| | | Three Months Ended September 30, | |
| | | 2008 | | 2007 | |
| Net revenues | | | 100 | % | | 100 | % |
| Network costs | | | 91 | | | 98 | |
| Gross profit | | | 9 | | | 2 | |
| Operating expenses: | | | | | | | |
| Sales and marketing | | | 6 | | | 8 | |
| General and administrative | | | 21 | | | 30 | |
| | | | | | | | |
| Total operating expenses | | | 27 | | | 38 | |
| Operating loss | | | (18 | ) | | (36 | ) |
| Gain/(loss) on option and warrant liability | | | — | | | — | |
| Interest expense | | | 10 | | | 3 | |
| Loss before provision for income tax | | | (28 | ) | | (39 | ) |
| Net loss | | | (28 | )% | | (39 | )% |
Net Revenue. Net revenues increased $1.2 million,$693,000, or 24.5%12.1%, to $6.1$6.4 million for the three months ended JuneSeptember 30, 2008 from $4.9$5.7 million for the three months ended JuneSeptember 30, 2007. We have been acquiring new customers which contributed approximately $976,000$1.2 million in additional revenues in the three months ending JuneSeptember 30, 2008 and have also had increasingas compared to the same period in 2007. The increase in revenue from new customers was offset both by decreasing revenues from existing customers and the loss of certain customers.
Network Costs. Network costs increased $288,000,$218,000, or 5.4%3.9%, to $5.8 million for the three months ended September 30, 2008 from $5.6 million for the three months ended June 30, 2008 from $5.3 million for the three months ended JuneSeptember 30, 2007. Included within total network costs, variable network costs increased by $390,000$465,000 to $5.0$5.2 million (81.8%(81.9% of revenues) for the three months ended JuneSeptember 30, 2008 from $4.6$4.8 million (94.0%(83.8% of revenues) for the three months ended JuneSeptember 30, 2007, primarily from increased revenue, while fixed network costs decreased by $101,000$247,000 to $589,000$552,000 for the three months ended JuneSeptember 30, 2008 from $691,000$799,000 for the three months ended JuneSeptember 30, 2007, with the decrease coming primarily from the elimination of legacyunderutilized network components that were not yet removed from the network in operation during the three months ended JuneSeptember 30, 2007 while the SS-7 replacement components were concurrently being expensed.2007. There were no significant fixed network expenses added during the three months ended JuneSeptember 30, 2008.
Gross margin increased to 9% for the three months ended September 30, 2008 from a gross margin of 2% for the three months ended September 30, 2007. This increase in gross margin was attributable to the increasing utilization of capacity and fixed network costs.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 three months ended September 30, 2008 was $111,000 (1.7% of net revenues) as compared to $243,000 (4.3% of net revenues) for the three months ended September 30, 2007.
Sales and Marketing. Sales and marketing expenses decreased $39,000, or 8.2% to $438,000 for the three months ended September 30, 2008 from $477,000 for the three months ended September 30, 2007. Sales and marketing expenses as a percentage of net revenues were 6.8% and 8.4% for the three months ended September 30, 2008 and 2007, respectively. The Company’s efforts to minimize expenses in sales and marketing resulted in decreased expenses for advertising, consulting, outsourced customer service, salaries and promotions, partially offset by an increase in agent commissions. Sales and marketing expenses included stock-based charges related to warrants and stock options of $11,000 for each of the three months ended September 30, 2008 and 2007.
General and Administrative. General and administrative expenses decreased $382,000, or 22.2% to $1.3 million for the three months ended September 30, 2008 from $1.7 million for the three months ended September 30, 2007. General and administrative expenses as a percentage of net revenues were 20.9% and 30.1% for the three months ended September 30, 2008 and 2007, respectively. General and administrative expenses included stock-based charges related to warrants and stock options of $74,000 and $77,000 for the three months ended September 30, 2008 and 2007, respectively. The decrease in general and administrative expenses for the three months ended September 30, 2008 is primarily attributable to a $179,000 reduction in professional service fees and a $284,000 reduction in payroll related expenses due to reduction in workforce and wages offset by a $100,000 non-recurring, non-cash consulting expense.
Interest Expense, net. Interest expense, net increased $491,000 to $648,000 for the three months ended September 30, 2008 from $157,000 for the three months ended September 30, 2007. Interest expense for the three months ended September 30, 2008 includes $273,000 amortization of debt discount, $120,000 secured note interest and $40,000 line of credit interest. Interest expense for the three months ended September 30, 2007 includes a $90,000 non-recurring credit related to renegotiation of a fixed asset purchase agreement.
Results of Operations for the Nine months Ended September 30, 2008 and 2007
The following table sets forth, for the periods indicated, the results of our operations expressed as a percentage of revenue:
| | | Nine Months Ended September 30 , | |
| | | 2008 | | 2007 | |
| Net revenues | | | 100 | % | | 100 | % |
| Network costs | | | 93 | | | 108 | |
| Gross profit | | | 7 | | | (8 | ) |
| Operating expenses: | | | | | | | |
| Sales and marketing | | | 7 | | | 10 | |
| General and administrative | | | 22 | | | 41 | |
| Total operating expenses | | | 29 | | | 51 | |
| Operating loss | | | (22 | ) | | (59 | ) |
| Gain of forgiveness of debt | | | — | | | — | |
| Gain/(loss) on option and warrant liability | | | — | | | (35 | ) |
| Interest expense | | | 8 | | | 2 | |
| Loss before provision for income tax | | | (30 | ) | | (96 | ) |
| Net loss | | | (30 | )% | | (96 | )% |
Net Revenues. Net revenues increased $3.0 million, or 19.2%, to $18.9 million for the nine months ended September 30, 2008 from $15.9 million for the nine months ended September 30, 2007. We have been acquiring new customers which contributed approximately $2.6 million in additional revenues in the nine months ending September 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 both decreasing revenues from existing customers and the loss of certain customers.
Network Costs. Network costs increased $389,000, or 2.3%, to $17.6 million for the nine months ended September 30, 2008 from $17.2 million for the nine months ended September 30, 2007. Included within total network costs, variable network costs increased by $960,000 to $15.6 million (82.7% of revenues) for the nine months ended September 30, 2008 from $14.7 million (92.5% of revenues) for the nine months ended September 30, 2007, primarily from increased revenue, while fixed network costs decreased by $569,000 to $1.9 million for the nine months ended September 30, 2008 from $2.5 million for the nine months ended September 30, 2007, with the decrease coming primarily from the elimination of underutilized network components that were in operation during nine months ended September 30, 2007. There were no significant fixed network expenses added during the nine months ended September 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
9%7.3% for the
threenine months ended
JuneSeptember 30, 2008 from a gross margin of
(8)(8.0)% for the
threenine months ended
JuneSeptember 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.costs. 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
threenine months ended
JuneSeptember 30, 2008 was
$168,000 (2.7%$479,000 (2.5% of net revenues) as compared to
$209,000 (4.2%$747,000 (4.7% of net revenues) for the
threenine months ended
JuneSeptember 30, 2007.
Sales and Marketing. Sales and marketing expenses decreased $120,000,$270,000, or 23.0%17.0% to $401,000$1.3 million for the threenine months ended JuneSeptember 30, 2008 from $521,000$1.6 million for the threenine months ended JuneSeptember 30, 2007. Sales and marketing expenses as a percentage of net revenues were 6.5%6.9% and 10.6%10.0% for the threenine months ended JuneSeptember 30, 2008 and 2007, respectively. The Company’s efforts to minimize expenses in sales and marketing resulted in decreased expenses for advertising, consulting, outsourced customer service, salaries and promotions, partially offset by an increase in compensation expense.agent commissions. Sales and marketing expenses included stock-based charges related to warrants and stock options of $11,000$32,000 for the threenine months ended JuneSeptember 30, 2008 and 2007.
General and Administrative. General and administrative expenses decreased $1.5$2.3 million or 51.47%35.50% to $1.4$4.2 million for the threenine months ended JuneSeptember 30, 2008 from $3.0$6.5 million for the threenine months ended JuneSeptember 30, 2007. General and administrative expenses as a percentage of net revenues were 23.4%22.1% and 60.1%40.9% for the threenine months ended JuneSeptember 30, 2008 and 2007, respectively. General and administrative expenses included stock-based charges related to warrants and stock options of $79,000$233,000 and $939,000$1.2 million for the threenine months ended JuneSeptember 30, 2008 and 2007, respectively. The threenine months ended JuneSeptember 30, 2007 included a $819,000 non-recurring charge related to warrants. The additional approximate $700,000$1.5 million decrease in general and administrative expenses for the threenine months ended JuneSeptember 30, 2008 is primarily attributable to a $417,000$945,000 reduction in professional service fees and a $234,000$718,000 reduction in payroll related expenses due to reduction in workforce and wages offset by a $77,000 reduction in the cost of insurance as the company has continued to minimize expenses.$100,000 non-recurring, non-cash consulting expense. Certain professional service fees in the threenine months ended JuneSeptember 30, 2007 were non-recurring fees attributable to becoming a publicly traded company.
Interest Expense, Netnet. Interest expense, net increased $520,000$1.3 million to $526,000$1.6 million for the threenine months ended JuneSeptember 30, 2008 from $6,000$297,000 for the threenine months ended JuneSeptember 30, 2007. Interest expense for the threenine months ended JuneSeptember 30, 2008 includes $263,000$628,000 amortization of debt discount. Interest expense for the three months ended June 30, 2007 includes a $90,000 non-recurringdiscount, $120,000 secured note interest, $62,000 line of credit related to renegotiation of a fixed asset purchase agreement.
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Results of Operations for the Six Months Ended June 30, 2008 and 2007
The following table sets forth, for the periods indicated, the results of our operations expressed as a percentage of revenue:
 | | | | |
| | 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 | )% |
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
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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 discountinterest and $50,000 related to an addendum to a vendor agreement. Interest expense for the three months ended JuneSeptember 30, 2007 includes a $90,000 non-recurring credit related to renegotiation of a fixed asset purchase agreement.
Liquidity and Capital Resources At JuneSeptember 30, 2008, we had $295,000$1.0 million in cash. The Company’s working capital position, defined as current assets less current liabilities, has historically been negative and was negative $13.5$15.3 million at JuneSeptember 30, 2008 and negative $12.0 million at December 31, 2007. Included in current liabilities was a bank overdraft of $555,000 at JuneSeptember 30, 2008 and $464,000 at December 2007. Also included in current liabilities at September 30, 2008 was $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 the sixnine months ended JuneSeptember 30, 2008 as compared to the sixnine months ended JuneSeptember 30, 2007:2007
: Net cash used in operating activities was
$2.5$2.3 million for the
sixnine months ended
JuneSeptember 30, 2008 as compared to net cash used in operating activities of
$8.2$8.4 million for the
sixnine months ended
JuneSeptember 30, 2007. The most significant use of cash in operating activities was our net loss for the
sixnine months ended
JuneSeptember 30, 2008 of approximately
$3.8$5.5 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
$660,000$2.0 millions 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
sixnine months ended
JuneSeptember 30, 2007 were the
$13.0$15.3 million net loss and a
$2.0$2.3 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. Partially offsetting these uses of funds was the add-back of the $5.6 million non-cash loss on liability for options and warrants,
as well asa $2.6 million increase in accounts payable and non-cash expenses for stock based compensation and depreciation.
There were no purchases of property and equipment in the six months ended June 30, 2008.
Net cash used in investing activities for the
sixnine months ended
JuneSeptember 30,
2008 and 2007 was
$79,000 attributable to
the purchasenetwork-related equipment purchases of
network-related equipment.$33,000 and $79,000, respectively.
Net cash provided by financing activities for the sixnine months ended JuneSeptember 30, 2008 was $2.5$3.1 million as compared to cash provided by financing activities of $8.9$8.8 million for the sixnine months ended JuneSeptember 30, 2007. Net cash provided by financing activities for the sixnine months ended JuneSeptember 30, 2008 was primarily attributable to the receipt of $1.9 million from the issuance of secured notes offset by $600,000 cancellation of debt due to loan
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TABLE OF CONTENTS
modification and $1.4$2.0 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 sixnine months ended JuneSeptember 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.
The Company has incurred net losses of $3.8$5.6 million and $13.0$15.3 million and negative cash flow from operations of $2.5$2.3 million and $8.2$8.4 million for the sixnine months ended JuneSeptember 30, 2008 and 2007, respectively. As of JuneSeptember 30, 2008, the Company has a working capital deficit of $13.5$15.3 million. In addition to the continued net losses, in the three months ended September 30, 2008 the increase in working capital deficit was impacted by an increase in the line of credit facility balance related to a decrease in debt discount. (see Note 10 to the Consolidated Financial Statements for detailed discussion.) 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. From November 2007 to
JuneSeptember 30, 2008, the Company received $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$2.0 million on a
$1.5$2.0 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.
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)
sixnine 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. TheIn September 2008, the Company entered into Amendment No. 1 to the agreement which increased the access to $2.0 million. As of September 30, 2008, the Company is permitted to borrow an amount not to exceed 80%110% of its eligible accounts receivable. As of JuneSeptember 30, 2008, the Company has borrowed $1.4$2.0 million. The Company’sCompany'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 NoteNotes 10 and 14 to the Consolidated Financial Statements for detailed discussion.).
Critical Accounting Policies and the Use of Estimates 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 Recognition.Recognition. We recognize our VoIP services revenues when services are provided, primarily on usage. Revenues derived from sales of calling cards through related distribution partners are deferred upon the sale of the cards. These deferred revenues are recognized as revenues generally when all usage of the cards occurs. We recognize 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 performance obligations remain for us and collection of the related receivable is reasonably assured. Our deferred revenues consist of fees received or billed in advance of the delivery of the services or services performed in which cash receipt is not reasonably assured. This revenue is recognized when the services are provided and no significant performance obligations remain or when cash is received for previously performed services. We assess 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, we do not request collateral from our customers. If we determine that collection of revenues are not reasonably assured, we defer the recognition of revenue until the time collection becomes reasonably assured, which is generally upon receipt of cash.
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)
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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: | | | | | | | | |
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 Share |
| 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 | | | — | | | $ | — | | | $ | — | | | $ | — | |
| June 30, 2008 | | | — | | | $ | — | | | $ | — | | | $ | — | |
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 Share | |
| 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 | | | — | | $ | — | | $ | — | | $ | — | |
| June 30,2008 | | | — | | $ | — | | $ | — | | $ | — | |
| September 30,2008 | | | — | | $ | — | | $ | — | | $ | — | |
Deferred Stock-Based Compensation 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 and the Allowance for Doubtful Accounts 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
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and by reviewing significant past due balances for individual collectibility. If estimated allowances for uncollectible accounts subsequently prove insufficient, additional allowance may be required.
Impairment of Long-Lived Assets We assess impairment of our other long-lived assets in accordance with the provisions of SFAS 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 us include:
· 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.
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.
Accounting for Income Taxes 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 JuneSeptember 30, 2008 and December 31, 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 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.
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Contingencies and Litigation 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 JuneSeptember 30, 2008, there is approximately $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.
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
JuneSeptember 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 Years |
| Capital lease obligations | | $ | 201 | | | $ | 138 | | | $ | 63 | | | | — | | | | — | |
| Operating lease obligations | | | 197 | | | | 197 | | | | — | | | | — | | | | — | |
| Total | | $ | 398 | | | $ | 335 | | | $ | 63 | | | $ | — | | | $ | — | |
| | | Payments Due by Period (Dollars in Thousands) | |
Contractual Obligations | | Total | | Less Than 1 Year | | 1-3 Years | | 3-5 Years | | More Than 5 Years | |
| Capital lease obligations | | $ | 173 | | $ | 141 | | $ | 32 | | | — | | | — | |
| Operating lease obligations | | | 131 | | | 131 | | | — | | | — | | | — | |
| Total | | $ | 304 | | $ | 272 | | $ | 32 | | $ | — | | $ | — | |
Recent Accounting Pronouncements For a discussion of the impact of recently issued accounting pronouncements, see the subsection entitled
“Recent"Recent Accounting
Pronouncements”Pronouncements" contained in Note 1 of the Notes to Consolidated Financial Statements under
“Item"Item 1. Financial
Statements.”Statements".
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Market Risks. We currently do not have significant exposure to foreign currency exchange rates as all of our sales are denominated in U.S. dollars.
Interest Rate Market Risk. Our cash is invested in bank deposits and money market funds denominated in U.S. dollars. The carrying value of our cash, restricted cash, accounts receivable, deposits, other current assets, trade accounts payable, accrued expenses, deferred revenue and customer deposits, and current portion of long-term capital lease obligations approximate fair value because of the short period of time to maturity. At JuneSeptember 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.
Item 4T. Controls and Procedures 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.
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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
JuneSeptember 30, 2008 (please see the Company’s filing on Form 10-KSB filed with the Securities and Exchange Commission on April 15, 2008).
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. | · | 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. |
We are in the process of implementing remediation efforts with respect to the material weaknesses which include:
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).
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| · | 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.
| · | We are considering re-assigning roles and responsibilities in order to improve segregations of duties with regards to control activities for our equity accounts. |
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.
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PART II
- OTHER INFORMATION
Item 1. Legal Proceedings 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 filehas filed counterclaims including, but not limited to, breach of contract and misrepresentation.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None.
Item 4. Submission of Matters to a Vote of Security Holders None.
Item 5. Other Information None.
Exhibit Number | | Description of Exhibits |
Exhibit
Number | | Description 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. |
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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.
| | |
| INTERMETRO COMMUNICATIONS, INC. |
|
|
|
Dated: AugustNovember 19, 2008 | By: | By:
/s/ Charles Rice
|
|
Charles Rice,
Chairman of the Board,
|
| Chief Executive Officer, and President |
| | |
|
|
|
Dated: AugustNovember 19, 2008 | By: | By:
/s/ Vincent Arena
|
|
Vincent Arena
|
| Chief Financial Officer and Director |
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