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NET TALK.COM, INC. - 10-Q - 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 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: ? 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 prospectus, 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, which 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 products are the "DUO" and the "DUO WIFI". The DUO WIFI is expected to roll out to customers during March 2012. Both of these products are analog telephone adapters that provide connectivity for analog telephones and faxes to home, home office or corporate local area networks ("LAN"). The DUO WIFI allows users to use these services without an Ethernet cable plugged into the device. We no longer offer the TK 6000 for sale to customers. Our DUO and DUO WIFI and their related services are cost effective solution for individuals, small businesses and telecommuters connecting to any analog telephone, fax or private branch exchange ("PBX"). Our DUO and DUO WIFI provide a USB port, one Ethernet port and one analog telephone port. The DUO WIFI additionally provides a wireless chip so that users can connect to the device over WIFI hotspots. A full suite of internet protocol features is available to maximize universal connectivity. In addition, analog telephones attached to our DUO and DUO WIFI are able to use advanced calling features such as call forwarding, caller ID, 3-way calling, call holding, call retrieval and call transfer. 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 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. On September 10, 2008, we changed our name from Discover Screens, Inc. to Net Talk.com, Inc. On September 10, 2008, we acquired certain tangible and intangible assets, formerly owned by Interlink Global Corporation ("Interlink"), directly from Interlink's creditor who had seized the assets pursuant to a Security and Collateral Agreement. 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. Our Products At this time, our main products are the DUO and DUO WIFI. Our DUO and DUO WIFI are designed to provide specifications unique to each customer's existing equipment. They allow the customer full mobile flexibility by being able to take internet interface anywhere the customer has an internet connection. Our DUO and DUO WIFI both have the following features: A Universal Serial Bus ("USB") connection allowing the interconnection of our DUO and DUO WIFI to any host computer. In addition to the USB power source option, our DUO and DUO WIFI 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 DUO WIFI both have standalone feature allowing them to be plugged directly into a standard internet connection. Our DUO and DUO WIFI are compact, space-efficient products. Our DUO and DUO WIFI both have interface components 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 a broadband internet connection is available. 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. Patents - Domestic and International Our products are currently under US patent pending as well as International patent pending in over 123 countries. 23 Government Regulation As a telecommunications supplier, we are subject to extensive government regulation. The majority of our government regulation comes from the Federal Communications Commission (the "FCC"). Telecommunications is an area of rapid regulatory change. Changes in the laws and regulations and new interpretations of existing laws and regulations may affect permissible activities, the relative costs associated with doing business and amounts paid to us for our services. We cannot predict the future of federal, state and local regulations or legislation, including FCC regulations. Federal Communications Commission ("FCC") regulation The FCC is an independent United States government agency. The FCC was established by the Communications Act of 1934 and is charged with regulating interstate and international communications by radio, television, wire, satellite and cable. The FCC's jurisdiction covers all fifty states, the District of Columbia and U.S. possessions. The FCC works to create an environment promoting competition and innovation to benefit communications customers. Where necessary, the FCC has acted to ensure VoIP providers comply with important public safety requirements and public policy goals. Interconnected VoIP providers must comply with the Commission's Telecommunications Relay Services (TRS) requirements, including contributing to the TRS Fund used to support the provision of telecommunications services to persons with speech or hearing disabilities, and offering 711 abbreviated dialing for access to relay services. Interconnected VoIP providers and equipment manufacturers also must ensure that, consistent with Section 255 of the Communication Act, their services are available to and usable by individuals with disabilities, if such access is readily achievable. Finally, the FCC now requires interconnected VoIP providers and telephone companies that obtain numbers from them to comply with Local Number Portability (LNP) rules. These rules allow telephone, and now VoIP, subscribers that change providers to keep the subscribers telephone numbers provided that they stay in the same geographic area. VoIP providers must also contribute to funds established to share LNP and numbering administrative costs among all telecommunications providers benefiting from these services. The FCC monitors and investigates complaints against VoIP providers and, if necessary, can bring enforcement actions against VoIP providers that do not comply with applicable regulations. Federal CALEA On August 5, 2005, the Federal Communication Commission (the FCC) released an Order extending the obligation of the Communication Assistance for Law Enforcement Act ("CALEA") to interconnect VOIP providers. Under CALEA , telecommunication carriers must assist law enforcement in executing electronic surveillance, which includes the capability of providing call content and call indentifying information to local enforcement agencies, or LEA, pursuant to a court order or other lawful authorization. The FCC required all interconnect VOIP providers to become CALEA compliant by May 14, 2007. To date, we are fully compliant with CALEA. State Telecommunication Regulation We are also registered with the Florida Public Utilities Commission as a Competitive Local Exchange Carrier ("CLEC") and Interexchange ("IXC") Carrier. In Florida, a "competitive local exchange carrier" is defined as any company, other than an incumbent local exchange company, certificated by the Public Service Commission to provide local exchange telecommunication services in the state of Florida on or after July 1, 1995. CLEC companies providing services in Florida after July 1, 1995, must be certificated by the Florida Public Service Commission, and competitive local exchange companies are required to file a price list specifying their rates and charges for basic local telecommunication services. 24 Florida, as well as other states, also regulates providers of Interexchange Telecommunications ("IXC"). The Florida Public Service Commission includes the following as examples of IXC providers: (1) operator service providers; (2) resellers; (3) switchless re-billers; (4) multi-location discount aggregators; (5) prepaid debit card providers; and (5) facilities based interexchange carriers. Section 364.02(13) of the Florida Statutes requires IXCs to provide current contact information and a tariff to the Florida Public Service Commission. We have been granted and or are applying for Competitive Local Exchange Carrier ("CLEC") Licenses in forty three states, as follows: Alabama Hawaii Massachusetts New York Utah Arizona Idaho Michigan North Carolina Vermont Arkansas Illinois Minnesota North Dakota Washington, D.C. California Indiana Missouri Ohio Washington Colorado Iowa Montana Oregon West Virginia Connecticut Kansas Nebraska Pennsylvania Wisconsin Delaware Kentucky Nevada South Carolina Wyoming Florida Maine New Jersey South Dakota Georgia Maryland New Mexico Texas The law relating to regulation of VoIP technology is in a flux. In recent court cases, other VoIP providers have challenged whether state regulations can be applied to VoIP technology or whether such regulation has been preempted by the Telecommunications Act of 1996 and other Federal laws. At least one of our competitors has successfully fought the application of state laws to VoIP technology. However, to be cautious, we will continue to obtain a competitive local exchange carrier license from each state in which we conduct business. An added advantage of obtaining a CLEC license from each state is that we can obtain an operational carrier number from the North American Numbering Plan Administration. The operational carrier number will allow us to assign our customers telephone numbers in the area code in which they reside. 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. 25 Results of Operations Three months ended March 31, 2012 compared to three months ended March 31, 2011 Revenues: Our revenues amounted to $1,056,321 and $611,779 for the three months ended March 31, 2012, and 2011, 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. Cost of sales: Our cost of sales amounted to $1,412,297 and $972,577 for the three months ended March 31, 2012, and 2011, 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. Gross margin: Our gross margin amounted to $(355,976) and $(360,798) for the three months ended March 31, 2012 and 2011, respectively. Our gross margin remains negative due to economies of scale. 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 $429,243 and $373,701 for the three months ended March 31, 2012 and 2011, respectively. The breakdown of our advertising expense is as follows: March 31, 2012 2011 Media and others $ 383,922 $ 373,701 Smartphone application costs (branding) 45,321 - Total $ 429,243 $ 373,701 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 600,000 users of our application at March 31, 2012. Compensation and Benefits: Our compensation and benefits expense amounted to $321,996 and $104,917 for the three months ended March 31, 2012 and 2011, respectively. This amount represents normal salaries and wages paid to management members and employees including marketing and administrative functions. We continue to increase our technical staff by hiring IT engineers and software developers. Professional Fees: Our professional fees amounted to $141,635 and $77,642 for the three months ended March 31, 2012 and 2011, 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 $62,559 and $90,914 for the three months ended March 31, 2012 and 2011, 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 March 31, 2012, 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. 26 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. Three Months Ended March 31, 2012 2011 Components of research and development: Product development and engineering $ 37,282 $ 31,325 Payroll and benefits 300,111 117,794 Total $ 337,393 $ 149,119 General and Administrative Expenses: General and administrative expenses amounted to $582,490 and $232,686 for the three months ended March 31, 2012 and 2011, respectively, and consisted of general corporate expenses. General corporate expenses included $81,105 in occupancy costs for the three months ended March 31, 2012 and $66,779 for the comparable period ended March 31, 2011. Our general and administrative expenses are made up of the following accounts: Three Months Ended March 31, 2012 2011 Bad debt expense $ - $ (582 ) Commission 179,774 - Rent and occupancy 81,105 66,779 Insurance 48,319 25,190 Software - 13,260 Taxes and licenses 20,757 17,482 Telephone 7,833 5,548 Customer support cost - - Travel 69,880 36,813 Other 174,822 68,196 Total $ 582,490 $ 232,686 Interest Expense: Interest expense amounted to $1,301,969 and $149,964 for the three months ended March 31, 2012 and 2011 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. Derivative income (expense): Derivative expense amounted to $0.00 and $(22,260,451) for the three months ended March 31, 2012 and 2011, 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. Net loss: Net loss amounted to $3,533,013 and $24,167,077 for the three months ended March 31, 2012 and 2011, 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 $3,533,013 and $24,167,077 for the three months ended March 31, 2012 and 2011, respectively. 27 Net 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. |