###### Exhibit 99.1

 

 

### VILLAGEEDOCS

 

###### Financial Statements

Forthe Years December 31, 2003 and 2002

Togetherwith Independent Auditors' Report

** **

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**INDEPENDENT AUDITORS' REPORT**

** **

To the Boardof Directors of VillageEDOCS

 

We haveaudited the accompanying balance sheet of VillageEDOCS (the "Company"), a California corporation, as ofDecember 31, 2003, and the related statements of operations, stockholders'deficit and cash flows for each of the years in the two-year period then ended.These financial statements are the responsibility of the Company's management.Our responsibility is to express an opinion on these financial statements basedon our audits. 

We conductedour audits in accordance with auditing standards generally accepted in theUnited States of America. Those standards require that we plan and perform theaudits to obtain reasonable assurance about whether the financial statementsare free of material misstatement. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

In ouropinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of VillageEDOCS at December 31, 2003,and the results of its operations and its cash flows for each of the years inthe two-year period then ended in conformity with accounting principlesgenerally accepted in the United States of America.

Theaccompanying financial statements have been prepared assuming that the Companywill continue as a going concern.  Asdiscussed in Note 2 to the financial statements, the Company has incurred bothsignificant operating losses and has significant negative cash flows fromoperations for the years ended December 31, 2003 and 2002, and has a workingcapital deficit of $151,295 and a stockholders' deficit of $2,941,140 atDecember 31, 2003.  These factors, amongothers, raise substantial doubt as to the Company's ability to continue as agoing concern.  Management's plans inregard to these matters are described in Note 2.  The financial statements do not include any adjustments relatingto the recoverability and classification of asset carrying amounts or theamount and classification of liabilities that might result should the Companybe unable to continue as a going concern.

 

                                                                                                /s/Corbin& Company, LLP

Irvine,California

February 20,2004

 

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| **VillageEDOCS**                                                                                                                       |  |                                                                                                                                                                               |
|----------------------------------------------------------------------------------------------------------------------------------------|--|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Balance Sheet**                                                                                                                 |  |                                                                                                                                                                               |
|                                                                                                                                        |  | **December 31, **                                                                                                                                                   |
|                                                                                                                                        |  | **2003 **                                                                                                                                                                |
|                                                                                                                                        |  |  **------------------------------- **                                                                                                                               |
|                                                                                                                                        |  |                                                                                                                                                                               |
| **ASSETS**                                                                                                                             |  |                                                                                                                                                                               |
| Current assets:                                                                                                                   |  |                                                                                                                                                                               |
|    Cash                                                                                                                 |  |  $                      64,702                        |
|    Accounts receivable, net of allowance for doubtful                                     |  |                                                                                                                                                                               |
|       accounts of $30,000                                                                      |  |                        198,448                        |
|                                                                                                                                        |  |  --------------------------                                                                                                                                         |
|          Total current assets                                                   |  |                        263,150                        |
|                                                                                                                                        |  |                                                                                                                                                                               |
| Property and equipment, net                                                                                             |  |                        147,892                        |
| Web site development costs, net                                                                                    |  |                          43,208             |
| Other assets                                                                                                                      |  |                            6,888  |
|                                                                                                                                        |  |  --------------------------                                                                                                                                         |
|                                                                                                                                        |  |  $                    461,138                                   |
|                                                                                                                                        |  |  =================                                                                                                                                                  |
|                                                                                                                                        |  |                                                                                                                                                                               |
|                                                                                                                                        |  |                                                                                                                                                                               |
| **LIABILITIES AND STOCKHOLDERS' DEFICIT**                                                                               |  |                                                                                                                                                                               |
| Current liabilities:                                                                                                              |  |                                                                                                                                                                               |
|    Accounts payable                                                                                                |  |  $                    150,399                                   |
|    Accrued expenses                                                                                                |  |                        253,380                        |
|    Current portion of capital lease obligations                                                |  |                          10,666             |
|                                                                                                                                        |  |  --------------------------                                                                                                                                         |
|         Total current liabilities                                                    |  |                        414,445                        |
|                                                                                                                                        |  |                                                                                                                                                                               |
| Capital lease obligations, net of current portion                                                        |  |                            8,352  |
| Convertible notes and accrued interest                                                                             |  |                                                                                                                                                                               |
|    payable to related parties                                                                            |  |                     2,979,481                                        |
|                                                                                                                                        |  |  --------------------------                                                                                                                                         |
|         Total liabilities                                                                 |  |                     3,402,278                                        |
|                                                                                                                                        |  |  --------------------------                                                                                                                                         |
|                                                                                                                                        |  |                                                                                                                                                                               |
|                                                                                                                                        |  |                                                                                                                                                                               |
| Stockholders' deficit:                                                                                                            |  |                                                                                                                                                                               |
|    Common stock, no par value:                                                                 |  |                                                                                                                                                                               |
|       Authorized -- 90,000,000 shares                                                     |  |                                                                                                                                                                               |
|            Issued and outstanding -- 31,135,525 shares |  |                     6,972,683                                        |
| Additional paid-in capital                                                                                                   |  |                     2,056,732                                        |
| Accumulated deficit                                                                                                               |  |                 (11,970,555)                                                                  |
|                                                                                                                                        |  |  --------------------------                                                                                                                                         |
|          Total stockholders' deficit                                            |  |                   (2,941,140)                                                       |
|                                                                                                                                        |  |  --------------------------                                                                                                                                         |
|                                                                                                                                        |  |  $                    461,138                                   |
|                                                                                                                                        |  |  =================                                                                                                                                                  |
|                                                                                                                                        |  |                                                                                                                                                                               |
| See independent auditors' report and accompanying notes to financial statements.          |
|                                                                                                                                        |  |                                                                                                                                                                               |

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| **VillageEDOCS**                                                                           |        |        |        |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             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|                                                                                            |   |   |   |   |
| **Statements of Operations**                                                     |        |        |        |        |
| **For the Years Ended December 31, 2003 and 2002** |        |        |
|                                                                                            |        |        |        |        | **    Years Ended December 31, ****2003****2002**** --------------------------- **** --------------------------- **Net sales $            1,882,027  $             1,611,546       Cost of sales                  920,410                    803,983  -----------------------  -----------------------                Gross profit                  961,617                    807,563  -----------------------  -----------------------       Operating expenses:            Product and technology               development                  488,115                    432,293             Sales and marketing                  806,138                    564,633             General and administrative                  922,332                    714,962             Depreciation and amortization                  148,975                    123,331  -----------------------  -----------------------                Total operating expenses               2,365,560                 1,835,219  -----------------------  -----------------------                Loss from operations              (1,403,943)              (1,027,656)      Interest expense                 (661,659)                 (263,847)      Loss on buyout of leased equipment                   (39,943)                            -    -----------------------  -----------------------                Loss before provision for                   income taxes              (2,105,545)              (1,291,503)      Provision for income taxes                         800                           800  -----------------------  -----------------------                Net loss $           (2,106,345) $           (1,292,303) =============  =============       Basic and diluted loss available to         common stockholders per common   share $                    (0.07) $                    (0.05) =============  =============       Weighted average shares outstanding             30,828,738               24,102,729  =============  =============       See independent auditors' report and accompanying notes to financial statements.
 

 
**VillageEDOCS****Statements of Stockholders' Deficit****For the Years Ended December 31, 2003 and 2002** 
**Common Stock ****---------------------------------------****Additional****Accumulated ****Shares****Amount****Paid-in Capital****Deficit****Total****------------------****-------------------****---------------------****-------------------****---------------------**Balances, January 1, 2002     14,050,146  $    4,758,176  $       1,289,324  $   (8,571,907) $       (2,524,407)      Common stock issued for exercise of warrants          212,839               2,129                       -                        -                     2,129 Common stock issued for  conversion of debt     15,686,502        2,039,245                       -                        -              2,039,245 
Common stock issued to non-employees for services            32,000               6,000                       -                        -                     6,000       Warrants issued to employees for services                    -                       -                  25,565                      -                   25,565 Estimated fair market value of   options granted to employees and   non-employees for services                    -                       -                  95,800                      -                   95,800       Estimated value of beneficial conversion        feature on new convertible notes payable                    -                       -                  94,429                      -                   94,429 Net loss                    -                       -                         -         (1,292,303)          (1,292,303)-------------------------------------------------------------------------------------Balances, December 31, 2002     29,981,487        6,805,550           1,505,118       (9,864,210)          (1,553,542)      Common stock issued to employees and   non-employees for services       1,154,038           167,133                       -                        -                 167,133       Estimated value of beneficial conversion        feature on new convertible notes payable                    -                       -                471,586                      -                 471,586 Estimated fair market value of        options granted to employees and   non-employees for services                    -                       -                  80,028                      -                   80,028 Net loss                    -                       -                         -         (2,106,345)          (2,106,345)-------------------------------------------------------------------------------------Balances, December 31, 2003     31,135,525  $    6,972,683  $       2,056,732  $ (11,970,555) $       (2,941,140) ==========  ==========  ==========  ==========  ===========       See independent auditors' report and accompanying notes to financial statements.          
 

 
**VillageEDOCS**                    **Statements of Cash Flows****For the Years Ended December 31, 2003 and 2002****2003****2002****------------------------****------------------------**      Cash Flows from Operating Activities:Net loss $           (2,106,345) $              (1,292,303)      Adjustments to reconcile net loss to net cash         used in operating activities:            Depreciation and amortization          148,975                       123,331             Provision for doubtful accounts receivable                    16,502                         41,416             Estimated fair market value of stock options issued                to employees and non-employees for services rendered                    80,028                         94,806             Stock purchase warrants issued to employees for               services rendered                              -                         25,565             Imputed interest expense on convertible debentures                  471,586                         94,429             Common stock issued to employees and               non- employees for services rendered                  143,133                           6,000             Common stock issued for settlement of debt                    24,000                                   -             Loss on buyout of leased equipment                    39,943                                   -             Changes in operating assets and liabilities:                  Accounts receivable                 (112,630)                      (61,174)                  Other current assets                    18,487                           4,325                   Accounts payable                   (53,940)                      (25,010)                  Accrued expenses and other                  330,500                       147,228 ------------------------------------------------                        Net cash used in operating activities                 (999,761)                    (841,387)------------------------------------------------      Cash Flows from Investing Activities:            Purchases of property and equipment                   (69,263)                      (44,727)            Payments for buyout of leased equipment                   (10,919)                                  -             Web site development costs                              -                     (107,667) ------------------------ ------------------------                        Net cash used in investing activities                   (80,182)                    (152,394) ------------------------ ------------------------      Cash Flows from Financing Activities:         Proceeds from convertible notes payable to related parties               1,132,000                    1,110,000          Principal payments under capital leases                   (40,682)                    (104,342)         Proceeds from the exercise of warrants                              -                           2,129  ------------------------ ------------------------                        Net cash provided by financing activities               1,091,318                    1,007,787  ------------------------ ------------------------         Net change in cash                    11,375                         14,006          Cash, beginning of period                    53,327                         39,321 ------------------------------------------------         Cash, end of period $                 64,702  $                     53,327  ==============  ==============       Supplemental disclosure of cash flow information -         Cash paid during the period for:                        Interest $                   5,284  $                     22,091  ==============  ==============                         Income taxes $                      800  $                          800  ==============  ============== continued.

 

 
Supplemental Schedule of Noncash Investing and      Financing Activities:         During the year ended December 31, 2003, the Company financed certain      computer equipment totaling $21,233   through      capital leases.         During the year ended December 31, 2002, the Company converted      $2,039,245 of related party notes payable to    15,686,502      shares of common stock.See      independent auditors' report and accompanying notes to financial      statements
 

**VillageEDOCS**

**Notes toFinancial Statements**

**For the Years Ended December 31, 2003 and2002**

 

 
1.                 Background and Organization
 

VillageEDOCS (the "Company") was incorporated in1995 in Delaware and reincorporated in California in 1997. The Company developsand markets internet-enabled fax services to organizations throughout theUnited States and internationally.

 

2.                 GoingConcern

 

The accompanying financialstatements have been prepared assuming that the Company will continue as agoing concern. The Company has a working capital deficit and has incurredsignificant losses from operations in each year since inception.  The Company's losses are continuing and areexpected to continue until such time as the Company is able to sufficientlyexpand its internet-enabled fax services or is able to consummate businesscombination transactions with other businesses whose profits are sufficient tooffset any ongoing losses from operating the internet-enabled fax services.

 

The Company's success isdependent upon numerous items, certain of which are the successfulimplementation and marketing of its internet-enabled fax services, its abilityto obtain new customers in order to achieve levels of revenues adequate tosupport the Company's current and future cost structure, its success incompleting business combination transactions with profitable entities, and itssuccess in obtaining financing for equipment and operations. Unanticipatedproblems, expenses, and delays are frequently encountered in establishing a newbusiness and continuing to operate it profitably.  These include, but are not limited to, competition, the need todevelop customer support capabilities and market expertise, setbacks in productdevelopment, technical difficulties, market acceptance and sales andmarketing.  The failure of the Companyto meet any of these conditions could have a materially adverse effect upon theCompany and may force the Company to reduce or curtail operations. No assurancecan be given that the Company can, or will ever, operate profitably, or thatprofitability, once attained, will be sustainable.

 

Until sufficient revenuelevels are achieved, the Company will require additional financing to supportits operations. Such sources of financing could include capital infusions,additional equity financing or debt offerings, or the acquisition of companiesthat have operating cash flows sufficient to partially or fully offset anynegative cash flows generated from the Company's current operations. Managementplans to obtain convertible debt and equity financing from new and existingshareholders, and to continue to pursue the goal of acquiring companies thatare cash-flow accretive during 2004. Management is actively pursuing each of these financingarrangements.  If the planned financingsare obtained, or if certain of the planned acquisitions are completed, theCompany believes it will have adequate cash to sustain operations until itbecomes profitable.  There can be noassurance that funding will be available on acceptable terms, if at all, orthat such funds, if raised, would enable the Company to achieve and maintainprofitable operations.  Although theCompany successfully completed one acquisition in February 2004 (See Note 11),there can be no assurance that the Company will be successful in completingadditional business combination transactions on acceptable terms, or at all, orthat such transactions will result in additional operating revenues or cashflows.

 

These factors, amongothers, raise substantial doubt about the Company's ability to continue as agoing concern.  The financial statementsdo not include any adjustments to reflect the possible future effects on therecoverability and classification of assets or the classification ofliabilities that might result from the outcome of these uncertainties.

 

3.                  Summary of Significant Accounting Policies

 

a.       Concentrationof Credit Risk

 

The Company extends credit to its customers andperforms ongoing credit evaluations of such customers.  The Company does not obtain collateral tosecure its accounts receivable.  TheCompany evaluates its accounts receivable on a regular basis for collectibilityand provides for an allowance for potential credit losses as deemednecessary.  At December 31, 2003, theCompany has recorded an allowance for doubtful accounts of approximately$30,000.  

 

One customer accounted for 16% of total accountsreceivable as of December 31, 2003.  Nosingle customer accounted for more than 10% of total sales for 2003 or2002.  

 

b.      Useof Estimates in the Preparation of Financial Statements

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Significant estimates made by management are, among others,the realizability of accounts receivable, property and equipment and web sitedevelopment costs, and valuation of deferred tax assets.   Actual results could differ from thoseestimates.

 

c.       Propertyand Equipment

 

Propertyand equipment are stated at cost and are depreciated using the straight-linemethod over the estimated useful lives of the assets, ranging from three toseven years.  Equipment under capitallease obligations is depreciated over the shorter of the estimated useful lifeor the term of the lease.  Majorbetterments and renewals are capitalized, while routine repairs and maintenanceare charged to expense when incurred.  TheCompany leases certain of its computer equipment and software under capitalizedand operating lease arrangements.

 

TheCompany assesses the recoverability of property and equipment by determiningwhether the depreciation amounts can be recovered through projectedundiscounted cash flows.  The amount ofimpairment, if any, is measured based on fair value and is charged tooperations in the period in which impairment is determined by management.  At December 31, 2003, management hasdetermined that there is no impairment of property and equipment.  There can be no assurance, however, thatmarket conditions will not change, which could result in future property andequipment impairment.

 

d.      RevenueRecognition

 

TheCompany provides internet-enabled fax services to businesses and charges forthese services on either a per page faxed or per minute used basis. Servicerevenues are recognized when the services are performed.  

 

e.       Product and TechnologyDevelopment

 

Product and technology development expenseincludes personnel costs relating to developing the features, content andfunctionality of the Company's internet-enabled fax services and web site.  Product and technology development costs areexpensed as incurred.

 

f.        Advertising

 

The Company expenses all advertising costs asincurred.  Advertising costs were$121,123 and $62,474 for the years ended December 31, 2003 and 2002,respectively. 

 

g.      Risks and Uncertainties

 

The Company operates in a highly competitiveindustry that is subject to intense competition, government regulation andrapid technological change.  TheCompany's operations are subject to significant risks and uncertaintiesincluding financial, operational, technological, regulatory and other risksassociated with an emerging business, including the potential risk of businessfailure.

 

h.   Fair Value of Financial Instruments

 

The carrying amount ofcertain of the Company's financial instruments as of December 31, 2003approximate their respective fair values because of the short-term nature ofthese instruments. Such instruments consist of cash, accounts receivable, accountspayable, and accrued expenses. The fair value of convertible notes payable torelated parties is not determinable as the borrowings are with related parties.

 

i.         Loss per Share

 

Basic loss per share iscomputed by dividing loss available to common shareholders by the weightedaverage number of common shares assumed to be outstanding during the period ofcomputation. Diluted loss per share is computed similar to basic loss per shareexcept that the denominator is increased to include the number of additionalcommon shares that would have been outstanding if the potential shares had beenissued and if the additional common shares were dilutive.  All potentially dilutive shares, 27,784,019and 12,652,086 as of December 31, 2003 and 2002, respectively, have beenexcluded from dilutive loss per share, as their effect would be anti-dilutivefor fiscal 2003 and 2002.

 

j.        Segment Information

 

The Company views itsoperations and manages its business as principally one segment.

 

k.      ComprehensiveIncome

 

The Company has no itemsof comprehensive income.

 

l.         Web Site Development Costs

 

During the year endedDecember 31, 2003, the Company did not capitalize any additional amountsrelated to its web site in accordance with the Emerging Issues Task Force IssueNo. 00-2, *Accounting for Web Site Development Costs.*  Web site development costs are amortizedusing the straight-line method over the estimated useful life of threeyears.  Amortization expense for the website development costs for 2003 and 2002 was $35,889 and $28,570, respectively.

 

m.    Income Taxes

 

The Company accounts for income taxes inaccordance with the liability method for financial accounting and reportingpurposes.  Under this method, deferredtax assets and liabilities are determined based on differences between thefinancial reporting and the tax basis of assets and liabilities and aremeasured using the enacted tax rates and laws that will be in effect when thedifferences are expected to reverse.  Avaluation allowance is provided for certain deferred tax assets if it is morelikely than not that the Company will not realize tax assets through futureoperations.

 

n.      Stock-Based Compensation

 

The Company accounts fornon-employee stock-based compensation under Statement of Financial AccountingStandards ("SFAS") No. 123, *Accounting For Stock-Based Compensation*.  SFAS No. 123 defines a fair value basedmethod of accounting for stock-based compensation.  However, SFAS No. 123 allows an entity to continue to measurecompensation cost related to stock and stock options issued to employees usingthe intrinsic method of accounting prescribed by Accounting Principles BoardOpinion No. 25, as amended ("APB 25"), *Accounting for Stock Issuedto Employees*. Under APB 25, compensation cost, if any, is recognized overthe respective vesting period based on the difference, on the date of grant,between the fair value of the Company's common stock and the grant price.Entities electing to remain with the accounting method of APB 25 must make proforma disclosures of net income and earnings per share, as if the fair valuemethod of accounting defined in SFAS No. 123 had been applied.

 

At December 31, 2003,the Company has two stock-based employee compensation plans, which aredescribed more fully in Note 6.  TheCompany accounts for those plans under the recognition and measurementprinciples of APB 25, and related interpretations.  During the years ended December 31, 2003 and 2002, $15,000 and$15,000, respectively, of compensation expense was recognized in the accompanyingstatements of operations for options issued to employees in 1999 for thevesting period from the date of grant through December 31, 2003, pursuant toAPB 25, and for options that were issued in 2002 but modified as to vesting andexpiration date during 2003 in connection with the retirement of employees (SeeNote 6).  No other stock-based employeecompensation cost is reflected in the statements of operations, as all optionsgranted since 1999 under those plans had exercise prices equal to or greaterthan the market value of the underlying common stock on the date of grant.  The following table illustrates the effecton net loss and loss per share if the Company had applied the fair valuerecognition provisions of SFAS No. 123 to stock-based employee compensation:

 

 

 

 

**Year ended December 31,**

 

 

 

 

**2003**

**2002**

 

 

 

 

-----------------

-----------------

 

 

Net  loss as reported

 

$ (2,106,345)

$ (1,292,303)

 

 

 

 

 

 

 

 

Deduct:  Total stock-based employee

 

 

 

 

 

compensation  expense under APB 25

 

15,000  

15,000 

 

 

 

 

 

 

 

 

Add:  Total stock-based employee

 

 

 

 

 

compensation  expense under fair value

 

 

 

 

 

based  method for all awards, net of

 

 

 

 

 

related  tax effects

 

(520,008)

(209,783)

 

 

 

 

-----------------

-----------------

 

 

Pro forma net  loss

 

$ (2,611,353)

$ (1,487,086)

 

 

 

 

==========

==========

 

 

Basic  and diluted loss per share - as

 

 

 

 

 

reported

 

$          (0.07)

$          (0.05)

 

 

 

 

==========

==========

 

 

Basic  and diluted loss per share - pro

 

 

 

 

 

forma

 

$          (0.08)

$          (0.06)

 

 

 

 

==========

==========

 

 

 

 

 

 

 

 

 

o.      NewAccounting Pronouncements

 

In May 2003, theFinancial Accounting Standards Board ("FASB") issued SFAS No. 150, *Accountingfor Certain Financial Instruments with Characteristics of Both Liabilities andEquity*. SFAS No. 150 establishes standards for how an issuerclassifies and measures certain financial instruments with characteristics ofboth liabilities and equity.  Itrequires that an issuer classify a financial instrument that is within itsscope as a liability (or an asset in some circumstances).  SFAS No. 150 is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning afterJune 15, 2003.  It is to be implementedby reporting the cumulative effect of a change in an accounting principle forfinancial instruments created before the issuance date of SFAS No. 150 andstill existing at the beginning of the interim period of adoption.  Restatement is not permitted. The adoptionof SFAS No. 150 did not have a material impact on the Company's financialposition, cash flows or results of operations.

 

 

4.                  Property and Equipment

 

Property and equipmentconsist of the following as of December 31, 2003:

                                                                                                

 

Equipment  and software under capital leases

$

174,031 

 

 

Computer  equipment

 

210,631 

 

 

Furniture  and equipment

 

84,328 

 

 

Software

           

35,100 

 

 

 

 

------------

 

 

 

 

504,090 

 

 

Less--  accumulated depreciation

 

(356,198)

 

 

 

 

------------

 

 

 

$

147,892 

 

 

 

 

=======

 

                

Depreciation expense forthe property and equipment for 2003 and 2002 was $113,086 and $94,761,respectively.

 

 

5.                  Convertible Notes Payable to Related Parties 

 

Duringthe years ended December 31, 2003 and 2002, the Company borrowed $1,132,000 and$1,110,000, respectively, from C. Alan and Joan P. Williams and issuedconvertible promissory notes bearing interest at 10 percent per annum.  At December 31, 2003, the outstandingprincipal balance of convertible secured promissory notes payable (the"Notes") to Mr. and Mrs. Williams was $1,882,000.  The Notes are secured by a security interestin all of the Company's assets.  Thenotes and accrued interest are due at the earlier of one of three events: 1)October 31, 2005; 2) acquisition of controlling interest in the Company by athird party; or 3) the Company achieves equity financing of a minimum of$3,000,000.  If the Company is acquired,the principal and accrued interest on the Notes, as modified, are convertibleinto shares of the Company's common stock at the lower of $2.50 per share orthe price paid per share by the acquirer. The principal and accrued interest on $530,000 of these convertiblepromissory notes, as modified, are convertible at any time into shares of the Company'scommon stock at a conversion price equal to the lower of $2.50 per share or theaverage of the Company's common stock closing bid price on the OTCBB, NASDAQ orother established securities exchange or market for the ten (10) consecutivetrading days prior to the date Mr. and Mrs. Williams deliver written notice oftheir conversion election to the Company. The principal and accrued interest on $1,352,000 of these convertiblepromissory notes issued between October 30, 2002 and December 31, 2003 areconvertible at any time into shares of the Company's common stock at a conversion priceequal to the lower of $0.07 per share (below the fair market value on the dateof issuance) or the average of the Company's common stock closing bid price onthe OTCBB, NASDAQ or other established securities exchange or market for theten (10) consecutive trading days prior to the date Mr. and Mrs. Williamsdeliver written notice of their conversion election to the Company.  The beneficial conversion feature resultedin a charge to interest expense in the accompanying statement of operations of$471,586 and $94,429 during the years ended December 31, 2003 and 2002,respectively.

 

 

OnMay 15, 2002, C. Alan Williams and Joan P. Williams acquired 15,686,502 sharesof the restricted common stock of the Company by exercising their conversionrights with respect to $2,039,245 in convertible promissory notes payable bythe Company, at a conversion price of $0.13 per share, the average of theCompany's common stock closing bid price on the OTCBB for the ten (10)consecutive trading days prior to May 15, 2002.

 

OnJuly 15, 2002, the Company entered into a Promissory Note ModificationAgreement with James Townsend with respect to $507,747 in convertible promissorynotes issued through January 12, 2001 and due between June 2002 and October2003 (the "Townsend Notes").  Pursuantto this agreement, the Townsend Notes were modified and now include thefollowing terms:  the principal andaccrued interest on the Notes, as modified, are due at the earlier of one ofthree events: 1) October 31, 2005; 2) acquisition of controlling interest inthe Company by a third party; or 3) the Company achieves equity financing of aminimum of $3,000,000.  If the Companyis acquired, the principal and accrued interest on the Notes, as modified, areconvertible into shares of the Company's common stock at the lower of $2.50 pershare or the price paid per share by the acquirer.  In addition, the principal and accrued interest on the Notes, asmodified, are convertible at any time into shares of the Company's common stockat a conversion price equal to the lower of $0.10 per share or the average ofthe Company's common stock closing bid price on the OTCBB, NASDAQ or otherestablished securities exchange or market for the ten (10) consecutive tradingdays prior to the date Mr. Townsend delivers written notice of his conversionelection to the Company.  In addition,the agreement grants to Mr. Townsend piggyback registration rights with respectto all previously unregistered shares of the Company's common stock held byhim, whether issued for cash or for conversion of the Notes, as modified.  As there was no beneficial conversionfeature related to these modifications, no interest expense was recordedrelated to a beneficial conversion feature during 2002.  At December 31, 2003, the outstandingprincipal balance of the Townsend Notes was $507,747.

 

OnJuly 30, 2002, the Company granted Mr. and Mrs. Williams a full ratchetanti-dilution right to receive additional shares of the Company's common stockin the event that Mr. Townsend converts some or all of his outstandingpromissory notes to the Company's common stock at any price lower than $0.13per share such that Mr. and Mrs. William's conversion price shall be equivalentto Mr. Townsend's conversion price with respect to the same number of shares.

 

Interestexpense recognized on all the convertible notes payable was $184,789 and$147,327 during the years ended December 31, 2003 and 2002, respectively.  Total interest accrued and not paid on theconvertible notes payable to related parties as of December 31, 2003 totaled$589,734 and is included in the accompanying balance sheet.

 

 

6.                  Stockholders' Equity (Deficit)

 

a.      Common Stock

 

On January 28, 2003, the Company entered into an agreementwith a non-related party pursuant to which the party agreed to accept 109,091shares of the Company's common stock as payment in full for $24,000 inconsulting fees owed to the party by the Company for product and servicemarketing consulting services.  Theshares were issued on February 11, 2003.

 

On February 11, 2003, the Company issued 510,124 shares ofrestricted common stock to consultants and employees in consideration forservices valued at $71,417, and 320,000 shares to the Company's former founder,who is a less than ten percent shareholder, in consideration for marketingcommunications services valued at $44,800, or $0.14 per share (fair marketvalue on the date of issuance).

 

On December 9, 2003, the Company issued 214,823 shares ofrestricted common stock to a consultant in consideration for services valued at$26,916 (fair market value on the date of issuance).

 

During the year ended December 31, 2002, theCompany issued 212,839 shares of restricted common stock for $2,129 in cash inconnection with the exercise of warrants, and 32,000 shares of restrictedcommon stock in consideration for $6,000 in consulting services rendered.

 

On May 15, 2002, C. Alan Williams and Joan P.Williams acquired 15,686,502 shares of the restricted common stock of theCompany by exercising their conversion rights with respect to $2,039,245 inconvertible promissory notes payable by the Company (see Note 5).

 

 

b.     Stock Options

 

Effective January 30, 2002, the Board of Directors of theCompany adopted an equity incentive plan (the "2002 Plan") that authorizes theissuance of options to acquire up to 6,226,258 shares of common stock to employeesand certain outside consultants.   OnNovember 25, 2002, the Board of Directors of the Company increased the numberof shares reserved for issuance pursuant to the 2002 Plan to 11,634,584 shares.  On November 27, 2002, the stockholders ofthe Company approved the 2002 Plan and the number of shares reserved forissuance pursuant to the 2002 Plan.  The2002 Plan allows for the issuance of either non-qualified or, subject tostockholder approval, incentive stock options pursuant to Section 422 of the InternalRevenue Code. Options vest at the discretion of the Board of Directors asdetermined at the grant date, but not longer than a ten-year term.  Under the 2002 Plan, the exercise price ofeach option shall not be less than fair market value on the date the option isgranted.  The number of options underthe 2002 Plan available for grant at December 31, 2003 was 1,448,830.

 

Options to purchase 3,710,000 shares of the Company'scommon stock under the 2002 Plan at per share prices ranging from $0.10 to $0.1875(above or at the fair market value on the dates of grant) were issued toemployees during the year ended December 31, 2003, vesting on various datesfrom the date of grant through December 2008.    

 

Options to purchase 50,000 shares at $0.10 (the fairmarket value on the date of grant) were granted to a non-employee consultantduring the year ended December 31, 2003. These options vested on February 28, 2004.  Total consulting expense to be recognized in the statement of operationsover the vesting period pursuant to SFAS No. 123 is $4,500, none of which wasrecognized during 2003.

 

Options to purchase 833,030 shares of the Company's commonstock under the 2002 Plan at $0.1875 per share (above or at the fair marketvalue on the dates of grant) that were issued in 2002 (included in total optionsissued in 2002 below) were modified as tovesting and expiration date during 2003 in connection with the retirement ofemployees.  As a result, $65,028 ofcompensation expense was recognized in connection with the modifications under SFAS No. 123 in the accompanying statement of operations.

 

Options to purchase 7,203,532 shares of the Company'scommon stock under the 2002 Plan at per-share prices ranging from $0.17 to$0.21 (the fair market value on the dates of grant) were issued to employeesduring the year ended December 31, 2002, vesting on various dates from the dateof grant through November, 2007.    

 

Options to purchase 45,000 shares at $0.19 (the fairmarket value on the date of grant) were granted to a non-employee consultantduring the year ended December 31, 2002. These options vest on various dates one year from the date of grantthrough January 2007.  Total consultingexpense to be recognized in the statement operations over the vesting periodpursuant to SFAS No. 123 is $4,050, none of which was recognized during theyear ended December 31, 2002.

 

Options to purchase 555,555 shares of the Company's commonstock at $0.18 per share (which was below the fair market value on the date ofgrant), vesting immediately, were issued to a non-employee in consideration forlegal services during the year ended December 31, 2002.  In connection with this issuance, andpursuant to SFAS No. 123, the Company recorded legal expense and prepaidexpense of $21,006 and $994, respectively, during the year ended December 31,2002.  

 

During 1997, the Board of Directors of theCompany adopted a stock option plan (the "1997 Plan") that authorizes theissuance of options to acquire up to 5,000,000 shares of common stock toemployees and certain outside consultants. The 1997 Plan allows for the issuance of either non-qualified orincentive stock options pursuant to Section 422 of the Internal Revenue Code.Options vest at the discretion of the Board of Directors as determined at thegrant date, but not longer than a ten-year term.  Under the 1997 Plan, the exercise price of each option shall notbe less than 85 percent of fair market value on the date the option isgranted.  The number of options underthe 1997 Plan available for grant at December 31, 2003 were 1,935,163 .

 

During the year ended December 31, 2001, stockoptions to purchase 35,000 shares at $2.50 were granted to a non-employeeconsultant.  These options vest one yearfrom the date of grant.  Totalconsulting expense to be recognized in the statement of operations over thevesting period pursuant to SFAS No. 123 is $58,800, which was recognized duringthe year ended December 31, 2002.

 

During each of the years ended December 31, 2003and 2002, $15,000 of compensation expense was recognized in the accompanyingstatements of operations for options issued to employees in 1999 under the 1997Plan for the vesting period from the date of grant through December 2003,pursuant to APB 25.

 

1,374,609 and 419,303 options under the 2002 or1997 Plan were cancelled during the years ended December 31, 2003 and 2002,respectively due to their expiration or the termination of employment.

 

Stock option activity for the years endedDecember 31, 2003 and 2002 is as follows:

 
 Weighted Average NumberExercise Price of OptionsPer Share  -----------------  ------------------        Outstanding at January 1, 2002    3,480,416  $              1.02              Granted    7,804,087                  0.19              Exercised -      -                  Canceled     (419,303)                (0.72)  -------------  ----------------        Outstanding at December 31, 2002  10,865,200                  0.43              Granted    3,760,000                  0.16              Exercised
 -                          -                Canceled  (1,374,609)                (0.35)  -------------  ----------------        Outstanding at December 31, 2003  13,250,591  $              0.37   =========  ===========        Exercisable at December 31, 2003    5,995,120  $              0.43   =========  ===========         Weighted average fair value of options granted2002 $              0.13  2003 $              0.08  
 

 

 

The following summarizes information about stockoptions outstanding at December 31, 2003:

 

 
                                   Options Outstanding                      Options Exercisable       ------------------------------------------------------------------------------------------ Weighted AverageWeightedWeighted       Range ofNumber ofRemainingAverageNumber ofAverage       ExerciseSharesContractualExerciseSharesExercise       PricesOutstandingLife (Years)PriceExercisablePrice       ---------------------------------------------------------------------------------------------        $0.10 - $0.25  12,219,547 5.0 $   0.18  5,350,784  $   0.20  $1.00         50,000 5.1 $   1.00       50,000  $   1.00  $2.50       981,044 6.5 $   2.50     594,336  $   2.50  ----------------------------------------------------------------   13,250,591  $   0.37  5,995,120  $   0.43  ========================================== 
 

 

The fair value of each option granted during2003 and 2002 to consultants and outside service providers is estimated using theBlack-Scholes option pricing model on the date of grant using the followingassumptions: (i) no dividend yield, (ii) average volatility of 171 percent and47 percent, respectively, (iii) weighted average risk free interest rate ofapproximately 2.78 percent and 4.55 percent, and (iv) average expected life of5 years.

 

The Black-Scholes option valuation method wasdeveloped for use in estimating the fair value of traded options which have novesting restrictions and are fully transferable.  In addition, option valuation models require the input of highlysubjective assumptions including the expected stock price volatility.  Because the Company's employee stock optionshave characteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect thefair value estimate, in management's opinion, the existing models do notnecessarily provide a reliable single measure of the fair value of its employeestock options.

 

c.       Warrants

 

From time to time, the Company issues warrantspursuant to various consulting and third party agreements.  

 

There was no warrant activity during 2003.  During the year ended December 31, 2002, theCompany issued a warrant to purchase 24,019 shares of the Company's commonstock at $0.01 per share to an employee and recorded compensation expense of$25,565 in connection with the issuance. During the year ended December 31, 2002, warrants to purchase 212,839shares of common stock were exercised for cash, and warrants to purchase113,777 shares of the common stock of the Company expired unexercised and werecancelled.  

 

The following represents a summary of thewarrants outstanding for the years ended December 31, 2003and 2002:

 

**]**
 
** Weighted Average** **Number****Exercise Price** **of Warrants****Per Share** ** ----------------- **** ---------------------- **     Outstanding at January 1, 2002        391,872  $                  0.42            Granted          24,019                      0.01            Exercised       (212,839)                     0.01            Expired/Forfeited       (113,777)                     0.01   ---------------  ------------------      Balance at December 31, 2002          89,275                      1.83            Granted                  -                           -              Exercised                  -                           -              Expired/Forfeited                  -                           -     --------------  ------------------      Balance at December 31, 2003          89,275  $                  1.83   =========  ============       Weighted average fair value of warrants granted2002 $                  0.07  
 

 

           The following summarizesinformation about warrants outstanding at December 31, 2003:

 

 
 
         Warrants Outstanding  and Exercisable 
------------------------------------------------- Weighted Average Remaining     Exercise
Number of Contractual     PriceSharesLife (Years)     ------------------------------------      $0.01 24,0191.5     $2.50 65,2560.6  ------------ 89,275 ======== 
 

 

The fair value of each warrant granted during2002 for services is estimated using the Black-Scholes option pricing model onthe date of grant using the following assumption: (i) no dividend yield, (ii)average volatility of 47 percent, (iii) weighted average risk free interestrate of approximately 4.55 percent, and (iv) average expected life of 5 years.

 

7.                  Income Taxes

 

As the Company incurred net operating losses throughDecember 31, 2003, the provision for income taxes for the years presentedconsists of minimum state taxes only. At December 31, 2003, the Company had approximately $11,860,000 and$9,526,000, respectively, of federal and state net operating loss carryforwardsfor tax reporting purposes available to offset future taxable income; federaland state net operating loss carryforwards expire through 2023 and 2010,respectively. Under the Tax Reform Act of 1986, the amounts of and benefitsfrom net operating losses carried forward may be impaired or limited in certaincircumstances. Events which may cause limitations in the amount of netoperating losses that the Company may utilize in any one year include, but arenot limited to, a cumulative ownership change of more than 50 percent over athree-year period. At December 31, 2003, the effect of such limitation, ifimposed, has not been determined.

 

Deferredtax assets consist primarily of the tax effect of net operating loss carryforwards. The Company has provided a full valuation allowance on thedeferred tax assets because of the uncertainty regarding realizability.  The valuation allowance increasedapproximately $839,000 and $514,000 during the years ended December 31, 2003and 2002, respectively.

 

 

Deferred tax assetsconsist of the following at December 31, 2003:

                        

 

Deferred  tax assets:

 

 

 

Net  operating loss carryforwards

$     4,643,000 

 

 

Less  valuation allowance

(4,643,000)

 

 

 

----------------

 

 

 

$                 -  

 

 

 

 =========

 

 

A reconciliation ofincome taxes computed at the federal statutory rate of 34% to the provision forincome taxes is as follows for the years ended December 31:

 

 

 

2003 

 

2002 

 

 

----------------

 

----------------

Computed benefit at  federal statutory rate

 

$   (716,000)

 

$   (439,000)

State income tax  benefit, net of federal effect

 

(123,000)

 

(75,000)

Increase in valuation  allowance

 

839,000.       

 

514,000 

Other

 

800 

 

800 

 

 

----------------

 

----------------

 

 

$            800 

 

$            800 

 

 

=========

 

=========

 

 

8.       Earningsper Share

 

Basic and diluted lossper common share is computed as follows for the years ended December 31:

 
   
 

 

2003

 

2002

 
   
 

 

--------------

 

--------------

 
   
Numerator  for basic and diluted loss per common share:

 

 

 

 

 
   
Net  loss available to common stockholders

 

$(2,106,345)

 

$(1,292,303)

 
   
 

 

=========

 

=========

 
   
 

 

 

 

 

 
   
Denominator  for basic and diluted loss per common share:

 

 

 

 

 
   
Weighted  average common shares outstanding

 

30,828,738

 

24,102,729

 
   
 

 

=========

 

=========

 
   
Net  loss per common share available to common stockholders

 

 

 

 

 
   
 

 

 

 

 

 
   
Net  loss per share

 

$         (0.07)

 

$         (0.05)

 
   
 

 

=========

 

=========

 

 

9.            Commitments and Contingencies

 

a.      Leases

 

The Company is a lessee of certain property andequipment under capital lease agreements that expire on various dates through2005.  Terms of the leases requiremonthly payments ranging from $248 to $726, including interest ranging up to15%.  The assets and liabilities under capitalleases are recorded at the lower of the present value of the minimum leasepayments or the fair market value of the related assets.

 

In addition, the Company leases certain propertyand equipment under operating lease agreements, which expire on various datesthrough July 2004 and provide for monthly lease payments ranging from $276 to$5,957.  The lease for the Company's office space expires in May 2004;however, we are currently negotiating the terms of a  new lease with thelandlord.  During 2004, the Companyintends to either return or buy out a material portion of the equipment underoperating leases as of December 31, 2003.

 

During the year ended December 31, 2003, theCompany purchased certain equipment under capital leases for $10,191 andrecorded a loss of $39,943 on the buyout of the equipment which was a result ofthe significant decline in the fair market value of the equipment.

 

Future annual minimum payments under operating and capital leases is as follows:

 

 
 CapitalOperating  td>    
Total  ---------------  ------------  ------------   2004 $          12,000  $     79,000  $   91,000  2005               9,000 
 --           9,000   ---------------  ------------  ------------      Total minimum lease payments              21,000  $     79,000  $ 100,000   ========  ========      Less: amounts representing interest              (1,982)  ---------------      Present value of lease obligations             19,018       Less: current portion            (10,666)  ---------------   $            8,352   ==========  
 

 

 

Rent expense for the fiscal years ended December31, 2003 and 2002 was $267,138 and $268,955, respectively.  Interest expense incurred pursuant to thecapital lease obligations was $5,284 and $21,608 for the fiscal years endedDecember 31, 2003 and 2002, respectively.

 

The following is an analysis of the leasedequipment under capital leases as of December 31, 2003, which is included inproperty and equipment.

 

 

Computer  equipment

$   174,031 

 

Accumulated  depreciation

(125,947)

 

 

---------------

 

 

$     48,084 

 

 

=========

 

 

b.     Litigation

 

The Company is, from time to time, involved invarious legal and other proceedings which arise in the ordinary course ofoperating its business. In the opinion of management, the amount of ultimateliability, if any, with respect to these actions will not materially affect thefinancial position or results of operations of the Company. ** **

 

c.      Consulting and Employee Agreements

 

The Company has entered into a variety ofconsulting and employee agreements for services to be provided to the Companyin the ordinary course of business. These agreements call for minimum salary levels and/or option grantsand/or common share issuances and various payments upon performance of servicesand/or termination of the agreements (except for cause).

 

d.     Indemnities and Guarantees

 

During the normal course of business, theCompany has made certain indemnities and guarantees under which it may berequired to make payments in relation to certain transactions.  The Company indemnifies its directors,officers, employees and agents to the maximum extent permitted under the lawsof the State of California.  Theseindemnities include certain agreements with the Company's officers under whichthe Company may be required to indemnify such person for liabilities arisingout of their employment relationship.  Inconnection with its facility leases, the Company has indemnified its lessor forcertain claims arising from the use of the facilities..  The duration of these indemnities andguarantees varies and, in certain cases, is indefinite.  The majority of these indemnities andguarantees do not provide for any limitation of the maximum potential futurepayments the Company could be obligated to make.  Historically, the Company has not been obligated to makesignificant payments for these obligations and no liabilities have beenrecorded for these indemnities and guarantees in the accompanying balancesheet.

 

 

10.       RelatedParty Transactions

 

During the year endedDecember 31, 2002, the Company entered into a Consulting Services Agreementwith the Company's founder to provide marketing communications services for upto four months in consideration for up to 320,000 shares of the Company'scommon stock.  The compensation shall beearned on a pro-rata basis at the end of each of four thirty-day work periodsand only upon receipt and acceptance by the Company of the related party's workproduct.  No shares were earned underthis agreement during the year ended December 31, 2002.  On February 11, 2003, 320,000 of theseshares were issued and were valued at $44,800, the fair market value on thedate of issuance.

 

11.      Subsequent Events

 

*Debt Financing*

 

During January and February, 2004, the Companyissued $140,000 in secured convertible promissory notes for cash.  The notes were issued to a related party, C.Alan and Joan P. Williams, and bear interest at 10 percent per annum.  The notes and accrued interest are due atthe earlier of one of three events: 1) October 31, 2005; 2) acquisition of controllinginterest in the Company by a third party; or 3) the Company achieves equityfinancing of a minimum of $3,000,000. If the Company is acquired, the principal and accrued interest on thenotes are convertible into shares of the Company's common stock at the lower of$2.50 per share or the price paid per share by the acquirer.  In addition, the principal and accruedinterest on the notes are convertible into shares of the Company's common stockat a conversion price equal to the lower of $0.07 per share (which was belowthe fair market value on the date of issuance) or the average of the Company'scommon stock closing bid price on the OTCBB, NASDAQ or other establishedsecurities exchange or market for the ten (10) consecutive trading days priorto the date Mr. and Mrs. Williams deliver written notice of their conversionelection to the Company.  The beneficialconversion feature will result in a charge to interest expense of $51,287 infiscal 2004.

 

On February 17, 2004, the Company issued a$1,700,000 secured convertible promissory note for cash.  The note was issued to a related party, C.Alan and Joan P. Williams, and bears interest at 10 percent per annum.  The note and accrued interest are due at theearlier of one of three events: 1) October 31, 2007; 2) acquisition ofcontrolling interest in the Company by a third party; or 3) the Companyachieves equity financing of a minimum of $3,000,000.  If the Company is acquired, the principal and accrued interest onthe note are convertible into shares of the Company's common stock at the lowerof $2.50 per share or the price paid per share by the acquirer.  In addition, the principal and accruedinterest on the note are convertible into shares of the Company's common stockat a conversion price equal to eighty five percent of average of the Company'scommon stock closing bid price on the OTCBB, NASDAQ or other establishedsecurities exchange or market for the ten (10) consecutive trading days priorto the date Mr. and Mrs. Williams deliver written notice of their conversionelection to the Company.  As aninducement for Mr. and Mrs. Williams to provide the loan, the Company agreed toissue them a warrant to purchase 5,000,000 shares of the Company's restrictedcommon stock at $0.10 per share until February 17, 2009.  There is no beneficial conversion featureassociated with this promissory note. In connection with the issuance of the detachable warrant, the companywill record a debt discount of approximately $400,000. The Company will amortize the disoucnt using the effective interestmethod through October 31, 2007.  In theevent that the related debenture is converted to shares of the Company's commonstock, the Company will immediately eliminate the corresponding unamortizeddebt discount against equity.

 

*Acquisition of Tailored BusinessSystems, Inc.*

* *

On February 17, 2004, the Company purchased 100%of the issued and outstanding capital stock of Tailored Business Systems, Inc.("TBS"), from Stephen A. Garner and James L. Campbell.

 

The Company purchased TBS with $1.5 million incash, convertible secured promissory notes totaling $600,000, and 11 millionrestricted shares of the Company's common stock.   Payment of 4,400,000 (or 40%) of the shares were made at theclosing , and payment of 6,600,000 (or 60%) of the shares is contingent uponTBS meeting certain net revenue goals in each of the first three fiscal yearsfollowing the closing and, therefore, will take place over a three yearperiod.   The Company's common stock wasvalued at $0.10 per share, the average closing bid price of the Company's common stockfor the thirty day period ending February 16, 2004.   

 

The acquisition will be accounted for using thepurchase method of accounting. The Company funded the cash portion of thepurchase price of TBS from the proceeds of a $1.7 million convertible secured promissorynote offering subscribed to by Mr. and Mrs. Williams.

 

The terms of the purchase were the result ofarms-length negotiations.  Neither ofthe TBS shareholders was previously affiliated with VillageEDOCS.

 

As of the date of these financial statements,the Company, in connection with the acquisition of TBS, has incurredapproximately $60,000 in consulting expenses to an unrelated third party (paidduring February 2004 in a combination of cash and 220,000 shares of common stockissued in March 2004), $76,000 incompensation to an employee (paid during February 2004 in a combination of cashand 132,000 shares of common stock issued in March 2004) and $53,000 in other acquisition-related costs including, butnot limited to, expenses incurred for legal, accounting, and travel.

 

The following represents an allocation of thepurchase price over the historical net book value of the acquired assets andliabilities of TBS as of October 31, 2003, the end of TBS's most recent fiscalyear, and is for illustrative pro forma purposes only.  Actual fair values will be based onfinancial information as of the acquisition date (February 17, 2004) which maybe different than the historical net book value of the acquired assets andliabilities.  Assuming the transactionoccurred on October 31, 2003, the allocation would have been as follows:

 

 

Cash

$         134,003 

 

Accounts receivable

           314,362 

 

Inventories

             18,102 

 

PP&E

           279,745 

 

Other assets

             93,048 

 

Total liabilities

          (858,362)

 

 

-----------------

 

Net assets

          (19,102)

 

 

-----------------

 

Goodwill and other intangible assets

        2,748,245 

 

 

-----------------

 

 

$      2,729,143 

 

 

==========

 

 

 

 

 

 

This allocation is preliminary and may besubject to change upon evaluation of the fair value of TBS's acquired assetsand liabilities as of the acquisition date as well as the potentialidentification of certain intangible assets. The Company is in the process of analyzing the components of theintangible assets it acquired and will determine the final purchase priceallocation during 2004.

 

After the debt financing and acquisition of TBS (seediscussions above) subsequent to the year ended December 31, 2003, the Companymight potentially not have sufficient authorized shares available to settle itsopen stock-based contracts. The number of shares required to settle thesecontracts at any particular date can vary considerably based on several factorsincluding the market price of the Company's common stock, grants, expirationsand cancellations of employee incentive compensation, and issuance, conversion,and retirement of convertible debentures. The Company's management intends to seek an approval to increase thenumber of shares authorized based on their preliminary discussions with itsmajority shareholder. If the approval is not received and the Company does notincrease its authorized shares, beginning in the quarter ended March 31, 2004, the Company willbe required to account for its freestandingderivative financial instruments potentially settled in its own common stockunder Emerging Issues Task Force ("EITF") Issue No. 00-19, *Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany's Own Stock*.  This change, if required, is not anticipated tohave an immediate material impact on the Company's financial position oroperating results.

 

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