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NET TALK.COM, INC. - 10-Q/A - Management Discussion and Analysis of Financial Conditions and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Our Management's Discussion and Analysis should be read in conjunction with our financial statements included in this report. Forward Looking Statements Certain statements contained in this quarterly report on Form 10-Q and other written material and oral statements made from time to time by us do not relate to historical or current facts. As such, they are referred to as "forward-looking statements," which are intended to convey our expectations or predictions regarding the occurrence of possible future events or the existence of trends and factors that may impact our future plans and operating results. These forward-looking statements are derived, in part, from various assumptions and analyses we have made in the context of our current business plan and information currently available to us and in light of our experience and perceptions of historical trends, current conditions and expected future developments and other factors we believe to be appropriate in the circumstances. You can generally identify forward-looking statements through words and phrases such as " seek, " " anticipate, " " believe, " " estimate, " " expect, " " intend, " " plan, " " budget, " " project, " " may be, " " may continue, " " may likely result, " and similar expressions. When reading any forward looking statement, you should remain mindful that actual results or developments may vary substantially from those expected as expressed in or implied by that statement for a number of reasons or factors, such as those relating to: · whether or not a market for our products and services develop and, if a market develops, the pace at which it develops; · our ability to successfully sell our products and services if a market develops; · our ability to attract the qualified personnel to implement our growth strategies; · our ability to develop sales and marketing capabilities; · the accuracy of our estimates and projections; · our ability to fund our short-term and long-term financing needs; · changes in our business plan and corporate strategies; and other risks and uncertainties discussed in greater detail in the sections of this quarterly report, including the section captioned "Plan of Operation". Each forward-looking statement should be read in context with, and with an understanding of, the various other disclosures concerning our Company and our business made elsewhere in this prospectus, as well as other public reports filed with the SEC. You should not place undue reliance on any forward-looking statement as a prediction of actual results or developments. We are not obligated to update or revise any forward-looking statement contained in this report to reflect new events or circumstances unless and to the extent required by applicable law. Background Company and Business We are a telephone company, who provides, sells and supplies commercial and residential telecommunication services, including services utilizing voice over internet protocol ("VoIP") technology, session initiation protocol ("SIP") technology, wireless fidelity technology, wireless maximum technology, marine satellite services technology and other similar type technologies. Our main product is the DUO, an analog telephone adapter that provides connectivity for analog telephones and faxes to home, home office or corporate local area networks ("LAN"). Our newest product, the DUO was launched on July 14, 2010. The DUO offers our customers free nationwide calls to any landline or mobile phone in the U.S. and Canada from anywhere in the world, as well as low-cost international rates. It's also a versatile digital phone service with no monthly fees, no contracts and no computer required. The DUO offers a full suite of advanced calling features including call forwarding, caller ID, 3-way calling, call holding, call retrieval and call transfer. Our first product, the TK 6000 and its related services is a cost effective solution for individuals, small businesses and telecommuters connecting to any analog telephone, fax or private branch exchange ("PBX"). The TK 6000 provides one USB port, one Ethernet port and one analog telephone port. A full suite of internet protocol features is available to maximize universal connectivity. In addition, analog telephones attached to the TK 6000 are able to use advanced calling features such as call forwarding, caller ID, 3-way calling, call holding,call retrieval and call transfer. On July 14, 2010 we revealed our newest product the netTALK DUO ("DUO"). We are presently working on other new products and anticipate future deployment over the next year. 22 -------------------------------------------------------------------------------- History and Overview We are a Florida corporation, incorporated on May 1, 2006 under the name Discover Screens, Inc. ("Discover Screens"). Prior to September 10, 2008, we were known as Discover Screens, a development-stage company, dedicated to providing advertising through interactive, audiovisual, information and advertising portals located in high-traffic indoor venues. Our name and business operations changed in a series of transactions beginning in December of 2007. Pursuant to an asset purchase agreement dated December 30, 2007, we sold all of the assets associated with the advertising business as a going concern to Robert H. Blank, who was then our President and Chief Operating Officer. Following that transaction, we ceased all existing operations, and from December 30, 2007 to September 9, 2008, we owned nominal assets and generated no revenue. In February of 2008, Mr. Blank resigned as officer and director. On September 9, 2008, Robin C. Hoover, our sole remaining officer and director, appointed four new members to the Board of Directors, Anastasios Kyriakides, Kenneth Hosfeld, Guillermo Rodriguez and Leo Manzewitsch. Mr. Hoover then resigned as an officer and director. Mr. Richard Diamond was appointed by the Board of Directors to fill the vacancy left by Mr. Hoover's resignation. Mr. Diamond resigned as a director of the Company, effective November 23, 2009. On September 10, 2008, we changed our name from Discover Screens, Inc. to NetTalk.com, Inc. On September 10, 2008, we entered into a Contribution Agreement with Vicis Capital Master Fund ("Vicis") by which Vicis contributed certain operating assets to the Company in exchange for (a) a 12% Senior Secured Convertible Debenture in the principal amount of $1,000,000; and (b) a Series B Warrant to purchase 4,000,000 shares of common stock of the Company. Also on September 10, 2008, the Company entered into a Securities Purchase Agreement with Debt Opportunity Fund, LLP ("DOF") by which DOF purchased (a) a 12% Senior Secured Convertible Debenture in the principal amount of $500,000; and (b) a Series B Warrant to purchase 2,000,000 shares of Common Stock of the Company. On September 10, 2008, we acquired certain tangible and intangible assets, formerly owned by Interlink Global Corporation ("Interlink"), (the "Interlink Asset Group") directly from Interlink's creditor who had seized the assets pursuant to a Security and Collateral Agreement. Our purpose in acquiring these assets, which included employment rights to the executive management team of Interlink who now currently serve as our officers, was to advance the TK 6000 VoIP Technology Program, which Interlink launched in July 2008. Accordingly, these assets substantially comprise our current business assets and the infrastructure for our future operations. Contemporaneously with this purchase, we executed an assignment and intellectual property agreement with Interlink that served to perfect our ownership rights to the assets. Consideration for the acquisition consisted of a face value $1,000,000 convertible debenture, plus warrants to purchase 4,000,000 shares of our common stock. On the date of the Interlink Asset Group acquisition, we also entered into a financing agreement with DOF (as described above) that provided for the issuance of a face value $500,000 convertible debenture, plus warrants to purchase 2,000,000 shares of our common stock for net cash consideration of $448,300. In connection with this acquisition, we issued 6,000,000 shares of common stock to our new management team in connection with the Interlink Asset Group acquisition. We continue to improve and enhance the following factors in building and expanding our customer base: · Deployment and distribution of our products TK 6000 and DUO devices. · Attractive and innovative value proposition. We offer our customers an attractive and innovative value proposition: a portable telephone replacement with multiple and unique features that differentiates our services from the competition. · Innovative, high technology and low cost technology platform. We believe our innovative software and network technology platform provides us with a competitive advantage over our competition and allows us to maintain a low cost infrastructure relative to our competitors. Plan of Operation We provide, sell and supply commercial and residential telecommunication services, including services utilizing voice over internet protocol ("VoIP") technology, session initiation protocol ("SIP") technology, wireless fidelity technology, wireless maximum technology, marine satellite services technology and other similar type technologies. We are developing our business infrastructure and new products and services. 23 -------------------------------------------------------------------------------- Our Products At this time, our main products are the DUO and TK 6000. Our DUO and TK 6000 are designed to provide specifications unique to each customer's existing equipment. It allows the customer full mobile flexibility by being able to take internet interface anywhere the customer has an internet connection. Our DUO and TK 6000 both have the following features: -A Universal Serial Bus ("USB") connection allowing the interconnection of our DUO and TK 6000 to any host computer. -In addition to the USB power source option, our DUO and TK 6000 have an external power supply allowing the phone to independently power itself when not connected to a host computer; -Unlike most VoIP telephone systems, our DUO and TK 6000 both have standalone feature allowing them to be plugged directly into a standard internet connection. -Our DUO and TK 6000 are compact, space-efficient products. Our DUO and TK 6000 both have interface component so that the customer can purchase multiple units that can communicate with each other allowing simultaneous ringing from multiple locations. Our products are portable and allow our customers to make and receive phone calls with a telephone anywhere where a broadband internet connection is available without the need of a computer. We transmit the calls using Voice over Internet Protocol "VOIP" technology, which converts voice signals into digital data transmissions over the internet. Our Services Our business is to provide products and services that utilize Voice Over Internet Protocol, which we refer to as "VoIP." VoIP is a technology that allows the consumer to make telephone calls over a broadband internet connection instead of using a regular (or analog) telephone line. VoIP works by converting the user's voice into a digital signal that travels over the internet until it reaches its destination. If the user is calling a regular telephone line number, the signal is converted back into a voice signal once it reaches the end user. Our business model is to develop and commercialize software technology solutions for cost effective, real-time communications over the internet and related services. Services provided or to be provided Text to phone reminder service: We are currently developing a service that will allow VoIP to synchronize with the customer's data base schedule management system (such as Microsoft Office Outlook © ). Our goal is to develop a service that will call the customer at a pre-designated time to provide an audio reminder of that day's agenda to the customer. By offering this service at a low price point of less than five dollars per month we hope to appeal to a broad customer base. This software is currently under development. Free conference server. This product is currently available to all our customers. Future Voice Message Delivery: This service allows the user to record a voice message which will be delivered to a recipient at a later date and time specified by the user. Speech to text services for the hearing impaired: This is a standalone service that will allow the hearing impaired to receive real time conversion of incoming voice signals into text displayed on an incorporated display panel. Patents - Domestic and International Our products are currently under US patent pending as well as International patent pending in over 123 countries. 24 -------------------------------------------------------------------------------- Federal CALEA On August 5, 2005, the Federal Communications Commission (the "FCC") released an Order extending the obligations of the Communication Assistance for Law Enforcement Act ("CALEA") to interconnected VoIP providers. Under CALEA, telecommunication carriers must assist law enforcement in executing electronic surveillance, which includes the capability of providing call content and call-identifying information to a local enforcement agency, or LEA, pursuant to a court order of other lawful authorization. The FCC required all interconnected VoIP providers to become fully CALEA compliant by May 14, 2007. To date, we have complied with all lawful CALEA requests. Marketing We have developed direct sales channels, as represented by web sites and toll free numbers. Our direct sales channels are supported by highly integrated advertising campaigns across multiple media such as infomercials, television and other media channels. Our website is www.nettalk.com, our telephone number is (305) 621-1200 and our fax number is (305) 621-1201. Our primary source of revenue is the sale and distribution of our DUO and TK 6000 products. We also generate revenue from the sale of accessories to our product and international long distance monthly charges that are billed to our customers. Advertising Our goal is to position ourselves as a premier supplier of choice for VoIP services. Our current business strategy is to focus our advertising dollars on our home market in South Florida. Our advertising will consist of mass marketing campaigns focusing on television infomercials for the South Florida market and other states including cable television channels. Customers Our customers are made up of residential and small businesses. We anticipate that future services will appeal to our existing customers and hope that our additional phone products and services will provide a complete phone package experience to our customers. Our target audience is individual consumers and small businesses looking to lower their current cost of telecommunications. We are also reaching a large audience with our websites. We hope that consumers will find our websites by doing an internet search for VoIP service providers. We also use other means of advertising such as direct to consumer sales, eCommerce and wholesale sales to retail stores. Geographic Markets Our primary geographic market is our home market of South Florida. Our target audience is individual consumers and small businesses looking to lower their current cost of telecommunications. We also expect to reach a large audience with our websites. We hope that consumers will find our websites by doing an internet search for VoIP service providers. We will also use other means of advertising such as direct to consumer sales, ecommerce and wholesale sales to retail stores. We have been granted and or are applying for Competitive Local Exchange Carrier ("CLEC") Licenses in thirty two states, as follows: Alabama Idaho Massachusetts New York South Dakota West Virginia Arkansas Illinois Missouri North Carolina Texas Wisconsin California Indiana Montana North Dakota Utah Connecticut Iowa Nebraska Ohio Vermont Florida Kansas New Jersey Oregon Washington D.C. Georgia Kentucky New Mexico Pennsylvania Washington It is our intent to focus our expansion on the geographic markets in which we have been granted CLEC Licenses. We also intend to expand our market place to reach customers worldwide. Results of Operations Three months ended June 30, 2011 compared to three months ended June 30, 2010 Revenues: Our revenues amounted to $589,257 and $167,820 for the three months ended June 30, 2011, and 2010, respectively. The increase in revenues relates to increase in sales activities due to market penetration, increase in advertising and marketing expenditures and new sales to large retailers. 25 -------------------------------------------------------------------------------- Cost of sales: Our cost of sales amounted to $631,007 and $224,613 for the three months ended June 30, 2011, and 2010, respectively. The increase in cost of sales relates to increase in sales activities due to market penetration, increase advertising and marketing expenditures and new sales to large retailers. We also reclassified our customer support costs and commissions from cost of sales to operating expenses, similar to other large VOIP providers. Gross margin: Our gross margin amounted to $(41,750) and $(56,793) for the three months ended June 30, 2011 and 2010, respectively. The decrease in gross margin is negative due to original costing of the DUO upon release, which initially was much higher because components were purchased in small amounts, resulting in higher per unit costs and manufacturing of the DUO was done in the United States at a much higher cost. We now have full manufacturing set up in China and are able to buy components in larger quantities resulting in overall lower per unit costs. We have also had to air ship product in from China to meet demand for the short term. We expect to have all product shipped by container in the future, which will reduce our overall per unit cost. We expect our build of material cost to reduce over time consistent with sales as we take advantages of economies of scale, Further, we are working with call terminating vendors to reduce our price per minute costs, which we expect to be much lower as we expand our subscriber base and take advantage of economies of scale and other opportunities. Advertising and marketing: Our advertising and marketing expenses amounted to $612,046 and $59,151 for the three months ended June 30, 2011 and 2010, respectively. The breakdown of our advertising expense is as follows: June 30, 2011 2010 Infomercial/production time $ - $ - Media and others 529,965 59,151 Smartphone application costs (branding) 82,081 - Total $ 578,321 $ 59,151 Smartphone Application: We released our Smartphone application during December of 2010. The smart phone application continues to be one of the top downloaded apps in Canada. We had more than 350,000 users of our application at June 30, 2011. Compensation and Benefits: Our compensation and benefits expense amounted to $325,796 and $193,685 for the three months ended June 30, 2011 and 2010, respectively. This amount represents normal salaries and wages paid to management members and employees including marketing and administrative functions. Professional Fees: Our professional fees amounted to $83,469 and $45,435 for the three months ended June 30, 2011 and 2010, respectively. This amount includes normal payments and accruals for legal, accounting and other professional services. Our costs associated with legal and accounting fees will remain higher than historical amounts because, as a reporting company, we are required to comply with the reporting requirements of the Securities and Exchange Act of 1934, as amended (the "Exchange Act"). This involves the preparation and filing of the quarterly and annual reports required under the Exchange Act as well as other reporting requirements under the Exchange Act. We will also incur additional expenses associated with the services provided by our transfer agent. In addition, to the work we are presently doing, we will need to focus our time and energy to complying with the Exchange Act. This will detract from our ability and efforts to develop and market our products and services. We anticipate incurring these additional expenses related to being a public company without receiving a substantial increase in revenues associated with this undertaking. Depreciation and Amortization: Depreciation and amortization amounted to $91,792 and $90,948 for the three months ended June 30, 2011 and 2010, respectively. These amounts represent amortization of our long-lived tangible and intangible assets using straight-line methods and lives commensurate with the assets' remaining utility. Our long-lived assets, both tangible and intangible, are subject to annual impairment review, or more frequently if circumstances so warrant. During the three months ended June 30, 2011, we did not calculate or record impairment charges. However, negative trends in our business and our inability to meet our projected future results could give rise to impairment charges in future periods. Research and Development and Software Costs: We expense research and development expenses, as these costs are incurred. We account for our offering-related software development costs as costs incurred internally in creating a computer software product and are charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model. At this time our main product TK6000 is being sold in the market place. Therefore, research and development cost reported in our financial statements relates to pre - marketing cost and are expensed accordingly. 26 -------------------------------------------------------------------------------- Three months ended June 30, 2011 2010 Components of research and development: Product development and engineering $ 90,648 $ 52,126 Payroll and benefits 129,485 39,927 Total $ 220,133 $ 92,053 General and Administrative Expenses: General and administrative expenses amounted to $514,689 and $165,360 for the three months ended June 30, 2011 and 2010, respectively, and consisted of general corporate expenses. General corporate expenses included $74,950 in occupancy costs for the three months ended June 30, 2011 and $43,384 for the comparable period ended June 30, 2010. Due to our growth, we have expanded office space under our current lease to accommodate our increased number of employees. All increased space is within the same building under the same lease as discussed in our financial statements for the quarter ended June 30, 2011. Our other increased general and administrative costs are associated with increased administrative support related to our growth and efforts of being a public company. Our general and administrative expenses are made up of the following accounts: June 30, 2011 2010 Bad debt expense $ - $ 2,628 Commission 148,739 10,818 Rent and occupancy 74,950 43,384 Insurance 31,205 16,803 Software - 638 Taxes and licenses 14,713 18,288 Telephone - 4,739 Customer support cost 144,173 33,555 Travel 55,319 7,488 Other 45,590 27,019 Total $ 514,689 $ 165,360 Interest Expense: Interest expense amounted to $266,130 and $0 for the three months ended June 30, 2011 and 2010 respectively. Such amount represented (i) stipulated interest under our aggregate $4,200,000 face value convertible debentures, (ii) the related amortization of premiums and discounts and (iii) the amortization of deferred finance costs. Aggregate premiums continue to be credited to interest expense over the term of the debentures using the effective interest method. On June 30, 2011, we issued face value $5,266,130, 12% debentures, due July 1, 2013 and warrants to purchase 21,064,520 shares of our common stock for $0.50 per share, which expire five years from the issuance date, for $2,500,000 cash, settlement of $2,500,000 in bridge financing and settlement of $266,130 in accrued interest on the former convertible debentures. Derivative income (expense): Derivative expense amounted to $5,086,209 and $7,239,856 for the three months ended June 30, 2011 and 2010, respectively. Such amount represents the change in fair value of liability-classified warrants. Derivative financial instruments are carried as liabilities, at fair value, in our financial statements with changes reflected in income. In addition to the liability-classified warrants, we also have certain compound derivative financial instruments related to our $4,200,000 face value convertible debentures that had de minimus values. We are required to adjust our warrant and compound derivatives to fair value at each reporting period. The fair value of our warrant derivative is largely based upon fluctuations in the fair value of our common stock. The fair value of our compound derivative is largely based upon estimates of cash flow arising from the derivative and credit-risk adjusted interest rates. Accordingly, the volatility in these underlying valuation assumptions will have future effects on our earnings. 27 -------------------------------------------------------------------------------- Debt extinguished: Debt extinguished expense amounted to $824,922 and $0 for the three months ended June 30, 2011 and 2010, respectively. The extinguishment expense arose from inducement warrants that were issued as part of the conversion of our convertible debt to equity and to induce the investors to roll up the existing accrued interest at June 30, 2011 to the new debentures issued on June 30, 2011. Extinguishment Calculation $266,130 face value of debentures $ 284,238 Warrants to purchase 1,064,520 shares of common stock 416,014 700,252 Carrying value of settled obligation (266,130 ) Inducement warrants for conversion of debt and accrued interest 390,800 Extinguishment loss $ 824,922 Net income (loss): Net income (loss) amounted to $2,106,781 and $6,542,015 for the three months ended June 30, 2011 and 2010, respectively. Net income includes derivative income associated with the valuation of debentures, embedded conversion features and warrants, extinguishment expense, negative gross margin and increase in rent expense, travel expenses and customer support costs. Net loss applicable to common stockholders: The net loss applicable to common stockholders amounted to $485,905 and $6,396,153 for the three months ended June 30, 2011 and 2010, respectively. This includes the components of net income discussed above, accretion of preferred stock of $2,442,686 and $91,000 and preferred stock dividends of $150,000 and $54,862 for the three months ended June 3, 2011 and 2010 respectively. Income (loss) Per Common Share: Basic income (loss) per common share represents our income (loss) applicable to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted income (loss) per common share gives effect to all potentially dilutive securities. We compute the effects on diluted loss per common share arising from warrants and options using the treasury stock method or, in the case of liability classified warrants, the reverse treasury stock method. We compute the effects on diluted loss per common share arising from convertible securities using the if-converted method. The effects, if anti-dilutive are excluded. Results of Operations Nine months ended June 30, 2011 compared to six months ended June 30, 2010 Revenues: Our revenues amounted to $1,671,410 and $597,649 for the nine months ended June 30, 2011, and 2010, respectively. The increase in revenues relates to increase in sales activities due to market penetration, increase advertising and marketing expenditures and new sales to large retailers. Cost of sales: Our cost of sales amounted to $1,730,545 and $651,972 for the nine months ended June 30, 2011, and 2010, respectively. The increase in cost of sales relates to increase in sales activities due to market penetration, increase advertising and marketing expenditures and new sales to large retailers. We also reclassified our customer support costs and commissions from cost of sales to operating expenses, similar to other large VOIP providers. Gross margin: Our gross margin amounted to $(59,135) and $(54,323) for the nine months ended June 30, 2011 and 2010, respectively. The decrease in gross margin is negative due to original costing of the DUO upon release, which initially was much higher because components were purchased in small amounts, resulting in higher per unit costs and manufacturing of the DUO was done in the United States at a much higher cost. We now have full manufacturing set up in China and are able to buy components in larger quantities resulting in overall lower per unit costs. We have also had to air ship product in from China to meet demand for the short term. We expect to have all product shipped by container in the future, which will reduce our overall per unit cost. We expect our build of material cost to reduce over time consistent with sales as we take advantages of economies of scale, Further, we are working with call terminating vendors to reduce our price per minute costs, which we expect to be much lower as we expand our subscriber base and take advantage of economies of scale and other opportunities. 28 -------------------------------------------------------------------------------- Advertising and Marketing: Our advertising expenses amounted to $1,127,767 and $223,189 for the nine months ended June 30, 2011 and 2010, respectively. The breakdown of our advertising expense is as follows: June 30, 2011 2010 Infomercial/production time $ - $ 18,400 Media and others 1,013,662 204,789Smartphone application costs (branding) 114,105 - Total $ 1,127,767 $ 223,189 Compensation and Benefits: Our compensation and benefits expense amounted to $868,790 and $494,685 for the nine months ended June 30, 2011 and 2010, respectively. This amount represents normal salaries and wages paid to management members and employees including marketing and administrative functions. Professional Fees: Our professional fees amounted to $229,205 and $187,039 for the nine months ended June 30, 2011 and 2010, respectively. This amount includes normal payments and accruals for legal, accounting and other professional services. Our costs associated with legal and accounting fees will remain higher than historical amounts because, as a reporting company, we are required to comply with the reporting requirements of the Securities and Exchange Act of 1934, as amended (the "Exchange Act"). This involves the preparation and filing of the quarterly and annual reports required under the Exchange Act as well as other reporting requirements under the Exchange Act. We will also incur additional expenses associated with the services provided by our transfer agent. In addition, to the work we are presently doing, we will need to focus our time and energy to complying with the Exchange Act. This will detract from our ability and efforts to develop and market our products and services. We anticipate incurring these additional expenses related to being a public company without receiving a substantial increase in revenues associated with this undertaking. Depreciation and Amortization: Depreciation and amortization amounted to $272,739 and $272,156 for the nine months ended June 30, 2011 and 2010, respectively. These amounts represent amortization of our long-lived tangible and intangible assets using straight-line methods and lives commensurate with the assets' remaining utility. Our long-lived assets, both tangible and intangible, are subject to annual impairment review, or more frequently if circumstances so warrant. During the six months ended June 30, 2011, we did not calculate or record impairment charges. However, negative trends in our business and our inability to meet our projected future results could give rise to impairment charges in future periods. Research and Development and Software Costs: We expense research and development expenses, as these costs are incurred. We account for our offering-related software development costs as costs incurred internally in creating a computer software product and are charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model. At this time our main product TK6000 is being sold in the market place. Therefore, research and development cost reported in our financial statements relates to pre - marketing cost and are expensed accordingly. Components of research and development: June 30, 2011 2010 Product development and engineering $ 215,882 $ 77,621 Payroll and benefits 338,928 138,896 Total $ 554,810 $ 216,517 General and Administrative Expenses: General and administrative expenses amounted to $1,231,713 and $543,363 for the nine months ended June 30, 2011 and 2010, respectively, and consisted of general corporate expenses and certain other start up expenses. General corporate expenses included $195,944 in occupancy costs for the nine months ended June 30, 2011 and $129,774 for comparable period ended June 30, 2010. Our increased costs are associated with our efforts of being a public company. 29 -------------------------------------------------------------------------------- Our general and administrative expenses are made up of the following accounts: June 30, 2011 2010 Bad debt expense $ 408 $ 12,860 Commission 328,570 76,131 Rent and occupancy 195,944 129,774 Insurance 76,775 52,435 Software 24,485 5,587 Taxes and licenses 32,195 28,329 Telecommunication 276,294 105,349 Travel 144,282 62,207 Other 152,760 70,691 Total $ 1,231,713 $ 543,363 Interest Expense: Interest expense amounted to $542,094 and $1,184,363 for the nine months ended June 30, 2011 and 2010 respectively. Such amount represented (i) stipulated interest under our aggregate $4,200,000 face value convertible debentures, (ii) the related amortization of premiums and discounts and (iii) the amortization of deferred finance costs. Aggregate premiums continue to be credited to interest expense over the term of the debentures using the effective interest method. On June 30, 2011, we issued face value $5,266,130, 12% debentures, due July 1, 2013 and warrants to purchase 21,064,520 shares of our common stock for $0.50 per share, which expire five years from the issuance date, for $2,500,000 cash, settlement of $2,500,000 in bridge financing and settlement of $266,130 in accrued interest on the former convertible debentures. In addition, our convertible debentures as of June 30, 2010 were issued on February 24, 2010 in connection with an exchange agreement with our creditors that provided for, among other things, the consolidation of our previous secured convertible debt instruments, and included the capitalization of $798,773 of accrued interest. The capitalization of accrued interest was to include interest up to December 31, 2010. Therefore, during quarter ended June 30, 2010 we recorded no interest expense. Derivative income (expense) : Derivative (expense) income amounted to $(17,280,018) and $1,892,559 for the nine months ended June 30, 2011 and 2010, respectively. Such amount represents the change in fair value of liability-classified warrants. Derivative financial instruments are carried as liabilities, at fair value, in our financial statements with changes reflected in income. In addition to the liability-classified warrants, we also have certain compound derivative financial instruments related to our $4,200,000 face value convertible debentures that had de minimus values. We are required to adjust our warrant and compound derivatives to fair value at each reporting period. The fair value of our warrant derivative is largely based upon fluctuations in the fair value of our common stock. The fair value of our compound derivative is largely based upon estimates of cash flow arising from the derivative and credit-risk adjusted interest rates. Accordingly, the volatility in these underlying valuation assumptions will have future effects on our earnings. Debt extinguished: Debt extinguished expense amounted to $1,192,422 and $3,617,983 for the nine months ended June 30, 2011 and 2010, respectively. The extinguishment expense arose from inducement warrants that were issued as part of the conversion of our convertible debt to equity and to induce the investors to roll up the existing accrued interest at June 30, 2011 to the new debentures issued on June 30, 2011. The extinguishment expense for the nine months ended June 30, 2010 resulted from the modification of our convertible debt, which resulted in a cash flow difference of greater than 10%. Under US GAAP rules, debt modifications that result in a cash flow difference of greater than 10% must be treated as an extinguishment of the debt and issuance of new debt based on the new terms. The result was an extinguishment expense of $3,617,983. Net loss: The net loss amounted to $23,355,225 and $4,889,494 for the nine months ended June 30, 2011 and 2010, respectively. The net loss includes derivative expense associated with valuation of debentures and warrants, negative gross margin and an increase in rent expense, travel expenses and customer support costs. Net income (loss) excluding derivative valuation: Net loss excluding derivative valuation expenses amounted to $(4,882,785) and $(3,164,070) for the nine months ended June 30, 2011 and 2010. Derivative valuation expenses are "paper loss" and are not normal recurring operating expenses. Net loss applicable to common stockholders: The net loss applicable to common stockholders amounted to $28,079,590 and $5,110,362 for the nine months ended June 30, 2011 and 2010, respectively. This includes the components of net loss discussed above, accretion of preferred stock of $4,287,698 and $126,000 and preferred stock dividends of $436,667 and $94,868 for the nine months ended June 30, 2011 and 2010 respectively. 30 -------------------------------------------------------------------------------- Loss Per Common Share: Basic loss per common share represents our loss applicable to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted loss per common share gives effect to all potentially dilutive securities. We compute the effects on diluted loss per common share arising from warrants and options using the treasury stock method or, in the case of liability classified warrants, the reverse treasury stock method. We compute the effects on diluted loss per common share arising from convertible securities using the if-converted method. The effects, if anti-dilutive are excluded. |