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INTERMETRO COMMUNICATIONS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Statements
This Report contains financial projections and other "forward-looking
statements," as that term is used in federal securities laws, about our
financial condition, results of operations and business. These statements
include, among others: statements concerning the potential for revenues and
expenses and other matters that are not historical facts. These statements may
be made expressly in this Report. You can find many of these statements by
looking for words such as "believes," "expects," "anticipates," "estimates," or
similar expressions used in this Report. These forward-looking statements are
subject to numerous assumptions, risks and uncertainties that may cause our
actual results to be materially different from any future results expressed or
implied by us in those statements. The most important factors that could prevent
us from achieving our stated goals include, but are not limited to, the risks
and uncertainties discussed in the "Business" "Risk Factors" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
sections, as applicable, of our Annual Report on Form 10-K for the year ended
December 31, 2011 (the "2011 10-K") as well as the following:
(a) our success in renegotiating and settling the terms of our
indebtedness and other liabilities;
(b) Our ability to raise additional financing to the extent
necessary to continue to operate our business;
(c) volatility or decline of our stock price;
(d) potential fluctuation in quarterly results;
(e) our failure to earn revenues or profits;
(f) inadequate capital and barriers to raising capital or to
obtaining the financing needed to implement our business plans;
(g) changes in demand for our products and services;
(h) rapid and significant changes in markets;
(i) litigation with or legal claims and allegations by outside parties;
(j) insufficient revenues to cover operating costs;
(k) the possibility we may be unable to manage our growth;
(l) extensive competition;
(m) loss of members of our senior management;
(n) our dependence on local exchange carriers;
(o) our need to effectively integrate businesses we acquire;
(p) risks related to acceptance, changes in, and failure and security
of, technology; and
(q) regulatory interpretations and changes.
We caution you not to place undue reliance on forward looking statements, which
speak only as of the date of this Report. The cautionary statements contained or
referred to in this section should be considered in connection with any
subsequent written or oral forward-looking statements that we or persons acting
on behalf of us may issue. We do not undertake any obligation to review or
confirm analysts' expectations or estimates or to release publicly any revisions
to any forward-looking statements to reflect events or circumstances after the
date of this Report or to reflect the occurrence of unanticipated events.
The following discussion should be read in conjunction with our condensed
consolidated financial statements and notes to those statements.
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Background
InterMetro Communications, Inc., (hereinafter, "we," "us," "InterMetro" or the
"Company") is a Nevada corporation which through its wholly owned subsidiary,
InterMetro Communications, Inc. (Delaware) (hereinafter, "InterMetro Delaware"),
is engaged in the business of providing voice over Internet Protocol ("VoIP")
communications services.
General
We have built a national, private, proprietary voice-over Internet Protocol, or
VoIP, network infrastructure offering an alternative to traditional long
distance network providers. We use our network infrastructure to deliver voice
calling services to traditional long distance carriers, broadband phone
companies, VoIP service providers, wireless providers, other communications
companies and end users. Our VoIP network utilizes proprietary software,
configurations and processes, advanced Internet Protocol, or IP, switching
equipment and fiber-optic lines to deliver carrier-quality VoIP services that
can be substituted transparently for traditional long distance services. We
believe VoIP technology is generally more cost efficient than the circuit-based
technologies predominantly used in existing long distance networks and is easier
to integrate with enhanced IP communications services such as web-enabled phone
call dialing, unified messaging and video conferencing services.
We focus on providing the national transport component of voice services over
our private VoIP infrastructure. This entails connecting phone calls of carriers
or end users, such as wireless subscribers, residential customers and broadband
phone users, in one metropolitan market to carriers or end users in a second
metropolitan market by carrying them over our VoIP infrastructure. We compress
and dynamically route the phone calls on our network allowing us to carry up to
approximately eight times the number of calls carried by a traditional long
distance company over an equivalent amount of bandwidth. In addition, we believe
our VoIP equipment costs significantly less than traditional long distance
equipment and is less expensive to operate and maintain. Our proprietary network
configuration enables us to quickly, without modifying the existing network, add
equipment that increases our geographic coverage and calling capacity.
We enhanced our network's functionality by implementing Signaling System 7, or
SS-7, technology. SS-7 allows access to customers of the local telephone
companies, as well as customers of wireless carriers. SS-7 is the established
industry standard for reliable call completion, and it also provides
interoperability between our VoIP infrastructure and traditional telephone
company networks. While we expect to continue to add to capacity, as of
September 30, 2012 and 2011, the SS-7 network expansion was a fully operating
and revenue generating component of our VoIP infrastructure. A key aspect of our
current business strategy is to focus on sales to increase these voice minutes.
We are advancing our research and development efforts and are focused on
producing a next-generation routing product. This technology is currently in
alpha testing and no assurances are provided. The technology is designed to
significantly reduce what we would otherwise need in capital expenditures for
future revenue growth.
Overview
History. InterMetro began business as a VoIP on December 29, 2006 and began
generating revenue at that time. Since then, we have increased our revenue to
approximately $21.0 million for the year ended December 31, 2011.
Trends in Our Industry and Business
A number of trends in our industry and business could have a significant effect
on our operations and our financial results. These trends include:
Increased competition for end users of voice services. We believe there are an
increasing number of companies competing for the end users of voice services
that have traditionally been serviced by the large incumbent carriers. The
competition has come from wireless carriers, competitive local exchange
carriers, or CLECs, and interexchange carriers, or IXCs, and more recently from
broadband VoIP providers, including cable companies and DSL companies offering
broadband VoIP services over their own IP networks. All of these companies
provide national calling capabilities as part of their service offerings,
however, most of them do not operate complete national network infrastructures.
These companies previously purchased national transport services exclusively
from traditional carriers, but are increasingly purchasing transport services
from us.
Merger and acquisition activities of traditional long distance carriers.
Recently, the three largest operators of traditional long distance service
networks were acquired by or have merged with several of the largest local
wireline and wireless telecommunications companies. AT&T Corp. was acquired by
SBC Communications Inc., MCI, Inc. was acquired by Verizon Communications, Inc.
and Sprint Corporation and Nextel Communications, Inc. engaged in a merger
transaction. While we believe it is too early to tell what effects these
transactions will have on the market for national voice transport services, we
may be negatively affected by these events if these companies increase their end
user bases, which could potentially decrease the amount of services purchased by
our carrier customers. In addition, these companies have greater financial and
personnel resources and greater name recognition. However, we could potentially
benefit from the continued consolidation in the industry, which has resulted in
fewer competitors.
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Regulation. Our business has developed in an environment largely free from
regulation. However, the Federal Communications Commission ("FCC") and many
state regulatory agencies have begun to examine how VoIP services could be
regulated, and a number of initiatives could have an impact on our business.
These regulatory initiatives include, but are not limited to, proposed reforms
for universal service, the intercarrier compensation system, FCC rulemaking
regarding emergency calling services related to broadband IP devices, and the
assertion of state regulatory authority over us. Complying with regulatory
developments may impact our business by increasing our operating expenses,
including legal fees, requiring us to make significant capital expenditures or
increasing the taxes and regulatory fees applicable to our services. One of the
benefits of our implementation of SS-7 technology is to enable us to purchase
facilities from incumbent local exchange carriers under switched access tariffs.
By purchasing these traditional access services, we help mitigate the risk of
potential new regulation related to VoIP.
Our Business Model
Historically, we have been successful in implementing our business plan through
the expansion of our VoIP infrastructure. Since our inception, we have grown our
customer base to include over 200 customers, including several large
publicly-traded telecommunications companies and retail distribution partners.
In connection with the addition of customers and the provision of related voice
services, we have expanded our national VoIP infrastructure.
Revenue. We generate revenue primarily from the sale of voice minutes that are
transported across our VoIP infrastructure. In addition, ATI, as a reseller,
generates revenues from the sale of voice minutes that are currently transported
across other telecom service providers' networks. However, we have migrated a
significant amount of these revenues on to our VoIP infrastructure and continue
to migrate ATI's revenues. We negotiate rates per minute with our carrier
customers on a case-by-case basis. The voice minutes that we sell through our
retail distribution partners are typically priced at per minute rates, are
packaged as calling cards and are competitive with traditional calling cards and
prepaid services. Our carrier customer services agreements and our retail
distribution partner agreements are typically one year in length with automatic
renewals. We generally bill our customers on a weekly or monthly basis with
either a prepaid balance required at the beginning of the week or month of
service delivery or with net terms determined by the customers'
creditworthiness. Factors that affect our ability to increase revenue include:
· Changes in the average rate per minute that we charge our customers.
Our voice services are sold on a price per minute basis. The rate per minute for
each customer varies based on several factors, including volume of voice
services purchased, a customer's creditworthiness, and, increasingly, use of our
SS-7 based services, which are priced higher than our other voice transport
services.
· Increasing the net number of customers utilizing our VoIP services.
Our ability to increase revenue is primarily based on the number of carrier
customers and retail distribution partners that we are able to attract and
retain, as revenue is generated on a recurring basis from our customer base. We
expect increases in our customer base primarily through the expansion of our
direct sales force and our marketing programs. Our customer retention efforts
are primarily based on providing high quality voice services and superior
customer service. We expect that the addition of SS-7 based services to our
network will significantly increase the universe of potential customers for our
services because many customers will only connect to a voice service provider
through SS-7 based interconnections.
· Increasing the average revenue we generate per customer.
We increase the revenue generated from existing customers by expanding the
number of geographic markets connected to our VoIP infrastructure. Also, we are
typically one of several providers of voice transport services for our larger
customers, and can gain a greater share of a customer's revenue by consistently
providing high quality voice service.
· Acquisitions.
We expect to expand our revenue base through the acquisition of other voice
service providers. We plan to continue to acquire businesses whose primary cost
component is voice services or whose technologies expand or enhance our VoIP
service offerings.
We expect that our revenue will increase in the future primarily through the
addition of new customers gained from our direct sales and marketing activities
and from acquisitions.
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Network Costs. Our network, or operating, costs are primarily comprised of fixed
cost and usage based network components. In addition, ATI incurs usage based
costs from its underlying telecom service providers. We generally pay our fixed
network component providers at the beginning or end of the month in which the
service is provided and we pay for usage based components on a weekly or monthly
basis after the delivery of services. Some of our vendors require a prepayment
or a deposit based on recurring monthly expenditures or anticipated usage
volumes. Our fixed network costs include:
· SS-7 based interconnection costs.
During the first nine months of 2006, we added a significant amount of capacity,
measured by the number of simultaneous phone calls our VoIP infrastructure can
connect in a geographic market, by connecting directly to local phone companies
through SS-7 based interconnections purchased on a monthly recurring fixed cost
basis. As we expand our network capacity and expand our network to new
geographic markets, SS-7 based interconnection capacity will be the primary
component of our fixed network costs. Until we are able to increase revenues
based on our SS-7 services, these fixed costs significantly reduce the gross
profit earned on our revenue.
· Other fixed costs.
Other significant fixed costs components of our VoIP infrastructure include
private fiber-optic circuits and private managed IP bandwidth that interconnect
our geographic markets, monthly leasing costs for the collocation space used to
house our networking equipment in various geographic markets, local loop
circuits that are purchased to connect our VoIP infrastructure to our customers
and usage based vendors within each geographic market. Other fixed network costs
include depreciation expense on our network equipment and monthly subscription
fees paid to various network administrative services.
The usage-based cost components of our network include:
· Off-net costs.
In order to provide services to our customers in geographic areas where we do
not have existing or sufficient VoIP infrastructure capacity, we purchase
transport services from traditional long distance providers and resellers, as
well as from other VoIP infrastructure companies. We refer to these costs as
"off-net" costs. Off-net costs are billed on a per minute basis with rates that
vary significantly based on the particular geographic area to which a call is
being connected.
· SS-7 based interconnections with local carriers.
The SS-7 based interconnection services that are purchased from the local
exchange carriers, include a usage based, per minute cost component. The rates
per minute for this usage based component are significantly lower than the per
minute rates for off-net services. The usage based costs for SS-7 services
continue to be the largest cost component of our network as we grow revenue
utilizing SS-7 technology.
Our fixed-cost network components generally do not experience significant price
fluctuations. Factors that affect these network components include:
· Efficient utilization of fixed-cost network components.
Our customers utilize our services in identifiable fixed daily and weekly
patterns. Customer usage patterns are characterized by relatively short periods
of high volume usage, leaving a significant amount of time during each day where
the network components remain idle.
Our ability to attract customers with different traffic patterns, such as
customers who cater to residential calling services, which typically spike
during evening hours, with customers who sell enterprise services primarily for
use during business hours, increases the overall utilization of our fixed-cost
network components. This decreases our overall cost of operations as a
percentage of revenues.
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· Strategic purchase of fixed-cost network components.
Our ability to purchase the appropriate amount of fixed-cost network capacity to
(1) adequately accommodate periods of higher call volume from existing
customers, (2) anticipate future revenue growth attributed to new customers, and
(3) expand services for new and existing customers in new geographic markets is
a key factor in managing the percentage of fixed costs we incur as a percentage
of revenue.
From time to time, we also make strategic decisions to add capacity with newly
deployed technologies, such as the SS-7 based services, which require purchasing
a large amount of network capacity in many geographic markets prior to the
initiation of customer revenue.
We expect that both our fixed-cost and usage-based network costs will increase
in the future primarily due to the expansion of our VoIP infrastructure and use
of off-net providers related to the expected growth in our revenues.
Our usage-based network components costs are affected by:
· Fluctuations in per minute rates of off-net service providers.
Increasing the volume of services we purchase from our vendors typically lowers
our average off-net rate per minute, based on volume discounts. Another factor
in the determination of our average rate per minute is the mix of voice services
we use by carrier type, with large fluctuations based on the carrier type of the
end user which can be local exchange carriers, wireless providers or other voice
service providers.
· Sales mix of our VoIP infrastructure capacity versus off-net services.
Our ability to sell services connecting our on-net geographic markets, rather
than off-net areas, affects the volume of usage based off-net services we
purchase as a percentage of revenue.
· Acquisitions of telecommunications businesses.
Long term, we expect to continue to make acquisitions of telecommunications
companies. As we complete these acquisitions and add an acquired company's
traffic and revenue to our operations, we may incur increased usage-based
network costs. These increased costs will come from traffic that remains with
the acquired company's pre-existing carrier and from any of the acquired
company's traffic that we migrate to our SS-7 services or our off-net carriers.
We may also experience decreases in usage based charges for traffic of the
acquired company that we migrate to our network. The migration of traffic onto
our network requires network construction to the acquired company's customer
base, which may take several months or longer to complete.
Sales and Marketing Expense . Sales and marketing expenses include salaries,
sales commissions, benefits, travel and related expenses for our direct sales
force, marketing and sales support functions. Our sales and marketing expenses
also include payments to our agents that source carrier customers and retail
distribution partners. Agents are primarily paid commissions based on a
percentage of the revenues that their customer relationships generate. In
addition, from time to time we may cover a portion or all of the expenses
related to printing physical cards and related posters and other marketing
collateral. All marketing costs associated with increasing our retail consumer
user base are expensed in the period in which they are incurred. We expect that
our sales and marketing expenses will increase in the future primarily due to
increases in our direct sales force.
General and Administrative Expense . General and administrative expenses include
salaries, benefits and expenses for our executive, finance, legal and human
resources personnel. In addition, general and administrative expenses include
fees for professional services, occupancy costs and our insurance costs, and
depreciation expense on our non-network depreciable assets. Our general and
administrative expenses also include stock-based compensation on option grants
to our employees and options and warrant grants to non-employees for goods and
services received.
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Results of Operations for the Three Months Ended September 30, 2012 and 2011
The following table sets forth, for the periods indicated, the results of our
operations expressed as a percentage of revenue:
Three Months Ended
September 30,
2012 2011
Net revenues 100 % 100 %
Network costs 76 83
Gross profit 24 17
Operating expenses:
Sales and marketing 4 4
General and administrative 14 19
Impairment of goodwill - 9
Total operating expenses 18 32
Operating income (loss) 6 (15 )
Accounts payable write-off and gain on forgiveness of debt 4 32
Interest expense (5 ) (6 )
Net income 5 % 11 %
Net Revenues. Net revenues increased $584,000, or 11.8%, to $5.5 million for the
three months ended September 30, 2012 from $4.9 million for the three months
ended September 30, 2011. We have continued to increase new customers and expand
revenue to certain existing customers. This has been partially offset by the
loss of certain low-margin customers, primarily attributable to ATI, combined
with decreased revenues from existing customers. Specifically, while the
addition of new customers and increased revenues from existing customers
contributed approximately $3.3 million to revenue in the three months ended
September 30, 2012 these revenue gains were offset by an approximate $2.7
million decrease in revenue attributable to the loss of customers or decreased
revenue from existing customers.
Network Costs. Network costs increased 81,000, or 2.0%, to $4.2 million for the
three months ended September 30, 2012 from $4.1 million for the three months
ended September 30, 2011. Included within total network costs, variable network
costs increased by $240,000 to $4.0 million (72.1% of revenues) for the three
months ended September 30, 2012 from $3.7 million (75.8% of revenues) for the
three months ended September 30, 2011. Fixed network costs decreased by $159,000
to $223,000 for the three months ended September 30, 2012 from $382,000 for the
three months ended September 30, 2011. There were reductions to fixed network
expenses during the three months ended September 30, 2012 as part of
streamlining the use of fixed cost facilities. Gross margin increased to 23.8%
for the three months ended September 30, 2012 from a gross margin of 16.5% for
the three months ended September 30, 2011. The decrease in variable costs as a
percentage of revenues and the increase in gross margin were related primarily
to changes in traffic patterns during the three months ended September 30, 2012
as well as the reduction in fixed cost.
Sales and Marketing. Sales and marketing expenses increased $22,000, or 13.3% to
$188,000 for the three months ended September 30, 2012 from $166,000 for the
three months ended September 30, 2011. Sales and marketing expenses as a
percentage of net revenues were 3.4% for the three months ended September 30,
2012 and 2011. The increase is in direct relation to the increase in revenues.
General and Administrative. General and administrative expenses decreased
$172,000 or 18.0% to $782,000 for the three months ended September 30, 2012 from
$954,000 for the three months ended September 30, 2011. General and
administrative expenses as a percentage of net revenues were 14.2% and 19.3% for
the three months ended September 30, 2012 and 2011, respectively. Bad debt
expense was $0 in the three months ended September 30, 2012 as compared to
$110,000 in the three months ended September 30, 2011. A $37,000 decrease in
payroll for ATI also contributed to the decrease in general and administrative
expense from the previous period. General and administrative expenses for the
three months ended September 30, 2012 included stock-based compensation of
$36,000.
Impairment of goodwill. The Company determined that due to the decline in
revenue and operating income of ATI in 2011, the carrying value of the Company's
goodwill was not fully recoverable and took a charge for the impairment of
goodwill in the amount of $450,000 in the three months ended September 30, 2011.
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Accounts Payable Write Off and Gain on Forgiveness of Debt. During the three
months ended September 30, 2012, the Company recorded a gain on forgiveness of
debt of $216,000 related to cash payment plan agreements with vendors for
amounts less than the liability recorded in account payable and accrued
expenses. During the three months ended September 30, 2011, the Company entered
into numerous cash payment plan agreements with vendors for amounts less than
the liability recorded in accounts payable and accrued expenses. As a result of
these agreements, the Company recorded a gain on forgiveness of debt of
$1,087,000 for the three months ended September 30, 2011. In addition, the
Company wrote-off certain accounts payable for Competitive Local Exchange
Carriers ("CLEC") that resulted in a gain of $527,000 for the same period in
2011and was included in accounts payable write-off. The CLEC accounts payable
were written off based on a two year statute of limitations on such accounts
payable balances.
Interest Expense, net. Interest expense, net decreased $25,000, or 7.9%, to
$292,000 for the three months ended September 30, 2012 from $317,000 for the
three months ended September 30, 2011.
Results of Operations for the Nine months Ended September 30, 2012 and 2011
The following table sets forth, for the periods indicated, the results of our
operations expressed as a percentage of revenue:
Nine months Ended
September 30,
2012 2011
Net revenues 100 % 100 %
Network costs 76 77
Gross profit 24 23
Operating expenses:
Sales and marketing 3 4
General and administrative 17 17
Impairment of goodwill - 3
Total operating expenses 20 24
Operating income 4 (1 )
Accounts payable write-off and gain on forgiveness of debt 4 23
Interest expense (6 ) (5 )
Net income 2 % 17 %
Net Revenues. Net revenues decreased approximately $1.7 million, or 10.2%, to
$14.9 million for the nine months ended September 30, 2012 from $16.6 million
for the nine months ended September 30, 2011 Though we have continued to
increase new customers, this has been offset by a reduction in offering third
party low margin services and attributable to both decreasing revenues from
existing customers in certain areas and the loss of certain customers. The
addition of new customers and increased revenues from existing customers
contributed approximately $5.3 million to revenue in the nine months ended
September 30, 2012. These gains were offset by an approximate $7.0 million
decrease in revenue attributable to the loss of customers or decreased revenue
from existing customers.
Network Costs. Network costs decreased $1.5 million, or 11.5%, to $11.2 million
for the nine months ended September 30, 2011 from $12.7 million for the nine
months ended September 30, 2011. Included within total network costs, variable
network costs decreased by $1.1 million to $10.5 million (70.7% of revenues) for
the nine months ended September 30, 2012 from $11.6 million (69.9% of revenues)
for the nine months ended September 30, 2011. Fixed network costs decreased by
$402,000 to $749,000 for the nine months ended September 30, 2012 from $1.2
million the nine months ended September 30, 2011. Gross margin increased to
24.2% for the nine months ended September 30, 2012 from a gross margin of 23.1%
for the nine months ended September 30, 2011. The increase in gross margin was
related primarily to changes in traffic patterns during the nine months ended
September 30, 2012 as well as the reduction in fixed cost.
Sales and Marketing. Sales and marketing expenses decreased $92,000, or 15.3% to
$511,000 for the nine months ended September 30, 2012 from $603,000 for the nine
months ended September 30, 2011. Sales and marketing expenses as a percentage of
net revenues were 3.4% and 3.6% for the nine months ended September 30, 2012 and
2011, respectively. The decrease is primarily attributable to the decrease in
ATI revenues from which agent commissions are paid. In addition, a change in
product mix resulted in a decrease in certain high percentage commissions.
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General and Administrative. General and administrative expenses decreased
$253,000 or 8.9% to $2.6 million for the nine months ended September 30, 2012
from $2.8 million for the nine months ended September 30, 2011. General and
administrative expenses as a percentage of net revenues were 17.3% and 17.1% for
the nine months ended September 30, 2012 and 2011, respectively. Bad debt
expense was $0 in the nine months ended September 30, 2012 as compared to
$152,000 in the nine months ended September 30, 2011. A $101,000 decrease in
payroll for ATI, a $65,000 reduction in insurance cost and a $61,000 reduction
in legal fees also contributed to the decrease in general and administrative
expense from the previous period. General and administrative expenses for the
nine months ended September 30, 2012 included stock-based compensation of
$213,000.
Impairment of goodwill. The Company determined that due to the decline in
revenue and operating income of ATI in 2011, the carrying value of the Company's
goodwill was not fully recoverable and took a charge for the impairment of
goodwill in the amount of $450,000 in the nine months ended September 30, 2011.
Accounts Payable Write Off and Gain on Forgiveness of Debt. During the nine
months ended September 30, 2012, the Company entered into numerous cash payment
plan agreements with vendors for amounts less than the liability recorded in
accounts payable and accrued expenses. As a result of these agreements, the
Company recorded a gain on forgiveness of debt of $329,000 for the nine months
ended September 30, 2012. Also, the Company has a policy, based on the statute
of limitations, as prescribed by law, to write-off accounts payable with written
contract more than four years old with no current activity and two years when
there is no written agreement. The Company recorded a gain of $293,000 for the
nine months ended September 30, 2012 related to these write-offs which is
included in accounts payable write-off. During the nine months ended September
30, 2011, the Company entered into numerous cash payment plan agreements with
vendors for amounts less than the liability recorded in accounts payable and
accrued expenses. As a result of these agreements, the Company recorded a gain
on forgiveness of debt of $3,010,000 for the nine months ended September 30,
2011. In addition, the Company wrote-off certain accounts payable for
Competitive Local Exchange Carriers ("CLEC") that resulted in a gain of $864,000
for the same period, and is included in accounts payable write-off. The CLEC
accounts payable were written off based on a two year statute of limitations on
such accounts payable balances.
Interest Expense, net. Interest expense, net decreased $39,000, or 4.3%, to
$868,000 for the nine months ended September 30, 2012 from $907,000 for the nine
months ended September 30, 2011.
Liquidity and Capital Resources
At September 30, 2012, we had $489,000 in cash as compared to cash of $390,000
at December 31, 2011. The Company's working capital position, defined as current
assets less current liabilities, has historically been negative and was negative
$10.0 million at September 30, 2012 and negative $12.7 million at December 31,
2011.
Significant changes in cash flows from September 30, 2012 as compared
to September 30, 2011:
Net cash provided by operating activities was $273,000 for the nine months ended
September 30, 2012 as compared to net cash used in operating activities of
$237,000 for the nine months ended September 30, 2011. Net income for the nine
months ended September 30, 2012 included non-cash gains of approximately
$622,000 while the non-cash gains included in net income for the period ending
September 30, 3011 were approximately $3.9 million and such gains are subtracted
from net income in arriving at net cash provided by operating activities. The
most significant adjustments increasing cash from operating activities in the
nine months ended September 30, 2012 were the increase in accounts payable and
accrued expenses and the non-cash expense of stock based compensation.
Net cash used in investing activities for the nine months ended September 30,
2012 was $33,000 which was attributable to the purchase of computers and
network-related equipment. Purchases of network-related equipment were $30,000
in the nine months ended September 30, 2011.
Net cash used in financing activities for the nine months ended September 30,
2012 was $141,000 as compared to cash used in financing activities of $105,000
for the nine months ended September 30, 2011. The primary use of cash for
financing activities for the nine months ended September 30, 2012 was $118,000
in principal payments of lines of credit. The primary use of cash for financing
activities for the nine months ended September 30, 2011 was a $100,000 payment
for the exercise of a warrant put.
The Company had a working capital deficit of $10,006,000 and a stockholders'
deficit of $12,793,000 as of September 30, 2012. The Company's ability to
continue as a going concern will require additional financings if its ability to
generate cash from operations does not fund required payments on its debt
obligations. Obligations to the Company's debt holders include interest and
principal payments to its secured note holders (see Note 7), principal and
interest due on its revolving line of credit (see Note 11) and settlement
payments due (see Note 6). The loan under the revolving line of credit is
secured by substantially all of the Company's assets. The Company has other
significant matters of importance, including contingencies such as vendor
disputes and lawsuits discussed in Note 12 that could have material adverse
consequences, including cessation of operations at any time.
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If the Company were to require additional financings in order to fund ongoing
operations there can be no assurance that it will be successful in completing
the required financings, that could ultimately cause the Company to cease
operations. The consolidated financial statements do not include any
adjustments relating to the recoverability and classification of asset carrying
amounts or the amount and classification of liabilities that might result should
the Company be unable to continue as a going concern. There are many claims and
obligations that could ultimately cause the Company to cease operations. The
report from the Company's independent registered public accounting firm relating
to the year ended December 31, 2011 states that there is substantial doubt about
the Company's ability to continue as a going concern.
Management believes that the losses in past years were primarily attributable to
costs related to building out and supporting a telecommunications
infrastructure, and the requirement for continued expansion of the customer
base, in order for the Company to become profitable. This resulted in the
Company taking on debt and delaying payment to certain vendors. The Company may
be required to obtain other financing during the next twelve months or
thereafter as a result of future business developments, including any
acquisitions of business assets or any shortfall of cash flows generated by
future operations in meeting the Company's ongoing cash requirements. Such
financing alternatives could include selling additional equity or debt
securities, obtaining long or short-term credit facilities, or selling operating
assets. Management continues to work with its historical vendors in order to
secure the continued extension of credit. Management believes that cash flows
from operations and additional debt conversions are integral to management's
plan to retire past due obligations and be positioned for growth. No assurance
can be given, however, that the Company will be successful in restructuring its
debt on terms favorable to the Company or at all. Should the Company be
unsuccessful in this restructuring, material adverse consequences to the Company
could occur such as cessation of its operations. Any sale of additional common
stock or convertible equity or debt securities would result in additional
dilution to the Company's stockholders.
Credit Facilities
Revolving Credit Facility - In April 2008, the Company entered into a
convertible revolving credit agreement pursuant to which the Company may access
funds up to $1.5 million. In September 2008, the Company entered into Amendment
No. 1 to the agreement which increased the access to $2.0 million, in November
2008 the Company entered into Amendment No 2 to the agreement which increased
the access to $2.4 million and in May 2009 the Company entered into Amendment
No. 4 to the agreement which increased the access to $2.55 million. The
availability of loan amounts at December 31, 2009 under the revolving credit
agreement was to expire on April 30, 2009. The Company entered into Amendment
No. 5 to the agreement as of January 31, 2010 that extended the expiration to
April 30, 2010. The Company entered into Amendment No. 6 on September 29, 2010,
effective April 30, 2010, that extended the expiration to March, 30, 2011and
Amendment No. 7 as of December 31, 2010 that lowered the amount of the principal
reduction payments required as of December, 31, 2010. The Company entered into
Amendment No. 8 as of March 30, 2011 that extended the expiration to June 30,
2011, Amendment No.9 as of June 30, 2011 that extended the expiration to
September 30, 2011, Amendment No.10 as of September 30, 2011 that extended the
expiration to November 30, 2011, Amendment No. 11 that extended the expiration
to March 30, 2012, Amendment No. 12 that extended the expiration to May 30, 2012
and Amendment No. 13 that extended the expiration to August 16, 2012. As of
September 30, 2012, the Company is permitted to borrow an amount not to exceed
85% of its eligible accounts receivable. As of September 30, 2012, the Company
had borrowed $2.025 million. The Company's obligations are secured by all of the
assets of the Company. Annual interest on the loans is equal to the greater of
(i) the sum of (A) the Prime Rate (B) 4% or (ii) 15%, and shall be payable in
arrears prior to the maturity date, on the first business day of each calendar
month, and in full on August 16, 2012. The Agreement includes covenants that the
Company must maintain including financial covenants pertaining to cash flow
coverage of interest and fixed charges, limitations on the ratio of debt to cash
flow and a minimum ratio of current assets to current liabilities. The Company
is not in compliance with the financial covenants as of September 30,
2012. (See Note 11 to the Consolidated Financial Statements for detailed
discussion.)
Effective October 12, 2012 the Company secured a new credit facility with
Transportation Alliance Bank, Inc. ("TAB Bank"). and entered into agreements
with Moriah to pay off its debt. The Company has secured a $3,000,000 senior
credit facility with TAB Bank pursuant to which the Company is permitted to
borrow $3,000,000, up to 85% of its eligible accounts, at any time until the
maturity date of September 29, 2014. This facility generally accrues interest at
the greater of (i) 9.50% per annum, or (ii) the sum of the lender's stipulated
prime rate plus 6.25%. The Company initially borrowed $1,338,000 from this
facility. The loan provides for interest-only monthly payments, is generally
secured by all the Company's assets but subject to certain prior liens, and
includes financial covenants pertaining to cash flow coverage of interest and
fixed charges and a requirement for a minimum level of tangible net worth.
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Critical Accounting Policies and the Use of Estimates
Our financial statements are prepared in accordance with accounting principles
generally accepted in the U.S. The preparation of these financial statements
requires us to make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenue, costs and expenses and related disclosures. We
base our estimates on historical experience and on various other assumptions
that we believe to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying value of assets and
liabilities that are not readily apparent from other sources. We evaluate our
estimates and assumptions on an ongoing basis. Actual results may differ from
these estimates under different assumptions or conditions.
We believe that the following accounting policies involve the greatest degree of
judgment and complexity. Accordingly, these are the policies we believe are the
most critical to aid in fully understanding and evaluating our financial
condition and results of operations.
Revenue Recognition.
We recognize our VoIP services revenues when services are provided, primarily on
usage. Revenues derived from sales of calling cards through related distribution
partners are deferred upon the sale of the cards. These deferred revenues are
recognized as revenues generally when all usage of the cards occurs. The Company
has revenue sharing agreements based on successful collections. The Company
recognizes revenue from these customers at time of invoicing based on the
history of collections with such customers. We recognize revenue in the period
that services are delivered and when the following criteria have been met:
persuasive evidence of an arrangement exists, the fees are fixed and
determinable, no significant performance obligations remain for us and
collection of the related receivable is reasonably assured. Our deferred
revenues consist of fees received or billed in advance of the delivery of the
services or services performed in which cash receipt is not reasonably assured.
This revenue is recognized when the services are provided and no significant
performance obligations remain or when cash is received for previously performed
services. We assess the likelihood of collection based on a number of factors,
including past transaction history with the customer and the credit worthiness
of the customer. Generally, we do not request collateral from our customers. If
we determine that collection of revenues are not reasonably assured, we defer
the recognition of revenue until the time collection becomes reasonably assured,
which is generally upon receipt of cash.
Stock-Based Compensation.
The Company has adopted FASB ASC 718 "Compensation - Stock Compensation". The
Company is applying the "modified prospective transition method" under which it
continues to account for nonvested equity awards outstanding at the date of
adoption of FASB ASC 718 in the same manner as they had been accounted for prior
to adoption, that is, it would continue to apply APB 25 in future periods to
equity awards outstanding at the date it adopted FASB ASC 718, unless the
options are modified or amended.
For grants to employees under the 2004 plan and 2007 plan in the year ended
December 31, 2008, the Company estimated the fair value of each option award on
the date of grant using the Black-Scholes option-pricing model using the
assumptions noted in the following table. Expected volatility is based on the
historical volatility of a peer group of publicly traded entities. The expected
term of the options granted is derived from the average midpoint between vesting
and the contractual term, as described in the SEC's Staff Accounting Bulletin
No. 107, "Share-Based Payment." The risk-free rate for the expected term of the
option is based on the U.S. Treasury yield curve in effect at the time of grant.
Accounts Receivable and the Allowance for Doubtful Accounts
Accounts receivable consist of trade receivables arising in the normal course of
business. We do not charge interest on our trade receivables. The allowance for
doubtful accounts is our best estimate of the amount of probable credit losses
in our existing accounts receivable. We review our allowance for doubtful
accounts monthly. We determine the allowance based upon historical write-off
experience, payment history and by reviewing significant past due balances for
individual collectibility. If estimated allowances for uncollectible accounts
subsequently prove insufficient, additional allowance may be required.
Impairment of Long-Lived Assets
We assess impairment of our other long-lived assets in accordance with the
provisions of FASB ASC 360, "Property, Plant and Equipment". An impairment
review is performed whenever events or changes in circumstances indicate that
the carrying value may not be recoverable. Factors considered by us include:
· Significant underperformance relative to expected historical or projected
future operating results;
· Significant changes in the manner of use of the acquired assets or the
strategy for our overall business; and
· Significant negative industry or economic trends.
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When we determine that the carrying value of a long-lived asset may not be
recoverable based upon the existence of one or more of the above indicators of
impairment, an estimate is made of the future undiscounted cash flows expected
to result from the use of the asset and its eventual disposition. If the sum of
the expected future undiscounted cash flows and eventual disposition is less
than the carrying amount of the asset, an impairment loss is recognized in the
amount by which the carrying amount of the asset exceeds the fair value of the
asset, based on the fair market value if available, or discounted cash flows if
not. To date, we have not had an impairment of long-lived assets and are not
aware of the existence of any indicators of impairment.
Goodwill
We record goodwill when consideration paid in a business acquisition exceeds the
fair value of the net tangible assets and the identified intangible assets
acquired. The Company accounts for goodwill and intangible assets in accordance
with FASB ASC 350 "Goodwill and Other". FASB ASC 350 requires that goodwill and
intangible assets with indefinite useful lives not be amortized, but instead be
tested for impairment. FASB ASC 350 also requires the Company to amortize
intangible assets over their respective finite lives up to their estimated
residual values. At September 30, 2012, management does not believe there is any
impairment in the value of goodwill.
Accounting for Income Taxes
We account for income taxes using the asset and liability method in accordance
with FASB ASC 740 "Income Taxes", which requires the recognition of deferred tax
assets and liabilities for the expected future tax consequences of temporary
differences between the carrying amounts and tax bases of the assets and
liabilities. We periodically review the likelihood that we will realize the
value of our deferred tax assets and liabilities to determine if a valuation
allowance is necessary. We have concluded that it is more likely than not that
we will not have sufficient taxable income of an appropriate character within
the carryforward period permitted by current law to allow for the utilization of
certain of the deductible amounts generating deferred tax assets; therefore, a
full valuation allowance has been established to reduce the deferred tax assets
to zero at September 30, 2012 and 2011. In addition, we operate within multiple
domestic taxing jurisdictions and are subject to audit in those jurisdictions.
These audits can involve complex issues, which may require an extended period of
time for resolution. Although we believe that our financial statements reflect a
reasonable assessment of our income tax liability, it is possible that the
ultimate resolution of these issues could significantly differ from our original
estimates.
Net Operating Loss Carryforwards
As of September 30, 2012 and December 31, 2011, our net operating loss
carryforwards for federal tax purposes were approximately $39 million and $40
million, respectively. These net operating losses occurred subsequent to our
business combination in December 2006.
Contingencies and Litigation
We evaluate contingent liabilities including threatened or pending litigation in
accordance with FASB ASC 450 "Contingencies" and record accruals when the
outcome of these matters is deemed probable and the liability is reasonably
estimable. We make these assessments based on the facts and circumstances and in
some instances based in part on the advice of outside legal counsel.
It is not unusual in our industry to occasionally have disagreements with
vendors relating to the amounts billed for services provided. We currently have
disputes with vendors that we believe did not bill certain charges correctly.
While we have paid the undisputed amounts billed for these non-recurring charges
based on rate information provided by these vendors, as of September 30, 2012,
there is approximately $61,000 of unresolved charges in dispute. We are in
discussion with these vendors regarding these charges and may take additional
action as deemed necessary against these vendors in the future as part of the
dispute resolution process.
Contractual Obligations
We have no capital lease obligations at September 30, 2012. The operating lease
for our corporate offices expires March 31, 2013 with a monthly lease payment of
$14,000. There are no significant provisions in our agreements with our network
partners that are likely to create, increase, or accelerate obligations due
thereunder other than changes in usage fees that are directly proportional to
the volume of activity in the normal course of our business operations.
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The following table reflects a summary of our contractual obligations at
September 30, 2012:
Payments Due by Period
(Dollars in Thousands)
Less Than More Than
Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years
Operating lease obligations 84 84 - - -
Total $ 84 $ 84 $ - $ - $ -
Recent Accounting Pronouncements
For a discussion of the impact of recently issued accounting pronouncements, see
the subsection entitled "Recent Accounting Pronouncements" contained in Note 1
of the Notes to Condensed Consolidated Financial Statements under "Item 1.
Financial Statements".
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