x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended ~~September 30, 2008~~March 31, 2009

or TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Exact Name of Registrant as Specified in its Charter)

Nevada	88-0476779
(State of Incorporation)	(IRS Employer Identification No.)

2685 Park Center Drive, Building A,

Simi Valley, California 93065

(Address of Principal Executive Offices) (Zip Code)

(805) 433-8000

(Registrant’s Telephone Number, ~~Including~~0Including Area Code)

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□ No ox

Indicate 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”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o□ Accelerated Filer o□Non-accelerated filer o□Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

State the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

As of ~~November 14, 2008~~May 15, 2009 there were ~~61,553,971~~69,563,901 shares outstanding of the registrant’s only class of common stock.

Table of Contents

TABLE OF CONTENTS

		Page
Part I. Financial Information

Item 1.	Condensed Consolidated Financial Statements	3
	Condensed Consolidated Balance Sheets at ~~September 30, 2008~~March 31, 2009 (unaudited) and December 31, ~~2007~~2008	23
	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2009 and ~~Nine months Ended September 30,~~ 2008 ~~and 2007~~ (unaudited)	34
	Condensed Consolidated Statement of Changes in Stockholders’ Deficit for the ~~Nine months~~Three Months Ended ~~September 30, 2008~~March 31, 2009 (unaudited)	45
	Condensed Consolidated Statements of Cash Flows for the ~~Nine months~~Three Months Ended ~~September 30,~~March 31, 2009 and 2008 ~~and 2007~~ (unaudited)	56
	Notes to Condensed Consolidated Financial Statements (unaudited)	67

Item 2.	Management’s Discussion and Analysis	2219
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27
Item 4T.	Controls and Procedures	27

~~Item 3.~~		~~Quantitative and Qualitative Disclosures About Market Risk~~	34

~~Item 4T.~~	~~Controls and Procedures~~	34

Part II. Other Information

Item 1.	Legal Proceedings	35
		28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	35
		28
Item 4.	Submission of Matters to a Vote of Security Holders	3528
Item 5.	Other Information	28
Item 6.	Exhibits	29

~~Item 5.~~	~~Other Information~~	35
Signatures
~~Item 6.~~	~~Exhibits~~	35

~~Signatures~~		3630

Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

INTERMETRO COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, except par value)

September 30,
2008

December 31,
2007

(unaudited)
ASSETS

Cash $ 1,047 $ 277
Accounts receivable, net of allowance for doubtful accounts of $125 at September 30, 2008 and December 31, 2007 2,256 1,875
Deposits 150 180
Other current assets 414 333
Total current assets 3,867 2,665
Property and equipment, net 473 937
Goodwill 1,800 1,800
Other intangible assets, net 92 119
Other long-term assets 36 36
Total Assets
$ 6,268 $ 5,557

LIABILITIES AND STOCKHOLDERS’ DEFICIT

Accounts payable, trade $ 10,587 $ 8,924
Accrued expenses 3,568 3,519
Bank overdraft 555 464
Deferred revenues and customer deposits 867 586
Borrowings under line of credit facilities net of debt discount of $273 in 2008 1,887 190
Notes payable, related party 75 215
Current portion of long-term capital lease obligations 141 170
Promissory notes, including $250 from related parties — 600
Secured notes, including $500 from related parties net of debt discount of $572 in 2008 1,348 —
Liability for warrant put feature 180 —
Total current liabilities 19,208 14,668

Capital lease obligations, net of current portion 32 106
Liability for warrant put feature 78 —
Total long-term liabilities 110 106
Total liabilities 19,318 14,774

Commitments and contingencies

Stockholders’ Deficit

Preferred stock — $0.001 par value; 10,000,000 shares authorized; 0 shares issued and outstanding at September 30, 2008 and December 31, 2007 — —
Common stock — $0.001 par value; 150,000,000 and 50,000,000 shares authorized at September 30, 2008 and December 31, 2007; 61,553,971 and 59,575,194 shares issued and outstanding at September 30, 2008 and December 31, 2007 62 60
Additional paid-in capital 27,383 25,807
Deferred stock based compensation — (167 )
Accumulated deficit (40,495 ) (34,917 )
Total stockholders’ deficit (13,050 ) (9,217 )
Total Liabilities and Stockholders’ Deficit
$ 6,268 $ 5,557

	March 31, 2009			December 31, 2008
	(unaudited)
ASSETS
Cash	$	329		$	171
Accounts receivable, net of allowance for doubtful accounts of $150 and $125 at March 31, 2009 and December 31, 2008, respectively		2,994			2,333
Deposits		145			150
Other current assets		396			101
Total current assets		3,864			2,755
Property and equipment, net		285			377
Goodwill		900			900
Other intangible assets		73			82
Other long-term assets		2			36
Total Assets	$	5,124		$	4,150

LIABILITIES AND STOCKHOLDERS’ DEFICIT
Accounts payable net of dispute reserve of $3,890 and $3,402 at March 31, 2009 and December 31, 2008, respectively	$	10,964		$	10,395
Accrued expenses		5,121			4,049
Bank overdraft		244			562
Deferred revenues and customer deposits		622			602
Note payable to equipment leasing vendor		325			—
Borrowings under line of credit facilities net of debt discount of $122 and $487 at March 31, 2009 and December 31, 2008, respectively (in default)		2,475			2,112
Amount due to Former ATI shareholder (in default)		75			75
Capital lease obligations		—			133
Advances including $375 and $310 from related parties at March 31, 2009 and December 31, 2008, respectively		462			310
Secured promissory notes, including $500 from related parties net of debt discount of $209 and $392 at March 31, 2009 and December 31, 2008, respectively (in default)		1,711			1,528
Liability for common stock put feature		288			—
Liability for warrant put feature		250			250
Total current liabilities		22,537			20,016

Liability for warrant put feature		—			78
Total liabilities		22,537			20,094

Commitments and contingencies (Note 10 )

Stockholders’ Deficit
Preferred stock — $0.001 par value; 10,000,000 shares authorized; 0 shares issued and outstanding at March 31, 2009 and December 31, 2008		—			—
Common stock — $0.001 par value; 150,000,000 shares authorized 69,533,901 and 65,643,901 shares issued and outstanding at March 31, 2009 and December 31, 2008, respectively		70			66
Additional paid-in capital		28,467			28,333
Accumulated deficit		(45,950	)		(44,343	)
Total stockholders’ deficit		(17,413	)		(15,944	)
Total Liabilities and Stockholders’ Deficit	$	5,124		$	4,150

The accompanying notes are an integral part of these condensed consolidated financial statements

Table of Contents

INTERMETRO COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, except per share amounts)

(Unaudited)

Three Months Ended September 30,

Nine months Ended
September 30 ,

2008

2007

2008

2007

Net revenues $ 6,402 $ 5,709 $ 18,930 $ 15,879
Network costs 5,799 5,581 17,545 17,156
Gross profit (loss) 603 128 1,385 (1,277 )
Operating expenses
Sales and marketing (includes stock based compensation of $11 for each of the three months ended September 30, 2008 and 2007, respectively and $32 for each of the nine months ended September 30, 2008 and 2007, respectively) 438 477 1,316 1,586
General and administrative (includes stock based compensation of $74 and $77 for the three months ended September 30, 2008 and 2007, respectively and $233 and $1,170 for the nine months ended September 30, 2008 and 2007, respectively.) 1,337 1,719 4,188 6,494
Total operating expenses 1,775 2,196 5,504 8,080
Operating loss (1,172 ) (2,068 ) (4,119 ) (9,357 )
Interest expense, net (includes amortization of debt discount of $273 and $0 for the three months ended September 30, 2008 and 2007, respectively and $628 and $0 for the nine months ended September 30, 2008 and 2007, respectively) 648 157 1,551 297
Gain on forgiveness of debt — — (92 ) —
Loss on liability for options and warrants — — — 5,615
Loss before provision for income taxes (1,820 ) (2,225 ) (5,578 ) (15,269 )
Provision for income taxes — 5 — 5
Net loss $ (1,820 ) $ (2,230 ) $ (5,578 ) $ (15,274 )
Basic and diluted net loss per common share $ (0.03 ) $ (0.04 ) $ (0.09 ) $ (0.26 )
Shares used to calculate basic and diluted net loss per common share (in thousands) 61,438 59,575 60,335 59,575

	Three Months Ended March 31,
	2009			2008
Net revenues	$	6,126		$	6,387
Network costs		4,682			6,132
Gross profit		1,444			255
Operating expenses
Sales and marketing (includes stock based compensation of $11 each for the three months ended March 31, 2009 and 2008)		585			477
General and administrative (includes stock based compensation of $49 and $79 for the three months ended March 31, 2009 and 2008, respectively)		1,245			1,410
Total operating expenses		1,830			1,887
Operating loss		(386	)		(1,632	)
Interest expense, net (includes stock-based charges of $834 and $91 for the three months ended March 31, 2009 and 2008, respectively)		1,246			376
Gain on forgiveness of debt		(25	)		(92	)

Net loss	$	(1,607	)	$	(1,916	)
Basic and diluted net loss per common share	$	(0.02	)	$	(0.03	)
Shares used to calculate basic and diluted net loss per common share		67,401			59,754

The accompanying notes are an integral part of these condensed consolidated financial statements.

Table of Contents

~~INTERMETRO COMMUNICATIONS, INC.~~

INTERMETRO COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ DEFICIT ~~(unaudited)~~

(Dollars in Thousands)

(Unaudited)

Preferred Stock

Common Stock

Additional

Deferred

Total

Shares

Amount

Shares

Amount

Paid-In
Capital

Stock Based
Compensation

Accumulated
Deficit

Stockholders’
Deficit

Balance at January 1, 2008 — $ — 59,575,194 $ 60 $ 25,807 $ (167 ) $ (34,917 ) $ (9,217 )
Reclassification of deferred stock-based compensation — — — —
(167
)
167
— —
Stock-based compensation — — — — 265
—
— 265
Warrant issuance — — — — 1,214 — — 1,214
Cashless warrants exercise relating to equipment purchase — — 635,612 1 165 — — 166
Stock issuance — — 200,000 — 100 — — 100
Stock issued on cashless exercise of stock options — — 1,143,165 1 (1 ) — — —
Net loss for the nine months ended September 30, 2008 — — — — — — (5,578 ) (5,578 )
Balance at September 30, 2008 — $ — 61,553,971 $ 62 $ 27,383 $
—
$ (40,495 ) $ (13,050 )

	Common Stock
	Shares		Amount		Additional Paid-In Capital			Accumulated Deficit			Total Stockholders’ Deficit
Balance at January 1, 2009		65,643,901	$	66	$	28,333		$	(44,343	)	$	(15,944	)
Amortization of stock-based compensation		—		—		60			—			60
Cashless warrants exercise relating to secured promissory notes		3,840,000		4		(4	)		—			—
Reclassification of warrants put liability to equity		—		—		78			—			78
Stock issued to equipment vendor		50,000		—		—			—			—
Net loss for the three months ended March 31, 2009		—		—		—			(1,607	)		(1,607	)
Balance at March 31, 2009		69,533,901	$	70	$	28,467		$	(45,950	)	$	(17,413	)

The accompanying notes are an integral part of these condensed consolidated financial statements.

Table of Contents

~~INTERMETRO COMMUNICATIONS, INC.~~

INTERMETRO COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ~~(unaudited)~~

(Dollars in Thousands)

(Unaudited)

Nine months Ended September 30,

2008

2007

Cash flows from operating activities:
Net loss $ (5,578 ) $ (15,274 )
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 524 799
Stock based compensation 265 1,202
Amortization of debt discount 628 —
Loss on options and warrants — 5,615
Stock issuance for consulting 100 —
Gain on forgiveness of debt (92 ) —
(Increase) decrease in operating assets:
Accounts receivable (381 ) (609 )
Deposits 30 16
Other current assets (81 ) (189 )
Other long-term assets — (8 )
Increase (decrease) in operating liabilities:
Accounts payable, trade 1,662 2,636
Accrued expenses 307 (2,301 )
Deferred revenues and customer deposits 281 (281 )
Net cash used in operating activities (2,335 ) (8,394 )

Cash flows from investing activities:
Purchase of property and equipment (33 ) (79 )

Cash flows from financing activities:
Proceeds from secured notes 1,320 —
Bank overdraft 91 —
Payment of amounts to related party (140 ) (304 )
Proceeds from line of credit 1,969 —
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 (102 ) (144 )
Net cash provided by financing activities 3,138 8,838

Net increase in cash 770 365
Cash at beginning of period 277 151
Cash at end of period $ 1,047 $ 516

	Three Months Ended March 31,
	2009			2008
Cash flows from operating activities:
Net loss	$	(1,607	)	$	(1,916	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		102			219
Stock based compensation		60			90
Amortization of debt discount		834			91
Provision for doubtful accounts		25			—
Gain on forgiveness of debt		(25	)		(92	)
(Increase) decrease in assets:
Accounts receivable		(686	)		(195	)
Deposits		—			20
Other current assets		(296	)		(191	)
Increase (decrease) in liabilities:
Accounts payable		826			1,061
Accrued expenses		1,071			272
Deferred revenues and customer deposits		20			92
Net cash provided by (used in) operating activities		324			(549	)

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	)
Advances, including $65 from related parties		152			—
Bank overdraft		(318	)		(19	)
Principal payments on capital lease obligations		—			(43	)
Net cash (used in) provided by financing activities		(166	)		638

Net increase in cash		158			89
Cash at beginning of period		171			277
Cash at end of period	$	329		$	366

The accompanying notes are an integral part of these condensed consolidated financial statements.

Table of Contents

INTERMETRO COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ~~(unaudited)~~(Unaudited)

1 — Nature of Operations and Summary of Significant Accounting Policies

Company Background - 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.

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 - 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.

The accompanying unaudited interim condensed 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 condensed consolidated 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 nine~~ month ~~periods~~period ended ~~September 30, 2008~~March 31, 2009 are not necessarily indicative of the results to be expected for the full year. These condensed consolidated statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, ~~2007~~2008 which are included in ~~the~~ Form ~~10-KSB~~10-K filed by the Company on April 15, ~~2008.~~

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.2009.

Going Concern - 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 ~~$5,578,000~~$1,607,000 and $1,916,000 for the ~~nine~~three months ended ~~September 30,~~March 31, 2009 and 2008, ~~and $16,915,000 for the year ended December 31, 2007.~~respectively. In addition, the Company had total ~~stockholders’~~shareholders’ deficit of ~~$13,050,000 and $9,217,000 at September 30, 2008 and December 31, 2007, respectively~~$17,413,000 and a working capital deficit of ~~$15,341,000 and $12,003,000~~$18,673,000 as of ~~September 30, 2008 and December~~March 31, ~~2007, respectively.~~2009. The ~~Company's auditors~~Company anticipates it will not have ~~indicated there is substantial doubt about~~sufficient cash flows to fund its operations through fiscal 2009 without the ~~Company's ability to continue as a going concern.~~completion of additional financing. 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. There are many claims and obligations that could ultimately cause the Company to cease operations. The report from the Company’s independent registered public accounting firm states that there is substantial doubt about the Company’s ability to continue as a going concern.

As discussed in Note 9, the Company entered into agreements with Moriah Capital, L.P. (“Moriah”) under which it could borrow up to $2,400,000. At March 31, 2009, the Company had borrowed $2,400,000. These agreements include financial and other covenants that the Company needed to maintain at March 31, 2009. The availability of loan amounts under the agreements expired on April 30, 2009. The Company was not in compliance with certain covenants as of March 31, 2009, and accordingly, Moriah can call the loan immediately payable at any time. The Company is currently in negotiation with Moriah regarding all aspects of this loan including extension of the maturity date. The Company has other significant matters of importance, including: other contingencies such as vendor disputes and lawsuits discussed in Note 10 and covenant defaults on the secured notes as discussed in Note 6 that could cause an acceleration of those amount due. There can be no assurance that the Company will be successful in causing the defaults to be waived. These matters, individually or in the aggregate, could have material adverse consequences to the Company’s operations and financial condition at any time.

Management believes that the recent losses are primarily attributable to costs related to building out and supporting a ~~robust~~ telecommunications infrastructure, ~~that has significantly more capacity than is currently being utilized by its existing customer base as well as~~and the ~~cost of marketing required~~requirement for continued expansion of the customer base ~~which is expected to result in an~~and the resultant increase in revenues, in order for the Company to become profitable. The Company continues to require outside financing until such time as weit can achieve positive cash flow from operations. In November and December 2007, the Company received $600,000 and in the ~~nine months ended September 30,~~period from January to June 2008 the Company received an additional $1,320,000 pursuant to the sale of secured notes with individual investors for general working capital and advances of an additional $462,500 from November 2008 to February 2009. The terms of the secured notes are 18 months maturity (beginning in June 2009) with an interest rate of 13% per annum due at the maturity date. The secured notes are secured by substantially all of the assets of the Company. The Company is also required to pay an origination fee of 3.00% and documentation fee of 2.50% of the principal amount of the secured notes at the maturity date. Prepayment of the credit facilities requires payment of interest that would have accrued through maturity, discounted by 20%, in addition to principal, accrued interest and fees. The Company can continue to sell similar secured notes up to a maximum offering of $3 million. ~~We anticipate completing~~In addition, the ~~additional financing required but there~~Company entered into a revolving credit agreement with Moriah, effective on April 30, 2008 (See Note 9) and expiring on April 30, 2009, pursuant to which the Company could access funds up to $2,400,000. The Company is currently in negotiations with Moriah regarding an extension of the maturity date and an increase to advance rates under the revolving credit agreement. There can be no assurance that wethe Company will be successful in completing this required financing (or other financing) or that weit will continue to expand ~~our revenue base~~its revenue. Should the Company be unsuccessful in this financing attempt or other financings, material adverse consequences could occur should the Company be unable to ~~the extent required to achieve positive cash-flows from operations in the future.~~secure alternate financing.

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.

Table of Contents

Principles of Consolidation - 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.

Use of Estimates - 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.

Revenue Recognition - 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 of 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 - 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. An additional bad debt allowance of $25,000 was recorded in the three months ended March 31, 2009.

Network Costs - 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.

Advertising Costs - The Company expenses advertising costs as incurred. Advertising costs included in sales and marketing expenses were ~~$3,000~~$0 and ~~$16,500~~$2,000 for the three months ended ~~September 30,~~March 31, 2009 and 2008, ~~and 2007, respectively and $5,000 and $77,450 for the nine months ended September 30, 2008 and 2007,~~ respectively.

Depreciation and Amortization - - Depreciation and amortization of property and equipment is computed using the straight-line method based on the following estimated useful lives:

Telecommunications equipment		2-3 years
Telecommunications 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

Maintenance and repairs are charged to expense as incurred; significant betterments are capitalized.

Impairment of Long-Lived Assets - 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 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 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 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 - 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. At March 31, 2009, there is no impairment in the value of Goodwill and intangible assets with indefinite useful lives.

Table of Contents

Vendor Disputes - 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.

Stock-Based Compensation - 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 ~~unvested~~nonvested 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.

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 three or nine months ended September 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~~		~~3.2~~	%
~~Expected lives (in years)~~		~~2.8 - 2.9~~
~~Dividend yield~~		0	%
~~Expected volatility~~		~~71% -72~~	%
~~Forfeiture rate~~		0	%

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 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 or nine months ended September 30, 2008. The Company calculated the fair value of non-employee grants for the nine months ended September 30, 2007 as described in SFAS 123(R) using the following assumptions:

	~~September 30, 2007~~
~~Risk-free interest rate~~		~~4.4~~	%
~~Expected lives (in years)~~		~~4.3 Years~~
~~Dividend yield~~		0	%
~~Expected volatility~~		93	%
~~Forfeiture rate~~		0	%

~~Debt with Detachable Warrants and/or~~~~Beneficial Conversion Feature~~ - 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.

Concentration of Credit Risk - - 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 ~~$250,000 per account.~~$250,000. 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.

The Company had one customer which ~~individually~~ accounted for ~~10.5%~~14% or more of net revenue for the three ~~month period~~months ended ~~September 30, 2008~~March 31, 2009 and no customer which individually accounted for 10.0% or more of net revenues for the nine month period ended September 30, 2008. There was no customer which individually accounted for 10.0% or more of net revenues for the three month period ended September 30, 2007 and one customercustomers which accounted for ~~10.7%~~more than 10% or more of net revenue for the ~~nine month period~~three months ended ~~September 30, 2007.~~March 31, 2008.

NoOne customer had an outstanding accounts receivable balance ~~in excess of 10%~~which accounted for 31% and 21% of the total accounts receivable at ~~September 30, 2008 or~~March 31, 2009 and December 31, ~~2007.~~2008, respectively.

Income Taxes - 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.

Effective October 1, 2007, the Company adopted Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. FIN 48 requires the recognition in the financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position.

Segment and Geographic Information - 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 and Diluted Net Loss per Common Share - 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 ~~possible~~ exercise of stock options and warrants ~~was~~were not considered in the computation of diluted net loss per common share because ~~the~~their effect ~~would be~~is anti-dilutive.

Recent Accounting Pronouncements - In September 2006, the Financial Accounting Standards Board (“FASB”) issued ~~Statements~~Statement 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. WeThe Company adopted SFAS 157 as of January 1, 2008 and ~~have~~has determined that the adoption of this statement did not have ~~a material~~an impact on ~~the~~its consolidated financial statements.

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. WeThe Company adopted SFAS 159 as of January 1, 2008 and ~~have~~has determined that the adoption of this statement did not have ~~a material~~an impact on the consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations,” (“SFAS No. 141(R)” ). 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.

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 ("SFAS No. 160") to establish accounting and reporting standards for noncontrolling interests in subsidiaries and for the deconsolidation of subsidiaries. It 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~~requirements of SFAS 160 ~~and believes there will be no material impact on our consolidated financial statements or financial condition.~~

~~In December 2007,~~do not currently apply to the SEC issued SAB No. 110, “Certain Assumptions Used in Valuation Methods - 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 the valuation of stock-based compensation.Company.

109

Table of Contents

In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS 133.” ("SFAS No. 161") 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 entity'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~~did not impact ~~on our consolidated financial statements or financial condition.~~

~~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 principles’.” The Company is currently evaluating the potential impact, if any, of the adoption of SFAS 162 on its consolidated financial statements.

Company.

2 — Acquisition and Intangible Assets

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 its 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 $150,000 two-year unsecured promissory ~~note in an amount tied to ATI’s working capital of $150,000.~~note. These amounts ~~are~~were payable to the former selling shareholder of ATI who was appointed President of ATI at the acquisition closing date. As of March 31, 2009, $75,000 remained unpaid to the selling shareholder. The ~~amount~~fair value of the shares issued was based on the guaranteed price of $4.87 per share. The number of shares of common stock consideration paid to the selling shareholder of ATI iswas subject to an 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~~did 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~~was also entitled to contingent consideration of ~~the purchase price of the ATI acquisition.~~

~~The selling shareholder of ATI may earn an additional 308,079~~common shares ~~of the Company’s common stock~~ and ~~additional~~ cash ~~amounts~~ during the ~~two-year period following~~two succeeding years from the ~~closing~~acquisition date upon meeting certain performance targets tied to revenue and ~~profitability, which could make~~profitability. In December 2008, the ~~total purchase price~~Company issued 4,089,930 shares of ~~this acquisition approximately $3.9 million. Half~~common stock, with a fair value of $611,043, as payment 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 the Company expects 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 308,079 shares of the Company’s common stock. These shares are subject to the same adjustment as the initial shares already paid (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. This payment could result in a material change to the Company’s financial statements.contingent consideration.

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.

~~The consideration paid for ATI was comprised of (in thousands):~~

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

~~The purchase price of ATI was allocated as follows (in thousands):~~

Liabilities assumed in excess of net assets acquired $ (43 )
Goodwill 1,800
Customer relationships 183
Total purchase price $ 1,940

~~The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (in thousands):~~

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

The following is a summary of the Company’s other current assets (in thousands):

September 30,
2008

December 31,
2007

(unaudited)
Employee advances $ 106 $ 66
Federal excise tax receivable - 109
Prepaid expenses 308 158
Other current assets $ 414 $ 333

	March 31, 2009		December 31, 2008
	(unaudited)
Employee advances	$	44	$	40
Deferred loan costs		21		—
Prepaid expenses		331		61
Other current assets	$	396	$	101

4 — Property and Equipment

The following is a summary of the Company’s property and equipment (in thousands):

	September 30, 2008			December 31, 2007			March 31, 2009			December 31, 2008
	(unaudited)						(unaudited)
Telecommunications equipment	$	3,251		$	3,218		$	3,257		$	3,257
Computer equipment		174			174			174			174
Telecommunications software		107			107			107			107
Leasehold improvements, office equipment and furniture		86			86			86			86
Total property and equipment		3,618			3,585			3,624			3,624
Less: accumulated depreciation		(3,145	)		(2,648	)
Less: accumulated depreciation and amortization								(3,339	)		(3,247	)
Property and equipment, net	$	473		$	937		$	285		$	377

1210

Table of Contents

Depreciation expense included in network costs was ~~$111,000~~$89,070 and ~~$243,000~~$200,217 for the three months ended ~~September 30,~~March 31, 2009 and 2008, ~~and 2007, respectively and $479,000 and $747,000 for the nine months ended September 30, 2008 and 2007,~~ respectively. Depreciation and amortization expense included in general and administrative expenses ~~were $4,000~~was $3,594 and ~~$10,000~~$9,876 for the three months ended ~~September 30,~~March 31, 2009 and 2008, ~~and 2007, respectively and $18,000 and $25,000 for the nine months ended September 30, 2008 and 2007,~~ respectively.

~~In May 2004, the~~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~~amounts due to the vendor resulting in a $92,368 gain on forgiveness of debt. ~~At September 30, 2008,~~As of March 31, 2009, the Company had purchased telecommunications equipment under this agreement totaling ~~$1,439,000,~~$1,439,222, of which approximately $376,000 and $386,000 remained to be paid at ~~September 30, 2008.~~March 31, 2009 and December 31, 2008, respectively.

~~In May 2006, the~~The Company entered into a strategic agreement with Cantata Technology, Inc. (“Cantata”), a VoIP equipment and support services provider. Under the terms of this agreement, the Company ~~can obtain certain~~obtained VoIP equipment to expand its ~~current~~ operations. ~~Repayment of these assets is~~Payments were scheduled to be based on the actual underlying traffic utilized by each piece of equipment or fixed cash payments. ~~At September 30, 2008,~~As of March 31, 2009, the Company ~~has~~had purchased VoIP equipment under this agreement totaling $691,000. The value of the equipment was based on the present value of future scheduled payments. As more fully explained in Note 11, the Company was sued by Cantata for breach of contract and lack of payment. As of ~~September 30, 2008, $29,000~~March 31, 2009, the Company had accrued $1,096,000 due to Cantata, which is equal to the undiscounted future scheduled payments.

In March 2009, the Company entered into a loan and security agreement with a vendor that is a significant lessor of ~~this~~network equipment to the Company. As part of the agreement, the Company signed a promissory note to the vendor in the amount ~~has been paid and~~of $328,976 with an ~~additional $191,000 has been accrued~~interest rate of 12.011% per annum to be paid ~~based on traffic utilization. Subsequent to entering into~~in eighteen (18) monthly installments through October 2010. The Company also issued 50,000 shares of its common stock valued at $0.01 per share. As a result of this loan and security 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 andrecorded a $24,500 gain on forgiveness of debt during 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 $90,000.2009.

5 — Accrued Expenses

The following is a summary of the Company’s accrued expenses (in thousands):

September 30,
2008

December 31,
2007

(unaudited)
Amounts due under equipment agreements $ 1,163 $ 1,394
Commissions, network costs and other general accruals 1,329 1,125
Deferred payroll and other payroll related liabilities 522 525
Interest due on convertible promissory notes and other debt 209 5
Payments due to third party providers 345 470
Accrued expenses $ 3,568 $ 3,519

	March 31, 2009		December 31, 2008
	(unaudited)
Amounts due under equipment agreements (in default)	$	1,178	$	1,170
Commissions, network costs and other general accruals		2,497		1,798
Deferred payroll and other payroll related liabilities		532		503
Interest due on convertible promissory notes and other debt		670		315
Payments due to third party providers		244		263
Accrued expenses	$	5,121	$	4,049

6 — Secured Promissory Notes and Advances

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~~including $330,000 from a related ~~party.~~parties. During the ~~nine~~twelve months ended ~~September 30,~~December 31, 2008, the Company received an additional $1,320,000, including $170,000 from related parties, pursuant to the sale of additional secured notes with individual investors for a total of $1,920,000 and ~~can~~the Company may 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%~~13% 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 Company accrued $107,000 related to these fees and recorded related interest expense of $86,000 during the three months ended March 31, 2009. 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 collateralized by substantially all of the assets of the Company.

In connection with the notes, the Company issued two common stock purchase warrants for every dollar received or 3.84 million common stock purchase warrants with an exercise price of $1.00, 1.92 million of which expire on January 16, 2013 (the “Initial Warrants”) and 1.92 million of which expire on February 1, 2014 ( the “Additional Warrants”). With respect to the 1.92 million Initial Warrants issued in this financing, if such warrants ~~are~~were still held by the lenders at February 1, 2009, the lenders ~~will be~~were 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”) iswas less than $1.00. The Reference Payment ~~will be~~was equal to the difference between $1.00 and the Reference Price. The Company, in its sole discretion, ~~will have~~had 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~~elected 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. The Company has offered to make the Reference Payment by issuing one share of common stock per dollar invested.

1311

Table of Contents

With respect to the remaining 1.92 million Additional Warrants issued in this financing that expire on February 1, 2014, if such warrants ~~are~~were still held by the lenders at February 1, 2009, the lenders ~~will be~~were 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”) iswas less than $2.00. The Second Reference Payment ~~will be~~was 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~~had 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. The Company has offered to make the Second Reference Payment by issuing one share of common stock per dollar invested.

In regards to the Reference Payment and Second Reference Payment, the Company exercised its right to make the payments by issuing Common Stock in lieu of cash and 13 of the 15 warrant holders have provided the Company with shares requests and have been issued shares of the Company’s Common Stock. A total of 2,640,000 shares of Common Stock have been issued as payment. The remaining 1,200,000 shares for the 2 warrant holders who have not formally requested shares are deemed to be issued and have been recorded as such. These shares represent the maximum shares allowed to be issued in connection with the notes, therefore, the warrants have in effect been exercised for Common Stock at $0.01, the market price at the date of issuance.

Also in connection with the issuance and deemed issuance of stock for warrants, the Company recognized an additional $201,000 of interest expense as a result of expensing the full amount of the remaining unamortized debt discount related to the warrants.

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 dates 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~~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~~were 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 $975,000 and was recorded as an offset to the principal balance of the secured notes and is being amortized into interest expense using the effective interest method. The total expense recorded by the Company was ~~$170,000~~$392,000 (including additional expense related to fully amortizing the original debt discount) and ~~$403,000~~$91,000 for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2009 and 2008, respectively. ~~The~~As of March 31, 2009, the net amount of the notes ~~of $1,348,000 has been recorded as of September 30, 2008.~~was $1,711,000.

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 one 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 requires 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 gain or loss. A put warrant liability of $78,000 was ~~determined and has been~~originally recorded ~~as of September 30, 2008~~related to the Initial Warrants using the same valuation methodology as described in detail in the preceding paragraph in regards to the warrant valuation for the ~~three~~twelve months ended ~~September 30,~~December 31, 2008. Also in connection with the issuance and deemed issuance of stock for warrants, the Company reclassified to equity the original $78,000 put liability related to the warrants and recorded a new $288,000 put liability and debt discount for the $0.15 put price of the 1,920,000 Initial Warrants. The Company ~~did not obtain an additional third-party valuation~~recognized $79,000 of interest expense from the ~~warrants issued~~amortization of this debt discount in the three months ended ~~September 30, 2008 or the revaluation of the liability associated with the put feature of the warrants as of September 30, 2008 and the same range of assumptions used at January 16, 2008.~~

~~The warrants and put feature associated with the $600,000 promissory notes from the period ended December~~March 31, ~~2007 were valued using the following range of assumptions:~~

	~~January 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	%

2009.

The warrants and put feature associated with the ~~$770,000 secured~~$1,920,000 promissory notes from the ~~quarter~~period ended ~~March~~December 31, 2008 were valued using the ~~following range of assumptions:~~

Black Sholes formula.

	~~March 31, 2008~~
~~Risk-free interest rate~~		~~2.98% - 3.14~~	%
~~Expected lives (in years)~~		~~9 - 15 months~~
~~Dividend yield~~		0	%
~~Expected volatility~~		~~100.1% - 103.4~~	%
~~Forfeiture rate~~		0	%

~~The warrants and put feature associated with the $500,000 of the secured notes from the quarter ended September 30, 2008 were valued using the following range of assumptions:~~

	~~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	%

~~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:~~

	~~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	%

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 September 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:

	~~September 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	%

At ~~September 30, 2008,~~March 31, 2009, the Company was in default of certain non-payment related items under the secured notes agreements. The Company ~~expects to remedy these defaults and~~ is working with ~~representatives for~~ the ~~agreements~~note holders to remedy these defaults.

In November and December 2008, two related party secured note holders advanced an additional $310,000 and during the three months ended March 31, 2009 there were advances of an additional $152,500 from existing note holders, including $65,000 from related parties, paying 13% interest per annum. No additional terms have been defined.

1512

Table of Contents

7 — Common and Preferred Stock

Common Stock - As of ~~September 30, 2008,~~March 31, 2009, the total number of authorized shares of common stock, par value $0.001 per share, was 150,000,000 of which ~~61,553,971~~69,533,901 shares were issued and outstanding.

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.

In July 2008, the Company issued 200,000 shares of stock pursuant to an agency agreement for services related to potential financing activities. The closing price of the Company’s common stock on the day of issuance was $0.50 and $200 was recorded at $0.001 par value to Common Stock and $99,800 was recorded as Additional Paid in Capital.

Preferred Stock - On May 31, 2007, the Company filed Amended and Restated Articles of Incorporation authorizing 10,000,000 shares of preferred stock, par value $0.001 per share, none of which are issued and outstanding.

8 — Stock Options and Warrants

2004 Stock Option Plan - 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.

A total of 5,730,222 shares of the Company’s common stock ~~as adjusted for share splits,~~ had been reserved for issuance at ~~September 30, 2008~~March 31, 2009 and December 31, ~~2007.~~2008. 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.

As of ~~September 30, 2008,~~March 31, 2009, 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, 462,120 expired in the quarter ended March 31, 2008 and 61,614 expired in the quarter ended June 30, 2008.~~2007. 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.

Omnibus Stock and Incentive Plan– - 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. ~~The Company's~~Our shareholders ratified the 2007 Plan pursuant to the Schedule 14C Information Statement filed with the 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~~the Company's subsidiaries or other affiliates will be eligible to receive awards under the 2007 Plan. ~~We have~~The Company has reserved 8,903,410 shares of common stock ~~have been reserved~~ for awards under the 2007 Plan.

In November 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. In October 2008, InterMetro granted 600,000 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. 30% vested at date of grant with the remaining vesting 1/12 per subsequent quarter over the succeeding 3 years expiring 5 years from date of grant. No ~~stock~~ options to purchase shares of common stock were granted under the 2007 plan in the ~~nine~~three months ended ~~September 30, 2008.~~March 31, 2009.

The following presents a summary of activity under the Company’s 2004 and 2007 Plans for the ~~nine~~three months ended ~~September 30, 2008~~March 31, 2009 (unaudited):

Number
of
Shares

Price
per
Share

Weighted
Average
Exercise
Price

Weighted
Average
Remaining
Contractual Term

Aggregate
Intrinsic
Value

Options 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 September 30, 2008 6,000,688 0.21 7.25 1,461,838

Options vested and expected to vest in the future at September 30, 2008 6,000,688 0.21 7.25 1,461,838

Options exercisable at September 30, 2008 4,976,134 0.20 6.98 1,288,611

	Number of Shares		Price per Share		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value
Options outstanding at December 31, 2008		6,600,688	$	—	$	0.18		7.16	$	0.0
Granted		—		—		—
Exercised		—		—		—
Forfeited/expired		—		—		—

Options outstanding at March 31, 2009		6,600,688				0.21		6.91		0.0

Options vested and expected to vest in the future at March 31, 2009		6,600,688				0.21		6.91		0.0

Options exercisable at March 31, 2009		5,535,955				0.20		6.64		0.0

Table of Contents

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 ~~nine~~three month period ended ~~September 30, 2008~~March 31, 2009 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 ~~September 30, 2008.~~March 31, 2009.

Additional information with respect to the outstanding options at ~~September 30, 2008~~March 31, 2009 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 5.25
$0.04
1,478,748 $0.04
0.04 154,039 5.50 0.04 154,039 0.04
0.04 431,307 5.75 0.04 431,307 0.04
0.04 123,231 6.25 0.04 123,231 0.04
0.22 277,269 7.00 0.22 235,679 0.22
0.25 2,350,000 9.00 0.25 1,566,669 0.25
0.27 338,884 7.00 0.27 271,108 0.27
0.41 643,879 7.25 0.41 540,674 0.41
0.81 110,908 7.25 0.81 82,256 0.81
0.97 92,423 7.50 0.97 92,423 0.97
6,000,688 4,976,134

		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		4.75	$	0.04		1,478,747	$	0.04
	0.04		154,038		5.00		0.04		154,038		0.04
	0.04		431,307		5.25		0.04		431,307		0.04
	0.04		123,231		5.75		0.04		123,231		0.04
	0.22		277,269		6.50		0.22		263,405		0.22
	0.25		2,950,000		8.50		0.25		2,012,502		0.25
	0.27		338,884		6.50		0.27		304,996		0.27
	0.41		643,880		6.75		0.41		581,957		0.41
	0.81		110,908		6.75		0.81		93,347		0.81
	0.97		92,423		7.00		0.97		92,423		0.97
			6,600,688						5,535,955

For option grants ~~prior to January 1, 2006,~~during the ~~intrinsic value per share is being recognized over the applicable vesting period which equals the service period. For option grants after~~years ended December 31, ~~2006,~~2008 and 2007, 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 September 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 $25,000 and $51,000 during the three months ended September 30, 2008 and 2007, respectively and $79,000 and $153,000 during the nine months ended September 30, 2008 and 2007, respectively.

As of ~~September 30, 2008,~~March 31, 2009, there was ~~$356,000~~$150,000 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.

Warrants – Historically, the Company has issued warrants to providers of equipment financing. For a detailed description of the warrants issued in connection with equipment financing arrangements, see Note 4. 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.

9 — ~~Liability For Options~~Credit Facilities

AsATI Bank Lines of ~~December 29, 2006 (the date~~Credit – ATI has two $100,000 lines of credit. The line of credit with Bank of America has an interest rate of 7.13% per annum. The line of credit with Wells Fargo Bank has an interest rate of 6.50% per annum. The lines of credit are personally guaranteed by the ~~Business Combination), the Company did not have a sufficient number~~former stockholder 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.

~~The Company calculated the fair value of these grants as described in SFAS 123R using the following assumptions:~~

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 %

~~10 — Credit Facilities~~ATI.

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) nine 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 ~~originally~~ could ~~access funds~~borrow up to ~~$1,500,000 such access increased to $2,000,000~~$2,400,000 per ~~Amendment~~Amendments No. 1 and No. 2 to the Agreements (the ~~“Amendment”) dated September 10, 2008.~~“Amendments).

Pursuant to the ~~original~~ Agreements, the Company was 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. Pursuant to the ~~Amendment,~~Amendments, from September 10, 2008 through ~~December 10,~~November 4, 2008 this borrowing base ~~increases~~increased to 110% of eligible accounts, from November 5, 2008 through December 15, 2008 increased to 135% of eligible accounts, from December 16, 2008 to January 15, 2009 decreases to 120% of eligible accounts, from January 16, 2009 through February 15, 2009 decreased to 110% of the eligible accounts, from February 16, 2009 to March 15, 2009 decreased to 100% of eligible accounts and thereafter iswas reduced to 85%. As of ~~September 30, 2008~~March 31, 2009, the Company has borrowed ~~$1,970,000.~~$2,400,000. 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 a minimum ratio of current assets to current liabilities. ~~All financial~~As of March 31, 2009, the Company was not in compliance with all of the covenants ~~except minimum ratio of current assets to current liabilities are effective October 1, 2008.~~

~~The~~and the availability of loan amounts under the Agreements expires on April 30, 2009. The Company is currently in active negotiation in regards to the terms of an extension of the Agreements.

Table of Contents

Annual interest on the ~~loans~~credit facitlty 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~~was to 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 1.)

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.

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 original 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. As part of the ~~Amendment,~~Amendments No.1 and No. 2, Moriah received warrants to purchase an additional 1,000,000 and 3,000,000 shares, respectively, of the Company’s common stock under the same terms as the original 2,000,000 warrants. 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. As of September 30, 2008, the Company determined that the expected lives (in years) of the warrants valued as of June 30, 2008 should be 3.5 years rather than 7 years as originally reported. Using the revised expected lives, theThe value associated with the ~~3,000,000~~6,000,000 warrants was ~~$497,000~~$928,000 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 ~~$180,000~~$250,000 and the ~~$317,000~~$678,000 difference was credited to Additional Paid in Capital. The expense recognized by the Company in the three ~~and nine~~ months ended ~~September 30, 2008 as~~March 31, 2009 from the amortization of the debt discount was ~~$103,000 and $224,000, respectively.~~$364,000. The ~~change in debt discount amortization expense in~~Company calculated the ~~three months ended June 30, 2008 attributable to~~fair value of the ~~change in expected lives is not considered material.~~warrants using the following assumptions:

June 30, 2008

September 30, 2008

Risk-free interest rate 2.63 % 2.42 %
Expected lives (in years) 3.5 years 3.1 years
Dividend yield 0 % 0 %
Expected volatility 74.0 % 74.0 %
Forfeiture rate 0 % 0 %

	June 30, 2008		September 30, 2008		December 31, 2008
Risk-free interest rate	2.63	%	2.42	%	1.63	%
Expected lives (in years)	3.5 years		3.5 years		3.5 years
Dividend yield	0	%	0	%	0	%
Expected volatility	74.0	%	74.0	%	74.0	%
Forfeiture rate	0	%	0	%	0	%

The Company has also granted Moriah an option as part of the Agreements and Amendment pursuant to which Moriah can sell the warrants back to the Company for ~~$180,000~~$250,000 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 ~~$180,000~~$250,000 as of ~~September 30, 2008.~~March 31, 2009.

1110 — Commitments and Contingencies

Vendor Agreements - – 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.

Vendor Disputes -– 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, or in some cases, to receive invoices from companies that the Company does not consider a vendor. The Company currently has disputes with vendors and other companies that it believes did not bill certain charges correctly or should not have billed any charges at all. 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. As of ~~September 30, 2008,~~March 31, 2009, there ~~are~~were approximately ~~$1.8~~$3.9 million of ~~unresolved charges in dispute and the Company has not recorded a net liability for the unresolved charges.~~disputed payables. The Company is in discussion with the significant vendors, or companies that have sent invoices, 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~~settlements would have a material adverse effect on the Company’s financial position 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 $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 $728,000, only $30,000 has been accrued and the remaining $698,000 would be a charge against network cost if we were to lose the complaint.

In April 2008, the Company entered into a settlement agreement with a significant ~~vendor as described in~~provider of network services to the ~~Company’s Form 10K filed~~Company. The settlement agreement included a payment arrangement for past due amounts of approximately $3.0 million with full repayment due prior to December 31, 2008. The settlement agreement also provided a separate credit to the ~~Securities and Exchange Commission on April 15, 2008.~~Company of approximately $1.4 million for past disputes. As of ~~September 30, 2008,~~March 31, 2009, the Company iswas not in compliance with the payment terms of the agreement and, therefore, iswas at risk of losing the $1.4 million credit ~~associated~~and service termination. The Company currently owes $2.4 million, net of the $1.4 million credit, and is in discussions with the vendor. The Company has not received a notice of default. The resulting potential termination of the related service and collection proceedings would have a material adverse impact on the Company’s operating results, financial condition, and business performance.

The Company has periodically received “credit hold” and disconnect notices from major telecommunications carriers. Suspension of service by any major carrier could have a material adverse effect on the company’s operations and financial condition. These disconnect notices were generated primarily due to the non-payment of charges claimed by each carrier, including some amounts disputed by the Company. Service has been maintained with each carrier, although further notices are possible if the Company is unable to make timely payments to its counterparties or to resolve the disputed amounts. Such payments would be in addition to current charges generated with such carriers.

Table of Contents

The Company has received notices from regulatory and taxing authorities in 27 states regarding its failure to file certain documents including but not limited to annual reports, articles of incorporation, and foreign corporation status. Additionally, the Company is in discussions with state-level regulatory and taxing authorities regarding amounts that may be due to them including minimum corporate taxes, registered corporation fees, sales and use taxes, as well as penalties and interest. The majority of these matters pertain to the Company’s wholly-owned subsidiary ATI, and the amounts at issue in most states are de minimis and have been reserved. The Company has provided documentation to the various state authorities in connection with these inquiries and is actively cooperating with their investigations.

Legal Proceedings – On January 15, 2008, a telecommunications carrier filed a lawsuit against the Company asserting unpaid invoices. The carrier is also one of the Company’s customers. On January 13, 2009, the parties entered into a settlement agreement whereby the Company will credit the carrier’s account in the amount of $20,000 each month for 18 months against which the carrier’s use of the Company’s services will be charged, for a total credit of $360,000. Included in accounts payable as of March 31, 2009, is $360,000 of amounts due to the carrier, which will be reduced by $20,000 per month.

Blue Casa Communication, Inc. – On December 12, 2007, Blue Casa Communications, Inc. (“Blue Casa”) filed a complaint against the Company asserting various causes of action, including breach of contract, breach of implied contract and unjust enrichment. Blue Casa claims that the Company owes Blue Casa payment of access charges in the amount of $300,000. The Company denies that it owes Blue Casa payment of access charges. On March 9, 2009, the Court renewed the stay for an additional 180 days.

Cantata Technology, Inc. – On August 12, 2008, Cantata filed a lawsuit against the Company asserting a breach of contract claim arising out of the parties’ term sheet dated May 2, 2006. Cantata is seeking $1.1 million together with interest costs, and attorney fees. Cantata is also seeking $63,000 for support services provided during the second year of the parties’ relationship. As discussed in Note 4, the Company has accrued $1,096,000 due to Cantata as of March 31, 2009. The Company has filed a counterclaim against Cantata and a third party claim against its parent company, Dialogic. The Company is vigorously asserting its claims against Cantata and Dialogic and a ruling against the Company could have a material adverse impact on its operating results, financial condition and business performance.

Hypercube/KMC – On April 30, 2007, the Company initiated litigation against KMC Data, LLC and its affiliate Hypercube, LLC (collectively referred to herein as “KMC”), or (the “KMC Litigation”). KMC, in turn, filed various counterclaims against the Company. The KMC Litigation concerns the issue of whether or to what extent the Company is obligated to pay KMC fees related to the transmission and routing of wireless communications traffic, and if so, what rates would be appropriate. As of March 31, 2009, there are approximately $1.2 million of charges that the Company disputes. As of March 31, 2009, the Company has recorded the $1.2 million in accounts payable, with a corresponding offset to unresolved disputed amounts. On August 6, 2007, the Court stayed the KMC Litigation pending referral of certain issues in the case to the Federal Communications Commission under the doctrine of primary jurisdiction. The case is currently stayed. The Company cannot predict the outcome of these proceedings at this time or how long the Court’s stay will remain in place. A ruling against the Company could have a material adverse impact on its operating results, financial condition and business performance.

In addition, the following vendors, carriers and customers have sent written notice of their intent to file suit against the Company:

A Local Exchange Carrier – A local exchange carrier (LEC) invoiced the Company access charges in connection with certain wireless originated calls of a third party provider. During the period from November 2008 through February 2009, the Company paid the LEC’s invoiced charges in connection with these wireless originated calls. During this time frame, the Company submitted disputes to the LEC for the wireless call charges equaling approximately $337,000. The LEC has denied the disputes submitted by the Company. The Company has withheld payment to the LEC asserting that it has overpaid for services. To date, the Company and the LEC have not resolved the dispute.

An Interexchange Carrier – An interexchange carrier (IXC) asserts to the Company that it is owed approximately $1.1 million in past due disputed and undisputed charges. The carrier has threatened to disconnect services to the Company and to initiate litigation against the Company. The carrier and the Company have been engaged in discussions to resolve these payment issues. If the carrier suspends its provision of services to the Company or initiates litigation against the Company, it could have a material adverse impact on the Company’s operating results, financial condition and business performance.

Federal Communications Commission - On November 26, 2008, the Company received letters of inquiry from the Federal Communications Commission (“FCC”) in connection with nonpayment of fees and surcharges required pursuant to the FCC’s regulations. The Company has provided documentation to the FCC in connection with these inquiries and is actively cooperating with the FCC’s investigations.

Universal Service Administrative Company – The Universal Service Administrative Company (USAC) administers the Universal Service Fund (USF). The Company may not have made all of the payments claimed by the USAC in a timely manner, including payments owed pursuant to agreed upon payment plans with the Company. The USAC has transferred some of these unpaid amounts to the Federal Communications Commission (FCC) for collection. The FCC may transfer the unpaid amounts to the Department of the Treasury. If the amounts are not resolved, they may then be transferred to the Department of Justice for collection action. With each transfer, additional fees, surcharges and penalties are added to the amount due. As of February 28, 2009, USAC and the FCC have claimed approximately $410,000 is due and payable in connection with the USF. The Company is working with USAC and the FCC to resolve these amounts.

Consulting Agreement – Commencing in December 2006, the Company entered into a three-year consulting agreement with an affiliate of a stockholder and debt holder pursuant to which the Company received services related to strategic planning, investor relations, acquisitions, and corporate governance. The Company was obligated to pay $13,000 a month for these services, subject to annual increases. In June 2008, the parties orally agreed to cancel the agreement and ~~may also be subject to service disconnection.~~any future obligation. Included in accounts payable is $182,000 at March 31, 2009 for unpaid amounts.

~~The company has ongoing disputes related to charges from two competitive local exchange carriers that aggregate approximately $815,000 and both~~

Table of ~~these carriers are pursuing legal action to collect on the disputed amounts. These charges are included in the Company’s accounts payable.~~Contents

1211 — Income Taxes

At ~~December~~March 31, ~~2007,~~2009, the Company had net operating loss carryforwards to offset future taxable income, if any, of approximately ~~$14.0~~$19.1 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):

September 30,
2008

December 31,
2007

(unaudited)
Current assets and liabilities:
Current assets and liabilities:
Deferred revenue $ 87 $ (58 )
Accrued expenses (116 ) (9 )
(29 ) (67 )
Valuation allowance 29 67

Net current deferred tax asset $ — $ —

Non-current assets and liabilities:
Depreciation and amortization $ 6 $ 53
Net operating loss carryforward 16,168 13,966
16,174 14,019
Valuation allowance (16,174 ) (14,019 )
Net non-current deferred tax asset $ — $ —

	March 31, 2009			December 31, 2008
	(unaudited)
Current assets and liabilities:
Current assets and liabilities:
Deferred revenue	$	108		$	20
Bad Debt		25			—
Accrued expenses		97			335
		230			355
Valuation allowance		(230	)		(355	)

Net current deferred tax asset	$	—		$	—

Non-current assets and liabilities:
Depreciation and amortization	$	12		$	31
Net operating loss carryforward		19,132			17,736
		19,144			17,767
Valuation allowance		(19,144	)		(17,767	)
Net non-current deferred tax asset	$	—		$	—

The reconciliation between the statutory income tax rate and the effective rate is as follows:

For the Nine Months Ended
September 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 — % — %

	For the Three Months Ended March 31,
	2009			2008
	(unaudited)
Federal statutory tax rate		(34	)		(34	)%
State and local taxes		(6	)		(6	)
Valuation reserve for income taxes		40			40
Effective tax rate		—			—	%

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 ~~September 30,~~December 31, 2008 and ~~December~~March 31, ~~2007.~~2009.

13Table of Contents

12 — Cash Flow Disclosures

The table following presents a summary of the Company’s supplemental cash flow information (in thousands):

Nine Months Ended September 30,

2008

2007

(unaudited)
Cash paid:
Interest $ 168 $ 209

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) $ 1,214 $ —

Stock issued on cashless exercise of common stock purchase options $ 100 $ —

	Three Months Ended March 31,
	2009		2008
	(unaudited)
Cash paid:
Interest	$	73	$	67

Non-cash information:

Issuance of common stock for cashless exercise of warrants	$	4	$	165

Note payable replacing equipment capital leases	$	329	$	—

Fair value of debt discount (net of put liability)		288		627

Reclassification of warrants put liability to equity		78		—

Stock issued on cashless exercise of common stock purchase options	$	—	$	1

~~14 — Subsequent Event~~Table of Contents

~~Revolving Credit Facility~~ - The Company entered into Amendment No. 2 to its credit facility with Moriah Capital on November 6, 2008. Pursuant to the Amendment, the amount of funds that can be accessed was increased from $2,000,000 to $2,400,000. The amount that the Company is permitted to borrow as a percent of its eligible receivables was increased from 110% to 135%. This percentage will reduce in subsequent periods until it reaches 85%. As of November 19, 2008, the Company has borrowed $2,400,000, the maximum amount of the facility. All other terms of the facility have remained unchanged. In consideration for the Amendment, the lender received warrants to purchase 3,000,000 shares of the Company’s common stock with an exercise price of $1.00 which expire on November 7, 2015. The put warrant liability associated with warrants issued earlier in connection with the credit facility was increased from $180,000 to $250,000.

Item 2. Management’s Discussion and Analysis

Cautionary Statements

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:

(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)

~~losses from~~ litigation with or legal claims and allegations by outside parties;

(h)

insufficient revenues to cover ~~fixed network costs,~~ operating ~~costs and other~~ 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.

~~(p)~~

~~malfunction of equipment or other aspects of VoIP infrastructure; and~~

~~(q)~~

~~inability to repay indebtedness and other defaults.~~

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.

Background

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 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.

2219

Table of Contents

General

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~~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 ~~September 30,~~March 31, 2009 and 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

History. InterMetro ~~was founded~~began business as a ~~California corporation in July 2003~~VoIP on December 29, 2006 and began generating revenue ~~in March 2004.~~at that time. Since ~~that time,~~then, we have increased our revenue to approximately ~~$22.7~~$25.1 million for the year ended December 31, ~~2007 which includes approximately $7.8 million of revenue from our March 2006 acquisition.~~2008.

Trends in Our Industry and Business

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 competition for end users of voice services. We believe there are an increasing number of companies competing for the end users of voice services that have traditionally been serviced by the large incumbent carriers. The competition has come from wireless carriers, competitive local exchange carriers, or CLECs, and interexchange carriers, or IXCs, and more recently from broadband VoIP providers, including cable companies and DSL companies offering broadband VoIP services over their own IP networks. All of these companies provide national calling capabilities as part of their service offerings, however, most of them do not operate complete national network infrastructures. These companies previously purchased national transport services exclusively from traditional carriers, but are increasingly purchasing transport services from us.

Merger and acquisition activities of traditional long distance carriers. Recently, the three largest operators of traditional long distance service networks were acquired by or have merged with several of the largest local wireline and wireless telecommunications companies. AT&T Corp. was acquired by SBC Communications Inc., MCI, Inc. was acquired by Verizon Communications, Inc. and Sprint Corporation and Nextel Communications, Inc. engaged in a merger transaction. While we believe it is too early to tell what effects these transactions will have on the market for national voice transport services, we may be negatively affected by these events if these companies increase their end user bases, which could potentially decrease the amount of services purchased by our carrier customers. In addition, these companies have greater financial and personnel resources and greater name recognition. However, we could potentially benefit from the continued consolidation in the industry, which has resulted in fewer competitors.

Regulation. Our business has developed in an environment largely free from regulation. However, the Federal Communications Commission (“FCC”) and many state regulatory agencies have begun to examine how VoIP services could be regulated, and a number of initiatives could have an impact on our business. These regulatory initiatives include, but are not limited to, proposed reforms for universal service, the intercarrier compensation system, FCC rulemaking regarding emergency calling services related to broadband IP devices, and the assertion of state regulatory authority over us. Complying with regulatory developments may impact our business by increasing our operating expenses, including legal fees, requiring us to make significant capital expenditures or increasing the taxes and regulatory fees applicable to our services. One of the benefits of our implementation of SS-7 technology is to enable us to purchase facilities from incumbent local exchange carriers under switched access tariffs. By purchasing these traditional access services, we help mitigate the risk of potential new regulation related to VoIP.

Our Business Model

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.

Table of Contents

Revenue. We generate revenue primarily from the sale of voice minutes that are transported across our VoIP infrastructure. In addition, ATI, as a reseller, generates revenues from the sale of voice minutes that are currently transported across other telecom service providers’ networks. However, we have migrated a significant amount of these revenues on to our VoIP infrastructure and continue to migrate ATI’s revenues. We negotiate rates per minute with our carrier customers on a case-by-case basis. The voice minutes that we sell through our retail distribution partners are typically priced at per minute rates, are packaged as calling cards and are competitive with traditional calling cards and prepaid services. Our carrier customer services agreements and our retail distribution partner agreements are typically one year in length with automatic renewals. 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:

	·	Changes in the average rate per minute that we charge our customers.

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.

	·	Increasing the net number of customers utilizing our VoIP 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.

	·	Increasing the average revenue we generate per customer.

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.

Acquisitions.


		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. Our network, or operating, costs are primarily comprised of fixed cost and usage based network components. In addition, ATI incurs usage based costs from its underlying telecom service providers. We generally pay our fixed network component providers at the beginning or end of the month in which the service is provided and we pay for usage based components on a weekly or monthly basis after the delivery of services. Some of our vendors require a prepayment or a deposit based on recurring monthly expenditures or anticipated usage volumes. Our fixed network costs include:

SS-7 based interconnection 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 fixed costs.

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 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.

Table of Contents

The usage-based cost components of our network include:

Off-net costs.

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.

SS-7 based interconnections with local carriers.

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:

Efficient utilization of fixed-cost network components.

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.

Strategic purchase of fixed-cost network components.

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:

Fluctuations in per minute rates of off-net service providers.

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.

Sales mix of our VoIP infrastructure capacity versus off-net services.

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.

Acquisitions of telecommunications businesses.

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.

Table of Contents

Sales and Marketing Expense. Sales and marketing expenses include salaries, sales commissions, benefits, travel and related expenses for our direct sales force, marketing and sales support functions. Our sales and marketing expenses also include payments to our agents that source carrier customers and retail distribution partners. Agents are primarily paid commissions based on a percentage of the revenues that their customer relationships generate. In addition, from time to time we may cover a portion or all of the expenses related to printing physical cards and related posters and other marketing collateral. All marketing costs associated with increasing our retail consumer user base are expensed in the period in which they are incurred. We expect that our sales and marketing expenses will increase in the future primarily due to increases in our direct sales force.

General and Administrative Expense. General and administrative expenses include salaries, benefits and expenses for our executive, finance, legal and human resources personnel. In addition, general and administrative expenses include fees for professional services, occupancy costs and our insurance costs, and depreciation expense on our non-network depreciable assets. Our general and administrative expenses also include stock-based compensation on option grants to our employees and options and warrant grants to non-employees for goods and services received.

Results of Operations for the Three Months Ended ~~September 30,~~March 31, 2009 and 2008 ~~and 2007~~

The following table sets forth, for the periods indicated, the results of our operations expressed as a percentage of revenue:

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 )%

	Three Months Ended March 31,
	2009			2008
Net revenues		100	%		100	%
Network costs		76			96
Gross profit		24			4
Operating expenses:
Sales and marketing		10			7
General and administrative		20			22
Total operating expenses		30			29
Operating loss		(6	)		(25	)
Gain on forgiveness of debt		0			(1	)
Interest expense		19			6

Net loss		(25	)%		(30	)%

Net ~~Revenue~~Revenues. Net revenues ~~increased $693,000,~~decreased $261,000, or ~~12.1%~~4.1%, to $6.1 million for the three months ended March 31, 2009 from $6.4 million for the three months ended ~~September 30, 2008~~March 31, 2008. Though we have continued to increase new customers, this has been offset by a reduction in offering third party low margin services and attributable to both decreasing revenues from ~~$5.7~~existing customers in certain areas and the loss of certain customers.

Network Costs. Network costs decreased $1.4 million, or 23.6%, to $4.7 million for the three months ended September 30, 2007. We have been acquiring new customers which contributed approximately $1.2 million in additional revenues in the three months ending September 30, 2008 as compared to the same period in 2007. The increase in revenueMarch 31, 2009 from ~~new customers was offset both by decreasing revenues from existing customers and the loss of certain customers.~~

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.

Gross margin increased to ~~7.3%~~23.6% for the ~~nine~~three months ended ~~September 30, 2008~~March 31, 2009 from a gross margin of ~~(8.0)%~~4.0% for the ~~nine~~three months ended ~~September 30, 2007.~~March 31, 2008. This increase in gross margin was attributable to the increasing utilization of capacity and decreased 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 ~~nine~~three months ended ~~September 30, 2008~~March 31, 2009 was ~~$479,000 (2.5%~~$89,000 (1.5% of net revenues) as compared to ~~$747,000 (4.7%~~$200,000 (3.1% of net revenues) for the ~~nine~~three months ended ~~September 30, 2007.~~March 31, 2008.

Sales and Marketing. Sales and marketing expenses ~~decreased $270,000,~~increased $108,000, or ~~17.0%~~22.6% to ~~$1.3 million~~$585,000 for the ~~nine~~three months ended ~~September 30, 2008~~March 31, 2009 from ~~$1.6 million~~$477,000 for the ~~nine~~three months ended ~~September 30, 2007.~~March 31, 2008. Sales and marketing expenses as a percentage of net revenues were ~~6.9%~~9.6% and ~~10.0%~~7.5% for the ~~nine~~three months ended ~~September 30,~~March 31, 2009 and 2008, ~~and 2007,~~ respectively. The ~~Company’s efforts~~increase is attributable to ~~minimize expenses in sales and marketing resulted in decreased expenses~~commission programs for ~~advertising, consulting, outsourced customer service, salaries and promotions, partially offset by an increase in agent commissions.~~higher margin services. Sales and marketing expenses included stock-based charges related to warrants and stock options of ~~$32,000~~$11,000 for the ~~nine~~three months ended ~~September 30, 2008~~March 31, 2009 and ~~2007.~~2008.

Table of Contents

General and Administrative. General and administrative expenses decreased ~~$2.3 million~~$165,000 or ~~35.50%~~11.7% to ~~$4.2~~$1.2 million for the ~~nine~~three months ended ~~September 30, 2008~~March 31, 2009 from ~~$6.5~~$1.4 million for the ~~nine~~three months ended ~~September 30, 2007.~~March 31, 2008. General and administrative expenses as a percentage of net revenues were ~~22.1%~~20.3% and ~~40.9%~~22.1% for the ~~nine~~three months ended ~~September 30,~~March 31, 2009 and 2008, ~~and 2007,~~ respectively. General and administrative expenses included stock-based charges related to warrants and stock options of ~~$233,000~~$49,000 and ~~$1.2 million~~$79,000 for the ~~nine~~three months ended ~~September 30,~~March 31, 2009 and 2008, ~~and 2007,~~ respectively. The ~~nine months ended September 30, 2007 included a $819,000 non-recurring charge related to warrants. The additional approximate $1.5 million~~ decrease in general and administrative expenses for the ~~nine~~three months ended ~~September 30, 2008~~March 31, 2009 is primarily attributable to a ~~$945,000~~ reduction in professional service fees and a $718,000 reduction in payroll related expenses due to reduction in workforce and wages offset by a $100,000 non-recurring, non-cash consulting expense. Certain professional service fees in the nine months ended September 30, 2007 were non-recurring fees attributable to becoming a publicly traded company.fees.

Interest Expense, net. Interest expense, net increased ~~$1.3 million~~$784,000, or 208.5%, to ~~$1.6~~$1.2 million for the ~~nine~~three months ended ~~September 30, 2008~~March 31, 2009 from ~~$297,000~~$376,000 for the ~~nine~~three months ended September 30, 2007. Interest expense for the nine months ended September 30, 2008 includes $628,000 amortization of debt discount, $120,000 secured note interest, $62,000 line of credit interest and $50,000 related to an addendum to a vendor agreement.March 31, 2008. Interest expense for the three months ended ~~September 30, 2007~~March 31, 2009 includes ~~a $90,000 non-recurring credit~~$364,000 from the amortization of debt discount related to ~~renegotiation of a fixed asset purchase agreement.~~the Moriah credit facility that was not present in the March 31, 2008 quarter. Interest expense related to the secured promissory notes was $545,000 for the three months ended March 31, 2009 as compared to $91,000 for the three months ended March 31, 2008.

Liquidity and Capital Resources

At ~~September 30,~~March 31, 2008, we had ~~$1.0 million~~$329,000 in ~~cash.~~cash and a bank overdraft of $244,000. The Company’s working capital position, defined as current assets less current liabilities, has historically been negative and was negative ~~$15.3~~$18.3 million at ~~September 30, 2008~~March 31, 2009 and negative ~~$12.0~~$17.3 million at December 31, ~~2007.~~2008. Included in current liabilities ~~was a bank overdraft of $555,000~~ at ~~September 30, 2008 and $464,000 at December 2007. Also included in current liabilities at September 30, 2008~~March 31, 2009 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 nine months ended September 30, 2008~~March 31, 2009 as compared to ~~the nine months ended September 30, 2007~~March 31, 2008:

Net cash ~~used in~~provided by operating activities was ~~$2.3 million~~$324,000 for the ~~nine~~three months ended ~~September 30, 2008~~March 31, 2009 as compared to net cash used in operating activities of ~~$8.4~~$549,000 million for the ~~nine~~three months ended ~~September 30, 2007.~~March 31, 2008. The most significant use of cash in operating activities was our net loss for the ~~nine~~three months ended ~~September 30, 2008~~March 31, 2009 of approximately ~~$5.5~~$1.3 million. The ~~primary offsets~~most significant change in cash flow from operations was the reduction in the loss for the period to ~~this use of~~1.5 million. Significant adjustments increasing cash from operating activities in 2009 were ~~add-backs related to non-cash expenses for depreciation and amortization, stock-based compensation and~~ amortization of debt ~~discount. In addition, a $2.0 millions~~discount of $834,000, an increase in accounts payable and accrued expenses from December 31, ~~2007 reduced the use~~2008 of ~~cash from operating activities. The most significant uses of cash in operating activities for the nine months ended September 30, 2007 were the $15.3~~$1.8 million ~~net loss~~ and a $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~~depreciation and ~~warrants, a $2.6 million~~amortization of $102,000. The primary offset that that decreased cash provided by operating activities was an increase in accounts ~~payable~~receivable from December 31, 2008 of 661,000.

There were no purchases of property and ~~non-cash expenses for stock based compensation~~equipment in the three months ended March 31, 2009 and ~~depreciation.~~2008.

Net cash used in ~~investing activities for the nine months ended September 30, 2008 and 2007 was attributable to network-related equipment purchases of $33,000 and $79,000, respectively.~~

~~Net cash provided by~~ financing activities for the ~~nine~~three months ended ~~September 30, 2008~~March 31, 2009 was ~~$3.1 million~~$166,000 as compared to cash provided by financing activities of ~~$8.8 million~~$638,000 for the ~~nine~~three months ended ~~September 30, 2007.~~March 31, 2008. Net cash used in financing activities for the three months ended March 31, 2009 included a 318,000 bank overdraft as a use of funds and $152,000 borrowings from related parties as a source of funds. Net cash provided by financing activities for the ~~nine~~three months ended ~~September 30,~~March 31, 2008 was primarily attributable to the receipt of ~~$1.9~~$1.4 million from the issuance of secured notes offset by $600,000 cancellation of debt due to loan ~~modification and $2.0 million proceeds from an asset based line of credit.~~modification. This was partially offset by payments made for capital lease obligations and to a related party. Net cash for the nine months ended September 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 ~~$5.6 million~~$1,607,000 and ~~$15.3 million and negative cash flow from operations of $2.3 million and $8.4 million~~$1,916,000 for the ~~nine~~three months ended ~~September 30,~~March 31, 2009 and 2008, ~~and 2007,~~ respectively. ~~As of September 30, 2008,~~In addition, the Company ~~has~~had total shareholders’ deficit of $17,413,000 and a working capital deficit of ~~$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~~$18,673,000 as of ~~credit facility balance related to a decrease in debt discount. (see Note 10 to the Consolidated Financial Statements for detailed discussion.)~~ March 31, 2009. The Company ~~plans to use its current~~anticipates it will not have sufficient cash ~~balance and capital raised from outside sources~~flows to fund ~~future operating losses until the Company has grown revenues so that cash flows from operating activities are sufficient to sustain~~its operations through fiscal 2009 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.~~additional financing. 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. The report from the Company’s independent registered public accounting firm states that there is substantial doubt about the Company’s ability to continue as a going concern. There are many claims and obligations that could ultimately cause the Company to cease operations. The report from the Company’s independent registered public accounting firm states that there is substantial doubt about the company’s ability to continue as a going concern.

~~From~~As discussed in Note 9, the Company entered into agreements with Moriah Capital, L.P. (“Moriah”) under which it could borrow up to $2,400,000. At March 31, 2009, the Company had borrowed $2,400,000. These agreements include financial and other covenants that the Company needed to maintain at March 31, 2009. The availability of loan amounts under the agreements expires on April 30, 2009. The Company was not in compliance with certain covenants as of March 31, 2009, and accordingly, Moriah can call the loan immediately payable at any time. The Company has other significant matters of importance, including: other contingencies such as vendor disputes and lawsuits discussed in Note 10; obligations with respect to warrants issued in connection with the secured promissory notes discussed in Note 6, and covenant defaults on the secured notes as discussed in Note 6 that could cause an acceleration of those amount due. These matters, individually or in the aggregate, could have material adverse consequences to the Company’s operations and financial condition at any time.

Management believes that the recent losses are primarily attributable to costs related to building out and supporting a telecommunications infrastructure, and the requirement for continued expansion of the customer base and the resultant increase in revenues, in order for the Company to become profitable. The Company continues to require outside financing until such time as it can achieve positive cash flow from operations. In November and December 2007, the Company received $600,000 and in the period from January to ~~September 30,~~June 2008 the Company received ~~$1,920,000~~an additional $1,320,000 and an additional $462,500 from November 2008 to February 2009 pursuant to the sale of secured notes with individual investors for general working capital. The terms of the secured notes are 18 months maturity (beginning in June 2009) with an interest rate of 13% per annum due at the maturity date. The secured notes are secured by substantially all of the assets of the Company. The Company is also required to pay an origination fee of 3.00% and documentation fee of 2.50% of the principal amount of the secured notes at the maturity date. Prepayment of the credit facilities requires payment of interest that would have accrued through maturity, discounted by 20%, in addition to principal, accrued interest and fees. 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~~In addition, the Company ~~can achieve positive cash flow from operations.~~entered into a revolving credit agreement, effective on April 30, 2008 (See Note 9) and expiring on April 30, 2009, pursuant to which the Company could access funds up to $2,400,000 per Amendment no. 2 to the agreement in November 2008. The Company is in negotiations with the ~~process of securing this required additional financing, however, there~~lender regarding an extension and an increase to the revolving credit agreement. There can be no assurance that wethe Company will be successful in completing ~~the~~this required financing ~~required to fund our ongoing operations~~ or that weit will continue to expand ~~our revenue base~~its revenue. Should the Company be unsuccessful in this financing attempt or other financings, material adverse consequences could occur should the Company be unable to ~~the extent~~secure alternate financing.

The Company will be required to ~~achieve positive cash-flows from~~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 future. The Company also has borrowed $2.0 million on a $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~~Company’s ongoing cash ~~requirements~~requirements. Such financing alternatives could 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~~selling 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~~securities, obtaining long or short-term credit facilities, or selling operating assets. No assurance can 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,given, 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~~the Company could obtain such financing on ~~hand~~terms favorable 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~~the Company 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. TheAny sale of additional common stock or convertible equity or debt securities ~~or additional equity securities could~~would result in additional dilution to ~~our~~the Company’s stockholders. ~~The incurrence~~

Table 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.Contents

Credit Facilities

~~Credit Facilities~~

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) nine 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 with Moriah pursuant to which the Company may access funds up to $1.5 million. In September 2008, the Company entered into Amendment No. 1 to the agreement which increased the access to $2.0 million and in November 2008 the Company entered into Amendment No 2 to the agreement which increased the access to $2.4 million. As of ~~September 30, 2008,~~March 31, 2009, the Company is permitted to borrow an amount not to exceed ~~110%~~100% of its eligible accounts receivable. As of ~~September 30, 2008,~~March 31, 2009, the Company has borrowed ~~$2.0~~$2.4 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.~~2009 and the Company is in active negotiations with the lender regarding terms for extending the credit agreement. 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 ~~Notes 10 and 14~~Note 9 to the Consolidated Financial Statements for detailed discussion.)

Legal Proceedings.

See Note 10 to the Consolidated Financial Statements.

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.

Stock-Based Compensation.

Effective January 1, 2006, we adopted SFAS No. 123(R), “Share-Based ~~Payments,~~Payments.” ~~which revises SFAS 123, “Accounting~~Since January 1, 2006, our stock-based compensation has been based on the balance of deferred stock-based compensation for ~~Stock-Based Compensation,” issued in 1995. Prior to the adoption of SFAS 123(R), we accounted for stock-based employee compensation arrangements~~unvested awards at January 1, 2006, using the intrinsic value ~~method in accordance with~~as previously recorded under APB 25, and the ~~provisions and related interpretations~~fair value of ~~Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). We adopted SFAS 123(R) applying~~ the ~~“modified prospective transition method” under which we continue to account for non-vested equity~~ awards ~~outstanding at~~on the date of grant for awards after January 1, 2006. The adoption of SFAS No. 123(R) ~~in the same manner as they had been accounted for prior to adoption, that is, we would~~has resulted and will continue to ~~apply APB 25~~result in ~~future periods~~higher amounts of stock-based compensation for awards granted after January 1, 2006 than would have been recorded if we had continued to ~~equity awards outstanding at the date we adopted SFAS 123(R).~~

~~Under~~apply the provisions of ~~SFAS 123(R), we elected to continue to recognize compensation cost for our employees under~~APB 25. For 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~~2006, the intrinsic value per share is being recognized as compensation ~~cost is reflected in net loss related to common stock options if~~expense over the applicable vesting period (which equals the service period). For those options granted ~~under~~January 1, 2006 and thereafter, compensation expense was determined based on the ~~2004 Plan have an exercise price below the deemed~~ fair ~~market~~ value of the ~~underlying common stock~~options and is being recognized in our Consolidated Statement of Operations over the applicable vesting period (which equals the service period). We estimated the fair value of each option award on the date of grant using the Black-Scholes option-pricing model using various assumptions. Expected volatility is based on the historical volatility of a peer group of publicly traded entities. The expected term of options granted is derived from the average midpoint between vesting and the contractual term, as described in the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107, “Share-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.

We account for equity instruments issued to non-employees in accordance with the provisions of SFAS ~~123,~~123(R), “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:~~

~~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 and by reviewing significant past due balances for individual collectibility. If estimated allowances for uncollectible accounts subsequently prove insufficient, additional allowance may be required.

Table of Contents

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.

Goodwill

We record 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. In December 2008, the Company determined that circumstances indicated that the full carrying value of the Company’s goodwill was not recoverable and took a charge for the impairment of goodwill. As of March 31, 2009, we are not aware of the existence of any indicators of additional 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 ~~September 30, 2008~~March 31, 2009 and ~~December 31, 2007.~~2008. 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 March 31, 2009 and December 31, ~~2007,~~2008, 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$19.1 million 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,$17.7 million, respectively. These net operating losses ~~subject~~occurred subsequent to ~~a Section 382 limitation are not lost if they are not utilized~~our business combination 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.~~December 2006.

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 ~~September 30, 2008,~~March 31, 2009, there is approximately ~~$1.8~~$3.9 million of unresolved charges in ~~dispute and the Company has not recorded a net liability for the unresolved charges.~~dispute. 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.~~

Table of Contents

Contractual Obligations

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~~capital lease obligations at March 31, 2009 and an extension on the operating lease for our corporate offices expires June 30, 2009. In March 2009, the Company entered into a loan and security agreement with a vendor that was a significant lessor of ~~more than three years.~~network equipment to the Company.

The following table reflects a summary of our contractual obligations at ~~September 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 $ 173 $ 141 $ 32 — —
Operating lease obligations 131 131 — — —
Total $ 304 $ 272 $ 32 $ — $ —
March 31, 2009:

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 $ — $ — $ — — —
Operating lease obligations 66 — — — —
Total $ 66 $ — $ — $ — $ —

Recent Accounting Pronouncements

For a discussion of the impact of recently issued accounting pronouncements, see the subsection entitled "Recent Accounting Pronouncements" contained in Note 1 of the Notes to Condensed Consolidated Financial Statements under "Item 1. Financial 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 ~~September 30, 2008,~~March 31, 2009, 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

Evaluation of Disclosure 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.

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~~were not able to conclude 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. Therefore, under Section 404 of the Sarbanne’s-Oxley Act of 2002, the Company must conclude that these controls and procedures are not effective.

Changes in Internal Control Over Financial Reporting

There ~~have been~~were no changes in our internal ~~controls~~control over financial reporting during the ~~most recent fiscal quarter~~three months ended March 31, 2009 that ~~have~~ materially affected, or are ~~reasonable~~reasonably likely to materially affect, our internal ~~controls~~control 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 September 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.

~~Because of the material weaknesses noted above, management concluded that we did not maintain effective internal control over financial reporting as of December 31, 2007, based on~~ ~~Internal Control over Financial Reporting - Guidance for Smaller Public Companies~~ ~~issued by (“COSO”).~~

~~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).

~~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.

3427

Table of Contents

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

~~In May 2006,~~None.

Item 1A. Risk Factors

See Risk Factors in the Form 10-K filed by 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 has filed counterclaims including, but not limited to, breach of contract and misrepresentation.April 15, 2009.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

None.

Table of Contents

Item 6. 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.

3529

Table of Contents

SIGNATURES

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.

Dated: ~~November 19, 2008~~May 20, 2009	By:	~~/s/~~ \s\ Charles Rice
		Charles Rice, Chairman of the Board,
		Chief Executive Officer, and President



Dated: ~~November 19, 2008~~May 20, 2009	By:	~~/s/~~ ~~Vincent Arena~~ \s\ David Olert David Olert
	~~Vincent Arena~~
	Chief Financial Officer and Director

3630

Table of Contents

	Three Months Ended September 30,						Nine months Ended September 30 ,
	2008			2007			2008			2007
Net revenues	$	6,402		$	5,709		$	18,930		$	15,879
Network costs		5,799			5,581			17,545			17,156
Gross profit (loss)		603			128			1,385			(1,277	)
Operating expenses
Sales and marketing (includes stock based compensation of $11 for each of the three months ended September 30, 2008 and 2007, respectively and $32 for each of the nine months ended September 30, 2008 and 2007, respectively)		438			477			1,316			1,586
General and administrative (includes stock based compensation of $74 and $77 for the three months ended September 30, 2008 and 2007, respectively and $233 and $1,170 for the nine months ended September 30, 2008 and 2007, respectively.)		1,337			1,719			4,188			6,494
Total operating expenses		1,775			2,196			5,504			8,080
Operating loss		(1,172	)		(2,068	)		(4,119	)		(9,357	)
Interest expense, net (includes amortization of debt discount of $273 and $0 for the three months ended September 30, 2008 and 2007, respectively and $628 and $0 for the nine months ended September 30, 2008 and 2007, respectively)		648			157			1,551			297
Gain on forgiveness of debt		—			—			(92	)		—
Loss on liability for options and warrants		—			—			—			5,615
Loss before provision for income taxes		(1,820	)		(2,225	)		(5,578	)		(15,269	)
Provision for income taxes		—			5			—			5
Net loss	$	(1,820	)	$	(2,230	)	$	(5,578	)	$	(15,274	)
Basic and diluted net loss per common share	$	(0.03	)	$	(0.04	)	$	(0.09	)	$	(0.26	)
Shares used to calculate basic and diluted net loss per common share (in thousands)		61,438			59,575			60,335			59,575

	Preferred Stock				Common Stock				Additional			Deferred						Total
	Shares		Amount		Shares		Amount		Paid-In Capital			Stock Based Compensation			Accumulated Deficit			Stockholders’ Deficit
Balance at January 1, 2008		—	$	—		59,575,194	$	60	$	25,807		$	(167	)	$	(34,917	)	$	(9,217	)
Reclassification of deferred stock-based compensation		—		—		—		—		(167	)		167			—			—
Stock-based compensation		—		—		—		—		265			—			—			265
Warrant issuance		—		—		—		—		1,214			—			—			1,214
Cashless warrants exercise relating to equipment purchase		—		—		635,612		1		165			—			—			166
Stock issuance		—		—		200,000		—		100			—			—			100
Stock issued on cashless exercise of stock options		—		—		1,143,165		1		(1	)		—			—			—
Net loss for the nine months ended September 30, 2008		—		—		—		—		—			—			(5,578	)		(5,578	)
Balance at September 30, 2008		—	$	—		61,553,971	$	62	$	27,383		$	—		$	(40,495	)	$	(13,050	)

	Nine months Ended September 30,
	2008			2007
Cash flows from operating activities:
Net loss	$	(5,578	)	$	(15,274	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		524			799
Stock based compensation		265			1,202
Amortization of debt discount		628			—
Loss on options and warrants		—			5,615
Stock issuance for consulting		100			—
Gain on forgiveness of debt		(92	)		—
(Increase) decrease in operating assets:
Accounts receivable		(381	)		(609	)
Deposits		30			16
Other current assets		(81	)		(189	)
Other long-term assets		—			(8	)
Increase (decrease) in operating liabilities:
Accounts payable, trade		1,662			2,636
Accrued expenses		307			(2,301	)
Deferred revenues and customer deposits		281			(281	)
Net cash used in operating activities		(2,335	)		(8,394	)

Cash flows from investing activities:
Purchase of property and equipment		(33	)		(79	)

Cash flows from financing activities:
Proceeds from secured notes		1,320			—
Bank overdraft		91			—
Payment of amounts to related party		(140	)		(304	)
Proceeds from line of credit		1,969			—
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		(102	)		(144	)
Net cash provided by financing activities		3,138			8,838

Net increase in cash		770			365
Cash at beginning of period		277			151
Cash at end of period	$	1,047		$	516

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

	Number of Shares		Price per Share		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Options 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 September 30, 2008		6,000,688				0.21		7.25		1,461,838

Options vested and expected to vest in the future at September 30, 2008		6,000,688				0.21		7.25		1,461,838

Options exercisable at September 30, 2008		4,976,134				0.20		6.98		1,288,611

	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		5.25		$0.04		1,478,748		$0.04
0.04		154,039		5.50		0.04		154,039		0.04
0.04		431,307		5.75		0.04		431,307		0.04
0.04		123,231		6.25		0.04		123,231		0.04
0.22		277,269		7.00		0.22		235,679		0.22
0.25		2,350,000		9.00		0.25		1,566,669		0.25
0.27		338,884		7.00		0.27		271,108		0.27
0.41		643,879		7.25		0.41		540,674		0.41
0.81		110,908		7.25		0.81		82,256		0.81
0.97		92,423		7.50		0.97		92,423		0.97
		6,000,688						4,976,134

	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	%

	June 30, 2008			September 30, 2008
Risk-free interest rate		2.63	%		2.42	%
Expected lives (in years)		3.5 years			3.1 years
Dividend yield		0	%		0	%
Expected volatility		74.0	%		74.0	%
Forfeiture rate		0	%		0	%

	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	)%

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		—	$	—	$	—	$	—

	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		$	—		$	—		$	—			—			—
Operating lease obligations			66			—			—			—			—
Total		$	66		$	—		$	—		$	—		$	—