
CAPITAL OPERATING ----------- ----------- Amounts past due .............................. $ 167 $ 79 2005 .......................................... 150 664 2006 .......................................... 17 639 2007 .......................................... -- 463 2008 .......................................... -- 88 2009 .......................................... -- 89 Thereafter .................................... -- 188 ----------- ----------- Total minimum obligations ..................... 334 $ 2,210 =========== Less: amount representing interest ............ (30) ----------- Present value of minimum obligations .......... 304 Less: current portion ......................... (289) ----------- Long-term obligation at March 31, 2004 ........ $ 15 ===========
The Company incurred rent expense of $470,000, $542,000 and $335,000 in fiscal 2004, 2003 and 2002, respectively. As a part of the discontinued dental practice management services segment, the Company leased facilities in Houston, Texas on behalf of one of its Affiliated Practices consisting of 1,500 square feet with a ten-year term costing $2,800 per month. The Affiliated Practice vacated the premises without notice to the Company even though he had assumed the lease. The Company is currently seeking reimbursement for any and all amounts owed on this lease from the Affiliated Practice and is seeking to terminate the lease with the current landlord. At March 31, 2004, the Company has an accrual totaling $93,000 with respect to termination of this lease. 68 EMPLOYMENT AGREEMENTS As of March 31, 2004, the Company had entered into employment agreements with Mr. Powers, Mr. Dunn, Mr. Zuckerman, and Mr. Cocozza, all of whom are officers and two of whom are directors of the Company. Each of these agreements provides for an annual base salary in an amount not less than the initial specified amount and entitles the employee to participate in all iLinc compensation plans in which other executive officers of iLinc participate. Each agreement establishes a base annual salary and provides for annual bonuses based on the Management Incentive Plan, as adopted by the Board of Directors, renews automatically, and is subject to the right of iLinc to terminate said employment at any time. Under each of the employment agreements, if iLinc terminates the employee's employment without cause (as therein defined), Mr. Powers, Mr. Dunn and Mr. Zuckerman will be entitled to a payment equal to twelve months' salary. Mr. Cocozza will be entitled to a payment equal to nine months' salary. Additionally, Mr. Powers, Mr. Dunn, and Mr. Zuckerman's employment agreements provide for a severance payment equal to one (1) year's compensation in the event of termination of employment following a change in control of the Company (as defined therein). Each of the foregoing agreements also contains a covenant limiting competition with the Company for one year following termination of employment. Subsequent to year-end, Mr. Zuckerman resigned from his employment with iLinc without any severance compensation. The minimum aggregate salary provisions under the contracts totals $506,000 in fiscal 2005. LITIGATION On June 14, 2002, the Company acquired the assets of Quisic Corporation. Subsequently, on November 4, 2002, two former employees of Quisic Corporation (their CEO and CIO), filed a lawsuit in the Superior Court of the State of California styled George B. Weathersby, et. al. vs. Quisic Corporation, et. al. claiming damages against Quisic and the Board of Directors of Quisic arising from their employment termination by the Quisic Board. The Company was also added as a third party defendant with an allegation of successor liability, but only to the extent that Quisic Corporation is found liable, and then only to the extent the plaintiffs prove their successor liability claim against the Company. The Company only acquired certain assets of Quisic Corporation in an asset purchase transaction. Based upon the facts and circumstances known, the Company believes that the plaintiffs' claims are without merit, and furthermore, that the Company is not the successor of Quisic, and therefore the Company intends to vigorously defend this aspect of the lawsuit. While in the opinion of management, resolution of these matters is not expected to have a material adverse effect on the Company's financial position, results of operations or cash flows, the ultimate outcome of any litigation is uncertain. Were an unfavorable outcome to occur that awarded to the Plaintiffs against defendant Quisic large sums, and then the court determined that the Company is a successor to Quisic, then the impact is likely to be material to the Company. Subsequent to the defendants' answers being filed, the court ordered that an arbitration of the merits be held, but the date of that arbitration has not been set. On June 11, 2003, Kepner-Tregoe, Inc. filed suit in the Supreme Court of the State of New York, County of New York, styled, Kepner-Tregoe, Inc. vs. Internal & External Communications, Inc., et. al., against Quisic Corporation and the Board of Directors of Quisic seeking to collect an arbitration award against Internal & External Communications, Inc. (a subsidiary of Quisic). The Company was also added as a third party defendant with an allegation of successor liability, but only to the extent that Quisic Corporation is found liable, and then only to the extent the plaintiffs prove their successor liability claim against the Company. The Company only acquired certain assets of Quisic Corporation in an asset purchase transaction. As a part of the Quisic acquisition transaction consideration, the Company placed into escrow 500,000 shares of its common stock that was to secure a revenue performance requirement. That revenue performance target was not achieved and the Company demanded the return of the shares of common stock. The shareholders of Quisic do not dispute the right of the Company to obtain those shares. However, since the claims of the plaintiffs assert potential rights to those shares, they were instead tendered to the registry of the trial court pending resolution of the party's respective claims. Those 500,000 shares are not counted as shares outstanding nor as treasury shares as the performance contingency associated with those shares was not met. The Company believes that it is not the successor of Quisic, and therefore the Company intends to vigorously defend this aspect of the lawsuit. While in the opinion of management, resolution of these matters is not expected to have a material adverse effect on the Company's financial position, results of operations or cash flows, the ultimate outcome of any litigation is uncertain. Were an unfavorable outcome to occur that awarded to the Plaintiffs against defendant Quisic large sums, and then the court determined that the Company is a successor to Quisic, then the impact is likely to be material to the Company. Subsequent to the defendants' answers being filed, the Quisic defendants sought an order dismissing the plaintiff's claims and that order is still pending. 69 ROYALTY AGREEMENTS In connection with the acquisition of certain assets of Mentergy, Inc., the Company agreed to pay a royalty of 20% for all cash revenues collected from the sale or license of LearnLinc software over a three-year period. The first $600,000 of sales are not subject to the royalty. The maximum amount due under the Royalty Agreement is $5,000,000. As a result of the acquisition of certain assets of Quisic and the acquisition of ThoughtWare, the Company is party to other agreements to pay royalties to third-party providers of online courseware. These agreements call for payments to be made on a per user or percent of revenue basis and expire in fiscal 2005 and 2010. STOCK EXCHANGE LISTING The American Stock Exchange's continued listing standards require that the Company maintain stockholder's equity of at least $4.0 million if the Company has losses from continuing operations and/or net losses in three of its four most recent fiscal years. While the Company has sustained losses in three of its four most recent fiscal years, and had less than $4.0 million of stockholder's equity at March 31, 2004, the Company raised approximately $0.9 million in additional equity capital, converted certain other debt to equity and completed an acquisition subsequent to the fiscal year end and therefore has as of June 21, 2004 stockholder's equity in excess of the $4.0 million requirement. If in the future, the Company fails to maintain a sufficient level of stockholder's equity in compliance with those and other listing standards of the American Stock Exchange then the Company would be required to submit a plan to the American Stock Exchange describing how it intended to re-gain compliance with the requirements. CUSTOM CONTENT DEVELOPMENT Effective May 1, 2003, the Company terminated the employment of certain employees that had provided custom content development services. Those employees were permitted to create a new company, Interactive Alchemy, Inc. ("IA") and simultaneously entered into a non-cancelable three-year subcontractor agreement with the Company. IA continues to provide custom content development services to the Company for its customers in exchange for a fixed percentage of the Company's custom content project fee. The Company provides IA with certain facilities and administrative support for which in exchange it receives a specified amount of support services. During fiscal 2004, the Company incurred approximately $800,000 of fees to IA in connection with this agreement. The Company has open accounts payable and accrued liabilities to IA of approximately $149,000 as of March 31, 2004. 15. RELATED PARTY TRANSACTIONS In December 2001, the Company, under the initiative of the Compensation Committee with the approval of the Board of Directors, issued its chief executive officer an incentive stock grant under the 1997 Stock Compensation Plan of 450,000 restricted shares of the Company's common stock as a means to retain and incentivize the chief executive officer. The shares 100% vest after 10 years from the date of grant. The shares were valued at $405,000 based on the closing price of the stock on the date of grant, which is recorded as compensation expense ratably over the ten-year vesting period. The vesting of the incentive shares accelerates based on the Company's share price as follows:
PERFORMANCE CRITERIA SHARES VESTED --------------------------------------------------------------------- --------------- Share price trades for $4.50 per share for 20 consecutive days 150,000 shares Share price trades for $8.50 per share for 20 consecutive days 150,000 shares Share price trades for $12.50 per share for 20 consecutive days 150,000 shares
In connection with the restricted stock grant, the Company loaned the Chief Executive Officer $179,000 to fund the immediate tax consequences of the grant. The Company recognized a $179,000 charge to income at the date of grant. During fiscal 2004 and 2003, the Company recognized $18,200 and $2,500 respectively of legal expense to the Bogatin law firm of which a member of the Company's Board of Directors is a partner. 70 In May of 2003 Barnhill's Buffet purchased 50 LearnLinc Core Licenses with Voice over IP and 2- way Live Videoconferencing plus annual maintenance for $62,000. The remaining balance due under this contract was $28,000 at March 31, 2004. The price paid and the payment terms granted to Barnhill's was consistent with price paid and the terms extended to other customers of the Company. James M. Powers, Jr. is a co-founder and director of Barnhill's Buffet. Please refer to other related party transactions discussed in Note 10. 16. SUPPLEMENTAL CASH FLOW INFORMATION
YEAR ENDED YEAR ENDED YEAR ENDED MARCH 31, MARCH 31, MARCH 31, 2004 2003 2002 ----------- ----------- ----------- (IN THOUSANDS) Cash paid Interest ............................................................... $ 1,047 $ 849 $ 1,137 Income taxes ........................................................... -- -- -- Supplemental information on non-cash transactions Subordinated notes, Series A conversion into common shares ............. 849 -- -- Debt conversion into common shares ..................................... 156 -- -- Convertible redeemable subordinated notes converted into common shares ........................................................ 150 -- -- Issuance of common stock in connection with acquisitions ............... -- 1,840 3,150 Issuance of notes payable in connection with acquisitions .............. -- 250 1,102 Notes payable offset against receivables from Affiliated Practices ............................................................ -- 362 656 Conversion of receivables from Affiliated Practices to notes receivables .......................................................... -- -- 204 Capital leases incurred for equipment .................................. -- -- 373 Treasury stock acquired for payment of receivable from Affiliated Practices and purchase of property and equipment .......... -- -- 15 Notes payable offset against future management service fees ............ -- -- 122 Accrued interest capitalized to notes payable .......................... -- 93 -- Escrow shares returned in connection with ThoughtWare acquisitions ......................................................... -- 507 --
71 17. QUARTERLY FINANCIAL DATA (UNAUDITED) The following table sets forth summary quarterly results of operations for the Company for the years ended March 31, 2004 and 2003:
FIRST SECOND THIRD FOURTH 2004 QUARTER QUARTER QUARTER QUARTER - ---- ------------ ------------ ------------ ------------ (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net revenue ................................................ $ 1,342 $ 1,393 $ 1,580 $ 1,591 Operating expenses ......................................... 1,522 1,641 1,788 2,342 Loss from operations ....................................... (180) (248) (208) (751) Loss from continuing operations before income taxes ........ (135) (590) (473) (1,095) Income taxes ............................................... -- -- -- -- Loss from continuing operations ............................ (135) (590) (473) (1,095) Income (loss) from discontinued operations ................. 9 129 150 (13) Net loss ................................................... $ (126) $ (461) $ (323) $ (1,108) Loss available to common shareholders ...................... $ (126) $ (723) $ (352) $ (1,139) Basic and diluted per share data: (1) Loss per common share from continuing operations ......... $ (0.01) $ (0.05) $ (0.03) $ (0.06) Income (loss) per common share from discontinued operations ........................................... $ 0.00 $ 0.01 $ 0.01 $ 0.00 Weighted average common share outstanding: Basic and diluted ........................................ 15,798 16,025 17,304 17,667 FIRST SECOND THIRD FOURTH 2003 QUARTER QUARTER QUARTER QUARTER - ---- ------------ ------------ ------------ ------------ (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net revenue ................................................ $ 1,131 $ 1,141 $ 1,074 $ 730 Operating expenses ......................................... 1,139 1,727 1,581 2,301 Loss from operations ....................................... (8) (586) (507) (1,571) Loss from continuing operations before income taxes ........ (359) (948) (889) (1,693) Income taxes ............................................... -- -- -- -- Loss from continuing operations ............................ (359) (948) (889) (1,693) Income (loss) from discontinued operations ................. 4 594 (78) (387) Loss available to common shareholders ...................... $ (355) $ (354) $ (967) $ (2,080) Basic and diluted per share data: (1) Loss per common share from continuing operations ......... $ (0.02) $ (0.06) $ (0.05) $ (0.12) Income (loss) per common share from discontinued operations ........................................... $ 0.00 $ 0.04 $ 0.00 $ (0.02) Weighted average common share outstanding: Basic and diluted ........................................ 14,429 16,137 16,138 16,134
- -------------- (1) Earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share does not equal the total computed for the year due to stock transactions that occurred. 18. SUBSEQUENT EVENTS In April of 2004, the Company completed a private placement offering with gross proceeds of $4.25 million that provided the Company $3.8 million of net proceeds. Under the terms of this offering, the Company issued $3,187,500 in unsecured senior notes and 1,634,550 shares of Common Stock of the Company. The senior notes were issued as a series of notes pursuant to a unit purchase and agency agreement. The senior notes are unsecured, non-convertible, and the 72 purchasers received no warrants. The placement agent received a commission equal to 10% of the gross proceeds together with a warrant for the purchase of 163,455 shares of the Company's common stock at a price equal to 120% of the price paid by investors. The senior notes bear interest at a rate of 10% per annum and accrued interest is due and payable on a quarterly basis beginning July 15, 2004, with principal due at maturity on July 15, 2007. The senior notes are redeemable by the Company at 100% of the principal value at any time after July 15, 2005. The senior notes are unsecured obligations of the Company but are senior in right of payment to all existing and future indebtedness of the Company. Individuals and entities participating in this offering have the right to demand registration of the common stock issued therefrom upon written notice to the Company and also have piggy-back registration rights should the company file a registration statement before the shares are otherwise registered. On June 3, 2004, the Company executed an agreement to acquire substantially all of the assets of and assume certain liabilities of Glyphics Communications, Inc., a Utah based private company that is a provider of comprehensive audio conferencing products and services. The acquisition had a stated effective date of June 1, 2004 and was fully consummated on June 14, 2004. The purchase price, which is expected to total $5.568 million, is based on a multiple of the Glyphics' 2003 estimated annual audited net audio conferencing business revenues. The purchase price will be paid with the assumption of approximately $2.114 million in specific liabilities, with the balance paid using the Company's common stock at the fixed price of $1.05 per share, or an estimated 3.524 million shares. The actual purchase price to be paid, and the resulting number of shares to be issued will be based upon the audited results that are expected to be obtained within sixty days of the closing date. Twenty percent of the consideration due is being held in escrow. Amounts held in escrow will be available to the Company to satisfy contingent claims and seller's indemnification obligations. Amounts held in escrow also may be returned to the Company in the event that audio conferencing revenue performance measures required to be obtained by the Company during the 2004 calendar year are not met. Individuals and entities participating in this transaction who are shareholders receiving the Company's common stock have the right to demand registration of the common stock issued therefrom upon written notice, one year from the date of the transaction, to the Company and also have piggy-back registration rights should the Company file a registration statement before the shares are otherwise registered. On April 9, 2004, one holder of a subordinated promissory note relating to the Learning-Edge acquisition converted the unpaid principal balance of the note of $47,057 into 44,817 shares of the Company's common stock. On April 13, 2004, an investor of the 2003 private placement of preferred stock with detachable warrants converted 2,500 shares of the Company's preferred stock into 50,000 shares of the Company's common stock. Effective April 15, 2004, Preston A. Zuckerman terminated his employment with the Company and resigned from the board of directors. The note conversion and settlement agreement associated with this termination resulted in the conversion of promissory notes relating to the Learning-Edge acquisition totaling $766,969 converting into 272,378 shares of the Company's common stock, payment of $40,000 of deferred compensation and a new promissory note in the amount of $230,757. On June 4, 2004, this promissory note was converted to 233,088 shares of the Company's common stock. During May 2004 and June 2004, all holders of the unsecured subordinated convertible notes, relating to the February 2004 capital raise of $500,000, converted the notes into 714,285 shares of common stock of the Company. On June 16, 2004, an investor of the 2003 private placement of preferred stock with detachable warrants converted 20,000 shares of the Company's preferred stock into 400,000 shares of the Company's common stock. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On April 3, 2003 the Company dismissed PricewaterhouseCoopers LLP as its independent accountants and engaged BDO Seidman, LLP. The Company's Audit Committee and Board of Directors participated in and approved the decision to change independent accountants. BDO Seidman, LLP audited the consolidated financial statements of the Company for the fiscal years ended March 31, 2004 and 2003. 73 The report of PricewaterhouseCoopers LLP on the consolidated financial statements for the fiscal year ended March 31, 2002 contained no adverse opinion or disclaimer of opinion and was not qualified as to audit scope or accounting principle, except that the report contained an explanatory paragraph expressing substantial doubt regarding the Company's ability to continue as a going concern. In connection with its audit for the fiscal years ended March 31, 2002 and through April 3, 2003, there have been no disagreements with PricewaterhouseCoopers LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements if not resolved to the satisfaction of PricewaterhouseCoopers LLP would have caused them to make reference thereto in their report on the consolidated financial statements for such years. During the fiscal year ended March 31, 2002 and through April 3, 2003, there have been no reportable events (as defined in Regulation S-K Item 304(a)(1)(v)). For the fiscal year of the Company ended March 31, 2002 and the subsequent interim period through April 3, 2003, the Company did not consult with BDO Seidman, LLP regarding the application of accounting principles to a specified transaction, type of audit opinion that might be rendered on the Registrant's financial statements, or any other accounting, auditing or reporting matters. ITEM 9A. CONTROLS AND PROCEDURES We evaluated the design and operation of our disclosure controls and procedures to determine whether they are effective in ensuring that we disclose the required information in a timely manner and in accordance with the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the rules and forms of the Securities and Exchange Commission. Management, including our principal executive officer and principal financial officer, supervised and participated in the evaluation. The evaluation was completed as of the end of the period covered by the report. The principal executive officer and principal financial officer concluded, based on their review, that our disclosure controls and procedures, as defined by Exchange Act Rules 13a-14(c) and 15d-14(c), are effective and ensure that we disclose the required information in reports that we file under the Exchange Act and that the filings are recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. No significant changes were made to our internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation. 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. Because of the inherent limitations in all control systems no evaluation of controls can provide absolute assurance that all control issues if any, within a company have been detected. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item with respect to the Company's directors and executive officers and compliance by the Company's directors, executive officers and certain beneficial owners of the Company's Common Stock with Section 16(a) of the Securities and Exchange Act of 1934 will be set forth under the captions "Election of Directors' and "Section 16 Reports" in the Company's definitive Proxy Statement (the "2004 Proxy Statement") for its 2004 annual meeting of stockholders, which sections are incorporated herein by reference. The Company's Code of Ethics will be set forth in the Company's 2004 Proxy Statement, with such information incorporated herein by this reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this item will be set forth in the section entitled "Executive Compensation" in the 2004 Proxy Statement, which section is incorporated herein by reference. 74 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS The information required by this item will be set forth in the section entitled "Security Ownership of Certain Beneficial Owners and Management" in the 2004 Proxy Statement, which section is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item will be set forth in the section entitled "Certain Transactions" in the 2004 Proxy Statement, which section is incorporated herein by reference. In May of 2003 Barnhill's Buffet purchased 50 LearnLinc Core Licenses with Voice-over-IP and 2- way Live Videoconferencing plus annual maintenance for $62,000. The remaining balance due under this contract was $28,000 at March 31, 2004. The price paid and the payment terms granted to Barnhill's was consistent with price paid and the terms extended to other customers of the Company. James M. Powers, Jr. is a co-founder and director of Barnhill's Buffet. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES BDO Seidman, LLP audited our consolidated financial statements for the years ended March 31, 2004 and 2003. AUDIT AND NON-AUDIT FEES Aggregate fees for professional services rendered to the Company by BDO Seidman, LLP for the years ended March 31, 2004 and 2003, were as follows: SERVICES PROVIDED 2004 2003 --------------- -------------- Audit Fees $ 190,293 $ 98,000 Audit Related Fees 26,025 -- Tax Fees 1,050 -- All Other Fees -- -- --------------- -------------- Total $ 217,368 $ 98,000 =============== ============== AUDIT FEES. The aggregate fees billed for the years ended March 31, 2004 and 2003 were for the audits of the Company's consolidated financial statements and reviews of the Company's interim consolidated financial statements included in the Company's annual and quarterly reports, and for services provided with respect to the Company's other regulatory filings AUDIT RELATED FEES. The aggregate fees billed for the years ended March 31, 2004 and 2003 were primarily for services provided for review and consultation on acquisition and capital raising transactions. TAX FEES. The aggregate fees billed for the years ended March 31, 2004 and 2003 were for miscellaneous tax consulting services related to acquisition accounting. AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES The Audit Committee has implemented pre-approval policies and procedures related to the provision of audit and non-audit services. Under these procedures, the Audit Committee pre-approves both the type of services to be provided by its auditor and the estimated fees related to these services. During the approval process, the Audit Committee considers the impact of the types of services and the related fees on the independence of the auditor. The services and fees must be deemed compatible with the maintenance of the auditor's independence, including compliance with SEC rules and regulations. 75 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) FINANCIAL STATEMENTS Reports of Independent Registered Public Accounting Firms Consolidated Balance Sheets as of March 31, 2004 and 2003. Consolidated Statements of Operations for the Years Ended March 31, 2004, 2003 and 2002. Consolidated Statements of Shareholders' Equity (Deficit) for the Years Ended March 31, 2004, 2003 and 2002. Consolidated Statements of Cash Flows for the Years Ended March 31, 2004, 2003 and 2002. Notes to the Consolidated Financial Statements. (a)(2) FINANCIAL STATEMENT SCHEDULES Reports of Independent Registered Public Accounting Firms The following financial statement schedule is filed as a part of this Report under Schedule II on page 81. Schedule II -- Valuation and Qualifying Accounts for the three fiscal years ended March 31, 2004. All other schedules called for by Form 10-K are omitted because they are inapplicable or the required information is shown in the financial statements, or notes thereto, included herein. 76 (a)(3) EXHIBITS EXHIBIT NUMBER DESCRIPTION OF EXHIBITS ------ ----------------------- 3.1(1) Restated Certificate of Incorporation of Pentegra Dental Group, Inc. 3.2(1) Bylaws of Pentegra Dental Group, Inc. 3.3(7) Restated Certificate of Incorporation of Pentegra Dental Group, Inc. 3.4(7) Amendment of Bylaws of Pentegra Dental Group, Inc. 3.5(8) Restated Certificate of Incorporation of e-dentist.com, Inc. 3.6(14) Certificate of Designations of Series A Preferred Stock 3.7(15) Certificate of Amendment of Restated Certificate of Incorporation of EDT Learning, Inc. 4.1(1) Form of certificate evidencing ownership of Common Stock of Pentegra Dental Group, Inc. 4.2(1) Form of Registration Rights Agreement for Owners of Founding Affiliated Practices 4.3(1) Registration Rights Agreement dated September 30, 1997 between Pentegra Dental Group, Inc. and the stockholders named therein 4.4(2) Form of Stockholders' Agreement for Owners of Affiliated Practices 4.5(3) Form of Indenture from Pentegra Dental Group, Inc. to U.S. Trust Company of Texas, N.A., as Trustee relating to the Convertible Debt Securities 4.6(7) Form of certificate evidencing ownership of Common Stock of e-dentist.com, Inc. 4.7(8) Form of Convertible Redeemable Subordinated Note 4.8(8) Form of Redeemable Warrant (2002 Private Placement Offering) 4.9(14) Form of Redeemable Warrant (2003 Private Placement Offering) +10.1(1) Pentegra Dental Group, Inc. 1997 Stock Compensation Plan +10.2(1) Form of Service Agreement +10.9(7) Employment Agreement dated November 12, 2000 between e-dentist.com and James M. Powers, Jr. +10.11(7) Employment Agreement dated February 15, 2001 between e-dentist.com and James Dunn, Jr. 10.14(9) Plan of Reorganization and Agreement of Merger by and among EDT Learning, Inc., Edge Acquisition Subsidiary, Inc. and the Stockholders of Learning-Edge, Inc. 10.15(10) Plan of Reorganization and Agreement of Merger by and among EDT Learning, Inc., TW Acquisition Subsidiary, Inc., ThoughtWare Technologies, Inc. and the Series B Preferred Stockholder of ThoughtWare Technologies, Inc. 10.16(11) Asset Purchase Agreement by and among EDT Learning, Inc., and Quisic Corporation. Common Stock Purchase Agreement by and between EDT Learning, Inc., Investor Growth Capital Limited, A Guernsey Corporation and Investor Group, L.P., A Guernsey Limited Partnership and Leeds Equity Partners III, L.P. 10.16(12) Asset Purchase Agreement by and among EDT Learning, Inc., and Mentergy, Inc. and its wholly-owned subsidiaries, LearnLinc Corp and Gilat-Allen Communications, Inc. 10.17(14) Subcontractor Agreement between EDT Learning, Inc. and Interactive Alchemy, Inc. ++10.18 Employment Agreement dated January 6, 2004 between iLinc Communications, Inc. and Nathan Cocozza ++10.19 Note Purchase Agreement dated February 12, 2004 between iLinc Communications, Inc. and the "Lenders" ++10.20 Unit Purchase and Agency Agreement dated April 19, 2004 between iLinc Communications, Inc. and Cerberus Financial, Inc. ++10.21 Placement Agency Agreement dated March 10, 2004 between iLinc Communications, Inc. and Peacock, Hislop, Staley, and Given, Inc. 10.22(16) Asset Purchase Agreement and Plan of Reorganization by and between iLinc Communications, Inc. and Glyphics Communications, Inc. ++12 Ratio of Earnings to Fixed Charges 16(13) Letter re Change in Certifying Accountant ++21.1 Subsidiaries of the Registrant ++23.1 Consent of BDO Seidman, LLP ++23.2 Consent of Pricewaterhouse Coopers, LLP ++31.1 Chief Executive Officer Section 302 Certification ++31.2 Principal Financial Officer Section 302 Certification ++32.1 Chief Executive Officer Section 906 Certification ++32.2 Principal Financial Officer Section 906 Certification 77 - ----------------- (1) Previously filed as an exhibit to iLinc's Registration Statement on Form S-1 (No. 333-37633), and incorporated herein by reference. (2) Previously filed as an exhibit to iLinc's Registration Statement on Form S-4 (No. 333-78535), and incorporated herein by reference. (3) Previously filed as an exhibit to iLinc's Registration Statement on Form S-4 (No. 333-64665), and incorporated herein by reference. (4) Previously filed as an exhibit to iLinc's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1998. (5) Previously filed as an exhibit to iLinc's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1998. (6) Previously filed as an exhibit to iLinc's Annual Report on Form 10-K for the year ended March 31, 2000. (7) Previously filed as an exhibit to iLinc's Annual Report on Form 10-K for the year ended March 31, 2001. (8) Previously filed as an exhibit to iLinc's Annual Report on Form 10-K for the year ended March 31, 2002. (9) Previously filed as an exhibit to iLinc's Form 8-K filed October 16, 2001. (10) Previously filed as an exhibit to iLinc's Form 8-K filed January 30, 2002 (11) Previously filed as an exhibit to iLinc's Form 8-K filed July 2, 2002. (12) Previously filed as an exhibit to iLinc's Form 8-K filed December 20, 2002. (13) Previously filed as an exhibit to iLinc's Form 8-K filed April 3, 2003. (14) Previously filed as an exhibit to iLinc's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2003. (15) Previously filed as an exhibit to iLinc's Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 2003. (16) Previously filed as an exhibit to iLinc's Form 8-K filed June 14, 2004. + Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to the requirements of Item 15 of Form 10-K. ++ Furnished herewith as an Exhibit (b) REPORTS ON FORM 8-K. A Report on Form 8-K was filed February 5, 2004 furnishing under Item 12 our press release announcing our operating results for the quarter ended December 31, 2003. A Report on Form 8-K was filed March 23, 2004 furnishing under Item 5 disclosures regarding the Company's intent to raise additional capital. A Report on Form 8-K was filed April 20, 2004 furnishing under Item 9 disclosures regarding the closing of the $4.25 million Private Placement offering. A Report on Form 8-K was filed April 23, 2004 furnishing under Item 5 the resignation of Preston A. Zuckerman from the Company's Board of Directors. A Report on Form 8-K was filed June 3, 2004 under Item 9 our press release announcing the acquisition of certain assets of Glyphics Communications, Inc. A Report on Form 8-K was filed June 14, 2004 under Item 2 disclosing the acquisition of certain assets of Glyphics Communications, Inc. A Report on Form 8-K was filed June 17, 2004 under Item 12 our press release announcing our operating results for the quarter and fiscal year ended March 31, 2004. 78 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANCIAL STATEMENT SCHEDULES To the Board of Directors and Shareholders iLinc Communications, Inc. and Subsidiaries Our audit of the 2004 and 2003 consolidated financial statements referred to in our report dated May 21, 2004, except for Note 18, as to which the date is June 21, 2004, appearing in the 2004 Annual Report to Shareholders of iLinc Communications, Inc. also included in audits of the 2004 and 2003 information included in the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the 2004 and 2003 information set forth therein when read in conjunction with the related 2004 and 2003 consolidated financial statements, included therein. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has a significant working capital deficiency and has suffered substantial recurring losses and negative cash flows from operations. These matters, among others, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are described in Note 2. The long-term continuation of the Company is dependent on the Company's ability to raise additional equity or debt capital, to increase its revenues, to generate positive cash flows from operations and to achieve profitability. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ BDO Seidman, LLP Costa Mesa, California May 21, 2004, except for Note 18, as to which the date is June 21, 2004 79 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANCIAL STATEMENT SCHEDULES To The Board of Directors and Shareholders of iLinc Communications, Inc. and Subsidiaries Our audits of the consolidated financial statements referred to in our report dated July 11, 2002 appearing in the 2004 Annual Report to Shareholders of iLinc Communications, Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP Phoenix, Arizona July 11, 2002 80 ILINC COMMUNICATIONS, INC. VALUATION AND QUALIFYING ACCOUNTS SCHEDULE II
ADDITION DEDUCTIONS ------------- ---------------------------- BALANCE AT THE CHARGED TO WRITE-OFFS BALANCE AT FISCAL BEGINNING BAD DEBT RECOVERIES CHARGED TO END OF YEAR DESCRIPTION OF PERIOD EXPENSE (1) ALLOWANCE PERIOD - ------ -------------------------------------- ------------ ------------- ------------ ------------ ------------ 2004 Accounts receivable - allowance for doubtful accounts .............. $ 172 $ 24 $ 142 $ 30 $ 24 2003 Accounts receivable - allowance for doubtful accounts .............. $ 24 $ 172 $ 6 $ 18 $ 172 2002 Accounts receivable - allowance for doubtful accounts .............. $ -- $ 67 $ 2 $ 41 $ 24 (1) This amount represents recoveries for accounts which were not charged off; accordingly, these recoveries are reflected as a decrease in allowance and decrease to bad debt expense as the collection of recoveries are reflected as applications to the respective accounts and notes receivable. 81
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Phoenix, State of Arizona, on June 29, 2004. ILINC COMMUNICATIONS, INC. By: /s/ JAMES M. POWERS, JR. ------------------------------- James M. Powers, Jr., Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
NAME CAPACITY DATE - ---- -------- ---- /s/ JAMES M. POWERS, JR. Chairman of the Board, President and Chief June 29, 2004 - ---------------------------------- Executive Officer (Principal Executive Officer) James M. Powers, Jr. /s/ JAMES H. COLLINS Director June 29, 2004 - ---------------------------------- James H. Collins /s/ KENT PETZOLD Director June 29, 2004 - ---------------------------------- Kent Petzold /s/ DANIEL T. ROBINSON, JR. Director June 29, 2004 - ---------------------------------- Daniel T. Robinson, Jr. /s/ GEORGE M. SIEGEL Director June 29, 2004 - ---------------------------------- George M. Siegel 82
EX-10.18 2 ilinc_10kex10-18.txt EXHIBIT 10.18 EMPLOYMENT AGREEMENT This employment agreement (the "Agreement"), to be effective on January 6, 2004 (the "Effective Date"), by and between EDT Learning, Inc., a Delaware corporation (the "Company"), and Nathan Cocozza ("Employee"). WHEREAS, the Company wishes to offer employment to Employee on the terms and conditions expressed herein; and, WHEREAS, the Employee wishes to accept employment with the Company on the terms and conditions described herein; NOW THEREFORE, in consideration of the mutual premises and conditions contained herein, including the recitals hereto, which, by this reference, are incorporated herein and made a part hereof, the parties agree as follows: 1. EMPLOYMENT. The Company hereby agrees to employ Employee, and Employee hereby accepts employment by the Company, upon the terms and subject to the conditions hereinafter set forth. 2. DUTIES. Employee shall serve as the Senior Vice President of Sales of the Company (the "Position") reporting to the Company's President. Employee's duties and powers shall be those consistent with the Position, with such additional duties or titles as determined necessary and appropriate from time to time by the Company's President. Employee agrees to devote his full time, attention and best efforts to the Company in the performance of Employee's duties. All of the Employee's powers and authorities shall be subject to the reasonable direction and control of the Company's President. Employee acknowledges that the executive offices of the Company will be located in Phoenix, Arizona and he shall perform his duties under this Agreement from those offices. 3. TERM. Unless earlier terminated in accordance with Section 6 hereof, the term of this Agreement shall be for one (1) year (the "Term"), beginning on the Effective Date. This Agreement may be extend and renewed at the Company's election for an additional one (1) year term by providing to Employee notice of the Company's intent to renew no later than sixty (60) days prior to the first annual anniversary of the Effective Date. If this Agreement is extended and renewed beyond the second anniversary date of the Effective Date, the parties agree to renegotiate an increase in Employee's Base Salary as defined in Section 4 below. 4. COMPENSATION AND BENEFITS. In consideration for the services of the Employee hereunder, the Company will compensate Employee as follows: a. BASE SALARY. Beginning with the Effective Date and continuing thereafter until this Agreement is terminated, Employee shall receive a monthly minimum base salary (the "Base Salary") equal to fourteen thousand five hundred eighty three and 34/100 dollars ($14,583.34) per month. Employee's Base Salary shall be paid in accordance with Company's standard policy regarding payment of compensation to employees but no less frequently than monthly. b. BONUS. Commencing with the Effective Date and continuing thereafter until this Agreement is terminated, Employee will be eligible to receive a yearly cash bonus equal to one hundred thousand and 00/100 dollars ($100,000.00) (the "Bonus"). Sixty percent (60%) of the Bonus is to be paid Page 1 of 8 quarterly based upon the achievement of established quarterly targets and forty percent (40%) of the Bonus is to be paid based upon the achievement of established annual targets, with such annual targets measured during the period beginning April 1, 2004 through March 31, 2005 and during the subsequent fiscal year upon renewal of this Agreement, if any, with such targets and payment terms determined in writing by Employee and the Company, but in no event will the quarterly or annual targets be greater than those assigned to the Company's senior management team. Notwithstanding anything to the contrary herein or contained in the writing related hereto, any quarterly Bonus due to Employee shall be due up to and including the termination date of this Agreement, but no Bonus shall accrue after the termination date of this Agreement. Furthermore, if the Employee is terminated (other than "for cause") prior to the end of the third quarter of the Company's fiscal year, then the annual Bonus shall not be due, but if the Employee is terminated (other than "for cause") during the fourth quarter of the Company's fiscal year then the accrued but unpaid annual Bonus through and including the termination date shall be due and payable. By way of example but not limitation, should Employee accrue a bonus for the quarter ending September 30th and then this Agreement be terminated on October 15th, then the bonus for the quarter beginning in October shall be paid on a pro-rata basis and the annual bonus shall not be due or payable. c. BENEFITS. The Company shall grant Employee options to purchase shares of the Company's Common Stock in such amounts, with such vesting and at such prices as determined by the President all in accordance with the terms of the Company's standard form stock option agreement. In addition, during the term of this Agreement, Employee shall be allowed to participate in, and be entitled to benefits, plans and programs, including improvements or modifications of the same, which are now, or may hereafter be, those available to officers or employees of a like position. Employee shall be entitled to medical, dental and retirement benefits which are generally made available to employees of a like position, and specifically Company will pay the total premium costs associated with the medical and dental insurance, not including deductibles and/or co-payments, covering the health of Employee, Employee's spouse and Employee's dependants. Medical, dental and disability insurance shall become effective ten (10) days after the Effective Date. During each year of his employment Employee shall be entitled to fifteen (15) days of vacation, and such other days of compensated absences, (i.e. sick leave or personal days) in accordance with the Company's policies and procedures as determined from time to time by the President. 5. EXPENSES. It is acknowledged by the parties that Employee, in connection with the services to be performed by him pursuant to the terms of this Agreement, will be required to make payments for travel, meals, hotel, entertainment of business associates, mobile telephone and similar expenses (the "Out of Pocket Expenses"). The Company will reimburse Employee for all reasonable and necessary Out of Pocket Expenses incurred by Employee in the performance of his duties. Employee will comply with such budget limitations, approval and reporting requirements with respect to such Out of Pocket Expenses as the Company may establish from time to time. 6. TERMINATION. Employee's employment will begin on the Effective Date and continue until the end of the Term, including any renewals thereof, except that the employment of Employee hereunder will terminate upon the occurrence of the following events: a. BY EMPLOYEE. Employee's employment will terminate upon Employee's notice to Company, in writing at least thirty (30) days prior to Employee's last day of employment, of Employee's intent to terminate this Agreement. In the event of the Page 2 of 8 termination of this Agreement pursuant to this sub-section 6(a), Employee will not be entitled to any Severance Amount (as hereinafter defined) or further consideration, except for any portion of the Base Salary accrued but unpaid from the last monthly payment date to the date of termination and expense reimbursements under Section 5 hereof for expenses incurred in the performance of his duties hereunder prior to termination. b. DEATH OR DISABILITY. Employee's employment will terminate immediately upon the death of Employee during the term of his employment hereunder or, at the option of the Company, in the event of Employee's disability, upon 30 days notice to Employee. Employee will be deemed "disabled" if, as a result of Employee's incapacity due to physical or mental illness, Employee shall have been continuously absent from his duties with the company on a full-time basis for 120 consecutive business days, and Employee shall not reasonably be expected to be able to resume his duties within 60 days of the end of such 120 day period. In the event of the termination of this Agreement pursuant to this subsection 6(b), Employee will not be entitled to any Severance Amount (as hereinafter defined) or other compensation except for any portion of his Base Salary accrued but unpaid from the last monthly payment date to the date of termination and expense reimbursements under Section 5 hereof or for expenses incurred in the performance of his duties hereunder prior to termination. c. FOR CAUSE. The Company may terminate the Employee's employment "for cause" immediately upon written notice by the Company to Employee. For purposes of this Agreement, a termination will be for Cause if: (i) Employee willfully and continuously fails to perform his duties with the Company (other than any such failure resulting from incapacity due to physical or mental illness); (ii) Employee willfully engages in gross misconduct materially and demonstrably injurious to the Company; (iii) Employee has been convicted of a felony which the President reasonably believes will result in injury to the Company or which would disqualify employee for coverage by the Company's surety bond; (iv) Employee materially breaches the representations contained in Section 9 (Employee Representations) after written notice and failure to cure such breach. In the event of the termination of this Agreement pursuant to this sub-section 6(c), Employee will not be entitled to any Severance Amount (as hereinafter defined) or further consideration, except for any portion of the Base Salary accrued but unpaid from the last monthly payment date to the date of termination and expense reimbursements under Section 5 hereof for expenses incurred in the performance of his duties hereunder prior to termination. d. BY COMPANY WITHOUT CAUSE. The Company may terminate this Agreement during the Term at any time for any reason "without cause." In the event of the termination of this Agreement pursuant to this subsection 6(d) and only in that event, then the Company will pay Employee, as Employee's sole remedy in connection with such termination, severance (the "Severance Amount"); (i) if in the first twelve (12) months of the Agreement an amount determined by multiplying Employee's monthly Base Salary by six (6) months or (ii) if after the first twelve (12) months of the Agreement an amount determined by multiplying Employee's monthly Base Salary by nine (9) months. The Company will also pay Employee the portion of his Base Salary and Bonus accrued but unpaid from the last monthly payment date to the date of termination and expense reimbursements under Section 5 hereof for expenses incurred in the performance of his duties hereunder prior to termination. The Company will also pay the total premium costs associated with the medical and dental insurance, not including deductibles and/or co-payments, covering the health of Employee, Employee's spouse, and Employee's dependants for six (6) months after the termination date or until employee obtains other medical and dental insurance, whichever occurs first. The Company will pay the Severance Amount in a lump sum Page 3 of 8 and within thirty (30) days of the Employee's last day of employment. The Company will not be entitled to offset or mitigate the amount due under this subsection by any other amounts payable to Employee, including amounts payable or paid to Employee by third parties for Employee's services after the date of termination, except as provided for otherwise in Section 10(b) hereinafter. e. CHANGE OF CONTROL. A "Change of Control" shall be deemed to have occurred: (i) when in a single transaction or a series of transactions a change of stock ownership of the Company of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and any successor item of a similar nature has occurred; (ii) upon the acquisition of beneficial ownership, directly or indirectly, by any person (as such term is used in Section 13(d) and 14(d)(2) of the Exchange Act of securities of the Company) in a single transaction or a series of transactions representing thirty three percent (33%) or more of the combined voting power of the Company's then outstanding securities; or (iii) sale of substantially all of the assets of the Company in a single transaction or a series of transactions; provided that a Change in Control will not be deemed to have occurred for purposes of clauses (i) and (ii) hereof with respect to any person meeting the requirements of Rule 13d-1(b)(1) promulgated under the Securities Exchange Act of 1934, as amended. 7. STOCK OPTIONS. Employee shall be granted within ten (10) days of the Effective Date, an option (the "Option") to purchase from the Company all or any part of a total of 200,000 shares of the Company's Common Stock, par value $.001 per share, at an exercise price equal to the closing price of the Company's Common stock on the date of grant (the "Date of Grant") of the Option. The Option is an "incentive stock option" within the meaning of Section 422 of the Internal Revenue Code. The Option will expire on the day prior to the tenth (10th) anniversary of the Date of Grant, or such earlier date as may be provided in the 1997 Stock Compensation Plan (the "Plan"). Subject to the provisions of Plan, the Option may be exercised as follows; on the date that is six (6) months from the Effective Date, twenty-five percent (25.000%) of the options granted shall be vested, and thereafter beginning on the first day of the seventh month after the Effective Date, one thirty-sixth (1/36) of the remaining portion shall vest on the first day of each month, from month to month, until fully vested. In addition to the foregoing stock option grant, Employee will be eligible to participate in the Company's stock option plan and therefore deligible for an annual grant of additional stock options, if any, that are awarded to all of the Company's employees. If Employee is terminated "for cause" under Section 6(c) above, then the effect of the termination of the Employee's employment on such options shall be determined by the terms of the Plan under which the options are issued and the option agreement related to such options, except that Employee shall retain those options which are already vested and shall have ninety (90) days to exercise those vested options. Notwithstanding anything to the contrary herein or in any option agreement, in the event of a Change of Control, then the Options issued and outstanding to Employee shall immediately vest (100%), and the Employee may exercise his options at any time during the original term of the option agreement (as defined therein), and such termination of this Agreement shall not cause termination or expiration of the Options. 8. CONFIDENTIAL INFORMATION. Employee recognizes and acknowledges that certain assets of the Company and its affiliates, including without limitation information regarding customers, pricing policies, methods of operation, proprietary computer programs, sales, products, profits, costs, markets, key personnel, formulae, product applications, technical processes, and trade secrets (herein called "Confidential Information") are valuable, special and unique assets of the Company and its affiliates. Employee will not, during or after the term of his employment, disclose any of the Confidential Information to any person, Page 4 of 8 firm, corporation, association, or any other entity for any reason or purpose whatsoever, directly or indirectly, except as may be required pursuant to his employment hereunder, unless and until such Confidential Information becomes publicly available other than as a consequence of the breach by Employee of his confidentiality obligations hereunder. In the Event of the termination of his employment, whether voluntary or involuntary, and whether by the Company or Employee, Employee will deliver to the Company all documents and data pertaining to the Confidential Information and will not take with him any documents or data of any kind or any reproductions (in whole or in part) of any items relating to the Confidential Information. 9. REPRESENTATIONS OF EMPLOYEE. a. NON-COMPETITION. For the period beginning with the Effective Date and continuing thereafter until, (x) if before the first annual anniversary of the Effective Date the expiration of six (6) months after termination of Employee's employment with the Company, or (y) if after the first annual anniversary of the Effective Date the expiration of nine (9) months after termination of Employee's employment with the Company, then Employee covenants, warrants and represents that he will not: (i) engage directly or indirectly, alone or as a shareholder, partner, officer, director, employee or consultant of any other business organization that engages in any business activities that are directly competitive with the Company; (ii) divert to any competitor of the Company any customer of the Company or induce a customer to cease doing business with the Company or, (iii) solicit or encourage any employee of the Company to leave their employment with the Company or seek employment by or with any competitor of the Company. The parties hereto acknowledge that Employee's non-competition obligations hereunder will not preclude Employee from (i) owning less than 5% of the common stock of any publicly traded corporation conducting business activities that are competitive with the Company or (ii) serving as an officer, director, stockholder or employee of an entity whose business operations are not competitive with those of the Company. Employee will continue to be bound by the provisions of this Section 9 until their expiration and will not be entitled to any compensation from the Company with respect thereto. If at any time the provisions of this Section 9 are determined to be invalid or unenforceable, by reason of being vague or unreasonable as to area, duration or scope of activity, this Section 9 will be considered divisible and will become and be immediately amended to only such area, duration, scope of activity as will be determined to be reasonable and enforceable by the court or other body having jurisdiction over the matter; and Employee agrees that this Section 9 as so amended will be valid and binding as though any invalid or unenforceable provision had not been included herein. b. GENERAL REPRESENTATIONS. As of the Effective Date, Employee expressly warrants and represents to the Company that: (i) All employment agreements, employment letters or employment relationships, whether as an employee or as an independent contractor, have been terminated (ii) The execution and delivery of this Agreement does not violate any provision of any existing employment agreement to which Employee is a party and which on the Effective Date remain in effect; and (iii) Employee is not (by virtue of any act or omission) in violation of any non-competition or like covenant that would have the effect of prohibiting Employee from lawfully engaging in the activities contemplated by this Agreement. Page 5 of 8 10. GENERAL. a. NOTICES. All notices and other communications hereunder will be in writing or by written telecommunication, and will be deemed to have been duly given if delivered personally or if mailed by certified mail, return receipt requested or by written telecommunication, to the relevant address set forth below, or to such other address as the recipient of such notice or communication will have specified to the other party hereto in accordance with this Section 10(a):
If to the Company, to: If to Employee: EDT Learning, Inc. Nathan Cocozza 2999 N. 44th Street, Suite 650 15131 East Twilight View Drive Phoenix, Arizona 85018 Fountain Hills, Arizona 85268 Attn: President Fax No.: (602) 952-0544
b. WITHHOLDING AND OFFSET. All payments required to be made by the Company under this Agreement to Employee will be subject to the withholding of such amounts, if any, relating to federal, state and local taxes as may be required by law. No payment under this Agreement will be subject to offset or reduction attributable to any amount Employee may owe to the Company or any other person. c. EQUITABLE REMEDIES. Each of the parties hereto acknowledges and agrees that upon any breach by Employee of his obligations under any of the Sections 8 and 9 hereof, the Company will have no adequate remedy at law, and accordingly will be entitled to specific performance and other appropriate injunctive and equitable relief. d. SEVERABILITY. If any provision of this Agreement is held to be illegal, invalid or unenforceable, such provision will be fully severable and this Agreement will be construed and enforced as if such illegal, invalid or unenforceable provision never comprised a part hereof; and the remaining provisions hereof will remain in full force and effect and will not be affected by the illegal, invalid or unenforceable provision or by its severance herefrom. Furthermore, in lieu of such illegal, invalid or unenforceable provision, there will be added automatically as part of this Agreement a provision as similar in its terms to such illegal, invalid or unenforceable provision as may be possible and be legal, valid and enforceable. Any and all covenants and obligations of either party hereto which by their terms or by reasonable implication are to be performed, in whole or in part, after the termination of this Agreement, shall survive such termination, including specifically the obligations arising under Sections: 6, 7, 8 and 9. e. WAIVERS. No delay or omission by either party hereto in exercising any right, power or privilege hereunder will impair such right, power or privilege, nor will any single or partial exercise of any such right, power or privilege preclude any further exercise thereof or the exercise of any other right, power or privilege. Page 6 of 8 f. COUNTERPARTS. This Agreement may be executed in multiple counterparts, each of which will be deemed an original, and all of which together will constitute one and the same instrument. g. CAPTIONS. The captions in this Agreement are for convenience of reference only and will not limit or otherwise affect any of the terms or provisions hereof. h. REFERENCE TO AGREEMENT. Use of the words "herein," "hereof," "hereto " and the like in this Agreement refer to this Agreement only as a whole and not to any particular subsection or provision of this Agreement, unless otherwise noted. i. BINDING AGREEMENT. This Agreement will be binding upon and inure to the benefit of the parties and will be enforceable by the personal representatives and heirs of Employee and the successors of the Company. If Employee dies while any amounts would still be payable to him hereunder, such amounts will be paid to Employee's estate. This Agreement is not otherwise assignable by Employee. j. ENTIRE AGREEMENT. Except as provided in the benefit plans and programs referenced herein, this Agreement contains the entire understanding of the parties, supersedes all prior agreements and understandings relating to the subject matter hereof and may not be amended except by a written instrument hereafter signed by each of the parties hereto. Any modification of this Agreement shall be effective only if it is in writing and signed by the parties hereto. k. GOVERNING LAW. This Agreement and the performance hereof will be construed and governed in accordance with the laws of the State of Arizona, without regard to its choice of law principles. l. ATTORNEYS' FEES. If legal action is commenced by either party to enforce or defend its rights under this Agreement, the prevailing party in such action shall be entitled to recover its court costs and reasonable attorneys' fees, including expert witnesses fees actually incurred which shall be awarded to the that party, in addition to any other relief granted. m. AUTHORITY. The signatories to this Agreement represent and warrant that such signatory has the authority to enter into this Agreement, and that neither that signatory nor the party on whose behalf this Agreement may be signed has assigned any claims related to the parties' relationship or this Agreement to any person or entity. 11. BINDING ARBITRATION. Any controversy or claim arising out of or relating to this Agreement, or breach thereof, shall be settled exclusively by arbitration in Phoenix, Arizona, in accordance with the Commercial Arbitration Rules of the American Arbitration Association then in effect. A sole arbitrator shall conduct Arbitration and he or she shall render his or her award within forty five (45) days of appointment. Judgment upon the award rendered by the arbitrator may be entered in, and enforced by, any court having jurisdiction thereof. The award of the arbitrator may grant any relief available to the parties in law or in equity; and the award may contain a provision for payment of costs and attorney's fees to the prevailing party, if any. Page 7 of 8 EXECUTED to be effective as of the Effective Date first written above. EDT LEARNING, INC. EMPLOYEE: NATHAN COCOZZA By: ______________________________ By: ___________________________________ James M. Powers, Jr., President Page 8 of 8 EX-10.19 3 ilinc_10kex10-19.txt EXHIBIT 10.19 ILINC COMMUNICATIONS, INC. (A DELAWARE CORPORATION) NOTE PURCHASE AGREEMENT This note purchase agreement (this "Agreement" or "Purchase Agreement") is made and entered into on this 12th day of February, 2004, by and between iLinc Communications, Inc. (formerly known as EDT Learning, Inc.), a Delaware corporation having its principal place of business at 2999 North 44th Street, Suite 650, Phoenix, Arizona ("the Company"), Katsinam Partners, LP, ("Katsinam") an Arizona limited partnership whose address is 7377 East Doubletree Ranch Road, Suite 290, Scottsdale, AZ 85258, Anthony Silverman, as Trustee of the Anthony Silverman Trust, dated January 5, 2004 ("Silverman"), whose address is 7305 E. Del Acero Drive, Scottsdale, AZ 85258, Stanley L. Schloz ("Schloz") as Trustee of the Schloz Family 1998 Trust, whose address is 10050 East Sonoran Vista Circle, Scottsdale, AZ 85255, Mountainview Canadian Opportunistic Growth Fund, LP, a limited partnership organized under the laws of the Province of Ontario, Canada ("Mountainview"), whose address is 69 Lord Seaton Road, Toronto, Ontario M2P 1K6 Canada, Agger Fund LP, a Delaware limited partnership, whose address is 7878 East Belleview, Suite 800, Englewood, Colorado 80111 and Agger Institutional Fund LP, a Delaware limited partnership, whose address is 7878 East Belleview, Suite 800, Englewood, Colorado 80111 (collectively referred to as "Agger"). Katsinam, Silverman, Schloz, Mountainview, and Agger are sometimes each separately called herein a "Lender" and collectively the "Lenders". WHEREAS, the Company wishes to raise capital for general working capital purposes from certain accredited investors pursuant to exemptions provided by the federal securities laws by issuance of convertible promissory notes in the aggregate principal balance of $500,000, pursuant to the terms and conditions of this Agreement; and WHEREAS, each undersigned Lender individually desires to purchase the convertible promissory note (as defined herein below) from the Company in the amount set forth herein opposite such Lender's name on the terms and conditions of this Agreement; and NOW THEREFORE, in consideration of the mutual promises and covenants contained herein and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows: 1. TRANSACTION 1.1 FORM OF TRANSACTION. The Company, by due action of its Board of Directors, has authorized the offer and sale to the Lenders, under this Agreement, of a series of Convertible Notes (collectively the "Notes", separately a ("Note") with the aggregate principal amount of all Notes totaling $500,000, and with each Note convertible into shares of common stock of the Company, $0.001 par value (the "Common Stock"). The form of the Note is attached as Exhibit "A". 1.2 THE LENDERS. The obligations of the Lenders to purchase Notes and to make the representations, warranties and agreements contained in this Agreement are several and not joint. 2. PURCHASE AND SALE 2.1 NOTES. Subject to all of the terms and conditions of this Agreement, the Company will issue and sell Notes to the Lenders as follows; provided that all such terms and conditions are satisfied: ---------------------------- ----------------- NAME AMOUNT ---------------------------- ----------------- Katsinam $140,000 ---------------------------- ----------------- Silverman $135,000 ---------------------------- ----------------- Schloz $25,000 ---------------------------- ----------------- Note Purchase Agreement Page 1 of 25 ---------------------------- ----------------- Mountainview $100,000 ---------------------------- ----------------- Agger $100,000 ---------------------------- ----------------- Total Investment: $500,000 ---------------------------- ----------------- Upon Silverman's written request, the Company will issue his Note (and the Common Stock issuable upon the due conversion thereof, to the Custodian of an IRA Account for his benefit. 2.2 CLOSING. The purchase by and sale to the Lenders of the Notes (the "Closing") shall take place on February 12, 2004 at the offices of the Company (such date being hereinafter called the "Closing Date"). At the Closing, the Company shall deliver to the Lenders or their representative their respective Notes and other items required to be delivered to the Lenders pursuant to this Purchase Agreement. At the Closing, the Lenders shall tender to the Company valid and sufficient funds represented from each respective Lender the principal balance of the Lender's Note, and such other documents or items required to be delivered to the Company pursuant to this Purchase Agreement. 3. REPRESENTATIONS, WARRANTIES AND AGREEMENTS OF THE COMPANY As an inducement to the lenders to enter into this Agreement and to purchase and pay for the respective Notes, the Company represents, warrants to the Lenders and agrees that as of the Closing Date: 3.1 DISCLOSURE DOCUMENTS. The Company has heretofore delivered to the Lenders a copy of the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2003, as filed with the Securities and Exchange Commission ("SEC"), every subsequent Report filed with the SEC pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act"), a certain draft Report on Form 10-Q for the period ending December 31, 2003, and each press release or other form of public announcements including without limitation all shareholder communications (such Reports, draft and the exhibits annexed thereto, press releases, public announcements and shareholder communications are called collectively herein the "Disclosure Documents"). The Company has carefully prepared the Disclosure Documents or has caused them to be so prepared. The Disclosure Documents as of their respective dates are, true and correct and shall not omit to state any material fact necessary to make the statements made in the Disclosure Documents not misleading on and as of such date required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made. 3.2 VALID EXISTENCE. The Company was duly organized and is validly existing as a corporation under the laws of Delaware and is duly qualified to do business as a foreign corporation in Arizona and in each other jurisdiction where such qualification is material to its business as presently or as proposed to be conducted. 3.3 AUTHORITY FOR AGREEMENT. This Agreement has been duly authorized by all necessary corporate action of the Company and, when executed and delivered by the Company, will be a legal, valid and binding obligation of the Company, enforceable in accordance with its terms except to the extent that the enforce ability hereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other laws affecting creditors' rights generally. 3.4 VALIDITY OF NOTES. The Notes, when issued and paid for at the Closing, will be duly authorized, validly existing obligations of the Company, enforceable in accordance with their terms. 3.5 VALIDITY OF COMMON STOCK. The shares of Common Stock issuable upon the due conversion of the Notes will, when issued in accordance with the terms of such Notes, constitute duly authorized, legally and validly issued shares of Common Stock, fully paid and non-assessable. 3.6 PERMITS AND CONSENTS. No consent, approval, qualification, order or authorization of, or filing with, any local, state, or federal governmental authority is required on the part of the Company in connection with the Company's execution, delivery or performance of this Agreement, the offer, sale or issuance of the Notes or the issuance of Common Stock upon conversion of the Notes, except any notices of sale required to be filed with the SEC under Note Purchase Agreement Page 2 of 25 Regulation D of the Securities Act of 1933 or such post-closing filings as may be required under applicable state securities laws, which will be timely filed within the applicable periods therefor. 3.7 NO CONFLICTING RIGHTS. The Company is not presently under any obligation and has not granted any rights to register any of its presently outstanding securities under the Securities Act of 1933, except those granted to the holders of the Company's securities listed on Schedule 3.7 attached hereto. The holders of the outstanding Common Stock and Preferred Stock of the Company are not entitled to pre-emptive or other rights to subscribe for the Notes. This transaction does not give rise to any rights relating to the registration of any shares of Common Stock, except as provided in Section 6, below. 3.8 COMPLIANCE WITH AGREEMENTS. The Company is not in violation or default in any material respect of any material mortgage, indenture, agreement, instrument or contract to which it is a party or by which it is bound. To the best of its knowledge, the Company is not in violation or default, of any state or federal judgment, order, writ, decree, statute, rule, regulation or restriction applicable to the Company. The execution, delivery and performance by the Company of this Agreement and the Notes and the consummation of the transactions contemplated hereby, will not result in any violation or cause be in material conflict with or constitute, with or without the passage of time or giving of notice, either a material default of any material mortgage, indenture, agreement or contract to which the Company is a party or the creation of any material lien, charge or encumbrance upon any assets of the Company or the suspension, revocation, impairment, forfeiture or nonrenewable of any material permit, license, authorization or approval applicable to the Company, its business or operations or any of its assets. 3.9 NO MATERIAL ADVERSE CHANGE. There has not been, since the date of the Company's most recent report to the SEC under the Exchange Act, any event or condition of any type that has materially adversely affected the business, properties, prospects or financial condition of the Company (a "Material Adverse Change"). 3.10 QUISIC ASSETS. The use by the Company of the assets acquired by the Company from Quisic Corporation, a California corporation ("Quisic"), including without limitation those described in a certain Assets Purchase Agreement dated the 14th day of June, 2002 between the Company and Quisic are not material to the business and prospects of the Company and the loss of such assets by rescission of the transaction between Quisic and the Company would not be materially adverse to the Company, its business or prospects, provided however that such loss could result in a violation or default of existing license agreements related to those assets. 3.11 LITIGATION COUNSEL. The Company is being represented by the law firm of Seyfarth Shaw, of Los Angeles, California and by no other counsel in the cause entitled WEATHERSBY, ET AL. VS. QUISIC CORPORATION, et al., Case No. BC284645 in the Superior Court of the State of California, County of Los Angeles (the "Weathersby Case"), and by the law firm of Kornstein Veisz Wexler & Pollard, LLP, of New York, NY and by no other counsel in the Supreme Court of the State of New York, County of New York in the cause entitled KEPNER-TREGOE, INC. VS. QUISIC CORPORATION, ET. AL. , Index No. 601865/03 in the Supreme Court of the State of New York, County of New York (the "Kepner Case"). 4. REPRESENTATIONS, WARRANTIES AND AGREEMENTS OF THE LENDERS Each Lender, for himself or itself and not for any other Lender, hereby represents and warrants to and agrees with the Company as follows (provided that such representations, warranties, and agreements do not diminish or obviate the representations, warranties, and agreements of the Company set forth in this Agreement): 4.1 AUTHORITY. Such Lender has full power and authority to enter into this Agreement which, when executed and delivered, will constitute his or its valid and legally binding obligation. Note Purchase Agreement Page 3 of 25 4.2 PURCHASE FOR OWN ACCOUNT. The Notes and the Common Stock issuable upon the due conversion of the Notes ("the Securities") will be acquired for investment for the respective account of each Lender and not with a view to the resale or distribution of any part thereof, and such Lender has no present intention of selling, granting any participation in or otherwise distributing the same; and has no contract, undertaking, agreement or arrangement with any person to sell, transfer or grant participating to any third person with respect to any of the Securities. Nothing in this paragraph 4.2, however, limits the right of such Lender to have the Securities registered as provided in Section 6 of this Agreement. Each respective Lender has substantial experience in evaluating and investing in private placement transactions of securities in companies similar to the Company so that the Lender is capable of evaluating the merits and risks of its own investment in the securities of the Company, and has the capacity to protect its own interests. The undersigned Lender has carefully reviewed the Company's public filings, the Disclosure Documents together with all other documents and information furnished by the Company in connection herewith. Each Lender must bear the economic risk of its investment. Each Lender understands that while the Company intends to seek registration of the Common Stock underlying the Note, there can be no assurance that until such registration any exemption from registration under the Securities Acts will be available and further that, even if available, such exemption may not allow Lender to transfer all or any portion of the Common Stock received upon conversion of the Note. Lender has not engaged any broker or finder in connection with this Agreement or the transactions contemplated hereby. 4.3 ACCREDITED INVESTORS. Katsinam, Silverman and Schloz are each familiar with the definition of "Accredited Investor" under the Securities Act of 1933, as amended (the "Securities Act") and the regulations promulgated thereunder, specifically Rule 501 of Regulation D and do hereby represent to the Company that they are Accredited Investors. The term "net worth" as used in this paragraph means the excess of the Lender's assets over his liabilities and, if included among his assets, his principal residence is valued at fair market value. Silverman and Schloz each represent and warrant that his net worth, or joint net worth together with his spouse, exceeds $1,000,000. Katsinam represents and warrants that each of its members is an Accredited Investor. Schloz separately represents and warrants that the Schloz Family 1998 Trust is a revocable "grantor trust" for the benefit of himself and his spouse. 4.4 MOUNTAINVIEW. Mountainview separately represents and warrants that (a) it is a limited partnership, duly organized and existing under the laws of the Province of Ontario, Canada, (b) that it is familiar with the definition of "Accredited Investor" under the Securities Act, (c) that it is experienced in making investments where qualification as an Accredited Investor is required, (d) that each of its members is an Accredited Investor as defined under the Securities Act and, (e) upon consultation with qualified legal counsel in Ontario, (i) that it is satisfied as to the full observance of the laws of Ontario and Canada with respect to the offer and sale of the Notes and the Common Stock issuable upon the due conversion thereof and (ii) that its subscription and payment therefor will not violate any applicable securities or other laws of Ontario or Canada. 4.5 AGGER. Each Agger LP separately represents and warrants that (a) it is a limited liability company, duly organized and existing under the laws of the State of Delaware, (b) that it is familiar with the definition of "Accredited Investor" under the Securities Act, (c) that it is experienced in making investments where qualification as an Accredited Investor is required, (d) that each of its members is an Accredited Investor as defined under the Securities Act and, (e) upon consultation with qualified legal counsel in Delaware, (i) that it is satisfied as to the full observance of the laws of Delaware and the United States with respect to the offer and sale of the Notes and the Common Stock issuable upon the due conversion thereof and (ii) that its subscription and payment therefor will not violate any applicable securities or other laws of Delaware or the United States. 4.6 RESTRICTED SECURITIES. The undersigned Lenders acknowledges that the securities that will be received will not have been registered under the Securities Act of 1933 (the "1933 Act") or qualified under applicable state securities laws, and that the transferability thereof is restricted by the registration provisions of the 1933 Act as well as such state laws. Based upon the representations if each respective Lender concerning his Accredited Investor Note Purchase Agreement Page 4 of 25 status, and agreements being made by the undersigned herein, this transaction is being done pursuant to an exemption from such registration provided by Section 4(2) of the 1933 Act and Regulation D promulgated thereunder and applicable state securities law qualification exemptions. Each Lender acknowledges that he or it has been granted a reasonable time prior to the date hereof during which such Lender has had the opportunity to obtain such additional information as Lender deemed necessary to permit Lender to make an informed decision with respect to the investment contemplated. Each Lender represents and warrants that such Lender (i) has reviewed such other documents and obtained such other information from the Company as Lender deems necessary to make an informed investment decision; (ii) has had access to all relevant documents, instruments, books, and other records of or pertaining to the Company and has had the opportunity to ask questions of and receive answers from management and of the Company; and (iii) is fully aware of the current business prospects, financial condition, and operating history relating to the Company. Other than the representations and warranties provided in this Agreement, Lender warrants that no representations, statements or inducements were made and that Lender is not relying upon any representations other than those contained in the Disclosure Document, this Agreement or the attachments hereto. The Lenders understand that none of the Securities may be sold, transferred, or otherwise disposed of without registration under the Securities Act of 1933 or an exemption therefrom and that in the absence of an effective registration statement covering the Securities or an available exemption from registration under the Securities Act, the Securities must be held indefinitely. 4.7 LEGENDS. To the extent applicable, the Note and any certificate evidencing any of the common stock issuable upon the due conversion thereof will be endorsed with legends substantially in the following form: THE SECURITIES REPRESENTED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1993, AS AMENDED, AND MAY NOT BE SOLD, TRANSFERRED, ASSIGNED, PLEDGED, OR HYPOTHECATED UNLESS AND UNTIL REGISTERED UNDER SUCH ACT, OR UNLESS THE COMPANY HAS RECEIVED AN OPINION OF COUNSEL, OR OTHER EVIDENCE SATISFACTORY TO THE COMPANY AND ITS COUNSEL THAT SUCH REGISTRATION IS NOT REQUIRED. 4.8 No Short Sales. Each Lender agrees that until the expiration of two years from the Closing Date and while the Lender holds shares of the Company's Common Stock from conversion of the Note, such Lender will not sell, transfer or otherwise dispose of its Common Stock through a put or other short sale arrangement. 5. CONDITIONS TO THE OBLIGATIONS OF THE LENDERS The respective obligations of the Lenders to purchase Notes under this Agreement are subject to the fulfillment on or before the Closing of each of the following conditions: 5.1 REPRESENTATIONS AND WARRANTIES. The representations and warranties of the Company contained in Section 3 shall be true and correct as of the Closing Date. 5.2 NO DETERIORATION. Nothing shall have occurred since the date of the Disclosure Documents that has or may reasonably be expected to affect materially adversely the Company, its assets or its business 5.3 [This Section Deleted and Reserved.] 5.4 OFFICER CERTIFICATES. The President and the Chief Financial Officer of the Company shall have delivered at the Closing a certificate, substantially in the form shown by Exhibit "B" attached hereto, to the effect that the Company has complied with all agreements, obligations and conditions required of it pursuant to this Agreement. Note Purchase Agreement Page 5 of 25 5.5 OPINION OF COUNSEL. Lenders shall have received from Jackson & Walker, counsel for the Company, a written opinion, dated the Closing Date, in form and substance satisfactory to the Lenders and their counsel, an opinion as to the execution and delivery of this Agreement and the other documents and agreements to be executed pursuant hereto, the good standing and authority of the Company, the enforceability of this Agreement and the other agreements and documents to be executed in connection herewith, and the due authorization as to the issuance of the Notes. 5.6 SATISFACTION WITH INQUIRIES. The Lenders shall be satisfied with the results of their inquiries into the Company and its business and affairs, including without limitation, the status of all executive employment agreements to which the Company is a party and the status, as outstanding or terminated, of all rights, options and warrants for the purchase of any of the Company's securities that were in the past awarded or purported to be awarded to any executive employee of the Company. 5.7 REPRESENTATION LETTERS. The Lenders shall have received letters addressed to them and in form and substance acceptable to them, from Kornstein, Veisz, Wexler, & Pollard, LLP, ("New York Counsel") and from Seyfarth Shaw ("California Counsel"), litigation legal counsel to the Company, containing the following: (a) details relating to all matters of pending or threatened litigation, claims or assessments that such firm is handling on behalf of the Company, including (i) a description of the nature of each matter, (ii) the progress of each matter to date, (iii) how the Company has responded or intends to respond in terms of pleadings or other public court filings and (iv) an evaluation of the likelihood of an unfavorable outcome and an estimate of the amount or range of potential loss; (b) the knowledge, if any of such firm of other asserted or unasserted possible claims that such firm believes are probable of assertion and should be disclosed in accordance with Statement of Financial Accounting Standards No. 5 ("FASB 5"); (c) confirmation that if such firm has formed a professional conclusion that the Company should disclose or consider disclosure of such possible claims, it will, as a matter of professional responsibility to the Company and its shareholders, so advise the Company and will consult with the Company concerning the question of such disclosure and the applicable requirements of Statement of FASB 5; (d) a statement of the nature of and reasons for any limitation on the response of such firm. On or about May 29, 2003, California Counsel wrote a letter to the Company's auditors discussing the facts and circumstances surrounding the Weathersby Case in the form required by this Section 5.7. Lenders have had direct communications with California Counsel concerning the Weathersby Case, and thereafter have requested from California Counsel that they directly receive a like letter concerning specifically the Weathersby Case in accordance with this Section 5.7 (a "Weathersby Representation Letter"). However, California Counsel is unable to tender that Weathersby Representation Letter before Closing, but intends to tender the Weathersby Representation Letter as soon as practicable after the Closing Date. As an inducement to Closing and to assure compliance with this Section 5.7, the Company and Lenders agree that: (x) if the Weathersby Representation Letter is not tendered before the expiration of ten (10) business days of the Closing Date, or (y) if the Weathersby Representation Letter is tendered and within it states facts and circumstances that are materially different than those represented by California Counsel concerning the Weathersby Case, then (after notice by Lenders of breach of the foregoing and failure to cure such breach within five (5) business days of the receipt of such notice), and only in that event and unless already converted, Lenders shall be repaid out of the Peacock Offering Proceeds, but if the Peacock Offering is not consummated, then the Maturity Date of the Notes shall be April 15, 2005. 6. REGISTRATION RIGHTS The Company covenants and agrees as follows: 6.1 DEFINITIONS. For purposes of this Section 6: (a) The term "Holder" means any person owning or having the right to acquire Registrable Securities pursuant to the Note or upon the conversion thereof. (b) The terms "register," "registered" and "registration" refer to a registration effected by preparing and filing a registration Note Purchase Agreement Page 6 of 25 statement or similar document in compliance with the Securities Act, and such registration statement or document becoming effective. (c) The term "Registrable Securities" means the (i) Common Stock issuable or issued upon the conversion of any Note and (ii) any Common Stock issued (or issuable upon the conversion or exercise of any warrant, right, or other security which is issued) as a dividend or other distribution with respect to, or in exchange for or in replacement of shares referenced in (i) and (ii) above, but excluding in all cases, however, any Registrable Securities sold by a person in a transaction in which his rights under this Section 6 are not assigned. (d) The number of shares of "Registrable Securities then outstanding" shall be determined by the number of shares of Common Stock outstanding which are, and the number of shares of Common Stock issuable pursuant to then exercisable or convertible securities which are, Registrable Securities. (e) The term "SEC" means the United States Securities and Exchange Commission. All other capitalized terms used in this Section, which are not defined herein, shall have the meaning otherwise given in this Agreement. 6.2 REQUEST FOR REGISTRATION. (a) If the Company shall receive at any time after the Closing Date, a written request from the Holders of forty-nine percent (49%) or greater of the Registrable Securities then outstanding that the Company file a registration statement under the Securities Act covering the registration of any part of the Registrable Securities then outstanding, then the Company shall: (i) within ten (10) calendar days of the receipt thereof, give written notice of such request to all Holders; and (ii) use its best efforts to effect as soon as practicable, and in any event within sixty (60) calendar days of the receipt of such request, the filing of a registration statement under the Securities Act covering all Registrable Securities which the Holders request to be registered, subject to the limitations of paragraph 6.2(b), within two hundred ten (210) business days of the mailing of such notice by the Company, provided, however, that the Holders may not utilize this demand right more than once in any twelve-month period after the Closing Date. (b) If the Holders initiating the registration request hereunder ("Initiating Holders") intend to distribute the Registrable Securities covered by their request by means of an underwriting, they shall so advise the Company as a part of their request made pursuant to paragraph 6.2(a) and the Company shall include such information in the written notice referred to in paragraph 6.2(a)(i). The underwriter will be selected by a majority in interest of the Initiating Holders and shall be reasonably acceptable to the Company. In such event, the right of any Holder to include his Registrable Securities in such registration shall be conditioned upon such Holder's participation in such underwriting and the inclusion of such Holder's Registrable Securities in the underwriting (unless otherwise mutually agreed by a majority in interest of the Initiating Holders and such Holder) to the extent provided herein. All Holders proposing to distribute their securities through such underwriting shall (together with the Company as provided in paragraph 6.4(e)) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting. (c) Notwithstanding the foregoing, if the Company shall furnish to Holders requesting a registration statement pursuant to this paragraph 6.2, a certificate signed by the Chief Executive Officer of the Company stating that in the good faith judgment of the Board of Directors of the Company, it would be seriously detrimental to the Company and its shareholders for such registration statement to be filed and it is therefore essential to defer the filing of such registration statement, the Company shall have the right to defer taking action with respect to such filing for a period of not more than sixty (60) calendar Note Purchase Agreement Page 7 of 25 days after receipt of the request of the Initiating Holders; provided, however, that the Company may not utilize this right more than once in any twelve-month period. (d) In addition, the Company shall not be obligated to effect, or to take any action to effect, any registration pursuant to this paragraph 6.2: (i) After the Company has effected one registration pursuant to this paragraph 6.2 and such registration has been declared or ordered effective; or (ii) After the Closing Date, if the Company has filed and had declared effective a registration statement with respect to the sale of all of the Registrable Securities and has kept such registration statement effective until the expiration of two hundred ten (210) calendar days after the effective date of such registration statement. Notwithstanding the foregoing, the above period for maintenance of effectiveness of the 210-day period set forth in this paragraph 6.2(d)(ii) shall be extended for a period of time equal to the period a Holder refrains from selling any securities included in such registration at the request of an underwriter of the Common Stock. 6.3 COMPANY ("PIGGYBACK") REGISTRATION. If at any time commencing on the Closing Date (but without any obligation to do so) the Company proposes to register (including for this purpose a registration effected by the Company for shareholders other than the Holders) any of its stock or other securities under the Securities Act in connection with the public offering of such securities solely for cash (other than a registration of securities to be offered by employees pursuant on employee benefit plan on Form S-8, or a registration in connection with an exchange offer or any acquisition or a registration on any form which does not include substantially the same information as would be required to be included in a registration statement covering the sale of the Registrable Securities), the Company shall, each such time, give each Holder written notice of such proposed registration at least thirty (30) days prior to filing the registration statement respecting such proposed registration. Upon the written request of any Holder given within twenty (20) days after mailing of such notice by the Company in accordance with this Agreement, the Company shall cause to be registered under the Securities Act all of the Registrable Securities that each such Holder has requested to be registered. 6.4 OBLIGATIONS OF THE COMPANY. Whenever required under this Section 6 to effect the registration of any Registrable Securities, the Company shall use its best efforts to, as expeditiously as reasonably possible: (a) Prepare and file with the SEC a registration statement with respect to such Registrable Securities and use its best efforts to cause such registration statement to become effective, and, keep such registration statement current and effective for a period of up to the earlier of two hundred seventy (270) calendar days or until the distribution contemplated in the Registration Statement has been completed; provided, however, that such period shall be extended for a period of time equal to the period a Holder refrains from selling any securities included in such registration at the request of an underwriter of the Common Stock. (b) Prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement as may be necessary to comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such registration statement. (c) Furnish to the Holders such numbers of copies of a prospectus, including a preliminary prospectus, in conformity with the requirements of the Securities Act, and such other documents as they may reasonably request in order to facilitate the disposition of Registrable Securities owned by them. (d) Register and qualify the securities covered by such registration statement under such other securities or blue sky laws of such jurisdictions as shall be reasonably requested by the Holders; provided that in no event shall the Company be required to qualify to do business in any state or to take any action which would subject it to general or unlimited service of process in any state where it is not now so subject. Note Purchase Agreement Page 8 of 25 (e) In the event of any underwritten public offering, enter into and perform its obligations under an underwriting agreement with terms generally satisfactory to the managing underwriter of such offering. Each Holder participating in such underwriting shall also enter into and perform its obligations under such an agreement. (f) Notify each Holder of Registrable Securities covered by such registration statement at any time when a prospectus relating thereto is required to be delivered under the Securities Act of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing. (g) Cause all such Registrable Securities registered pursuant hereunder to be listed on each securities exchange on which similar securities issued by the Company are then listed. (h) Provide a transfer agent and registrar for all Registrable Securities registered pursuant hereunder and a CUSIP number for all such Registrable Securities, in each case not later than the effective date of such registration. (i) Furnish, at the request of any Holder requesting registration of Registrable Securities pursuant to this Section 6, on the date that such Registrable Securities are delivered to the underwriters for sale in connection with a registration pursuant to this Section 6, if such securities are being sold through underwriters, or, if such securities are not being sold through underwriters, on the date that the registration statement with respect to such securities becomes effective, (I) an opinion, dated on such date, of the counsel representing the Company for the purposes of such registration, in form and substance as is customarily given to underwriters in an underwritten public offering, addressed to the underwriters, if any, and to the Holders requesting registration of Registrable Securities and (ii) a letter dated such date, from the independent certified public accountants of the Company, in form and substance as is customarily given by independent certified public accountants to underwriters in an underwritten public offering, addressed to the underwriters, if any, and to the Holders requesting registration of Registrable Securities. 6.5 FURNISH INFORMATION. It shall be a condition precedent to the obligations of the Company to take any action pursuant to this Section 6, that the selling Holders shall furnish to the Company such information regarding themselves, the Registrable Securities held by them, and on the intended method of disposition of such securities as shall be required to effect the registration of their Registrable Securities. 6.6 EXPENSES OF REGISTRATION. All expenses incurred in connection with any registration, filing or qualification pursuant to this Section 6, including without limitation, all registration, filing and qualification fees, printers' and accounting fees, and fees and disbursements of counsel for the Company, but excluding underwriter's commissions and fees and any fees of others employed by a selling Holder, shall be borne by the Company. 6.7 UNDERWRITING REQUIREMENTS. In connection with any offering involving an underwriting of securities being issued by the Company, the Company shall not be required under paragraph 6.3 to include any of the Holders' securities in such underwriting unless they accept the terms of the underwriting as agreed upon between the Company and the underwriters selected by it, and then only in such quantity, if any, as will not, in the opinion of the underwriters, jeopardize or in any way reduce the success of the offering by the Company. If the total amount of securities, including Registrable Securities, requested by shareholders to be included in such offering exceeds the amount of securities sold other than by the Company that the underwriters determine in their sole discretion is compatible with the success of the offering, then the Company shall be required to include in the offering only that number of such securities, including Registrable Securities, which the underwriters determine in their sole discretion will not jeopardize the success of the offering (the securities so included to be apportioned pro rata among the selling shareholders according to the total amount of securities entitled to be included therein owned by each selling Shareholder or in such other proportions as shall mutually be agreed to by such selling shareholders) but in no event shall the amount of securities of the selling Holders included in the offering be reduced below twenty percent (20%) of the total amount of Registrable Securities included in Note Purchase Agreement Page 9 of 25 such offering. For purposes of the preceding parenthetical concerning apportionment, for any selling shareholder which is a holder of Registrable Securities and which is a partnership or corporation, the partners, retired partners and shareholders of such holder, or the estates and family members of any such partners and retired partners and any trusts for the benefit of any of the foregoing persons shall be deemed to be a single "selling shareholder", and any pro rata reduction with respect to such "selling shareholder" shall be based upon the aggregate amount of shares carrying registration rights owned by all entities and individuals included in such "selling shareholder", as defined in this sentence. 6.8 INDEMNIFICATION. In the event any Registrable Securities are included in a registration statement under this Section 6: (a) To the extent permitted by law, the Company will indemnify and hold harmless each Holder, the officers and directors of each Holder, and each person, if any, who controls such Holder (within the meaning of the Securities Act or the Exchange Act) against any losses, claims, damages, or liabilities (joint or several) to which they may become subject under the Securities Act, the Exchange Act or any state securities law or regulation, insofar as such losses, claims, damages, or liabilities (or actions in respect thereof) arise out of or are based upon any of the following statements, omissions or violations (collectively a "Violation"): (i) any untrue statement or alleged untrue statement of a material fact contained in such registration statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto, (ii) the omission or alleged omission to state therein a material fact required to be stated therein, or necessary to make the statements therein not misleading, or (iii) any violation or alleged violation by the Company of the Securities Act, the Exchange Act, any state securities law or any rule or regulation promulgated under the Securities Act, the Exchange Act or any state securities law; and the Company will reimburse each such Holder, officer or director, underwriter or controlling person for any legal or other expenses reasonably incurred by them in a connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement contained in this paragraph 6.8(a) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of the Company (which consent shall not be unreasonably withheld), nor shall the Company be liable in any such case for any such loss, claim, damage, liability, or action to the extent that it arises out of or is based upon a Violation which occurs in reliance upon and in conformity with written information furnished expressly for use in connection with such registration by any such Holder, underwriter or controlling person or his or their representative or agent. (b) To the extent permitted by law, each selling Holder will indemnify and hold harmless the Company, each of its directors and officers, any underwriter (as defined in the Securities Act) for the Company, each person, if any, who controls the Company or any such underwriter within the meaning of the Securities Act or the Exchange Act, and any other holder selling securities in such registration statement or any of its directors or officers or any person who controls such Holder, against any losses, claims, damages, or liabilities (or actions in respect thereto) which arise out of or are based upon any Violation, in each case to the extent (and only to the extent) that such Violation occurs in reliance upon and in conformity with written information furnished by such Holder or his representative or agent expressly for use in connection with such registration; and each such Holder will reimburse any legal or other expenses reasonably incurred by the Company or any such director, officer, any person who controls the Company, any underwriter or controlling person of any such underwriter, any other such Holder, officer, director, or controlling person in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement contained in this paragraph 6.8(b) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability or action if such settlement is effected without the consent of the Holder (which consent shall not be unreasonably withheld), and provided further that the obligations of each selling Holder hereunder shall be limited to an amount equal to the proceeds of each such selling Holder of the shares sold by such selling Holder pursuant to such registration. Note Purchase Agreement Page 10 of 25 (c) Promptly after receipt by an indemnified party under this paragraph 6.8 of notice of the commencement of any action (including any governmental action), such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this paragraph 6.8, notify the indemnifying party in writing of the commencement thereof and the indemnifying party shall have the right to participate in, and, to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly noticed, to assume the defense thereof with counsel mutually satisfactory to the parties; provided, however, that an indemnified party shall have the right to retain its own counsel, with the fees and expenses to be paid by the indemnifying party, if representation of such indemnified party by the counsel retained by the indemnifying party would be inappropriate due to actual or potential differing interests between such indemnified party and any other party represented by such counsel in such proceeding. The failure to notify an indemnifying party within a reasonable time of the commencement of any such action shall not relieve such indemnifying party of any liability that it may have to any indemnified party otherwise than under this paragraph 6.8. (d) If the indemnification provided for in this paragraph 6.8 is held by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any loss, liability, claim, damage, or expense referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party hereunder, shall contribute to the amount paid or payable by such indemnified party as a result of such loss, liability, claim, damage, or expense in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and of the indemnified party on the other in connection with the statements or omissions that resulted in such loss, liability, claim, damage, or expense as well as any other relevant equitable considerations. The relative fault of the indemnifying party and of the indemnified party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party. (e) Notwithstanding the foregoing, to the extent that the provisions on indemnification and contribution contained in the underwriting agreement entered into in connection with the underwritten public offering are in conflict with the foregoing provisions, the provisions in the underwriting agreement shall control. (f) The obligations of the Company and Holders under this Section shall survive the completion of any offering of Registrable Securities in a registration statement under this Section 6, or otherwise. 6.9 REPORTS UNDER THE EXCHANGE ACT. With a view to making available to the Holders the benefits of Rule 144 promulgated under the Securities Act and any other rule or regulation of the SEC that may at any time permit a Holder to sell securities of the Company to the public without registration or pursuant to a registration form which permits inclusion or incorporation of substantial information by reference to other documents filed by the Company with the SEC, the Company agrees to for up to two (2) years: Furnish to any Holder, so long as the Holder owns any Registrable Securities, forthwith upon reasonable request (i) a written statement by the Company that it has complied with the reporting requirements of the Exchange Act (at any time after it has become subject to such reporting requirements), (ii) a copy of the most recent annual or quarterly report of the Company and such other reports and documents so filed by the Company, and (iii) such other information as may be reasonably requested in availing any Holder of any rule or regulation of the SEC permitting the selling of any such securities without registration or pursuant to such form. The utilization of Rule 144 by any Holder to sell any securities of the Company, including without limitation any Registrable Securities, shall not affect the Company's obligations to register any Registrable Securities pursuant to this Agreement. Note Purchase Agreement Page 11 of 25 6.10 DELAY OF REGISTRATION. No holder shall have any right to obtain or seek an injunction restraining or otherwise delaying any such registration as the result of any controversy that might arise with respect to the interpretation or implementation of this Agreement. 6.11 ASSIGNMENT OF REGISTRATION RIGHTS. The rights to cause the Company to register Registrable Securities pursuant to this Section 6 may be assigned (but only with all related obligations) by a Holder to a transferee or assignee of such securities who, after such assignment or transfer, holds at least ten percent (10%) of the Registrable Securities (subject to appropriate adjustment for stock splits, stock dividends, combinations and other recapitalizations), provided: (a) the Company is, within a reasonable time after such transfer, furnished with written notice of the name and address of such transferee or assignee and the securities with respect to which such registration rights are being assigned; (b) such transferee or assignee agrees in writing to be bound by and subject to the terms and conditions of this Agreement, including without limitation, the provisions of paragraph 6.13 below; and (c) such assignment shall be effective only if immediately following such transfer the further disposition of such securities by the transferee or assignee is restricted under the Securities Act. For the purposes of determining the number of shares of Registrable Securities held by a transferee or assignee, the holdings of transferees and assignees of a partnership who are partners or retired partners of such partnership (including spouses and ancestors, lineal descendants and siblings of such partners or spouses who acquire Registrable Securities by gift, will or intestate succession) shall be aggregated together and with the partnership; provided that all assignees and transferees who would not qualify individually for assignment of registration rights shall have a single attorney-in-fact for the purpose of exercising any rights, receiving notices or taking any action under this Section 6. 6.12 LIMITATIONS ON SUBSEQUENT REGISTRATION RIGHTS. From and after the date of this Agreement, the Company shall not, without the prior written consent of the Holders of a majority of the outstanding Registrable Securities, enter into any agreement with, grant registration rights to, or register securities on behalf of, any holder of any debentures, notes or other evidence of indebtedness issued by the Company to investors in a certain private offering in which Peacock, Hislop, Staley & Given, Inc. ("Peacock") is to act as agent for the Company in accordance with the terms more fully described in the term sheet between the Company and Peacock (the "Peacock Offering") which could result in registration of any common stock offered as a part of the Peacock Offering being declared effective prior to the expiration of thirty (30) days of the effective date of any registration statement covering the Registrable Securities. 6.13 TERMINATION OF REGISTRATION RIGHTS. No Holder shall be entitled to exercise any right provided for in this Section 6 after the expiration of three (3) years following the Closing Date nor at any time when the Holder has the right to sell all of his Registrable Securities pursuant to SEC Rule 144(k). 6.14 AMENDMENTS AND WAIVERS. Any term or provision of the registration rights stated in this Agreement may be amended and the observance of any term of such rights may be waived (either generally or in a particular instance and either retroactively or prospectively), only with the written consent of the Company and the holders of at least sixty-seven percent (67%) of the Registrable Securities then outstanding. Any amendment or waiver effected in accordance with this paragraph shall be binding upon each holder of any Registrable Securities then outstanding, each future holder of all such Registrable Securities, and the Company. 7. FURTHER AGREEMENTS 7.1 SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon the successors and assigns, if any, of each Lender. 7.2 INDEMNIFICATION. Each Lender shall indemnify, hold harmless and defend the Company and its affiliates and agents with respect to any and all loss, damage, expense, claim, action or liability any of them may incur as a result of the breach or untruth of any representations or warranties made by such Lender herein, and each Lender agrees that in the event of any breach or untruth of any representations or warranties made by him herein, the Company may, at its option, forthwith rescind the sale of the Notes and Common Stock to such Lender. Note Purchase Agreement Page 12 of 25 7.3 SUBSEQUENT PUBLIC INFORMATION. For as long as any of the Notes remain outstanding, the Company shall furnish to the Lenders, forthwith upon the preparation, filing and public release thereof press releases and other public announcements, and its quarterly, annual and other Reports filed with the Securities and Exchange Commission 7.4 LEGAL FEES AND EXPENSES. At the Closing, the Company shall reimburse the Lenders for their reasonable legal fees actually incurred in connection with this transaction with such legal fees not to exceed $8,000. 8. GENERAL AND MISCELLANEOUS 8.1 SURVIVAL OF WARRANTIES. The warranties, representations and covenants of the parties contained in or made pursuant to this Agreement shall survive the execution and delivery of this Agreement and the Closing until the expiration of two (2) years from the Closing Date. 8.2 ENTIRE AGREEMENT. This Agreement, and the attachments hereto, constitutes the entire agreement concerning the subject matter hereof among the parties, and no party shall be liable or bound to any other party in any manner by any warranties, representations, guarantees or covenants except as specifically set forth in this Agreement or the attachments hereto. The terms and conditions of this Agreement shall inure to the benefit of and be binding upon the respective successors and assigns of the parties. Nothing in this Agreement, express or implied, is intended to confer upon any party other than the parties hereto or their respective successors and assigns any rights, remedies, obligations, or liabilities under or by reason of this Agreement, except as expressly provided in this Agreement. 8.3 GOVERNING LAW. This Agreement shall be governed by and construed under the internal laws of the State of Arizona without regard to conflicts of law. 8.4 COUNTERPARTS. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. [Signature Pages Follow - The remainder of this page intentionally left blank.] Note Purchase Agreement Page 13 of 25 IN WITNESS WHEREOF, the parties have executed this Note Purchase Agreement February 12, 2004. iLinc Communications, Inc. KATSINAM PARTNERS, LP, BY GNTC, LLC, ITS GENERAL PARTNER By: ___________________________________ By___________________________________ James M. Powers, Jr. President Title: ______________________________ Printed Name: _______________________ X____________________________________ Stanley L. Schloz X____________________________________ Anthony Silverman MOUNTAINVIEW CANADIAN OPPORTUNISTIC GROWTH FUND, LP By __________________________________ Printed Name: _______________________ Title: ______________________________ AGGER FUND LP By __________________________________ Printed Name: _______________________ Title: ______________________________ AGGER INSTITUTIONAL FUND LP By __________________________________ Printed Name: _______________________ Title: ______________________________ Note Purchase Agreement Page 14 of 25 EXHIBIT "A" FORM OF CONVERTIBLE PROMISSORY NOTE THE SECURITIES EVIDENCED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED ("THE 1933 ACT") AND MAY NOT BE SOLD, TRANSFERRED, ASSIGNED OR HYPOTHECATED UNLESS THERE IS AN EFFECTIVE REGISTRATION STATEMENT UNDER THE 1933 ACT COVERING SUCH SECURITIES OR THE COMPANY RECEIVES AN OPINION OF COUNSEL FOR THE HOLDER OF THESE SECURITIES, REASONABLY SATISFACTORY TO THE COMPANY, STATING THAT SUCH SALE, TRANSFER, ASSIGNMENT OR HYPOTHECATION IS EXEMPT FROM THE REGISTRATION AND PROSPECTUS DELIVERY REQUIREMENTS OF THE 1933 ACT. THE TRANSFER OF THIS NOTE (AND THE SHARES OF COMMON STOCK THAT MAY BE ACQUIRABLE UPON CONVERSION) IS SUBJECT TO RESTRICTIONS AS PROVIDED HEREIN. AN INVESTMENT IN THIS NOTE (AND THE COMMON STOCK THAT MAY BE ACQUIRED UPON CONVERSION) IS HIGHLY SPECULATIVE. ILINC COMMUNICATIONS, INC. A DELAWARE CORPORATION CONVERTIBLE PROMISSORY NOTE ----------------------------------------- ------------------------------------ Note Number: Place of Issue: Phoenix, Arizona ----------------------------------------- ------------------------------------ ----------------------------------------- ------------------------------------ Principal Balance: $__________ Date of Issue: February 12, 2004 ----------------------------------------- ------------------------------------ FOR VALUE RECEIVED, iLinc Communications, Inc., a Delaware corporation (the "Company"), hereby promises to pay to [NAME] or registered assigns (hereinafter referred to as the "Holder"), the original principal sum of $_____________. This Convertible Promissory Note (the "Note") is being issued as one of a series of Notes of like tenor that are being issued by the Company pursuant to a certain Note Purchase Agreement between the Company, the payee of this Note and certain other Lenders, dated February 12, 2004 ("Purchase Agreement") (with the capitalized but undefined terms herein having the meaning given them in the Purchase Agreement) and with the aggregate principal amount of all notes totaling $500,000 (collectively, the "Notes"). Until converted pursuant to Section 4 hereof, interest on the unpaid principal sum of and any accrued but unpaid interest under this Note shall be paid at the rate of 8% per annum for a period of one year from the date hereof and thereafter at the rate of 12% per annum until paid in full. If, however, a registration statement under the Securities Act of 1933 with respect to all of the Registrable Securities (as defined in the Purchase Agreement) has not become effective by July 31, 2004 ("Registration Date"), the rate of interest under this Note shall be adjusted retroactive effective to the date of this Note to the rate of 15% per annum ("Adjusted Rate"). In such event, the difference between the interest paid or accrued at the Registration Date and interest accrued under the Adjusted Rate for the period between the date of this Note and the Registration Date shall be immediately due and payable and, if not paid immediately, shall be added to the principal amount of this Note and shall bear interest at the Adjusted Rate. Payments of interest shall be made quarterly in arrears and shall be paid on the first day of each calendar quarter; provided that a registration statement not Note Purchase Agreement Page 15 of 25 become effective before the Registration Date, then during any period in which interest accrues at the Adjusted Rate payments of interest shall be made on a monthly basis, on the first day of each calendar month. 1. PAYMENTS. Accrued interest shall be due and payable at the end of each calendar quarter following the Issue Date. Unless earlier converted pursuant to Section 4 hereof, the principal of and any accrued but unpaid interest under this Note shall be due and payable two (2) years after the Issue Date (the "Maturity Date"). Payment shall be made in lawful money of the United States of America at the address of the Holder shown in the above-mentioned Note Purchase Agreement, or at such other place as the Holder may designate in writing or, if earlier, an Event of Default (as defined below). Prepayment of principal and accrued interest may be made upon thirty (30) days' prior written notice to the Holder. Except as otherwise set forth in Section 4, the Company shall have the right to prepay all principal and accrued but unpaid interest of this Note prior to the Maturity Date without penalty or premium, provided however that upon receipt of written notice of the Company's intent to prepay this Note, Holder shall have thirty (30) days to exercise its right to convert this Note into Common Stock, as provided in Section 4 (the "Prepayment Notice Period"). The Company and Holder agree that should the Company breach Section 5.7 of the Purchase Agreement, (after notice by Lenders of breach thereof and the failure to cure such breach within five (5) business days of the receipt of such notice as provided therein), and only in that event, and unless already converted, Holder shall be repaid out of the Peacock Offering Proceeds, but if the Peacock Offering is not consummated, then the Maturity Date of this Note shall be April 15, 2005, at which time the then outstanding principal and accrued but unpaid interest shall be then due and payable. 2. DEFAULT. If any of the following events (hereafter called "Events of Default") shall occur: (a) the Company shall default in the payment of any principal or accrued interest due under this Note on the date the same shall become due and payable, whether at maturity or by acceleration or otherwise; or (b) upon any breach by the Company of any material representation, warranty or covenant in this Note or the Note Purchase Agreement; provided that, in the event of such material breach, shall not have been cured by the Company within 30 days after receipt by the Company of written notice to the Company of such breach; or (c) the Company shall make a general assignment for the benefit of creditors; or (d) the Company shall file a voluntary petition in bankruptcy, or shall be insolvent or adjudicated bankrupt, or shall file any petition or answer seeking any reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief under the present or any future federal bankruptcy act or other applicable federal, state or other statute, law or regulation, or shall file any answer admitting the material allegation of a petition filed against the Company in such proceeding, or shall seek or consent to or acquiesce in the appointment of any trustee, receiver or liquidator of the Company of all or any substantial part of the properties of the Company, or the Company shall commence the winding up or the dissolution or liquidation of the Company; or (e) within sixty (60) days after the commencement of an action against the Company (and service of process in connection therewith on the Company) seeking any bankruptcy, insolvency, reorganization, liquidation, dissolution or similar relief under any present or future statute, law or regulation, such action shall not have been resolved in favor of the Company or all orders or proceedings thereunder affecting the operations or the business of the Company stayed, or if the stay of any such order or proceeding shall thereafter be set aside, or if, within sixty (60) days after the appointment without the consent or acquiescence of the Company of any trustee, receiver or liquidator of the Company or of all or any substantial part of the properties of the Company, such appointment shall not have been vacated; or Note Purchase Agreement Page 16 of 25 (f) the Company (i) repurchases any shares of its common stock or preferred stock, other than shares issued to officers, directors, employees and consultants of the Company pursuant to agreements obligating the Company to repurchase such shares upon termination of employment with or service to the Company, (ii) pays a cash dividend or makes any other property distribution (other than a dividend in the form of equity in the Company) to its equity holders, or (iii) repays any of the Notes other than a repayment concurrently made on all Notes on a pro rata basis. Should an Event of Default occur and failure to cure if provided, then, and in each and every such case, the Holder of the Note may, by written notice to the Company, declare all amounts under this Note and all other Notes to be forthwith due and payable without presentation, protest or further demand or notice of any kind, all of which are hereby expressly waived. 3. SUBORDINATION. The indebtedness evidenced by this Note is hereby expressly subordinated, to the extent and in the manner hereinafter set forth, in right of payment to the prior payment in full of all the Company's Senior Indebtedness, as hereinafter defined. (a) SENIOR INDEBTEDNESS. As used in this Note, the term "Senior Indebtedness" shall mean the principal of and unpaid accrued interest on: (i) all indebtedness (whether or not secured) of the Company to banks, insurance companies or other financial institutions regularly engaged in the business of lending money, which is for money borrowed by the Company, (ii) amounts due to software and equipment lessors pursuant to lease agreements whereunder the Company is the lessee, and (iii) any debentures, notes or other evidence of indebtedness issued in exchange for such Senior Indebtedness, or any indebtedness arising from the satisfaction of such Senior Indebtedness by a guarantor. (b) DEFAULT ON SENIOR INDEBTEDNESS. If there should occur any receivership, insolvency, assignment for the benefit of creditors, bankruptcy, reorganization or arrangements with creditors (whether or not pursuant to bankruptcy or other insolvency laws), sale of all or substantially all of the assets, dissolution, liquidation or any other marshaling of the assets and liabilities of the Company, or if this Note shall be declared due and payable upon the occurrence of a default with respect to any Senior Indebtedness, then (i) no amount shall be paid by the Company in respect of the principal of or interest on this Note at the time outstanding, unless and until the principal of and interest on the Senior Indebtedness then outstanding shall be paid in full, and (ii) no claim or proof of claim shall be filed with the Company by or on behalf of the Holder of this Note that shall assert any right to receive any payments in respect of the principal of and interest on this Note, except subject to the payment in full of the principal of and interest on all of the Senior Indebtedness then outstanding. If there occurs an event of default that has been declared in writing with respect to any Senior Indebtedness as defined in the instrument governing such Senior Indebtedness or in the instrument under which any Senior Indebtedness is outstanding, permitting the holder of such Senior Indebtedness to accelerate the maturity there of, then, unless and until such default shall have been cured or waived or shall have ceased to exist, or all Senior Indebtedness shall have been paid in full, no payment shall be made in respect of the principal of or interest on this Note. (c) EFFECT OF SUBORDINATION. Subject to the rights, if any, of the holders of Senior Indebtedness under this Section 3 to receive cash, securities or other properties otherwise payable or deliverable to the Holder of this Note, nothing contained in this Section 3 shall impair, as between the Company and the Holder, the obligation of the Company, subject to the terms and conditions hereof, to pay to the Holder the principal hereof as and when the same become due and payable, or shall prevent the Holder of this Note, upon default hereunder, from exercising all rights, powers and remedies otherwise provided herein or by applicable law. (d) SUBROGATION. Subject to the payment in full off all Senior Indebtedness and until this Note shall be paid in full, the Holder shall be subrogated to the rights of the holders of Senior Indebtedness (to the extent of payments or distributions previously made to such holders of Senior Indebtedness pursuant to the provisions of Section 3(b) above) to receive payments or distributions of assets of the Company applicable to the Senior Indebtedness. No Note Purchase Agreement Page 17 of 25 such payments or distributions applicable to the Senior Indebtedness shall, as between the Company and its creditors, other than the holders of Senior Indebtedness and the Holder, be deemed to be a payment by the Company to or on account of this Note; and for the purposes of such subrogation, no payments or distributions to the holders of Senior Indebtedness to which the Holder would be entitled except for the provisions of this Section 4 shall, as between the Company and its creditors, other than the holders of Senior Indebtedness and the Holder, be deemed to be a payment by the Company to or on account of the Senior Indebtedness. (e) UNDERTAKING. By its acceptance of this Note, the Holder agrees to execute and deliver such documents as may be reasonably requested from time to time by the Company or the holder of any Senior Indebtedness in order to implement the foregoing provisions of this Section 3. 4. CONVERSION. (a) GRANT OF RIGHT. Subject to the terms of Section 4(d) hereof, any Holder of this Note has the right, at the Holder's option, at any time prior to the Maturity Date or earlier payment in full of the entire principal balance of and accrued interest under this Note, including without limitation, during the thirty (30) day Prepayment Notice Period to convert, in accordance with the provisions of this Section 4, (i) the outstanding principal amount of this Note, in whole but not in part, and (ii) at the Holder's option, the accrued interest under the Note which has been unpaid for thirty (30) or more days beyond its due date as of the date of such conversion into fully paid and non-assessable shares of the Common Stock, $0.001 par value, of the Company. The number of shares into which this Note may be converted ("Shares") shall be determined by dividing the then outstanding principal amount of the Note and/or accrued unpaid interest under the Note by the conversion price in effect at the time of such conversion. The initial conversion price ("Conversion Price") shall be $0.70 per Share. (b) NOTICE OF CONVERSION. Before the Holder shall be entitled to convert this Note into Shares, he shall surrender this Note at the office of the Company and shall give written notice by mail, postage prepaid, to the Company at its principal corporate office, of the election to convert the same, if the Holder is electing to convert pursuant to Section 4(a), and shall state therein on the Notice of Conversion annexed to this Note the entire principal amount of the Note to be converted and the accrued and unpaid interest on such principal amount that is also to be converted. (c) SATISFACTION WITH REQUIREMENTS OF SECURITIES ACT OF 1933. Notwithstanding anything to the contrary contained herein, each and every conversion of this Note, is contingent upon the Company's satisfaction that the issuance of Common Stock upon the conversion is exempt from the requirements of the Securities Act of 1933, as amended, and all applicable state securities laws. The Holder agrees to execute any and all documents deemed necessary by the Company to effect a conversion of this Note. (d) MECHANICS AND EFFECT OF CONVERSION. No fractional Shares shall be issued upon conversion of this Note. In lieu of the Company issuing any fractional Shares to the Holder upon the conversion of this Note, the Company shall pay to the Holder, when it is due, the amount of outstanding principal that is not so converted and shall pay all accrued but unpaid interest thereof not converted. Upon the conversion of this Note pursuant to Section 4(a) above, the Holder shall surrender this Note, duly endorsed, at the principal office of the Company. At its expense, the Company shall, as soon as practicable thereafter, issue and deliver to such Holder at such principal office a certificate or certificates evidencing the number of Shares of Common Stock to which the Holder shall be entitled upon such conversion (bearing such legends as are required by the Purchase Agreement and applicable state and federal securities laws in the opinion of counsel to the Company), together with any other securities and property to which the Holder is entitled upon such conversion under the terms of this Note, including a check payable to the Holder for any cash amounts payable for unpaid and accrued interest and for fractional shares as described above. In the event of any conversion of this Note pursuant Note Purchase Agreement Page 18 of 25 to Section 4(a) above, such conversion shall be deemed to have been made immediately prior to the closing of the issuance of such Common Stock and on and after such date the Holder of this Note is entitled to receive the shares of such Common Stock issuable upon such conversion and shall be treated for all purposes as the record holder of such shares. Upon conversion of this Note, then the Note shall be irrevocably extinguished and the Company shall be forever released from all its obligations and liabilities under this Note, except that the Company shall be obligated to pay the Holder within ten (10) days after the date of such conversion any cash amounts resulting from fractional shares as described above, and any unpaid and accrued interest to and including the date of such conversion, and no more. 5. CONVERSION PRICE ADJUSTMENTS. (a) STOCK SPLITS AND COMBINATIONS. If the Company shall at any time subdivide or combine its outstanding shares of Common Stock, this Note shall, after that subdivision or combination, evidence the right to convert into the number of shares of Common Stock that would have been issuable as a result of that change with respect to the Shares of Common Stock which were issuable upon conversion of this Note immediately before that subdivision or combination. If the Company shall at any time subdivide the outstanding shares of Common Stock, the Conversion Price then in effect immediately before that subdivision shall be proportionately decreased, and, if the Company shall at any time combine the outstanding shares of Common Stock, the Conversion Price then in effect immediately before that combination shall be proportionately increased. Any adjustment under this section shall become effective at the close of business on the date the subdivision or combination becomes effective. (b) RECLASSIFICATION, EXCHANGE AND SUBSTITUTION. If the Common Stock issuable upon conversion of this Note shall be changed into the same or a different number of shares of any other class or classes of stock, whether by capital reorganization, reclassification, or otherwise (other than a subdivision or combination of shares provided for above), the holder of this Note, shall, on its conversion be entitled to receive in lieu of the Common Stock which the Holder would have become entitled to receive but for such change, a number of shares of such other class or classes of stock equivalent to the number of shares of Common Stock that would have been received by the holder on conversion of this Note immediately before that change. (c) REORGANIZATIONS, MERGERS, CONSOLIDATIONS OR SALE OF ASSETS. If at any time there shall be a capital reorganization of the Company's Common Stock (other than a combination, reclassification, exchange, or subdivision of shares provided for elsewhere above) or merger or consolidation of the Company with or into another corporation with the Company not being the survivor of the merger, or the sale of substantially all of the Company's properties and assets to any other person, then, as a part of such reorganization, merger, consolidation or sale, lawful provision shall be made so that the holder of this Note shall thereafter be entitled to receive upon conversion of this Note, the number of shares of Common Stock or other securities or property of the Company, or of the successor corporation resulting from such merger or consolidation, to which a holder of the Common Stock deliverable upon conversion of this Note would have been entitled in such capital reorganization, merger, or consolidation or sale if this Note had been converted immediately before that capital reorganization, merger, consolidation, or sale. In any such case, appropriate adjustment (as determined in good faith by the Company's Board of Directors) shall be made in the application of the provisions of this Note with respect to the rights and interests of the holder of this Note after the reorganization, merger, consolidation, or sale to the end that the provisions of this Note (including adjustment of the Conversion Price then in effect and number of Shares purchasable upon conversion of this Note) shall be applicable after that event, as near as reasonably may be, in relation to any shares or other property deliverable after that event upon conversion of this Note. The Company shall, within thirty (30) days after making such adjustment, give written notice (by first class mail, postage prepaid) to the registered holder of this Note at the address of that holder shown on the Company's books. That notice shall set Note Purchase Agreement Page 19 of 25 forth, in reasonable detail, the event requiring the adjustment and the method by which the adjustment was calculated and specify the Conversion Price then in effect after the adjustment and the increased or decreased number of Shares purchasable upon conversion of this Note. When appropriate, such notice may be given in advance and include as a part thereof the notice required under other provisions of this Note. If any capital reorganization or reclassification of the capital stock of the Company, or consolidation or merger of the Company with another corporation, or the sale of all or substantially all of the assets to another corporation, shall be effected in such a way that holders of Common Stock shall be entitled to receive stock, securities or assets with respect to or in exchange for Common Stock, then, as a condition of such reorganization, reclassification, consolidation, merger or sale, the Company or such successor or purchasing corporation, as the case may be, shall execute with the Holder a supplemental agreement providing that the Holder of each Note then outstanding shall have the right thereafter and until the expiration of the period of convertibility to convert such Note into the kind and amount of stock, securities or assets receivable upon such reorganization, reclassification, consolidation, merger or sale by a holder of the number of shares of Common Stock into which such Note might have been converted immediately prior to such reorganization, reclassification, consolidation, merger or sale, subject to adjustment which shall be as nearly equivalent as may be practicable to the adjustments provided for in this section. (d) ISSUANCE OF STOCK BELOW CONVERSION PRICE. If the Company shall at any time before the earlier of (x) the expiration of six (6) months after the Issue Date of this Note or (y) the date upon which a registration statement that covers the Shares that are available upon conversion become effective, issue common stock to an investor with a purchase price per share that is less than the Conversion Price ("Additional Stock") then in effect under this Note, then the Conversion Price will be reduced concurrently with such issue to an amount equal to the price per share paid upon such issuance. For the purposes of this Agreement, "Additional Stock" shall include shares of Common Stock issued directly and also the maximum number of shares of Common Stock issuable upon the due exercise of options for the purchase of Common Stock or the conversion of securities convertible into Common Stock, in which case the purchase price shall be the exercise or conversion price, as the case may be. Notwithstanding the foregoing, if anytime before the expiration of one (1) year from the Issue Date, any options to purchase equity or any common stock or any debentures, notes or other evidence of indebtedness issued by the Company is sold to investors in the Peacock Offering (as defined in the Purchase Agreement) then the common stock or other equity associated with the Peacock Offering shall not be considered for purposes of Additional Stock, and accordingly the Holder hereof acknowledges that it is the intention of the Company to engage in a debt offering as a part of the Peacock Offering that may include the sale of common stock or the issuance of options at a price below the Conversion Price without the issuance of Additional Stock. 6. DIVIDENDS. In the event that the Company shall make any distribution of its assets upon or with respect to its Common Stock, as a liquidating or partial liquidating dividend, or other than as a dividend payable out of earnings or any surplus legally available for dividends under the laws of the state of incorporation of the Company, each Holder of any Note then outstanding shall, upon the exercise of his right to convert after the record date for such distribution or, in the absence of a record date, after the date of such distribution, receive, in addition to the shares subscribed for, the amount of such assets (or, at the option of the Company, a sum equal to the value thereof at the time of distribution as determined by the Board of Directors in good faith which would have been distributed to such Holder if he had exercised his right to convert this Note) or the Common Stock issuable upon the conversion of this Note immediately prior to the record date for such distribution or, in the absence of a record date, immediately prior to the date of such distribution. 7. LIMITATIONS ON DISPOSITION. Holder agrees not to make any disposition of all or any portion of this Note or any of the Common Stock issuable upon the due conversion hereof (other than the valid conversion thereof in accordance with Note Purchase Agreement Page 20 of 25 its terms) unless and until: (a) there is then in effect a registration statement under the Securities Act of 1933 covering such proposed disposition, and such disposition is made in accordance with such registration statement; or (b) (i) Holder has notified the Company of the proposed disposition and has furnished the Company with a detailed statement of the circumstances surrounding the proposed disposition, and (ii) if requested by the Company, Holder has furnished the Company with an opinion of counsel, reasonably satisfactory to the Company, that such disposition will not require registration of such Securities under the Securities Act of 1933 or registration or qualification under any applicable state securities law. Notwithstanding the foregoing, no investment representation letter or opinion of counsel shall be required for any transfer of Securities (i) in compliance with Rule 144 or Rule 144A of the Securities Act of 1933 or (ii) by gift, will or intestate succession by Holder to his or her spouse or lineal descendants or ancestors or any trust for any of the foregoing; provided that, in each of the foregoing cases, the transferee agrees in writing to be subject to the terms of this Note. In addition, if the holder of any Securities delivers to the Company an unqualified opinion of counsel that no subsequent transfer of such Securities shall require registration under the Securities Act of 1933, the Company shall, upon such contemplated transfer, promptly deliver new documents/certificates for such Securities that do not bear the legend set forth in Section 8 hereof. 8. LEGENDS. It is understood that the certificates evidencing the Common Stock may bear one or more of the following legends: (a) The following legend under the Securities Act of 1933: "THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF A REGISTRATION STATEMENT IN EFFECT WITH RESPECT TO THE SECURITIES UNDER SUCH ACT OR AN OPINION OF COUNSEL SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED", or (b) Any legend required by state securities laws. The Company agrees to remove promptly, upon the request of the holder of Securities issued upon conversion of this Note, the legend set forth in Section 8(a) hereof from the documents/certificates for such Securities upon full compliance with this Note, Rule 144 under the Securities Act of 1933 and any other applicable provisions of the Securities Act of 1933 or the regulations promulgated thereunder. 9. ASSIGNMENT. This Note applies to, inures to the benefit of and binds the successors and assigns of the parties hereto. Any transfer of this Note will be effected only by surrender of this Note to the Company and reissuance of a new note to transferee. The Holder and any subsequent holder(s) of this Note receive this Note subject to the foregoing items and conditions, and agree to comply with the foregoing terms and conditions for the benefit of the Company and any other holders. 10. NOTICES. Any notice, request or other communication required or permitted hereunder shall be in writing and shall be deemed to have been duly given (i) when received, if personally delivered, faxed, sent by nationally recognized courier or U.S. Mail return-receipt requested, or (ii) on the third business day after deposit in the U.S. Mail, if sent by first-class mail, in any such case to the address of the recipient set forth in the above-mentioned Purchase Agreement and, if to the Company, Attention: Chief Executive Officer. Any party hereto may by notice so given change its address for future notice hereunder. 11. NO STOCKHOLDER RIGHTS. Nothing contained in this Note shall be construed as conferring upon the Holder or any other person the right to vote or to consent or to receive notice as a stockholder in respect of meetings of stockholders for the election of directors of the Company or any other matters or any rights whatsoever as a stockholder of the Company; and no dividends shall be payable or accrued in respect of this Note or the capital stock obtainable hereunder until, and only to the extent that, this Note shall have been converted. Note Purchase Agreement Page 21 of 25 12. NOTE REGISTER. This Note is transferable only upon the books of the Company, which it shall cause to be maintained for such purpose. The Company may treat the registered holder of this Note as he, she or it appears on the Company's books at any time as the Holder for all purposes. 13. LOSS OF NOTE. Upon receipt of evidence satisfactory to the Company of the loss, theft, destruction or mutilation of this Note, and of indemnity reasonably satisfactory to the Company if this Note is lost, stolen or destroyed, and upon surrender and cancellation of this Note if this Note is mutilated, the Company shall execute and deliver to the Holder a new Note of like date, tenor and denomination. 14. AMENDMENT, WAIVER. The terms of this Note may be amended or waived only upon the written agreement of the Company and the Holder. 15. HEADING: REFERENCES. All headings used herein are used for convenience only and shall not be used to construe or interpret this Note. Except where otherwise indicated, all references herein to Sections refer to Sections hereof. 16. SEVERABILITY. If one or more provisions of this Note are held to be unenforceable under applicable law, such provision shall be excluded from this Note and the balance of this Note shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. 17. MISCELLANEOUS. This Note shall be governed by and construed in accordance with the laws of the State of Arizona. If an action is brought for collection under this Note, the Company will pay all costs of collection actually incurred by the Holder, including, but not limited to, the reasonable attorneys' fees. 18. MAXIMUM INTEREST. Regardless of any provision contained herein, the Company shall never be required to pay and the holder hereof shall never be entitled to receive, collect or apply as interest hereon, any amount in excess of the highest lawful interest rate permitted under applicable law, and in the event the holder hereof receives, collects or applies, as interest, any such excess, such amounts which would be excessive interest shall be deemed a partial prepayment of principal and treated hereunder as such for all purposes; and, if the principal hereof is paid in full, any remaining excess shall be refunded to the Company. In determining whether or not the interest paid or payable, under any specific contingency, exceeds the highest lawful interest rate, the Company and the holder hereof shall, to the maximum extent permitted under applicable law (a) characterize any non-principal payment as an expense, fee or premium rather than as interest, (b) exclude prepayments and the effects thereof, and (c) pro rate, allocate and spread the total amount of interest throughout the entire contemplated term hereof; provided that if the indebtedness evidenced hereby is paid and performed in full prior to the end of the full contemplated term hereof, and if the interest received for the actual period of existence thereof exceeds the highest lawful interest rate, the holder hereof shall either apply as principal reduction or refund to the Company the amount of such excess, and in such event, the holder hereof shall not be subject to any penalties provided by any laws for contracting for, charging or receiving interest in excess of the highest lawful interest rate. Note Purchase Agreement Page 22 of 25 IN WITNESS WHEREOF, the undersigned have caused this Note to be executed by the undersigned as of the date first set forth above. ILINC COMMUNICATIONS, INC., a Delaware corporation By ____________________________ James M. Powers, Jr. President ATTEST: _______________________ James L. Dunn, Jr. Corporate Secretary Note Purchase Agreement Page 23 of 25 EXHIBIT "B" FORM OF OFFICER'S CERTIFICATE FOR ILINC COMMUNICATIONS, INC. The undersigned, _______________________, hereby certifies that he is the [Chief Executive Officer] [Chief Financial Officer] of iLinc Communications, Inc., a Delaware corporation ("the Company") and further certifies as follows to the purchasers of the Company's Convertible Promissory Notes on a date even herewith: 1. As such officer he is familiar with the business, affairs and assets of the Company and with the provisions of a certain Note Purchase Agreement ("Agreement") between the Company on the one hand and certain Lenders on the other and acknowledges that the making, delivery and accuracy of this Certificate is a condition to the performance of the Lenders under the Agreement. 2. To the best of his knowledge, after careful inquiry, the representations and warranties of the Company contained in the Agreement are true and correct on and all conditions required to be fulfilled as a condition to the obligations of the Lenders have been fulfilled and as of the date of this Certificate. 3. To the best of his knowledge, after careful inquiry, nothing in the Agreement or any attachment thereto or document delivered in connection therewith contains any untrue statement of a material fact or omits to make a statement of material fact necessary to make the statements made therein not misleading. _______________________________________ James M. Powers, Jr., President On Behalf of iLinc Communications, Inc. Note Purchase Agreement Page 24 of 25 SCHEDULE 3.7 LIST OF OUTSTANDING SECURITIES WITH ASSOCIATED DEMAND OR PIGGY BACK REGISTRATION RIGHTS o Holders of the Company's convertible notes and attached warrants as a part of an offering with gross proceeds of $5.757 Million that are convertible into 12,705,000 shares of common stock. o Holders of Preferred Stock and attached warrants as a part of an offering with gross proceeds of $1.5 Million that is convertible into convertible into 6,325,000 (@$0.50 per share) or 4,125,000 (@$0.30 per share) shares of common stock. o Warrants held by Bank One, NA representing 847,664 shares of common stock. o Warrants held by Renaissance Capital representing 250,000 shares of common stock. o Warrants held by Jackson Walker representing 25,000 shares of common stock. o Holders of 2 Million shares of common stock arising from the Quisic transaction. o Holders of 1,184,600 shares of common stock arising from the ThoughtWare transaction. o Holders of 1,950,000 shares of common stock arising from the LearningEdge transaction. o Warrants held by Quisic shareholders for Debt Conversion Agreement representing 333,333 shares of common stock. o Holders of 734,906 shares of common stock arising from the Dexpo transaction. o Holders of 439,885 shares of common stock arising from the Liberty transaction. o Holders of 1,572,222 shares of common stock arising from the Series A Convertible Note Conversion Agreements. Note Purchase Agreement Page 25 of 25 EX-10.20 4 ilinc_10kex10-20.txt EXHIBIT 10.20 UNIT PURCHASE AND AGENCY AGREEMENT By and Between iLinc Communications, Inc., a Delaware Corporation and Cerberus Financial, Inc., an Arizona Corporation Acting for the Benefit of Certain Noteholders TABLE OF CONTENTS PAGE ---- Article 1. RECITALS...........................................................1 1.1 Purchase of Units...........................................1 1.2 Agency Duties...............................................1 Article 2. DEFINITIONS; INTERPRETATION........................................1 2.1 Definitions.................................................1 2.2 Accounting Principles.......................................4 Article 3. ISSUE, DESCRIPTION, EXECUTION, REGISTRATION AND EXCHANGE OF NOTES..............................................5 3.1 Amount and Issue of Notes...................................5 3.2 Form of Notes...............................................5 3.3 Denominations and Date of Notes.............................5 3.4 Execution of Notes..........................................5 3.5 Registration, Exchange and Registration of Transfer of Notes...........................5 3.6 Mutilated, Destroyed, Lost or Stolen Notes..................6 3.7 Cancellation of Notes; Acquisition of Notes by the Company.....................................................6 3.8 Persons Entitled to Interest Payments.......................7 3.9 Benefits of Provisions of This Agreement....................7 Article 4. REDEMPTION.........................................................7 4.1 Redemption Generally........................................7 4.2 Optional Redemption.........................................7 4.3 Change of Control Redemption................................8 Article 5. PAYMENT OF PRINCIPAL AND INTEREST..................................8 5.1 Date for Payment of Principal and Interest..................8 5.2 Interest Payable on Notes...................................8 5.3 Paying Agent................................................8 5.4 Application of Payment......................................8 Article 6. REPRESENTATIONS AND WARRANTIES OF THE COMPANY......................9 6.1 Organization, Good Standing, and Qualification..............9 6.2 Authorization...............................................9 6.3 Capitalization..............................................9 6.4 Compliance with Laws........................................9 6.5 Taxes.......................................................9 6.6 Intellectual Property.......................................9 6.7 SEC Reports and Financial Statements.......................10 6.8 Litigation.................................................11 6.9 Governmental Authorizations and Regulations................11 6.10 No Untrue Statements.......................................11 -i- Article 7. COVENANTS OF THE COMPANY..........................................11 7.1 Maintenance of Office; Operation of Business...............11 7.2 Compliance with Laws and Regulations; Licenses and Permits; No Violation.........................12 7.3 Appointment to Fill a Vacancy in Office of Note Agent......12 7.4 Further Instruments and Acts...............................12 7.5 Payment of Notes...........................................12 7.6 Compliance Certificates and Annual Reports.................12 7.7 Corporate Existence........................................13 7.8 Waiver of Stay, Extension or Usury Laws....................13 7.9 Maintenance of Properties and Insurance....................13 7.10 Sale of Assets; Consolidation; Equity; Merger..............13 7.11 Limitation on Incurrence of Additional Indebtedness........14 7.12 Restricted Payments........................................14 7.13 Limitations on Payment Restrictions Affecting Subsidiaries.....................................14 7.14 Loans, Acquisitions and Guaranties.........................14 7.15 Issuance of Stock; Change in Ownership or Control.................................................14 7.16 Payment on or Modification of Subordinated Indebtedness...............................................14 7.17 Limitations on Pledge of Capital Stock of Company or Subsidiaries....................................15 Article 8. NOTEHOLDER'S LIST.................................................15 8.1 Noteholders' List..........................................15 8.2 Preservation and Disclosure of List........................15 Article 9. REMEDIES OF THE NOTE AGENT AND THE NOTEHOLDERS IN EVENT OF DEFAULT...............................................15 9.1 Events of Default..........................................15 9.2 Payment of Notes on Default; Suit Therefor.................16 9.3 Application of Moneys Collected by Note Agent..............17 9.4 Proceedings by Noteholders.................................18 9.5 Proceedings by Note Agent..................................18 9.6 Remedies Cumulative and Continuing.........................18 9.7 Direction of Proceedings and Waiver of Defaults by Majority of Noteholders........................19 9.8 Notice of Defaults.........................................19 9.9 Undertaking to Pay Costs...................................19 9.10 Default on Indebtedness....................................19 Article 10. NOTE AGENT.......................................................19 10.1 Duties and Liabilities of Note Agent.......................19 10.2 Reliance on Documents, Opinions, Etc.......................21 10.3 No Responsibility for Recitals; etc........................22 10.4 Moneys to be Held in Trust.................................22 10.5 Compensation of Note Agent.................................22 10.6 Expenses of Note Agent.....................................22 10.7 Resignation or Removal of Note Agent.......................22 10.8 Acceptance by Successor Note Agent.........................23 Article 11. ACTS OF NOTEHOLDERS; EVIDENCE OF OWNERSHIP OF NOTES..............23 11.1 Acts of Noteholders........................................23 -ii- 11.2 Ownership of Notes.........................................23 11.3 Action Taken by the Noteholders............................23 Article 12. registration rights..............................................24 12.1 Required Registration.......................................24 12.2 Incidental Registration....................................25 12.3 Registration Procedures....................................25 12.4 Expenses...................................................27 12.5 Information by Holder......................................27 12.6 Indemnification and Contribution...........................27 12.7 Changes in Common Stock or Preferred Shares................29 12.8 Damages....................................................30 Article 13. AMENDMENTS AND SUPPLEMENTS.......................................30 13.1 Amendments and Supplements Without Noteholders' Consent....................................................30 13.2 Amendments With Noteholders' Consent....................................................30 13.3 Note Agent Authorized to Join Amendments; Reliance on Counsel....................................................30 Article 14. SATISFACTION AND DISCHARGE OF AGREEMENT; UNCLAIMED MONIES...........................................................30 14.1 Discharge of Agreement.....................................30 14.2 Deposited Moneys to be Held in Trust by the Note Agent....................................30 14.3 Unclaimed Moneys...........................................30 Article 15. NO REGISTRATION OF NOTES; RESTRICTIONS ON TRANSFERABILITY..................................31 Article 16. MISCELLANEOUS PROVISIONS.........................................31 16.1 Provisions Binding on the Company's Successors.................................................31 16.2 Addresses for Notice.......................................31 16.3 Representations and Warranties.............................31 16.4 Governing Law..............................................31 16.5 Effect of Invalidity of Provisions.........................31 16.6 Table of Contents and Headings.............................32 16.7 Execution in Counterparts..................................32 -iii- UNIT PURCHASE AND AGENCY AGREEMENT This Unit Purchase and Agency Agreement ("AGREEMENT") dated as of April 19, 2004, is made by and between iLinc Communications, Inc., a Delaware corporation ("COMPANY"), and Cerberus Financial, Inc., an Arizona corporation ("NOTE AGENT"), acting for the equal and ratable benefit of and on behalf of certain Noteholders identified in Schedule 1 attached hereto. ARTICLE 1. RECITALS 1.1 PURCHASE OF UNITS. The Company is offering in a private placement transaction that is exempt from registration (the "Offering") up to 60 units (the "Units") that will provide gross proceeds to the Company of $3,000,000; with the total units consisting of $2,250,000 in notes (more fully described herein) and $750,000 of the Company's common stock (the "Stock"). Each unit will cost the purchaser of the unit $50,000 and will entitle the Purchaser to: (i) a Note with a principal balance of $37,500, and (ii) $12,500 of the Company's common stock. The Offering and number of units sold may be increased in the sole discretion of the Company by 20 Units to a total of 80 Units thereby providing gross proceeds of $4,000,000 (with the total of all units then consisting of $3,000,000 in Notes and $1,000,000 of common stock). 1.2 AGENCY DUTIES. This Agreement provides the terms and conditions upon which the Notes are to be authenticated, issued, delivered, registered, and transferred, the terms upon which the Note Agent will act as note registrar and paying agent with respect to the Notes, and the terms upon which the Note Agent will act as the agent of the Noteholders in the collection of amounts due under the Notes if an Event of Default occurs and in the enforcement of the rights of the Noteholders pursuant to this Agreement and the Notes. ARTICLE 2. DEFINITIONS; INTERPRETATION 2.1 Definitions. As used in this Agreement, the following terms shall have the following respective meanings: AGREEMENT means this Unit Purchase and Agency Agreement, as may be amended by mutual written consent and in force from time to time. AUTHORIZED DENOMINATIONS means minimum principal amounts of $18,750 and integral multiples of $3,750 in excess of $18,750. BOARD OF DIRECTORS means, with respect to the Company, the Board of Directors of such the Company or any committee of the Board of Directors of the Company duly authorized to act on behalf of the Board of Directors. BUSINESS DAY means any day other than (i) a Saturday or Sunday, or (ii) a day on which banking institutions in Arizona are authorized or obligated by law or executive order to be closed. CAPITAL STOCK means, with respect to the Company any and all classes of common stock of the Company. 1 CAPITALIZED LEASE OBLIGATIONS of the Company means the obligations of the Company to pay rent or other amounts under a lease of property, real or personal, that is appropriately capitalized for financial reporting purposes in accordance with GAAP. CHANGE OF CONTROL means any event or series of events by which (i) any "person" (as such term is used in SECTIONS 13(d) and 14(d) of the Securities Exchange Act of 1934) is or becomes the "beneficial owner" (as defined in Rules 13d-3 and 13-d5 under the Exchange Act) of 50% or more of the total voting power of the voting stock of the Company; (ii) the Company consolidates with or merges with or into another entity or any entity consolidates with, or merges with or into the Company, in any such event pursuant to a transaction in which the outstanding voting stock of the Company is changed into or exchanged for cash, securities or other property, other than any such transaction where the outstanding voting stock of the Company is changed into or exchanged for voting stock of the surviving corporation and the holders of the voting stock of the Company immediately prior to such transaction own, directly or indirectly, not less than a majority of the voting stock of the surviving corporation immediately after such transaction; or (iii) the stockholders of the Company approve any plan of liquidation or dissolution of the Company. CLOSING means any closing of the Offering and the issuance and sale of the Units. CLOSING DATE has the meaning set forth in SECTION 3.1(b). COMPANY means iLinc Communications, Inc. and its successors or assigns in accordance with the terms of this Agreement. DEFAULT means any event which is, or after notice or passage of time would be, an Event of Default, after notice as provided herein and failure to cure such default provided such cure is permitted. DISCLOSURE DOCUMENT means that certain Confidential Private Placement Memorandum of the Company dated March 19, 2004, as it may be amended or supplemented from time to time. ERISA means the Employee Retirement Income Security Act of 1974, as amended, and any successor statute of similar import, together with the regulations thereunder, in each case as in effect from time to time. EVENT OF DEFAULT means one of the events listed as such in Section 9.1. EXCHANGE ACT means the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder, in each case as in effect from time to time. GAAP means generally accepted accounting principles as in effect in the United States of America from time to time. HOLDER or NOTEHOLDER means a Person in whose name a Note is registered on the books of the Company. INDEBTEDNESS means, without duplication, with respect to the Company, (i) all obligations of the Company (A) in respect of borrowed money (whether or not the recourse of the lender is to the whole of the assets of the Company or only to a portion thereof), (B) evidenced by bonds, notes, debentures or similar instruments, (C) representing the balance deferred and unpaid of the purchase price of any property or services (other than accounts payable or other obligations arising in the ordinary course of business), (D) evidenced by bankers' acceptances or similar instruments issued or accepted by banks, (E) for 2 the payment of money relating to a Capitalized Lease Obligation, or (F) evidenced by a letter of credit or a reimbursement obligation of the Company with respect to any letter of credit; (ii) all net obligations of the Company under interest swap obligations and foreign currency hedges; (iii) all liabilities of others of the kind described in the preceding clauses (i) or (ii) that the Company has guaranteed or that are otherwise its legal liability; (iv) Indebtedness (as otherwise defined in this definition) of another Person secured by a Lien on any asset of the Company, whether or not such Indebtedness is assumed by the Company, the amount of such obligations being deemed to be the lesser of (A) the full amount of such obligations so secured, and (B) the fair market value of such asset, as determined in good faith by the Board of Directors of the Company, which determination shall be evidenced by a resolution of the Board of Directors of the Company; and (v) any and all deferrals, renewals, extensions, refinancings and refundings (whether direct or indirect) of, or amendments, modifications or supplements to, any liability of the kind described in any of the preceding clauses (i), (ii), (iii), or (iv) or this clause (v), whether or not between or among the same parties. INTEREST means the interest rate per annum on the unpaid principal balance of the Notes set forth in Section 3.1(a). INTEREST PAYMENT DATES means the 15th day of January, April, July and October during the term of the Notes, commencing July 15, 2004; provided, however, if such date is not a Business Day, the Interest Payment Date shall be the immediately preceding Business Day. ISSUE DATE means the date on which the Notes are originally issued under this Agreement. LIEN means, with respect to the Company, any mortgage, pledge, lien, encumbrance, affecting title or resulting in an encumbrance against property of the Company, or a security interest arising under the Uniform Commercial Code of any kind (including any conditional sale or other title retention agreement securing obligations of the Company, and any filing of or agreement to give any financing statement under the Uniform Commercial Code (or equivalent statute or statutes) of any jurisdiction). MATURITY DATE means July 15, 2007, which is the date on which the Notes become due and payable in full pursuant to the terms of this Agreement. NOTE AGENT means Cerberus Financial, Inc., and any successor appointed pursuant to this Agreement. NOTES means the 10% Senior Notes due July 15, 2007 issued pursuant to the purchase of Units in accordance with this Agreement, which Notes are unsecured Senior Indebtedness of the Company. OSHA means the Occupational Safety and Health Act, as amended, and any successor statute of similar import, together with the regulations thereunder, in each case as in effect from time to time. OFFERING means the offering of Notes to be issued hereunder pursuant to the Disclosure Document. OFFICE has the meaning set forth in Section 7.1(a). OFFICER means, the CEO, the President, any Sr. Vice President, the Chief Financial Officer or the Secretary of the Company. OFFICERS' CERTIFICATE means a certificate signed by two Officers or by an Officer and the Secretary of the Company. 3 OPINION OF COUNSEL means a written opinion, in form and substance reasonably acceptable to the Note Agent or other party receiving such opinion, from legal counsel who is reasonably acceptable to the Note Agent or other party receiving such opinion. Such counsel may be an employee of or counsel to the Company or the Note Agent. PERSON means any individual, corporation, limited liability company, partnership, joint venture, trust, estate, unincorporated organization, or government or any agency or political subdivision thereof. PLACEMENT AGENCY AGREEMENT means the Placement Agency Agreement dated March 19, 2004 between the Company and the Placement Agent. PLACEMENT AGENT means Peacock, Hislop, Staley & Given, Inc., an Arizona corporation. PRINCIPAL BUSINESS means the business of the Company, specifically providing Web conferencing, virtual classroom and Web collaboration software and services more fully described in the Disclosure Document. RECORD DATE means with respect to any Interest payment, the last Business Day of the calendar month preceding each Interest Payment Date. REFERENCE PERIOD means, with respect to the Company, the four full fiscal quarters ended immediately preceding any date upon which any determination is to be made pursuant to the terms of the Notes or this Agreement. REGISTRABLE SECURITIES shall mean (i) the Stock, and (ii) shares of Common Stock issued or issuable with respect to the Stock upon an adjustment for stock splits, stock dividends and similar events. RESTRICTED PAYMENT means, with respect to the Company, any of the following: (i) any dividend or other distribution in cash or property to the holders of the Company's Capital Stock; or (ii) the purchase, redemption or other acquisition or retirement for in cash or property of any Capital Stock or preferred stock or any option, warrant, or other right to acquire shares of Capital Stock of the Company or any of its Subsidiaries. SENIOR INDEBTEDNESS means any indebtedness of the Company which is senior in right of payment to or pari passu with the Notes. s SUBORDINATED INDEBTEDNESS means any Indebtedness of the Company (whether outstanding on the date hereof or hereafter incurred), which is contractually or by operation of law subordinate or junior in right of payment and priority to the Notes including, without limitation, the Subordinated Indebtedness set forth on EXHIBIT B attached hereto. SECURITIES ACT means the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder, in each case as in effect from time to time. SUBSIDIARIES OR SUBSIDIARY means all or any of the subsidiaries as are identified now or hereafter in the audited financial statements of the Company. 2.2 ACCOUNTING PRINCIPLES. Where the character or amount of any asset or liability or item of income or expense is required to be determined, or any consolidation or other accounting computation is required to be made for the purposes of this Agreement, the same shall be done in accordance with GAAP, to 4 the extent applicable, except where such principles are inconsistent with the requirements of this Agreement. ARTICLE 3. ISSUE, DESCRIPTION, EXECUTION, REGISTRATION AND EXCHANGE OF NOTES 3.1 AMOUNT AND ISSUE OF NOTES. (a) If the conditions to the Closing set forth in the Placement Agency Agreement shall have been satisfied, a Note shall be issued to each of the Purchasers in accordance with the terms of the Disclosure Document and subscription agreement and delivered to the Note Agent at the Closing. The Note Agent shall authenticate and deliver such Notes to the Noteholders. The Notes shall bear interest from their date of issue at the rate of ten percent (10.0%) per annum, payable as provided in ARTICLE 5. (b) Delivery of the Notes will be made through the Note Agent upon completion of the Offering, against payment therefor, by the Noteholders to the Company, in current and immediately available funds in the amount of 100% of the principal amount thereof, less commissions and expenses payable to the Placement Agent and less certain other expenses payable by the Company in connection with the Offering on the Business Day specified by the Company, but not less than three (3) Business Days prior written notice to the Note Agent ("CLOSING DATE"). 3.2 FORM OF NOTES. The Notes and the Note Agent's Certificate of Authentication to be borne by or attached to the Notes shall be in the form of Note attached as Exhibit "A" to this Agreement. Any of the Notes may have printed thereon such legends or endorsements as the Company may deem appropriate and as are not inconsistent with the provisions of this Agreement, or as may be required to comply with any law or with any rule or regulation made pursuant to such laws. 3.3 DENOMINATIONS AND DATE OF NOTES. The Notes shall be issued in Authorized Denominations, and shall be numbered, lettered or otherwise distinguished in such manner or in accordance with such plan as the Company may determine with the approval of the Note Agent. The Notes shall be dated as of the Issue Date, except that any Note issued upon the transfer, exchange or substitution of another Note shall be dated the date of its authentication. 3.4 EXECUTION OF NOTES. The Notes shall be signed (manually or in facsimile) in the name of or on behalf of the Company by an authorized Officer. 3.5 REGISTRATION, EXCHANGE AND REGISTRATION OF TRANSFER OF NOTES. (a) The Note Agent will keep a register or registers in which it will register all Notes. The Note Agent will serve as its own registrar and paying agent for the Notes. (b) Subject to the restrictions on transferability of the Notes pursuant to Article 15, upon surrender for registration of transfer of any Note, the Company shall execute and deliver, in the name of the transferee or transferees, a new Note or Notes for with an appropriate principal amount taking into account any prepayments of principal thereof. (c) Notes to be exchanged shall be surrendered at the office of the Note Agent who will cause the Company to execute and deliver in exchange therefor the Note or Notes that the Noteholder making the exchange shall be entitled to receive, bearing serial numbers not previously issued. 5 (d) All Notes presented for registration of transfer, exchange or payment shall, if so required by the Company, be duly endorsed by or be accompanied by a written instrument or instruments of transfer in form reasonably satisfactory to the Company, duly executed by the registered Noteholder or by his, her or its duly authorized attorney. (e) Upon exchange or registration of transfer the Company may require payment of a sum sufficient to cover any tax, or other governmental charge, legal fees, agent fees or accounting charges that may be imposed or incurred by the Company in relation thereto and any other expenses connected therewith. 3.6 MUTILATED, DESTROYED, LOST OR STOLEN NOTES. (a) If any Note shall become mutilated or be destroyed, lost or stolen, the Company shall, upon the written request of the Holder thereof, execute and deliver a new Note, bearing a serial number not previously issued, in exchange and substitution for the mutilated Note or in lieu of and substitution for the Note destroyed, lost or stolen; provided, however, that the Company shall not be obligated to execute and deliver a new Note unless, (i) in every case, the applicant requesting a substituted Note shall furnish to the Company such security or indemnity as may be reasonably required by the Company to save it harmless, and (ii) in every case of destruction, loss or theft, such applicant shall also furnish to the Company evidence reasonably satisfactory to it of the destruction, loss or theft of such Note and of the ownership thereof. (b) Upon the issuance of any substituted Note, the Company may require the payment of a sum sufficient to cover any tax or other governmental charge, legal fees, agent fees or auditing fees that may be incurred by the Company or imposed in relation thereto and any other expenses connected therewith, including, without limitation, counsel fees of the Note Agent, and in addition a further sum not exceeding $100 for each Note so issued in substitution. In case any Note that has matured or is about to mature shall have become mutilated or be destroyed, lost or stolen, the Company may, with the consent of the applicant, instead of issuing a substitute Note, pay or authorize the payment of the same (without surrender thereof, except in the case of a mutilated Note), if the applicant for such payment shall furnish the Company with such security or indemnity as it may reasonably require to save it harmless and, in case of destruction, loss or theft, evidence reasonably satisfactory to the Company of the destruction, loss or theft of such Note and of the ownership thereof. Every substituted Note issued pursuant to the provisions of this SECTION 3.6 by virtue of the fact that any Note is destroyed, lost or stolen, shall constitute an additional contractual obligation of the Company, whether or not the destroyed, lost or stolen Note shall be found at any time, and shall be entitled to all of the benefits of this Agreement equally and proportionately with any and all other Notes duly issued hereunder. All Notes shall be held and owned upon the express condition that the foregoing provisions are exclusive with respect to the replacement or payment of mutilated, destroyed, lost or stolen Notes and shall preclude any and all other rights and remedies, notwithstanding any law or statute existing or hereafter enacted to the contrary with respect to the replacement or payment of negotiable instruments or other securities without their surrender. 3.7 Cancellation of Notes; Acquisition of Notes by the Company. All Notes surrendered for the purpose of payment, redemption, exchange or registration of transfer shall be delivered to the Company for cancellation and the Company shall cancel such Notes and all Notes that have been surrendered directly to the Company for cancellation, and no Notes shall be issued in lieu thereof except as expressly permitted by any of the provisions of this Agreement. The Company shall indicate clearly on the face and on each and every page of such canceled Notes the fact that such Notes are canceled. If the Company shall acquire any of the Notes, such acquisition shall not operate as a redemption or satisfaction of the Indebtedness represented by such Notes, unless and until the same are canceled, and the Company shall not be entitled to vote 6 or participate in directing the activities of the Note Agent pursuant to this Agreement with respect to any such acquired Notes. 3.8 PERSONS ENTITLED TO INTEREST PAYMENTS. The person in whose name a Note is registered at the close of business on any Record Date with respect to any Interest Payment Date shall be entitled to receive any Interest payable with respect to that Note on the Interest Payment Date next following such Record Date, notwithstanding the cancellation of such Note upon any registration of transfer or exchange thereof subsequent to such Record Date and prior to such Interest Payment Date. The Holder of any Note issued upon the transfer, exchange or substitution of another Note shall only be entitled to receive Interest payable with respect to that Note from and after the Interest Payment Date next following the first Record Date occurring after the issuance of that Note. 3.9 BENEFITS OF PROVISIONS OF THIS AGREEMENT. Nothing in this Agreement or in the Notes, expressed or implied, shall give or be construed to give the Company, other than the parties thereto and the Noteholders, any legal or equitable right, remedy or claim under or in respect of this Agreement, or under any covenant, condition or provision herein contained, all the covenants, conditions and provisions contained in this Agreement or in the Notes being for the sole benefit of the parties hereto and the Noteholders. ARTICLE 4. REDEMPTION 4.1 REDEMPTION GENERALLY. No redemption of the Notes shall be made, except to the extent and in the manner provided in this Agreement. 4.2 OPTIONAL REDEMPTION. (a) The Notes are redeemable, in whole or in part, at the option of the Company, at any time on or after July 15, 2005 by payment by the Company of a sum that represents payment of principal of the Notes or portion thereof or accrued and unpaid interest thereon, if any, to the date of such payment. (b) The Company shall give written notice of its intent to prepay any portion of the Notes to the Note Agent, not less than thirty (30) days nor more than sixty (60) days before the date fixed for such pre-payment. Such notice shall state (i) the date of redemption; (ii) the total amount of principal to be redeemed on the redemption date and that, after the redemption date, upon surrender of such Note, a new Note or Notes in principal amount equal to the unredeemed portion will be issued; and (iii) the estimated accrued interest applicable to such payment. The Notes called for redemption must be surrendered to the Company at the address specified in the notice to collect the redemption price and the accrued interest thereon. Unless the Company Defaults in the payment of the redemption price or accrued interest on Notes called for redemption ceases to accrue interest and the only remaining right of the Holders is to receive payment of the redemption prices upon surrender of the Notes to the Company. (c) If less than all of the balance of the Notes then outstanding are to be called for redemption, then upon notice of the Company's intention to redeem pursuant to SECTION 4.2(b) hereof, the Holders shall forthwith surrender their Notes to the Company (i) for payment of the principal amount called for redemption (including accrued and unpaid interest thereon, if any, to the date of redemption) and (ii) exchange for a new Note of the aggregate principal amount of the unredeemed balance with like maturity and interest rate. New Notes representing the unredeemed balance of the principal amount of such Notes shall be issued to the Holders thereof, without charge. If the Holder of any Note shall fail to present such Note for payment and exchange to the extent of the principal amount called for redemption (and to that extent only), interest shall cease to accrue on the portion of the principal amount of such Notes called for 7 redemption on and after the redemption date, and such Notes shall not be entitled to the benefit of this Agreement to the extent of the portion of their principal amounts (and accrued and unpaid interest thereon, if any, to the date of redemption) called for redemption. (d) If less than all of the total principal balance of the Notes then outstanding are to be called for redemption, the Note Agent shall select the particular Notes or portions thereof to be redeemed pro rata, by lot or by any other method that the Note Agent considers fair and appropriate. 4.3 CHANGE OF CONTROL REDEMPTION. (a) In the event that a Change of Control shall occur, the Company will give written notice ("COMPANY NOTICE") thereof to the Noteholders. The Company Notice shall be delivered no later than three (3) Business Days following the occurrence of any Change of Control. The Company Notice shall (i) describe the facts and circumstances of such Change of Control in reasonable detail; (ii) make reference to this SECTION 4.3 and the right of the Noteholders to require payment on the terms and conditions provided for in this SECTION 4.3; and (iii) offer in writing to redeem the outstanding Notes for a redemption price ("REDEMPTION PRICE") equal to 100% of the principal amount of the Notes, plus accrued interest to the date of redemption. Each Noteholder shall have the right to accept such offer and require redemption of the Notes held by the Noteholder by written notice to the Company ("NOTEHOLDER NOTICE") within thirty (30) days following receipt of the Company Notice specifying a date for redemption ("REDEMPTION DATE") which Redemption Date shall not be later than three (3) Business Days after the date of the Noteholder Notice. The Company shall on each Redemption Date pay the redemption price with accrued interest to the Redemption Date. (b) Without limiting the foregoing, notwithstanding the failure on the part of the Company to give the Company Notice herein required as a result of the occurrence of a Change of Control, each Noteholder shall have the right to require the Company to redeem such Noteholder's Note for the Redemption Price within thirty (30) days after such Noteholder has actual knowledge of any Change of Control. In such event, the Company shall redeem such Noteholder's Note on the date designated in the Noteholder's Notice delivered by such Noteholder. ARTICLE 5. PAYMENT OF PRINCIPAL AND INTEREST 5.1 DATE FOR PAYMENT OF PRINCIPAL AND INTEREST. Interest shall be payable on the Interest Payment Dates and on the Maturity Date; and principal shall be payable on the Maturity Date. 5.2 INTEREST PAYABLE ON NOTES. The Company shall pay the Interest on the unpaid principal balance of the Notes as provided herein. 5.3 PAYING AGENT. The Note Agent shall serve as paying agent for the Notes and shall make all payments pursuant to the Notes and this Agreement to the Holders when due, but only as received in advance from the Company. 5.4 APPLICATION OF PAYMENT. All payments received shall be applied to the payment of the Notes in the following order of priority: first, to the payment of accrued interest, and second, to the payment of principal then due. 8 ARTICLE 6. REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company on the Closing Date hereby represents and warrants as follows: 6.1 ORGANIZATION, GOOD STANDING, AND QUALIFICATION. The Company is a Delaware corporation duly organized, validly existing, and in good standing under the laws of the state of Delaware and has all requisite power and authority to own or lease and operate its properties and assets and to carry on its business as now conducted. 6.2 AUTHORIZATION. The Company has the power and authority to enter into this Agreement and to perform all of its obligations hereunder. The execution, delivery, and performance of this Agreement by the Company has been duly authorized by all necessary actions, and this Agreement constitutes a legal, valid, binding, and enforceable obligation of the Company except as such may be limited by bankruptcy, insolvency, reorganization, assignment, moratorium, or other similar laws relating to or affecting the rights of creditors generally. No consent, approval, authorization, or order of any court or governmental agency is required to execute, delivery and perform this Agreement. The issuance of the Notes and the Stock has been duly authorized and, when the Notes are executed and delivered and paid for in accordance with the terms of this Agreement, the Notes will be valid and binding obligations of the Company, enforceable in accordance with their terms. 6.3 CAPITALIZATION. The authorized capital stock of the Company consists of (a) 100,000,000 shares of Common Stock, par value $.001 per share, and (b) 10,000,000 shares of Preferred Stock, par value $.001 per share, of which 17,665,647 shares of common stock (net of all treasury stock) and 150,000 shares of preferred stock are issued and outstanding. All of the issued and outstanding shares of stock have been duly authorized and are validly issued, fully paid and nonassessable. 6.4 COMPLIANCE WITH LAWS. Except as set forth in the Disclosure Document, the Company has at all times complied and is in compliance in all material respects with all laws applicable to the Company and its assets, properties, operations and businesses, which failure or default would materially adversely affect the business, properties, operations, or financial condition of the Company (a "Material Adverse Effect"). 6.5 TAXES. Except as set forth in the Disclosure Document, all taxes owed by the Company (whether or not shown on any tax return) have been paid, and the Company has adequately provided for liability for current taxes not yet due and payable on its books and records. 6.6 INTELLECTUAL PROPERTY. (a) Except as set forth in the Disclosure Document, all patents, trademark or service mark registrations, copyright registrations and applications therefor (collectively, "INTELLECTUAL PROPERTY") necessary to conduct the Company's business, and all such Intellectual Property is valid, in full force, and has been properly maintained and, if applicable, renewed in accordance with the laws of any relevant jurisdictions. Except as set forth in the Disclosure Document, none of the Intellectual Property has been or is now involved in any opposition, invalidation or cancellation proceeding, and no such action is threatened. (b) The Company owns or possesses adequate, enforceable and transferable licenses or other rights to use, without payment, all Intellectual Property now used or employed in the Company's business, and (ii) the transactions contemplated by this Agreement will not have a material adverse effect on the rights of the Company in the Intellectual Property. 9 (c) The right, title and interest of the Company in and to the Intellectual Property are freely assignable and not subject to liens of any other person or entity (in whole or in part) and are adequate and sufficient to permit the Company to conduct its business as presently being conducted. (d) No action is presently planned or pending against any person to protect or enforce any right or interest of the Company thereof in and to the Intellectual Property. (e) No other person has infringed, violated, conflicted or interfered with or is infringing, violating, conflicting with or interfering with, or is engaged in any activity which would constitute a misappropriation of, any of the rights or interest of the Company in and to any of the Intellectual Property or any contract rights of any third party, (ii) the rendering by the Company of their services and uses of the Intellectual Property does not infringe, violate, conflict with or interfere with the patent, copyright, trademark, service mark, trade secret, trade name or other intellectual property or proprietary right of any third party, and (iii) the Company has not received any notice or any threat of claim that the Intellectual Property infringes, violates, conflicts with or interferes with any proprietary right of any other person. 6.7 SEC REPORTS AND FINANCIAL STATEMENTS. (a) The Company has filed on a timely basis with the SEC all forms, reports, schedules, registration statements, definitive proxy statements and other documents (as they have been amended since the time of their filing, and including any documents filed as exhibits thereto, collectively, the "SEC REPORTS") required to be filed by the Company with the SEC since January 1, 2001, except that late filing of that certain Form 8-K related to the acquisition transaction with Quisic Corporation, or any proper extensions permitted by the Securities Laws. As of their respective dates and for the periods reflected therein, the SEC Reports (including, without limitation, any financial statements or schedules included or incorporated by reference therein) complied in all material respects with the requirements of the Exchange Act or the Securities Act, and the rules and regulations of the SEC promulgated thereunder applicable, as the case may be, to such SEC Reports, and none of the SEC Reports contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements made therein, in light of the circumstances under which they were made, not misleading. (b) The consolidated balance sheets as of March 31, 2003 and March 31, 2002 and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended March 31, 2003 (including the related notes and schedules thereto) of the Company contained in the Company's Form 10-K for the year ended March 31, 2003 included in the SEC Reports present fairly, in all material respects, the consolidated financial position and the consolidated results of operations and cash flows of the Company and its consolidated subsidiaries as of the dates or for the periods presented therein in conformity with GAAP applied on a consistent basis during the periods involved except as otherwise noted therein. (c) The Company's unaudited consolidated balance sheet as of December 31, 2003 and the related consolidated statements of income, shareholders' equity and cash flows for the three months and nine months then ended, as applicable (collectively, the "MOST RECENT FINANCIAL STATEMENTS"), contained in the Company's Form 10-Q for the fiscal quarter ended December 31, 2003 present fairly, in all material respects (subject to normal year-end adjustments that will not be material), the consolidated financial position and the consolidated results of operations and cash flows of the Company and its consolidated subsidiaries as of the date or for the periods presented therein in conformity with GAAP applied on a consistent basis during the periods involved except as otherwise noted therein. 10 6.8 LITIGATION. Except as set forth in the Disclosure Document, the SEC Reports set forth each instance in which the Company (a) is subject to any outstanding injunction, judgment, order, decree, ruling or charge or (b) is a party to any action, suit, proceeding, hearing or investigation of, in or before any governmental or regulatory authority or before any arbitrator, is threatened to be made a party to any action, suit, proceeding, hearing or investigation of, in or before any governmental or regulatory authority or before any arbitrator. 6.9 GOVERNMENTAL AUTHORIZATIONS AND REGULATIONS. The Company holds all permits necessary to the conduct of its business. Such permits are valid, binding and in full force and effect and the Company is in compliance with the terms thereof. The Company has received no notice that any governmental or regulatory authority intends to cancel, terminate or not renew any such permit. 6.10 NO UNTRUE STATEMENTS. The representations and warranties contained in this Agreement, and the statements contained in the Disclosure Document, taken as a whole, do not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statement herein or therein, in the light of the circumstances under which they were made, not misleading. ARTICLE 7. COVENANTS OF THE COMPANY 7.1 MAINTENANCE OF OFFICE; OPERATION OF BUSINESS. The Company covenants and agrees that, so long as any of the Notes remain outstanding, it will: (a) Maintain an office or agency where Notes may be presented for registration, registration of transfer, exchange and payment as in this Agreement provided, and where notices and demands to or upon the Company in respect of the Notes and this Agreement may be served ("OFFICE"). The principal office of the Company is currently located at 2999 North 44th Street, Suite 650, Phoenix, Arizona 85018, or such other place as the Company may hereafter designate by notice to the Note Agent and to the Noteholders, shall be such Office. (b) Promptly pay and discharge, or cause to be paid and discharged, all taxes, assessments and governmental charges or levies imposed upon the Company, any of its Subsidiaries, or upon any of their respective assets, or upon any part thereof; provided, however, that the Company shall not be required to pay and discharge or cause to be paid and discharged any such tax, assessment, charge or levy so long as the validity thereof shall be contested in good faith by appropriate proceedings, nor shall the Company be obligated hereunder to pay and discharge or cause to be paid and discharged any such tax, assessment, charge or levy if such property shall, in the opinion of the Company, no longer be advantageous to the Company in the conduct of its business, or if in the opinion of the Company, any such tax assessment or charge exceeds the value of such property on which it is levied, except where the failure to do so would not result in a Material Adverse Effect. (c) Pay or cause to be paid the principal of and interest on all Indebtedness heretofore or hereafter incurred or assumed by the Company, when and as the same shall become due and payable, unless such Indebtedness shall be renewed or extended, or unless such payment is not permitted under provisions subordinating such Indebtedness to the Notes by operation of agreement or law and not permit the occurrence of any act or omission which is or may be declared to be a default thereunder; provided, however, that the Company shall not be required to make any payment or to take any action by reason of the provisions of this subsection at any time while it shall be contesting in good faith its obligation to make such payment. 11 (d) At all times keep proper books of record and account and consolidated financial statements of the Company, together with all appropriate notes and schedules that present fairly in all material respects the financial position and the results of operations of the Company, as at the dates and for the indicated periods in accordance with GAAP. (e) Continue to engage in the Principal Business. (f) After the date of the Disclosure Document, not permit through the Company's act or omission any material adverse change in or affecting the financial condition of the Company or any of its Subsidiaries or the earnings, management, or business prospects of the Company or any of its Subsidiaries, whether or not occurring in the ordinary course of business. 7.2 COMPLIANCE WITH LAWS AND REGULATIONS; LICENSES AND PERMITS; NO VIOLATION. The Company shall, and shall cause each of its Subsidiaries, as applicable, to: (a) Conduct its business in compliance with all applicable federal, state and local laws, rules and regulations. including, without limitation, ERISA, OSHA, environmental laws, rules and regulations, and all federal laws, rules and regulations, except where the failure to do so would not result in a Material Adverse Effect. (b) Maintain in effect all certificates, licenses, permits or other authorities issued by federal, state or local regulatory authorities which may be required to conduct its business and retain possession of its properties except where the failure to do so will not result in a Material Adverse Effect. (c) Not be in violation of or default under any provision of its articles of incorporation, bylaws, or any of its agreements, leases, licenses, contracts, franchises, mortgages, permits, deeds of trust, indentures or other instruments or obligations to which it is a party or by which it or any of its properties is bound, except where the failure to do so would not result in a Material Adverse Effect. 7.3 APPOINTMENT TO FILL A VACANCY IN OFFICE OF NOTE AGENT. The Company, whenever necessary to fill a vacancy in the office of the Note Agent, will appoint, in the manner provided in SECTION 10.7, a new Note Agent, so that there shall at times be a Note Agent hereunder; provided, however, that the Company shall not be deemed in Default hereunder during the pendency of any court proceeding to appoint a new Note Agent. 7.4 FURTHER INSTRUMENTS AND ACTS. The Company will, upon receipt thereof from the Note Agent, execute and deliver such further instruments and do such acts as may reasonably be necessary or proper to carry out the purposes of this Agreement. 7.5 PAYMENT OF NOTES. The Company shall pay the principal of and accrued interest on the Notes on the dates and in the manner provided in the Notes and this Agreement. The Company shall pay Interest (including post-petition interest in any proceeding under any bankruptcy law) on overdue principal at the default rate of interest stated on the Notes to the extent lawful; and it shall pay Interest (including post-petition interest in any proceeding under any bankruptcy law) on overdue installments of Interest (without regard to any applicable grace period) at the same rate to the extent lawful. 7.6 COMPLIANCE CERTIFICATES AND ANNUAL REPORTS. (a) The Company shall deliver to the Note Agent, on the Issue Date, an Officers' Certificate stating that to the best of such Officer's knowledge the activities of the Company and its Subsidiaries the Company is in compliance with each and every covenant contained in this Agreement and is not in default in the 12 performance or observance of any of the terms, provisions and conditions hereof and that to the best of such Officer's knowledge no event has occurred and remains in existence by reason of which payments on account of the principal of, or Interest, if any, on the Notes would be prohibited or, if such event has occurred, a description of the event and what action the Company is taking or proposes to take with respect thereto. (b) The Company shall, so long as any of the Notes are outstanding, deliver to the Note Agent forthwith upon any Officer becoming aware of any Default or Event of Default or default in the performance of any covenant, agreement or condition contained in this Agreement, an Officers' Certificate specifying such Default or Event of Default and what action the Company or any Subsidiary proposes to take with respect thereto. 7.7 CORPORATE EXISTENCE. At its own cost and expense, the Company will do or cause to be done all things necessary to preserve and keep in full force and effect its corporate existence and the corporate existence of each Subsidiary in their respective jurisdictions of formation, and all rights (charter and statutory) and franchises of the Company and the Subsidiaries; provided, however, that the Company shall not be required to preserve the corporate existence of any Subsidiary, or any such right or franchise, if the Board of Directors of the Company shall determine that the preservation thereof is no longer desirable in the conduct of the business of the Company and that the loss thereof is not disadvantageous to the Company. 7.8 WAIVER OF STAY, EXTENSION OR USURY LAWS. The Company covenants (to the extent that it may lawfully do so) that it will not at any time insist upon, plead, or in any manner whatsoever claim an interest arising under any Arizona usury law. 7.9 MAINTENANCE OF PROPERTIES AND INSURANCE. (a) The Company shall cause all properties used or held for use in the conduct of its business or the business of any Subsidiary to be maintained and kept in good condition, repair and working order (ordinary wear and tear excepted) and supplied with all necessary equipment and shall cause to be made all necessary repairs, renewals, replacements, betterments, and improvements thereof, all as in the judgment of the Company may be necessary so that the business carried on in connection therewith may be properly and advantageously conducted at all times, except where the failure to do so would not result in a Material Adverse Effect; provided further that nothing in this SECTION 7.9 shall prevent the Company from discontinuing the operation or maintenance of any such property, or disposing of it, if such discontinuance or disposal is, in the judgment of the Company, desirable in the conduct of its business. (b) The Company shall provide or cause to be provided, for itself and each of its Subsidiaries, insurance against loss or damage of the kinds that, in the reasonable, good faith opinion of the Company are adequate and appropriate for the conduct of the business of the Company and such Subsidiaries in a prudent manner, with reputable insurers or with the government of the United States or any agency or instrumentality thereof in such amounts, with such deductibles or retentions, and by such methods as shall be customary, in the reasonable, good faith opinion of the Company. 7.10 SALE OF ASSETS; CONSOLIDATION; EQUITY; MERGER. The Company shall not (a) sell, transfer, or otherwise dispose of or grant a security interest in, or otherwise encumber any the Company's property for an amount or value that is less than the amount the Company reasonably believes to be a fair and equivalent value in return; or, (b) cease its operations, liquidate or dissolve. 13 7.11 LIMITATION ON INCURRENCE OF ADDITIONAL INDEBTEDNESS. (a) The Company will not, and will not permit any of the Subsidiaries, directly or indirectly, to authorize, issue, incur, assume, guarantee, become liable, or otherwise become responsible for the payment of (collectively "incur") any Indebtedness, except as provided herein. (b) The Company shall not, directly or indirectly, create or permit to be created or allow to exist any Lien on any property now owned or hereafter acquired by the Company, except (i) if the Lien arises from an operating and/or capital lease that is for a sum not to exceed $50,000 per transaction; or (ii) if the obligation giving rise to the Lien, which Lien shall always be Subordinate Indebtedness, is obtained upon the written consent of the Note Agent and a Subordination Agreement is entered into between the Note Agent and the holder of the Subordinated Indebtedness acknowledging that the Notes are senior in right of payment and priority to the Subordinated Indebtedness. (c) If a lien arises from an acquisition transactions, whether through an asset purchase transaction and/or merger transaction, the Company may grant to the seller a security interest in and to the assets that are acquired from the seller to secure obligations or indebtedness to the seller, provided that the Company will not grant to the seller any security interests and/or liens in any of the Company's other property or assets not acquired from the seller in that transaction; provided further, that notice is given to the Note Agent and a Subordination Agreement is entered into between the Note Agent and the holder of the Subordinated Indebtedness acknowledging that the Notes are senior in right of payment and priority to the Subordinated Indebtedness. 7.12 RESTRICTED PAYMENTS. The Company will not, and will not permit any of the Subsidiaries to, directly or indirectly, make any Restricted Payment without the prior written consent of the Note Agent. 7.13 LIMITATIONS ON PAYMENT RESTRICTIONS AFFECTING SUBSIDIARIES. The Company will not, and will not permit any of its Subsidiaries to, directly or indirectly, create or otherwise cause or suffer to exist or become effective any consensual encumbrance or restriction of any kind on the ability of any Subsidiary to (i) pay dividends or make any other distributions on its Capital Stock, or any other interest or participation in or measured by its profits, owned by the Company or a Subsidiary, (ii) pay any Indebtedness owed to the Company or a Subsidiary of the Company, (iii) make loans or advances to the Company or a Subsidiary of the Company, or (iv) transfer any of its properties or assets to the Company or a Subsidiary of the Company. 7.14 LOANS AND GUARANTIES. The Company shall not, directly or indirectly, (a) loan or advance money or assets to any other Person or invest in any other Person other than a Subsidiary; (b) loan or advance money to any officer or director of the Company in excess of $50,000 per loan or loan amounts in excess of an aggregate of $500,000; or (c) incur any obligation as surety or guarantor. 7.15 ISSUANCE OF STOCK; CHANGE IN OWNERSHIP OR CONTROL. [Deleted and Reserved] 7.16 PAYMENT ON OR MODIFICATION OF SUBORDINATED INDEBTEDNESS. The Company shall not, directly or indirectly, make or accelerate any payment under any Subordinated Indebtedness except regularly scheduled interest payments provided that no default has occurred with respect to the Subordinated Indebtedness, or amend, modify or supplement any provision of any Subordinated Indebtedness. 14 7.17 LIMITATIONS ON PLEDGE OF CAPITAL STOCK OF COMPANY OR SUBSIDIARIES. The Company will not, and will not permit any of the Subsidiaries to, create, incur, assume or suffer to exist any Liens upon any of their respective Capital Stock. ARTICLE 8. NOTEHOLDER'S LIST 8.1 NOTEHOLDERS' LIST. The Company covenants and agrees that it and every obligor upon the Notes will furnish or cause to be furnished to the Note Agent at such times as the Note Agent may request in writing, within thirty (30) days after receipt by the Company of any such request, a list in such form as the Note Agent may reasonably require containing all information in the possessions or control of the Company as to the name and addresses of the Noteholders obtained (in the case of each list other than the first list) since the date as of which the next previous list was furnished. Any such list may be dated as of the date not more than fifteen (15) days prior to the time any information is furnished or caused to be furnished and need not include information received after such date. 8.2 PRESERVATION AND DISCLOSURE OF LIST. (a) The Note Agent shall preserve, in as current a form as is reasonably practicable, all information as to the names and addresses of the Noteholders (i) contained in the most recent list furnished to it as provided in SECTION 8.1 and (ii) received by it thereunder. (b) The Note Agent may destroy any list furnished to it as provided in SECTION 8.1 upon receipt of a new list as provided therein. ARTICLE 9. REMEDIES OF THE NOTE AGENT AND THE NOTEHOLDERS IN EVENT OF DEFAULT 9.1 EVENTS OF DEFAULT. The occurrence of one or more of the following events shall constitute an Event of Default: (a) the Company shall fail to pay any installment of principal or Interest on any of the Notes when due and payable, whether upon the Maturity Date or otherwise pursuant to this Agreement or the Notes; or (b) the Company shall fail to comply with any material covenant or agreement, including those set forth in SECTION 4.2, on the part of the Company in the Notes or in this Agreement for a period of thirty (30) days after the date on which written notice of such failure, requiring the same to be remedied, shall have been given to the Company by the Note Agent; or (c) [Deleted and Reserved]; or (d) (i) the Company shall commence or consent to any case, proceeding or other action (1) under any existing or future law of any jurisdiction relating to bankruptcy, insolvency, reorganization or relief of debtors seeking reorganization, arrangement, adjustment, liquidation, dissolution, composition or other relief with respect to it or its debts, or (2) seeking appointment of a receiver, trustee, custodian, conservator or other similar official for it or for all or any substantial part of its assets or the Company or any Subsidiary shall make a general assignment for the benefit of creditors or admit in writing that it is unable to pay its debts as they become due; or 15 (ii) there shall be commenced against the Company, any such case, proceeding or other action referred to in SECTION 9.1(d)(i) that (1) results in the entry of an order for relief or any such adjudication or appointment, or (2) is not dismissed, discharged or stayed within sixty (60) days from the entry thereof; or (iii) there shall be awarded against the Company a writ of attachment, writ of execution, or similar attachment process against all or any part of the Company's assets which the Company shall not have set aside a reserve for the payment of such within thirty (30) days from the entry or have been vacated, discharged or stayed within thirty (30) days from the entry thereof; or (iv) the Company shall have been dissolved or terminated; (v) any declared default of the Company under any Indebtedness that gives the holder thereof the right to accelerate such Indebtedness, and such Indebtedness is in fact accelerated by the holder; or (vi) the Company or any Subsidiary shall take any action authorizing or in furtherance of or indicating its consent to approval or acquiescence in any of the acts set forth above in this SECTION 9.1(d). In each and every such Event of Default, unless the principal of all the Notes shall have already become due and payable, the Note Agent shall notify all of the Noteholders of the occurrence of an Event of Default, and upon the direction of the holders of more than 50% in aggregate principal amount of the Notes then outstanding, by notice in writing to the Company, the Note Agent shall declare the principal of and all accrued Interest on all the Notes to be due and payable immediately, and upon any such declaration the same shall become and shall be immediately due and payable, anything in this Agreement or in the Notes contained to the contrary notwithstanding. This provision, however, is subject to the condition that if, at any time after the principal of the Notes shall have been so declared due and payable, and before any judgment or decree for the payment of the moneys due shall have been obtained or entered as hereinafter provided, the Company shall pay or shall deposit with the Note Agent a sum sufficient to pay all Interest or principal that shall have become due otherwise than by acceleration and the reasonable expenses of the Note Agent, and any and all defaults under this Agreement, other than the nonpayment of principal of and accrued Interest on Notes that shall have become due by acceleration, shall have been remedied, then and in every such case the Holders of more than 50% in aggregate principal amount of the Notes then outstanding, by written notice to the Company and to the Note Agent, may waive all Defaults and rescind and annul such declaration and its consequences; but no such waiver, rescission or annulment shall extend to or shall affect any subsequent Default or shall impair any right consequent thereon. In addition, upon each and every such Event of Default, the Company shall not (x) make any payment under any Subordinated Indebtedness; or (y) make a payment of any dividend or make any distribution in cash or property to the holders of the Company's preferred stock. 9.2 PAYMENT OF NOTES ON DEFAULT; SUIT THEREFOR. (a) The Company covenants that (i) in case Default shall be made in the payment of any installment of Interest upon any of the Notes as and when the same shall become due and payable, or (ii) in case Default shall be made in the payment of the principal of any of the Notes as and when the same shall have become due and payable, whether at the Maturity Date or otherwise pursuant to this Agreement or the Notes, then the Company will pay to the Note Agent, for the benefit of the Noteholders, the whole amount that then shall have become due and payable on all such Notes for principal or Interest, or both, as the case may be, with Interest upon the overdue principal; and, in addition thereto, upon demand of the Note Agent, such further amount as shall be sufficient to cover 16 the reasonable costs and expenses of collection, including reasonable compensation to the Note Agent, its agents, attorneys and counsel, and any reasonable expenses or liability incurred by the Note Agent hereunder other than through its gross negligence or bad faith. (b) In case the Company shall fail forthwith to pay such amounts upon such demand and thirty (30) days written notice and failure to cure, the Note Agent, for itself as principal with respect to amounts due to it, and as agent of the Holders of the Notes then outstanding, shall notify the Noteholders of such failure, and upon request of the Holders of more than 50% in aggregate principal amount of the Notes then outstanding, shall institute any actions or proceedings at law or in equity for the collection of the sums so due and unpaid, and may prosecute any such action or proceeding to judgment or final decree, and may enforce any such judgment or final decree against the Company and collect in the manner provided by law out of the property of the Company, whenever situated, the moneys adjudged or decreed to be payable; provided, however, that the Note Agent shall have no obligation to institute or prosecute any actions or proceedings or to enforce any judgment or decree if the Note Agent reasonably believes it is prohibited from doing so by automatic stay or other similar provisions of the bankruptcy code or any other applicable law. (c) In case there shall be pending proceedings for the bankruptcy or for the reorganization of the Company or any other obligor on the Notes under the bankruptcy code or any other applicable law relative to the Company or such other obligor, its or their creditors or its or their property, or in case a receiver or trustee shall have been appointed for its or their property, the Note Agent, irrespective of whether the principal of the Notes shall be due and payable as therein expressed or by declaration or otherwise, and irrespective of whether the Note Agent shall have made any demand pursuant to the provisions of this SECTION 9.2, shall be entitled and empowered, by intervention in such proceedings or otherwise, to file and prove a claim or claims for the whole amount of principal and Interest owing and unpaid in respect of the Notes, and, in case of any judicial proceedings, to file such proofs as are advisable in order to have the claims of the Note Agent and of the Noteholders allowed in such judicial proceedings relative to the Company or any obligor on the Notes, its or their creditors, or its or their property, and to collect and receive any moneys or other property payable or deliverable on any such claims, and to distribute the same after the deduction of its charges and expenses except as a result of its gross negligence or bad faith; and any receiver, assignee or trustee in bankruptcy or reorganization is hereby authorized by each of the Noteholders to make such payments to the Note Agent, and, in the event that the Note Agent shall consent to the making of such payments directly to the Noteholders, to pay to the Note Agent any amount due it for reasonable compensation and expenses, including reasonable counsel fees incurred by it up to the date of such distribution except as a result of its gross negligence or bad faith. (d) All rights of action and of asserting claims under this Agreement or under any of the Notes may be enforced by the Note Agent without the possession of any of the Notes, or the production thereof on any trial or other proceeding relative thereto, and any such suit or proceeding instituted by the Note Agent shall be brought by it as agent of the Holders of the Notes then outstanding, and any recovery of judgment shall be for the ratable benefit of the Noteholders. 9.3 APPLICATION OF MONEYS COLLECTED BY NOTE AGENT. Any moneys collected by the Note Agent pursuant to SECTION 9.2 shall be applied in the following order of priority at the date or dates fixed by the Note Agent for the distribution of such moneys, upon presentation of the several Notes, and stamping thereon the payment if only partially paid and upon surrender thereof if fully paid: (a) First, to the payment of reasonable costs and expenses of collection incurred by the Note Agent, its agents, attorneys and counsel, and of all other reasonable expenses and liability incurred and all advances made by the Note Agent, except as a result of its gross negligence or bad faith. 17 (b) Second, if the principal of the outstanding Notes shall not have become due and be unpaid, to the payment of Interest on the Notes, such payments to be made ratably to the persons entitled thereto, without discrimination or preference; (c) Third, if the principal of the outstanding Notes shall have become due, whether at the Maturity Date or otherwise pursuant to this Agreement or the Notes, to the payment of the whole amount then owing and unpaid upon the Notes for principal and Interest, with interest on the overdue principal; such payment is to be first applied to the payment of unpaid Interest, then to payment and principal, without preference or priority of any Note over any other Note; and (d) Fourth, the payment of the remainder, if any, to the Company, its successors or assigns, or to whomsoever may be lawfully entitled to receive the same, or as a court of competent jurisdiction may direct. 9.4 PROCEEDINGS BY NOTEHOLDERS. (a) No Noteholder shall have any right by virtue of any provision of this Agreement to institute any suit, action or proceedings in equity or at law upon or under or with respect to this Agreement, or for the appointment of a receiver or trustee, or for any other remedy hereunder, unless such Noteholder previously shall have given to the Note Agent written notice of Default and of the continuance thereof, as herein before provided, and unless also the Holders of more than 50% in aggregate principal amount of the Notes then outstanding shall have made written request upon the Note Agent to institute such action, suit or proceedings as Note Agent and on behalf of the Holders of the Notes then outstanding, and shall have offered to the Note Agent such reasonable indemnity as it may require against the costs, expenses and liabilities to be incurred therein or thereby, and the Note Agent, for sixty days after its receipt of such notice, request and offer of indemnity, shall have neglected or refused to institute any such action, suit or proceeding in accordance with such written request as shall have been given to the Note Agent pursuant to SECTION 9.7; it being understood and intended, and being expressly covenanted by the taker and Holder of every Note with every other taker and Holder and the Note Agent, that no one or more Noteholders shall have any right in any manner whatsoever by virtue of this Agreement to affect, disrupt or prejudice the rights of any other Noteholders, or to obtain or seek to obtain priority over or in preference to any other such Noteholder, or to enforce any right under this Agreement, except in the manner herein provided and for the equal, ratable and common benefit of all Noteholders. (b) Notwithstanding any other provision in this Agreement, the right of any Noteholder to receive payment of the principal of and Interest on such Note on or after the respective Interest Payment Date or Maturity Date, or to institute suit for the enforcement of any such payment on or after such respective dates, shall not be impaired or affected without the consent of such Noteholder. 9.5 PROCEEDINGS BY NOTE AGENT. In case of any Event of Default hereunder, the Note Agent may, upon the direction of the Holders of more than 50% in aggregate principal amount of the Notes then outstanding, proceed to protect and enforce the rights vested in it by this Agreement by such appropriate judicial proceedings as the Note Agent shall deem most effectual to protect and enforce any of such rights, either by suit in equity or by action at law or by proceeding in bankruptcy or otherwise, whether for the specific enforcement of any covenant or agreement contained in this Agreement, or to enforce any other legal or equitable right vested in the Note Agent by this Agreement or by law. 9.6 REMEDIES CUMULATIVE AND CONTINUING. All powers and remedies given by this Article 9 to the Note Agent or to the Noteholders shall, to the extent permitted by law, be deemed cumulative and not exclusive of any other power or remedy or of any other power, and, subject to the provisions of SECTION 9.4, every power and remedy given by this Article 9 or by law to the Note Agent or to 18 the Noteholders may be exercised from time to time and as often as shall be deemed expedient by the Note Agent or by the Noteholders. 9.7 DIRECTION OF PROCEEDINGS AND WAIVER OF DEFAULTS BY MAJORITY OF NOTEHOLDERS. The Holders of more than 50% in aggregate principal amount of the Notes then outstanding shall have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Note Agent or exercising any power conferred on the Note Agent; provided, however, that such direction shall not be otherwise than in accordance with law and the provisions of this Agreement, and the Note Agent, subject to the provisions of SECTION 10.1, shall have the right to decline to follow any such direction if the Note Agent in good faith shall, by an officer of the Note Agent, if the Note Agent is a corporation, determine that the proceeding so directed would be unjustly prejudicial to the Noteholders not taking part in such direction or would involve it in personal liability; and, provided further, that, subject to the provisions of SECTION 10.1, nothing contained in this Agreement shall impair the right of the Note Agent in its discretion to take any action deemed proper by the Note Agent and that is not inconsistent with such direction by the Noteholders. Prior to any declaration accelerating the maturity of the Notes, the Holders of more than 50% in aggregate principal amount of the Notes then outstanding may on behalf of all of the Noteholders waive any past Default or Event of Default hereunder and its consequences except a Default in the payment of Interest on, or the principal of, the Notes. Upon any such waiver the Company, the Note Agent and the Noteholders shall be restored to their former positions and rights hereunder, respectively, but no such waiver shall extend to any subsequent or other Default or Event of Default or impair any right consequent thereon. Whenever any Default or Event of Default hereunder shall have been waived as permitted by this SECTION 9.7, such Default or Event of Default shall for all purposes of the Notes and this Agreement be deemed to have been cured and to be not continuing. 9.8 NOTICE OF DEFAULTS. The Note Agent shall, within sixty days after the occurrence of a Default, mail to all Noteholders, as the names and addresses of such Holders appear upon the registration books of the Company, notice of all Defaults known to the Note Agent, unless such defaults shall have been cured before the giving of such notice (the term "Defaults" for the purposes of this Section 9.8 being hereby defined to be the events specified in SECTION 9.1, not including any periods of grace provided for therein and irrespective of the giving of written notice provided for therein); provided, however, that, except in the case of Default in the payment of the principal of or Interest on any of the Notes, the Note Agent shall be protected in withholding such notice if the Note Agent determines in good faith that the withholding of such notice is in the interests of the Noteholders. 9.9 UNDERTAKING TO PAY COSTS. All parties to this Agreement agree, and each Holder of a Note by his, her or its acceptance thereof shall be deemed to have agreed, that any court may in its discretion require, in any suit for the enforcement of any right or remedy under this Agreement, or in any suit against the Note Agent for any action taken or omitted by it as Note Agent, the filing by any party litigant in such suit of any undertaking to pay the costs of such suit, and that such court may in its discretion assess reasonable costs, including reasonable attorney's fees, against any party litigant in such suit, having due regard to the merits and good faith of the claims or defenses made by such party litigant. 9.10 DEFAULT ON INDEBTEDNESS If any Indebtedness shall be declared due and payable upon the occurrence of a default with respect to any Indebtedness, then no amount shall be paid by the Company in respect to the Indebtedness, unless and until the principal of and interest on the Notes then outstanding shall be paid in full. ARTICLE 10. NOTE AGENT 10.1 DUTIES AND LIABILITIES OF NOTE AGENT. 19 (a) The Note Agent, prior to the occurrence of an Event of Default and after the curing of all Events of Default that may have occurred, undertakes to perform such duties and only such duties as are specifically set forth in this Agreement. In case an Event of Default has occurred (which has not been cured), the Note Agent shall exercise such of the rights and powers vested in it by this Agreement and use the same degree of care and skill in its exercise as a prudent man would exercise or use under the circumstances in the conduct of his own affairs. (b) No provision of this Agreement shall be construed to relieve the Note Agent from liability for its own gross negligence in acting or omitting to act, or its own willful misconduct, except that: (i) prior to the occurrence of an Event of Default which may have occurred: (A) the duties and obligations of the Note Agent shall be determined solely by the express provisions of this Agreement, and the Note Agent shall not be liable except for the performance of such duties and obligations as are specifically set forth in this Agreement, and no implied covenants or obligations shall be read into this Agreement against the Note Agent; and (B) in the absence of bad faith on the part of the Note Agent, the Note Agent may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon any certificates or opinions furnished to the Note Agent and conforming to the requirements of this Agreement; but in the case of any such certificates or opinions that by any provision hereof are specifically required to be furnished to the Note Agent, the Note Agent shall be under a duty to examine the same to determine whether or not they conform to the requirements of this Agreement; (ii) the Note Agent shall not be liable for any error of judgment made in good faith, unless it shall be proved that the Note Agent was grossly negligent in ascertaining the pertinent facts; (iii) the Note Agent shall not be liable with respect to any action taken or omitted to be taken by it in good faith in accordance with the direction of the Holders of more than 50% in aggregate principal amount of the Notes then outstanding relating to the time, method and place of conducting any proceeding for any remedy available to the Noteholders, or exercising any power conferred upon the Note Agent, under this Agreement; and (iv) none of the provisions of this Agreement shall require the Note Agent to expend or risk its own funds or otherwise incur any personal financial liability in the performance of any of its duties hereunder, or in the exercise of any of its rights or powers, if it shall have reasonable grounds for believing that repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it. (c) Whether or not herein expressly so provided, every provision of this Agreement relating to the conduct or affecting the liability of or affording protection to the Note Agent shall be subject to the provisions of this SECTION 10.1. 20 10.2 RELIANCE ON DOCUMENTS, OPINIONS, ETC. Except as otherwise provided in SECTION 10.1: (a) the Note Agent may rely and shall be protected in acting upon any resolution, certificate, statement, instrument, opinion, report, notice, request, consent, order, note, bond, debenture. or other paper or document reasonably believed by it to be genuine and to have been signed or presented by the proper party or parties; (b) whenever in the administration of the provisions of this Agreement the Note Agent shall deem it necessary or desirable that a matter be proved or established prior to taking or omitting any action hereunder, such matter (unless other evidence in respect thereof be herein specifically prescribed) may, in the absence of gross negligence or bad faith on the part of the Note Agent, be deemed to be conclusively proved and established by a certificate signed by the Company and delivered to the Note Agent, and such certificate, in the absence of gross negligence or bad faith on the part of the Note Agent, shall be full warrant to the Note Agent for any action taken or omitted by it under the provisions of this Agreement upon the faith thereof; (c) any request, direction, order or demand of the Company mentioned herein shall be sufficiently evidenced by a certificate of the Company (unless other evidence in respect thereof be herein specifically prescribed); (d) the Note Agent may consult with legal counsel and any action taken in accordance with such opinion of counsel shall be made with full and complete authorization and protection hereunder if made in good faith and in reliance thereon; (e) the Note Agent shall be under no obligation to exercise any of the rights or powers vested in it by this Agreement at the request, order or direction of any of the Noteholders, pursuant to the provisions of this Agreement, unless such Noteholders shall have offered to the Note Agent reasonable security or indemnity against the costs, expenses and liabilities which may be incurred therein or thereby; nothing herein contained shall, however, relieve the Note Agent of the obligations, upon the occurrence of any Event of Default (which has not been cured), to exercise such of the rights and powers vested in it by this Agreement and to use the same degree of care and skill in their exercise as a prudent man would exercise or use under the circumstances in the conduct of his own affairs; (f) the Note Agent shall not be liable for any action taken or omitted by it in good faith and reasonably believed by it to be authorized or within the discretion or rights or powers conferred upon it by this Agreement; (g) prior to the occurrence of an Event of Default hereunder and after the curing of all Events of Default that may have occurred, the Note Agent shall not be bound to make any investigation into the facts or matters stated in the resolution, certificate, statement, instrument, opinion, report, notice, request, consent, order, note, bond, debenture, or other paper or document, unless requested in writing so to do by the Holders of more than 50% in aggregate principal amount of the Notes then outstanding; provided that if the payment within a reasonable time to the Note Agent of the costs. expenses or liabilities likely to be incurred by it in the making of such investigation is not, in the opinion of the Note Agent, reasonably assured to the Note Agent by the security afforded to it by the terms of this Agreement, the Note Agent may require reasonable indemnity against such expense or liability as a condition to so proceeding, the reasonable expense of every such examination shall be paid by the Company, or, if paid by the Note Agent, shall be repaid by the Company upon demand; and (h) the Note Agent may execute any of the rights or powers hereunder or perform any duties hereunder either directly or by or through its agents or attorneys. 21 10.3 NO RESPONSIBILITY FOR RECITALS; ETC. The recitals contained herein and in the Notes (except in the Note Agent's Certificate of Authentication) shall be taken as the statements of the Company and the Note Agent assumes no responsibility for the correctness of the same. The Note Agent makes no representations as to the validity or sufficiency of this Agreement or of the Notes. The Note Agent shall not be accountable for the use or application by the Company of any Notes or the proceeds of any Notes authenticated and delivered by the Note Agent in conformity with the provisions of this Agreement. 10.4 MONEYS TO BE HELD IN TRUST. Subject to the provisions of Section 14.3, all moneys received by the Note Agent shall, until used or applied as herein provided, be held in trust for the purposes for which they are received. 10.5 COMPENSATION OF NOTE AGENT. The Company shall pay the Note Agent a non-refundable set up fee of $5,000 on the Issue Date. 10.6 EXPENSES OF NOTE AGENT. The Company shall reimburse the Note Agent upon its request for all reasonable expenses incurred by the Note Agent in the performance of Note Agent's obligations arising under the Agreement. The Company also shall indemnify the Note Agent for, and hold it harmless against, any loss, liability or expense incurred without gross negligence or bad faith on the part of the Note Agent and arising out of or in connection with the acceptance or administration of this agency, including the reasonable costs and expenses of defending itself against any claim of liability in the premises. 10.7 RESIGNATION OR REMOVAL OF NOTE AGENT. (a) Subject to SECTION 10.8(a), the Note Agent may at any time resign by giving written notice of such resignation to the Company and by mailing notice thereof to the Noteholders at their addresses, as they shall appear on the registry books of the Company. Upon receiving such notice of resignation, the Company shall promptly appoint a successor Note Agent by written instrument, in duplicate, executed by the Company, one copy of which instrument shall be delivered to the resigning Note Agent and one copy to the successor Note Agent. If no successor Note Agent shall have been so appointed and have accepted appointment within sixty days after the publication of such notice of resignation, the resigning Note Agent may petition any court of competent jurisdiction for the appointment of a successor Note Agent, or any Noteholder who has been a bona fide Holder of a Note or Notes for at least six months may, subject to the provisions of SECTION 9.9, on behalf of himself and all others similarly situated, petition any such court for the appointment of a successor Note Agent. Such court may thereupon, after such notice, if any, as it may deem proper and prescribe, appoint a successor Note Agent. (b) In case at any time the Note Agent shall become incapable of acting, or in connection with the performance of its obligations hereunder shall have acted in bad faith, shall have been grossly negligent or shall have willfully breached this Agreement; or shall be adjudged a bankrupt or insolvent, or a receiver of the Note Agent or of its property shall be appointed, or any public officer shall take charge or control of the Note Agent or of its property or affairs for the purpose of rehabilitation, conservation or liquidation, then in any such case the Company may remove the Note Agent and appoint a successor Note Agent by written instrument, in duplicate, executed by order of the Company, one copy of which instrument shall be delivered to the Note Agent so removed and one copy to the successor Note Agent, or, subject to the provisions of SECTION 9.9, any Noteholder who has been a bona fide Holder of a Note or Notes for at least six months may, on behalf of himself and all others similarly situated, petition any court of competent jurisdiction for the removal of the Note Agent and the appointment of a successor Note Agent. Such court may thereupon, after such notice, if any, as it may deem proper and prescribe, remove the Note Agent and appoint a successor Note Agent. 22 (c) Except as expressly provided in SECTION 10.7(b), the Company shall have no right or power to remove Note Agent. (d) Any resignation or removal of the Note Agent and appointment of a successor Note Agent pursuant to any of the provisions of this SECTION 10.7 shall become effective upon acceptance of appointment by the successor Note Agent as provided in SECTION 10.8. 10.8 ACCEPTANCE BY SUCCESSOR NOTE AGENT. (a) Any successor Note Agent appointed as provided in Section 10.7 shall execute, acknowledge and deliver to the Company and to its predecessor Note Agent an instrument accepting such appointment hereunder, and thereupon the resignation of the predecessor Note Agent shall become effective and such successor Note Agent, without any further act, deed or conveyance, shall become vested with all the rights, powers, duties and obligations of his predecessor hereunder, with like effect as if originally named as Note Agent herein; but, nevertheless, on the written request of the Company or of the successor Note Agent, the Note Agent ceasing to act shall, upon payment of any amounts then due it pursuant to the provisions of SECTION 10.5, execute and deliver an instrument transferring to such successor Note Agent all the rights and powers of the Note Agent so ceasing to act. Upon request of any such successor Note Agent, the Company shall execute any and all instruments in writing for more fully and certainly vesting in and confirming to such successor all such rights and powers. (b) Upon acceptance of appointment by a successor Note Agent as provided in this SECTION 10.8, the Company shall mail notice of the succession of such Note Agent hereunder to the Noteholders at their addresses, as they shall appear on the registry books of the Company. If the Company fails to mail such notice within ten days after acceptance of appointment by the successor Note Agent, the successor Note Agent shall cause such notice to be mailed at the expense of the Company. ARTICLE 11. ACTS OF NOTEHOLDERS; EVIDENCE OF OWNERSHIP OF NOTES 11.1 ACTS OF NOTEHOLDERS. Any action to be taken by Noteholders may be evidenced by one or more concurrent written instruments of similar tenor signed or executed by such Noteholders in person or by any agent appointed in writing. The fact and date of the execution by any person or any such instrument may be proved by acknowledgment before a notary public or other officer empowered to take acknowledgments, or by an affidavit of a witness to such execution. 11.2 OWNERSHIP OF NOTES. Prior to due presentment of any Note for registration of transfer, the Company and the Note Agent may deem the person in whose name the Note shall be registered upon the books of the Company as the absolute owner of such Note (whether or not such Note shall be overdue and notwithstanding any notation of ownership or writing thereon by anyone other than the Note Agent), for the purpose of receiving payment of or on account of the principal of and Interest on such Note and for all other purposes, and neither the Company nor the Note Agent shall be affected by any notice to the contrary. Payment of the principal amount of or Interest on such Note shall be made only to or upon the order in writing of the registered owner thereof. All such payments shall be valid and, to the extent of the sum or sums so paid, effectual to satisfy and discharge the liability for moneys payable upon any such Note. 11.3 ACTION TAKEN BY THE NOTEHOLDERS. Any action taken by the Holders of more than 50% in aggregate principal amount of the Notes specified in this Agreement in connection with such action shall be conclusively binding upon the Company, the Note Agent and the Noteholders. Any action by any Noteholder shall 23 bind all future Holders of the same Note in respect of anything done or suffered by the Company or the Note Agent in pursuance thereof. ARTICLE 12. REGISTRATION RIGHTS 12.1 REQUIRED REGISTRATION. (a) Following the date which is ninety (90) days following the Issue Date, the holders of Stock constituting at least fifty percent (50%) of the Registrable Securities then owned beneficially or of record by Purchasers and their permitted transferees may request the Company to register under the Securities Act all or any portion of the shares of Registrable Securities held by such requesting holder or holders for sale in the manner specified in such notice; provided, however, that the Company may, by notice to the requesting holders, delay such requested registration if the Company's Board of Directors determines in good faith that such registration at the time requested would have a material adverse effect upon the Company; provided, further, however, that the Company's ability to delay such registration shall be limited to durations of no longer than ninety (90) days and the Company shall not delay more than once during any twelve (12) month period. The Company shall not be obligated pursuant to this SECTION 12.1 to effectuate more than one (1) registration. (b) Following receipt of any notice pursuant to SECTION 12.1(a), the Company shall promptly notify all Purchasers and permitted transferees from whom such notice has not been received and, as soon thereafter as practicable, shall use its reasonable efforts to register under the Securities Act, for public sale in accordance with the method of disposition specified in such notice from requesting holders, the number of shares of Registrable Securities specified in such notice (and in all notices received by the Company from other holders within twenty (20) days after the giving of such notice by the Company). If such method of disposition shall be an underwritten public offering, the Company shall designate the managing underwriter of such offering, following consultation and subject to the approval of the Purchasers and permitted transferees from whom notice has been received, which approval shall not be unreasonably withheld or delayed. All sellers must participate in the underwriting. The Company's registration obligation hereunder shall be deemed satisfied only when a registration statement or statements covering all shares of Registrable Securities specified in notices received as aforesaid, for sale in accordance with the method of disposition specified by the requesting holders, shall have become effective and, if such method of disposition is a firm commitment underwritten public offering, all such shares shall have been sold pursuant thereto. (c) The Company shall be entitled to include in any registration statement referred to in this SECTION 12.1, for sale in accordance with the method of disposition specified by the requesting holders, shares of Common Stock to be sold by the Company for its own account and for the account of other selling stockholders, except as and to the extent that, in the reasonable opinion of the managing underwriter (if such method of disposition shall be an underwritten public offering), such inclusion would materially adversely affect the marketing of the Registrable Securities to be sold. Except for registration statements on Form S-4, S-8 or any successor thereto, the Company will not file with the Commission any other registration statement with respect to its Common Stock, whether for its own account or that of other shareholders, from the date of receipt of a notice from requesting holders pursuant to this SECTION 12.1 until the completion of the lesser of (i) the period of distribution of the shares of Registrable Securities registered thereby or (ii) 180 days from the effective date of the registration statement, unless the Registrable Securities shall be entitled to be included therein in accordance with SECTION 12.2 below. 24 (d) The Company will use commercially reasonable efforts to maintain the effectiveness of any form used to register the shares pursuant to this SECTION 12.1 for up to one hundred eighty (180) days or such earlier time as all of the Registrable Securities have been sold. 12.2 INCIDENTAL REGISTRATION. If at any time prior to the two-year anniversary of the Issue Date the Company determines to register any of its securities under the Securities Act for sale to the public, whether for its own account or for the account of other security holders or both (except with respect to registration statements on Form S-8 or its then equivalent, or in connection with a Rule 145 transaction or Form S-4 or its equivalent, or another form not available for registering the Registrable Securities for sale to the public), each such time it will give prompt written notice to all holders of outstanding Registrable Securities of its intention so to do and of the proposed method of distribution of such securities. Upon the written request of any such holder, received by the Company within 20 days after the giving of any such notice by the Company, to include in the registration all or any part of the Registrable Securities, the Company will use all reasonable efforts to cause the Registrable Securities as to which registration shall have been so requested under this SECTION 12.2 to be included in the securities to be covered by the registration statement proposed to be filed by the Company, all to the extent and under the conditions such registration is permitted under the Securities Act. In the event that any registration pursuant to this SECTION 12.2 shall be, in whole or in part, an underwritten public offering of Common Stock, the number of shares of Registrable Securities to be included in such an underwriting may be reduced (pro rata among the requesting holders under this SECTION 12.2 based upon the number of shares of Registrable Securities owned by such holders) if and to the extent that the managing underwriter shall be of the opinion that the inclusion of some or all of the Registrable Securities would adversely affect the marketing of the securities to be sold by the Company therein. Any such limitation shall be imposed in such manner so as to avoid any diminution in the number of shares the Company may register for sale by giving first priority for the shares to be registered for issuance and sale by the Company, by giving second priority for the shares to be registered pursuant to this SECTION 12.2, and by giving third priority for the shares to be registered for sale by any stockholder of the Company (including any Purchaser or permitted transferee) pursuant to the terms of any other agreement; provided, however, that no such limitation shall reduce the amount of securities of Purchasers or permitted transferees included in the registration below twenty percent (20%) of the total amount of securities included in such registration. Notwithstanding the foregoing provisions, the Company may, in its sole discretion, terminate or withdraw any registration statement referred to in this SECTION 12.2 without thereby incurring any liability to the holders of Registrable Securities. 12.3 REGISTRATION PROCEDURES. If and whenever the Company is required by the provisions of SECTIONS 12.1 or 12.2 to use all reasonable efforts to effect the registration of any shares of Registrable Securities under the Securities Act, the Company will, at its cost and expense (including, without limitation, payment of the costs and expenses described in SECTION 12.4), as expeditiously as reasonably practicable: (a) prepare and file with the Securities and Exchange Commission (the "SEC") a registration statement (which, in the case of an underwritten public offering, shall be on Form S-1 or other form of general applicability satisfactory to the managing underwriter selected as therein provided) with respect to such securities and use all reasonable efforts to cause such registration statement to become and remain effective for the period of the distribution contemplated thereby (determined as hereinafter provided); (b) prepare and file as expeditiously as reasonably practicable and in any event within 90 days with the SEC such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective for the period specified in SECTION 12.3(a) above and comply with the provisions of the Securities Act with respect to the disposition of all Registrable Securities covered by such 25 registration statement in accordance with the sellers' intended method of disposition set forth in such registration statement for such period; (c) furnish to each seller of Registrable Securities and to each underwriter such number of copies of the registration statement and the prospectus included therein (including each preliminary prospectus) as such persons reasonably may request in order to facilitate the public sale or other disposition of the Registrable Securities covered by such registration statement; (d) use all reasonable efforts to register or qualify the Registrable Securities covered by such registration statement under the securities or "blue sky" laws of such jurisdictions as the sellers of Registrable Securities or, in the case of an underwritten public offering, the managing underwriter reasonably shall request; provided, however, that the Company shall not for any such purpose be required to qualify generally to transact business as a foreign corporation in any jurisdiction where it is not so qualified or to consent to general service of process in any such jurisdiction; (e) use all reasonable efforts to list the Registrable Securities covered by such registration statement with Nasdaq or any securities exchange on which the Common Stock of the Company is then listed; (f) immediately notify each seller of Registrable Securities and each underwriter under such registration statement, at any time when a prospectus relating thereto is required to be delivered under the Securities Act, of the happening of any event of which the Company has knowledge as a result of which the prospectus contained in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing. The sellers of Registrable Securities agree upon receipt of such notice forthwith to cease making offers and sales of Registrable Securities pursuant to such registration statement or deliveries of the prospectus contained therein for any purpose until the Company has prepared and furnished such amendment or supplement to the prospectus as may be necessary so that, as thereafter delivered to purchasers of such Registrable Securities, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing; (g) notify each seller of Registrable Securities under such registration statement of (i) the effectiveness of such registration statement, (ii) the filing of any post-effective amendments to such registration statement, or (iii) the filing of a supplement to such registration statement; (h) if the distribution is an underwritten offering, at the request of any seller of Registrable Securities, use all reasonable efforts to furnish on the date that Registrable Securities are delivered to the underwriters for sale pursuant to such registration: (i) an opinion (dated such date) of counsel representing the Company for the purposes of such registration, addressed to the sellers and the underwriters, and in customary form; and (ii) a letter (dated such date) from the independent public accountants retained by the Company, addressed to the sellers and the underwriters and covering such matters with respect to such registration as such underwriters reasonably may request; and (i) make available for inspection upon reasonable notice during the Company's regular business hours by each seller of Registrable Securities, any underwriter participating in any distribution pursuant to such registration statement, and any attorney, accountant or other agent retained by such seller or underwriter, all material financial and other records, pertinent corporate documents and properties of the Company, and cause the Company's officers and directors to supply all information reasonably requested by any such seller, 26 underwriter, attorney, accountant or agent in connection with such registration statement. For purposes of SECTIONS 12.3(a), 12.3(b) and 12.1(c), the period of distribution of Registrable Securities in a firm commitment underwritten public offering shall be deemed to extend until each underwriter has completed the distribution of all securities purchased by it, and the period of distribution of Registrable Securities in any other registration shall be deemed to extend until the earlier of (i) the sale of all Registrable Securities covered thereby or (ii) one hundred eighty (180) days after the effective date thereof, with reasonable extensions to be granted for suspensions thereof. In connection with each registration pursuant to SECTIONS 12.1 or 12.2 covering an underwritten public offering, the Company and each seller agree to enter into a written agreement with the managing underwriter selected in the manner herein provided in such form and containing such provisions as are customary in the securities business for such an arrangement between such underwriter and companies of the Company's size and investment stature. 12.4 EXPENSES. All expenses incurred by the Company in complying with SECTIONS 12.1 and 12.2, including, without limitation, all registration and filing fees, printing expenses, fees and disbursements of counsel and independent public accountants for the Company, fees and expenses (including counsel fees) incurred in connection with complying with state securities or "blue sky" laws, transfer taxes, fees of transfer agents and registrars, and the fees and disbursements of one counsel for the sellers of Registrable Securities but excluding any Selling Expenses, are called "Registration Expenses." All underwriting discounts and selling commissions applicable to the sale of Registrable Securities and the fees of more than one counsel are called "Selling Expenses." The Company will pay all Registration Expenses in connection with each registration statement under SECTIONS 12.1 or 12.2. The Company shall not, however, be required to pay for the Registration Expenses of any registration proceeding begun pursuant to SECTION 12.1, the request for which is subsequently withdrawn by the requesting holders of Registrable Securities, in which event the Registration Expenses shall be borne by the requesting holders of the Registrable Securities in proportion to the number of shares for which registration was requested. All Selling Expenses in connection with each registration statement under SECTIONS 12.1 or 12.2 shall be borne by the participating sellers in proportion to the number of shares sold by each, or by such participating sellers other than the Company (except to the extent the Company shall be a seller) as they may agree. 12.5 INFORMATION BY HOLDER. The holder or holders of Registrable Securities included in any registration shall furnish to the Company such information regarding such holder or holders of Registrable Securities, the Registrable Securities held by them and the distribution proposed by such holder or holders of Registrable Securities as the Company may reasonably request in writing and as shall be required in connection with any registration (including any amendment to a registration statement or prospectus), qualification or compliance. 12.6 Indemnification and Contribution. (a) In the event of a registration of any of the Registrable Securities under the Securities Act pursuant to SECTIONS 12.1 or 12.2, the Company will indemnify and hold harmless each seller of such Registrable Securities thereunder, each underwriter of such Registrable Securities thereunder and each other person, if any, who controls such seller or underwriter within the meaning of SECTION 15 of the Securities Act, from and against any losses, claims, damages or liabilities, joint or several, to which such seller, underwriter or controlling person may become subject under the Securities Act or under any other statute or at common law or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based 27 upon any untrue statement or alleged untrue statement of any material fact contained in any registration statement under which such Registrable Securities were registered under the Securities Act, any preliminary prospectus or final prospectus contained therein, or any amendment or supplement thereof, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading or any violations of applicable law relating to such registration, and will pay the legal fees and other expenses of each such seller, each such underwriter and each such controlling person incurred by them in connection with investigating or defending any action, whether or not resulting in any liability, insofar as such loss, claim, damage, liability or action results from the foregoing; provided, however, that the Company will not be liable to a seller, underwriter or controlling person in any such case if and to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission so made in reliance upon and in conformity with information furnished in writing by any such seller, any such underwriter or any such controlling person specifically for use in such registration statement or prospectus; and, provided, further, however, that the Company will not be liable to a holder in any such case to the extent that any such loss, claim, damage, liability or action arises out of or is based upon an untrue or alleged untrue statement or omission or an alleged omission made in any preliminary prospectus or final prospectus if (i) such holder failed to send or deliver a copy of the final prospectus or prospectus supplement with or prior to the delivery of written confirmation of the sale of the Registrable Securities, and (ii) the final prospectus or prospectus supplement would have corrected such untrue statement or omission. (b) In the event of a registration of any of the Registrable Securities under the Securities Act pursuant to SECTIONS 12.1 or 12.2, each seller of such Registrable Securities thereunder, severally and not jointly, will indemnify and hold harmless the Company, each person, if any, who controls the Company within the meaning of the Securities Act, each officer of the Company who signs the registration statement, each director of the Company, each underwriter and each person who controls any underwriter within the meaning of the Securities Act, against all losses, claims, damages or liabilities, joint or several, to which the Company or such officer, director, underwriter or controlling person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the registration statement under which such Registrable Securities were registered under the Securities Act, any preliminary prospectus or final prospectus contained therein, or any amendment or supplement thereof, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will pay the legal fees and other expenses of the Company and each such officer, director, underwriter and controlling person incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action; provided, however, that such seller will be liable hereunder in any such case if and only to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in reliance upon and in conformity with information furnished in writing to the Company by such seller specifically for use in such registration statement or prospectus; and provided, further, however, that the liability of each seller hereunder shall be limited to the amount of net proceeds received by such seller in connection with such registration. (c) Promptly after receipt by an indemnified party hereunder of notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against the indemnifying party hereunder, notify the indemnifying party in writing thereof, but the omission so to notify the indemnifying party shall not relieve it from any liability that it may have to such indemnified party under this SECTION 12.6 except and only to the extent the indemnifying party is prejudiced by such omission. In case any such action shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to 28 participate in and, to the extent it shall wish, to assume and undertake the defense thereof with counsel satisfactory to such indemnified party, and, after notice from the indemnifying party to such indemnified party of its election so to assume and undertake the defense thereof, the indemnifying party shall not be liable to such indemnified party under this SECTION 12.6 for any legal expenses subsequently incurred by such indemnified party in connection with the defense thereof; provided, however, that, if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded (based on the advice of counsel) that there may be reasonable defenses available to it which are different from or additional to those available to the indemnifying party or if the interests of the indemnified party reasonably may be deemed to conflict with the interests of the indemnifying party, the indemnified party shall have the right to select a separate counsel and to assume such legal defenses and otherwise to participate in the defense of such action, with the expenses and fees of such separate counsel and other expenses related to such participation to be reimbursed by the indemnifying party as incurred, it being understood, however, that the indemnifying party shall not, in connection with any one such action or separate but substantially similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances, be liable for the fees and expenses of more than one separate firm of attorneys (together with appropriate local counsel as required by the local rules of such jurisdiction) at any time for all such indemnified parties. (d) In order to provide for just and equitable contribution to joint liability under the Securities Act in any case in which either (i) any holder of Registrable Securities exercising rights under this Agreement, or any controlling person of any such holder, makes a claim for indemnification pursuant to this SECTION 12.6 but it is judicially determined (by the entry of a final judgment or decree by a court of competent jurisdiction and the expiration of time to appeal or the denial of the last right of appeal) that such indemnification may not be enforced in such case notwithstanding the fact that this SECTION 12.6 provides for indemnification in such case, or (ii) contribution under the Securities Act may be required on the part of any such selling holder or any such controlling person in circumstances for which indemnification is provided under this SECTION 12.6; then, and in each such case, the Company and each such holder will contribute to the aggregate losses, claims, damages or liabilities to which they may be subject (after contribution from others) in such proportion as may be reasonable taking into account such matters as (A) their relative fault as to the matters giving rise to such losses, claims, damages or liabilities and (B) their relative ability or opportunity to have avoided such losses, claims, damages or liabilities; provided, however, that, in any such case, no person or entity guilty of fraudulent misrepresentation (within the meaning of SECTION 11(f) of the Securities Act) will be entitled to contribution from any person or entity who was not guilty of such fraudulent misrepresentation. (e) No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement of any pending or threatened action, suit or proceeding in respect of which any indemnified party is or could have been a party and indemnity could have been sought hereunder by such indemnified party, unless such settlement includes an unconditional release of such indemnified party from all liability on claims that are the subject matter of such action, suit or proceeding. (f) Notwithstanding the foregoing, to the extent that the provisions on indemnification and contribution contained in the underwriting agreement entered into in connection with the underwritten public offering are in conflict with the foregoing provisions, the provisions in the underwriting agreement shall control. 12.7 CHANGES IN COMMON STOCK OR PREFERRED SHARES. If, and as often as, there is any change in the Common Stock by way of a stock split, stock dividend, combination or reclassification, or through a merger, consolidation, reorganization or recapitalization, or by any other means, then the registration rights granted by this SECTION 12 shall continue with respect to all of the Registrable Securities as though not changed. 29 12.8 DAMAGES The Company recognizes and agrees that the holders of Registrable Securities will suffer irreparable harm and will not have an adequate remedy at law if the Company fails to comply with any provision of this Article 12, and the Company expressly agrees that, in the event of such failure, the holders of Registrable Securities or any other person entitled to the benefits of this Article 12 shall be entitled to seek specific performance of any and all provisions hereof and may seek to enjoin the Company from continuing to commit any further breach of this Article 12. ARTICLE 13. AMENDMENTS AND SUPPLEMENTS 13.1 AMENDMENTS AND SUPPLEMENTS WITHOUT NOTEHOLDERS' CONSENT. This Agreement may be amended or supplemented at any time and from time to time, without the consent of Note Holders , by the written agreement of the Company and the Note Agent for the purpose of curing any ambiguity or curing, correcting or supplementing any defective provision of this Agreement in such manner as shall not be inconsistent with this Agreement and shall not materially adversely affect the Purchasers. 13.2 AMENDMENTS WITH NOTEHOLDERS' CONSENT. This Agreement may be amended from time to time by a written amendment approved in writing by the Noteholders who hold more than 50% in aggregate principal amount of the Notes. 13.3 NOTE AGENT AUTHORIZED TO JOIN AMENDMENTS; RELIANCE ON COUNSEL. The Note Agent is authorized to join in the execution and delivery of any amendment to this Agreement permitted by this SECTION 13 and in so doing shall be fully protected by an opinion of counsel that such amendment is so permitted and that all things necessary to make it a valid and binding agreement have been done. ARTICLE 14. SATISFACTION AND DISCHARGE OF AGREEMENT; UNCLAIMED MONIES 14.1 DISCHARGE OF AGREEMENT. When the principal and Interest on all Notes issued hereunder have been paid, or provision has been made for payment of the same, together with all other sums payable hereunder by the Company, the right, title and interest of the Note Agent shall thereupon cease, and the Note Agent, on demand of the Company, shall release this Agreement and shall execute such documents to evidence such releases as may be reasonably required by the Company and shall turn over to the Company for and on account of the Company or such other person, body or authority as may be entitled to receive the same, all balances, if any, held by it, not required for the payment of the Notes and such other sums. Provision for the payment of the Notes shall be deemed to have been made upon the delivery to the Note Agent of cash and in amounts sufficient to make all payments specified above. 14.2 DEPOSITED MONEYS TO BE HELD IN TRUST BY THE NOTE AGENT. Any moneys deposited with the Note Agent pursuant to SECTION 14.1 shall be held in trust and, subject to the provisions of SECTION 14.3, applied by it to the payment to the Holders of the particular Notes for the payment or redemption of which such moneys have been deposited with the Note Agent of all sums due thereon for principal and Interest. 14.3 UNCLAIMED MONEYS. Any moneys deposited with the Note Agent not applied but remaining unclaimed by the Noteholders for six years after the date upon which the principal and Interest on such Notes shall have become due and payable shall be repaid to the Company by the Note Agent on demand, or if held in trust by the Company may at the Company's option be released from such trust, and the Noteholder entitled to receive such payment shall thereafter look only to the Company, as the holder of a general claim, for the payment thereof. 30 ARTICLE 15. NO REGISTRATION OF NOTES; RESTRICTIONS ON TRANSFERABILITY. The Notes and Stock issued pursuant hereto have not been registered under the Securities Act, and this Agreement has not been qualified under the Trust Indenture Act of 1939, as amended (the "INDENTURE ACT"), in reliance on exemptions from registration and qualification provided by the Securities Act and the Indenture Act, respectively. No Purchaser may sell, transfer, pledge or hypothecate all or any portion of his Note or Stock at any time in the absence of (1) a current and effective registration statement under the Securities Act and applicable state securities laws with respect to the Notes or the Stock or (2) an opinion of counsel acceptable to the Company (obtained at the expense of the Purchaser) to the effect that such registration is not required. The Notes and the Stock shall bear a legend to the foregoing effect. The Company has no present intention of registering the Notes under the Securities Act or of qualifying this Agreement under the Indenture Act. In addition, none of the Notes may be transferred unless the Assignment Form attached to the Note (or such other form prescribed by the Company) is executed by the transferring Noteholder and the transferee and is duly notarized and delivered to the Company. ARTICLE 16. MISCELLANEOUS PROVISIONS. 16.1 PROVISIONS BINDING ON THE COMPANY'S SUCCESSORS. All the covenants, stipulations, promises and agreements in this Agreement contained by or on behalf of the Company shall bind its successors and assigns, whether so expressed or not. 16.2 ADDRESSES FOR NOTICE. Any notice or demand that by any provision of this Agreement is required or permitted to be given or served may be given or served by personal delivery or by being deposited in the U.S. mail, registered or certified mail, return receipt requested, postage prepaid, and addressed (until another address is filed by the intended recipient with the other party hereto): If to Note Agent: Cerberus Financial, Inc. 2999 North 44th Street, Suite 100 Phoenix, Arizona 85018 Attention: Thomas R. Hislop If to Company: iLinc Communications, Inc. 2999 North 44th Street, Suite 650 Phoenix, Arizona 85018 Attention: __________ If to any Purchaser at such address as set forth in the Note Agent's records. 16.3 REPRESENTATIONS AND WARRANTIES. [Intentionally Omitted]. 16.4 GOVERNING LAW. This Agreement and each Note shall be deemed to be a contract made under the laws of the State of Arizona and for all purposes shall be construed in accordance with and governed by the laws of such State without giving effect to its principles of conflicts of laws. 16.5 EFFECT OF INVALIDITY OF PROVISIONS. In case any one or more of the provisions contained in this Agreement or in the Notes shall for any reason be held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality or unenforceability shall not affect any other provisions of this Agreement or of such Notes, and this Agreement and such Notes shall be construed as if such invalid or illegal or unenforceable provision had never been contained herein or therein. 31 16.6 TABLE OF CONTENTS AND HEADINGS. The table of contents, titles and headings of the articles and sections of this Agreement have been inserted for convenience of reference only, are not to be considered to be a part hereof, and shall in no way modify or restrict any of the terms or provisions hereof. 16.7 EXECUTION IN COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall be an original, but all of such counterparts shall constitute but one and the same instrument. EXECUTED to be effective as of the date first set forth above. COMPANY: NOTE AGENT: iLINC COMMUNICATIONS, INC., CERBERUS FINANCIAL, INC., a Delaware corporation an Arizona corporation By: By: ----------------------------------- ----------------------------------- Name: James M. Powers, Jr. Name: ---------------------------------- ---------------------------------- Title: Chairman, President and CEO Title: --------------------------- --------------------------------- PURCHASERS: - -------------------------------- ------------------------------------- [Printed Name] [Printed Name] - -------------------------------- ------------------------------------- [Signature] [Signature] [The Remainder of This Page Intentionally Left Blank.] 32 SCHEDULE 1 - ------------------------------------------------------------------------------- Number of Shares Principal Amount Name of Common Stock Note Number of Note - --------------------------- ----------------- ------------ -------------------- - --------------------------- ----------------- ------------ -------------------- - --------------------------- ----------------- ------------ -------------------- - --------------------------- ----------------- ------------ -------------------- - --------------------------- ----------------- ------------ -------------------- - --------------------------- ----------------- ------------ -------------------- - --------------------------- ----------------- ------------ -------------------- 33 EXHIBIT A --------- Form of Note [CERTIFICATE NUMBER] THIS NOTE HAS BEEN ACQUIRED FOR INVESTMENT AND HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES ACT.("1933 ACT"). THIS NOTE HAS NOT BEEN ISSUED PURSUANT TO AN INDENTURE QUALIFIED UNDER THE TRUST INDENTURE ACT OF 1939, AS AMENDED. THIS NOTE MAY NOT BE SOLD, TRANSFERRED, PLEDGED, HYPOTHECATED OR OTHERWISE DISPOSED OF, IN WHOLE OR IN PART, TO ANY PERSON IN THE ABSENCE OF: (1) A CURRENT AND EFFECTIVE REGISTRATION STATEMENT UNDER THE 1933 ACT AND APPLICABLE STATE SECURITIES LAWS WITH RESPECT TO THIS NOTE OR (2) AN OPINION OF COUNSEL ACCEPTABLE TO iLINC COMMUNICATIONS, INC. THAT SUCH REGISTRATION IS NOT REQUIRED. ILINC COMMUNICATIONS, INC. 10.0% SENIOR NOTE DUE JULY 15, 2007 [$________________] [__________, 2004] iLinc Communications, Inc., a Delaware corporation ("Company"), promises to pay to (the "Holder") or the Holder's registered assigns, the principal sum of _____________ Dollars ($_________) and to pay interest (computed on the basis of a 360-day year composed of 12 months of 30 days each) on the principal amount then outstanding from time to time remaining unpaid hereon, at the rate of ten percent (10.0%) per annum (the "Stated Rate") from the date hereof until the later of July 15, 2007 (the "MATURITY DATE") or the date upon which the principal, interest and all other Indebtedness evidenced hereby shall have been satisfied, with such interest payable quarterly on the fifteenth day of each January, April, July and October commencing July 15, 2004 and payable in such currency of the United States of America as at the time of payment shall be legal tender for payment of public and private debts. Upon an Event of Default, after notice and failure to cure, the Company shall pay interest, on overdue principal and (to the extent legally enforceable) on any overdue installment of interest, at the rate of the Stated Rate plus 5.0% per annum after maturity whether by acceleration or otherwise, until fully paid. If any amount of principal or interest on or in respect of this Note becomes due and payable on any date which is not a Business Day, such amount shall be payable on the next preceding Business Day. All capitalized terms used but not otherwise defined herein shall have the meaning set forth in the Note Agreement (as defined in the next paragraph). This Note is one of the 10% Senior Notes due July 15, 2007 of the Company issued as a part of the Offering under and pursuant to the terms and provisions of the Unit Purchase and Agency Agreement dated March 19, 2004 ("Unit Agreement") entered into by the Company, the Note Agent , and the Purchasers. This Note, and the Holder hereof, is subject to the terms and conditions of the Unit Agreement, with all of such terms incorporated herein by this reference, and with each Holder entitled equally and ratably with the Holders of all other Notes outstanding under the Unit Agreement to all the benefits and subject to all of the obligations provided for thereby or referred to in the Unit Agreement. Exhibit A-1 THIS NOTE IS SENIOR AND WILL RANK IN PRIORITY IN RIGHT OF PAYMENT TO ALL INDEBTEDNESS OF THE COMPANY AS DEFINED IN THE UNIT AGREEMENT. This Note may be declared due prior to the Maturity Date, upon the occurrence of an Event of Default, and on the terms and in the manner and amounts as provided in the Note Agreement. This Note is subject to prepayment or redemption at the option of the Company prior to the expressed Maturity Date any time after July 15, 2005, and on the terms and conditions and in the amounts set forth in the Note Agreement. Upon the occurrence of an Event of Default, the entire principal balance outstanding hereunder, together with all accrued interest and other amounts payable hereunder, at the election of the Holder, shall become immediately due and payable, without any notice to Company. The Notes are issuable as registered Notes as set forth in the Note Agreement. In the manner and subject to the limitations provided in the Note Agreement, Notes are exchangeable for other Notes of any other Authorized Denomination or Denominations of an equal aggregate principal amount at the office of the Company maintained in Phoenix, Arizona at 2999 N. 44th Street, Suite 650, or at such other place as the Company may hereafter designate pursuant to the Note Agreement. The transfer of this Note is registrable by the registered Holder hereof or by his attorney duly authorized in writing at the office of the Company in the manner and subject to the limitations provided in the Note Agreement and upon surrender of this Note. Upon any such registration of transfer, a new Note or Notes of Authorized Denominations for a like aggregate principal amount will be issued in exchange for this Note. Prior to due presentment of this Note for registration of transfer, the Company and the Note Agent may deem the registered Holder hereof as the absolute owner hereof (whether or not this Note shall be overdue and notwithstanding any notation of ownership or other writing hereon by anyone other than the Company or the Note Agent), for the purpose of receiving payment of or on account of the principal hereof and Interest hereon, and for all other purposes, and neither the Company nor the Note Agent shall be affected by any notice to the contrary. All such payments shall be valid and effectual to satisfy and discharge the liability upon this Note to the extent of the sum or sums so paid. The Note shall not be valid or become obligatory for any purpose until the Certificate of Authentication hereon shall have been signed by both an Officer of the Company and the Note Agent. iLINC COMMUNICATIONS, INC. By: ------------------------------------ Name: --------------------------------- Title: --------------------------------- Date: ---------------------------------- Exhibit A-2 NOTE AGENT'S CERTIFICATE OF AUTHENTICATION The undersigned Note Agent does hereby certify that this Note is one of a series of Notes described in the Note Agreement, and further that and the Holder hereof, is subject to the terms and conditions of the Note Agreement. CERBERUS FINANCIAL, INC., an Arizona Corporation DATED: By: ---------------- --------- --------------------------------- Name: ------------------------ Title: ---------------------- Exhibit A-3 ASSIGNMENT I or we represent that we are the Holder of this Note with all right, title and interest and that we have not sold, assigned or otherwise transferred any interest in or to this Note. We hereby assign and transfer our right and title in and to this Note to: - ------------------------------------------------------------------------------- Insert Social Security Number or Tax Identification Number of Transferee (Print or type name, address and zip code of assignee) - ------------------------------------------------------------------------------- and do irrevocably appoint: ____________________________________________________ as agent to transfer this Note on the books for registration thereof. Dated: -------------------- - --------------------- ------------------------------------------------- Signature Guaranteed Signature Name: Title: ------------------------- -------------- - --------------------- ------------------------------------------------- Signature Guaranteed Signature Name: Title: ------------------------- -------------- Notice: Signature(s) must be Notice: The assignor's signature to this guaranteed by an eligible assignment must correspond with the name guarantor institution as it appears upon the face of the Note pursuant to Securities and in every particular, without altercation Exchange Commission Rule 17Ad-15. or any change whatsoever. Exhibit A-4 EXHIBIT B --------- LIST OF SUBORDINATED INDEBTEDNESS o A series of 41 Convertible Promissory Notes issued in a private placement offering in March of 2002 with an aggregate original principal amount of $5.625 million o A series of promissory notes issued in a private placement offering in February 2004 with an aggregate original principal balance of $500,000 as follows: o Note number NPA-1 with an original principal balance of $140,000.00 o Note number NPA-2 with an original principal balance of $135,000.00 o Note number NPA-3 with an original principal balance of $25,000.00 o Note number NPA-4 with an original principal balance of $100,000.00 o Note number NPA-5 with an original principal balance of $14,000.00 o Note number NPA-6 with an original principal balance of $86,000.00 o A series of promissory notes issued as part of a transaction with Learning-Edge in October 2001 with an aggregate original principal balance of $1,101,860.48 as follows: o Note number 1 with an original principal balance of $322,111.00 o Note number 1a with an original principal balance of $161,055.50 o Note number 1b with an original principal balance of $161,055.50 o Note number 2 with an original principal balance of $248,919.48 o Note number 3 with an original principal balance of $36,104.00 o Note number 4 with an original principal balance of $76,097.00 o Note number 5 with an original principal balance of $26,450.00 o Note number 6 with an original principal balance of $5,951.00 o Note number 7 with an original principal balance of $9,919.00 o Note number 8 with an original principal balance of $47,057.00 o Note number 9 with an original principal balance of $7,141.00 EXHIBIT B EX-10.21 5 ilinc_10kex10-21.txt EXHIBIT 10.21 PLACEMENT AGENCY AGREEMENT This Placement Agency Agreement (the "AGREEMENT"), made effective as of the 10th day of March, 2004, by and between iLinc Communications, Inc. (the "COMPANY"), and Peacock, Hislop, Staley & Given, Inc., (the "PLACEMENT AGENT"). 1. DESCRIPTION OF THE OFFERING. The Company proposes to offer and sell to accredited investors within the meaning of Rule 501(a) of the Securities Act of 1933, as amended (the "SECURITIES ACT"), through the Placement Agent hereby appointed as exclusive selling agent, up to $3,000,000 of units (the "OFFERING") consisting of $2,250,000 of Senior Notes and $750,000 of Common Stock (such Senior Notes and Common Stock together comprise the "UNITS"). Each Unit will consist of $37,500 of Senior Notes and $12,500 of Common Stock. The Common Stock will be priced at a forty percent (40%) discount to the average closing price of the Common Stock for the ten trading days preceding the Closing Date (the "OFFERING PRICE"). The total shares of Common Stock per Unit will be an amount such that the investment in Common Stock closest approximates $12,500. Subject to market conditions, the Offering may be expanded up to $4,000,000. Subscriptions obtained in the Offering may be accepted or rejected in whole or in part by the Company for any reason. Except as required by applicable laws or regulations, subscriptions which are accepted by the Company may not be withdrawn by any subscriber. The Units will be offered through a Private Placement Memorandum dated March 12, 2004, including all exhibits, financial statements, schedules, appendices, supplements or amendments thereto (collectively, the "MEMORANDUM"). All capitalized terms used herein, unless specifically defined herein, shall have the meanings set forth in the Memorandum. 2. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE COMPANY. The Company represents, warrants and covenants to the Placement Agent that: (a) The Units have not been and will not be registered with the Securities and Exchange Commission or any state securities regulatory authorities ("REGULATORS"). The Units shall be offered and sold pursuant to an exemption from registration under the Securities Act. The Company will: (i) offer the Units only to accredited investors, and (ii) conduct the Offering as a private placement in substantial compliance with the requirements of Regulation D, promulgated under the Securities Act, and with all other applicable federal or state securities laws and rules and regulations (collectively, the "SECURITIES LAWS AND REGULATIONS"). The Company will, in a timely manner, make any required filings with any applicable Regulators. The issuance, offer, sale and delivery of the Units, in the manner and circumstances contemplated by the Memorandum and this Agreement, is exempt from the registration requirements of the Securities Act. (b) The Memorandum, with respect to the Units, has been or will be prepared by the Company in conformity with the applicable requirements of the Securities Laws and Regulations. (c) No Regulators have issued any order preventing or suspending the Offering contemplated herein or use of the Memorandum, nor instituted, or to the best knowledge of the Company, contemplated instituting proceedings for that purpose. The Memorandum does not contain any untrue statement of any material fact and does not omit to state any material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (d) Neither the Company nor its Affiliates is in violation of or default under any provision of its articles of incorporation or bylaws. Neither the Company nor its Affiliates is in violation or default under any of its material agreements, leases, licenses, contracts, franchises, mortgages, loans, notes, permits, deeds of trust, security agreements, indentures or other instruments or obligations to which it is a party or by which it or any of its properties is bound or may be affected (collectively, the "CONTRACTS"), which failure or default would materially adversely affect the business, prospects, properties, operations, or financial condition of the Company or any of its Affiliates (a "MATERIAL ADVERSE Effect"). The execution, delivery and performance of this Agreement and the consummation of the transactions contemplated herein and in the Memorandum do not and will not (i) conflict with or result in a material breach or violation of any of the terms or provisions of, or constitute, either with or without notice or the passage of time or both, a default under, any Contract to which the Company or its Affiliates is a party or by which the Company or its Affiliates is bound, which default would have a Material Adverse Effect upon the Company or its Affiliates, (ii) violate any statute, rule or regulation applicable to the Company or its Affiliates or any order, judgment or decree of any court or of any regulatory, administrative or governmental body or agency or arbitral forum having jurisdiction over the Company or its Affiliates or any of its property which violation would have a Material Adverse Effect upon the Company, (iii) result in the creation or imposition of any lien, charge or encumbrance upon any of the assets of the Company or its Affiliates, or (iv) violate any of the provisions of the articles of incorporation or bylaws of the Company or its Affiliates. No other consent, approval, authorization or action is required for the consummation of the transactions herein contemplated other than such as has been obtained. There are no Contracts or other documents required to be described in the Memorandum or to be included as exhibits to the Memorandum in order to make the information therein not misleading which have not been described or included as required. (e) The Company shall provide to the Placement Agent and to each purchaser such information, documents and instruments as may be reasonably requested and are required to be provided pursuant to applicable Securities Laws and Regulations and the laws of any state in which the offer or sale of securities has been approved by the Company and the Placement Agent and to otherwise comply with such requirements. (f) The Company: (i) Has not offered for sale or sold any other securities of the Company, the offer for sale or sale of which would be "integrated" under the standards of existing Securities Laws and Regulations with the offers for sale or sales of the Units proposed to be made by the Placement Agent pursuant hereto in determining whether a public offering of the Units has been made so as to impose with respect to the Offering of the Units hereunder by the Placement Agent any compliance with different requirements of the applicable Securities Laws and Regulations; and (ii) Shall not offer for sale or sell any Units or other securities except and to the extent that any such offer for sale or sale shall not cause the provisions of the Securities Laws and Regulations relied upon with respect to the Offering and sale of the Units contemplated by this Agreement to be inapplicable thereto. (g) The Company and each of its Affiliates is duly authorized to transact the business in which it is engaged and in which it proposes to engage as described in the Memorandum. (h) Since the respective dates as of which information is given in the Memorandum and other than as therein contemplated, neither the Company nor any of its Affiliates have incurred, nor during the period of the Offering will any such party incur, any material liabilities or obligations contingent or otherwise, except in the ordinary course of business, or as set forth in the Memorandum and there has not been, and during the period of the Offering there will not be, any material adverse change in the condition of the Company, or its financial condition. 2 (i) The Company will notify the Placement Agent immediately and confirm the notice in writing of the issuance by the Regulators of any stop order suspending the effectiveness of any qualification of the Units for sale, suspending the sale of the Units or the use of the Memorandum, or of the initiation of any proceedings for any such purpose. The Company will use its best efforts to prevent the issuance of any such stop order and, if any such stop order shall at any time be issued, to obtain the lifting thereof at the earliest possible moment. (j) Other than as disclosed in the Memorandum, neither the Company, nor to its knowledge, after due and diligent inquiry, any person other than the Placement Agent, has made any representation, promise or warranty, whether verbal or in writing to anyone, whether an existing shareholder or not, that any of the Units will be reserved for or directed to them during the proposed Offering. (k) The Company and each of its Affiliates has been incorporated and is validly existing and in good standing under the laws of its jurisdictions of incorporation. The Company and each of its Affiliates is duly qualified to transact business in all jurisdictions in which the conduct of its business requires such qualification where the failure to do so would have a Material Adverse Effect. The Company has fully disclosed to the Placement Agent the existence of each of its Affiliates. (l) The Company and each of its Affiliates possess all requisite licenses, permits and other authorities which may be required to conduct its business, each of which remains in full force and effect in accordance with its terms, where the failure to possess the same would have a Material Adverse Effect. The government authority which issued each such license has not determined or threatened to revoke or suspend any such license, no investigation or proceeding is pending or threatened with respect to any such license, and the Company has disclosed to the Placement Agent and in the Memorandum any current unresolved dispute or disagreement between the Company or any Affiliate and any such governmental authority regarding the business or financial condition of the Company or any Affiliate or the Company's or any Affiliate's alleged lack of compliance with applicable laws, rules or regulations, which dispute or disagreement if resolved adversely to the Company or any Affiliate would have a Material Adverse Effect. (m) The Company and each of its Affiliates is conducting business in compliance with all applicable federal, state and local laws, rules and regulations, including, without limitation, ERISA, OSHA, environmental laws, rules and regulations, and all federal laws, except where the failure to so comply would not have a Material Adverse Effect. (n) All representations, warranties and covenants of the Company made to investors in the Unit Purchase Agreement relating to the Units are hereby made to the Placement Agent and are incorporated herein by reference. (o) The Company has the legal right, corporate power and authority to enter into this Agreement on behalf of itself and to perform as contemplated thereby. All necessary and proper corporate proceedings have been or will be taken to validly authorize the Units and no further approval or authority of the stockholders of the Company is required for the offer and sale of the Units as contemplated herein and in the Memorandum. This Agreement has been duly authorized, executed and delivered by the Company, and is legally binding upon and enforceable against the Company in accordance with its terms, except as its enforceability may be limited by applicable bankruptcy, reorganization, insolvency, moratorium or other similar laws from time to time in effect affecting creditors' rights generally or by principles governing the availability of equitable remedies. 3 (p) The Units conform with the statements concerning them in the Memorandum in all material respects. (q) The consolidated financial statements of the Company, together with related notes and schedules as set forth in the Memorandum, present fairly in all material respects the financial position and the results of operations of the Company and its Affiliates, as at the dates and for the indicated periods. Such financial statements, schedules and related notes have been prepared in accordance with generally accepted accounting principles, consistently applied throughout the periods involved, and all adjustments necessary for a fair presentation of results for such periods have been made. The summary and selected financial and statistical data and schedules included in the Memorandum present fairly the information shown therein and have been compiled on a basis consistent with the financial statements presented therein. (r) There is no securities action, suit or proceeding pending or, to the best knowledge of the Company after due inquiry, threatened against the Company or any Affiliate before any court or regulatory, governmental or administrative agency or body, or arbitral forum, domestic or foreign, which might result in any Material Adverse Effect, except as set forth in the Memorandum. Neither the Company nor any Affiliate is subject to the provisions of any injunction, judgment, decree or order of any court, regulatory body, administrative agency or other governmental body or arbitral forum that would have a Material Adverse Effect, except as set forth in the Memorandum. There are no labor disputes involving the Company or any Affiliate that exist or are imminent which could have a Material Adverse Effect. (s) The Company and each of its Affiliates has good and marketable title to all of the properties and assets reflected as owned by such party in either the financial statements or as described in the Memorandum, and such properties and assets are subject to no lien, mortgage, security interest, pledge or encumbrance (other than easements, if any) of any kind, except those (i) reflected in such financial statements or as described in the Memorandum; or (ii) that, individually or in the aggregate, would not have a Material Adverse Effect. (t) The Company and each Affiliate has filed all federal, state, local and foreign income tax returns which have been required to be filed and has paid all taxes indicated by such returns and has paid all tax assessments against it where the failure to file or pay would have a Material Adverse Effect. There is no income, sales, use, transfer or other tax deficiency or assessment which has been or might reasonably be expected to be asserted or threatened against the Company or its Affiliates which could have a Material Adverse Effect. (u) Any material transactions among the Company and the officers, directors, and Affiliates of the Company have been accurately disclosed in the Memorandum to the extent necessary to make the statements therein, in light of the circumstances under which the Memorandum is to be used, not misleading. (v) If and to the extent required to do so, each of the Company and its Affiliates is in material compliance with all reporting requirements under Section 12(b), Section 12(g) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended ("EXCHANGE ACT"). 3. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE PLACEMENT AGENT. The Placement Agent represents, warrants and covenants to the Company that: 4 (a) The Placement Agent is a corporation duly organized, validly existing and in good standing under the laws of the State of Arizona, with all requisite power and authority to enter into this Agreement and to carry out its obligations hereunder; (b) This Agreement has been duly authorized, executed and delivered by the Placement Agent and is a valid and binding agreement on the part of the Placement Agent, except as its enforceability may be limited by applicable bankruptcy, reorganization, insolvency, moratorium or other similar laws from time to time in effect affecting creditors' rights generally or by principles governing the availability of equitable remedies. (c) The execution, delivery and performance of this Agreement and the consummation of the transactions contemplated herein and those contemplated by the Memorandum will not result in a material violation or breach of any of the terms or conditions of or constitute a default under any indenture, agreement, judgment, decree, order or other instrument to which the Placement Agent is a party which default would have a Material Adverse Effect upon the Placement Agent or its business, or, assuming the accuracy of the representations and warranties of the Company made herein, violate any law or any order directed to the Placement Agent of any court or any federal or state regulatory body or administrative agency having jurisdiction over the Placement Agent. (d) The Placement Agent is duly registered pursuant to the provisions of the Exchange Act as a broker-dealer and is a member in good standing of the National Association of Securities Dealers, Inc. ("NASD") and is duly registered as a broker-dealer in those states in which it is required to be so registered in order to carry out the Offering contemplated by the Memorandum. (e) The Placement Agent will conduct the Offering in compliance with applicable Securities Laws and Regulations and in this regard it will: (i) During the course of the Offering, make every reasonable effort to avoid making representations other than those set forth in the Memorandum, and to the extent any representations other than those set forth in the Memorandum are made, not to make any untrue statements of a material fact or omit to state a material fact required to be stated or necessary to make any statement made not misleading concerning the Offering or the Company or any matters set forth in or contemplated by the Memorandum not misleading; (ii) Not offer, offer for sale or sell the Units by any means prohibited by applicable Securities Laws and Regulations; (iii) Limit its offer and sale of the Units to persons who it has reasonable grounds to believe, based upon representations by those investors, are accredited investors, and maintain for the Placement Agent's benefit and for the benefit of the Company, memoranda and other appropriate records substantiating the foregoing; (iv) Prior to the sale of any of the Units, have reasonable grounds to believe, based upon representations by those investors, that each subscriber alone or together with such subscriber's duly appointed purchaser representative, if any, meets the suitability standards set forth in the Memorandum; (v) Distribute no sales materials to prospective investors, other than the Memorandum; 5 (vi) Provide each investor with a copy of the Memorandum during the course of the Offering prior to the investor executing a Unit Purchase Agreement; and (vii) Until the Closing Date (as defined below), if any event affecting the Company should occur which the Company, or its counsel, or the Placement Agent or its counsel believe should be set forth in a supplement or amendment to the Memorandum, the Placement Agent shall promptly distribute such supplement or amendment to the Memorandum to persons who have previously received a copy of the Memorandum from the Placement Agent and who continue to be interested in the Company, and the Placement Agent shall include such supplement or amendment in all further deliveries of the Memorandum. The Company shall, at its own expense, promptly prepare and furnish to the Placement Agent a reasonable number of copies of each such supplement or amendment to the Memorandum for such distribution. (f) Upon receipt of an executed Unit Purchase Agreement and the payments representing subscriptions for Units, the Placement Agent will promptly forward copies of the Unit Purchase Agreement (together with all consideration received for such Units, as applicable) to the Company or its counsel. (g) The Placement Agent will not take any action which, assuming the Company's representation in Section (2) hereof is correct, it believes would cause the Offering to violate the provisions of the Securities Act, the Securities and Exchange Act of 1934, (the "EXCHANGE ACT"), the respective rules and regulations promulgated thereunder or applicable Blue Sky laws of any state or jurisdiction. (h) The Placement Agent shall use commercially reasonable efforts to determine (i) whether any prospective purchaser is an Accredited Investor (or qualified non-Accredited Investor) and (ii) that any material information furnished by a prospective investor is true and accurate. Except as set forth in the immediately preceding sentence, the Placement Agent shall have no obligation to insure that any check, note, draft or other means of payment for the Units will be honored, paid or enforceable against the subscriber in accordance with its terms. 4. FURTHER UNDERTAKINGS OF THE COMPANY. The Company represents, covenants and warrants that: (a) Except as set forth or otherwise contemplated in the Memorandum, the Company shall not offer for sale or sell the Units, nor shall any employee or agent of the Company do so, during the Offering without the prior approval of the Placement Agent. (b) Until the Closing Date (as defined below), if any event affecting the Company shall occur which, in the Company's or the Placement Agent's opinion, should be set forth in a supplement or an amendment to the Memorandum, the Company will forthwith, at its own expense, prepare and furnish to the Placement Agent a reasonable number of copies of a supplement or amendment to the Memorandum so that it, as so supplemented or amended, will not contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading. The Company shall not prepare or file any such amendment or supplement of which the Placement Agent shall not previously have been advised and furnished with a copy or to which the Placement Agent shall have reasonably objected in writing or which is not in compliance with applicable Securities Laws and Regulations. (c) The Company will cause to be prepared, executed and timely filed with respect to the Offering, any and all notices or filings required by applicable Securities Laws and Regulations, will promptly furnish the Placement 6 Agent and its counsel with a true and correct copy of each such notice of filing and will take all acts necessary or appropriate to comply with all applicable Securities Laws and Regulations. (d) The Company will apply the net proceeds from the sale of the Units substantially in accordance with the use of proceeds section of the Memorandum. 5. STATE SECURITIES FILINGS. The Company further represents, warrants and covenants that: (a) It shall take all necessary action and file all necessary forms and documents required to be filed in connection with an offering exempt from registration pursuant to the Securities Act in the State of Arizona, and in such other states as the Placement Agent and the Company mutually agree. (b) In each jurisdiction where the Units have been offered in an exempt transaction as provided above after notice from the Placement Agent of such an offer in each jurisdiction, the Company will make and file such statements, documents, materials and reports in each year and take all other actions as are or may be required to be made or filed by the Company by the laws of each such jurisdiction. (c) The Company will promptly provide to the Placement Agent for delivery to all purchasers and their representatives any additional information, documents and instruments which the Placement Agent or the Company deems necessary to comply with the rules, regulations and judicial and administrative interpretations with respect to compliance with such exemptions or qualifications and registration requirements in those states where the Units are to be offered or sold. 6. APPOINTMENT OF THE PLACEMENT AGENT AND NATURE OF THE OFFERING. (a) On the basis of the representations, warranties and covenants herein contained, and subject to the conditions herein set forth, the Company hereby appoints the Placement Agent as its exclusive agent to effect sales of the Units during the Offering Period (hereinafter defined) and upon the terms and conditions set forth in the Memorandum. The Placement Agent hereby accepts such appointment and, as agent for the Company, shall use its best efforts to find purchasers for the Units. (b) The Offering shall commence on the date designated by the Placement Agent and the Company shall continue until the earlier of (i) the maximum number of Units described in the Memorandum, or (ii) April 30, 2004, or a date thereafter mutually agreed upon by the parties. The offering period may be extended for a period of up to sixty (60) days at the discretion of the Company. (c) The Placement Agent shall remit all funds received from purchasers of the Units to the Company on the Closing Date. Payment for the Units sold is to be made by certified or bank cashier's check(s) drawn to the order of the Company, or by wire transfer of funds, against delivery of such Units to the Placement Agent. Such payment and delivery is to be made at the offices of the Placement Agent set forth in SECTION 14 hereof at 10:00 A.M., Phoenix time, on the third business day after the sale, or at such other time, date and place not later than five business days thereafter as the Placement Agent and the Company shall agree upon (such time and date the "CLOSING DATE"). The common stock comprising a portion of the Units, which shall be represented by certificates in definitive form, and the Senior Notes comprising a portion of the Units shall be made to the order of such holders of Units as the Placement Agent requests in writing not later than the third full business day prior to the Closing Date, and shall be made available for inspection by the Placement Agent prior to the Closing Date at the offices of the Placement Agent noted in SECTION 14. As used herein, "BUSINESS DAY" means a day other than (i) a Saturday 7 or a Sunday or (ii) a day on which banks in Arizona are authorized or obligated by law or executive order to be closed. (d) The Placement Agent shall be entitled to (i) a commission equal to ten percent (10%) of the gross amount raised through the sale of the Units and, (ii) reimbursement for all reasonable expenses incurred by the Placement Agent in connection with the sale of the Units, including fees and expenses of Placement Agent's legal counsel incurred in connection with this Agreement, the Unit Purchase Agreement, and the Offering; PROVIDED, HOWEVER, that the Company shall not be liable for any expense, other than legal expenses incurred in connection with the offering, exceeding $5,000 without the prior consent of the Company. In addition, the Placement Agent will be granted a three-year warrant (the "WARRANT") equal to ten percent (10%) of the shares of Common Stock sold in the Offering. The Warrant shall be exercisable at 120% of the Offering Price of the Common Stock. The Warrant will have net exercise rights and piggyback registration rights. On the Closing Date, the Placement Agent shall deduct the commission and expenses from the proceeds received from the sale of the Units prior to transmitting payment to the Company. (e) The Placement Agent has not assumed, will not assume, and will not be permitted to assume any duties, responsibilities or obligations regarding the management, operations or any of the business affairs of the Company after the Closing Date. The Placement Agent shall be held harmless by the Company from and against any claim, suit, loss, damage, liability or securities action by or against the Company based upon or arising out of the assertion that the Placement Agent has any continuing duty or obligations after the Closing Date to the Company, except the indemnification obligations as set forth in SECTION 11 of this Agreement. 7. EXPENSES OF SALE. Subject to SECTION 6(D), the Company will pay all reasonable costs, expenses and fees in connection with the Offering or incident to the performance of the obligations of the Company hereunder including, but not limited to, the fees and expenses of the Company, the fees and expenses of the Company's counsel and accounting firm, the fees and expenses of the Placement Agent's counsel, the cost of qualifying the offer and sale of the Units in various states for an exemption from state registration requirements, the cost of preparing, printing and delivering the Memorandum to, or as requested by, the Placement Agent, the Units and copies of the Memorandum and other documents related to the Offering, and any transfer taxes imposed on the sale of the Units. If the transactions contemplated by this Agreement shall not be consummated because this Agreement is terminated by the Placement Agent pursuant to SECTION 8, 9 OR 12 hereof, or because of a decision by the Company to terminate or delay the Offering for any reason or a failure, refusal or inability on the part of the Company to perform any undertaking or satisfy any condition of this Agreement or to comply with any of the terms hereof on its part to be performed, then in lieu of the foregoing provisions in this SECTION 7 (and without prejudice to all other rights and remedies which the Placement Agent may have against the Company at law and in equity, and which are in accordance with the NASD's Rules of Fair Practice) the Company shall reimburse the Placement Agent for all reasonable costs and expenses, including all fees and disbursements of the Placement Agent's counsel, actually incurred by the Placement Agent in connection with investigating, marketing and proposing to market the Units or in contemplation of performing its obligations hereunder. 8. CONDITIONS TO THE PLACEMENT AGENT'S OBLIGATIONS. The Company's right to receive proceeds from the sale of the Units and the obligations of the Placement Agent hereunder shall be subject to the accuracy of and compliance with, as of the date hereof and on the Closing Date, the representations, covenants and warranties contained herein, to the performance by the Company of its obligations hereunder required to be performed on or before the Closing Date, and to the following additional conditions: 8 (a) During the period of the Offering there has not been any material adverse change affecting the Company. (b) No stop order suspending the Offering contemplated herein or use of the Memorandum, as amended or supplemented, shall have been issued and no proceedings for that purpose shall have been taken or, to the best knowledge of the Company, after due inquiry, shall be contemplated by the Regulators. (c) The Placement Agent shall have received on the Closing Date the opinion of Jackson Walker, LLP, counsel for the Company, in a form reasonably satisfactory to the Placement Agent. Such opinion shall be dated as of the Closing Date and addressed to the Placement Agent. (d) The Placement Agent shall have received on the Closing Date a certificate or certificates of the Chief Executive Officer and the Chief Financial Officer of the Company to the effect that, as of the Closing Date, each of them jointly and severally represents as follows: (i) No stop order suspending the Offering contemplated herein or use of the Memorandum has been issued, and no proceedings for such purpose have been taken or are, to the best of their knowledge, after due inquiry, contemplated or threatened by the Regulators; (ii) They do not know of any material investigation, litigation, or proceeding instituted or threatened or contemplated against the Company which is not disclosed in the Memorandum. The representations and warranties of the Company contained in SECTION 2 hereof are true and correct in all respects as of the Closing Date as if such representations and warranties were made as of such date; (iii) They have carefully examined the Memorandum and, in their opinion, at the time the Memorandum was distributed or used and at the Closing Date and through the date the Offering is terminated, the statements contained in the Memorandum were and are correct, in all material respects, and such Memorandum does not omit to state a material fact required to be stated therein or necessary in order to make the statements therein not misleading and, in their opinion, no event has occurred which should be set forth in a supplement to or an amendment of the Memorandum which has not been so set forth in such supplement or amendment; (iv) The Company has performed all of its obligations pursuant to this Agreement required to be performed on or prior to the Closing Date; and (v) The Company has provided all due diligence materials requested by the Placement Agent. (e) The Company shall have furnished to the Placement Agent such further certificates and documents confirming the representations, warranties and covenants contained herein and related matters as the Placement Agent may reasonably have requested. The opinions and letters described in this Agreement shall be addressed to the Placement Agent. The opinions, letters and certificates described in this Agreement shall be deemed to be in compliance with the provisions hereof only if they are in all respects satisfactory in form and substance to the Placement Agent and to counsel for the Placement Agent. If any of the conditions provided for in this SECTION 8 shall not have been fulfilled when and as required by this Agreement to be fulfilled, the obligations of the Placement Agent hereunder may be terminated by the Placement Agent by notifying the Company of such termination in writing or by 9 telegram at or prior to the Closing Date. In such event, the Company and the Placement Agent shall not be under any obligation to each other (except to the extent provided in SECTIONS 7 AND 11 hereof). 9. CONDITIONS OF COMPANY'S OBLIGATIONS. The obligations of the Company (other than its obligations under SECTIONS 7 AND 11 hereof) shall be subject to: (i) the accuracy of and compliance with, as of the date hereof and on the Closing Date, the representations, covenants and warranties contained herein made by the Placement Agent, and (ii) the performance by the Placement Agent of its material obligations required to be performed on or before the Closing Date. 10. PLACEMENT AGENT'S AUTHORITY. Neither the Placement Agent nor any of its representatives is authorized to make any representations on behalf of the Company other than those contained in the Memorandum or to act as the agent of the Company in any other capacity except as expressly set forth herein. 11. INDEMNIFICATION AND CONTRIBUTION. (a) The Company will indemnify and hold the Placement Agent harmless for, from and against any losses, claims, damages or liabilities, joint or several, to which the Placement Agent may become subject under applicable Securities Laws and Regulations, including, but not limited to, any applicable state securities laws or regulations or otherwise, insofar as such losses, claims, damages or liabilities (or securities actions with respect thereto) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any material fact contained in the Memorandum, any amendment or supplement thereto, any additional information provided with respect to the Offering or that arises out of or is based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading and/or (ii) a breach by the Company of the representations, covenants, agreements and warranties contained in this Agreement; and will reimburse the Placement Agent for any legal or other expense reasonably incurred in connection with investigating or defending any such loss, claim, damage, liability or securities actions. The foregoing indemnity agreement shall extend upon the same terms and conditions to, and shall inure to the benefit of, the Placement Agent's officers, directors and counsel, and each person, if any, who "controls" the Placement Agent. (b) The Placement Agent will indemnify and hold the Company harmless for, from and against any losses, claims, damages or liabilities, joint or several, to which the Company may become subject under the applicable Securities Laws and Regulations, the various state securities laws or regulations or otherwise, insofar as such losses, claims, damages or liabilities (or securities actions with respect thereto) arise out of or are based upon a breach by the Placement Agent of the representations, covenants and warranties contained in SECTION 3 of this Agreement; and will reimburse the Company for any legal or other expenses reasonably incurred in connection with investigating or defending any such loss, claim, damage, liability or securities actions. Notwithstanding the preceding sentence, the Placement Agent shall in no event be liable for any lost profits or loss of bargain damages of the Company. The foregoing indemnity agreement shall extend upon the same terms and conditions to, and shall inure to the benefit of, the Company's officers, directors, and counsel, and each person, if any, who "controls" the Company. (c) Promptly after receipt by an indemnified person of notice of the commencement of any securities action, such indemnified person shall, if a claim in respect thereof is to be made against the indemnifying party pursuant to this SECTION 11, notify the indemnifying party in writing of the commencement 10 thereof; but the omission to so notify the indemnifying party shall not relieve it from any liability which it may have to any indemnified party. In case any such securities action shall be brought against such indemnified party, it shall notify the indemnifying party of the commencement thereof, and the indemnifying party shall be entitled to participate in, and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel approved by the indemnified party. The indemnified party shall not be responsible for any legal or other expenses incurred by such indemnified party in connection with the defense thereof, other than reasonable costs of investigation. (d) If the indemnification provided for in this SECTION 11 is unavailable to or insufficient to hold harmless an indemnified party under SECTION 11(A) above in respect of any losses, claims, damages or liabilities referred to therein, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities in such proportion as is appropriate to reflect the relative benefits received by the Company on the one hand and the Placement Agent on the other from the Offering of the Units. If, however, the allocation provided by the immediately preceding sentence is not permitted by applicable law, then each indemnifying party shall contribute to such amount paid or payable by such indemnified party in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of the Company on the one hand and the Placement Agent on the other in connection with the statements, omissions or breaches which resulted in such losses, claims, damages or liabilities, as well as any other relevant equitable considerations. The relative benefits received by the Company on the one hand and the Placement Agent on the other shall be deemed to be in the same proportion as the total net proceeds from the Offering (before deducting expenses) received by the Company bear to the total commissions received by the Placement Agent. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company on the one hand or the Placement Agent on the other and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and the Placement Agent agree that it would not be just and equitable if contributions pursuant to this SECTION 11(D) were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to above in this SECTION 11(D). The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities referred to above in this SECTION 11(D) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such securities action or claim. Notwithstanding the provisions of this SECTION 11(D), (i) the Placement Agent shall not be required to contribute any amount in excess of the commission received by it, and (ii) no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. In any proceeding relating to the Memorandum or any supplement or amendment thereto, each party against whom contribution may be sought under this SECTION 11(D) hereby consents to the jurisdiction of any court having jurisdiction over any other contributing party, agrees that process issuing from such court may be served upon them or it by any other contributing party and consents to the service of such process and agrees that any other contributing party may join them as an additional defendant in any such proceeding in which such other contributing party is a party. 11 12. TERMINATION. This Agreement may be terminated by the Placement Agent or the Company, as the case may be, by notice to the other party as follows: (a) at any time prior to the closing itself if any of the following has occurred: (i) since the respective dates as of which information is given in the Memorandum, any material adverse change or any development involving a prospective material adverse change in or affecting the condition, financial or otherwise, of the Company, or the earnings, business affairs, management or business prospects of the Company, whether or not arising in the ordinary course of business; (ii) any outbreak of hostilities, act of terrorism or other national or international calamity or crisis or change in economic or political conditions if the effect of such outbreak, calamity, crisis or change on the financial markets or economic conditions would, in the Placement Agent's or the Company's reasonable judgment, make the offering or delivery of the Units impracticable; (iii) suspension of trading in securities on the American Stock Exchange or limitation on prices (other than limitations on hours or numbers of days of trading) for securities on such Exchange; (iv) the enactment, publication, decree or other promulgation of any federal or state statute, regulation, rule or order of any code or other governmental authority which in the Placement Agent's or the Company's reasonable opinion materially adversely affects or will materially adversely affect the business or operations of the Company; (v) the taking of any securities action by any federal, state or local government or agency in respect of its monetary or fiscal affairs which in the Placement Agent's or the Company's reasonable opinion has a material adverse effect on the securities markets in the United States or the prospects of the Company; or (vi) if the Placement Agent's "due diligence" review discloses information which (A) is in any material respect inconsistent with the information previously provided to the Placement Agent; (B) discloses matters concerning the business (past, current or prospective) of the Company not previously fully disclosed to the Placement Agent; or (C) would require any material amendment or modification to the Memorandum previously circulated to reflect additional risk factors or material changes which may have a Material Adverse Effect; and (b) failure of the Company or the Placement Agent to fulfill the obligations set forth in SECTION 8 or 9. 13. REPRESENTATIONS AND AGREEMENTS TO SURVIVE DELIVERY. All representations, warranties and agreements of the Company and the Placement Agent, herein or in certificates delivered pursuant hereto, and the indemnity agreement provisions contained in SECTION 11 hereof, shall survive the delivery, execution and closing hereof and shall remain operative and in full force and effect regardless of any investigation made by or on behalf of the Placement Agent or the Company, and shall survive delivery of the Units hereunder. The indemnification provisions of SECTION 11 hereof are in addition to any and all other remedies or rights any of the parties hereto may have, including the right to sue and recover damages for any breach of any representation, warranty or covenant made or given by one or more parties to any other party. 12 14. NOTICES. All notices required or permitted hereunder shall be in writing and shall be mailed, delivered or telegraphed to the following address: If to the Placement Agent: Peacock, Hislop, Staley & Given, Inc. 2999 North 44th Street Suite 100 Phoenix, Arizona 85018 Attention: Tom Thomas, Managing Director with a copy to Placement Agent Counsel: Greenberg Traurig, LLP 2375 East Camelback Road, Suite 700 Phoenix, Arizona 85016 Attention: Quinn P. Williams, Esq. If the Company: iLinc Communications, Inc. 2999 North 44th Street, Suite 650 Phoenix, Arizona 85018 Attention: James L. Dunn, Jr. Any such notices shall be either (a) sent by certified mail, return receipt requested, in such case notice shall be deemed delivered three (3) business days after deposit, postage prepaid, in the U.S. mail, or (b) personally delivered to recipient or sent by a nationally recognized overnight courier, in which case it shall be deemed delivered upon receipt, if personally delivered, or one (1) business day after deposit with an overnight courier for overnight delivery. The above addresses may be changed by written notice to the other party; provided, however, that no notice of a change of address shall be effective until actual receipt of such notice. 15. PARTIES. This Agreement shall inure to the benefit of and be binding upon the Placement Agent and the Company and each of their respective successors and assigns and, if expressly applicable, their Affiliates. Nothing expressed or mentioned in this Agreement is intended or shall be construed to give any person or corporation, other than the parties hereto and their respective successors and assigns, Affiliates, and the controlling persons, officers, directors and counsel referred to in SECTION 11, any legal or equitable right, remedy or claim under or with respect to this Agreement and all conditions and provisions hereof are intended to be and are for the sole and exclusive benefit of the parties hereto. No purchaser of any of the Units shall be construed a successor or assignee by reason merely of such purchase. "AFFILIATE" means a Person who, with respect to any other Person: (a) directly or indirectly controls, is controlled by or is under common control with such other Person; (b) owns or controls 10 percent or more of the outstanding voting securities of such other Person; (c) is an officer, director, partner or member of such other Person, or (d) if such other Person is an officer, director, partner or member, any Person for which such other Person acts in any such capacity. "PERSON" means an individual or a firm, corporation, partnership, limited liability company, association, estate, trust, pension or profit-sharing plan, or any other entity. 16. SEVERABILITY. Every provision in this Agreement is intended to be severable. If any term or provision hereof is illegal or invalid for any reason whatsoever, such illegality or invalidity shall not affect the validity of the remainder hereof. 17. CAPTIONS. The captions or headings in this Agreement are inserted for convenience and identification only and are in no way intended to describe, interpret, define, or limit the scope, extent, or intent of this Agreement or any provision hereof. 13 18. APPLICABLE LAW. This Agreement and all disputes and controversies relating hereto or in connection with the transactions contemplated hereby shall be governed by and construed in accordance with the internal laws of the State of Arizona without regard to choice or conflict of law principals. 19. JURISDICTION AND VENUE. Each of the parties to this Agreement hereby agree that all actions or proceedings arising in connection with this Agreement shall be tried and litigated only in the state and federal courts located in the County of Maricopa, State of Arizona. The Company hereby waives any right it may have to assert the doctrine of forum non conveniens or to object to the venue to the extent any proceeding is brought in accordance with this SECTION 19 and stipulates that the state and federal courts located in the County of Maricopa, State of Arizona, shall have in personam jurisdiction and venue over the Company for the purpose of litigating any such dispute, controversy or proceeding arising out of or related to this Agreement. Service of process sufficient for personal jurisdiction in any action against either party hereto may be made by registered or certified mail, return receipt requested to its address indicated in SECTION 14. 20. PRIOR AGREEMENTS. This Agreement supersedes all prior agreements, oral or written, covered in the same subject matter. 21. COUNTERPARTS. This Agreement and any notices delivered hereunder may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. This Agreement and any and all notices may be delivered by telecopy and shall be effective upon receipt, with the original of such document to be deposited promptly in the U.S. Mail. IN WITNESS WHEREOF, the parties hereto have executed this Agreement this 12th day of March, 2004, to be effective as of the date first written above. ILINC COMMUNICATIONS, INC. PEACOCK, HISLOP, STALEY & GIVEN, INC. (Company) (Placement Agent) By: __________________________________ By: __________________________________ Name: ________________________________ Name: ________________________________ Title: _______________________________ Title: _______________________________ 14 EX-12 6 ilinc_10kex12.txt EXHIBIT 12 ILINC COMMUNICATIONS, INC. RATIO OF EARNINGS TO FIXED CHARGES The following table sets forth the Company's earnings to fixed charges for the periods indicated: YEAR ENDED MARCH 31, ----------------------------------- 2004 2003 2002 ----------- ---------- ---------- Ratio of Earnings to Fixed Charges (a) (a) (a) (a) (a) Due to the loss recorded in 2004, 2003 and 2002 the ratio coverage was less than 1:1. The Company would have needed to generate additional earnings of $2.3 million, $3.9 million and $1.1 million to achieve a ratio coverage of 1:1 in 2004, 2003 and 2002. (b) For the purposes of computing the consolidated ratio of earnings to fixed charges, earnings consist of income before income taxes and extraordinary items. Fixed charges consist of interest on all indebtedness, amortization of debt discount and expense, and that portion of rental expense that we believe to be representative of interest. EX-21.1 7 ilinc_10kex21-1.txt EXHIBIT 21.1 SUBSIDIARIES OF THE REGISTRANT 1. Liberty Acquisition Corporation, a Tennessee corporation and wholly owned subsidiary of iLinc Communications, Inc. 2. Special Omega Acquisition Corporation, a Delaware corporation and wholly owned subsidiary of iLinc Communications, Inc. 3. Pentegra Investments, Inc., a Delaware corporation and wholly owned subsidiary of iLinc Communications, Inc. 4. Edge Acquisition Subsidiary, Inc., a Delaware Corporation and wholly owned subsidiary of iLinc Communications, Inc. 5. TW Acquisition Subsidiary, Inc., a Delaware Corporation and wholly owned subsidiary of iLinc Communications, Inc. EX-23.1 8 ilinc_10kex23-1.txt EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-71332) of iLinc Communications, Inc., of our report dated May 21, 2004, except for Note 18, as to which the date is June 21, 2004, relating to the consolidated financial statements which appears in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated May 21, 2004, except for Note 18, as to which the date is June 21, 2004, relating to the financial statement schedule, which appears in this Form 10-K. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has a significant working capital deficiency and has suffered substantial recurring losses and negative cash flows from operations. These matters, among others, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are described in Note 2. The long-term continuation of the Company is dependent on the Company's ability to raise additional equity or debt capital, to increase its revenues, to generate positive cash flows from operations and to achieve profitability. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ BDO Seidman, LLP Costa Mesa, California June 29, 2004 EX-23.2 9 ilinc_10kex23-2.txt EXHIBIT 23.2 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-71332) of iLinc Communications, Inc., of our report dated July 11, 2002, which appears in this Form 10-K. We also consent to the incorporation by reference of our report dated July 11, 2002 relating to the financial statement schedules which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP Phoenix, Arizona June 29, 2004 EX-31.1 10 ilinc_10kex31-1.txt EXHIBIT 31.1 CERTIFICATION I, James M. Powers, Jr. certify that: 1. I have reviewed this annual report on Form 10-K of iLinc Communications, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure control and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and; 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, possess, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. By: /s/ James M. Powers, Jr. - ------------------------------------ James M. Powers, Jr., Chairman of the Board, President and Chief Executive Officer June 29, 2004 EX-31.2 11 ilinc_10kex31-2.txt EXHIBIT 31.2 CERTIFICATION I, James L. Dunn, Jr. certify that: 1. I have reviewed this annual report on Form 10-K of iLinc Communications, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure control and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and; 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, possess, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. By: /s/ James L. Dunn, Jr. - --------------------------- James L. Dunn, Jr. Senior Vice President and Principal Financial Officer June 29, 2004 EX-32.1 12 ilinc_10kex32-1.txt EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of iLinc Communications, Inc. (the "Company") on Form 10-K for the period ending March 31, 2004 as filed with the Securities Exchange Commission on the date here of (the "Report"). I, James M. Powers, Jr., Chief Executive Officer of the Company, hereby certify, to my knowledge, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company in respect to those items required to be described or presented in such Report under Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934. By: /s/ James M. Powers, Jr. - ------------------------------------ James M. Powers, Jr., Chairman of the Board, President and Chief Executive Officer June 28, 2004 EX-32.2 13 ilinc_10kex32-2.txt EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of iLinc Communications, Inc. (the "Company") on Form 10-K for the period ending March 31, 2004 as filed with the Securities Exchange Commission on the date here of (the "Report"). I, James L. Dunn, Jr., Senior Vice President and Principal Financial Officer of the Company, hereby certify, to my knowledge, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company in respect to those items required to be described or presented in such Report under Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934. By: /s/ James L. Dunn, Jr. - --------------------------- James L. Dunn, Jr. Senior Vice President and Principal Financial Officer June 28, 2004 -----END PRIVACY-ENHANCED MESSAGE-----