UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q/A
(Amendment No. 2)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 |
For the quarter ended March 31, 2006
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to .
Commission File Number 000-51023
INPHONIC, INC.
(Exact name of Registrant as specified in its Charter)
| Delaware | 52-2199384 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer identification no.) |
1010 Wisconsin Avenue, Suite 600, Washington, DC | 20007 | |
| (Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (202) 333-0001
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x. No ¨.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.). Yes ¨. No x.
The registrant had 35,835,157 shares of common stock outstanding as of April 28, 2006.
EXPLANATORY NOTE
We filed our Quarterly Report on Form 10-Q for the three months ended March 31, 2006 with the Securities and Exchange Commission (the “SEC”) on May 10, 2006. We filed Amendment No. 1 on Form 10-Q/A on June 1, 2007 to amend and restate our unaudited financial statements for the three months ended March 31, 2006 and related footnote disclosures to correct errors in our accounting for activations and services revenue identified during the year-end audit. We are filing this Amendment No. 2 on Form 10-Q/A to clarify those disclosures in Note 1(c) to our unaudited condensed consolidated financial statements regarding the restatement of the unaudited financial statements for the three months ended March 31, 2006 and to clarify our disclosure of changes in internal control in accordance with Item 308(c) of Regulation S-K.
This Amendment No. 2 to our Quarterly Report on Form 10-Q for the three months ended March 31, 2006 amends only the following items:
Part I, Item 1 - Financial Statements
Part I, Item 4 - Controls and Procedures
Part II, Item 6 - Exhibits
INPHONIC, INC.
FORM 10-Q/A
PART I. – FINANCIAL INFORMATION
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| ITEM 1. | FINANCIAL STATEMENTS |
Condensed Consolidated Balance Sheets
(in thousands, except per share and share amounts)
| December 31, 2005 | March 31, 2006 | |||||||
(restated) (unaudited) | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 70,783 | $ | 63,854 | ||||
Short-term investments | — | 5,000 | ||||||
Accounts receivable, net of allowance of $2,042 and $1,695, respectively | 34,606 | 34,823 | ||||||
Inventory, net | 17,693 | 23,079 | ||||||
Prepaid expenses | 2,405 | 3,417 | ||||||
Other current assets | 6,823 | 2,821 | ||||||
Current assets of discontinued operations | 2,430 | 1,527 | ||||||
Total current assets | 134,740 | 134,521 | ||||||
Restricted cash and cash equivalents | 400 | — | ||||||
Property and equipment, net | 12,121 | 14,032 | ||||||
Goodwill | 31,140 | 34,125 | ||||||
Intangible assets, net | 12,651 | 11,606 | ||||||
Deposits and other assets | 3,058 | 3,745 | ||||||
Total assets | $ | 194,110 | $ | 198,029 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Current liabilities: | ||||||||
Current maturities of long-term debt and capital leases | $ | 377 | $ | 15,385 | ||||
Accounts payable | 29,556 | 38,721 | ||||||
Accrued expenses and other liabilities | 31,588 | 29,457 | ||||||
Deferred revenue | 14,135 | 13,929 | ||||||
Current liabilities of discontinued operations | 3,130 | 1,681 | ||||||
Total current liabilities | 78,786 | 99,173 | ||||||
Long term debt and capital lease obligations, net of current maturities | 15,474 | 385 | ||||||
Total liabilities | 94,260 | 99,558 | ||||||
Stockholders’ equity: | ||||||||
Common stock, $0.01 par value | ||||||||
Authorized 200,000,000 shares at December 31, 2005 and March 31, 2006; issued and outstanding 35,232,869 and 35,356,326 shares at December 31, 2005 and March 31, 2006, respectively | 353 | 354 | ||||||
Additional paid-in capital | 264,155 | 267,088 | ||||||
Accumulated deficit | (164,658 | ) | (168,971 | ) | ||||
Total stockholders’ equity | 99,850 | 98,471 | ||||||
Total liabilities and stockholders’ equity | $ | 194,110 | $ | 198,029 | ||||
See accompanying notes to unaudited condensed consolidated financial statements
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Unaudited Condensed Consolidated Statements of Operations
(in thousands, except per share and share amounts)
Three Months Ended March 31, | ||||||||
| 2005 | 2006 | |||||||
| (restated) | ||||||||
Revenue: | ||||||||
Activations and services | $ | 49,751 | $ | 66,742 | ||||
Equipment | 18,400 | 20,236 | ||||||
Total revenue | 68,151 | 86,978 | ||||||
Cost of revenue, exclusive of depreciation and amortization: | ||||||||
Activations and services | 1,173 | 260 | ||||||
Equipment | 38,950 | 47,921 | ||||||
Total cost of revenue | 40,123 | 48,181 | ||||||
Operating expenses: | ||||||||
Sales and marketing, exclusive of depreciation and amortization | 17,498 | 26,722 | ||||||
General and administrative, exclusive of depreciation and amortization | 16,278 | 13,231 | ||||||
Depreciation and amortization | 1,777 | 3,483 | ||||||
Restructuring costs | 149 | — | ||||||
Total operating expenses | 35,702 | 43,436 | ||||||
Operating loss | (7,674 | ) | (4,639 | ) | ||||
Other income (expense): | ||||||||
Interest income | 482 | 627 | ||||||
Interest expense | (226 | ) | (336 | ) | ||||
Total other income | 256 | 291 | ||||||
Loss from continuing operations | (7,418 | ) | (4,348 | ) | ||||
Discontinued operations: | ||||||||
Income from discontinued operations | 424 | 35 | ||||||
Net loss | $ | (6,994 | ) | $ | (4,313 | ) | ||
Basic and diluted net loss per share: | ||||||||
Net loss from continuing operations | $ | (0.22 | ) | $ | (0.12 | ) | ||
Net income from discontinued operations | 0.01 | 0.00 | ||||||
Basic and diluted net loss per share | $ | (0.21 | ) | $ | (0.12 | ) | ||
Basic and diluted weighted average shares outstanding | 32,901,398 | 35,348,335 | ||||||
See accompanying notes to unaudited condensed consolidated financial statements
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Unaudited Condensed Consolidated Statements of Stockholders’ Equity
(in thousands, except share amounts)
| Common stock | Additional paid-in capital | Accumulated deficit | Total | ||||||||||||||||
| Shares | Amount | ||||||||||||||||||
| (restated) | |||||||||||||||||||
Balance, December 31, 2005 | 35,232,869 | $ | 353 | $ | 264,155 | $ | (164,658 | ) | $ | 99,850 | |||||||||
Stock-based compensation expense | — | — | 3,002 | — | 3,002 | ||||||||||||||
Repurchase and retirement of common stock | (62,761 | ) | (1 | ) | (502 | ) | — | (503 | ) | ||||||||||
Exercise of common stock options, restricted stock awards, and other | 186,218 | 2 | 433 | — | 435 | ||||||||||||||
Net loss | — | — | — | (4,313 | ) | (4,313 | ) | ||||||||||||
Balance, March 31, 2006 (restated) | 35,356,326 | $ | 354 | $ | 267,088 | $ | (168,971 | ) | $ | 98,471 | |||||||||
See accompanying notes to unaudited condensed consolidated financial statements
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Unaudited Condensed Consolidated Statements of Cash Flows
(in thousands)
| Three Months Ended March 31, | ||||||||
| 2005 | 2006 | |||||||
| (restated) | ||||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (6,994 | ) | $ | (4,313 | ) | ||
Adjustments to reconcile net loss to net cash provided (used) by operating activities: | ||||||||
Depreciation and amortization | 1,777 | 3,483 | ||||||
Non-cash interest expense, net | 162 | 16 | ||||||
Stock-based compensation | 7,004 | 2,882 | ||||||
Changes in operating assets and liabilities, net of assets and liabilities received from business acquisition: | ||||||||
Accounts receivable | (9,975 | ) | (690 | ) | ||||
Inventory | (5,129 | ) | (5,386 | ) | ||||
Prepaid expenses | (1,316 | ) | (1,012 | ) | ||||
Other current assets | (197 | ) | 4,006 | |||||
Deposits and other assets | (312 | ) | (109 | ) | ||||
Accounts payable | 3,387 | 8,432 | ||||||
Accrued expenses and other liabilities | (1,594 | ) | (5,878 | ) | ||||
Deferred revenue | 3,703 | (206 | ) | |||||
Net cash provided (used) in operating activities | (9,484 | ) | 1,225 | |||||
Cash flows from investing activities: | ||||||||
Capitalized expenditures, including internal capitalized labor | (2,078 | ) | (4,199 | ) | ||||
Cash paid for acquisitions | (45 | ) | — | |||||
Purchase of short-term investments | (4,967 | ) | (5,000 | ) | ||||
Proceeds from the sale of assets of discontinued operations | — | 794 | ||||||
Reduction in restricted cash and cash equivalents | — | 400 | ||||||
Net cash used in investing activities | (7,090 | ) | (8,005 | ) | ||||
Cash flows from financing activities: | ||||||||
Principal repayments on debt | (80 | ) | (81 | ) | ||||
Cash paid for repurchase of common stock | — | (502 | ) | |||||
Proceeds from exercise of warrants and options | 647 | 434 | ||||||
Net costs of initial public offering | (203 | ) | — | |||||
Net cash provided (used) by financing activities | 364 | (149 | ) | |||||
Net decrease in cash and cash equivalents | (16,210 | ) | (6,929 | ) | ||||
Cash and cash equivalents, beginning of the period | 100,986 | 70,783 | ||||||
Cash and cash equivalents, end of the period | $ | 84,776 | $ | 63,854 | ||||
Supplemental disclosure of cash flows information: | ||||||||
Cash paid during the period for: | ||||||||
Interest | $ | 62 | $ | 260 | ||||
Income taxes | — | — | ||||||
Supplemental disclosure of non-cash activities: | ||||||||
Issuance of common stock in business acquisition | $ | 3,736 | $ | — | ||||
Release of funds in escrow related to A1 Wireless acquisition | 10,700 | — | ||||||
VMC earn-out consideration included in accrued liabilities | — | 2,985 | ||||||
See accompanying notes to unaudited condensed consolidated financial statements
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| (1) | The Company and Basis of Presentation |
| (a) | Preparation of Interim Financial Statements |
We have prepared the accompanying condensed consolidated financial statements pursuant to the rules and regulations of the U.S Securities and Exchange Commission (the “SEC”) for interim financial reporting. The financial information included herein, other than the consolidated balance sheet as of December 31, 2005, has been prepared without audit. The consolidated balance sheet at December 31, 2005 has been derived from, but does not include all the disclosures contained in the audited financial statements for the year ended December 31, 2005. The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reported period. In the opinion of management, these unaudited statements include all the adjustments and accruals necessary for a fair presentation of the results of the periods presented herein. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2005. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for a full year. Certain prior year amounts have been reclassified to conform to the current period presentation.
| (b) | Business |
We are a leading online seller of wireless services and devices based on the number of activations of wireless services sold online in the United States. We sell wireless service plans and devices, including satellite television services through our own branded websites; including Wirefly.com, A1 Wireless.com, and VMCsatellite.com and through websites that we create and manage for third parties. We offer marketers the ability to sell wireless voice and data services and devices under mobile virtual network enabler (“MVNE”) agreements. This service utilizes the same e-commerce platform, operational infrastructure and marketing relationships that we use in our operations. We provide customers the ability to organize personal communication by providing real time wireless access to e-mail, voicemail, faxes, contacts, scheduling, calendar and conference calling functionality through a website or telephone.
| (c) | Restatement |
We have restated our consolidated financial statements to reflect the correction of an error in the application of revenue recognition of certain receivables. During the three months ended March 31, 2006, we had recorded $549 of revenue for certain commissions from features activations in which it was subsequently determined that collectibility was not reasonably assured. Additionally, prior to the restatement, we recognized $156 related to certain feature activation commissions in the three months ended September 30, 2006, which as a result of the restatement, we have concluded that we had met all revenue recognition criteria as of March 31, 2006. As a result, we reduced our revenue and accounts receivable by $393 for these adjustments. The impact of the restatement on the three months ended March 31, 2006 is shown in the table below:
| March 31, | March 31, | March 31, | ||||||||||
| 2006 | 2006 | 2006 | ||||||||||
| (reported) | (adjustments) | (restated) | ||||||||||
Accounts receivable | $ | 35,216 | $ | (393 | ) | $ | 34,823 | |||||
Total current assets | 134,914 | (393 | ) | 134,521 | ||||||||
Total assets | 198,422 | (393 | ) | 198,029 | ||||||||
Accumulated deficit | (168,578 | ) | (393 | ) | (168,971 | ) | ||||||
Total stockholders’ equity | 98,864 | (393 | ) | 98,471 | ||||||||
Total liabilities and stockholders’ equity | 198,422 | (393 | ) | 198,029 | ||||||||
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| For the three months ended | ||||||||||||
| 31-Mar | 31-Mar | 31-Mar | ||||||||||
| (reported) | (adjustments) | (restated) | ||||||||||
Revenue: | ||||||||||||
Activations and services | $ | 67,135 | $ | (393 | ) | $ | 66,742 | |||||
Total revenue | 87,371 | (393 | ) | 86,978 | ||||||||
Operating loss | (4,246 | ) | (393 | ) | (4,639 | ) | ||||||
Loss from continuing operations | (3,955 | ) | (393 | ) | (4,348 | ) | ||||||
Net loss | (3,920 | ) | (393 | ) | (4,313 | ) | ||||||
Net loss per share: | ||||||||||||
Net loss from continuing operations | (0.11 | ) | (0.01 | ) | (0.12 | ) | ||||||
Basic and diluted net loss per share | (0.11 | ) | (0.01 | ) | (0.12 | ) | ||||||
| For the three months ended | ||||||||||||
| 31-Mar | 31-Mar | 31-Mar | ||||||||||
| (reported) | (adjustments) | (restated) | ||||||||||
Cash flows from operating activities: | ||||||||||||
Net loss | $ | (3,920 | ) | $ | (393 | ) | $ | (4,313 | ) | |||
Accounts receivable | (1,083 | ) | 393 | $ | (690 | ) | ||||||
| (d) | Risks and Uncertainties |
Our operations are subject to certain risks and uncertainties including, among others, actual and potential competition by entities with greater financial resources, rapid technological changes, the need to retain key personnel and protect intellectual property and the availability of additional capital financing on terms acceptable to us.
Since inception we have incurred net losses attributable to common stockholders of approximately $168,971. To date, management has relied on debt and equity financings to fund our operating deficit. While we currently have $68,854 of cash and cash equivalents and short-term investments on hand as of March 31, 2006, we may require additional financing to fund future operations.
| (e) | Acquisitions and Discontinued Operations |
We acquired certain assets and assumed certain liabilities of A1 Wireless USA, Inc. (“A1 Wireless”) on January 4, 2005 and VMC Satellite, Inc. (“VMC”) on April 26, 2005. We accounted for these transactions using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141,Business Combinations.Accordingly our results of operations include the operating results of A1 Wireless effective January 1, 2005 and VMC as of the April 26, 2005 acquisition date.
On December 31, 2005, we completed the sale of substantially all of the operating assets of our mobile virtual network operator (“MVNO”) Liberty Wireless (“Liberty”) to Teleplus Wireless Corp, a subsidiary of Teleplus Enterprises, Inc. The Liberty sale has enabled us to streamline and focus our resources on our other operations including the growth of our MVNE . The sale of Liberty was recorded as a discontinued operation in the financial statements pursuant to SFAS No. 144,Accounting for Impairment or Disposal of Long Lived Assets.
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| (2) | Summary of Significant Accounting Policies |
| (a) | Revenue Recognition |
Activations and Services Revenue
We recognize revenue from the sale of wireless services and the provisioning of MVNE and data services.
Wireless Services:We generate revenue from wireless carriers, including a satellite television carrier, who pay commissions and volume and performance-based bonuses, for activating wireless subscribers. We recognize commissions from wireless carriers upon shipment of activated devices to the customer. In addition to activation commissions certain carriers pay us a monthly residual fee either for as long as a customer who we activate for that carrier continues to be its subscriber, or for a fixed period of time depending on the carrier. We purchase satellite activation certificates evidencing activation rights in advance of their resale to customers. Revenue from satellite television customers includes sales of these satellite activation certificates, net of the certificate cost, as we are acting as an agent in the transaction. Our wireless revenue is reduced for estimated deactivations of customers prior to the expiration of a time period that ranges 120 to 210 days from the date of activation, depending on the wireless carrier. We estimate deactivations based on historical experience, which we developed based on our experience with carriers, customer behavior and sources of customers, among other factors, allowing us to accrue estimates with what we believe is a high degree of certainty. If we determine that we cannot accurately predict future deactivation experience, we may be required to defer 100% of our carrier commissions revenue until the expiration of the appropriate chargeback period. Our reserves for deactivations are included in accounts receivables and deferred revenue on the accompanying balance sheets.
In addition to receiving commissions for each wireless subscriber activated, we earn performance bonuses from the wireless carriers based on negotiated performance targets. The most significant bonus we earn is the quarterly volume bonus, which we bill wireless carriers for on a monthly basis, based on current month activations. We record these bonuses as deferred revenue at the time of billing until we achieve the quarterly targets. We also earn other quarterly bonuses from certain carriers for maintaining low customer churn and signing up customers for certain additional monthly “features” such as text messaging or data service. Wireless carriers also periodically offer bonuses for achieving monthly volume and other performance targets. We recognize these monthly bonuses as earned in accordance with the provisions of Staff Accounting Bulletin (“SAB”) No. 104,Revenue Recognition in Financial Statements. Revenue is recognized only when all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the seller’s price to the buyer is fixed or determinable, and (4) collectibility is reasonably assured. Amounts collected in cash prior to meeting the above criteria are recorded as deferred revenue. Through 2005, commission revenue earned from the activation of carrier features had been deferred until the contractual chargeback period had lapsed. Beginning in 2006, we began to estimate commission revenue earned from feature activations based on historical experience which we have developed based on our experience with carriers and customer behavior over a period of time in excess of 24-months. This allows us to accrue estimates with what we believe is a high degree of certainty in accordance with SAB 104. Activation and service revenue included $669 as a result of this change.
MVNE Services:We offer marketers the ability to sell wireless services to their customers under their own brands using our e-commerce platform and operational infrastructure through MVNE contracts. We receive fees for the development of the network platform, as well as for operational support services. We defer the fees attributable to the production of the network platform and recognize these fees and costs over the expected life of the agreement (typically 12 to 48 months). Prepaid fees are deferred until all revenue criteria have been satisfied. Deferred revenue as of December 31, 2005 and March 31, 2006 included $1,852 and $1,918, respectively, from MVNE contracts.
Data Services:We sell data services, including a service that allows customers to access email, voicemail, facsimiles, contacts and personal calendar information through a website or a telephone; wireless email; and mobile marketing services. We bill customers and recognize revenue monthly, as the services are performed.
Equipment Revenue
Revenue from the sale of wireless devices and accessories in a multiple-element arrangement with services are recognized at the time of sale in accordance withEmerging Issues Task ForceEITF No. 00-21,Revenue Arrangements with Multiple Deliverables, when fair value of the services element exists. Customers have the right to return devices within a specific period of time or usage, whichever occurs first. We provide an allowance for estimated returns of devices based on historical experience. In accordance with the provisions of SAB
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No. 104, we determined we have sufficient operating history to estimate equipment returns. In connection with wireless activations, we sell customers wireless devices at a significant discount, which is generally in the form of a rebate. Rebates are recorded as a reduction of revenue. We recognize equipment revenue, less a reserve for customer rebates (accrued consumer liabilities), which is based on historical experience of rebates claimed. Future experience could vary based upon rates of consumers redeeming rebates.
| (b) | Concentrations of Credit Risk |
Financial instruments that potentially subject us to a concentration of credit risk consist principally of accounts receivable. We extend credit to wireless network carriers (“carriers”) on an unsecured basis in the normal course of business. Three carriers accounted for 67% and 70% of accounts receivable, net of the deactivation reserve, as of December 31, 2005 and March 31, 2006, respectively.
For the three months ended March 31, 2005 and 2006, revenue from three carriers exceeded 10% of our total revenue. Revenue as a percentage of total revenue for these carriers was as follows:
| Three Months Ended March 31, | ||||||
| 2005 | 2006 | |||||
Customer A | 24 | % | 35 | % | ||
Customer B | 24 | % | 16 | % | ||
Customer C | 22 | % | 15 | % | ||
Total | 70 | % | 66 | % | ||
| (c) | Accrued Expenses and Other Liabilities |
Accrued expenses and other liabilities at December 31, 2005 and March 31, 2006 consisted of:
| As of | ||||||
December 31, 2005 | March 31, 2006 | |||||
Accrued consumer liabilities | $ | 18,289 | $ | 15,478 | ||
Accrued payroll and related expenses | 1,452 | 1,073 | ||||
Accrued acquisition costs and severance costs | 5,063 | 7,769 | ||||
Accrued taxes payable | 593 | 389 | ||||
Other | 6,191 | 4,748 | ||||
| $ | 31,588 | $ | 29,457 | |||
| (d) | Restructuring Costs |
We implemented a restructuring plan in the first quarter of 2005 following the acquisition of A1 Wireless, to take advantage of synergies gained through the acquisition and to restructure our operations for efficiency purposes. For the three months ended March 31, 2005, we recognized $149 in restructuring costs, all of which related to workforce reduction. All costs related to this plan were paid out in 2005.
| (e) | Stock-Based Compensation |
We adopted Statement of Financial Accounting Standards “SFAS” No. 123 (revised 2004),Share Based Payment (SFAS No. 123(R)) on January 1, 2006 using the modified prospective application method (“MPA”). SFAS No. 123(R) established standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS No. 123(R) requires us to measure the cost of employee services received in exchange for an award of equity instruments (usually stock options or unvested (restricted) stock awards) based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award – the requisite service period (usually the vesting period).
Prior to our adoption of SFAS No. 123(R), we applied the intrinsic value method of accounting for employee stock-based compensation as prescribed by Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation (“FIN”) No. 44,Accounting for Certain Transactions involving Stock Compensation an Interpretation of APB Opinion No. 25, to account for our stock option grants to employees. Under this method, compensation expense was
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recorded on the date of the grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123,Accounting for Stock-Based Compensation(“SFAS No. 123”), established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As permitted by SFAS No. 123, we had elected to continue to apply the intrinsic value-based method of accounting described above, and had adopted the disclosure requirements of SFAS No. 123. All shares of restricted stock awarded to employees were accounted for at fair value in accordance with SFAS No. 123.
Under the MPA method, compensation cost for all share-based payments granted prior to, but not vested as of December 31, 2005, is based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123, and compensation cost for all share based payments granted subsequent to December 31, 2005, will be based on the grant date fair value estimated in accordance with the provisions of SFAS No.123(R). Results for prior periods have not been restated. We use the ratable method of attributing the value of stock-based compensation to expense. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In our pro forma information required under SFAS No. 123 for the periods prior to January 1, 2006, we accounted for forfeitures as they occurred. The fair value of each option granted is estimated on the grant date using the Black-Scholes option pricing model which takes into account as of the grant date the exercise price and expected life of the option, the current price of the underlying stock and its expected volatility, expected dividends on the stock and the risk-free interest rate for the term of the option.
Stock Options – We have two stock plans under which we have issued or may issue options to purchase shares of our common stock. The 1999 Stock Incentive Plan (the “1999 Plan”), provided for grants of stock-based awards from time to time to employees, officers, directors and consultants of the Company at exercise prices determined by the board of directors. Options granted under the 1999 Plan generally vest over a four-year period and expire ten years from the grant date. As of November 19, 2004, no additional options were available for grant under the 1999 Plan due to the adoption of the 2004 Equity Incentive Plan (the “2004 Plan”).
The 2004 Plan allows for grants of stock-based awards from time to time to employees, officers, directors and consultants at exercise prices determined by the board of directors. For incentive stock options, the exercise price must be at least equal to fair market value at the date of grant. For nonqualified stock options, the option may be granted with an exercise price less than fair market value. Options granted under the 2004 Plan vest over a period to be determined by the administrator, generally four years, and expire ten years from the grant date.
For the three months ended March 31, 2006 as a result of our adoption of SFAS No. 123 (R), we recognized stock-based compensation expense related to employee options granted prior to January 1, 2006 of $1,899 of which $148 was capitalized in accordance with our compensation policies and SFAS No. 123(R).
In addition on March 22, 2006, we granted options to certain of our employees to purchase 679,900 shares of our common stock at an exercise price of $6.46 per share. The grant date fair value of employee share options was estimated using the Black Scholes option-pricing model with the following assumptions: an expected life averaging 5.77 years; an average volatility of 72%; no dividend yield; and a risk-free interest rate averaging 4.69%. The weighted average fair value per share of options granted was $4.28. Compensation cost of the grant was reduced by an estimated forfeiture amount based on an annual experience rate of 9.93%. As of the date of grant, total compensation cost related to the grant including estimated forfeitures was approximately $2,324. Stock-based compensation expense for this grant for the three months ended March 31, 2006 was $29.
The impact of adopting SFAS No. 123(R) increased stock-based compensation expense included in our operating expenses and reduced net income from continuing operations by approximately $850 for the three months ended March 31, 2006 or $0.02 per basic and diluted share. There was no impact from the adoption on cash flow from operations or cash flows from financing activities.
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The following table summarizes the activity for stock options granted to employees and non-employees for the three months ended March 31, 2006.
Number of options | Weighted average exercise price | Weighted average | Aggregate intrinsic value | ||||||||
Balance January 1, 2006 | 5,115,969 | $ | 9.47 | ||||||||
Granted | 679,900 | 6.46 | |||||||||
Exercised | (93,409 | ) | 5.07 | ||||||||
Forfeited | (151,929 | ) | 13.06 | ||||||||
Balance March 31, 2006 | 5,550,531 | $ | 9.06 | 8.17 | $ | 4,870 | |||||
Ending vested & expected to vest | 5,119,324 | $ | 9.02 | 8.09 | $ | 4,603 | |||||
Exercisable at March 31, 2006 | 2,406,746 | $ | 8.13 | 7.28 | $ | 2,590 | |||||
The weighted-average grant date fair value of options granted during the three months ended March 31, 2006 was $4.28. The total intrinsic value of options exercised during the three months ended March 31, 2006 was $139.
Restricted Common Stock – During the three months ended March 31, 2006, we granted 462,709 shares of restricted common stock to certain of our key employees. The restrictions on this common stock lapse and the stock vests over periods ranging up to 4 years from the grant date. The following table summarizes the activity for restricted stock for the three months ended March 31, 2006.
Number of restricted stock awards | Weighted-average grant-date fair value | |||||
Nonvested at January 1, 2006 | 1,137,878 | $ | 16.48 | |||
Granted | 462,709 | 6.46 | ||||
Vested | (92,809 | ) | 16.83 | |||
Surrendered for taxes | (4,710 | ) | 13.31 | |||
Forfeited | (63,067 | ) | 20.04 | |||
Nonvested at March 31, 2006 | 1,440,001 | $ | 13.23 | |||
As of March 31, 2006, there was approximately $12,200 of total unrecognized compensation cost related to restricted share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 1.65 years. The total fair value of shares vested during the three months ended March 31, 2006 was approximately $1,600.
Warrants– During the three month period ended March 31, 2006, we did not grant any warrants to purchase shares of our common stock. Warrants outstanding at March 31, 2006, were exercisable for 787,863 shares of our common stock.
Our pro forma net loss per common share, basic and diluted, for the three months ended March 31, 2005 was as follows:
Three Months Ended March 31, 2005 | ||||
Net loss as reported | $ | (6,994 | ) | |
Add: Stock-based employee compensation expense included in net loss as reported | 6,643 | |||
Less: Total stock-based employee compensation determined under fair value based methods for all stock awards, net of related tax effects | (2,518 | ) | ||
Pro forma net loss | $ | (2,869 | ) | |
Net loss per common share, basic and diluted, as reported | $ | (0.21 | ) | |
Net loss per common share, basic and diluted, pro forma | $ | (0.09 | ) | |
Basic and dilutive weighted average common shares outstanding | 32,901,398 | |||
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Stock-based compensation which includes compensation recognized on stock option grants and restricted stock awards has been included in the following line items in the accompanying condensed consolidated financial statements. There was no tax benefit recognized in the statements of operations for stock-based awards in either period:
Three Months Ended March 31, | ||||||
| 2005 | 2006 | |||||
Balance Sheets: | ||||||
Property and equipment, net | $ | — | $ | 148 | ||
Statements of operations: | ||||||
Sales and marketing | 596 | 719 | ||||
General and administrative | 6,345 | 2,163 | ||||
Income from discontinued operations | 63 | — | ||||
| $ | 7,004 | $ | 2,882 | |||
| (f) | Net Loss per Share |
We calculate net loss per share in accordance with SFAS No. 128,Earnings Per Share. Basic net loss per common share excludes any dilutive effects of options, warrants, restricted stock and convertible securities and is calculated by dividing net loss attributable to common stockholders by the weighted average number of common shares issuable and outstanding for the period. Diluted net loss per common share equals basic net loss per common share, as the effects of options, warrants, restricted stock and convertible securities will be anti-dilutive.
The following table reconciles net loss and basic and diluted weighted average common shares outstanding to the historical or pro forma net loss and the pro forma basic and diluted weighted average common shares outstanding for the three months ended March 31, 2005 and 2006.
Three Months Ended March 31, | ||||||||
| 2005 | restated 2006 | |||||||
Net loss from continuing operations | $ | (7,418 | ) | $ | (4,348 | ) | ||
Net income from discontinued operations | 424 | 35 | ||||||
Net loss | $ | (6,994 | ) | $ | (4,313 | ) | ||
Weighted average shares outstanding | 32,901,398 | 35,348,335 | ||||||
Basic and diluted earnings per share: | ||||||||
Net loss from continuing operations | $ | (0.22 | ) | $ | (0.12 | ) | ||
Net income from discontinued operations | 0.01 | 0.00 | ||||||
Basic and diluted earnings per share | $ | (0.21 | ) | $ | (0.12 | ) | ||
Anti dilutive weighted average shares excluded from diluted loss per share | 8,149,335 | 1,348,878 | ||||||
| (3) | Discontinued Operations |
On December 31, 2005, we completed the sale of substantially all of the operating assets of our Liberty Wireless business. During the three months ended March 31, 2006 we collected $794 of notes receivable recorded at December 31, 2005 related to the divestiture.
Summary of operating results for the discontinued operations are as follows:
Three Months Ended March 31, | |||||||
| 2005 | 2006 | ||||||
Revenue | $ | 8,456 | $ | — | |||
Costs and expenses | (8,032 | ) | 35 | ||||
Income from discontinued operations | $ | 424 | $ | 35 | |||
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Balance sheet data included:
| As of | ||||||
December 31, 2005 | March 31, 2006 | |||||
Accounts and notes receivable, net | $ | 1,848 | $ | 1,527 | ||
Other current assets | 582 | — | ||||
Assets of discontinued operations | $ | 2,430 | $ | 1,527 | ||
Accounts payable | $ | 931 | $ | 199 | ||
Other accrued expenses | 2,199 | 1,482 | ||||
Liabilities of discontinued operations | $ | 3,130 | $ | 1,681 | ||
| (4) | Intangible Assets and Goodwill |
| (a) | Acquired Intangible Assets |
We amortize intangible assets on a straight-line basis over periods ranging from one to ten years. Supplier relationships and trade name have indefinite lives. Amortized intangible assets comprised the following:
| December 31, 2005 | |||||||||
| Gross Carrying Amount | Accumulated Amortization | Net Amount | |||||||
Software and technology | $ | 1,123 | $ | 1,045 | $ | 78 | |||
Customer contracts | 885 | 885 | — | ||||||
Affiliate and carrier relationships | 3,960 | 676 | 3,284 | ||||||
Non-compete agreement | 5,049 | 1,431 | 3,618 | ||||||
Supplier relationships | 3,730 | — | 3,730 | ||||||
Trade name | 1,110 | — | 1,110 | ||||||
Other | 1,935 | 1,104 | 831 | ||||||
Total | $ | 17,792 | $ | 5,141 | $ | 12,651 | |||
| March 31, 2006 | |||||||||
| Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||
Software and technology | $ | 90 | $ | 16 | $ | 74 | |||
Affiliate and carrier relationships | 3,960 | 874 | 3,086 | ||||||
Non-compete agreement | 5,049 | 1,993 | 3,056 | ||||||
Supplier relationships | 3,730 | — | 3,730 | ||||||
Trade name | 1,110 | — | 1,110 | ||||||
Other | 1,935 | 1,385 | 550 | ||||||
Total | $ | 15,874 | $ | 4,268 | $ | 11,606 | |||
The following table reflects the changes to goodwill for the three months ended March 31, 2006.
Balance as of December 31, 2005 | $ | 31,140 | |
Goodwill arising from VMC earn-out (1) | 2,985 | ||
Balance as of March 31, 2006 | $ | 34,125 | |
| (1) | We achieved the earn-out performance target stipulated in the VMC Asset Purchase Agreement on February 28, 2006 and accordingly recorded additional goodwill of $2,985. The earn-out consideration consisted of amounts that will be payable in cash of $2,363 and 119,389 shares of our common stock with a fair value of $622. Such consideration was reflected in accrued expenses and other liabilities in the accompanying balance sheet at March 31, 2006. We distributed the cash consideration and shares of common stock in April 2006. |
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| (5) | Debt |
We maintain a revolving operating line of credit which allows for aggregate borrowings of up to $25,000 subject to certain limits based on accounts receivable and inventory levels. At March 31, 2006 and December 31, 2005, there was $15,000 outstanding under this line of credit. As of March 31, 2006, we have an additional $176 of availability under the line of credit based on the limits described above. The line of credit expires effective January 1, 2007 and accordingly the outstanding balance has been classified as a current liability as of March 31, 2006. Borrowings outstanding under the line of credit are secured by substantially all of the company’s assets. Under the terms of our line of credit facility we are required to maintain a current ratio, as defined, of no less than 1.1 to 1. We are also required to maintain an unrestricted cash balance of no less than $10,000 held at the bank and to meet certain minimum levels of EBITDA, as defined. As of March 31, 2006, we were in compliance with the EBITDA covenant under the credit facility.
| (6) | Repurchase of Common Stock |
On August 17, 2005, our Board of Directors authorized the repurchase of up to $30,000 of our common stock through August 2006. The shares may be repurchased by us from time to time at prevailing market prices. The timing and amount of any shares repurchased are based on market conditions and other factors. Repurchases may also be made under a Rule 10b5-1 plan, which permits shares to be repurchased when we might otherwise be precluded from doing so by laws prohibiting insider trading or by self imposed trading black out periods. There is no guarantee as to the exact number of shares that will be repurchased under the stock repurchase program, and we may discontinue purchases at any time. We intend to fund our share repurchases with cash on hand and cash generated from future operations. During the three months ended March 31, 2006, we repurchased 62,761 shares of our common stock at an average price of $8.01 per share for approximately $502. All shares repurchased were returned to the status of authorized but unissued shares of common stock as of March 31, 2006. Since the inception of this program, we have repurchased 1,144,248 shares for an aggregate consideration of $13,591.
| (7) | Commitments and Contingencies |
Legal Matters
We are subject to litigation, claims and assessments in the normal course of business including those arising from asset acquisitions or business combinations. We do not believe that any existing or anticipated litigation, claims or assessments will have a material effect on our consolidated financials statements.
On August 5, 2004, Avesair, Inc., a company whose assets we acquired, filed suit against us demanding, among other matters, that we issue to Avesair shares of our common stock valued at approximately $4,000 as of June 30, 2004. The stock demanded by Avesair represents the maximum value of shares that they could have earned for achieving certain performance-based targets under the asset purchase agreement. We believe the performance-based targets were not achieved and intend to vigorously contest this matter.
On July 25, 2005, the Federal Communications Commission (“FCC”) issued a Notice of Apparent Liability, asserting that we registered with the FCC and reported and contributed to the Universal Service Fund (“USF”) and the Telecommunications Relay Service Fund later than required by FCC rules. The FCC has preliminarily proposed to fine us approximately $820 for late payment of such fees. In a letter dated August 24, 2005 we responded to the FCC’s preliminary finding and asserted that no fine is appropriate under the circumstances. However, any adverse resolution of this matter could have a material adverse impact on our financial results.
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| ITEM 4. | CONTROLS AND PROCEDURES |
Disclosure Controls and Procedures
Management had previously concluded that our disclosure controls and procedures were effective as of March 31, 2006. However, in connection with the restatement of our March 31, 2006, June 30, 2006 and September 30, 2006 interim financial statements as fully described in Note 1 of this Form 10-Q/A, management determined that the material weaknesses described below existed as of March 31, 2006. Accordingly, our Chief Executive Officer and Chief Accounting Officer have now concluded that disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were not effective as of March 31, 2006 to ensure information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified within the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure.
Not withstanding the material weaknesses described below, management believes the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q/A fairly present in all material respects our financial condition, results of operations and cash flows for all periods presented.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood, that a material misstatement of the annual or interim quarterly financial statements will not be prevented or detected. Management identified material weaknesses in our internal controls including the following:
| • | We did not maintain sufficient staffing of operational and financial resources.We did not maintain staffing in operational and financial resources sufficient to provide the level of controls and analysis required on a timely basis in light of the increasing complexity and growth of our business. This resulted in certain accounting processes and controls not being performed on a timely basis and the inability to maintain an adequate control environment, resulting in numerous material adjusting entries being made after year end. This material weakness contributed to errors such as those relating to proper revenue recognition and accounts receivable described below. |
| • | We did not always effectively communicate information to our finance department. Specifically, we failed to maintain effective communication channels to adequately identify and record certain transactions during 2006. The failure to provide this communication contributed to errors relating to accounting and reporting of expenses and liabilities. This material weakness caused or contributed to, adjustments necessary to appropriately record accounts receivable allowances and reserves for deactivations described below. |
| • | We did not maintain effective controls over the recordation, accuracy and completeness of activations and services revenue and related accounts receivable. |
We did not take steps to adequately identify and appropriately record certain commission and bonus revenue received during the year from various wireless carriers in a timely and accurate manner. Recording amounts received from carriers in the appropriate accounts in a timely and accurate manner is an important business process control that is essential to the correct reporting of amounts in the financial statements. This material weakness contributed to errors relating to accounting and reporting for revenue and accounts receivable.
We did not utilize an appropriate methodology during the year in recording receivables from wireless carriers associated with disputed deactivations, churn bonuses and other carrier related fees. We overstated accounts receivable by using a methodology that anticipated future improvements in collections beyond that supported by past experience, and which did not consider certain current factors and other information. As a result of this material weakness, an adjustment was necessary to properly record revenue and related receivables from these fees.
These material weaknesses resulted in adjustments to our revenue and accounts receivable and certain other financial statement line items as referred to above and resulted in the restatement of previously issued consolidated financial statements for the three month period ended March 31, 2006.
Internal Controls over Financial Reporting
With the exception of the items described above, there have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting for this current period.
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| ITEM 6. | EXHIBITS |
Exhibit No. | Description | |
31.1 | Rule 13a-14(a) Certification of Principal Executive Officer. | |
31.2 | Rule 13a-14(a) Certification of Principal Financial Officer. | |
32.1 | Section 1350 Certification of Chief Executive Officer. | |
32.2 | Section 1350 Certification of Chief Financial Officer. | |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| INPHONIC, INC. | ||
| By: | /S/ DAVID A. STEINBERG | |
David A. Steinberg Chairman of the Board and Chief Executive Officer | ||
| By: | /S/ KENNETH D. SCHWARZ | |
Kenneth D. Schwarz Executive Vice President and | ||
Date: August 10, 2007
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