TELANETIX, INC.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
As of August 7, 2009, 31,768,320 shares of the issuer's common stock, par value $0.0001 per share, were outstanding. The common stock is the issuer's only class of stock currently outstanding.
Telanetix, Inc.
The forward-looking statements in this report are based upon management's current expectations and belief, which management believes are reasonable. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor or combination of factors, or factors we are aware of, may cause actual results to differ materially from those contained in any forward looking statements. You are cautioned not to place undue reliance on any forward-looking statements. These statements represent our estimates and assumptions only as of the date of this Quarterly Report on Form 10-Q. Except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including:
Other risks and uncertainties include such factors, among others, pricing, the changing regulatory environment, the effect of our accounting policies, potential seasonality, industry trends, possible disruption in commercial activities occasioned by terrorist activity and armed conflict, and other risk factors detailed in this report and our other SEC filings. You should consider carefully the statements under "Item 1A. Risk Factors" in "Part II—Other Information" and other sections of this report, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the applicable cautionary statements.
TELANETIX, INC.
The accompanying notes are an integral part of these condensed consolidated financial statements.
TELANETIX, INC.
The accompanying notes are an integral part of these condensed consolidated financial statements.
TELANETIX, INC.
The accompanying notes are an integral part of these condensed consolidated financial statements.
TELANETIX, INC.
The accompanying notes are an integral part of these condensed consolidated financial statements.
TELANETIX, INC.
The accompanying unaudited financial statements, consisting of the condensed consolidated balance sheet as of June 30, 2009, the condensed consolidated statements of operations for the three and six months ended June 30, 2009 and 2008, and the condensed consolidated statements of cash flows for the six months ended June 30, 2009 and 2008, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q. Accordingly, these condensed consolidated financial statements do not include all of the information and footnotes typically found in the audited consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K. In the opinion of management, all adjustments (primarily consisting of normal recurring adjustments) considered necessary for a fair statement have been included.
The condensed consolidated balance sheet at December 31, 2008, has been derived from the audited consolidated financial statements as of that date but does not include all of the information and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. As of December 31, 2008, the Company’s independent registered auditors concluded that there was substantial doubt about the Company’s ability to continue as a going concern, and this condition remains as of June 30, 2009. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.
The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and equity and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include those related to the allowance for doubtful accounts; valuation of inventories; valuation of goodwill, intangible assets and property and equipment; valuation of stock based compensation expense; the valuation of warrants and conversion features; and other contingencies. On an on-going basis, the Company evaluates its estimates. The Company bases its estimates on historical experience and on various other assumptions that are believed 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. Actual results could differ from those estimates under different assumptions or conditions. Operating results for the three and six months ended June 30, 2009, are not necessarily indicative of the results that may be expected for the full fiscal year ending December 31, 2009.
The Company remains dependent on outside sources of funding until its results of operations provide positive cash flows. The Company’s previous independent registered auditors issued a going concern uncertainty in their report dated March 27, 2009, because there is substantial doubt about the Company’s ability to continue as a going concern.
During the years ended December 31, 2008 and 2007, the Company was unable to generate cash flows sufficient to support its operations and was dependent on debt and equity raised from qualified individual investors. The Company experienced negative financial results as follows:
These factors raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements contained herein do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence. The Company’s ability to continue as a going concern is dependent upon the Company’s ability to generate sufficient cash flows to meet its obligations on a timely basis, to obtain additional financing as may be required, and ultimately to attain profitable operations. However, there is no assurance that profitable operations or sufficient cash flows will occur in the future.
The Company has supported current operations by raising additional operating cash through the private sale of its preferred stock and convertible debentures. This has provided it with the cash flows to continue its business plan, but has not resulted in significant improvement in its financial position. The Company is considering alternatives to address its cash situation that include: (1) reducing cash operating expenses to levels that are in line with current revenues and (2) raising capital through additional sale of its common stock and/or debentures. The second alternative could result in substantial dilution of existing stockholders. There can be no assurance that the Company’s current financial position can be improved, that it can achieve positive cash flows from operations or that it can raise additional working capital.
The Company’s long-term viability as a going concern is dependent upon its ability to:
Certain previously reported amounts have been reclassified to conform to the current year’s presentation. The reclassifications had no impact on net loss or stockholders’ equity amounts previously reported.
2. Recent Accounting Pronouncements
3. Securities Exchange and Amendment Agreements
On June 30, 2008, the Company entered into a Securities Exchange Agreement with the investors in its previous debenture and preferred stock financings. Under this Securities Exchange Agreement the Company issued six-year, interest only debentures due June 30, 2014 in exchange for all of the outstanding debentures the Company issued in December 2006, August 2007 and March 2008 and shares of preferred stock the Company issued in August 2007. The debentures issued in this transaction amend and restate the terms of the debentures issued in December 2006, August 2007 and March 2008. The debentures issued in this transaction (an aggregate principal amount of $26.1 million) were exchanged for all of the then outstanding debentures held by the investors (an aggregate principal amount of $10.7 million), accrued interest on the outstanding debentures of $0.1 million, all of the then outstanding shares of preferred stock held by the investors (stated value of $14.9 million), and accrued dividends on such preferred stock of $0.4 million. In connection with this transaction, the exercise prices of the outstanding warrants issued in the previous debenture and preferred stock financings were reduced from $1.25 per share to $1.00 per share. The number of common shares underlying these warrants was not adjusted in connection with this change in exercise price. See Note 5 – Convertible Debentures, Note 6 – Warrants and Warrant Liabilities and Note 8 – Preferred Stock and Dividends.
Under the terms of the Amendment Agreement, the Company also agreed to add certain covenants to the PIPE Debentures, including a requirement to maintain at least $300,000 in cash at all times while the PIPE Debentures are outstanding, to sustain a level of gross revenue each quarter equal to at least 80% of the average gross revenue for the trailing two quarters, and commencing with the period ended June 30, 2009, to maintain a positive adjusted EBITDA in each rolling two quarter period. For example, ending September 30, 2009, the sum of the three-month adjusted EBITDA of the three months ended June 30 and September 30 must be at least $0.00 or greater. Adjusted EBITDA is calculated by taking the Company’s net income for the applicable period, and adding to that amount the sum of the following: (i) any provision for (or less any benefit from) income taxes, plus (ii) any deduction for interest expense, net of interest income, plus (iii) depreciation and amortization expense, plus (iv) non-cash expenses (such as stock-based compensation and warrant compensation), plus (v) expenses related to changes in fair market value of warrant and beneficial conversion features, plus (vi) expenses related to impairment of tangible and intangible assets.
In addition, under the terms of the Amendment Agreement, the holders of the PIPE Warrants were granted the right to exchange their outstanding PIPE Warrants for shares of the Company’s common stock at the rate of 1.063 shares of common stock underlying the PIPE Warrants for one share of common stock, subject to adjustment for stock splits and dividends. In exchange, the anti-dilution protection under the PIPE Warrants was eliminated. Previously the exercise price of the PIPE Warrants would decrease, and the number of shares issuable upon exercise would increase, generally, each time the Company issued common stock or common stock equivalents at a price less than the exercise price of the PIPE Warrants. The Amendment Agreement eliminates the potential for future dilution from the PIPE Warrants.
4. Fair Value Measurements
The Company adopted SFAS No. 157 as of January 1, 2008. SFAS No. 157 applies to certain assets and liabilities that are being measured and reported on a fair value basis. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosure about fair value measurements. SFAS No. 157 enables the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values. SFAS No. 157 requires that assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.
Level 3: Unobservable inputs that are not corroborated by market data.
The Company records liabilities related to its warrants (See Note 6 – Warrants and Warrant Liabilities) and the beneficial conversion feature of its convertible debentures (See Note 5 – Convertible Debentures) at their fair market values as provided by SFAS No. 157.
The following table provides fair market measurements of the warrant and beneficial conversion feature liabilities as of June 30, 2009:
The change in fair market value of the warrant and beneficial conversion feature liabilities is included in Other Income (Expense) in the Condensed Consolidated Statements of Operations.
The change in the fair market value of the beneficial conversion feature liability as a result of the decrease the conversion price of the PIPE Debentures from $0.40 to $0.30 per the Amendment Agreement (see Note 3 - Securities Exchange and Amendment Agreements) was recorded as additional debt discount of $4.0 million on May 8, 2009. In addition, as a result of the Amendment Agreement (see Note 3 - Securities Exchange and Amendment Agreements), the anti-dilution protection under the PIPE Warrants was removed, which eliminates the potential for future dilution from the PIPE Warrants. Accordingly, the PIPE Warrants are no longer a derivative liability and their value as of May 8, 2009, was reclassed to equity
The following table provides a reconciliation of the beginning and ending balances of the warrant and beneficial conversion feature liabilities as of June 30, 2009:
5. Convertible Debentures
As discussed in Note 3 – Securities Exchange and Amendment Agreements, pursuant to the terms of the Securities Exchange Agreement the Company entered into with certain investors on June 30, 2008, the Company exchanged the outstanding debentures it issued in December 2006, August 2007 and March 2008 for newly issued debentures, the terms of which are discussed below under the heading “June 2008.” Prior to entering into the Securities Exchange Agreement, the conversion prices on the December 2006, August 2007 and March 2008 debentures were reduced to $1.25 per share pursuant to the anti-dilution provisions of such debentures.
In August 2008, the Company issued $2.0 million principal amount of debentures, the terms of which are discussed below under the heading “August 2008.”
In December 2008, the Company issued $1.5 million principal amount of debentures and amended certain terms of the debentures issued in June 2008 and August 2008. See the discussion below under the heading “December 2008.”
In May 2009, the Company restructured the terms of its outstanding PIPE Debentures and all of the Company’s outstanding PIPE Warrants pursuant to the terms of the Amendment Agreement. See the discussion below under the heading “May 2009.”
As of June 30, 2009, the Company had reserved 98,831,000 shares of common stock for the conversion of the outstanding PIPE Debentures.
June 2008
On June 30, 2008, the Company entered into a Securities Exchange Agreement with the holders of all of the then outstanding debentures and shares of preferred stock of the Company, pursuant to which the Company issued six-year, interest only debentures due June 30, 2014 in exchange for all of the outstanding debentures the Company issued in December 2006, August 2007 and March 2008 and shares of preferred stock the Company issued in August 2007. See Note 3 – Securities Exchange Agreement. The debentures issued in this transaction amended and restated the terms of the previously outstanding debentures held by the investors.
In December 2008, the Company amended certain terms of the debentures issued in June 2008, the terms of which are discussed below under the heading “December 2008.” And, in May 2009, the Company restructured the terms of all of its outstanding debentures, the terms of which are discussed below under the heading “May 2009.”
The following summarizes the terms of the debentures issued in June 2008, as amended in December 2008 and May 2009:
Term. The debentures are due and payable on June 30, 2014.
Interest. When originally issued, interest accrued at the rate of 12.0% per annum and was payable monthly, commencing on August 1, 2008. In December 2008, the parties agreed to amend the interest payment provisions to eliminate monthly interest payments at the rate of 12% per annum. Following this amendment, interest was payable quarterly at the rate of (i) 0% per annum from October 1, 2008 until September 30, 2009, (ii) 13.5% per annum from October 1, 2009 until September 30, 2012 and (iii) 18% per annum from October 1, 2012 until maturity. In May 2009, the parties again agreed to amend the interest payment provisions to reduce the interest rate to 0% through June 30, 2011 and then to 5% per annum thereafter.
Principal Payment. The principal amount of the debenture, if not paid earlier, is due and payable on June 30, 2014.
Payments of Interest. Interest payments, as amended in May 2009, are due quarterly on January 1, April 1, July 1 and October 1, commencing on October 1, 2011. Interest payments are required to be paid in cash.
Early Redemption. The Company has the right to redeem the debentures before their maturity by payment in cash of the then outstanding principal amount plus (i) accrued but unpaid interest, (ii) an amount equal to all interest that would have accrued if the principal amount subject to such redemption had remained outstanding through the maturity date and (iii) all liquidated damages and other amounts due in respect of the debenture. To redeem the debentures the Company must meet certain equity conditions. The payment of the debentures would occur on the 10th day following the date the Company gave the holders notice of the Company's intent to redeem the debentures. The Company agreed to honor any notices of conversion received from a holder before the pay off date of the debentures.
Voluntary Conversion by Holder. When originally issued, the debentures were convertible at anytime at the discretion of the holder at a conversion price per share of $1.25, subject to adjustment including full-ratchet, anti-dilution protection. The conversion price was reduced to $0.40 with the December 2008 amendment and further reduced to $0.30 with the May 2009 amendment.
Forced Conversion. Subject to compliance with certain equity conditions, the Company also has the right to force conversion if the VWAP for its common stock exceeds 200% of the then effective conversion price for 20 trading days out of a consecutive 30 trading day period. Any forced conversion is subject the Company meeting certain equity conditions and is subject to a 4.99% cap on the beneficial ownership of the Company’s shares of common stock by the holder and its affiliates following such conversion.
Covenants. The debentures impose certain covenants on the Company, including restrictions against incurring additional indebtedness, creating any liens on the Company’s property, amending its certificate of incorporation or bylaws, redeeming or paying dividends on shares of its outstanding common stock, and entering into certain related party transactions. The debentures define certain events of default, including without limitation failure to make a payment obligation, failure to observe other covenants of the debenture or related agreements (subject to applicable cure periods), breach of representation or warranty, bankruptcy, default under another significant contract or credit obligation, delisting of the Company's common stock, a change in control, failure to be in compliance with Rule 144(c)(1) for more than 20 consecutive days, or more than an aggregate of 45 days in any 12 month period, or if any other conditions exist for such a period of time that the holder is unable to sell the shares issuable upon conversion of the debenture pursuant to Rule 144 without volume or manner of sale restrictions, or failure to deliver share certificates in a timely manner. In the event of default, the holders of the debentures have the right to accelerate all amounts outstanding under the debenture and demand payment of a mandatory default amount equal to 130% of the amount outstanding plus accrued interest and expenses. As of June 30, 2009, the Company is in compliance with the covenants described above.
Under the terms of the Amendment Agreement entered into in May 2009, the Company also agreed to additional financial performance covenants, including a requirement to maintain at least $300,000 in cash at all times while the PIPE Debentures are outstanding, to sustain a level of gross revenue each quarter equal to at least 80% of the average gross revenue for the trailing two quarters, and commencing with the period ended June 30, 2009, to maintain a positive adjusted EBITDA in each rolling two quarter period. For example, ending September 30, 2009, the sum of the three-month adjusted EBITDA of the three months ended June 30 and September 30 must be at least $0.00 or greater. Adjusted EBITDA is calculated by taking the Company’s net income for the applicable period, and adding to that amount the sum of the following: (i) any provision for (or less any benefit from) income taxes, plus (ii) any deduction for interest expense, net of interest income, plus (iii) depreciation and amortization expense, plus (iv) non-cash expenses (such as stock-based compensation and warrant compensation), plus (v) expenses related to changes in fair market value of warrant and beneficial conversion features, plus (vi) expenses related to impairment of tangible and intangible assets.
Security. The debentures the Company issued are secured by all of the Company's assets under the terms of the amended and restated security agreement the Company and its subsidiaries entered into with the holders of the June 2008 debentures, which amends and restates the security agreement the Company and the holders entered into in connection with the Company's August 2007 financing. Each of the Company's subsidiaries also entered into guarantees in favor of the investors, pursuant to which each subsidiary guaranteed the complete payment and performance by the Company of its obligations under the debentures and related agreements.
August 2008
On August 13, 2008, the Company entered into a debenture and warrant purchase agreement with one of the institutional investors that invested in the previous private placements. Under the terms of this purchase agreement, the Company issued a senior secured convertible debenture with a principal amount of $2.0 million, along with five year warrants to purchase 608,000 shares of common stock at a price of $1.00 per share, subject to adjustment, including full-ratchet anti-dilution protection. The rights and obligations of the investor and of the Company with respect to the debenture and the underlying common shares are identical to the debentures and underlying common shares issued pursuant to the Securities Exchange Agreement dated June 30, 2008, as amended. The rights and obligations of the investor and of the Company with respect to the warrant and the underlying common shares are identical to the warrants and underlying common shares issued pursuant to the Securities Purchase Agreement dated March 27, 2008 among the Company and the purchasers’ signatory thereto.
December 2008
On December 11, 2008, the Company entered into an amendment agreement with the holders of the debentures issued in June 2008 and August 2008, and the warrants the Company issued in December 2006, February 2007, March 2008 and August 2008. With respect to the debentures, the parties agreed to amend the interest rate and interest payment provisions, which had called for monthly interest payments at the rate of 12% per annum. As amended in December 2008, interest is payable quarterly at the rate of (i) 0% per annum from October 1, 2008 until September 30, 2009, (ii) 13.5% per annum from October 1, 2009 until September 30, 2012 and (iii) 18% per annum from October 1, 2012 until maturity. In May 2009, the parties again agreed to amend the interest payment provisions to reduce the interest rate to 0% through June 30, 2011 and then to 5% per annum thereafter.
On the same date, the Company entered into a debenture and warrant purchase agreement with an institutional investor and a holder of the Company's other outstanding debentures and warrants pursuant to which the Company issued a senior secured convertible debenture in the principal amount of $1.5 million, along with a warrant to purchase 456,000 shares of the Company's common stock with an exercise price of $0.40 per share. The terms of the debenture issued in December 2008 are substantially similar to the terms of the debentures issued in June 2008 and August 2008, as amended.
As a result of the issuance of the debenture and warrant in December 2008, the conversion price and exercise price, respectively, of the debentures issued in June 2008 and August 2008 and the warrants issued in December 2006, February 2007, March 2008 and August 2008 was reduced to $0.40. However, under the December 2008 amendment agreement, the parties agreed to waive the adjustment provision of such warrants that would have increased the number of shares subject to such warrants as a result of the issuance of the debentures and warrants in the December 2008 financing.
May 2009
In May 2009, the Company restructured the terms of its outstanding PIPE Debentures and all of the Company’s outstanding PIPE Warrants pursuant to the terms of the Amendment Agreement. The Amendment Agreement revised the terms of the PIPE Debentures to:
| | · | decrease the conversion price from $0.40 to $0.30; |
| | · | require that all future interest payments be made in cash; |
| | · | defer interest payments until October 1, 2011; |
| | · | reduce the interest rate to 0% through June 30, 2011 and then to 5% per annum thereafter; |
| | · | eliminate the requirement that, at the time of any conversion of principal, the Company pay the holders an amount in cash equal to the interest that would have accrued on such principal had such principal remained outstanding through the full term of the PIPE Debentures; and |
| | · | eliminate the 20% premium for voluntary prepayment. |
Under the terms of the Amendment Agreement, the Company also agreed to add certain covenants to the PIPE Debentures, including a requirement to maintain at least $300,000 in cash at all times while the PIPE Debentures are outstanding, to sustain a level of gross revenue each quarter equal to at least 80% of the average gross revenue for the trailing two quarters, and commencing with the period ended June 30, 2009, to maintain a positive adjusted EBITDA in each rolling two quarter period. For example, ending September 30, 2009, the sum of the three-month adjusted EBITDA of the three months ended June 30 and September 30 must be at least $0.00 or greater. Adjusted EBITDA is calculated by taking the Company’s net income for the applicable period, and adding to that amount the sum of the following: (i) any provision for (or less any benefit from) income taxes, plus (ii) any deduction for interest expense, net of interest income, plus (iii) depreciation and amortization expense, plus (iv) non-cash expenses (such as stock-based compensation and warrant compensation), plus (v) expenses related to changes in fair market value of warrant and beneficial conversion features, plus (vi) expenses related to impairment of tangible and intangible assets. As of June 30, 2009, the Company is in compliance with the covenants described above.
In addition, under the terms of the Amendment Agreement, the holders of the PIPE Warrants were granted the right to exchange their outstanding PIPE Warrants for shares of the Company’s common stock at the rate of 1.063 shares of common stock underlying the PIPE Warrants for one share of common stock, subject to adjustment for stock splits and dividends. In exchange, the anti-dilution protection under the PIPE Warrants was eliminated. Previously the exercise price of the PIPE Warrants would decrease, and the number of shares issuable upon exercise would increase, generally, each time the Company issued common stock or common stock equivalents at a price less than the exercise price of the PIPE Warrants. The Amendment Agreement eliminates the potential for future dilution from the PIPE Warrants.
General
The unamortized discounts on the debentures issued in December 2006, August 2007 and March 2008 were carried forward as discounts on the debentures issued in June 2008, and will be amortized to interest expense through June 30, 2014. The discounts on the debentures issued in August 2008 and December 2008 will be amortized to interest expense through June 30, 2014. The change in the fair market value of the beneficial conversion feature liability as a result of the decrease of the conversion price of the debentures from $0.40 to $0.30 per the Amendment Agreement was recorded as additional debt discount of $4.0 million on May 8, 2009. See Note 3 – Securities Exchange and Amendment Agreements.
The amendment agreement entered into in December 2008, provided for 0% interest until September, 30, 2009. The Amendment Agreement entered into in May 2009, provided for a further deferral of interest payments until October 1, 2011 and a reduction in the interest rate to 0% through June 30, 2011 and then to 5% per annum thereafter. However, the Company has recorded interest expense for the three and six months ended June 30, 2009, at the debt’s effective interest rate during those periods.
The following table summarizes information relative to the outstanding debentures at June 30, 2009 and December 31, 2008:
| | | June 30, 2009 | | | December 31, 2008 | |
| Convertible debentures | | $ | 29,649,300 | | | $ | 29,649,300 | |
| Less unamortized discounts: | | | | | | | | |
| Original issue discount | | | (4,656,559 | ) | | | (864,758 | ) |
| Detachable warrants discount | | | (2,334,440 | ) | | | (2,567,884 | ) |
| Beneficial conversion feature discount | | | (5,376,571 | ) | | | (5,914,228 | ) |
| Convertible debentures, net of discounts | | | 17,281,730 | | | | 20,302,430 | |
| Less current portion | | | — | | | | — | |
| Convertible debentures, long term portion | | $ | 17,281,730 | | | $ | 20,302,430 | |
The convertible debentures outstanding at June 30, 2009 are due June 30, 2014.
At each reporting period the Company assesses the convertible debentures under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”) and EITF No. 00-19, “Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in, a Company's Own Stock.” At June 30, 2009 and December 31, 2008, the Company determined that the beneficial conversion feature in the convertible debentures represented an embedded derivative liability. Accordingly, the Company bifurcated the embedded conversion feature and accounted for it as a derivative liability because the conversion price and ultimate number of shares can be adjusted if the Company subsequently issues common stock at a lower price and it was deemed possible the Company could have to net cash settle the contract if there were not enough authorized shares to issue upon conversion.
The convertible debentures contain embedded derivative features, which are accounted for at fair value as a compound embedded derivative at June 30, 2009 and December 31, 2008. This compound embedded derivative includes the following material features: (1) the standard conversion feature of the debentures; (2) a reset of the conversion price condition for subsequent equity sales; (3) the Company’s ability to pay interest in cash or shares of its common stock; (4) optional redemption at the Company’s election; (5) forced conversion; (6) holder’s restriction on conversion; and (7) a default put.
The Company, with the assistance of an independent valuation firm, calculated the fair value of the compound embedded derivative associated with the convertible debentures utilizing a complex, customized Monte Carlo simulation model suitable to value path dependant American options. The model uses the risk neutral methodology adapted to value corporate securities. This model utilized subjective and theoretical assumptions that can materially affect fair values from period to period.
At June 30, 2009 and December 31, 2008, the Company recorded beneficial conversion liabilities of $11.4 million and $4.8 million, respectively. The Company recognized other expense of $3.4 million and $2.7 million for the three and six months ended June 30, 2009, respectively and recognized other income of $2.1 million, for both the three and six months ended June 30, 2008, related to the change in fair market value of the beneficial conversion liabilities.
6. Warrants and Warrant Liabilities
In connection with its various financings through June 30, 2008, the Company issued warrants to purchase shares of common stock in conjunction with the sale of its debentures. Prior to the Securities Exchange Agreement executed on June 30, 2008, the exercise prices of the warrants were reduced to $1.25 per share, resulting in an increase in the number of aggregate shares of common stock underlying the warrants to 11,205,809. On June 30, 2008 in connection with the Securities Exchange Agreement, the exercise prices of the warrants discussed above were further reduced to $1.00 per share. The number of shares of common stock underlying the warrants remained at 11,205,809. The Company recorded $0.2 million of deferred financing costs related to the change in exercise price discussed above. See Note 3 – Securities Exchange and Amendment Agreements.
On August 13, 2008, the Company issued warrants to purchase 608,000 shares of common stock at $1.00 per share in conjunction with the sale of its debentures. The warrant is immediately exercisable and expires five years from the date of issuance.
On December 11, 2008, the Company issued warrants to purchase 456,000 shares of common stock at $0.40 per share in conjunction with the sale of its debentures. In addition, the exercise price of all previously issued warrants was reduced to $0.40. However, under the terms of the December 11, 2008 amendment, the parties agreed to waive the adjustment provision of the PIPE Warrants that would have increased the number of shares subject to the PIPE Warrants as a result of the issuance of the debentures and warrants in the December 2008 financing. Pursuant to SFAS No. 133 and EITF No. 00-19, the fair value of the warrants at the issuance was recorded as a warrant liability because the exercise price of the warrants can adjust if the Company subsequently issues common stock at a lower price and it is possible for the Company to not have enough authorized shares to settle the warrants and therefore would have to settle the warrants with cash.
In addition, the Company issued an additional 425,909 warrants to various entities as compensation for services provided to the Company during 2007 and 2008.
In May 2009, under the terms of the Amendment Agreement, the holders of the PIPE Warrants were granted the right to exchange their outstanding PIPE Warrants for shares of the Company’s common stock at the rate of 1.063 shares of common stock underlying the PIPE Warrants for one share of common stock, subject to adjustment for stock splits and dividends. In exchange, the anti-dilution protection under the PIPE Warrants was eliminated. Previously the exercise price of the PIPE Warrants would decrease, and the number of shares issuable upon exercise would increase, generally, each time the Company issued common stock or common stock equivalents at a price less than the exercise price of the PIPE Warrants. The Amendment Agreement eliminates the potential for future dilution from the PIPE Warrants. Accordingly, the warrants are no longer a derivative liability and their value as of May 8, 2009, was reclassed to equity.
The fair value of the warrants was estimated at their various issuance dates and revalued at May 8, 2009, using the Monte Carlo model discussed in Note 5 – Convertible Debentures, above. As a result of the reclass of the warrants to equity on May 8, 2009, the Company recorded no warrant liabilities at June 30, 2009. At December 31, 2008, the Company recorded warrant liabilities of $0.6 million. For the three and six months ended June 30, 2009, the Company recognized other expense of $1.1 million and $1.0 million, respectively, related to the change in fair market value of the warrants. For the three months and six months ended June 30, 2008, the Company recognized other income of $8.8 million and $6.7 million, respectively, related to the change in fair market value of the warrants.
There were 12,695,718 shares subject to warrants at a weighted average exercise price of $0.45 at June 30, 2009 and December 31, 2008.
The following table summarizes information about warrants outstanding at June 30, 2009:
| Exercise Prices | | Number of Shares Subject to Outstanding Warrants and Exercisable | | Weighted Average Remaining Contractual Life (years) |
| $ | 0.40 | | 12,269,809 | | 3.33 |
| $ | 1.25 | | 105,000 | | 4.17 |
| $ | 1.73 | | 200,000 | | 3.99 |
| $ | 1.92 | | 78,125 | | 3.99 |
| $ | 3.52 | | 12,784 | | 1.36 |
| $ | 4.00 | | 30,000 | | 3.88 |
| | | | 12,695,718 | | |
As of June 30, 2009, the Company had reserved 12,695,718 shares of common stock for the exercise of the outstanding warrants.
7. Commitments and Contingencies
Leases
The Company has non-cancelable operating and capital leases for corporate facilities and equipment.
Minimum Third Party Network Service Provider Commitments
The Company has a contract with a third party network service provider that facilitates interconnects with a number of third party network service providers. The contract contains a minimum usage guarantee of $0.2 million per monthly billing cycle. The contract commenced on October 16, 2003 with an initial 24 month term. The contract was extended in July 2005 for a 3 year term that expired in July 2008. On October 24, 2008, the contract was extended for another 3 year term. The cancellation terms are a 90 day written notice prior to the extended term expiring.
Litigation
From time to time, the Company may be involved in litigation relating to claims arising out of its operations in the normal course of business, including claims of alleged infringement, misuse or misappropriation of intellectual property rights of third parties. As of the date of this report, the Company is not a party to any litigation which it believes would have a material adverse effect on the Company’s business operations or financial condition.
Communications Assistance for Law Enforcement Act
On August 5, 2005, the Federal Communications Commission, or FCC, unanimously adopted an order requiring VoIP providers to comply with the Communications Assistance for Law Enforcement Act, or CALEA. CALEA requires covered providers to assist law enforcement agencies in conducting lawfully authorized electronic surveillance. Under the FCC order, all VoIP providers were to become fully CALEA compliant by May 14, 2007. The Company engaged a third party to help it develop a solution to be CALEA compliant. In February 2007, the Company notified the FCC that it did not expect to have a CALEA compliant solution completed by May 14, 2007, but that it instead expected to have the development complete by September 1, 2007. The Company’s formal CALEA compliance testing with the third party was completed on September 28, 2007. Currently, the Company’s CALEA solution is fully deployed in its network. However, the Company could be subject to an enforcement action by the FCC or law enforcement agencies for any delays related to meeting, or if the Company fails to comply with, any current or future CALEA obligations.
Universal Service Fund
In June 2006, the FCC concluded that VoIP providers must contribute to the Universal Service Fund, or USF. The FCC established a contribution safe harbor percentage of 64.9% of total VoIP service revenue. Alternatively, VoIP providers are permitted to calculate their contribution based on FCC pre-approved traffic studies. The Company began contributing to the USF on October 1, 2006 using the 64.9% safe harbor. In the meantime, the FCC continues to evaluate alternative methods for assessing USF charges, including imposing an assessment on telephone numbers. The outcome of these proceedings cannot be determined at this time nor can the Company determine the potential financial impact as the details of an alternative method of USF contribution have not been determined at this time. There is also a risk that state USF funds may attempt to impose state USF contribution obligations and other state and local charges.
Sales and additional taxes
Based upon a new Internal Revenue Service ruling, the Company ceased collecting federal excise tax on August 1, 2006 on long-distance or bundled services. The Company has not collected or accrued liabilities for E911 taxes for VoIP services prior to July 1, 2006, and it is possible that substantial claims for back taxes may be asserted against the Company. Also, the Company is currently working to obtain Inter Exchange Carrier (IXC) certification in Alaska, Maryland and Mississippi. The Company’s current certification status in these three states may leave it liable for fees and penalties that could decrease its ability to compete with traditional telephone companies. In addition, future expansion of the Company’s service, along with other aspects of its evolving business, may result in additional sales and other tax obligations. One or more taxing authorities may seek to impose sales, use or other tax collection obligations on the Company. The Company has received inquiries or demands from numerous state authorities and may be subjected to audit at any time. A successful assertion by one or more taxing authorities that the Company should collect sales, use or other taxes on the sale of its services could result in substantial tax liabilities for past sales.
Other
In connection with its acquisition of AccessLine, the Company was required to pay up to an additional $9.0 million in the form of 2,500,000 shares of the Company’s restricted common stock upon the achievement of certain future financial objectives, the value of which would increase the amount of goodwill recorded in the transaction. The first earn out period ended December 31, 2007. In April 2008, when the contingency related to the first earn out period was resolved, the Company issued 599,130 shares valued at $0.6 million, resulting in increases to goodwill and equity. The second earn out period ended June 30, 2008, and the Company issued 529,252 shares valued at $0.3 million in July 2008 when the contingency was resolved. The increase in goodwill and equity were recorded in the third fiscal quarter of 2008. The third earn out period ended December 31, 2008, and the Company issued 515,622 shares valued at $0.04 million in February 2009. The increase in goodwill and equity was recorded in the first quarter of fiscal 2009. The final earn out period ended on June 30, 2009 and the Company issued 401,658 shares valued at $0.04 million in July 2009. The increase in goodwill and equity will be recorded in the third quarter of fiscal 2009.
On April 18, 2007, the FCC released a Notice of Proposed Rulemaking tentatively concluding that VoIP providers should pay regulatory fees. According to the notice, the FCC would like to begin collection of such fees in the August to September 2007 timeframe. The FCC is considering calculating contribution obligations for VoIP providers based on either revenues or telephone numbers used. The Company cannot predict the outcome of this proceeding. On June 8, 2007, the FCC released an order implementing various recommendations from its Independent Panel Reviewing the Impact of Hurricane Katrina on Communications Networks Panel, including a requirement that certain VoIP providers submit reports regarding the reliability and resiliency of their 911 systems. At this time, the Company is not subject to these reporting requirements but may become subject in future years.
On June 8, 2007, the FCC released an order implementing various recommendations from its Independent Panel Reviewing the Impact of Hurricane Katrina on Communications Networks Panel, including a requirement that certain VoIP providers submit reports regarding the reliability and resiliency of their 911 systems. At this time, the Company is not subject to these reporting requirements but may become subject in future years.
On June 15, 2007, the FCC extended the disability access requirements of Sections 225 and 255 of the Communications Act, which applied to traditional phone services, to providers of VoIP services and to manufacturers of specially designed equipment used to provide those services. Section 255 of the Communications Act requires service providers to ensure that its equipment and service is accessible to and usable by individuals with disabilities, if readily achievable, including requiring service providers to ensure that information and documentation provided in connection with equipment or services be accessible to people with disabilities, where readily achievable and that employee training account for accessibility requirements. In addition, the FCC said that VoIP providers were subject to the requirements of Section 225, including contributing to the Telecommunications Relay Services, or TRS, fund and that they must offer 711 abbreviated dialing for access to relay services. Although the Company contributes to the TRS fund as required, it has not yet implemented a solution for the 711 abbreviated dialing requirement. The Company may be subject to enforcement actions including, but not limited to, fines, cease and desist orders, or other penalties if it does not comply with these obligations.
In the latter half of 2007, the FCC released two Report and Orders that increase the costs of doing business. One of them, released on August 6, 2007, concerns the collection of regulatory fees for fiscal year 2007, which, for the first time, mandates the collection of such fees from VoIP providers. This order, which became effective in November 2007, requires that VoIP providers pay regulatory fees based on reported interstate and international revenues. Regulatory fees for the FCC's fiscal year 2007 were due in 2008. Fiscal year 2008 fees were paid in 2008 during the normal regulatory fee payment window. The assessment of regulatory fees on the Company’s VoIP service offering will increase its costs and reduce its profitability or cause the Company to increase the retail price of its VoIP service offerings.
The other order, released on November 8, 2007, imposes local number portability and related obligations on VoIP providers, such as requiring VoIP providers to contribute to shared numbering administration costs on a competitively neutral basis. The assessment of local number portability fees to the Company’s VoIP service will increase its costs and reduce its profitability or cause the Company to increase the price of its VoIP service offerings.
8. Preferred Stock and Dividends
Pursuant to terms of the Company’s Series A preferred stock (the “Series A Stock”), effective April 1, 2008, the stated value of such stock increased by 15%, or $2.0 million, because the Company’s common stock was not listed on an exchange other than the OTC Bulletin Board by June 30, 2008. The Company recorded dividends of $0.6 million and $3.2 million during the three and six months ended June 30, 2008, respectively, related to the increase in stated value of the Series A Stock.
Pursuant to the Securities Exchange Agreement the Company entered into on June 30, 2008, all shares of the Series A Stock, which had a stated value of $14.9 million, and accrued dividends of $0.4 million were converted into the debentures issued on June 30, 2008. See Note 3 – Securities Exchange and Amendment Agreements. As of June 30, 2009, the Company has no shares of preferred stock issued or outstanding.
9. Computation of Net Loss Per Share
Net loss per share is calculated in accordance with the SFAS No. 128, “Earnings Per Share.” Basic net loss per share is based upon the weighted average number of shares of common stock outstanding. Diluted net loss per share is based on the assumption that all potential common stock equivalents (convertible preferred stock, convertible debentures, stock options, and warrants) are converted or exercised. The calculation of diluted net loss per share excludes potential common stock equivalents if the effect is anti-dilutive. The Company's weighted average shares of common stock outstanding for basic and dilutive are the same because the effect of the potential common stock equivalents is anti-dilutive, except for the three months ended June 30, 2008 when dilutive common stock equivalents of 821,053 are included.
The Company has the following dilutive common stock equivalents which were excluded from the net loss per share calculation because their effect is anti-dilutive for the three and six months ended June 30, 2009 and for the six months ended June 30, 2008:
| | June 30, |
| | 2009 | | 2008 |
| Convertible Debentures | 98,831,000 | | 20,912,285 |
| Stock Options | 9,922,543 | | 5,053,627 |
| Warrants | 12,695,718 | | 11,631,718 |
| Total | 121,449,261 | | 37,597,630 |
10. Business Segment Information
Telanetix is an IP communications company, offering a range of communications solutions from hosted IP voice and conferencing products, to text and data collaboration, to telepresence videoconferencing products. The Company’s offerings are organized along two product categories: Voice and Network Solutions and Video Solutions, which are considered segments for reporting purposes. The segments are determined in accordance with how management views and evaluates the Company’s business and based on the criteria as outlined in SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.”.
The Voice and Network Solutions segment includes the Company’s VoIP communications offerings which include a variety of voice and messaging solutions services. The Video Solutions segment includes the Company’s telepresence solutions and other supporting audio-visual applications.
Financial information for each reportable segment is as follows as of the three months ended June 30, 2009 and 2008:
| | | Voice and Network Solutions | | Video Solutions | | Total |
| 2009 | | | | | | | | | | | | |
| Revenues | | $ | 6,904,963 | | | $ | 687,346 | | | $ | 7,592,309 | |
| Gross profit | | $ | 4,190,867 | | | $ | 65,438 | | | $ | 4,256,305 | |
| Gross profit % | | | 60.7% | | | | 9.5% | | | | 56.1% | |
| Operating loss | | $ | (555,932) | | | $ | (991,834) | | | $ | (1,547,766) | |
| | | | | | | | | | | | | |
| Total assets | | $ | 29,530,751 | | | $ | 3,383,831 | | | $ | 32,914,582 | |
| | | | | | | | | | | | | |
| 2008 | | | | | | | | | | | | |
| Revenues | | $ | 6,352,520 | | | $ | 1,646,015 | | | $ | 7,998,535 | |
| Gross profit | | $ | 3,412,356 | | | $ | 308,827 | | | $ | 3,721,183 | |
| Gross profit % | | | 53.7% | | | | 18.8% | | | | 46.5% | |
| Operating loss | | $ | (1,155,723) | | | $ | (3,643,633) | | | $ | (4,799,356) | |
| | | | | | | | | | | | | |
| Total assets | | $ | 33,872,410 | | | $ | 5,098,077 | | | $ | 38,970,487 | |
Financial information for each reportable segment is as follows as of the six months ended June 30, 2009 and 2008:
| | | Voice and Network Solutions | | Video Solutions | | Total |
| 2009 | | | | | | | | | | | | |
| Revenues | | $ | 13,929,155 | | | $ | 2,222,718 | | | $ | 16,151,873 | |
| Gross profit | | $ | 8,088,288 | | | $ | 459,988 | | | $ | 8,548,276 | |
| Gross profit % | | | 58.1% | | | | 20.7% | | | | 52.9% | |
| Operating loss | | $ | (1,399,014) | | | $ | (1,872,834) | | | $ | (3,271,848) | |
| | | | | | | | | | | | | |
| Total assets | | $ | 29,530,751 | | | $ | 3,383,831 | | | $ | 32,914,582 | |
| | | | | | | | | | | | | |
| 2008 | | | | | | | | | | | | |
| Revenues | | $ | 12,601,378 | | | $ | 3,053,918 | | | $ | 15,655,296 | |
| Gross profit | | $ | 6,706,778 | | | $ | 428,167 | | | $ | 7,134,945 | |
| Gross profit % | | | 53.2% | | | | 14.0% | | | | 45.6% | |
| Operating loss | | $ | (2,276,332) | | | $ | (5,666,628) | | | $ | (7,942,960) | |
| | | | | | | | | | | | | |
| Total assets | | $ | 33,872,410 | | | $ | 5,098,077 | | | $ | 38,970,487 | |
Segment revenues consist of sales to external customers in the United States. Segment gross margin includes all segment revenues less the related cost of sales. Margin is used, in part, to evaluate the performance of, and allocate resources to, each of the segments.
For the three months ended June 30, 2009, one customer accounted for 12% of the Company’s Voice and Network Solutions segment net revenues and three customers accounted for 45% of its Video Solutions segment net revenues. For the three months ended June 30, 2008, one customer accounted for 15% of the Voice and Network Solutions segment net revenues and one customer accounted for 12% of the Video Solutions segment net revenues.
For the six months ended June 30, 2009, one customer accounted for 12% of the Company’s Voice and Network Solutions segment net revenues and two customers accounted for 41% of its Video Solutions segment net revenues. For the three months ended June 30, 2008, one customer accounted for 15% of the Voice and Network Solutions segment net revenues and no one customer accounted for more than 10% of the Video Solutions segment net revenues.
At June 30, 2009, no one customer accounted for more than 10% of gross accounts receivable in the Voice and Network Solutions segment and three customers accounted for 39% of gross accounts receivable in the Video Solutions segment. At June 30, 2008, one customer accounted for 17% of gross accounts receivable in the Voice and Network Solutions segment and one customer accounted for 11% of gross accounts receivable in the Video Solutions segment.
The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes and other financial information appearing elsewhere in this report. Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation, the disclosures made under "Item 1A. Risk Factors" included in Part II of this report and in our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2008, previously filed with the SEC.
Overview
Business
We are an IP communications company, offering a range of communications solutions from hosted IP voice and conferencing products, to text and data collaboration, to telepresence videoconferencing products.
Our subsidiary, AccessLine, Inc., provides customers with a range of business phone services and applications. At the core of AccessLine's business phone services are their software components, all of which are developed internally and loaded on standard commercial grade servers. AccessLine's phone service can be delivered with a variety of hosted features configured to meet the application needs of the customer. By delivering business phone service to the market in this manner, AccessLine offers flexibility to customers and can serve a variety of business sizes.
AccessLine offers two business dialtone products: SmartVoice TM and Digital Phone Service. SmartVoice TM replaces a customer's existing telephone lines with a VoIP alternative, but allows the customer to keep using its current phone equipment. This product is targeted at the mid-size business market. The customer has the ability to select the number of office locations, number of phone lines and types of phone numbers. Digital Phone Service is a combined package of a digital phone system and accompanying service, geared for small companies with 20 or fewer employees at a single location. The customer selects how many phone lines and how many stations, and selects optional features such as Automated Attendant, conference calling or fax numbers. AccessLine then preconfigures the phone system to the customer’s specifications, and ships it directly to the customer.
In addition, AccessLine offers a host of other phone services, including, conferencing calling services, toll-free service plans, a virtual phone system with after hours answering service that routes calls based on specific business needs, find-me and follow-me services, a full featured voice mail system that instantly contacts a customer via an email or cell phone text message the moment such customer receives a new voice mail or fax, and the ability to manage faxes from virtually anywhere.
Through our Digital Presence TM product line we provide our customers with a complete system for telepresence video conferencing. The core of our system is our software components—video and audio encoder and decoders, call signaling and bandwidth management—all of which are developed internally and pre-loaded on a standard Linux server. Our telepresence solutions are based on next generation IP standards. A Digital Presence TM system also includes the monitors, cameras and audio components to optimize the user experience, as well as the equipment necessary to enable a "hotspot" in the conference room for the wireless operation of the system controls and data-sharing. Our Digital Presence TM systems can be matched with a wide range of off-the-shelf monitors, cameras and audio components to meet certain room configuration or performance requirements. Our channel partners and our subsidiary, AVS, act as the system integrators to design, build-out and install the complete telepresence system including components and peripheral equipment to meet the application needs of the customer. By delivering Digital Presence™ to the market in this manner, we offer flexibility to customers and can support conference rooms for both small and large audiences.
History
We were a development stage company through 2005 working on our Digital PresenceTM product line. We completed the development of our initial telepresence solution and commenced sales of that product in 2005. In 2006 we focused our business efforts on developing our channel partner relationships and we secured our first significant telepresence customer accounts. In April 2007, we acquired AVS, which at the time was one of our channel partners who distributed our telepresence systems and related solutions in New York, New Jersey and nearby regions of the United States. With this acquisition, we expanded our business to provide integration, consultation and implementation solutions for customers desiring telepresence and audio-visual systems and products. We entered the VOIP voice and network services market in September 2007, with our acquisition of AccessLine, Inc.
Recent Financings
June 2008 Financing
On June 30, 2008, we entered into a securities exchange agreement with the investors in our previous debenture and preferred stock financings and issued six-year, interest only debentures due June 30, 2014 in exchange for all of the then outstanding debentures we issued in December 2006, August 2007 and March 2008 and shares of our preferred stock we issued in August 2007. The debentures issued in June 2008 amend and restate the terms of the debentures we issued December 2006, August 2007 and March 2008. The debentures issued in this transaction (an aggregate principal amount of $26.1 million) were exchanged for all of the then outstanding debentures held by the investors (an aggregate principal amount of $10.7 million), accrued interest on the outstanding debentures of $0.1 million, all of the then outstanding shares of preferred stock held by the investors (stated value of $14.9 million), and accrued dividends on such preferred stock of $0.4 million. In connection with this transaction, the exercise prices of the outstanding warrants issued in the previous debenture and preferred stock financings were reduced from $1.25 per share to $1.00, which was subsequently reduced to $0.40 per share in connection with our December 2008 financing, discussed below. The number of common shares underlying these warrants was not adjusted in connection with this change in exercise price.
In December 2008, we amended certain terms of the debentures issued in June 2008 which are discussed below under the heading “December 2008 Amendment of Outstanding Debentures and Warrants.” And, in May 2009, we further restructured the terms of our outstanding debentures issued in June 2008, August 2008 and December 2008 (collectively, the "PIPE Debentures") and all of our outstanding warrants issued in December 2006, February 2007, August 2007, March 2008, August 2008 and December 2008 (the "PIPE Warrants"). See “May 2009 Amendment of Outstanding Debentures and Warrants,” below.
The following summarizes the terms of the debentures issued in June 2008, as amended in December 2008 and May 2009:
Term. The debentures are due and payable on June 30, 2014.
Interest. When originally issued, interest accrued at the rate of 12.0% per annum and was payable monthly, commencing on August 1, 2008. In December 2008, the parties agreed to amend the interest payment provisions to eliminate monthly interest payments at the rate of 12% per annum. Following this amendment, interest was payable quarterly at the rate of (i) 0% per annum from October 1, 2008 until September 30, 2009, (ii) 13.5% per annum from October 1, 2009 until September 30, 2012 and (iii) 18% per annum from October 1, 2012 until maturity. In May 2009, the parties again agreed to amend the interest payment provisions to reduce the interest rate to 0% through June 30, 2011 and then to 5% per annum thereafter.
Principal Payment. The principal amount of the debenture, if not paid earlier, is due and payable on June 30, 2014.
Payments of Interest. Interest payments, as amended in May 2009, are due quarterly on January 1, April 1, July 1 and October 1, commencing on October 1, 2011. Interest payments are required to be paid in cash.
Early Redemption. We have the right to redeem the debentures before their maturity by payment in cash of the then outstanding principal amount plus (i) accrued but unpaid interest, (ii) an amount equal to all interest that would have accrued if the principal amount subject to such redemption had remained outstanding through the maturity date and (iv) all liquidated damages and other amounts due in respect of the debenture. To redeem the debentures we must meet certain equity conditions. The payment of the debentures would occur on the 10th day following the date we gave the holders notice of our intent to redeem the debentures. We agreed to honor any notices of conversion received from a holder before the pay off date of the debentures.
Voluntary Conversion by Holder. When originally issued, the debentures were convertible at anytime at the discretion of the holder at a conversion price per share of $1.25, subject to adjustment including full-ratchet, anti-dilution protection. The conversion price was reduced to $0.40 with the December 2008 amendment and further reduced to $0.30 with the May 2009 amendment.
Forced Conversion. Subject to compliance with certain equity conditions, we also have the right to force conversion if the VWAP for its common stock exceeds 200% of the then effective conversion price for 20 trading days out of a consecutive 30 trading day period. Any forced conversion is subject to our meeting certain equity conditions and is subject to a 4.99% cap on the beneficial ownership of our common stock by the holder and its affiliates following such conversion, which cap may increase to 9.99% by the holder upon not less than 61 days notice.
Covenants. The debentures impose certain covenants on us, including restrictions against incurring additional indebtedness, creating any liens on our property, amending our certificate of incorporation or bylaws, redeeming or paying dividends on shares of our outstanding common stock, and entering into certain related party transactions. The debentures define certain events of default, including without limitation failure to make a payment obligation, failure to observe other covenants of the debenture or related agreements (subject to applicable cure periods), breach of representation or warranty, bankruptcy, default under another significant contract or credit obligation, delisting of our common stock, a change in control, failure to be in compliance with Rule 144(c)(1) for more than 20 consecutive days, or more than an aggregate of 45 days in any 12 month period, or if any other conditions exist for such a period of time that the holder is unable to sell the shares issuable upon conversion of the debenture pursuant to Rule 144 without volume or manner of sale restrictions, or failure to deliver share certificates in a timely manner. In the event of default, the holders of the debentures have the right to accelerate all amounts outstanding under the debenture and demand payment of a mandatory default amount equal to 130% of the amount outstanding plus accrued interest and expenses.
Under the terms of the Amendment Agreement entered into in May 2009, we also agreed to additional financial performance covenants, including a requirement to maintain at least $300,000 in cash at all times while the PIPE Debentures are outstanding, to sustain a level of gross revenue each quarter equal to at least 80% of the average gross revenue for the trailing two quarters, and commencing with the period ended June 30, 2009, to maintain a positive adjusted EBITDA in each rolling two quarter period. For example, ending September 30, 2009, the sum of the three-month adjusted EBITDA of the three months ended June 30 and September 30 must be at least $0.00 or greater. Adjusted EBITDA is calculated by taking the Company’s net income for the applicable period, and adding to that amount the sum of the following: (i) any provision for (or less any benefit from) income taxes, plus (ii) any deduction for interest expense, net of interest income, plus (iii) depreciation and amortization expense, plus (iv) non-cash expenses (such as stock-based compensation and warrant compensation), plus (v) expenses related to changes in fair market value of warrant and beneficial conversion features, plus (vi) expenses related to impairment of tangible and intangible assets.
Security. The debentures we issued are secured by all of our assets under the terms of the amended and restated security agreement we and our subsidiaries entered into with the holders of the June 2008 debentures, which amends and restates the security agreement we and the holders entered into in connection with our August 2007 financing. Each of our subsidiaries also entered into guarantees in favor of the Investors, pursuant to which each subsidiary guaranteed the complete payment and performance by us of our obligations under the debentures and related agreements.
August 2008 Financing
On August 13, 2008, we entered into a debenture and warrant purchase agreement with one of the institutional investors that invested in the previous private placements. Under the terms of this purchase agreement we issued a senior secured convertible debenture in the principal amount of $2.0 million, along with a five year warrant to purchase 608,000 shares of our common stock at an exercise price of $1.00 per share, subject to adjustment, including full-ratchet anti-dilution protection. The terms of the debentures we issued in this financing were also amended by the terms of the amendment agreement we entered into in December 2008 and were further amended by the terms of the amendment agreement we entered into in May 2009. See "December 2008 Amendment of Outstanding Debentures and Warrants," and "May 2009 Amendment of Outstanding Debentures and Warrants," below. Our rights and obligations, as well as those of the investor, with respect to the debenture we issued in this financing are identical to the rights and obligations of the debentures we issued in June 2008, as amended.
December 2008 Financing
On December 11, 2008, we entered into a debenture and warrant purchase agreement with an institutional investor and a holder of the debentures we issued in June 2008 and August 2008. Under the terms of this purchase agreement we issued a senior secured convertible debenture in the principal amount of $1.5 million, along with a warrant to purchase 456,000 shares of our common stock with an exercise price of $0.40 per share. This financing transaction resulted in net proceeds to us of $1.5 million. We may refer to this financing as our December 2008 financing in this report.
The terms of the debenture we issued in December 2008 are substantially similar to the terms of the debentures we issued in June 2008, as amended.
December 2008 Amendment of Outstanding Debentures and Warrants
In connection with our December 2008 financing, we entered into an amendment agreement with the holders of the debentures we issued in June 2008 and August 2008, and the warrants we issued in December 2006, February 2007, March 2008 and August 2008. With respect to the debentures, the parties agreed to amend the interest rate and interest payment provisions, which had called for monthly interest payments at the rate of 12% per annum. As amended in December 2008, interest is payable quarterly at the rate of (i) 0% per annum from October 1, 2008 until September 30, 2009, (ii) 13.5% per annum from October 1, 2009 until September 30, 2012 and (iii) 18% per annum from October 1, 2012 until maturity. In May 2009, the parties further agreed to amend the interest payment provisions to reduce the interest rate to 0% through June 30, 2011 and then to 5% per annum thereafter.
As a result of the issuance of the debenture and warrant in the December 2008 financing discussed above, the conversion price and exercise price, respectively, of the debentures issued in June 2008 and August 2008 and the warrants issued in December 2006, February 2007, March 2008 and August 2008 was reduced to $0.40. However, under the amendment agreement, the parties agreed to waive the adjustment provision of such warrants that would have increased the number of shares subject to such warrants as a result of the issuance of the debentures and warrants in the December 2008 financing.
May 2009 Amendment of Outstanding Debentures and Warrants
In May 2009, we restructured the terms of our PIPE Debentures and all of PIPE Warrants pursuant to the terms of an Amendment Agreement dated May 8, 2009 entered into between the Company and the holders of the outstanding PIPE Debentures and PIPE Warrants (the "Amendment Agreement"). The Amendment Agreement revised the terms of the PIPE Debentures to:
| | · | decrease the conversion price from $0.40 to $0.30; |
| | · | require that all future interest payments be made in cash; |
| | · | defer interest payments until October 1, 2011; |
| | · | reduce the interest rate to 0% through June 30, 2011 and then to 5% per annum thereafter; |
| | · | eliminate the requirement that, at the time of any conversion of principal, we pay the holders an amount in cash equal to the interest that would have accrued on such principal had such principal remained outstanding through the full term of the PIPE Debentures; and |
| | · | eliminate the 20% premium for voluntary prepayment. |
Under the terms of the Amendment Agreement, we also agreed to add certain covenants to the PIPE Debentures, including a requirement to maintain at least $300,000 in cash at all times while the PIPE Debentures are outstanding, to sustain a level of gross revenue each quarter equal to at least 80% of the average gross revenue for the trailing two quarters, and commencing with the period ended June 30, 2009, to maintain a positive adjusted EBITDA in each rolling two quarter period. For example, ending September 30, 2009, the sum of the three-month adjusted EBITDA of the three months ended June 30 and September 30 must be at least $0.00 or greater. Adjusted EBITDA is calculated by taking the our net income for the applicable period, and adding to that amount the sum of the following: (i) any provision for (or less any benefit from) income taxes, plus (ii) any deduction for interest expense, net of interest income, plus (iii) depreciation and amortization expense, plus (iv) non-cash expenses (such as stock-based compensation and warrant compensation), plus (v) expenses related to changes in fair market value of warrant and beneficial conversion features, plus (vi) expenses related to impairment of tangible and intangible assets.
In addition, under the terms of the Amendment Agreement, the holders of the PIPE Warrants were granted the right to exchange their outstanding PIPE Warrants for shares of our common stock at the rate of 1.063 shares of common stock underlying the PIPE Warrants for one share of common stock, subject to adjustment for stock splits and dividends. In exchange, the anti-dilution protection under the PIPE Warrants was eliminated. Previously the exercise price of the PIPE Warrants would decrease, and the number of shares issuable upon exercise would increase, generally, each time we issued common stock or common stock equivalents at a price less than the exercise price of the PIPE Warrants. The Amendment Agreement eliminates the potential for future dilution from the PIPE Warrants.
Outlook
Our overriding objective in 2009 has been, and remains, to grow revenue while achieving operating profitability and generating cash from operations. We have reduced operating expenses, in part, through reducing our staffing levels.
We experienced growth in revenue and gross margin for our Voice and Network Solutions segment in 2008 and during the six months ended June 30, 2009. We increased revenue during the six months ended June 30, 2009 through, in part, spending more per quarter in advertising than we spent in the fourth quarter of 2008. Our Digital Phone Service continues to grow rapidly month over month. We increased gross margin through our continued progress in optimizing our network configuration.
Our Video Solutions segment experienced growth in 2008, but has been severely impacted by the down economy during the six months ended June 30, 2009, resulting in a substantial decline in revenue. It is unclear when, if ever, our Video Solutions segment will generate consistent growth in revenue and gross margins. As a result, due to our commitment to grow profitability and to avoid seeking additional capital, we believe that it is in the best interest of our shareholders to evaluate strategic alternatives to maximize shareholder value in this segment. We are currently exploring such strategic alternatives.
If we can continue to generate Voice and Network Solution revenue and gross margin improvements consistent with our growth in 2008 and during the six months ended June 30, 2009, moderate the effect of Video Solutions lower revenue while we evaluate and explore strategic alternatives and maintain control of our operating expenses, we believe that our existing capital will be sufficient to finance our operations for 2009. However, the uncertainties related to the global economic slowdown and the disruption in the financial markets has impacted our visibility on our business outlook. Weakening economic conditions may result in decreased demand for our products. We have witnessed a significant revenue slow down on our Video Solutions segment. In addition, we have limited financial resources. Unforeseen decreases in revenues, or increases in operating costs could impact our ability to fund our operations. We do not currently have any sources of credit available to us. See “Liquidity and Capital Resources” below.
Going Concern
We remain dependent on outside sources of funding until our results of operations provide positive cash flows. As of December 31, 2008, our independent registered auditors concluded that there was substantial doubt about the Company’s ability to continue as a going concern, and this condition remains as of June 30, 2009. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.
During the years ended December 31, 2008 and 2007, we were unable to generate cash flows sufficient to support our operations and have been dependent on debt and equity raised from qualified individual investors. We experienced negative financial results as follows:
| | 2008 | | | 2007 | |
| Net loss | $ | (9,683,630 | ) | | $ | (10,633,026 | ) |
| Negative cash flow from operating activities | | (5,447,148 | ) | | | (5,582,487 | ) |
| Working capital deficit | | (7,967,417 | ) | | | (13,585,737 | ) |
| Stockholders’ equity | | 944,324 | | | | 18,377,773 | |
These factors raise substantial doubt about our ability to continue as a going concern. The financial statements contained in this report do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should we be unable to continue in existence. Our ability to continue as a going concern is dependent upon our ability to generate sufficient cash flows to meet our obligations on a timely basis, to obtain additional financing as may be required, and ultimately to attain profitable operations. However, there is no assurance that profitable operations or sufficient cash flows will occur in the future.
We have supported current operations by raising additional operating cash through the private sale of our preferred stock and convertible debentures. This has provided us with the cash flows to continue our business plan, but have not resulted in significant improvement in our financial position. We are considering alternatives to address our cash situation that include: (1) reducing cash operating expenses to levels that are in line with current revenues and (2) raising capital through additional sale of our common stock and/or debentures. The second alternative could result in substantial dilution of existing stockholders. There can be no assurance that our current financial position can be improved, that we can achieve positive cash flows from operations or that we can raise additional working capital.
Our long-term viability as a going concern is dependent upon our ability to:
| | ● | achieve profitability and ultimately generate sufficient cash flow from operations to sustain our continuing operations; and |
| | | |
| | ● | locate sources of debt or equity funding to meet current commitments and near-term future requirements. |
Results of Operations
Three months ended June 30, 2009 Compared to Three months ended June 30, 2008
Our business operates in two segments: Voice and Network Solutions and Video Solutions. Our Voice and Network Solutions segment includes our SmartVoice™ and Digital Phone Service and other VoIP communications offerings including a variety of voice and messaging solutions. Our Video Solutions segment includes our Digital PresenceTM telepresence solutions and other supporting audio-visual applications and services.
Revenues, Cost of Revenues and Gross Profit
| | | Three months ended June 30, 2009 | | Three months ended June 30, 2008 | | Increase (decrease) |
| | | Voice and Network Solutions | | Video Solutions | | Total | | Voice and Network Solutions | | Video Solutions | | Total | | Voice and Network Solutions | | Video Solutions | | Total |
| Net revenues: | | $ | 6,904,963 | | | $ | 687,346 | | | $ | 7,592,309 | | | $ | 6,352,520 | | | $ | 1,646,015 | | | $ | 7,998,535 | | | $ | 552,443 | | | $ | (958,669 | ) | | $ | (406,226 | ) |
| Cost of revenues: | | | 2,714,096 | | | | 621,908 | | | | 3,336,004 | | | | 2,940,164 | | | | 1,337,188 | | | | 4,277,352 | | | | (226,068 | ) | | | (715,280 | ) | | | (941,348 | ) |
| Gross profit: | | $ | 4,190,867 | | | $ | 65,438 | | | $ | 4,256,305 | | | $ | 3,412,356 | | | $ | 308,827 | | | $ | 3,721,183 | | | $ | 778,511 | | | $ | (243,389 | ) | | $ | 535,122 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit % | | | 60.7 | % | | | 9.5 | % | | | 56.1 | % | | | 53.7% | | | | 18.8% | | | | 46.5% | | | | | | | | | | | | | |
Net revenues for the three months ended June 30, 2009 were $7.6 million, a decrease of $0.4 million, or 5.1%, over the same period in 2008. Net revenues in our Voice and Network Solutions segment increased $0.6 million. Net revenues in our Video Solutions segment decreased $1.0 million. The increase in Voice and Network Solutions revenues is due in part to organic growth of existing products and services as a result of the increase in advertising year over year and to the success of our Digital Phone Service product which was launched in mid-2008. The decrease in Video Solutions revenues was primarily due to the impact of the economy which has many potential customers avoiding spending on big ticket items such as our Telepresence systems and other video equipment.
For the three months ended June 30, 2009, one customer accounted for 12% of our Voice and Network Solutions segment net revenues and three customers accounted for 45% of our Video Solutions segment net revenues. For the three months ended June 30, 2008, one customer accounted for 15% of our Voice and Network Solutions segment net revenues and one customer accounted for 12% of our Video Solutions segment net revenues.
Cost of revenues for the three months ended June 30, 2009 was $3.3 million, a decrease of $0.9 million, or 22.0%, over the same period in 2008. Cost of revenues in our Voice and Network Solutions segment decreased $0.2 million due to several cost saving measures that we began implementing during the second quarter of 2009. Cost of revenues in our Video Solutions segment decreased by $0.7 million due primarily to the decrease in revenues.
Gross profit for the three months ended June 30, 2009 was $4.3 million, an increase of $0.5 million, or 14.4%, over the same period in 2008. Gross profit in our Voice and Network Solutions segment increased $0.8 million as a result of the increase in revenues combined with the improvement in cost of revenues. Gross profit in our Video Solutions segment decreased $0.2 million primarily as a result of the decrease in revenues as compared to the same period in the prior year.
Gross profit percentage was 56.1% for the three months ended June 30, 2009 compared to 46.5% in the same period in 2008. Gross profit percentage for our Voice and Network Solutions segment was 60.7% for the three months ended June 30, 2009 compared to 53.7% in the same period in 2008. Such increase is a result of improved purchasing power from network infrastructure providers allowing us to purchase network access at lower rates, combined with cost saving measures implemented during the period. Gross profit percentage for our Video Solutions segment was 9.5% for the three months ended June 30, 2009 compared to 18.8% in the same period in 2008, primarily due to a less profitable mix of products sold.
Selling and Marketing Expenses
Selling and marketing expenses for the three months ended June 30, 2009 were $1.6 million, a decrease of $0.2 million or 9.9%, over the same period in 2008. The decrease was primarily due to a reduction in our Video Solutions selling staff in late February 2009, partially offset by increased advertising expense in our Voice and Network solutions segment. We anticipate that selling and marketing expenses for future quarters of 2009 will be higher than those incurred in 2008 as we increase our advertising expense in order to increase market share and to promote our Digital Phone Service product line.
General and Administrative Expenses
General and administrative expenses for the three months ended June 30, 2009 were $2.2 million, a decrease of $1.9 million or 46.1%, over the same period in 2008. Approximately, 90% of the decrease is attributable to lower payroll and stock compensation expense as a result of a decrease in management staff and the impact of related severance costs in 2008.
Research, Development and Engineering Expenses
Research, development and engineering expenses for the three months ended June 30, 2009 were $1.1 million, a decrease of $0.7 million or 38.6%, over the same period in 2008. Research, development and engineering expenses decreased in 2009 as compared to 2008 primarily as a result of a decrease in research and development staffing and the impact of related severance costs in 2008.
Depreciation Expense
Depreciation expense for the three months ended June 30, 2009 was $0.3 million, an increase of $0.1 million or 26.7%, over the same period in 2008. The increase is primarily attributable to additions to fixed assets during the preceding twelve months.
Amortization of Purchased Intangibles
We recorded $0.6 million of amortization expense for the three months ended June 30, 2009 and 2008, related to the intangible assets acquired in the AVS and AccessLine acquisition transactions.
Interest Expense
Interest expense for the three months ended June 30, 2009 was $1.0 million, a decrease of $0.7 million or 39.0%, from the same period in 2008. Interest expense includes stated interest, amortization of note discounts, amortization of deferred financing costs, and interest on capital leases. Interest expense decreased in 2009 primarily as a result of the reduced interest rate on our debentures pursuant to the May 2009 Amendment Agreement, which is discussed in more detail below.
The debentures we issued prior to June 2008 had an interest rate of 6%, and we recorded discounts to the debentures for the beneficial conversion feature and for the value of the warrants granted in connection with those debentures. We also recorded deferred financing costs related to the private placements in which such debentures were issued.
On June 30, 2008, we exchanged our then outstanding debentures for new debentures with an aggregate face value of $26.1 million that have a six year term and, when originally issued, bore interest at 12%. As discussed in greater detail below, the interest rate on these debentures was amended in December 2008 and again in May 2009. During the second half of 2008, a portion of these debentures were converted into shares of our common stock. We recorded deferred financing costs of $0.2 million related to the issuance of the new debentures in June 2008. The unamortized discounts and deferred financing costs at June 30, 2008 related to the prior financing transactions will be amortized to interest expense in future periods over the term of the newly issued debentures, or through June 30, 2014.
In August, 2008, we issued a debenture with a face value of $2.0 million that, when originally issued, bore interest at 12% per annum. As discussed in greater detail below, the interest rate on this debenture was amended in December 2008 and again in May 2009. We recorded discounts aggregating to $1.3 million which will be amortized to interest expense in future periods over the term of the debenture, or through June 30, 2014.
In December, 2008, we issued a debenture with a face value of $1.5 million that, when originally issued, bore interest at a rate of (i) 0% per annum from the original issue date until the one year anniversary of the original issue date, (ii) 12% per annum from the one year anniversary of the original issue date until the four year anniversary of the original issue date, and (iii) 18% per annum from the four year anniversary of the original issue date until June 2014. The interest rate on this debenture was amended in May 2009.
In addition, in December 2008, with respect to the debentures we issued in June 2008 and August 2008, the parties agreed to amend the interest rate and interest payment provisions, which had called for monthly interest payments at the rate of 12% per annum. As amended in December 2008, interest is payable quarterly at the rate of (i) 0% per annum from October 1, 2008 until September 30, 2009, (ii) 13.5% per annum from October 1, 2009 until September 30, 2012 and (iii) 18% per annum from October 1, 2012 until maturity.
In May 2009, with respect to the debentures we issued in June 2008, August 2008 and December 2008, the parties agreed to amend the terms of such debentures to: (i) defer interest payments until October 1, 2011; (ii) reduce the interest rate to 0% through June 30, 2011 and then to 5% per annum thereafter; and (iii) require that all future interest payments be made in cash. This change in terms resulted in an effective interest rate for the period subsequent to May 8, 2009 of 1.5%. See "Recent Financings," above.
Change in Fair Value of Warrant and Beneficial Conversion Liabilities
Pursuant to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and EITF No. 00-19, “Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in, a Company's Own Stock”, we recorded the fair value of the warrants issued in connection with our various financings at the issuance dates as a warrant liability because the exercise price of the warrants can be adjusted if we subsequently issue common stock at a lower price and it is possible for us to not have enough authorized shares to settle the warrants and therefore would have to settle the warrants with cash.
The fair value of the then outstanding warrants was estimated at December 31, 2008 and again at each subsequent reporting date. However, as a result of the Amendment Agreement (see Recent Financings above), the anti-dilution protection under the PIPE Warrants was removed, which eliminates the potential for future dilution from the PIPE Warrants. Accordingly, the PIPE Warrants are no longer a derivative liability and their value as of May 8, 2009, was reclassed to equity.
For the three months ended June 30, 2009, we recorded non-operating expense of $1.1 million in the Consolidated Statement of Operations for the decrease in the fair values of the warrants from the period from April 1, 2009, through May 8, 2009, which is primarily attributable to the increase in the market price of our common stock.
At December 31, 2008 and again at each subsequent reporting date, we assessed the then outstanding convertible debentures under SFAS No. 133, and we determined that the beneficial conversion feature represented an embedded derivative liability. Accordingly, we bifurcated the embedded beneficial conversion feature and accounted for it as a derivative liability because the conversion price of the debentures could be adjusted if we subsequently issue common stock at a lower price and due to recent events it became possible that we could have to net cash settle the contract if there were not enough authorized shares to issue upon conversion.
The debentures we issued in December 2006, February 2007, August 2007 and March 2008 contained embedded derivative features which were accounted for at fair value as a compound embedded derivative up to June 30, 2008, the date we exchanged those debentures for debentures with a six year term and 12% interest rate. This compound embedded derivative included the following material features: (1) the standard conversion feature of the debentures; (2) a reset of the conversion price condition for subsequent equity sales; (3) our ability to pay interest in cash or shares of our common stock; (4) monthly redemption payments as per the debenture agreements; (5) optional redemption at our election; (6) forced conversion; (7) holder’s restriction on conversion; and (8) a default put.
The debentures we issued in June 2008, August 2008 and December 2008 contain embedded derivative features, which were accounted for at fair value as a compound embedded derivative at the issuance dates and at each subsequent reporting date. This compound embedded derivative included the following material features: (1) the standard conversion feature of the debentures; (2) a reset of the conversion price condition for subsequent equity sales; (3) our ability to pay interest in cash or shares of its common stock; (4) optional redemption at our election; (5) forced conversion; (6) holder’s restriction on conversion; and (7) a default put.
The change in the fair market value of the beneficial conversion feature liability on May 8, 2009 as a result of the decrease the conversion price of all of our debentures from $0.40 to $0.30 per the Amendment Agreement (see Recent Financings above) was recorded as additional debt discount of $4.0 million.
We, with the assistance of an independent valuation firm, calculated the fair value of the compound embedded derivative associated with the convertible debentures utilizing a complex, customized Monte Carlo simulation model suitable to value path dependant American options. The model uses the risk neutral methodology adapted to value corporate securities. This model utilized subjective and theoretical assumptions that can materially affect fair values from period to period.
For the three months ended June 30, 2009, we recorded non-operating expense of $3.4 million in the Consolidated Statement of Operations for the decrease in the fair market values of the embedded derivative features, which is primarily attributable to the increase in the market price of our common stock.
Provision for income taxes
No provision for income taxes has been recorded because we have experienced net losses from inception through June 30, 2009. As of December 31, 2008, we had net operating loss carryforwards (“NOL’s”) of approximately $42.0 million, some of which, if not utilized, will begin expiring in the current year. Our ability to utilize the NOL carryforwards is dependent upon generating taxable income. We have recorded a corresponding valuation allowance to offset the deferred tax assets as it is more likely than not that the deferred tax assets will not be realized. We recognize interest accrued and penalties related to unrecognized tax benefits in tax expense. During the years ended December 31, 2008 and 2007, we recognized no interest and penalties.
Six months ended June 30, 2009 Compared to Six months ended June 30, 2008
Revenues, Cost of Revenues and Gross Profit
| | | Six months ended June 30, 2009 | | Six months ended June 30, 2008 | | Increase (decrease) |
| | | Voice and Network Solutions | | Video Solutions | | Total | | Voice and Network Solutions | | Video Solutions | | Total | | Voice and Network Solutions | | Video Solutions | | Total |
| Net revenues: | | $ | 13,929,155 | | | $ | 2,222,718 | | | $ | 16,151,873 | | | $ | 12,601,378 | | | $ | 3,053,918 | | | $ | 15,655,296 | | | $ | 1,327,777 | | | $ | (831,200 | ) | | $ | 496,577 | |
| Cost of revenues: | | | 5,840,867 | | | | 1,762,730 | | | | 7,603,597 | | | | 5,894,600 | | | | 2,625,751 | | | | 8,520,351 | | | | (53,733 | ) | | | (863,021 | ) | | | (916,754 | ) |
| Gross profit: | | $ | 8,088,288 | | | $ | 459,988 | | | $ | 8,548,276 | | | $ | 6,706,778 | | | $ | 428,167 | | | $ | 7,134,945 | | | $ | 1,381,510 | | | $ | 31,821 | | | $ | 1,413,331 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit % | | | 58.1 | % | | | 20.7 | % | | | 52.9 | % | | | 53.2% | | | | 14.0% | | | | 45.6% | | | | | | | | | | | | | |
Net revenues for the six months ended June 30, 2009 were $16.2 million, an increase of $0.5 million, or 3.2%, over the same period in 2008. Net revenues in our Voice and Network Solutions segment increased $1.3 million. Net revenues in our Video Solutions segment decreased $0.8 million. The increase in Voice and Network Solutions revenues is due in part to organic growth of existing products and services as a result of the increase in advertising year over year and to the success of our Digital Phone Service product which was launched in mid-2008. The decrease in Video Solutions revenues was primarily due to the impact of the economy which has many potential customers avoiding spending on big ticket items such as video equipment.
For the six months ended June 30, 2009, one customer accounted for 12% of our Voice and Network Solutions segment net revenues and two customers accounted for 41% of our Video Solutions segment net revenues. For the three months ended June 30, 2008, one customer accounted for 15% of the Voice and Network Solutions segment net revenues and no one customer accounted for more than 10% of the Video Solutions segment net revenues.
Cost of revenues for the six months ended June 30, 2009 were $7.6 million, a decrease of $0.9 million, or 10.8%, over the same period in 2008. Cost of revenues in our Voice and Network Solutions segment decreased $0.1 million due to several cost saving measures that we began implementing during the second quarter of 2009. Cost of revenues in our Video Solutions segment decreased by $0.8 million due to the decrease in revenues.
Gross profit for the six months ended June 30, 2009 was $8.5 million, an increase of $1.4 million, or 19.8%, over the same period in 2008. Gross profit in our Voice and Network Solutions segment increased $1.4 million consistent with the increase in revenues. Gross profit in our Video Solutions segment remained flat despite the decrease in revenue primarily as a result of increased margin on product sales during the first quarter of 2009.
Gross profit percentage was 52.9% for the six months ended June 30, 2009 compared to 45.6% in the same period in 2008. Gross profit percentage for our Voice and Network Solutions segment was 58.1% for the six months ended June 30, 2009 compared to 53.2% in the same period in 2008, and the increase is a result of improved purchasing power from network infrastructure providers allowing us to purchase network access at lower rates as well as several cost saving measures that the Company began implementing during the second quarter of 2009. Gross profit percentage for our Video Solutions segment was 20.7% for the six months ended June 30, 2009 compared to 14.0% in the same period in 2008, and the increase is a result of a more profitable mix of products sold during the first quarter of 2009.
Selling and Marketing Expenses
Selling and marketing expenses for the six months ended June 30, 2009 were $3.4 million, a decrease of $0.1 million or 2.0%, over the same period in 2008. The decrease was primarily due to a reduction in our Video Solutions selling staff in late February 2009, partially offset by increased advertising expense in our Voice and Network solutions segment. We anticipate that selling and marketing expenses for future quarters of 2009 will be higher than those incurred in 2008 as we increase our advertising expense in order to increase market share and to promote our Digital Phone Service product line.
General and Administrative Expenses
General and administrative expenses for the six months ended June 30, 2009 were $4.4 million, a decrease of $2.6 million or 36.7%, over the same period in 2008. Approximately, 84% of the decrease is attributable to lower payroll and stock compensation expense as a result of a decrease in management staff and the impact of related severance costs in 2008. Approximately, 14% of the decrease is attributable to lower accounting costs in 2009 as compared to 2008, which included costs associated with the first time consolidation of the activity of our Accessline and AVS subsidiaries that were acquired during 2007. The remaining decrease is primarily attributable to lower consulting fees in 2009 as compared to 2008, which included costs associated with various valuations as a result of our acquisitions and various debt restructurings in 2007 and 2008.
Research, Development and Engineering Expenses
Research, development and engineering expenses for the six months ended June 30, 2009 were $2.3 million, a decrease of $0.8 million or 25.1%, over the same period in 2008. Research, development and engineering expenses decreased in 2009 as compared to 2008 primarily as a result of a decrease in research and development staffing and the impact of related severance costs in 2008.
Depreciation Expense
Depreciation expense for the six months ended June 30, 2009 was $0.6 million, an increase of $0.1 million or 35.9%, over the same period in 2008. The increase is primarily attributable to additions to fixed assets during the preceding twelve months.
Amortization of Purchased Intangibles
We recorded $1.2 million of amortization expense for the six months ended June 30, 2009 and 2008, related to the intangible assets acquired in the AVS and AccessLine acquisition transactions.
Interest Expense
Interest expense for the six months ended June 30, 2009 was $2.5 million, a decrease of $0.5 million or 20.3%, from the same period in 2008. Interest expense includes stated interest, amortization of note discounts, amortization of deferred financing costs, and interest on capital leases. Interest expense decreased in 2009 primarily as a result of the reduced interest rate on our debentures pursuant to the May 2009 Amendment Agreement. See also "—Three months ended June 30, 2009 Compared to Three months ended June 30, 2008—Interest Expense," above.
Change in Fair Value of Warrant and Beneficial Conversion Liabilities
For the six months ended June 30, 2009, we recorded non-operating expense of $1.0 million in the Consolidated Statement of Operations for the decrease in the fair values of the warrants from the period from January 1, 2009, through May 8, 2009, which is primarily attributable to the increase in the market price of our common stock.
For the six months ended June 30, 2009, we recorded non-operating expense of $2.6 million in the Consolidated Statement of Operations for the decrease in the fair market values of the embedded derivative features, which is primarily attributable to the increase in the market price of our common stock.
See also "—Three months ended June 30, 2009 Compared to Three months ended June 30, 2008—Change in Fair Value of Warrant and Beneficial Conversion Liabilities," above.
Provision for income taxes
No provision for income taxes has been recorded because we have experienced net losses from inception through June 30, 2009. See also "—Three months ended June 30, 2009 Compared to Three months ended June 30, 2008—Provision for income taxes,” above.
Liquidity and Capital Resources
Our cash balance as of June 30, 2009 was $1.1 million. At that time, we had accounts receivable of $2.2 million and a working capital deficit of $14.3 million, which includes beneficial conversion liabilities of $11.4 million.
Cash generated by operations during the six months ended June 30, 2009 was $1.0 million. This was primarily the result of the receipt of $1.6 million of accounts receivable partially offset by the net loss. The net loss of $9.3 million was almost entirely offset by the following non-cash charges: change in fair value of warrant and beneficial conversion liabilities of $3.5 million; amortization of intangible assets of $1.2 million; depreciation expense of $1.1 million (which includes depreciation expense of $0.5 million in cost of sales); amortization of note discounts of $1.0 million; and stock compensation expense of $0.6 million and the change in accrued interest of $1.4 million.
Net cash used by investing activities during the six months ended June 30, 2009 was $0.3 million, which consisted of purchases of property and equipment.
Net cash used by financing activities was $0.6 million during the quarter ended June 30, 2009. All of the cash used by financing activities was used for payments on our capital leases.
If we can continue to generate Voice and Network Solution revenue and gross margin improvements, moderate the effect of Video Solutions lower revenue during the process of evaluation of strategic alternatives and maintain control of our operating expenses, we believe that our existing capital will be sufficient to finance our operations for 2009. We do not currently have any unused credit arrangement or open credit facility available to us. Our PIPE Debentures are secured by a lien on all of our assets, and the terms of those debentures restrict our ability to borrow funds and pledge our assets as security for any such borrowing, without the consent of the holders of the PIPE Debentures.
If our cash reserves prove insufficient to sustain operations, we plan to raise additional capital by selling shares of capital stock or other equity or debt securities. However, there are no commitments or arrangements for future financings in place at this time, and we can give no assurance that such capital will be available on favorable terms or at all. We may need additional financing thereafter until we can achieve profitability. If we cannot, we will be forced to curtail our operations or possibly be forced to evaluate a sale or liquidation of our assets. Any future financing may involve substantial dilution to existing investors.
Commitments and Contingencies
Debentures
As of June 30, 2009, the principal balance we owe on our outstanding debentures is $29.6 million, all of which is due June 30, 2014. In May 2009, the terms of our debentures were amended to defer interest payments until October 1, 2011. All interest payments must be paid in cash. In addition, at any time, the holders of the debentures have the right to convert the debentures into common stock at the then effective conversion price (currently $0.30). See "Recent Financings," above.
If our cash flows from operations are not sufficient to make interest payments in cash, we will evaluate other equity financing opportunities, the proceeds of which could be used to repay the debentures.
If we are unable to make the payments due on our outstanding debentures, we would be in default under those securities. The holders of our debentures would be entitled to demand that all amounts due thereunder be immediately paid in cash, and the holders would have the right to demand that we pay 130% of the outstanding principal amount and the interest rate accrues at a rate equal to the lesser of 18% per annum or the maximum rate permitted under applicable law. In addition, the holders would have the right to foreclose on all of our assets pursuant to the terms of the security agreement we entered into with such holders and they would have the right to take possession of our assets and operate our business.
Leases
We have non-cancelable operating and capital leases for corporate facilities and equipment.
Future minimum rental payments required under non-cancelable operating and capital leases are as follows for the years ending December 31:
| | | Operating Leases | | | Capital Leases | |
| 2009 | | $ | 815,261 | | | $ | 516,485 | |
| 2010 | | | 1,418,485 | | | | 697,774 | |
| 2011 | | | 1,273,228 | | | | 281,989 | |
| 2012 | | | 1,269,119 | | | | 41,912 | |
| 2013 | | | 184,920 | | | | 14,139 | |
| Thereafter | | | — | | | | — | |
| Total minimum lease payments | | $ | 4,961,013 | | | | 1,552,299 | |
| Less amount representing interest | | | | | | | (173,399 | ) |
| Present value of minimum lease payments | | | | | | | 1,378,900 | |
| Less current portion | | | | | | | (752,934 | ) |
| Total long term portion | | | | | | $ | 625,966 | |
Minimum Third Party Network Service Provider Commitments
We have a contract with a third party network service provider that facilitates interconnectivity with a number of third party network service providers. The contract contains a minimum usage guarantee of $0.2 million per monthly billing cycle. The contract commenced on October 16, 2003 with an initial 24 month term. The contract was extended in July 2005 for a three year term that expired in July 2008. On October 24, 2008, the contract was extended for another three year term. The cancellation terms are a 90 day written notice prior to the then current term expiring.
Communications Assistance for Law Enforcement Act
On August 5, 2005, the Federal Communications Commission, or FCC, unanimously adopted an order requiring VoIP providers to comply with the Communications Assistance for Law Enforcement Act, or CALEA. CALEA requires covered providers to assist law enforcement agencies in conducting lawfully authorized electronic surveillance. Under the FCC order, all VoIP providers were to become fully CALEA compliant by May 14, 2007. We engaged a third party to help it develop a solution to be CALEA compliant. In February 2007, we notified the FCC that it did not expect to have a CALEA compliant solution completed by May 14, 2007, but that it instead expected to have the development complete by September 1, 2007. Our formal CALEA compliance testing with the third party was completed on September 28, 2007. Currently, our CALEA solution is fully deployed in its network. However, we could be subject to an enforcement action by the FCC or law enforcement agencies for any delays related to meeting, or if we fail to comply with, any current or future CALEA obligations.
Universal Service Fund
In June 2006, the FCC concluded that VoIP providers must contribute to the Universal Service Fund, or USF. The FCC established a contribution safe harbor percentage of 64.9% of total VoIP service revenue. Alternatively, VoIP providers are permitted to calculate their contribution based on FCC pre-approved traffic studies. We began contributing to the USF on October 1, 2006 using the 64.9% safe harbor. In the meantime, the FCC continues to evaluate alternative methods for assessing USF charges, including imposing an assessment on telephone numbers. The outcome of these proceedings cannot be determined at this time nor can we determine the potential financial impact as the details of an alternative method of USF contribution have not been determined at this time. There is also a risk that state USF funds may attempt to impose state USF contribution obligations and other state and local charges.
Sales and Additional Taxes
Based upon a new Internal Revenue Service ruling, we ceased collecting federal excise tax on August 1, 2006 on long-distance or bundled services. We had not collected or accrued liabilities for E911 taxes for VoIP services prior to July 1, 2006, and it is possible that substantial claims for back taxes may be asserted against us. Also, we are currently working to obtain Inter Exchange Carrier (IXC) certification in Alaska, Maryland and Mississippi. Our current certification status in these three states may leave it liable for fees and penalties that could decrease its ability to compete with traditional telephone companies. In addition, future expansion of our service, along with other aspects of its evolving business, may result in additional sales and other tax obligations. One or more taxing authorities may seek to impose sales, use or other tax collection obligations on us. We have received inquiries or demands from numerous state authorities and may be subjected to audit at any time. A successful assertion by one or more taxing authorities that we should collect sales, use or other taxes on the sale of its services could result in substantial tax liabilities for past sales.
Other
In connection with our acquisition of AccessLine, we are required to pay up to an additional $9.0 million in the form of 2,500,000 shares of our restricted common stock upon the achievement of certain future financial objectives, the value of which would increase the amount of goodwill recorded in the transaction. The first earn out period ended December 31, 2007. In April 2008, when the contingency related to the first earn out period was resolved, we issued 599,130 shares valued at $0.6 million, resulting in increases to goodwill and equity. The second earn out period ended June 30, 2008, and we issued 529,252 shares valued at $0.3 million in July 2008. The increase in goodwill and equity were recorded in the third fiscal quarter of 2008. The third earn out period ended December 31, 2008, and we issued 515,622 shares valued at less than $0.1 million in February 2009. The increase in goodwill and equity was recorded in the first quarter of fiscal 2009. The final earn out period ended on June 30, 2009 and the Company issued 401,658 shares valued at $0.04 million in July 2009. The increase in goodwill and equity will be recorded in the third quarter of fiscal 2009.
On April 18, 2007, the FCC released a Notice of Proposed Rulemaking tentatively concluding that VoIP providers should pay regulatory fees. According to the notice, the FCC would like to begin collection of such fees in the August to September 2007 timeframe. The FCC is considering calculating contribution obligations for VoIP providers based on either revenues or telephone numbers used. We cannot predict the outcome of this proceeding. On June 8, 2007, the FCC released an order implementing various recommendations from its Independent Panel Reviewing the Impact of Hurricane Katrina on Communications Networks Panel, including a requirement that certain VoIP providers submit reports regarding the reliability and resiliency of their 911 systems. At this time, the Company is not subject to these reporting requirements but may become subject in future years.
On June 8, 2007, the FCC released an order implementing various recommendations from its Independent Panel Reviewing the Impact of Hurricane Katrina on Communications Networks Panel, including a requirement that certain VoIP providers submit reports regarding the reliability and resiliency of their 911 systems. At this time, we are not subject to these reporting requirements but may become subject in future years.
On June 15, 2007, the FCC extended the disability access requirements of Sections 225 and 255 of the Communications Act, which applied to traditional phone services, to providers of VoIP services and to manufacturers of specially designed equipment used to provide those services. Section 255 of the Communications Act requires service providers to ensure that its equipment and service is accessible to and usable by individuals with disabilities, if readily achievable, including requiring service providers to ensure that information and documentation provided in connection with equipment or services be accessible to people with disabilities, where readily achievable and that employee training account for accessibility requirements. In addition, the FCC said that VoIP providers were subject to the requirements of Section 225, including contributing to the Telecommunications Relay Services, or TRS, fund and that they must offer 711 abbreviated dialing for access to relay services. Although we contribute to the TRS fund as required, we have not yet implemented a solution for the 711 abbreviated dialing requirement. We may be subject to enforcement actions including, but not limited to, fines, cease and desist orders, or other penalties if we do not comply with these obligations.
In the latter half of 2007, the FCC released two Report and Orders that increase the costs of doing business. One of them, released on August 6, 2007, concerns the collection of regulatory fees for fiscal year 2007, which, for the first time, mandates the collection of such fees from VoIP providers. This order, which became effective in November 2007, requires that VoIP providers pay regulatory fees based on reported interstate and international revenues. Regulatory fees for the FCC's fiscal year 2007 were due in 2008. Fiscal year 2008 fees were paid in 2008 during the normal regulatory fee payment window. The assessment of regulatory fees on our VoIP service offering will increase our costs and reduce our profitability or cause us to increase the retail price of its VoIP service offerings.
The other order, released on November 8, 2007, imposes local number portability and related obligations on VoIP providers, such as requiring VoIP providers to contribute to shared numbering administration costs on a competitively neutral basis. The assessment of local number portability fees to our VoIP service will increase our costs and reduce our profitability or cause us to increase the price of its VoIP service offerings.
Critical Accounting Policies Involving Management Estimates and Assumptions
Our discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and equity and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include those related to the allowance for doubtful accounts; valuation of inventories; valuation of goodwill, intangible assets and property and equipment; valuation of stock based compensation expense under SFAS No. 123(R), the valuation of warrants and conversion features; and other contingencies. On an on-going basis, we evaluate our estimates. We base our estimates on historical experience and on various other assumptions that are believed 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. Actual results could differ from those estimates under different assumptions or conditions.
The following is a discussion of certain of the accounting policies that require management to make estimates and assumptions where the impact of those estimates and assumptions may have a substantial impact on our financial position and results of operations.
Inventories:
Inventories, which consist primarily of finished goods, are valued at the lower of cost or market with cost computed on a first-in, first-out (FIFO) basis. Consideration is given to obsolescence, excessive levels, deterioration and other factors in evaluating net realizable value. We record write downs for excess and obsolete inventory equal to the difference between the cost of inventory and the estimated fair value based upon assumptions about future product life-cycles, product demand and market conditions.
Property and Equipment:
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Estimated useful lives are two to seven years. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the assets. Disposals of capital equipment are recorded by removing the costs and accumulated depreciation from the accounts and gains or losses on disposals are included in operating expenses in the Consolidated Statement of Operations.
Goodwill:
Goodwill is not amortized but is regularly reviewed for potential impairment. The identification and measurement of goodwill impairment involves the estimation of the fair value of our reporting units. The estimates of fair value of reporting units are based on the best information available as of the date of the assessment, which primarily incorporate management assumptions about expected future cash flows. Future cash flows can be affected by changes in industry or market conditions or the rate and extent to which anticipated synergies or cost savings are realized with newly acquired entities.
Impairment of Long-Lived Assets:
Purchased intangible assets with finite lives are amortized using the straight-line method over the estimated economic lives of the assets, which range from five to ten years. Purchased intangible assets determined to have indefinite useful lives are not amortized. Long-lived assets, including intangible assets with finite lives, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss for long-lived assets that management expects to hold and use is based on the fair value of the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
Revenue Recognition:
Voice and Network Solutions Revenue
Voice and network revenues are derived primarily from monthly recurring fees, which are recognized over the month the service is provided, activation fees, which are deferred and recognized over the estimated life of the customer relationship, and fees from usage which are recognized as the service is provided.
Video Solutions Revenue
We recognize revenue when persuasive evidence of an arrangement exists, title has transferred, product payment is not contingent upon performance of installation or service obligations, the price is fixed or determinable, and collectability is reasonably assured. In instances where final acceptance of the product or service is specified by the customer, revenue is deferred until all acceptance criteria have been met. Additionally, we recognize extended service revenue on our hardware and software products ratably over the service period, generally one year.
Our telepresence products are integrated with software that is essential to the functionality of the equipment. Additionally, we provide unspecified software upgrades and enhancements related to most of these products through maintenance contracts. Accordingly, we account for revenue for these products in accordance with Statement of Position (“SOP”) No. 97-2, “Software Revenue Recognition,” and all related interpretations.
We generally recognize revenue generated by integration, consultation and implementation solutions on a percentage completion basis based on direct labor costs in accordance with SOP No. 81-1, Accounting for Performance of Construction Type and Certain Production Type Contracts.
Income Taxes:
We account for income taxes under the liability method, which recognizes deferred tax assets and liabilities determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established to reduce deferred tax assets when, based on available objective evidence, it is more likely than not that the benefit of such assets will not be realized.
On January 1, 2007, we adopted the provisions of FASB 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 income tax positions. This interpretation requires us to recognize in the consolidated financial statements only those tax positions determined to be more likely than not of being sustained.
Derivative Financial Instruments
We do not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks.
We review the terms of convertible debt and equity instruments it issues to determine whether there are embedded derivative instruments, including the embedded conversion option, that are required to be bifurcated and accounted for separately as a derivative financial instrument. In circumstances where the convertible instrument contains more than one embedded derivative instrument, including the conversion option, that is required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument. Also, in connection with the sale of convertible debt and equity instruments, we may issue freestanding warrants that may, depending on their terms, be accounted for as derivative instrument liabilities, rather than as equity.
Bifurcated embedded derivatives are initially recorded at fair value and are then revalued at each reporting date with changes in the fair value reported as charges or credits to income. When the convertible debt or equity instruments contain embedded derivative instruments that are to be bifurcated and accounted for as liabilities, the total proceeds allocated to the convertible host instruments are first allocated to the fair value of all the bifurcated derivative instruments. The remaining proceeds, if any, are then allocated to the convertible instruments themselves, usually resulting in those instruments being recorded at a discount from their face amount.
The discount from the face value of the convertible debt, together with the stated interest on the instrument, is amortized over the life of the instrument through periodic charges to income, using the effective interest method.
Stock Based Compensation:
On January 1, 2006, we adopted SFAS No. 123(R) “Share-Based Payments”, which requires us to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized in the Consolidated Statement of Operations over the period during which the employee is required to provide service in exchange for the award – the requisite service period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. The grant-date fair value of employee share options and similar instruments is estimated using option-pricing models adjusted for the unique characteristics of those instruments.
Recent Accounting Pronouncements
Please see “Note 2 - Recent Accounting Pronouncements” of the Notes to Condensed Consolidated Financial Statements included in "Item 1. Financial Statements" of Part I of this report.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated under the Securities Act.
Intentionally omitted pursuant to Item 305(e) of Regulation S-K.
Evaluation of Disclosure Controls and Procedures
Our disclosure controls and procedures are designed to provide reasonable assurances that material information related to our company is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Our Chief Executive Officer and Chief Financial Officer have determined that as of June 30, 2009, our disclosure controls were effective at that "reasonable assurance" level.
Changes In Internal Controls over Financial Reporting.
No changes were made in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business, including claims of alleged infringement, misuse or misappropriation of intellectual property rights of third parties. As of the date of this report, we are not a party to any litigation which we believe would have a material adverse effect on our business operations or financial condition.
In addition to the other information set forth in this report, you should carefully consider the risk factors discussed in "Part I. Item 1A—Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008. The risks and uncertainties described in such risk factors and elsewhere in this report have the potential to materially affect our business, financial condition, results of operations, cash flows, projected results and future prospects. As of the date of this report, we do not believe that there have been any material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
In July 2009, we issued 401,658 shares of our common stock pursuant to the earn out provisions of the AccessLine acquisition agreement for the period ending June 30, 2009.
The issuance described above was exempt from registration under the Securities Act pursuant to Section 4(2) thereof. The transaction was not conducted in connection with a public offering, and no public solicitation or advertisement was made or relied upon by the investor in connection with the offering.
None.
The Company’s annual meeting of shareholders was held on June 17, 2009, at which the shareholders voted on the following proposals:
| (1) | Election of four directors to hold office for a term of one year to serve until their successors are elected and qualified. |
| | For | | | Withheld | |
| Steven J. Davis | | 23,577,741 | | 75.2 | % | | 159,071 | | 0.5 | % |
| James R. Everline | | 23,573,803 | | 75.2 | % | | 163,009 | | 0.5 | % |
| Douglas N. Johnson | | 23,577,741 | | 75.2 | % | | 159,071 | | 0.5 | % |
| David A. Rane | | 23,577,159 | | 75.2 | % | | 159,653 | | 0.5 | % |
The candidates each received a plurality of the votes properly cast, and therefore have been duly elected as directors of the Company.
| (2) | Approval of an amendment to the Company’s certificate of incorporation to increase the number of authorized shares of common stock from 200,000,000 to 300,000,000. |
| For | | Against | | Abstained/Broker Non-Votes |
| 19,914,933 | | 63.5% | | 3,808,900 | | 1.0% | | 12,977 | | 0.0% |
The amendment was approved by the affirmative vote of the holders of a majority of the outstanding shares of common stock.
| (3) | Approval of an amendment to the Telanetix, Inc. 2005 Equity Incentive Plan that increases the number of authorized shares of common stock subject to such plan from 8,500,000 to 15,500,000. |
| | | | | | | | | | | |
| For | | Against | | Abstained/Broker Non-Votes |
| 12,931,386 | | 41.2% | | 3,328,799 | | 10.6% | | 7,000 | | 0.0% |
The amendment was approved by the affirmative vote of the holders of a majority of the outstanding shares of common stock represented at the annual meeting.
None.
See the exhibit index immediately following the signature page of this report.
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.
| | |
| | TELANETIX, INC. |
| | |
| Date: August 12, 2009 | J. Paul Quinn, Chief Financial Officer |
| | (Duly Authorized Officer and Principal Financial Officer) |
| Exhibit No. | Description |
| 3.1 | Bylaws, as amended (1) |
| 3.2 | |
| 10.1 | Amendment Agreement dated May 8, 2009 (2) |
| 10.2 | |
| 10.3 | Amendment No. 1 to Employment Agreement with Douglas N. Johnson dated July 1, 2009 (3) |
| 10.4 | Amendment No. 1 to Employment Agreement with J. Paul Quinn dated July 1, 2009 (3) |
| 31.1 | |
| 31.2 | |
| 32.1 | |
| 32.2 | |
| | |
| * | Filed with this report |
| ** | Furnished with this report |
| (1) | Incorporated by reference to the registrant's Current Report on Form 8-K filed on April 29, 2009 |
| (2) | Incorporated by reference to the registrant's Current Report on Form 8-K filed on May 11, 2009 |
| (3) | Incorporated by reference to the registrant's Current Report on Form 8-K filed on July 2, 2009 |
