x | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
o | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
(Exact Name of Registrant as Specified in itsIts Charter)
Nevada | 88-0476779 | |
(State of Incorporation) | (IRS Employer Identification No.) |
(Address of Principal Executive Offices) (Zip Code)
(Registrant’s Telephone Number,
Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the proceeding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes
x NooIndicate by check mark whether the registrant is a large accelerated file, an accelerated file, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”,filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filero | Accelerated Filero | Non-Accelerated Filero | Smaller Reporting Companyx |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
o NoxState the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:
As of May 16,August 15, 2008 there were 61,353,97161,553,971 shares outstanding of the registrant’s only class of common stock.
Item 1. Consolidated Financial Statements Item 2. Management’s Discussion and Analysis Item 3. Quantitative and Qualitative Disclosures About Market Risk Item 4T. Controls and Procedures Item Legal Proceedings Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Item 4. Submission of Matters to a Vote of Security Holders Item 5. Other Information Item 6. Exhibits i 1 2 3 4 On December 29, 2006, the Company consummated the acquisition of InterMetro Delaware, a privately-held company, through a merger transaction (the “Business Combination”) which resulted in a share exchange such that the InterMetro Delaware Investors became the controlling shareholders of InterMetro, and such that InterMetro Delaware became a wholly owned subsidiary of InterMetro. All costs associated with the Business Combination were expensed as incurred. Pursuant to the Business Combination, the Company issued directly to the InterMetro Delaware Investors in two phases a total of 41,540,194 shares of common stock in exchange for all of their issued and outstanding shares of common stock (the “Private Company Common Stock”) and preferred stock, and outstanding convertible promissory notes on an as converted basis. The first phase issuance occurred effectively on December 29, 2006 and included the issuance of 27,490,194 shares of common stock in exchange for the entire principal amount of the convertible promissory notes and accrued interest due, all outstanding shares of preferred stock and Private Company Common Stock held by non-employees, and a portion of the Private Company Common Stock held by employees. On May 31, 2007, the Company filed Amended and Restated Articles of Incorporation increasing the Company’s authorized shares of common stock to 150,000,000, par value $0.001 per share, at which time the second phase of 14,049,580 shares of common stock were effectively issued in exchange for all of the remaining Private Company Common Stock held by the employees of InterMetro Delaware. All InterMetro Delaware securities were effectively cancelled except 100 shares of Private Company Common Stock which represent 100% of the outstanding stock of the wholly-owned subsidiary. Basis of Presentation The accompanying unaudited interim consolidated financial statements and information have been prepared in accordance with accounting principles generally accepted in the United States and in accordance with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, these financial statements contain all normal and recurring adjustments considered necessary to present fairly the financial position, results of operations and cash flows for the periods presented. The results for the three and six month All share and per share data provided in the Consolidated Financial Statements and in these Notes to Consolidated Financial Statements have been retroactively restated to reflect the conversion ratio related to the exchange of shares in the Business Combination, unless otherwise stated herein. 5 Going Concern Management believes that the recent losses are primarily attributable to costs related to supporting a robust telecommunications infrastructure that has significantly more capacity than is currently being utilized by its existing customer base as well as the cost of marketing required for continued expansion of the customer base which is expected to result in an increase in revenues in order for the Company to become profitable. The Company continues to require outside financing until such time as we can achieve positive cash flow from operations. In November and December 2007, the Company received $600,000 and in the The Company will be required to obtain other financing during the next twelve months or thereafter as a result of future business developments, including any acquisitions of business assets or any shortfall of cash flows generated by future operations in meeting the Company’s ongoing cash requirements. Such financing alternatives could include selling additional equity or debt securities, obtaining long or short-term credit facilities, or selling operating assets. No assurance can be given, however, that the Company could obtain such financing on terms favorable to the Company or at all. Any sale of additional common stock or convertible equity or debt securities would result in additional dilution to the Company’s stockholders. Principles of Consolidation Use of Estimates Revenue Recognition 6 the Company determines that collection of revenues are not reasonably assured, amounts are deferred and recognized as revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash. Accounts Receivable Network Costs Advertising Costs Depreciation and Amortization Maintenance and repairs are charged to expense as incurred; significant betterments are capitalized. Impairment of Long-Lived Assets When management of the Company determines that the carrying value of a long-lived asset may not be recoverable based upon the existence of one or more of the above indicators of impairment, an estimate is made of the future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future undiscounted cash flows and eventual disposition is less than the carrying amount of the asset, an impairment loss is recognized in the amount by which the carrying amount of 7 the asset exceeds the fair value of the asset, based on the fair market value if available, or discounted cash flows if not. To date, the Company has not had an impairment of long-lived assets and is not aware of the existence of any indicators of impairment. Goodwill and Intangible Assets Stock-Based Compensation Under the provisions of SFAS 123, the Company has elected to continue to recognize compensation cost for employees of the Company under the minimum value method of APB 25 and comply with the pro forma disclosure requirements under SFAS 123 for all options granted prior to January 1, 2006. Stock-based employee compensation cost is reflected in net loss related to common stock options if options granted under the plan have an exercise price below the deemed fair market value of the underlying common stock on the date of grant. There were no employee options granted during Prior to January 1, 2006, the Company accounted for equity instruments issued to non-employees in accordance with the provisions of SFAS 123, and Emerging Issues Task Force (“EITF”) Issue No. 96-18, “Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with, Selling Goods or Services.” Effective January 1, 2006, the Company accounts for equity 8 instruments issued to non-employees in accordance with the provisions of SFAS 123(R). All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more readily measured. The measurement date of the fair value of the equity instrument issued is the earlier of the date on which the counterparty’s performance is complete or the date on which it is probable that performance will occur. The Company did not recognize any expense from equity instruments issued to non-employees during the three Debt with Detachable Warrants and/or Concentration of Credit Risk 9 The Company had no customers which individually accounted for 10% or more of net revenue for the three No customer had an outstanding accounts receivable balance in excess of 10% of the total accounts receivable at Income Taxes Segment and Geographic Information Basic and Diluted Net Loss per Common Share Recent Accounting Pronouncements In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” including an amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We adopted SFAS 159 as of January 1, 2008 and have determined that the adoption of this statement did not have a material impact on the consolidated financial statements. In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations,” (“SFAS No. 141(R)” In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51.” SFAS No. 160 amends ARB No. 51 to establish accounting and reporting standards for noncontrolling interests in subsidiaries and for the deconsolidation of subsidiaries. It 10 clarifies that a noncontrolling interest in a subsidiary is an ownership interest that should be reported as equity in the consolidated financial statements. The provisions of SFAS No. 160 are effective for fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Company is evaluating the impact of the adoption of SFAS 160 and believes there will be no material impact on our consolidated financial statements or financial In December 2007, the SEC issued SAB No. 110, “Certain Assumptions Used in Valuation Methods In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS 133.” This statement requires enhanced disclosures about derivative instruments and hedging activities within an entity by requiring the disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It provides more information about an In May 2008, the FASB issued SFAS No. 162 “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. SFAS 162 is effective sixty days following the SEC’s approval of PCAOB amendments to AU Section 411, “The Meaning of ‘Present fairly in conformity with generally accepted accounting In May 2008, the FASB issued SFAS No.163, “Accounting for Financial Guarantee Insurance Contracts — an interpretation of SFAS 60.” SFAS 163 clarifies SFAS 60, “Accounting and Reporting by Insurance Enterprises,” by requiring expanded disclosures about financial guarantee insurance contracts. Additionally, it requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event), when there is evidence that credit deterioration has occurred in an insured financial obligation. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years, except for some disclosures about the insurance enterprise’s risk-management activities, which are effective the first period (including interim periods) beginning after May 23, 2008. Except for those disclosures, earlier application is not permitted. The Company is evaluating the impact of the adoption of SFAS 161 and believes there will be no material impact on our consolidated financial statements or financial condition. In March 2006, the Company acquired all of the outstanding stock of Advanced Tel, Inc. (“ATI”), a switchless reseller of wholesale long-distance services, for a combination of shares of common stock and cash. The Company acquired ATI to increase its customer base, to add minutes and revenue to its network and to access new sales channels. The initial portion of the purchase price included 308,079 shares of the Company’s common stock, a payable of $250,000 to be paid over the six-month period following the closing and a 11 two-year unsecured promissory note in an amount tied to ATI’s working capital of $150,000. These amounts are payable to the former selling shareholder of ATI who was appointed President of ATI at the acquisition closing date. The amount of common stock consideration paid to the selling shareholder of ATI is subject to adjustment (or the payment of additional cash in lieu thereof at the option of the Company) if the trading price of the Company’s common stock does not reach a minimum price of $4.87 per share during the two years following the closing date. The value of this guarantee on the initial shares issued to the selling shareholder of ATI has been included in the Company’s determination of the purchase price of the ATI acquisition. The selling shareholder of ATI may earn an additional 308,079 shares of the Company’s common stock and additional cash amounts during the two-year period following the closing upon meeting certain performance targets tied to revenue and profitability, which could make the total purchase price of this acquisition approximately $3.9 million. The value of the Company’s stock given to the selling shareholder of ATI at the closing was determined based on standard business valuation approaches, including a discounted future cash flow approach and a capital markets approach. The discounted future cash flow approach uses estimates of revenues, driven by market growth rates, and estimated costs as well as appropriate discount rates. These estimates are consistent with the Company’s plans and estimates that management uses to manage the business. The capital markets approach to valuation was used by identifying publicly traded companies considered sufficiently comparable to the Company. In addition, the Company included the value implied by recent equity-related financings, the accretive value of its business from various milestones (key management hires, volume thresholds (minutes and revenues), inroads into the retail distribution channel, positive cash flow, etc.). There is inherent uncertainty in making these estimates; however, management believes the value ascribed to the Company’s common stock given to the selling shareholder of ATI is reasonable as of the transaction date. The net tangible assets acquired and liabilities assumed in the acquisition were recorded at fair value. The Company determined the valuation of the identifiable intangible assets acquired in the transaction to be $182,620 using future revenue assumptions and a valuation analysis. Additionally, the Company recorded goodwill of $1,800,347 associated with the purchase of ATI at the date of acquisition. 12 The consideration paid for ATI was comprised of (in thousands): The purchase price of ATI was allocated as follows (in thousands): The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (in thousands): The following is a summary of the Company’s other current assets (in thousands): 13 The following is a summary of the Company’s property and equipment (in thousands): Depreciation expense included in network costs was In May 2004, the Company entered in an agreement with a vendor to provide certain network equipment. Under the terms of this agreement, the Company can obtain certain telecommunications equipment with a total purchase price of approximately $5.2 million to expand its current operations. Repayment for these assets is based on the actual underlying traffic utilized by each piece of equipment, plus the issuance of a warrant to purchase shares of the Company’s common stock at an exercise price of the Company’s most recent financing price per share. For certain assets that can be purchased under this agreement, the Company has an option to issue a predetermined warrant to purchase shares of the Company’s common stock at an exercise price of the Company’s most recent financing price per share as full payment. In March 2008, through an addendum to the agreement, the vendor exercised 635,612 of its warrants with a cash exercise value of $165,936 in a cashless exchange for a $258,304 reduction in payables due to the vendor resulting in a $92,368 gain on forgiveness of debt. At In May 2006, the Company entered into a strategic agreement with a VoIP equipment and support services provider. Under the terms of this agreement, the Company can obtain certain VoIP equipment to expand its current operations. Repayment of these assets is based on the actual underlying traffic utilized by each piece of equipment or fixed cash payments. At 14 The following is a summary of the Company’s accrued expenses (in thousands): In November and December 2007, the Company received $600,000 in advance payments, pursuant to the sale of secured notes with individual investors for general working capital in January 2008. $250,000 of the advance payments were from a related party. In connection with the notes, the Company issued two common stock purchase warrants for every dollar received or With respect to the remaining 15 At December 31, 2007, the advance payments carried a 10% interest rate. These funds were received prior to the closing of the sale of the secured notes and grant of stock warrants, which occurred on January 16, 2008 and the holders of the notes did not have the legal rights or recourse to the secured notes, warrants or other related features included in these agreements entered into in January 2008. As a result, the advance payments for notes were recorded at their total amount of $600,000 at December 31, 2007. Upon the closing of the sale of the secured notes and grant of the warrants on January 16, 2008, the Company accounted for the transaction in accordance with the provisions of Emerging Issues Task Force Issue No. 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments.” Management determined that the present value of the cash flows under the terms of the new debt instrument were at least 10% different from the present value of the remaining cash flows under the terms of the original instrument, resulting in a debt modification. Due to the substantial modification of terms, the Company accounted for the transaction as a debt extinguishment. As a result, the original $600,000 recorded as of December 31, 2007 was extinguished on January 16, 2008 and the new notes were recorded. The Company allocated the proceeds received between the notes and warrants in accordance with EITF Issue No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios.” The Company engaged an independent third party to perform the valuation of the warrants on the respective issuance The Initial Warrants also contain a put feature (not included in the Additional Warrants), which gives the holder the option to put the warrant back to the Company for $0.15 per share. The holder can exercise its put option after the maturity date and has the ability to do so for 16 The warrants and put feature associated with the $600,000 The warrants and put feature associated with the $770,000 secured notes from the quarter ended March 31, 2008 were valued using the following range of assumptions: The warrants and put feature associated with the $500,000 of the secured notes from the quarter ended June 30, 2008 were valued using the following range of assumptions: The warrants and put feature associated with the $50,000 of the secured notes from the quarter ended June 30, 2008 were valued using the following range of assumptions: In connection with the put feature of the warrants, the Company revalues the put warrant liability and calculates the gain or loss on the put warrant liability valuation at each period end date. The resultant gain for the three month period ended June 30, 2008 was not material and was not recorded by the Company. The put feature liability associated with the $1,920,000 of the secured notes was valued using the following range of assumptions: 17 Common Stock Holders of common stock are entitled to receive any dividends ratably, if declared by the board of directors out of assets legally available for the payment of dividends, subject to any preferential dividend rights of any outstanding preferred stock. Holders of common stock are entitled to cast one vote for each share held at all stockholder meetings for all purposes, including the election of directors. The holders of more than 50% of the common stock issued and outstanding and entitled to vote, present in person or by proxy, constitute a quorum at all meetings of stockholders. The vote of the holders of a majority of common stock present at such a meeting will decide any question brought before such meeting. Upon liquidation or dissolution, the holder of each outstanding share of common stock will be entitled to share equally in our assets legally available for distribution to such stockholder after payment of all liabilities and after distributions to preferred stockholders legally entitled to such distributions. Holders of common stock do not have any preemptive, subscription or redemption rights. All outstanding shares of common stock are fully paid and nonassessable. The holders of the common stock do not have any registration rights with respect to the stock. Preferred Stock 2004 Stock Option Plan A total of 5,730,222 shares of the Company’s common stock, as adjusted for share splits, had been reserved for issuance at As of Omnibus Stock and Incentive Plan 18 Securities and Exchange Commission which was declared effective on May 10, 2007. Any employee or director of, or consultant for, us or any of our subsidiaries or other affiliates will be eligible to receive awards under the 2007 Plan. We have reserved 8,903,410 shares of common stock for awards under the 2007 In 2007, InterMetro granted 2,350,000 stock options to purchase shares of common stock under the 2007 Plan at an average exercise price of $0.25 per share to employees and directors. 1,095,000 of the shares granted were immediately vested at date of grant. No stock options to purchase shares of common stock were granted under the 2007 plan in the The following presents a summary of activity under the Company’s 2004 and 2007 Plans for the The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the Company’s closing stock price on the last day of the Additional information with respect to the outstanding options at 19 For option grants prior to January 1, 2006, the intrinsic value per share is being recognized over the applicable vesting period which equals the service period. For option grants after December 31, 2006, the compensation cost was determined based on the fair value of the options and is being recognized over the applicable vesting period which equals the service period. At As of In the three months ended March 31, 2008 a vendor of network equipment exercised 635,612 of its warrants with a cash exercise value of $165,936 in a cashless exchange for a $258,304 reduction in payables due to the vendor that resulted in a $92,368 gain on forgiveness of debt. As of December 29, 2006 (the date of the Business Combination), the Company did not have a sufficient number of authorized shares for all share, option and warrant holders. Accordingly, the exchange of securities pursuant to the Business Combination was implemented in two phases with the second phase being automatic upon the filing on May 31, 2007 of Amended and Restated Articles of Incorporation which increased the number of authorized shares of the Company’s common stock to 150,000,000 shares. In the exchange agreements for the Business Combination, the InterMetro Delaware investors agreed to defer the exchange of certain warrants until such time that the Company increased the number of its authorized shares of common stock to 150,000,000. Also, employees of the Company agreed to defer the exchange of a portion of their Private Company Common Stock until such time that the Company had increased the number of its authorized shares of common stock to 150,000,000. The exchange agreements did not provide for a deferral of exercise rights for options issued under the 2004 Plan and the Company did not have enough authorized shares to accommodate the exercise of these options. Accordingly, effective on December 29, 2006, options under the 2004 Plan were not exercisable concurrently on the closing of the Business Combination and the Company determined that there was a liability for such options and included the liability within the accompanying financial statements for the year ended December 31, 2006. The options became exercisable without further act on the part of the holders thereof on May 31, 2007. The Company calculated the value of those options, valued under the fair value method, which would be exercisable at a later date based on EITF No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The value associated with the liability was estimated at $5,384,000 at December 29, 2006, the date of the Business Combination, and was recorded as an offset to additional paid in capital on that date. At December 31, 2006, the Company estimated that there had been no change in the value of these options since the date of the Business Combination. The Company determined the fair market value of this liability to be $11,013,000 at March 31, 2007 and as such recorded a derivative loss of $5,629,000 for the three months ended March 31, 2007. On May 31, 2007 the Company increased the number of its authorized shares of common stock and determined that as of that date there was no longer a liability for the options. The Company determined the fair market value of this liability to be $10,999,225 at May 31, 2007 and as such recorded a derivative gain of $13,528 for the three months ended June 30, 2007. The value associated with the liability was then credited to additional paid in capital. 20 The Company calculated the fair value of these grants as described in SFAS 123R using the following assumptions: In August 2006, the Company entered into unsecured credit facilities of an aggregate of $525,000, with certain of its directors and officers, for general working capital. The facilities had one-year maturities and accrued interest on outstanding principal at 10% per annum compounded monthly. Principal and accrued interest were payable on August 31, 2007. In January 2007 the Company repaid all of these facilities and all accrued fees and interest. On or about December 14, 2006, the Company entered into a Term Credit Agreement pursuant to which it borrowed $600,000 from The Hunter Fund Limited, an unaffiliated lender, bearing no interest as long as there is no default, and all principal and accrued interest was to be payable on the earlier of (i) the closing of the private placement, or (ii) six months from the date of funding, or (iii) the effective date of the termination of the placement agent. The bridge loan principal and all related fees and expenses were repaid in January 2007. Revolving Credit Facility — The Company entered into agreements (the “Agreements”), effective as of April 30, 2008 (the “Closing Date”), with Moriah Capital, L.P. (“Moriah”), pursuant to which the Company may access funds up to $1,500,000. Pursuant to the Agreements, the Company is permitted to borrow an amount not to exceed 80% of its eligible accounts (as defined in the Agreements), net of all taxes, discounts, allowances and credits given or claimed. As of June 30, 2008 the Company has borrowed $1,380,000. The Company’s obligations under the loans are secured by all of the assets of the Company, including but not limited to accounts receivable; provided, however, that Moriah’s lien on the collateral other than accounts receivable (as such terms are defined in the Agreements) are subject to the prior lien of the holders of the Company’s outstanding secured notes. The Agreements include covenants that the Company must maintain, including financial covenants pertaining to cash flow coverage of interest and fixed charges, limitations on the ratio of debt to cash flow and limitations on the amount of current liabilities. The covenants take effect beginning October 1, 2008. The availability of loan amounts under the Agreements expires on April 30, 2009. Annual interest on the loans is equal to the greater of (i) the sum of (A) the Prime Rate as reported in the “Money Rates” column of The Wall Street Journal, adjusted as and when such Prime Rate changes plus (B) 4% or (ii) 10%, and shall be payable in arrears prior to the maturity date, on the first business day of each calendar month, and in full on the April 30, 2009. In accordance with the agreement, the outstanding amount of the loan at any given time may be converted into shares of the Company’s common stock at the option of the lender. The conversion price is $1.00, subject to adjustments and limitations as provided in the Agreements. The Company has also agreed to register the resale of shares of the Company’s common stock issuable under the Agreements and the shares issuable upon conversion of the convertible note if the Company files a registration statement for its own account or for the account of any holder of the Company’s common stock. 21 Subject to certain conditions and limitations, the Company can terminate the ability to fund loans under the Agreements at any time if there are no loans outstanding. As part of the transaction, Moriah received warrants to purchase 2,000,000 shares of the Company’s common stock with an exercise price of $1.00 which expire on April 30, 2015. The Company accounts for the issuance of detachable stock purchase warrants in accordance with APB No. 14 and SFAS No. 150, whereby it separately measures the fair value of the debt and the detachable warrants, and in the case of detachable warrants with put features to the Company for cash, it also values the put feature as a separate component of the detachable warrant, and allocates the proceeds from the debt on a pro-rata basis to each. The resulting discount from the fair value of the debt allocated to the warrant and put feature for cash, which are accounted for as paid-in capital and a liability, respectively, is amortized over the estimated life of the debt. The warrants were valued using the Black-Scholes option-pricing model using the assumptions noted in the table below. The value associated with the warrants was $730,000 and was recorded as an offset to the principal balance of the revolving credit facility and is being amortized on a straight-line basis over the term of the Agreement. As discussed below, the put option liability was $120,000 and the $610,000 difference was credited to Additional Paid in Capital. The expense recognized by the Company in the quarter ended June 30, 2008 as the amortization of the debt discount was $122,000. The Company has also granted Moriah an option as part of the Agreements pursuant to which Moriah can sell the warrants back to the Company for $120,000 at any time during the 30 day period commencing on the earlier of the prepayment in full of all loans or April 30, 2009. The Company has determined that the put option associated with the warrants causes the instrument to contain a net cash settlement feature. In accordance with SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” the put option requires liability treatment. As a result, the put warrant liability was recorded at the warrant purchase price of $120,000 as of June 30, 2008. Vendor Agreements Vendor Disputes 22 or results of operations. Management reviews available information and determines the need for recording an estimate of the potential exposure when the amount is probable, reasonable and estimable based on SFAS 5, “Accounting for Contingencies.” On April 30, 2007, we filed a complaint against KMC Data, LLC (“KMC”) in Federal District Court in the State of California asserting the KMC’s tariffed charges are unlawful and are not applicable to us. On May 23, 2007 KMC filed counter claims attempting to collect on these tariffed charges. There are approximately Consulting Agreement. At December 31, 2007, the Company had net operating loss carryforwards to offset future taxable income, if any, of approximately $14.0 million for Federal and State taxes. The Federal net operating loss carryforwards begin to expire in 2021. The State net operating loss carryforwards begin to expire in 2008. The following is a summary of the Company’s deferred tax assets and liabilities (in thousands): 23 The reconciliation between the statutory income tax rate and the effective rate is as follows: Management has concluded that it is more likely than not that the Company will not have sufficient taxable income of an appropriate character within the carryforward period permitted by current law to allow for the utilization of certain of the deductible amounts generating the deferred tax assets; therefore, a full valuation allowance has been established to reduce the net deferred tax assets to zero at June 30, 2008 and December 31, The table following presents a summary of the Company’s supplemental cash flow information (in thousands): 24 This Report contains financial projections and other “forward-looking statements,” as that term is used in federal securities laws, about our financial condition, results of operations and business. These statements include, among others: statements concerning the potential for revenues and expenses and other matters that are not historical facts. These statements may be made expressly in this Report. You can find many of these statements by looking for words such as “believes,” “expects,” “anticipates,” “estimates,” or similar expressions used in this Report. These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be materially different from any future results expressed or implied by us in those statements. The most important facts that could prevent us from achieving our stated goals include, but are not limited to, the following: We caution you not to place undue reliance on the statements, which speak only as of the date of this Report. The cautionary statements contained or referred to in this section should be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on behalf of us may issue. We do not undertake any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this Report or to reflect the occurrence of unanticipated events. The following discussion should be read in conjunction with our condensed consolidated financial statements and notes to those statements. InterMetro Communications, Inc., formerly Lucy’s Cafe, Inc., (hereinafter, “we,” “us,” “InterMetro” or the “Company”) is a Nevada corporation which through its wholly owned subsidiary, InterMetro Communications, Inc. (Delaware) (hereinafter, “InterMetro Delaware”), is engaged in the business of providing voice over Internet Protocol (“VoIP”) communications services. On December 29, 2006, InterMetro, a public “shell” company, completed a business combination with InterMetro Delaware whereby InterMetro Delaware became our wholly-owned subsidiary. For financial reporting purposes, InterMetro Delaware was considered 25 the accounting acquirer in the business combination. Accordingly, the historical financial statements presented and the discussion of financial condition and results of operations prior to December 29, 2006 below are those of InterMetro Delaware and do not include the Company’s historical financial results. All costs associated with the business combination were expensed as incurred. We have built a national, private, proprietary voice-over Internet Protocol, or VoIP, network infrastructure offering an alternative to traditional long distance network providers. We use our network infrastructure to deliver voice calling services to traditional long distance carriers, broadband phone companies, VoIP service providers, wireless providers, other communications companies and end users. Our VoIP network utilizes proprietary software, configurations and processes, advanced Internet Protocol, or IP, switching equipment and fiber-optic lines to deliver carrier-quality VoIP services that can be substituted transparently for traditional long distance services. We believe VoIP technology is generally more cost efficient than the circuit-based technologies predominantly used in existing long distance networks and is easier to integrate with enhanced IP communications services such as web-enabled phone call dialing, unified messaging and video conferencing services. We focus on providing the national transport component of voice services over our private VoIP infrastructure. This entails connecting phone calls of carriers or end users, such as wireless subscribers, residential customers and broadband phone users, in one metropolitan market to carriers or end users in a second metropolitan market by carrying them over our VoIP infrastructure. We compress and dynamically route the phone calls on our network allowing us to carry up to approximately eight times the number of calls carried by a traditional long distance company over an equivalent amount of bandwidth. In addition, we believe our VoIP equipment costs significantly less than traditional long distance equipment and is less expensive to operate and maintain. Our proprietary network configuration enables us to quickly, without modifying the existing network, add equipment that increases our geographic coverage and calling capacity. During 2006, we enhanced our network’s functionality by implementing Signaling System 7, or SS-7, technology. SS-7 allows access to customers of the local telephone companies, as well as customers of wireless carriers. SS-7 is the established industry standard for reliable call completion, and it also provides interoperability between our VoIP infrastructure and traditional telephone company networks. For the quarter ended September 30, 2005, which was the last quarter prior to the initiation of our SS-7 network expansion, we had gross margin of approximately 30.0%. As part of the network expansion which began in December 2005, we began purchasing additional network capacity on a fixed-cost and monthly recurring basis. These costs, along with other expenses related to the expansion, such as certain nonrecurring costs for installing these services, are included in our total network expenses for the year ended December 31, 2006. However, we did not begin selling services utilizing the network expansion until the quarter ended June 30, 2006. The increase in network costs without a corresponding increase in revenues was a significant factor in reducing our gross margin to (8.9)% for the year ended December 31, 2006. While we expect to continue to add to capacity, as of We currently estimate that this expansion will allow us to provide approximately 10.2 billion minutes of additional voice services per year on our VoIP infrastructure, based on 60% utilization of the equipment we have connected via dedicated circuits to switches operated by local exchange carriers. History 26 A number of trends in our industry and business could have a significant effect on our operations and our financial results. These trends include: Increased Merger and Regulation Historically, we have been successful in implementing our business plan through the expansion of our VoIP infrastructure. Since our inception, we have grown our customer base, including the customers from our March 2006 acquisition, to include over 200 customers, including several large publicly-traded telecommunications companies and retail distribution partners. In connection with the addition of customers and the provision of related voice services, we have expanded our national VoIP infrastructure. In 2006, we also began to dedicate significant resources to acquisition growth, completing our first acquisition in March 2006. We acquired ATI to add minutes to our network and to access new sales channels and customers. We plan to grow our business through direct sales activities and potentially through acquisitions. Revenue 27 We generally bill our customers on a weekly or monthly basis with either a prepaid balance required at the beginning of the week or month of service delivery or with net terms determined by the customers’ creditworthiness. Factors that affect our ability to increase revenue include: Our voice services are sold on a price per minute basis. The rate per minute for each customer varies based on several factors, including volume of voice services purchased, a customer’s creditworthiness, and, increasingly, use of our SS-7 based services, which are priced higher than our other voice transport services. Our ability to increase revenue is primarily based on the number of carrier customers and retail distribution partners that we are able to attract and retain, as revenue is generated on a recurring basis from our customer base. We expect increases in our customer base primarily through the expansion of our direct sales force and our marketing programs. Our customer retention efforts are primarily based on providing high quality voice services and superior customer service. We expect that the addition of SS-7 based services to our network will significantly increase the universe of potential customers for our services because many customers will only connect to a voice service provider through SS-7 based interconnections. We increase the revenue generated from existing customers by expanding the number of geographic markets connected to our VoIP infrastructure. Also, we are typically one of several providers of voice transport services for our larger customers, and can gain a greater share of a customer’s revenue by consistently providing high quality voice service. We expect to expand our revenue base through the acquisition of other voice service providers. We plan to continue to acquire businesses whose primary cost component is voice services or whose technologies expand or enhance our VoIP service offerings. We expect that our revenue will increase in the future primarily through the addition of new customers gained from our direct sales and marketing activities and from acquisitions. Network Costs During the first nine months of 2006, we added a significant amount of capacity, measured by the number of simultaneous phone calls our VoIP infrastructure can connect in a geographic market, by connecting directly to local phone companies through SS-7 based interconnections purchased on a monthly recurring fixed cost basis. As we expand our network capacity and expand our network to new geographic markets, SS-7 based interconnection capacity will be the primary component of our fixed network costs. Until we are able to increase revenues based on our SS-7 services, these fixed costs significantly reduce the gross profit earned on our revenue. Other significant fixed costs components of our VoIP infrastructure include private fiber-optic circuits and private managed IP bandwidth that interconnect our geographic markets, monthly leasing costs for the collocation space used to house our networking equipment in various geographic markets, local loop circuits that are purchased to connect our VoIP infrastructure to our customers and usage 28 based vendors within each geographic market. Other fixed network costs include depreciation expense on our network equipment and monthly subscription fees paid to various network administrative services. The usage-based cost components of our network include: In order to provide services to our customers in geographic areas where we do not have existing or sufficient VoIP infrastructure capacity, we purchase transport services from traditional long distance providers and resellers, as well as from other VoIP infrastructure companies. We refer to these costs as “off-net” costs. Off-net costs are billed on a per minute basis with rates that vary significantly based on the particular geographic area to which a call is being connected. The SS-7 based interconnection services that are purchased from the local exchange carriers, include a usage based, per minute cost component. The rates per minute for this usage based component are significantly lower than the per minute rates for off-net services. The usage based costs for SS-7 services continue to be the largest cost component of our network as we grow revenue utilizing SS-7 technology. Our fixed-cost network components generally do not experience significant price fluctuations. Factors that affect these network components include: Our customers utilize our services in identifiable fixed daily and weekly patterns. Customer usage patterns are characterized by relatively short periods of high volume usage, leaving a significant amount of time during each day where the network components remain idle. Our ability to attract customers with different traffic patterns, such as customers who cater to residential calling services, which typically spike during evening hours, with customers who sell enterprise services primarily for use during business hours, increases the overall utilization of our fixed-cost network components. This decreases our overall cost of operations as a percentage of revenues. Our ability to purchase the appropriate amount of fixed-cost network capacity to (1) adequately accommodate periods of higher call volume from existing customers, (2) anticipate future revenue growth attributed to new customers, and (3) expand services for new and existing customers in new geographic markets is a key factor in managing the percentage of fixed costs we incur as a percentage of revenue. From time to time, we also make strategic decisions to add capacity with newly deployed technologies, such as the SS-7 based services, which require purchasing a large amount of network capacity in many geographic markets prior to the initiation of customer revenue. We expect that both our fixed-cost and usage-based network costs will increase in the future primarily due to the expansion of our VoIP infrastructure and use of off-net providers related to the expected growth in our revenues. Our usage-based network components costs are affected by: Increasing the volume of services we purchase from our vendors typically lowers our average off-net rate per minute, based on volume discounts. Another factor in the determination of our average rate per minute is the mix of voice services we use by carrier type, with large fluctuations based on the carrier type of the end user which can be local exchange carriers, wireless providers or other voice service providers. 29 Our ability to sell services connecting our on-net geographic markets, rather than off-net areas, affects the volume of usage based off-net services we purchase as a percentage of revenue. We expect to continue to make acquisitions of telecommunications companies. As we complete these acquisitions and add an acquired company’s traffic and revenue to our operations, we may incur increased usage-based network costs. These increased costs will come from traffic that remains with the acquired company’s pre-existing carrier and from any of the acquired company’s traffic that we migrate to our SS-7 services or our off-net carriers. We may also experience decreases in usage based charges for traffic of the acquired company that we migrate to our network. The migration of traffic onto our network requires network construction to the acquired company’s customer base, which may take several months or longer to complete. Sales and Marketing Expense General and Administrative Expense The following table sets forth, for the periods indicated, the results of our operations expressed as a percentage of revenue: 30 Net Network Costs Gross margin increased to Depreciation expense included within network costs for the three months ended Sales and Marketing General and Administrative Interest Expense, 31 The following table sets forth, for the periods indicated, the results of our operations expressed as a percentage of revenue: Net Revenues. Net revenues increased $2.4 million, or 23.2%, to $12.5 million for the six months ended June 30, 2008 from $10.1 million for the six months ended June 30, 2007. We have been acquiring new customers which contributed approximately $2.2 million in additional revenues in the six months ending June 30, 2008 and have also had increasing revenue from existing customers. This increase was partially offset by a $218,000 reduction in revenues attributable to the loss of a customer due to an acquisition as well as a reduction in revenues for several large customers. Network Costs. Network costs increased $170,000, or 1.5%, to $11.7 million for the six months ended June 30, 2008 from $11.6 million for the six months ended June 30, 2007. Included within total network costs, variable network costs increased by $474,000 to $10.4 million (83.0% of revenues) for the six months ended June 30, 2008 from $9.9 million (97.6% of revenues) for the six months ended June 30, 2007, primarily from increased revenue, while fixed network costs decreased by $302,000 to $1.3 million for the six months ended June 30, 2008 from $1.6 million for the six months ended June 30, 2007, with the decrease coming primarily from the elimination of legacy network components that were not yet removed from the network in the three months ended June 30, 2007 while the SS-7 replacement components were concurrently being expensed. There were no significant fixed network expenses added during the three months ended June 30, 2008. Through the migration of existing customers to the SS-7 based infrastructure and the addition of new customers, the Company expects to generate improved gross margins as it increases the utilization of its SS-7 network infrastructure. Gross margin increased to 6% for the six months ended June 30, 2008 from a gross margin of (14)% for the six months ended June 30, 2007. This increase in gross margin was attributable to the increasing utilization of capacity and fixed costs, deployment of SS-7 based technology in the network and the continued migration of customers related to the ATI acquisition to our network from third party networks. The Company expects to continue to generate improved gross margins as it increases the utilization of its SS-7 network infrastructure in the future through increased sales. Depreciation expense included within network costs for the six months ended June 30, 2008 was $368,000 (2.9% of net revenues) as compared to $504,000 (5.0% of net revenues) for the six months ended June 30, 2007. Sales and Marketing. Sales and marketing expenses decreased $231,000, or 20.8% to $877,000 for the six months ended June 30, 2008 from $1.1 million for the six months ended June 30, 2007. Sales and marketing expenses as a percentage of net revenues were 7.0% and 10.9% for the six months ended June 30, 2008 32 and 2007, respectively. The Company’s efforts to minimize expenses in sales and marketing resulted in decreased expenses for advertising, consulting, outsourced customer service and promotions, partially offset by an increase in compensation expense. Sales and marketing expenses included stock-based charges related to warrants and stock options of $21,000 for the six months ended June 30, 2008 and 2007. General and Administrative. General and administrative expenses decreased $1.9 million or 40.3% to $2.9 million for the six months ended June 30, 2008 from $4.8 million for the six months ended June 30, 2007. General and administrative expenses as a percentage of net revenues were 22.7% and 47.0% for the six months ended June 30, 2008 and 2007, respectively. General and administrative expenses included stock-based charges related to warrants and stock options of $159,000 and $1.1 million for the six months ended June 30, 2008 and 2007, respectively. The six months ended June 30, 2007 included a $819,000 non-recurring charge related to warrants. The additional approximate $1.1 million decrease in general and administrative expenses for the six months ended June 30, 2008 is primarily attributable to a $795,000 reduction in professional service fees and a $434,000 reduction in payroll related expenses due to reduction in workforce. Certain professional service fees in the six months ended June 30, 2007 were non-recurring fees attributable to becoming a publicly traded company. Interest Expense, Net. Interest expense, net increased $762,000 to $902,000 for the six months ended June 30, 2008 from $140,000 for the six months ended June 30, 2007. Interest expense for the six months ended June 30, 2008 includes $355,000 amortization of debt discount and $50,000 related to an addendum to a vendor agreement. At Net cash used in operating activities was There were no purchases of property and equipment in the Net cash provided by financing activities for the 33 modification and $1.4 million proceeds from an asset based line of credit. This was partially offset by payments made for capital lease obligations and to a related party. Net cash for the The Company has incurred net losses of From November 2007 to Our long-term operating cash requirements include the capital necessary to fund the expansion of capacity and continuing implementation of SS-7 technology in our existing metropolitan markets as well as expansion of our network infrastructure to additional metropolitan markets. We expect cash flow from operating activities of our existing network to offset the negative cash flow from operating activities and cash spent on financing of our capacity and metropolitan market expansions. We intend to adhere to a go-forward policy of fully funding all network infrastructure expansions in advance and intend to expand while maintaining sufficient cash to cover our projected needs. To the extent our plans change, we may need to seek additional funding by accessing the equity or debt capital markets. There is uncertainty regarding whether some of our VoIP services should be classified as telecommunications services. Any VoIP services so classified may be subject to third-party access charges, taxes and fees. If access charges, taxes and fees are imposed on services we have provided or continue to provide, it could have a material adverse effect on our results of operations and financial condition. We do not believe, however, that there would be substantial impairment of our liquidity. In addition, we may pursue acquisitions that require a portion or all of our cash on hand to complete and may also require us to seek additional funding. Our net losses to date may prevent us from obtaining additional funds on favorable terms or at all. Because of our history of net losses and our limited tangible assets, we do not fit traditional credit lending criteria, which could make it difficult for us to obtain loans or to access the debt capital markets. If additional funds were raised through the issuance of convertible debt or equity securities, the percentage of stock owned by our then-current stockholders would be reduced. Furthermore, such convertible debt and equity securities may have rights, preferences or privileges senior to those of our then-current equity securities. The sale of convertible debt securities or additional equity securities could result in additional dilution to our stockholders. The incurrence of indebtedness would result in incurring debt service obligations and could result in operating and financial covenants that would restrict our operations. In addition, there can be no assurance that any additional financing will be available on acceptable terms, if at all. 34 In August 2006, we entered into unsecured credit facilities of an aggregate of $525,000, with certain of our directors and officers, for general working capital. The facilities had one-year maturities and accrue interest on outstanding principal at 10% per annum compounded monthly. In August and October 2006, we took advances of $450,000 and $75,000 under these facilities, respectively, and in January 2007 we repaid all of these facilities and all accrued fees and interest. On or about December 14, 2006, we entered into a Term Credit Agreement pursuant to which we borrowed $600,000 from an affiliate of a placement agent that we had retained bearing no interest as long as there was no default, and all principal and accrued interest was to be payable on the earlier of (i) the closing of a private placement, or (ii) six months from the date of funding, or (iii) the effective date of the termination of the placement agent. The bridge loan principal and all related fees and expenses were repaid in January 2007. Revolving Credit Facility — In April 2008, the Company entered into a convertible revolving credit agreement pursuant to which the Company may access funds up to $1.5 million. The Company is permitted to borrow an amount not to exceed 80% of its eligible accounts receivable. As of June 30, 2008, the Company has borrowed $1.4 million. The Company’s obligations are secured by all of the assets of the Company. The availability of loan amounts under the revolving credit agreement expires on April 30, 2009. Annual interest on the loans is equal to the greater of (i) the sum of (A) the Prime Rate (B) 4% or (ii) 10%, and shall be payable in arrears prior to the maturity date, on the first business day of each calendar month, and in full on the April 30, 2009. (See Note 10 to the Consolidated Financial Statements for detailed discussion.). Our financial statements are prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following accounting policies involve the greatest degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations. Revenue Effective January 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payments,” which revises SFAS 123, “Accounting for Stock-Based Compensation,” issued in 1995. Prior to the adoption of SFAS 123(R), we accounted for stock-based employee compensation arrangements using the intrinsic value method in accordance with the provisions and related interpretations of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). We adopted SFAS 123(R) 35 applying the “modified prospective transition method” under which we continue to account for non-vested equity awards outstanding at the date of adoption of SFAS 123(R) in the same manner as they had been accounted for prior to adoption, that is, we would continue to apply APB 25 in future periods to equity awards outstanding at the date we adopted SFAS 123(R). Under the provisions of SFAS 123(R), we elected to continue to recognize compensation cost for our employees under the minimum value method of APB 25 and to comply with the pro forma disclosure requirements under SFAS 123(R) for all options granted prior to January 1, 2006. Stock-based employee compensation cost is reflected in net loss related to common stock options if options granted under the 2004 Plan have an exercise price below the deemed fair market value of the underlying common stock on the date of grant. We account for equity instruments issued to non-employees in accordance with the provisions of SFAS 123, “Accounting for Stock-Based Compensation,” and Emerging Issues Task Force (“EITF”) Issue No. 96-18, “Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.” All transactions involving goods or services as the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more readily measured. The measurement date of the fair value of the equity instrument issued is the earlier of the date on which the counterparty’s performance is complete or the date on which it is probable that performance will occur. The following presents a summary of stock option grants since January 1, 2004: We record deferred stock-based employee compensation charges in the amount by which the exercise price of an option is less than the deemed fair value of our common stock at the date of grant. We record deferred stock-based compensation for non-employee awards in the amount of the fair value related to the unvested awards or those for which a measurement date has not been reached as described above. We amortize the deferred compensation charges over the vesting period of the underlying option awards, which has been generally one year. Accounts receivable consist of trade receivables arising in the normal course of business. We do not charge interest on our trade receivables. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We review our allowance for doubtful accounts monthly. We determine the allowance based upon historical write-off experience, payment history 36 and by reviewing significant past due balances for individual collectibility. If estimated allowances for uncollectible accounts subsequently prove insufficient, additional allowance may be required. We assess impairment of our other long-lived assets in accordance with the provisions of SFAS 144, When we determine that the carrying value of a long-lived asset may not be recoverable based upon the existence of one or more of the above indicators of impairment, an estimate is made of the future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future undiscounted cash flows and eventual disposition is less than the carrying amount of the asset, an impairment loss is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset, based on the fair market value if available, or discounted cash flows if not. To date, we have not had an impairment of long-lived assets and are not aware of the existence of any indicators of impairment. We account for income taxes using the asset and liability method in accordance with SFAS 109, Accounting for Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of the assets and liabilities. We periodically review the likelihood that we will realize the value of our deferred tax assets and liabilities to determine if a valuation allowance is necessary. We have concluded that it is more likely than not that we will not have sufficient taxable income of an appropriate character within the carryforward period permitted by current law to allow for the utilization of certain of the deductible amounts generating deferred tax assets; therefore, a full valuation allowance has been established to reduce the deferred tax assets to zero at June 30, 2008 and December 31, As of December 31, 2007, our net operating loss carryforwards for federal tax purposes were approximately $14.0 million. Under Section 382 of the Internal Revenue Code, if a corporation undergoes an “ownership change” (generally defined as a greater than 50% change (by value) in its equity ownership over a three-year period), the corporation’s ability to use its pre-change of control net operating loss carryforwards and other pre-change tax attributes against its post-change income may be limited. This Section 382 limitation is applied annually so as to limit the use of our pre-change net operating loss carryforwards to an amount that generally equals the value of our stock immediately before the ownership change multiplied by a designated federal long-term tax-exempt rate. Subject to applicable limitations, net operating losses subject to a Section 382 limitation are not lost if they are not utilized in a particular year. Section 382 provides that all unused net operating losses can be carried forward and aggregated with the following year’s available net operating loss. 37 We evaluate contingent liabilities including threatened or pending litigation in accordance with SFAS 5, “Accounting for Contingencies” and record accruals when the outcome of these matters is deemed probable and the liability is reasonably estimable. We make these assessments based on the facts and circumstances and in some instances based in part on the advice of outside legal counsel. It is not unusual in our industry to occasionally have disagreements with vendors relating to the amounts billed for services provided. We currently have disputes with vendors that we believe did not bill certain charges correctly. While we have paid the undisputed amounts billed for these non-recurring charges based on rate information provided by these vendors, as of Our major outstanding contractual obligations relate to our capital lease obligations related to purchases of fixed assets, amounts due under our strategic equipment agreement, operating lease obligations, and other contractual obligations, primarily consisting of the underlying elements of our network. There are no significant provisions in our agreements with our network partners that are likely to create, increase, or accelerate obligations due thereunder other than changes in usage fees that are directly proportional to the volume of activity in the normal course of our business operations. We have no long-term obligations of more than three years. The following table reflects a summary of our contractual obligations at For a discussion of the impact of recently issued accounting pronouncements, see the subsection entitled Foreign Currency Market Risks Interest Rate Market Risk As required by Rules 13a-15(e) and 15d-15(e) under the Exchange Act, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer. 38 The Company maintains a set of disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms. Disclosure controls are also designed with the objective of ensuring that this information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon their evaluation as of the end of the period covered by this report, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, the Company’s disclosure controls and procedures are effective, except to the extent of the material weaknesses disclosed below, to ensure that information required to be included in the Company’s periodic Securities and Exchange Commission filings is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission rules and forms. There have been no changes in our internal controls over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonable likely to materially affect, our internal controls over financial reporting. At the end of 2007, Section 404 of the Sarbanes-Oxley Act required our management to provide an assessment of the effectiveness of our internal control over financial reporting, and at the end of 2009, our independent registered public accountants will be required to audit management’s assessment. We completed our assessment for the fiscal year ended December 31, 2007 and identified the following material weaknesses which have continued to be material weaknesses at June 30, 2008 (please see the Company’s filing on Form 10-KSB filed with the Securities and Exchange Commission on April 15, 2008). We are in the process of implementing remediation efforts with respect to the material weaknesses which include: 39 We believe the foregoing efforts will enable us to improve our internal control over financial reporting. Management is committed to continuing efforts aimed at improving the design adequacy and operational effectiveness of its system of internal controls. The remediation efforts noted above will be subject to our internal control assessment, testing and evaluation process. 40 In May 2006, the Company entered into an equipment agreement (“Equipment Agreement”) with Cantata Technology, Inc. (“Cantata”). The Company and Cantata have been unsuccessful in their efforts to informally resolve issues relating to the lack of performance of the equipment received under the Equipment Agreement. In August 2008, the Company received notice that it is a defendant in a lawsuit filed in United States District Court by Cantata seeking payment of approximately $1.1 million for the equipment and $63,000 for additional equipment support. The potential liability for the equipment is accounted for on the Company’s balance sheet in accounts payable and accrued expenses. The Company intends to rigorously defend itself in this matter and expects to file counterclaims including, but not limited to, breach of contract and misrepresentation. None. None. None. 41 In accordance with the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INTERMETRO COMMUNICATIONS, INC. By: /s/ Charles Rice By: /s/ Vincent Arena 42INTERMETRO COMMUNICATIONS, INC.
TABLE OF CONTENTS
Part I. Financial Information Page PART I. FINANCIAL INFORMATION Condensed Consolidated Balance Sheets at March 31,June 30, 2008 (unaudited) and December 31, 200721 Consolidated Statements of Operations for the Three and Six Months Ended March 31,June 30, 2008 and 2007 (unaudited)32 Consolidated Statement of Changes in Stockholders’ Deficit for the ThreeSix Months Ended March 31,June 30, 2008 (unaudited)43 Consolidated Statements of Cash Flows for the ThreeSix Months Ended March 31,June 30, 2008 and 2007 (unaudited)54 Notes to Consolidated Financial Statements (unaudited) 6 5 20 25 3038 38 PART II. OTHER INFORMATION 4T.1.Controls and Procedures30 Part II. Other Information Item 1.Legal Proceedings3131 41 31 41 31 41 Exhibits31 41 Signatures 3242 1PART I
-
FINANCIAL INFORMATIONItem 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, exceptExcept par value)Value) June 30,
2008 December 31,
2007 (Unaudited) ASSETS Cash $ 295 $ 277 Accounts receivable, net of allowance for doubtful accounts of $125 at June 30, 2008 and December 31, 2007 2,098 1,875 Deposits 150 180 Other current assets 441 333 Total current assets 2,984 2,665 Property and equipment, net 555 937 Goodwill 1,800 1,800 Other intangible assets, net 101 119 Other long-term assets 36 36 Total Assets $ 5,476 $ 5,557 LIABILITIES AND STOCKHOLDERS’ DEFICIT Accounts payable, trade $ 9,289 $ 8,924 Accrued expenses 3,557 3,519 Bank overdraft 520 464 Deferred revenues and customer deposits 617 586 Borrowings under line of credit facilities net of debt discount of $607 963 190 Current portion of amounts and notes due to related parties 75 215 Current portion of long-term capital lease obligations 138 170 Promissory notes, including $250 from related parties — 600 Secured notes net of debt discount of $742 1,178 — Liability for warrant put feature 120 — Total current liabilities 16,457 14,668 Capital lease obligations, net of current portion 63 106 Liability for warrant put feature 78 — Total long-term liabilities 141 106 Total liabilities 16,598 14,774 Commitments and contingencies Stockholders’ Deficit Common stock – $0.001 par value; 150,000,000 and 50,000,000 shares authorized at June 30, 2008 and December 31, 2007; 61,353,971 and 59,575,194 shares issued and outstanding at June 30, 2008 and December 31, 2007 62 60 Additional paid-in capital 27,603 25,807 Deferred stock based compensation (113 ) (167 ) Accumulated deficit (38,674 ) (34,917 ) Total stockholders’ deficit (11,122 ) (9,217 ) Total Liabilities and Stockholders’ Deficit $ 5,476 $ 5,557 (unaudited) Cash $ 366 $ 277 Accounts receivable, net of allowance for doubtful accounts of $125 at March 31, 2008 and December 31, 2007 2,070 1,875 Deposits 160 180 Other current assets 524 333 Total current assets 3,120 2,665 Property and equipment, net 727 937 Goodwill 1,800 1,800 Other intangible assets 110 119 Other long-term assets 36 36 $ 5,793 $ 5,557 Accounts payable, trade $ 9,985 $ 8,924 Accrued expenses 3,532 3,519 Bank overdraft 446 464 Deferred revenues and customer deposits 678 586 Borrowings under line of credit facilities 190 190 Current portion of amounts and notes due to related parties 145 215 Current portion of long-term capital lease obligations 151 170 Promissory notes, including $250,000 from related parties — 600 Secured notes net of debt discount 772 — Total current liabilities 15,899 14,668 Capital lease obligations 83 106 Liability for warrant put feature 61 — Total long-term liabilities 144 106 Total liabilities 16,043 14,774 62 60 Additional paid-in capital 26,661 25,807 Deferred stock based compensation (140 ) (167 ) Accumulated deficit (36,833 ) (34,917 ) Total stockholders’ deficit (10,250 ) (9,217 ) $ 5,793 $ 5,557 The accompanying notes are an integral part of these consolidated financial statements2INTERMETRO COMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(Dollars in Thousands, except per share amounts)(Unaudited) Net revenues $ 6,387 $ 5,238 Network costs 6,132 6,249 Gross profit (loss) 255 (1,011 ) Operating expenses 477 588 1,410 1,813 Total operating expenses 1,887 2,401 Operating loss (1,632 ) (3,412 ) 376 133 Gain on forgiveness of debt (92 ) — Loss on liability for options and warrants — 5,629 Loss before provision for income taxes (1,916 ) (9,174 ) Provision for income taxes — — Net loss $ (1,916 ) $ (9,174 ) Basic and diluted net loss per common share $ (0.03 ) $ (0.15 ) 59,754 59,575
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTSTATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICIT
(Dollars in Thousands)Thousands, Except per Share Amounts)
(Unaudited) Three Months Ended June 30, Six Months Ended June 30, 2008 2007 2008 2007 Net revenues $ 6,140 $ 4,931 $ 12,527 $ 10,170 Network costs 5,614 5,326 11,746 11,576 Gross profit (loss) 526 (395 ) 781 (1,406 ) Operating expenses Sales and marketing (includes stock based compensation of $11 and $11 for the three months ended June 30, 2008 and 2007, respectively and $21 and $21 for the six months ended June 30, 2008 and 2007, respectively) 401 521 877 1,108 General and administrative (includes stock based compensation of $79 and $939 for the three months ended June 30, 2008 and 2007, respectively and $159 and $1,094 for the six months ended June 30, 2008 and 2007, respectively) 1,440 2,963 2,851 4,777 Total operating expenses 1,841 3,484 3,728 5,885 Operating loss (1,315 ) (3,879 ) (2,947 ) (7,291 ) Interest expense, net (includes amortization of debt discount of $263 and $0 for the three months ended June 30, 2008 and 2007, respectively and $355 and $0 for the six months ended June 30, 2008 and 2007, respectively) 526 6 902 140 Gain on forgiveness of debt — — (92 ) — (Gain) loss on liability for options and warrants — (14 ) — 5,615 Loss before provision for income taxes (1,841 ) (3,871 ) (3,757 ) (13,046 ) Provision for income taxes — — — — Net loss $ (1,841 ) $ (3,871 ) $ (3,757 ) $ (13,046 ) Basic and diluted net loss per common share $ (0.03 ) $ (0.06 ) $ (0.06 ) $ (0.22 ) Shares used to calculate basic and diluted net loss per common share (in thousands) 61,354 59,575 60,561 59,575 (Unaudited) Balance at January 1, 2008 — $ — 59,575,194 $ 60 $ 25,807 $ (167 ) $ (34,917 ) $ (9,217 ) Amortization of stock-based compensation — — — — 63 27 — 90 Warrant issuance — — — — 627 — — 627 Cashless warrants exercise — — 635,612 1 165 166 Stock issued on cashless exercise — — 1,143,165 1 (1 ) — — — Net loss for the three months ended March 31, 2008 — — — — — — (1,916 ) (1,916 ) Balance at March 31, 2008 — $ — 61,353,971 $ 62 $ 26,661 $ (140 ) $ (36,833 ) $ (10,250 )
The accompanying notes are an integral part of these consolidated financial statements.4
CONSOLIDATED STATEMENTSSTATEMENT OF CASH FLOWS
(Unaudited)
(Dollars in Thousands)
Preferred Stock Common Stock Additional
Paid-In
Capital Deferred
Stock Based
Compensation Accumulated
Deficit Total
Stockholders’
Deficit Shares Amount Shares Amount Balance at January 1,
2008 — $ — 59,575,194 $ 60 $ 25,807 $ (167 ) $ (34,917 ) $ (9,217 ) Amortization of stock-based compensation — — — — 126 54 — 180 Warrant issuance — — — — 1506 — — 1,506 Cashless warrants exercise — — 635,612 1 165 — — 166 Stock issued on cashless exercise — — 1,143,165 1 (1 ) — — — Net loss for the six months ended June 30, 2008 — — — — — — (3,757 ) (3,757 ) Balance at June 30, 2008 — $ — �� 61,353,971 $ 62 $ 27,603 $ (113 ) $ (38,674 ) $ (11,122 ) (Unaudited) Cash flows from operating activities: Net loss $ (1,916 ) $ (9,174 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 219 309 Stock based compensation 90 165 Amortization of debt discount 91 — Loss on options and warrants — 5,629 Gain on forgiveness of debt (92 ) (Increase) decrease in assets: Accounts receivable (195 ) (210 ) Deposits 20 (63 ) Other current assets (191 ) (3 ) Increase (decrease) in liabilities: Accounts payable, trade 1,061 (462 ) Accrued expenses 272 (1,885 ) Bank overdraft (19 ) — Deferred revenues and customer deposits 92 (404 ) Net cash used in operating activities (568 ) (6,098 ) Cash flows from investing activities: Purchase of property and equipment — (77 ) Net cash used in investing activities — (77 ) Cash flows from financing activities: Proceeds from secured notes 1,370 — Cancellation of debt due to loan modification (600 ) Payment of amounts to related party (70 ) (305 ) Net proceeds from escrow for private placement — 10,235 Cash refunded from reduction of private placement fees — 176 Repayment of line of credit — (1,125 ) Principal payments on capital lease obligations (43 ) (36 ) Net cash provided by financing activities 657 8,945 Net increase in cash 89 2,770 Cash at beginning of period 277 151 Cash at end of period $ 366 $ 2,921
The accompanying notes are an integral part of these consolidated financial statements.5INTERMETRO COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in Thousands) Six Months Ended June 30, 2008 2007 Cash flows from operating activities: Net loss $ (3,757 ) $ (13,046 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 400 537 Stock based compensation 180 1,115 Amortization of debt discount 355 — Loss on options and warrants — 5,615 Gain on forgiveness of debt (92 ) — (Increase) decrease in operating assets: Accounts receivable (223 ) (243 ) Deposits 30 16 Other current assets (108 ) (57 ) Other long-term assets — (8 ) Increase (decrease) in operating liabilities: Accounts payable, trade 364 150 Accrued expenses 296 (1,956 ) Deferred revenues and customer deposits 32 (339 ) Net cash used in operating activities (2,523 ) (8,216 ) Cash flows from investing activities: Purchase of property and equipment — (79 ) Net cash used in investing activities — (79 ) Cash flows from financing activities: Proceeds from secured notes 1,320 — Bank overdraft 56 — Payment of amounts to related party (140 ) (304 ) Proceeds from line of credit 1,380 — Net proceeds from escrow for private placement — 10,235 Cash refunded from reduction of private placement fees — 176 Repayment of related party credit facility — (1,125 ) Principal payments on capital lease obligations (75 ) (85 ) Net cash provided by financing activities 2,541 8,897 Net increase in cash 18 602 Cash at beginning of period 277 151 Cash at end of period $ 295 $ 753
The accompanying notes are an integral part of these consolidated financial statements.INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)1 — Nature of Operations and Summary of Significant Accounting Policies
- — InterMetro Communications, Inc., formerly Lucy’s Cafe, Inc., (hereinafter, “InterMetro” or the “Company”) is a Nevada corporation which, through its wholly owned subsidiary, InterMetro Communications, Inc. (Delaware) (hereinafter, “InterMetro Delaware”), is engaged in the business of providing voice over Internet Protocol (“VoIP”) communications services. The Company owns and operates state-of-the-art VoIP switching equipment and network facilities that are utilized to provide traditional phone companies, wireless phone companies, calling card companies and marketers of calling cards with wholesale voice and data services, and voice-enabled application services. The Company’s customers pay the Company for minutes of utilization or bandwidth utilization on its national voice and data network and the Company’s calling card marketing customers pay per calling card sold. The Company’s business is located in Simi Valley, California. - — For accounting purposes, the Business Combination was accounted for as a recapitalization of InterMetro Delaware. Accordingly, the historical financial statements of the Company reflect the historical operations and financial statements of InterMetro Delaware before the Business Combination.periodperiods ended March 31,June 30, 2008 are not necessarily indicative of the results to be expected for the full year. These statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2007 which are included in the Form 10-KSB filed by the Company on April 15, 2008.INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)1 — Nature of Operations and Summary of Significant Accounting Policies – (continued)
- — The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and settlement of obligations in the normal course of business. The Company incurred net losses of $3,757,000 for the six months ended June 30, 2008 and $16,915,000 for the year ended December 31, 2007 and $1,916,000 for the three months ended March 31, 2008.2007. In addition, the Company had total shareholders’stockholders’ deficit of $10,250,000$11,122,000 and $9,217,000 at March 31,June 30, 2008 and December 31, 2007, respectively and a working capital deficit of $12,779,000$13,473,000 and $12,003,000 as of March 31,June 30, 2008 and December 31, 2007, respectively. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.threesix months ended March 31,June 30, 2008, the Company received an additional $770,000$1,320,000 pursuant to the sale of secured notes with individual investors and can continue to sell similar secured notes up to a maximum offering of $3 million. We anticipate completing the additional financing required but there can be no assurance that we will be successful in completing this required financing or that we will continue to expand our revenue base to the extent required to achieve positive cash-flows from operations in the future.6 - — The consolidated financial statements include the accounts of InterMetro, InterMetro Delaware, and InterMetro Delaware’s wholly owned subsidiary, Advanced Tel, Inc. (“ATI”). All intercompany balances and transactions have been eliminated in consolidation. - — In the normal course of preparing financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. - — VoIP services are recognized as revenue when services are provided, primarily based on usage. Revenues derived from sales of calling cards through retail distribution partners are deferred upon sale of the cards. These deferred revenues are recognized as revenue generally at the time card minutes are expended. The Company recognizes revenue in the period that services are delivered and when the following criteria have been met: persuasive evidence of an arrangement exists, the fees are fixed and determinable, no significant Company obligations remain and collection is reasonably assured. Deferred revenue consists of fees received or billed in advance of the delivery of the services or services performed in which collection is not reasonably assured. This revenue is recognized when the services are provided and no significant Company obligations remain. Management of the Company assesses the likelihood of collection based on a number of factors, including past transaction history with the customer and the credit worthiness of the customer. Generally, management of the Company does not request collateral from customers. If management ofINTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)1 — Nature of Operations and Summary of Significant Accounting Policies – (continued)
- — Accounts receivable consist of trade receivables arising in the normal course of business. The Company does not charge interest on its trade receivables. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company reviews its allowance for doubtful accounts monthly. The Company determines the allowance based upon historical write-off experience, payment history and by reviewing significant past due balances for individual collectibility. If estimated allowances for uncollectible accounts subsequently prove insufficient, additional allowance may be required. - — The Company’s network costs consist of telecommunication costs, leasing collocation facilities and certain build-outs, and depreciation of equipment related to the Company’s network infrastructure. It is not unusual in the Company’s industry to occasionally have disagreements with vendors relating to the amounts billed for services provided between the recipient of those services and the vendor. As a result, the Company currently has disputes with vendors that it believes did not bill certain network charges correctly. The Company’s policy is to include amounts that it intends to dispute or that it has disputed in a reserve account as an offset to accounts payable if management believes that the facts and circumstances related to the dispute provide probable support that the dispute will be resolved in the Company’s favor. - — The Company expenses advertising costs as incurred. Advertising costs included in sales and marketing expenses were $2,000$0 and $19,700$41,250 for the three months ended March 31,June 30, 2008 and 2007, respectively and $2,000 and $60,950 for the six months ended June 30, 2008 and 2007, respectively. - — Depreciation and amortization of property and equipment is computed using the straight-line method based on the following estimated useful lives:Telecommunications equipment 2-32 – 3 yearsTelecommunications software 18 months to 2 years Computer equipment 2 years Office equipment and furniture 3 years Leasehold improvements Useful life or remaining lease term, which ever is shorter 7 - — The Company assesses impairment of its other long-lived assets in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets.” An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered by the Company include:
significant negative industry or economic trends.·significant underperformance relative to expected historical or projected future operating results;·significant changes in the manner of use of the acquired assets or the strategy for our overall business; and·significant negative industry or economic trends.INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)1 — Nature of Operations and Summary of Significant Accounting Policies – (continued)
- — The Company records goodwill when consideration paid in a business acquisition exceeds the fair value of the net tangible assets and the identified intangible assets acquired. The Company accounts for goodwill and intangible assets in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS 142 requires that goodwill and intangible assets with indefinite useful lives not be amortized, but instead be tested for impairment at least annually or whenever changes in circumstances indicate that the carrying value of the goodwill may not be recoverable. SFAS No. 142 also requires the Company to amortize intangible assets over their respective finite lives up to their estimated residual values. - — Effective January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payments,” which revises SFAS 123, “Accounting for Stock-Based Compensation” issued in 1995. Prior to the adoption of SFAS 123(R), the Company accounted for stock-based employee compensation arrangements using the intrinsic value method in accordance with the provisions and related interpretations of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). The Company adopted SFAS 123(R) applying the “modified prospective transition method” under which it continues to account for nonvestedunvested equity awards outstanding at the date of adoption of SFAS 123(R) in the same manner as they had been accounted for prior to adoption, that is, it would continue to apply APB 25 in future periods to equity awards outstanding at the date it adopted SFAS 123(R), unless the options are modified or amended.the three or six months ended March 31,June 30, 2008. For grants to employees under 2007 plan in the year ended December 31, 2007, the Company estimated the fair value of each option award on the date of grant using the Black-Scholes option-pricing model using the assumptions noted in the following table. Expected volatility is based on the historical volatility of a peer group of publicly traded entities. The expected term of the options granted is derived from the average midpoint between vesting and the contractual term, as described in the SEC’s Staff Accounting Bulletin (“SAB”) No. 107, “Share-Based Payment as amended by SAB No. 110, “Shared Based Payment.” The risk-free rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. These employee options granted were valued using the following assumptions: December 31, 2007 Risk-free interest rate 3.23.2%%Expected lives (in years) 2.8 -– 2.9 Dividend yield 00%%Expected volatility 71% -72– 72%%Forfeiture rate 00%%8INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)1 — Nature of Operations and Summary of Significant Accounting Policies – (continued)
mothsor six months ended March 31,June 30, 2008. The Company calculated the fair value of non-employee grants for the threesix months ended March 31,June 30, 2007 as described in SFAS 123(R) using the following assumptions: March 31, 2007 June 30, 2007 Risk-free interest rate 4.44.4%%Expected lives (in years) 4.3 Years Dividend yield 00%%Expected volatility 9393%%Forfeiture rate 00%%- — The Company accounts for the issuance of detachable stock purchase warrants in accordance with APB No. 14 and SFAS No. 150, whereby it separately measures the fair value of the debt and the detachable warrants, and in the case of detachable warrants with put features to the Company for cash, it also values the put feature as a separate component of the detachable warrant, and allocates the proceeds from the debt on a pro-rata basis to each. The resulting discount from the fair value of the debt allocated to the warrant and put feature for cash, which are accounted for as paid-in capital and a liability, respectively, is amortized over the estimated life of the debt. The liability created by the put feature for cash will be realized if the put is exercised or will be reversed and accounted for as paid-in-capital if the put feature expires unexercised. In accordance with the provisions of EITF Issue No. 98-5 “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios” and Issue No. 00-27 “Application of EITF Issue No. 98-5 ‘Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios’ to Certain Convertible Instruments,” the Company allocates a portion of the proceeds received to any embedded beneficial conversion feature, based on the difference between the effective conversion price of the proceeds allocated to the convertible debt and the fair value of the underlying common stock on the date the debt is issued. In addition, for the detachable stock purchase warrants, the Company first allocates proceeds to the stock purchase warrants and the debt and then allocates the resulting debt proceeds between the beneficial conversion feature, which is accounted for as paid-in capital, and the initial carrying amount of the debt. - — Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, accounts receivable, accounts payable, accrued expenses, and short term debt. The Company maintains its cash with a major financial institution located in the United States. The balances are insured by the Federal Deposit Insurance Corporation up to $100,000 per account. Periodically throughout the year the Company maintained balances in excess of federally insured limits. The Company encounters a certain amount of risk as a result of a concentration of revenue from a few significant customers and services provided from vendors. Credit is extended to customers based on an evaluation of their financial condition. The Company generally does not require collateral or other security to support accounts receivable. The Company performs ongoing credit evaluations of its customers and records an allowance for potential bad debts based on available information. To date, such losses, if any, have been within management’s expectations.INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)1 — Nature of Operations and Summary of Significant Accounting Policies – (continued)
monthsand six month periods ended March 31,June 30, 2008 and one customer which accounted for 12% of net revenue for the three monthsand six month periods ended March 31,June 30, 2007.March 31,June 30, 2008 or December 31, 2007. - — The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using presently enacted tax rates in effect. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. - — The Company operates in one principal business segment primarily in the United States. All of the operating results and identified assets are located in the United States. - — Basic net loss per common share excludes dilution for potential common stock issuances and is computed by dividing net loss by the weighted-average number of common shares outstanding for the period. As the Company reported a net loss for all periods presented, the exercise of stock options and warrants were not considered in the computation of diluted net loss per common share because their effect is anti-dilutive.9 - — In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statements of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements.” This statement defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. The statement is effective for the fiscal years beginning after November 15, 2007. We adopted SFAS 157 as of January 1, 2008 and have determined that the adoption of this statement did not have a material impact on the consolidated financial statements.In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” an amendment of FASB Statements No. 87, 88, 106, and 132(R). This statement requires an employer to recognize the over-funded or under-funded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The funded status of the plan is measured as the difference between plan assets at fair value and the benefit obligation. The statement was effective for fiscal years ending after December 15, 2006. The Company does not have a pension plan or other post retirement plan. As such there was no impact on the Company’s financial position, results of operations, or cash flows. ).). SFAS No. 141(R) requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. Early adoption of the statement is not permitted. SFAS 141(R) is effective for business combinations which occur in fiscal years beginning on or after December 15, 2008. The adoption of SFAS 141(R) will impact the accounting for business combinations completed, if any, by the Company on or after January 1, 2009.INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)1 — Nature of Operations and Summary of Significant Accounting Policies – (continued)
operations.-— Expected Term” (“SAB 110”). According to SAB 110, under certain circumstances, the SEC staff will continue to accept, beyond December 31, 2007, the use of the simplified method in developing an estimate of expected term of share options that possess certain characteristics in accordance with SFAS 123(R). We adopted SAB 110 effective January 1, 2008 and will continue to use the simplified method in developing the expected term used for our valuation of stock-based compensation.entity'sentity’s liquidity by requiring disclosure of derivative features that are credit risk related, and it requires cross-referencing within footnotes to enable financial statement users to locate important information about derivative instruments. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early adoption permitted. The Company is evaluating the impact of the adoption of SFAS 161 and believes there will be no material impact on our consolidated financial statements or financial operations.principles."principles’.” The Company is currently evaluating the potential impact, if any, of the adoption of SFAS 162 on its consolidated financial statements.102 — Acquisition and Intangible Assets
INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)2 — Acquisition and Intangible Assets – (continued)
The firstHalf of the pay-out for the one year period following the transaction close was due to be paid on June 30, 2007 and the second half was due to be paid on June 30, 2008, however, the earn-out provisions are subject to qualitative factors and we expect to negotiate with the seller to determine the amount of earn-out that will be paid. Consequently, the Company has not accrued an earn-out. The maximum amount that could be paid for this earn-out is 154,040308,079 shares of the Company’s common stock.INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)2 — Acquisition and Intangible Assets – (continued)
Total amounts and notes payable to related party $ 400 Common stock (initial 308,079 shares issued at closing) 1,500 Direct acquisition related costs 40 Total consideration $ 1,940 Liabilities assumed in excess of net assets acquired $ (43 ) Goodwill 1,800 Customer relationships 183 Total purchase price $ 1,940 11 Cash $ 459 Accounts receivable 767 Other current assets 10 Total current assets acquired 1,236 Net fixed assets 42 Total assets acquired 1,278 Accounts payable 590 Accrued liabilities 731 Total current liabilities assumed 1,321 Liabilities assumed in excess of net assets acquired $ (43 ) 3 — Other Current Assets
June 30,
2008 December 31,
2007 (Unaudited) Employee advances $ 106 $ 66 Federal excise tax receivable — 109 Prepaid expenses 335 158 Other current assets $ 441 $ 333 (unaudited) Employee advances $ 92 $ 66 Federal excise tax receivable - 109 Other receivable 50 - Prepaid expenses 382 158 Other current assets $ 524 $ 333 INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)4 — Property and Equipment
June 30,
2008 December 31,
2007 (Unaudited) Telecommunications equipment $ 3,218 $ 3,218 Computer equipment 174 174 Telecommunications software 107 107 Leasehold improvements, office equipment and furniture 86 86 Total property and equipment 3,585 3,585 Less: accumulated depreciation and amortization (3,030 ) (2,648 ) Property and equipment, net $ 555 $ 937 (unaudited) Telecommunications equipment $ 3,218 $ 3,218 Computer equipment 174 174 Telecommunications software 107 107 Leasehold improvements, office equipment and furniture 86 86 Total property and equipment 3,585 3,585 Less: accumulated depreciation and amortization (2,858 ) (2,648 ) Property and equipment, net $ 727 $ 937 $200,217,$168,000 and $295,613$209,000 for the three months ended March 31,June 30, 2008 and 2007, respectively and $368,000 and $504,000 for the six months ended June 30, 2008 and 2007, respectively. Depreciation and amortization expense included in general and administrative expenses were $9,876$4,000 and $4,613$15,000 for the three months ended March 31,June 30, 2008 and 2007, respectively and $14,000 and $15,000 for the six months ended June 30, 2008 and 2007, respectively.March 31,June 30, 2008, the Company had purchased telecommunications equipment under this agreement totaling $1,439,222,$1,439,000, of which approximately $384,000$389,000 and $651,000 remained to be paid at March 31,June 30, 2008 and December 31, 2007, respectively.12March 31,June 30, 2008, the Company has purchased VoIP equipment under this agreement totaling $691,332.$691,000. As of March 31,June 30, 2008, $29,216$29,000 of this amount has been paid and an additional $89,083$124,000 has been accrued to be paid based on traffic utilization. Subsequent to entering into this agreement, the Company and the equipment provider agreed to delay the initial payment for the equipment until November 2006. Since there was no agreement in place to defer any payments past November 2006, for the two months ended December 31, 2006 and the three months ended March 31, 2007, the Company expensed an estimate of potential interest due based on the value of the equipment. In May 2007, the Company and the equipment provider agreed that payments would begin for the month ended June 30, 2007, and the Company would not incur any charges for the deferment. Accordingly, in the quarter ending June 30, 2007, the Company reversed the prior periods’ interest expense estimate totaling $90,000.INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)5 — Accrued Expenses
June 30,
2008 December 31,
2007 (Unaudited) Amounts due under equipment agreements $ 1,158 $ 1,394 Commissions, network costs and other general accruals 1,419 1,125 Deferred payroll and other payroll related liabilities 502 525 Interest due on convertible promissory notes and other debt 85 5 Payments due to third party providers 393 470 Accrued expenses $ 3,557 $ 3,519 (unaudited) Amounts due under equipment agreements $ 1,398 $ 1,394 Commissions, network costs and other general accruals 1,203 1,125 Deferred payroll and other payroll related liabilities 506 525 Interest due on convertible promissory notes and other debt 24 5 Payments due to third party providers 401 470 Accrued expenses $ 3,532 $ 3,519 6 — Secured Notes
InDuring the threesix months ended March 31,June 30, 2008, the Company received an additional $770,000$1,320,000 pursuant to the sale of additional secured notes with individual investors for a total of $1,370,000$1,920,000 and can continue to sell similar secured notes up to a maximum offering of $3 million. The secured notes mature 13 to 18 months after issuance and bear interest at a rate of 10% per annum due at the maturity date. The notes contained an origination and documentation fee equal to 3% and 2.5%, respectively, of the original principal amount of the note that is due on the date the Company makes its first prepayment or the maturity date. The holder of each note has the right upon the occurrence of a financing equal to or greater than $10 million, to convert the entire principal plus accrued interest and origination and documentation fee, or any portion thereof, into either securities sold in the financing at the price sold or common stock by dividing the conversion amount by $1.00. The secured notes are securedcollateralized by substantially all of the assets of the Company.2.743.84 million common stock purchase warrants with an exercise price of $1.00, 1.371.92 million of which expire on January 16, 2013 (the "Initial Warrants"“Initial Warrants”) and 1.371.92 million of which expire on February 1, 2014 (the "Additional Warrants"“Additional Warrants”). With respect to the 1.371.92 million Initial Warrants issued in this financing, if such warrants are still held by the lenders at February 1, 2009, the lenders will be entitled to receive a payment (the “Reference Payment”) to the extent that the volume weighted average price per share for the 30 trading days ending January 30, 2009 (the “Reference Price”) is less than $1.00. The Reference Payment will be equal to the difference between $1.00 and the Reference Price. The Company, in its sole discretion, will have the right, but not the obligation, to make this payment by issuing Common Stock, in lieu of cash, but in no event will the amount of stock issued be more than one share per dollar invested by the lenders. If the Company elects to make the above payment by issuing Common Stock any time after the maturity date of the note until the first anniversary of the date thereof the holder may submit the Common Stock to the Company for $0.15 per share of Common Stock.1.371.92 million Additional Warrants issued in this financing that expire on February 1, 2014, if such warrants are still held by the lenders at February 1, 2009, the lenders will be entitled to receive a payment (the “Second Reference Payment”) to the extent that the volume weighted average price per share for the 30 trading days ending January 30, 2009 (the “Second Reference Price”) is less than $2.00. The Second Reference Payment will be equal to the difference between $2.00 and the Second Reference Price up to a maximum value of $1.00. The Company, in its sole discretion, will have the right, but not the obligation, to make this payment by issuing Common Stock, in lieu of cash, but in no event will the amount of stock issued be more than one share per dollar invested by the lenders.INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)6 — Secured Notes – (continued)
13dates. Thedates for warrants issued during the three months ended March 31, 2008 and used the valuation for the warrants issued January 16, 2008 to determine the value of warrants issued in the three months ended June 30, 2008. Rather than re-engaging an independent third party to perform new valuations at the April 30, 2008 and June 16, 2008 warrant issuance dates, the Company determined that the closing stock price of $0.25 at January 16, 2008 along with all other assumptions used for the January 16, 2008 warrant valuation are materially representative of the assumptions and resultant valuations that would be used for the warrant issuances in the three month period ending June 30, 2008. On this basis, the value associated with all the warrants totaled $689,000$975,000 and was recorded as an offset to the principal balance of the secured notes and wasis being amortized into interest expense using the effective interest method. The total expense recorded by the Company was $141,000 and $233,000 for the three and six months ended March 31,June 30, 2008, was $91,000.respectively. The net amount of the notes of $772,000$945,000 has been recorded as of March 31,June 30, 2008.1one year. In addition, if the Company pays stock out for the warrants at the maturity date, the holder would have the right to put the common stock issued back to the Company for $0.15 per share. In both instances, the Company has determined that the put option associated with the Initial Warrants causes the instrument to contain a net cash settlement feature. As a result, in accordance with SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” the put option in the Initial Warrants have beenrequires liability treatment. Additionally, in accordance with SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” the Company will continue to report the fair value of the put option until either the liability is paid or the option is expired. Any changes in the fair value of the put liability will be recorded as a liability. In connection with the third-party valuation of the warrants discussed above, thegain or loss. A put warrant liability of $61,000$78,000 was determined and has been recorded as of March 31,June 30, 2008 using the same valuation methodology as described in detail in the preceeding paragraph in regards to the warrant valuation for the three months ended June 30, 2008. The Company did not obtain an additional third-party valuation of the warrants issued in the three months ended June 30, 2008 or the revaluation of the liability associated with the put feature of the warrants as of June 30, 2008 and used the same range of assumptions that were used at January 16, 2008.INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)6 — Secured Notes – (continued)
securedpromissory notes from the period ended December 31, 2007 were valued using the following range of assumptions: January 16, 2008 Risk-free interest rate 2.98% - 3.14– 3.14%%Expected lives (in years) 12 -– 18 months Dividend yield 00%%Expected volatility 81.2% - 87.7– 87.7%%Forfeiture rate 00%% March 31, 20072008 Risk-free interest rate 2.98% - 3.14– 3.14%%Expected lives (in years) 9 -– 15 months Dividend yield 00%%Expected volatility 100.1% - 103.4– 103.4%%Forfeiture rate 00%%April 30, 2008 Risk-free interest rate 2.98% – 3.14% Expected lives (in years) 12 – 18 months Dividend yield 0% Expected volatility 81.2% – 87.7% Forfeiture rate 0% June 16, 2008 Risk-free interest rate 2.98% – 3.14% Expected lives (in years) 12 – 18 months Dividend yield 0% Expected volatility 81.2% – 87.7% Forfeiture rate 0% June 30, 2008 Risk-free interest rate 2.98% – 3.14% Expected lives (in years) 12 – 18 months Dividend yield 0% Expected volatility 81.2% – 87.7% Forfeiture rate 0% INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)7 — Common and Preferred Stock
-March 31,June 30, 2008, the total number of authorized shares of common stock, par value $0.001 per share, was 150,000,000 of which 61,353,971 shares were issued and outstanding. -8 — Stock Options and Warrants
- — Effective January 1, 2004, the Company’s Board of Directors adopted the 2004 Stock Option Plan for Directors, Officers, and Employees of and Consultants to InterMetro Communications, Inc. (the “2004 Plan”). All stock options to purchase Private Company Common Stock issued under the 2004 Plan were converted into stock options to purchase shares of the Company’s common stock in connection with the Business Combination. The number of shares subject to the options and the exercise prices are presented on a pro forma basis as if the Business Combination had occurred at the beginning of the periods presented. The exercise periods and other terms and conditions of the stock options remained the same.14March 31,June 30, 2008 and December 31, 2007. Upon shareholder ratification of the 2004 Plan pursuant to the definitive Information Statement on Schedule 14C filed with the Securities and Exchange Commission on March 6, 2007, the Company froze any further grants of stock options under the 2004 Plan. Any shares reserved for issuance under the 2004 Plan that are not needed for outstanding options granted under that plan will be cancelled and returned to treasury shares.March 31,June 30, 2008, the Company has granted a total of 5,714,819 stock options under the 2004 Plan to the officers, directors, and employees, and consultants of the Company, of which 308,077 expired in the quarter ended September 2007.2007, 154,043 expired in the quarter ended March 31, 2008 and 61,614 expired in the current quarter ended June 30, 2008. In the three months ended March 31, 2008, the Company issued 1,143,165 shares of common stock on the cashless exercise of 1,232,320 stock purchase options. Of the remaining, 3,296,404 vest as follows: 20% on the date of grant and 1/16 of the balance each quarter thereafter until the remaining stock options have vested and 878,018 of which vest as follows: 50% on the date of grant and 50% at one year after the date of grant. These stock options are exercisable for a period of ten years from the date of grant and are exercisable at exercise prices ranging from approximately $0.04 to $0.97 per share.- — Effective January 19, 2007, our Board of Directors approved the 2007 Omnibus Stock and Incentive Plan (the “2007 Plan”) for directors, officers, employees, and consultants. Our shareholders ratified the 2007 Plan pursuant to the Schedule 14C Information Statement filed with theINTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)8 — Stock Options and Warrants – (continued)
Planthreesix months ended March 31,June 30, 2008.threesix months ended March 31,June 30, 2008 (unaudited): Number
of
Shares Price per
Share Weighted
Average
Exercise
Price Weighted
Average
Remaining
Contractual
Term Aggregate
Intrinsic
ValueOptions outstanding at December 31, 2007 7,756,742 $ — $ 0.18 7.56 $ 821,508 Granted — — — Exercised 1,232,320 — 0.04 135,847 Forfeited/expired 523,734 — 0.04 Options outstanding at June 30, 2008 6,000,688 0.21 7.50 1,809,679 Options vested and expected to vest in the future at June 30, 2008 6,000,688 0.21 7.50 1,809,679 Options exercisable at June 30, 2008 4,821,223 0.19 7.18 1,542,444 Options outstanding at December 31, 2007 7,756,742 $ — $ 0.18 7.56 $ 821,508 Granted — — — Exercised 1,232,320 135,847 Forfeited/expired 462,120 Options outstanding at March 31, 2008 6,062,302 0.18 8.00 239,349 Options vested and expected to vest in the future at March 31, 2008 6,062,302 0.18 8.00 239,349 Options exercisable at March 31, 2008 4,700,201 0.15 7.64 238,675 threesix month period ended March 31,June 30, 2008 and the exercises price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on March 31,June 30, 2008.15March 31,June 30, 2008 is as follows: Options Outstanding Options Exercisable Exercise Prices Number of
Shares Average
Remaining
Contractual Life
(in Years) Weighted
Average
Exercise
Price Number of
Shares Weighted
Average
Exercise
Price$0.04 1,478,748 5.50 $ 0.04 1,478,748 $ 0.04 0.04 154,039 5.75 0.04 154,039 0.04 0.04 431,307 6.00 0.04 431,307 0.04 0.04 123,231 6.50 0.04 123,231 0.04 0.22 277,269 7.25 0.22 221,815 0.22 0.25 2,350,000 9.25 0.25 1,468,753 0.25 0.27 338,884 7.25 0.27 254,163 0.27 0.41 643,879 7.50 0.41 520,033 0.41 0.81 110,908 7.50 0.81 76,711 0.81 0.97 92,423 7.75 0.97 92,423 0.97 6,000,688 4,821,223 $0.04 1,478,747 5.75 $ 0.04 1,478,747 $ 0.04 0.04 154,038 6.00 0.04 154,038 0.04 0.04 431,307 6.25 0.04 425,146 0.04 0.04 123,231 6.75 0.04 123,231 0.04 0.22 277,269 7.50 0.22 207,952 0.22 0.25 2,350,000 9.50 0.25 1,370,837 0.25 0.27 338,884 7.50 0.27 237,219 0.27 0.41 705,495 7.75 0.41 539,442 0.41 0.81 110,908 7.75 0.81 71,166 0.81 0.97 92,423 8.00 0.97 92,423 0.97 6,062,302 4,700,201 INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)8 — Stock Options and Warrants – (continued)
March 31,June 30, 2008, 1,170,691 of the Company’s outstanding options were granted with exercise prices at or below fair value. Compensation expense recognized in the consolidated statements of operations in connection with these options was $27,000 and $51,000 during the three months ended March 31,June 30, 2008 and 2007, respectively and $54,000 and $102,000 during the six months ended June 30, 2008 and 2007, respectively.March 31,June 30, 2008, there was $531,265$441,000 of total unrecognized compensation cost related to unvested share based compensation arrangements granted under the 2004 and 2007 option plans. The cost is expected to be recognized over a weighted average period of approximately 2 years.9 — Liability
Forfor Options16INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)9 — Liability for Options – (continued)
December 31, 2006 March 31, 2007 May 31, 2007 Risk-free interest rate 4.7% 4.5% 4.8% Expected lives (in years) 3.6 years to
5.4 years 3.5 years to
5.3 years 2.8 years to
4.5 years Dividend yield 0% 0% 0% Expected volatility 84% – 101% 77% – 93% 65% – 92% Risk-free interest rate 4.7 % 4.5 % Expected lives (in years) 3.6 years to 5.4 years 3.5 years to 5.3 years Dividend yield 0 % 0 % Expected volatility 84%-101 % 77%-93 % 10 — Credit Facilities
INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)10 — Credit Facilities – (continued)
June 30, 2008 Risk-free interest rate 2.62% Expected lives (in years) 7 years Dividend yield 0% Expected volatility 93.0% Forfeiture rate 0% 11 — Commitments and Contingencies
- — The Company has entered into agreements with its network partners and other vendors for various services which are, in general, for periods of twelve months and provide for month to month renewal periods. -March 31,June 30, 2008, there are approximately $1.6$1.8 million of unresolved charges in dispute and the Company has not recorded a net liability for the unresolved charges. The Company is in discussion with these vendors regarding these charges and it may take additional action as deemed necessary against these vendors in the future as part of the dispute resolution process. Management does not believe that any settlement would have a material adverse effect on the Company’s financial positionINTERMETRO COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)11 — Commitments and Contingencies – (continued)
$684,000$728,000 of charges that we dispute. We cannot predict the outcome of these proceedings at this time. A ruling against us could have a material adverse impact on our operating results, financial condition and business performance. Of the $684,000,$728,000, only $30,000 has been accrued and the remaining $654,000$698,000 would be a charge against network cost if we were to lose the complaint.monthsand six month periods ending March 31, 2008.12 — Income Taxes
17 June 30,
2008 December 31,
2007 (Unaudited) Current assets and liabilities: Current assets and liabilities: Deferred revenue $ 28 $ (58 ) Accrued expenses 108 (9 ) 136 (67 ) Valuation allowance (136 ) 67 Net current deferred tax asset $ — $ — Non-current assets and liabilities: Depreciation and amortization $ 19 $ 53 Net operating loss carryforward 15,486 13,966 15,505 14,019 Valuation allowance (15,505 ) (14,019 ) Net non-current deferred tax asset $ — $ — INTERMETRO COMMUNICATIONS, INC.
(unaudited) Current assets and liabilities: Current assets and liabilities: Deferred revenue $ 13 $ (58 ) Accrued expenses 83 (9 ) 96 (67 ) Valuation allowance (96 ) 67 Net current deferred tax asset $ — $ — Non-current assets and liabilities: Depreciation and amortization $ 11 $ 53 Net operating loss carryforward 14,749 13,966 14,760 14,019 Valuation allowance (14,760 ) (14,019 ) Net non-current deferred tax asset $ — $ —
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)12 — Income Taxes – (continued)
For the Six Months Ended
June 30, 2008 2007 (Unaudited) Federal statutory tax rate (34 )% (34 )% State and local taxes (6 ) (6 ) Valuation reserve for income taxes 40 40 Effective tax rate — % — % (unaudited) Federal statutory tax rate (34 )% (34 )% State and local taxes (6 ) (6 ) Valuation reserve for income taxes 40 40 Effective tax rate — % — % 2007 and March 31, 2008.13 — Cash Flow Disclosures
Six Months Ended
June 30, 2008 2007 (Unaudited) Cash paid: Interest $ 110 $ 173 Non-cash information: Issuance of common stock for cashless exercise of warrants $ 165 $ — Cancellation of debt due to loan modification $ 600 $ — Equipment obtained under capital leases $ — $ 233 Fair value of debt discount (net of put liability) $ 1,506 $ — Stock issued on cashless exercise of common stock purchase options $ 1 $ — (unaudited) Cash paid: Interest $ 67 $ 91 Non-cash information: Issuance of common stock for cashless exercise of warrants $ 165 $ — Equipment obtained under capital leases $ — $ 233 Fair value of debt discount (net of put liability) 627 — Stock issued on cashless exercise of common stock purchase options $ 1 $ — 1814 — Subsequent EventsPrivate Placement of Securities - As discussed in Note 6 the Company received $1,370,000 pursuant to the sale of secured notes with individual investors and can continue to sell similar secured notes up to a maximum offering of $3 million. In April 2008 the Company received an additional $500,000 under the same terms.Revolving Credit Facility - In April 2008, the Company entered into a revolving credit agreement pursuant to which the Company may access funds up to $1.5 million. The Company is permitted to borrow an amount not to exceed 80% of its eligible accounts receivable. As of May 20, 2008, the Company has borrowed $1.4 million. The Company's obligations are secured by all of the assets of the Company. The availability of loan amounts under the revolving credit agreement expires on April 30, 2009. Annual interest on the loans is equal to the greater of (i) the sum of (A) the Prime Rate (B) 4% or (ii) 10%, and shall be payable in arrears prior to the maturity date, on the first business day of each calendar month, and in full on the April 30, 2009.As part of the transaction the outstanding amount of the loan that the Company actually borrows may be converted to shares of the Company's common stock. The conversion price is $1.00, subject to adjustments and limitations as provided in the Agreements. Additionally, the lender received warrants to purchase 2,000,000 shares of the Company’s common stock with an exercise price of $1.00 which expire on April 30, 2015.19Cautionary Statements
(a) volatility or decline of our stock price; (b) potential fluctuation in quarterly results; (c) our failure to earn revenues or profits; (d) inadequate capital and barriers to raising capital or to obtaining the financing needed to implement our business plans; (e) changes in demand for our products and services; (f) rapid and significant changes in markets; (g) litigation with or legal claims and allegations by outside parties; (h) insufficient revenues to cover operating costs; (i) the possibility we may be unable to manage our growth; (j) extensive competition; (k) loss of members of our senior management; (l) our dependence on local exchange carriers; (m) our need to effectively integrate businesses we acquire; (n) risks related to acceptance, changes in, and failure and security of, technology; and(o) regulatory interpretations and changes.changes; and(p) malfunction of equipment or other aspects of VoIP infrastructure. Background
20General
March 31,June 30, 2008 and 2007, the SS-7 network expansion was a fully operating and revenue generating component of our VoIP infrastructure. We believe that increasing voice minutes utilizing our network expansion will ultimately generate gross margins approximating those generated prior to the network expansion. A key aspect of our current business strategy is to focus on sales to increase these voice minutes.Overview
Trends in Our Industry and Business
competitionCompetition for end usersEnd Users of voice services21acquisition activitiesAcquisition Activities of traditional long distance carriersOur Business Model
·Changes in the average rate per minute that we charge our customers.·Increasing the net number of customers utilizing our VoIP services.·Increasing the average revenue we generate per customer.22·Acquisitions.·SS-7 based interconnection costs.·Other fixed costs.·Off-net costs.·SS-7 based interconnections with local carriers.·Efficient utilization of fixed-cost network components.·Strategic purchase of fixed-cost network components.23·Fluctuations in per minute rates of off-net service providers.·Sales mix of our VoIP infrastructure capacity versus off-net services.·Acquisitions of telecommunications businesses.24Results of Operations for the Three Months Ended
March 31,June 30, 2008 and 2007 Three Months Ended
June 30, 2008 2007 Net revenues 100 % 100 % Network costs 91 108 Gross profit 9 (8 ) Operating expenses: Sales and marketing 7 11 General and administrative 23 60 Total operating expenses 30 71 Operating loss (21 ) (79 ) Gain/(loss) on option and warrant liability — — Interest expense 9 — Loss before provision for income tax (30 ) (79 ) Net loss (30 )% (79 )% Net revenues 100 % 100 % Network costs 96 119 Gross profit 4 (19 ) Operating expenses: Sales and marketing 8 11 General and administrative 22 35 Total operating expenses 30 46 Operating loss (26 ) (65 ) Gain/(loss) on option and warrant liability — (107 ) Interest expense 5 3 Loss before provision for income tax (31 ) (175 ) Net loss (31 )% (175 )% Revenues21.9%24.5%, to $6.4$6.1 million for the three months ended March 31,June 30, 2008 from $5.2$4.9 million for the three months ended March 31,June 30, 2007. We have been acquiring new customers which contributed approximately $1.6 million$976,000 in additional revenues in the three months ending March 31, 2008. This increase was partially offset by a $218,000 reduction in revenues attributable to the loss of a customer due to an acquisition as well as a reduction in revenues for several largeJune 30, 2008 and have also had increasing revenue from existing customers.decreased $117,000,increased $288,000, or 1.9%5.4%, to $6.1$5.6 million for the three months ended March 31,June 30, 2008 from $6.2$5.3 million for the three months ended March 31,June 30, 2007. Included within total network costs, variable network costs increased by $414,000 from $4.5$390,000 to $5.0 million (86%(81.8% of revenues) for the three months ended March 31, 2007 to $4.9June 30, 2008 from $4.6 million (77%(94.0% of revenues) for the three months ended March 31, 2008,June 30, 2007, primarily from increased revenue, while fixed network costs decreased by $357,000 from $1.7 million$101,000 to $589,000 for the three months ended March 31, 2007 to $1.4 millionJune 30, 2008 from $691,000 for the three months ended March 31, 2008,June 30, 2007, with the decrease coming primarily from the elimination of legacy network components that were not yet removed from the network in the three months ended March 31,June 30, 2007 while the SS-7 replacement components were concurrently being expensed. There were no significant fixed network expenses added during the three months ended March 31,June 30, 2008. Variable network costs for the three months ended March 31, 2008 include a $224,000 reduction in cost attributable to the settlement of a dispute from a prior period. Through the migration of existing customers to the SS-7 based infrastructure and the addition of new customers, the Company expects to generate improved gross margins as it increases the utilization of its SS-7 network infrastructure.4%9% for the three months ended March 31,June 30, 2008 from a gross margin of (19)(8)% for the three months ended March 31,June 30, 2007. This increase in gross margin was attributable to the increasing utilization of capacity and fixed costs, deployment of SS-7 based technology in the network and the continued migration of customers related to the ATI acquisition to our network from third party networks. The Company expects to continue to generate improved gross margins as it increases the utilization of its SS-7 network infrastructure in the future through increased sales.March 31,June 30, 2008 was $200,000 (3.1%$168,000 (2.7% of net revenues) as compared to $296,000 (5.6%$209,000 (4.2% of net revenues) for the three months ended March 31,June 30, 2007.$111,000,$120,000, or 18.9%23.0% to $477,000$401,000 for the three months ended March 31,June 30, 2008 from $588,000$521,000 for the three months ended March 31,June 30, 2007. Sales and marketing expenses as a percentage of net revenues were 7.5%6.5% and 11.2%10.6% for the three months ended March 31,June 30, 2008 and 2007, respectively. Expense controlsThe Company’s efforts to minimize expenses in sales and marketing resulted in decreased expenses for advertising, consulting, outsourced customer service and promotions, partially offset by an increase in compensation expense. Sales and marketing expenses included stock-based charges related to warrants and stock options of $11,000 for the three months ended March 31,June 30, 2008 and 2007.$403,000$1.5 million or 22.2%51.47% to $1.4 million for the three months ended March 31,June 30, 2008 from $1.8$3.0 million for the three months ended March 31,June 30, 2007. General and administrative expenses as a percentage of net revenues were 22.1%23.4% and 34.6%60.1% for the three months ended March 31,June 30, 2008 and 2007, respectively. General and administrative expenses included stock-based charges related to warrants and stock options of $79,000 and $154,000$939,000 for the three months ended March 31,June 30, 2008 and 2007, respectively. The three months ended June 30, 2007 included a $819,000 non-recurring charge related to warrants. The additional approximate $700,000 decrease in general and administrative expenses for the three months ended March 31,June 30, 2008 is primarily attributable to non-recurringa $417,000 reduction in professional service fees, incurreda $234,000 reduction in payroll related expenses due to reduction in workforce and a $77,000 reduction in the cost of insurance as the company has continued to minimize expenses. Certain professional service fees in the three months ended March 31,June 30, 2007 forwere non-recurring fees attributable to becoming a publicly traded company.25net$243,000, or 182.7%,$520,000 to $376,000$526,000 for the three months ended March 31,June 30, 2008 from $133,000$6,000 for the three months ended March 31,June 30, 2007. Interest expense for the three months ended March 31,June 30, 2008 includes $91,000$263,000 amortization of debt discount. Interest expense for the three months ended June 30, 2007 includes a $90,000 non-recurring credit related to renegotiation of a fixed asset purchase agreement.Results of Operations for the Six Months Ended June 30, 2008 and 2007
Six Months Ended
June 30, 2008 2007 Net revenues 100 % 100 % Network costs 94 114 Gross profit 6 (14 ) Operating expenses: Sales and marketing 7 11 General and administrative 23 47 Total operating expenses 30 58 Operating loss (24 ) (72 ) Gain of forgiveness of debt 1 — Gain/(loss) on option and warrant liability — (55 ) Interest expense 7 1 Loss before provision for income tax (30 ) (128 ) Net loss (30 )% (128 )% Liquidity and Capital Resources
March 31,June 30, 2008, we had $366,000$295,000 in cash. The Company’s working capital position, defined as current assets less current liabilities, has historically been negative and was negative $12.8$13.5 million at March 31,June 30, 2008 and negative $12.0 million at December 31, 2007. Included in current liabilities at March 31,June 30, 2008 was $1.4$1.2 million due under strategic equipment agreements used to finance equipment purchases. The Company has agreements with vendors that allow for significantly longer terms than the terms for payment offered to the majority of its customers. This difference in payment terms has been a significant factor in the Company reporting negative working capital as part of its ongoing operations, and the Company expects this difference to continue.Significant changes in cash flows from
March 31,the six months ended June 30, 2008 as compared to March 31, 2007:$568,000$2.5 million for the threesix months ended March 31,June 30, 2008 as compared to net cash used in operating activities of $6.1$8.2 million for the threesix months ended March 31,June 30, 2007. The most significant use of cash in operating activities was our net loss for the threesix months ended March 31,June 30, 2008 of approximately $1.9$3.8 million. The primary offsets to this use of cash were add-backs related to non-cash expenses for depreciation and amortization, stock-based compensation and amortization of debt discount. In addition, a $1.1 million$660,000 increase in accounts payable and accrued expenses from December 31, 2007 reduced the use of cash from operating activities. The most significant uses of cash in operating activities for the threesix months ended March 31,June 30, 2007 were the $9.2$13.0 million net loss and a $1.9$2.0 million reduction in accrued expenses principally related to payments made to our professional service providers for costs primarily attributable to our initial public offering which was subsequently withdrawn in December 2006. The primary offsets toPartially offsetting these uses of funds werewas the add-back of the $5.6 million non-cash loss on liability for options and warrants as well as non-cash expenses for stock based compensation and depreciation.threesix months ended March 31,June 30, 2008. Net cash used in investing activities for the threesix months ended March 31,June 30, 2007 was $77,000$79,000 attributable to the purchase of network-related equipment.threesix months ended March 31,June 30, 2008 was $657,000$2.5 million as compared to cash provided by financing activities of $8.9 million for the threesix months ended March 31,June 30, 2007. Net cash provided by financing activities for the threesix months ended March 31,June 30, 2008 was primarily attributable to the receipt of $1.4$1.9 million from the issuance of secured notes offset by $600,000 cancellation of debt due to loan modification.threesix months ended March 31,June 30, 2007 included the receipt of approximately $10.2 million in gross proceeds from our sale of common stock in December 2006 (proceeds were held in escrow at December 31, 2006) partially offset by the repayment of our related party credit facilities of $1.1 million.$1.9$3.8 million and $9.2$13.0 million and negative cash flow from operations of $568,000$2.5 million and $6.1$8.2 million for the threesix months ended March 31,June 30, 2008 and 2007, respectively. As of March 31,June 30, 2008, the Company has a working capital deficit of $12.8$13.5 million. The Company plans to use its current cash balance and capital raised from outside sources to fund future operating losses until the Company has grown revenues so that cash flows from operating activities are sufficient to sustain operations without the need for outside capital. Also, the Company will need additional cash from outside financing sources to continue operations and achieve its growth strategies, including cash for use in the completion of potential acquisitions.March 31,June 30, 2008, the Company received $1,370,000$1,920,000 pursuant to the sale of secured notes with individual investors for general working capital. The Company can continue to sell similar secured notes up to a maximum offering of $3 million. Such additional financing is necessary in order to fund ongoing operations until such time as the Company can achieve positive cash flow from operations. The Company is in the process of securing this required additional financing, however, there can be no assurance that we will be successful in completing the financing required to fund our ongoing operations or that we will continue to expand our revenue base to the extent required to achieve positive cash-flows from operations in the future. The Company also has borrowed $1.4 million on a $1.5 million asset-based line of credit (see Note 10 to the Consolidate Financial Statements). These circumstances raise substantial doubt about our ability to continue as a going concern.26Credit Facilities
Critical Accounting Policies and the Use of Estimates
Recognition.Stock-Based Compensation
27 Replacement for Grants Made
During Quarter Ended Number of
Options
Granted Weighted-
Average
Exercise
Price Weighted-
Average
Intrinsic Value
per Share Weighted-
Average
Fair Value
per ShareMarch 31, 2004 3,635,304 $ 0.041 $ — $ 0.041 September 30, 2004 554,536 $ 0.041 $ 0.171 $ 0.212 September 30, 2005 277,273 $ 0.220 $ 0.592 $ 0.811 December 31, 2005 338,885 $ 0.268 $ 0.624 $ 0.893 March 31, 2006 797,924 $ 0.453 $ 0.521 $ 0.974 June 30, 2006 110,895 $ 0.974 $ 0.745 $ 1.718 September 30, 2006 — $ — $ — $ — December 31, 2006 — $ — $ — $ — March 31, 2007 — $ — $ — $ — June 30, 2007 — $ — $ — $ — September 30, 2007 — $ — $ — $ — December 31, 2007 2,350,000 $ 0.250 $ 0.000 $ 0.110 March 31, 2008 — $ — $ — $ — June 30, 2008 — $ — $ — $ — March 31, 2004 3,635,304 $ 0.041 $ — $ 0.041 September 30, 2004 554,536 $ 0.041 $ 0.171 $ 0.212 September 30, 2005 277,273 $ 0.220 $ 0.592 $ 0.811 December 31, 2005 338,885 $ 0.268 $ 0.624 $ 0.893 March 31, 2006 797,924 $ 0.453 $ 0.521 $ 0.974 June 30, 2006 110,895 $ 0.974 $ 0.745 $ 1.718 September 30, 2006 — $ — $ — $ — December 31, 2006 — $ — $ — $ — March 31, 2007 — $ — $ — $ — June 30, 2007 — $ — $ — $ — September 30, 2007 — $ — $ — $ — December, 31 2007 2,350,000 $ 0.250 $ 0.000 $ 0.110 March 31, 2008 — $ — $ — $ — Deferred Stock-Based Compensation
Accounts Receivable and the Allowance for Doubtful Accounts
Impairment of Long-Lived Assets
· Significant underperformance relative to expected historical or projected future operating results;· Significant changes in the manner of use of the acquired assets or the strategy for our overall business; and· Significant negative industry or economic trends.28Accounting for Income Taxes
2007 and March 31, 2008.2007. In addition, we operate within multiple domestic taxing jurisdictions and are subject to audit in those jurisdictions. These audits can involve complex issues, which may require an extended period of time for resolution. Although we believe that our financial statements reflect a reasonable assessment of our income tax liability, it is possible that the ultimate resolution of these issues could significantly differ from our original estimates.Net Operating Loss Carryforwards
Contingencies and Litigation
March 31,June 30, 2008, there is approximately $1.6$1.8 million of unresolved charges in dispute and the Company has not recorded a net liability for the unresolved charges. We are in discussion with these vendors regarding these charges and may take additional action as deemed necessary against these vendors in the future as part of the dispute resolution process. Management does not believe that any settlement would have a material adverse effect on our financial position or results of operations.Contractual Obligations
March 31,June 30, 2008: Payments Due by Period
(Dollars in Thousands)Contractual Obligations Total Less than
1 Year 1 – 3 Years 3 – 5 Years More than
5 YearsCapital lease obligations $ 201 $ 138 $ 63 — — Operating lease obligations 197 197 — — — Total $ 398 $ 335 $ 63 $ — $ — Capital lease obligations $ 233 $ 150 $ 83 — — Operating lease obligations 262 262 — — — Total $ 495 $ 412 $ 83 $ — $ — 29Recent Accounting Pronouncements
"Recent“Recent Accounting Pronouncements"Pronouncements” contained in Note 1 of the Notes to Consolidated Financial Statements under "Item“Item 1. Financial Statements".March 31,June 30, 2008, the carrying value of the capital lease obligations approximate fair value as their contractual interest rates approximate market yields for similar debt instruments.
We have not maintained sufficient evidence to support that certain of our internal controls over financial reporting activities were performed on a timely basis, specifically related to confirmation testing of disputes of information received from our vendors, variance analysis, accounts receivable analyses and equity accounts.
Due to the small size of our Company, we have not adequately divided, or compensated for, functions among personnel to reduce the risk that a potential material misstatement of the financial statements would occur without being prevented or detected with regards to certain of our equity accounts. Specifically, with regards to equity awards, at times information used in our financial reporting is not able to be given to additional competent staff to mitigate the risk of erroneous or inappropriate actions.·While we have implemented control procedures for reviewing all material financial reporting items and test these control processes, certain of our control procedures are not sufficient to prevent the risk that a potential material misstatement of the financial statements would occur without being prevented or detected, specifically with regards to dispute reserves for accounts payable, accruals for third party charges and certain equity accounts. In each case, the Company does not have adequate staffing to ensure that the monitoring processes mitigate risks that external information used is correct and, in the case of equity accounts, that the Company has personnel with adequate understanding of the applicability of accounting principles.·We have not maintained sufficient evidence to support that certain of our internal controls over financial reporting activities were performed on a timely basis, specifically related to confirmation testing of disputes of information received from our vendors, variance analysis, accounts receivable analyses and equity accounts.·Due to the small size of our Company, we have not adequately divided, or compensated for, functions among personnel to reduce the risk that a potential material misstatement of the financial statements would occur without being prevented or detected with regards to certain of our equity accounts. Specifically, with regards to equity awards, at times information used in our financial reporting is not able to be given to additional competent staff to mitigate the risk of erroneous or inappropriate actions.30·We plan to improve our monitoring processes and add additional staff resources to monitor our dispute reserves, accruals for third party charges and equity reporting activities.·We intend on developing specific policies and procedures around the nature and retention of evidence of the operation of controls. For example, where other forms of sign-off and evidence of timeliness do not exist, reviews will be evidenced via sign-off (including signature and date).·We are considering re-assigning roles and responsibilities in order to improve segregations of duties with regards to control activities for our equity accounts.There have been no changes in our internal controls over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonable likely to materially affect, our internal controls over financial reporting.PART II
-
OTHER INFORMATIONNone.ExhibitNumber Exhibit
NumberDescription of Exhibits 3.1* Amended and Restated Articles of Incorporation 3.3** Amended and Restated Bylaws 31.1 Rule 13a-14(a) Certification of Principal Executive Officer 31.2 Rule 13a-14(a) Certification of Principal Accounting Officer 32.1 Certification of Principal Executive Officer pursuant to 18 U.S.C. 1350 32.2 Certification of Principal Accounting Officer pursuant to 18 U.S.C. 1350 * Incorporated by reference to the Schedule 14C Information Statement filed with the Securities and Exchange Commission dated May 9, 2007. ** Incorporated by reference to the Form 8K filed with the Securities and Exchange Commission dated June 28, 2007. 31INTERMETRO COMMUNICATIONS, INC. Dated: May 20,August 19, 2008By:\s\
Charles Rice
Chairman of the Board,
Chief Executive Officer, and PresidentDated: May 20,August 19, 2008By:\s\ Vincent ArenaVincent Arena
Vincent Arena
Chief Financial Officer and Director