Item 1. Description of Business
General
We own and operate a national, private, cloud-based, proprietary Voice-over Internet Protocol, or VoIP, network infrastructure, powered by state-of-the-art switching equipment and software that can serve as 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 and other communications companies. Our VoIP network utilizes proprietary software, configurations and processes, advanced Internet Protocol, or IP, proprietary switching equipment and fiber-optic lines to deliver Tier-1, carrier-quality, VoIP services that can be substituted transparently for traditional long distance services. Based on the ability to compress data transported across VoIP infrastructures and significantly lower capital cost per equivalent equipment capacity, we believe that VoIP technology in general, and the InterMetro proprietary VoIP network in particular, is generally more cost efficient than the circuit-based technologies predominately used in existing long distance networks. In addition, traditional circuit based switches typically use proprietary embedded call control systems. In contrast, we believe VoIP technology, which uses software specifically developed to facilitate the sharing of data across different systems, makes for easier integration with enhanced IP communications services such as web-enabled phone call dialing, unified messaging and video conferencing services. As well, the network functionality fully supports Signaling System 7, or SS-7, which is the industry standard for reliable call completion and which provides interoperability between our VoIP proprietary network and the traditional telephone company networks.
We focus on providing the national transport component of voice services over our private VoIP infrastructure. This entails connecting phone calls of our customers’ end users, in one metropolitan market to our customers’ end users in a second metropolitan market by carrying them over our proprietary VoIP infrastructure. We compress 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 while maintaining Tier-1, carrier-quality service. In addition, we believe our proprietary VoIP equipment costs significantly less than traditional long distance equipment based on the cost per equivalent voice port capacity and is less expensive to operate and maintain based on lower electricity needs, smaller space requirements and fewer engineers to operate. Our proprietary software and hardware enable us to quickly, without modifying the existing network, add equipment that increases our geographic coverage and calling capacity.
Historically, VoIP services have been hampered by poor sound quality and by lack of interoperability with traditional circuit-based phone devices. Our private, managed network design, as opposed to use of the unmanaged public Internet, gives us a high level of control of sound quality and we have designed internal hardware and software that provide access to our infrastructure from traditional phone devices. Our network services allow our customers to reduce costs while taking advantage of access to useful information about their voice traffic and can be easily accessed with both traditional phone devices and new IP-based devices, such as broadband IP phones, IP videophones and wireless IP phones.
Our proprietary VoIP infrastructure delivers significant benefits to our customers, including:
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increasing the margins earned from existing retail voice services or reducing the costs of using voice services;
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improving customer service through access to real-time information about network performance and billing;
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reducing the administrative burden for our customers of managing their end users;
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increasing the investment return on customer owned traditional circuit-based equipment; and
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enabling the creation of value-added enhanced voice services.
Our goal is to displace the current long distance carriers as the presumed choice for voice transport services and to continue to grow as a significant provider of VoIP infrastructure services for traditional phone companies and wireless carriers, as well as new high growth entrants in the consumer voice services market such as broadband phone companies, cable operators and web-based or mobile application providers.
We also package our VoIP services into calling cards and prepaid services. We have developed plug-and-play technology designed to enable IP devices, such as broadband phones and videophones, to be plugged directly into end users’ broadband internet routers, allowing for instant use of our services without having to configure the device or install any software to interoperate with our network. These technologies are expected to be sold under private label third-party arrangements. We sell our services through our direct sales force and independent sales agents. Our calling cards and prepaid services are primarily sold by our retail distribution partners. We believe that our proprietary technology and management experience in the communications industry, and in particular with VoIP, will enable us to benefit from the increased and continuing adoption of VoIP technologies by traditional phone companies.
Company Background
InterMetro Communications, Inc. (Ticker:IMTO) (hereinafter, “we,” “us,” “InterMetro” or the “Company”) is a publicly-owned 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. On December 29, 2006, InterMetro, a public “shell” company, completed a Business Combination with InterMetro Delaware whereby InterMetro Delaware became our wholly-owned subsidiary. On the closing of the Business Combination, we authorized the issuance of 27,490,194 shares of common stock and 3,652,842 common stock purchase warrants to the InterMetro Delaware security holders. On May 31, 2007, the Company filed Amended and Restated Articles of Incorporation increasing the Company’s authorized shares of common stock to 150,000,000, par value $0.001 per share, at which time the second phase of 14,049,580 shares of common stock and 2,983,335 common stock purchase warrants were effectively issued in exchange for all of the remaining InterMetro Delaware common stock and warrants held by InterMetro Delaware security holders. All InterMetro Delaware securities were effectively cancelled except 100 shares of InterMetro Delaware common stock which represent 100% of the outstanding stock of the wholly-owned subsidiary.
InterMetro Delaware was originally incorporated in the State of California on July 22, 2003 to build a communications business based on VoIP technology and was reincorporated in Delaware on May 10, 2006.
In March 2006, we acquired all of the outstanding stock of Advanced Tel, Inc. (“ATI”), a switchless reseller of wholesale long-distance services, for a combination of stock and cash. ATI was acquired to increase our customer base, to add minutes to our network, to access new sales channels and to provide a retail channel for future distribution of our products..
Our Service Offerings
We use our proprietary, cloud-based network backbone to deliver voice calling services to traditional long distance carriers, broadband phone companies, VoIP service providers, wireless providers and other communications companies.
Carrier Services . Carrier services consist of origination and termination services. Such services are provided over our VoIP network constructed as a nationwide system of regional IP nodes known as Points-of-Presence, or PoPs, connected by a fiber-optic backbone and other bandwidth segments utilizing a secure packet technology called asynchronous transfer mode, or ATM. Our PoPs are typically located in major metropolitan cities and allow us to connect to a majority of the personal and business telephones within a metropolitan geographic region to deliver Tier-1, carrier-grade voice service quality.
Because the cloud-based network is based on IP technology, the network enables a significant amount of information to be passed to our customers. This allows us to differentiate our service from traditional wholesale voice providers by providing unique, real-time information along with enhanced voice services. Important uses for this functionality include the ability to quickly identify misuse or fraud that is occurring with a customer’s user base or to react more quickly to marketing opportunities based on identifiable trends in traffic patterns.
We believe our services offer our carrier customers a competitive advantage by:
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providing an alternative to the large traditional network service providers that have influenced price and service levels;
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increasing margins transparently by reducing direct network costs while maintaining or improving the quality of service received by their end users;
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providing access to our VoIP infrastructure without altering the physical connection process to a voice network and without any required investment in new equipment or software; and
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providing new functionality to reduce the cost of customer care and improve fraud detection.
Retail Services . Our retail VoIP services are sold to consumers and distributed in the form of calling cards or through the distribution of personal identification numbers, or PINs. Our retail services integrate the installation of voice services with billing and customer care functionality and voice and data applications such as on-demand conferencing and find-me/follow-me service. We primarily distribute our retail services through retail distribution partners who keep a portion of the retail revenue as well as through our subsidiary, ATI. We have created an automated system for activating and recharging our retail products. We believe our automation significantly lowers costs for retail distribution partners. For example, our automated PIN generating system replaces the need for point of sale terminals which charge per sale transaction fees and require initial integration and software setup.
Our VoIP network is highly flexible and allows our retail distribution partners to design voice products that fit the needs of their underlying end users. Our VoIP network allows our retail distribution partners to take advantage of their brand name recognition and customer loyalty.
We believe our services offer end users and retail distribution partners attractive solutions by:
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allowing for delivery of “ready-to-shelf” customized voice service products tailored specifically to our retail distribution partners’ end user demographics without any outlay for inventory; and
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providing access to our VoIP network allowing retail customers to use their existing telephones with no requirement to purchase new equipment or software and without the need for broadband access.
IP Devices . We expect to enter into arrangements with one or more distribution partners under which they would sell plug-and-play product devices which do not require additional software. These devices would be purchased from manufacturers and would be configured to work exclusively with our network. We have developed three IP devices - the Broadband MetroFone, the VideoLine MetroFone, and the DialLine MetroFone. We do not currently generate any revenue from these products.
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Broadband MetroFone . The Broadband MetroFone looks and operates like a traditional phone but will use a customer’s broadband internet connection and our network to complete calls as compared to traditional phone calls which travel over low bandwidth copper line networks.
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VideoLine MetroFone . The VideoLine MetroFone operates in the same manner as the Broadband MetroFone but also has the additional capability of sending and receiving real-time television quality video between any of our videophones.
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DialLine MetroFone . The DialLine MetroFone is an IP device, which connects between a retail customer’s phone and wall jack to automatically connect a retail customer with our network.
Web-Services . We are in the process of developing a web-service offering. Web-services allow voice to be embedded in applications so that end users could move seamlessly between voice and data communications streams.
Technology and Network Infrastructure
Our state-of-the-art proprietary, cloud-based VoIP network is comprised of three basic components: switching equipment, software and network facilities. The underlying server platforms for our proprietary VoIP switching equipment are manufactured by leading telecommunications industry equipment manufacturers and enable us to manage voice and data traffic and the associated billing information. Our software applications, including both third party software and internally developed proprietary software, allow for web-based control of our VoIP switching platform and access to data gathered by our VoIP switches. We and our customers utilize this advanced functionality to monitor network performance, capacity utilization and traffic patterns, among other metrics, in real-time. Our IP-based core network facilities provide an efficient physical transport layer for voice and data traffic, and are supplemented by other carriers’ networks to provide extensive domestic and international coverage.
The geographic markets serviced by our VoIP infrastructure are connected by leased fiber lines and private IP circuits. In many geographic markets we have leased collocation facilities where we have installed our ATM/MPLS switching equipment which is used to interconnect these fiber lines and IP circuits. This equipment interconnects to the fiber lines running between markets in the network and our VoIP gateway equipment. The VoIP gateway equipment performs analog-to-digital conversion and compression of IP voice. The network is designed to be redundant and self-healing, so that isolated events do not disrupt overall service. Our proprietary software and hardware configuration enables us to quickly, without modifying the existing network, add equipment that increases our geographic coverage and calling capacity.
Our network switching system is configured to connect to carrier customers by connecting their switches with ours via traditional circuit-switched connections or, increasingly, through private and public IP connections. We utilize SS-7 technology, the industry standard for reliable call completion and interoperability, to connect our network directly to local telephone companies and wireless networks in the major metropolitan markets. The combination of SS-7 technology and direct local telephone company interconnections allows us to offer additional services to our customers that we believe make it easier for potential customers that use long distance companies to transition their voice traffic to our VoIP network.
We also believe that one of our competitive advantages is the ability to incorporate customized software applications into our VoIP network. This allows us to provide enhanced functionality and customer service tools. Our VoIP switching system has an application programming interface (“API”) to allow for the creation of software application tools to create the enhanced control and functionality features. Our engineering team has extensive experience in implementing value-added applications that allow for greater flexibility in creating services and greater control over network efficiencies and costs. We have developed technology to provide control of the network and access to network utilization data to us and to our customers. Customers can access their own customer service web interfaces that can be used for operations, such as rate modification, customer activation and deactivation, fraud/abuse detection and capacity utilization, among other services. Customers can also utilize the interfaces to control costs by managing traffic flow to their various network vendors, allowing them to least cost route in the same way as large telecommunications companies.
Sales, Marketing and Distribution
Carrier Services Sales Strategy . We employ a direct sales approach for carrier sales, which is led by experienced sales professionals with detailed knowledge of the carrier industry. We provide product knowledge, product application consulting, pricing, delivery, and performance information to potential customers so that they are able to assist us in designing services that meet their specific needs and preferences. As we expect to expand the resources of our sales department, our sales professionals will be increasingly focused on customer, channel, and geographic levels that are intended to allow us to manage the sales cycle more efficiently. We currently target traditional purchasers of wholesale voice transport services including: inter-exchange carriers, international-based carriers sending voice calls to the U.S., wireless carriers, prepaid service providers, internet-based voice service providers, such as broadband phone companies and cable companies.
We complement our direct sales force with an agent-based sales channel. Through the use of sales agents we reach a larger universe of potential customers. The agent community in the telecommunication industry is large and well-established. A typical agent promotes solutions from a variety of service providers into the carrier buying community. Agents act as telecommunications consultants to the customer creating long-term relationships and developing contacts within organizations. A key role of the agent is to advise the customer on various providers’ offerings.
Retail Services Sales Strategy . We package our VoIP services into calling card and other prepaid services and PIN products sold to retail customers of voice services. These VoIP services are sold through retail distribution partners, including general merchandise and discount retail chains, and do not require distributors to invest in any new technology or to understand the underlying technologies required to service and bill voice products. We enter into agreements with our retail distribution partners that define the terms under which they sell our services.
We design specific products for each retail distribution partner to improve adoption of our services and to improve our partners’ profitability. Retail distributors of our VoIP services collect the revenue from the sale of our products and pass on a majority of the funds collected, holding back a portion of the revenue as compensation for providing the distribution services. We continue to seek innovative ways to expand the scope of our distribution channels and enhance our ability to identify and retain retail distribution partners. In addition, we also intend to cross-sell services through existing retail distribution partners.
Marketing Overview . We create brand awareness and lead generation through our presence at key trade shows, targeted mailings to specific industry carrier lists and buyers and trade magazine advertising. Additionally, we maintain a web site presence and make available collateral describing our services and business.
Competition
Carrier Services. When selling to carrier customers, we primarily compete with other carriers, including Verizon, CenturyLink and Level(3). We also compete with a number of smaller IP-based providers that focus either on a specific product or set of products or within a geographic region. We compete primarily on the basis of transmission quality, network reliability, price and customer service and support.
Retail Services. We compete for retail distribution partners against long distance providers including AT&T, Sprint and IDT who provide calling cards and prepaid services. Retail distributors purchase these products based on price and private label customization.
Our Competitive Strengths
We believe our highly flexible, scalable and secure cloud-based VoIP infrastructure delivers the cost and functionality benefits of VoIP technology to our customers. Since inception, we have built our network on VoIP technology and, unlike most incumbent carriers with legacy networks, we do not have to make substantial investments to upgrade from less efficient circuit-based technology still in use today by many traditional carriers. We believe our VoIP network is robust and efficient, based on redundancies in equipment and network transmission paths, and utilizes some of the most advanced VoIP technology available. Based on our proprietary hardware, we also believe we have significantly lower capital costs for equivalent equipment expansion compared to some of the largest incumbent carriers.
We help our carrier customers increase their margins by lowering the cost of their wholesale voice transport usage, which enhances the economic value to them of their existing end users. We help our retail customers access lower cost VoIP-based solutions for their communications service needs by making our services accessible through calling cards which can be utilized from their existing residential and wireless phones. We intend to continue investing in our VoIP infrastructure to improve and expand our range of existing service offerings and to address the constantly evolving needs of voice transport customers.
Our competitive strengths include:
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State-of-the-art private, proprietary VoIP infrastructure. We built our cloud-based VoIP infrastructure from advanced IP technology. We are not burdened by some of the constraints commonly faced by traditional telecommunications companies that use circuit-based equipment. Legacy equipment is more difficult to combine with the latest add-on voice services and network transport technology because it typically uses proprietary embedded call control systems. We operate and maintain our VoIP technology with significantly fewer personnel and lower operating costs than switch-based technology while achieving comparable capacity.
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Cost-efficient IP-based voice services . We believe our proprietary hardware and software VoIP technology provides significant cost savings due to compression and routing efficiencies combined with reduced server requirements for equivalent capacities. In addition, we save money by using equipment that requires little space and significantly reduced electricity costs versus older circuit-switched equipment. Our management team has extensive experience in negotiating pricing and contract terms for these types of products and services with the largest carriers. We can pass a significant portion of our cost savings on to our customers to help drive sales growth.
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Experience marketing VoIP services . Our seasoned management team has significant experience with wireline and wireless telecommunications and experience with IP-based communications. Our in-depth knowledge of the VoIP industry, including familiarity with the hardware, software and vendors, allows us to advise potential customers on how to incorporate the technology to increase profitability and increase customer reach. Members of our management team have marketed VoIP services to a wide range of customers and have been instrumental in developing new products to meet individual customer demands.
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Product flexibility and speed of deployment . We believe our private network equipment provides a high level of integration between the installation of voice services and billing and customer care functions. We believe our VoIP technology, specifically developed to facilitate the sharing of data across different systems, allows us to create and deploy new products more quickly than many traditional communications companies. We also utilize our proprietary VoIP infrastructure to tailor retail products to the individual needs of our retail distribution partners.
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Strong engineering team with experience in both voice and data networking . Our engineering team is comprised of individuals with backgrounds in networking, software development, database administration and telecommunications installations. We believe our engineering team is among the most experienced in understanding VoIP services and the related software applications. Members of our engineering team have successfully deployed leading-edge technology in prior businesses, including the build-outs of both a national web hosting service and a large IP-based voice service network.
Intellectual Property
Our intellectual property is an important element of our business, but we believe that our competitive advantage depends primarily on the experience of our management team and the knowledge and skill of our engineering and technology staff. Our management team and technical staff periodically review our technological developments to identify core technologies that continue to provide us with a competitive advantage. We rely on a combination of patent, copyright, trademark and trade secret laws both domestically and internationally and confidentiality procedures to protect our intellectual property rights. Further, our employees and independent contractors are required to sign agreements acknowledging that all inventions, trade secrets, copyrights, works of authorship, developments and other processes generated by them on our behalf are our property, and assigning to us any ownership that they may claim in those matters. Our standard form agreements for carrier customers and retail distribution partners also contain provisions designed to protect our intellectual property rights.
We are the owners of one patent and two patent applications filed with the U.S. Patent and Trademark Office. Our patent relates to a system for routing toll free telephone calls. Both of our patent applications have been published. One patent application relates to the technology which combines instant messenger services with voice services. The other application relates to a method for transporting voice calls utilizing a combination of Internet Protocol and Asynchronous Transfer Mode. We are working with legal counsel to make all necessary filings to advance the examination of both patent applications. In January 2011, we filed a provisional patent with the U.S. Patent and Trademark Office relating to a proprietary system for lowest cost routing of voice calls over our network.
We are the owner of numerous trademarks and service marks for telecommunication services, phone cards, computer software, computer hardware, and telephone sets and have applied for registration of our trademarks and service marks to establish and protect our brand names as part of our intellectual property strategy.
In addition, we have non-exclusive license agreements with respect to technology and related databases from third parties related to the operations of our VoIP platform and the provision of certain service features. We believe our licenses will be renewable or replaceable on commercially reasonable terms.
While the Company currently utilizes its proprietary hardware and software technology primarily as a method for expanding and supporting its own VoIP network infrastructure, there may be future growth opportunities by productizing any of the technology for the marketplace.
Governmental Regulation
The use of the public Internet and private InternetProtocol networks to provide voice communications services, including VoIP, is a relatively recent market development. The provision of such services is largely unregulated within the U.S. The Federal Communications Commission (“FCC”) has not finally classified VoIP services for regulatory purposes. Some courts and other authorities classify VoIP services as “information services” rather than “telecommunications services”, which are subject to many more regulatory constraints. Most recently, the FCC ordered that, as of mid-2012, VoIP providers prospectively pay a form of “access charges” if they terminate or originate calls to a local exchange company (LEC) network, without ruling on the regulatory classification issue. The FCC has relied upon its ancillary authority to impose common obligations on VoIP providers and telecommunications providers. These include compliance with 911/E911 requirements, contributions to the federal Universal Service Fund, compliance with Local Number Portability and customer privacy/marketing restrictions and Communications Assistance for Law Enforcement obligations. The FCC requires VoIP providers to contribute to universal service, subject to some exclusions and limitations. At present, these contributions are calculated based on contributors’ interstate and international revenue derived from U.S. end users, as those terms are defined under FCC regulations
At the state level many states have recently passed laws that prohibit state public utility commissions from imposing new regulations on VoIP services without explicit authority from the state legislature. In September of 2012 California joined 24 other states in passing such legislation with SB 1161. This new law prohibits any law that regulates VoIP, unless required or delegated by federal law or expressly authorized by statute. Thus, the full extent of state and federal regulation over the Company’s VoIP services is limited and unclear at the present moment. The telecommunications industry is sharply divided in current regulatory proceedings over how the FCC should regulate the high-capacity protocol-based fiber-optic networks that are currently being deployed and there is disagreement on how those networks should interconnect with legacy networks. .
We are subject to federal, state, local and foreign laws, regulations of general applicability with respect to the conduct of business such as zoning requirements, permit or right-of-way procedures, taxation and franchise requirements and environmental laws. Foreign laws and regulations may apply to communications that originate or terminate in a foreign country. Regulation varies in each jurisdiction and may change in response to judicial proceedings, legislative and administrative proposals, government policies, competition, and technological developments.
We cannot predict the outcome of any current regulatory proceedings or any similar petitions and regulatory proceedings pending before the FCC or state public utility commissions. Moreover, we cannot predict how their outcomes may affect our operations or whether the FCC or state public utility commissions will impose additional requirements, regulations or charges upon our provision of IP communications services. Changes or uncertainties in the regulations applicable to our business and the communications industry may negatively affect our business. If regulatory approvals become a requirement, delays in receiving required regulatory approvals may result in higher costs and lower revenues. Further, changes in communications, trade, monetary, fiscal and tax policies in the U.S. may negatively impact our results of operations.
Employees
As of December 31, 2013, we had 24 employees, all of whom were full time and located in the United States. We have never had a work stoppage and none of our employees is represented by a labor organization or under any collective bargaining arrangements. We consider our employee relations to be good.
Item 1A.
Item 1A. Risk Factors
Our business is subject to a variety of risks and uncertainties including the material risks described below. If any of these risks materialize, our business, financial condition or operating results could be adversely affected. The risks described below are not the only ones we face. Additional risks not currently known to us or that we currently do not deem material also may become important factors that may materially and adversely affect our business.
Risks Related To Our Business
We have a working capital deficit and had losses in the past, which raise doubt about our ability to continue as a going concern.
We have a working capital deficit of $12.1 million as of December 31, 2013 and a net loss for the year of $2.4 million. Though we were profitable in the year ended December 2012, we had net losses in previous years and we will have to generate and sustain significant gross margin to maintain profitability. Our increasing gross margin growth trends in prior periods have not been sustainable, and we may not achieve sufficient revenue to maintain profitability. We may incur significant losses in the future for a number of reasons, including those discussed in other risk factors and due to factors that we cannot foresee. We have past due balances with certain vendors that may result in collection actions unless we settle them. We may not generate sufficient funds to bring these accounts current.
The Independent Auditor’s Report covering the Company’s audited financial statements for the year ended December 31, 2013 contains an explanatory paragraph expressing substantial doubt about the Company’s ability to continue as a going concern. As indicated in Note 1 to such financial statements, our ability to continue as a going concern will require additional financings if our ability to generate cash from operations does not fund required payments on our debt obligations. Additionally, the Company has other significant matters such as vendor disputes and lawsuits that could have material adverse consequences to the Company, including possible cessation of operations. While the Company is actively taking steps to address these issues (see Note 1), there can be no assurance that the Company will be successful in this regard.
If the Company were to require additional financings in order to fund ongoing operations until such time as the Company continues to consistently achieve positive cash flow from operations, there can be no assurance that we will be successful in completing the required financings or that we will continue operations.
A substantial portion of our revenue is generated from a limited number of carrier customers, and if we lose a major customer our revenue and profits could decrease.
A substantial portion of our revenue is generated from a limited number of our carrier customers. Our top 10 customers have accounted for approximately 65% and 79% of our revenues for the years ended December 31, 2013 and 2012, respectively. We expect that a limited number of carrier customers may continue to account for a significant percentage of our revenue and the loss of, or material reduction of, their purchases could materially decrease our revenue and profits and harm our business.
We have entered into a number of settlement and payment plans with vendors and our obligations under these plans may adversely affect our liquidity.
As a function of the losses the Company experienced in years prior to 2010, the Company delayed payments due to certain of its vendors. During 2013, 2012, 2011 and 2010, we entered into a number of payment plan agreements with vendors, and we will continue to approach vendors to enter into similar agreements. Although these agreements allowed the Company to record a gain on forgiveness of debt for 2013 and 2012 (see Note 6 to the Consolidated Financial Statements), our repayment obligations under the agreements entered into to date totals an aggregate of approximately $68,000 per month as of December 31, 2013. These obligations can be expected to have an adverse effect on our liquidity in the short to mid-term.
We have a relatively limited operating history, which could make it difficult to accurately evaluate our business and prospects.
We began offering VoIP services in March 2004. Accordingly, we have a relatively limited operating history and, as a result, we have limited historical financial data that you can use to evaluate our business and prospects. In addition, we derive nearly all of our revenue from VoIP services, which utilize a relatively new technology that has undergone rapid changes in its short history. Our business model is also evolving and it may not be successful. As a result of these factors, the future revenue and income potential of our business is uncertain. Although we have experienced revenue growth in the past, we have not been able to sustain this growth. Any evaluation of our business and our prospects must be considered in light of these factors and the risks and uncertainties often encountered by companies in our stage of development. Some of these risks and uncertainties relate to our ability to do the following:
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maintain and expand our current relationships, and develop new relationships, with carrier customers, retail distribution partners, network vendors and equipment providers;
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continue to grow our revenue and meet anticipated growth targets;
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manage our expanding operations and implement and improve our operational, financial and management controls;
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adapt to industry consolidation;
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continue to grow our sales force and marketing efforts;
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successfully introduce new, and upgrade our existing, VoIP technologies and services;
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respond to government regulations and legislation relating to VoIP, traditional telecommunications services, the Internet, IP-based services and other aspects of our business;
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respond effectively to competition; and
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attract and retain qualified management and employees.
If we are unable to address these risks, our business, results of operations and prospects could suffer.
Our operating results may fluctuate in the future, which could make our results of operations difficult to predict or cause them to fall short of expectations.
Our future operating results may vary significantly from quarter to quarter due to a variety of factors, many of which are beyond our control and could cause our results to be below investors’ expectations, causing the value of our securities to fall. Because our business is evolving, our historical operating results may not be useful in predicting our future operating results. Factors that may increase the volatility of our operating results include the following:
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the addition of new carrier customers and retail distribution partners or the loss of existing customers and retail distribution partners;
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changes in demand and pricing for our VoIP services;
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the timing of our introduction of new VoIP products and services and the costs we incur to develop these technologies;
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the timing and amount of sales and marketing expenses incurred to attract new carrier customers and retail distribution partners;
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changes in the economic prospects of carrier customers or the economy generally, which could alter current or prospective need for voice services, or could increase the time it takes us to close sales with customers;
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changes in our pricing policies, the pricing policies of our competitors or the pricing of VoIP services or traditional voice services generally;
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costs related to acquisitions of businesses or technologies; and
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the use of VoIP as a replacement for traditional voice services is a relatively new occurrence and carrier customers have not settled into consistent spending patterns.
Our industry is highly competitive and competitive pressures could prevent us from competing successfully in the voice transport services industry.
The carrier and retail markets for voice transport services are intensely competitive. We expect this competition to continue to increase because there are currently no significant barriers to entry into our market. We compete both for wholesale carrier business and for retail consumption of voice transport services. We compete for wholesale carrier business on the basis of a number of factors, including price, quality, geographic reach and customer service. Our competitors often are large, well-established in the communications industry and enjoy several competitive advantages over us, including:
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greater financial and personnel resources;
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greater name recognition;
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established relationships with greater numbers of wholesale carriers;
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established distribution networks;
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greater experience in obtaining and maintaining FCC and other regulatory approvals for products and product enhancements and greater experience in developing compliance programs under U.S. federal, state and local laws and regulations;
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greater experience in lobbying the U.S. Congress and state legislatures for the enactment of legislation favorable to their interests;
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greater experience in product research and development;
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greater experience in launching, marketing, distributing and selling products; and
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broader-based and deeper product lines.
Our primary current and potential competitors consist of carriers including AT&T, Sprint, Verizon, CenturyLink, Level (3) and other start-up VoIP providers that have been formed in the recent past and IP networking companies that are attempting to add voice as a supplement to their current data services offerings.
We also compete with companies focused on the distribution of retail voice services and expect to compete with companies providing VoIP services and broadband IP phones and videophones.
If we lose any member of our senior management team and are unable to find a suitable replacement, we may not have the depth of senior management resources required to efficiently manage our business and execute our growth strategy.
We depend on the continued contributions of our senior management and skilled employees. We do not maintain key person life insurance policies on any of our officers. There is a risk that the loss of a significant number of key personnel could have negative effects on our results of operations. We may not be able to attract and hire highly skilled personnel to replace lost employees necessary to carry out our business plan. There is also a risk that management may not be able to adopt or maintain an organizational structure that meets its objectives, including managing costs and attracting and retaining key employees.
We also need to hire additional members of senior management to adequately manage our growing business. We may not be able to identify and attract additional qualified senior management. Competition for senior management in our industry is intense. Qualified individuals are in high demand, and we may incur significant costs to attract them. If we are unable to attract and retain qualified senior management we may not be able to implement our business strategy effectively and our revenue may decline. Our success is substantially dependent on the performance of our executive officers and key employees. Given our early stage of development, we are dependent on our ability to retain and motivate high quality personnel. An inability to engage qualified personnel could materially adversely affect our ability to market our VoIP services. The loss of one or more of our key employees or our inability to hire and retain other qualified employees could have a material adverse effect on our business. See “Management”.
We are dependent on a limited number of suppliers and on other capacity providers.
We currently depend on critical services and equipment from a small number of suppliers. There is no guarantee that these suppliers will continue to offer us the services and equipment we require. If we cannot obtain adequate replacement equipment or services from our suppliers or acceptable alternate vendors, we could experience a material impact on our financial condition and operating results. In addition, we rely on other providers for network capacity beyond what we provide over our own network and there is a risk that current capacity providers may cease to provide capacity at economically justifiable rates.
We are dependent on providers of local telecommunications services to reach the end users for our services.
We currently depend on providers of local telecommunications services to provide end users with access to substantially all of our VoIP services. In the future, we may utilize other local telecommunications services suppliers to reach end users such as wireless carriers, cable companies, power companies and other providers of local broadband services. There is no guarantee that these suppliers will continue to offer the services we require, that these services will be available on economic terms sufficient to execute on our business model or that these suppliers will continue to do business with us. If we cannot obtain adequate replacement services from our suppliers or acceptable alternate vendors, we could experience a material impact on our financial condition and operating results.
We are from time to time subject to disputes with customers, vendors and other third parties relating to amounts claimed due for services which we may not be able to resolve in our favor.
It is not unusual in our industry to occasionally have disagreements with vendors and other third parties relating to amounts claimed due in connection with the services provided by us or companies like us. To the extent we are unable to favorably resolve these disputes, our revenues, profitability or cash may be adversely affected. The majority of these disputes relate to the difference in pricing that we expect to pay when calls originate and terminate in different U.S. states or international jurisdictions versus the characterizations of these calls as being originated and terminated within the same U.S. state.
We are negotiating with certain federal agencies regarding payment of amounts owing, and failure to finalize, or meet the terms of, the related payment plans could have a material adverse effect on the Company.
The Company had not made all of the payments claimed by the Universal Service Administrative Company (“USAC”) which administers the Universal Service Fund. See Item 3 (Legal Proceedings) below for a description of this matter. These unpaid amounts were transferred to the Federal Communications Commission (“FCC”) for collection, and the FCC has transferred some of these amounts to the Department of the Treasury, which has worked with the Company to establish long term payment plans. The Company is continuing to work with the FCC and the Department of the Treasury to resolve these amounts in long term payment programs. The failure for any reason to finalize a payment plan, or the failure to satisfy the terms of any such plan once established, could be expected to have a material adverse effect on the Company and its financial condition and results of operations.
We may pursue the acquisition of other businesses in order to grow our customer base and access technology and talent, and any such acquisition may not achieve the desired results or could result in operating difficulties, dilution and other harmful consequences.
We expect to pursue acquisitions in the future as a key component of our business strategy. We do not know if we will be able to successfully complete any future acquisitions. Furthermore, we do not know that we will be able to successfully integrate any other acquired business, product or technology or retain any key employees of any acquired business. Integrating any business, product or technology we acquire could be expensive and time-consuming, disrupt our ongoing business and distract our management. If we are unable to integrate any acquired businesses, products or technologies effectively, our results of operations and financial condition will suffer. There may not be attractive acquisition opportunities available to us in the future. In addition, acquisitions involve numerous risks, any of which could harm our business, including:
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diversion of management’s attention and resources from other business concerns;
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difficulties and expenditures associated with integrating the operations and employees from the acquired company into our organization, and integrating each company’s accounting, management information, human resources and other administrative systems to permit effective management;
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inability to maintain the key business relationships and the reputations of the acquired businesses;
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ineffectiveness or incompatibility of acquired technologies or services with our existing technologies and systems;
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potential loss of key employees of acquired businesses;
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responsibility for liabilities of acquired businesses;
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unavailability of favorable financing for future acquisitions;
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inability to maintain our standards, controls, procedures and policies, which could affect our ability to receive an unqualified attestation from our independent accountants regarding management’s required assessment of the effectiveness of our internal control structure and procedures for financial reporting; and
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increased fixed costs.
The acquisition of another business, particularly in another country, can subject us to liabilities and claims arising out of such business, including tax liabilities and liabilities arising under foreign regulations. Future acquisitions would also likely require additional financing, resulting in an increase in our indebtedness or the issuance of additional capital stock which could be dilutive to holders of shares issued in this offering. Finally, any amortization or charges resulting from the costs of acquisitions could harm our operating results.
If we fail to manage our growth effectively, our business could be adversely affected.
We have experienced rapid growth in our operations and to a lesser extent, our headcount, and we may experience continued growth in our business, both through acquisitions and internal growth. This growth will continue to place significant demands on our management and our operational and financial resources. In particular, continued growth will make it more difficult for us to accomplish the following:
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recruit, train and retain a sufficient number of highly skilled personnel;
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maintain our customer service standards;
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maintain the quality of our VoIP platform;
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develop and improve our operational, financial and management controls and maintain adequate reporting systems and procedures;
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successfully scale our VoIP platform, including network, software and other technology, to accommodate a larger business; and
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maintain carrier and end user satisfaction.
The improvements required to manage our growth will require us to make significant expenditures and allocate valuable management resources.
Sales of our IP devices may be severely limited due to their failure to gain broad market acceptance.
In the future, we intend to sell IP devices and related services. Market acceptance requires, among other things, that we
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educate consumers on the benefits of our products;
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commit a substantial amount of human and financial resources to secure strategic partnerships and otherwise support the retail and/or carrier distribution of our products;
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develop our own sales, marketing and support activities to consumers, broadband providers and retailers; and
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establish a sufficient number of retail locations carrying our products.
In the event we are unable to achieve any or all of these objectives, consumers may perceive little or no benefit from our products and may be unwilling to pay for them.
Rapid technological changes in the industry in which we operate our business or the market in which we intend to sell our IP devices may render such devices obsolete or otherwise harm us competitively.
We operate in a highly technological industry segment that is subject to rapid and frequent changes in technology and market demand. Frequently such changes can immediately and unexpectedly render existing technologies obsolete. Management expects that technology developed in the future will be superior to the technology that we (and others) now have. Our success depends on our ability to assimilate new technologies into our VoIP infrastructure and our IP devices and to properly train engineers, sales staff, distributors and resellers in the use of our technology. The success of our future service offerings or devices depends on several factors, including but not limited to proper new product definition, product cost, timely completion and market introduction of such services, differentiation of our future products from those of our competitors and market acceptance of these products. Competing technologies developed by others may render our current or future developed products or technologies obsolete or noncompetitive. The failure of our new product development efforts could have a detrimental effect on our business and results of operations.
If we discover IP device defects, we may have product-related liabilities that may cause us to lose revenues or delay market acceptance of our IP devices.
Devices as complex as those we intend to offer frequently contain errors, defects, and functional limitations when first introduced or as new versions are released. We have in the past experienced such errors, defects or functional limitations.
We intend to sell devices into markets that are demanding of robust, reliable and fully functional products. Therefore, delivery of devices with production defects or reliability, quality, or compatibility problems could significantly delay or hinder market acceptance, which could damage our credibility with our customers and adversely affect our ability to attract new customers. Moreover, such errors, defects, or functional limitations could cause problems, interruptions, delays, or a cessation of sales to our customers. Alleviating such problems may require significant expenditures of capital and resources by us. Despite our testing, our suppliers or our customers may find errors, defects or functional limitations in new products after commencement of commercial production, which could result in additional development costs, loss of, or delays in, market acceptance, diversion of technical and other resources from our other development efforts, product repair or replacement costs, claims by our customers or others against us, or the loss of credibility with prospective customers.
Uncertainty or negative publicity may negatively affect the VoIP industry generally and our business.
There is a possibility that uncertainty regarding broad market acceptance of VoIP technology or adverse publicity or negative perceptions about the VoIP industry as a whole could hinder our ability to obtain new customers or undermine our commercial relationship with existing customers. Further, the adoption of VoIP in the telecommunications industry may not materialize and, even if there is such adoption, our business may not benefit from it.
Our ability to protect our intellectual property is uncertain.
We rely on patent protection, trade secrets, know-how and contractual means to protect our proprietary technology. Patents may afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. For example, our pending U.S. patent applications may not issue as patents in a form that will be advantageous to us, or may issue and be subsequently successfully challenged by others and invalidated. In addition, our pending patent applications include claims to material aspects of our products and methods that are not currently protected by issued patents. Furthermore, competitors may be able to design around the claims of our patents, or develop products or methods outside the scope of our issued claims which provide outcomes which are comparable to ours. We also rely on know-how and trade secrets to maintain our competitive position. Confidentiality agreements or other agreements with our employees, consultants and advisors may not be enforceable or may not provide meaningful protection for our proprietary technology, know-how, trade secrets, or other proprietary information in the event of misappropriation, unauthorized use or disclosure or other breaches of the agreements, or, even if such agreements are legally enforceable, we may not have adequate remedies for breaches of such agreements. The failure of our patents or agreements to protect our proprietary technology could result in significantly lower revenues, reduced profit margins or loss of market share.
The market for our products depends to a significant extent upon the goodwill associated with our trademarks and service marks. We own, or have licenses to use, the material trademarks, service marks and trade names used in connection with the packaging, marketing and distribution of our products in the markets where those products are sold. Therefore, trademark protection is important to our business. Although most of our trademarks and service marks are registered in the U.S., we may not be successful in asserting trademark protection. In addition, the laws of certain foreign countries may not protect our trademarks or service marks to the same extent as the laws of the U.S. The loss or infringement of our trademarks or service marks could impair the goodwill associated with our brands, harm our reputation and have a material adverse effect on our financial results.
Network failures or delays may result in the loss of our customers or expose us to potential liability.
Our VoIP network infrastructure uses a collection of communications equipment, software, operating protocols and applications for the transport of voice among multiple locations. Given the complexity of the network, it is possible that there could be severe disruptions in our ability to timely turn up service requests, minimize service interruptions and meet requirements of customer service level agreements. We have critical systems in our Los Angeles, California and New York, New York collocation facilities. Our California facilities are located in areas with a high risk of major earthquakes. Our facilities and network are also subject to break-ins, sabotage, intentional acts of vandalism and terrorism and to potential disruptions if the operators of these facilities encounter financial difficulties. Some of our systems may not be fully redundant, and our disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster, an operator’s decision to close a facility we are using without adequate notice for financial reasons or other unanticipated problems at our facilities could result in lengthy interruptions in our service. Network failures or delays in the turn up of services could cause business interruptions resulting in possible losses to our customers. Such failures or delays may expose us to claims by our customers and may result in the loss of customers.
VoIP networks are vulnerable to unauthorized access or use by outside parties.
While we built a private secure fiber optic infrastructure to minimize security risks from third party unauthorized sources, no network is invulnerable to hackers. A small percentage of voice traffic transported across our network may at times utilize the public internet. However, providing entry or exit points to our customers via the internet could enable computer hackers to access our network, and could lead to the impairment, failure or theft of our services. Further, it could also lead to the unauthorized interception and monitoring of end user voice calls. Unauthorized access or use may have an adverse impact on our services and reputation.
Our products or activities may infringe, or may be alleged to infringe, upon intellectual property rights of others.
We may encounter future litigation by third parties based on claims that our products or activities infringe the intellectual property rights of others, or that we have misappropriated the trade secrets of others. If any litigation or claims are resolved against us, we may be required to do one or more of the following:
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cease selling, incorporating or using any of our products that incorporates the infringed intellectual property, which would adversely affect our revenue or costs or both;
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obtain a license from the holder of the infringed intellectual property right, which might be costly or might not be available on reasonable terms, if at all; or
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redesign our products to make them non-infringing, which could be costly and time-consuming and may not be possible at all.
Because patent applications can take many months to be published, there may be pending applications, unknown to us, that may later result in issued patents that our products or product candidates or processes may infringe. These patent applications may have priority over patent applications filed by us. Disputes may arise regarding the ownership or inventorship of our intellectual property. There also could be existing patents of which we are unaware that our products may be infringing. As the number of participants in the market grows, the possibility of patent infringement claims against us increases. It is difficult, if not impossible, to determine how such disputes would be resolved.
Furthermore, because of the substantial amount of discovery required in connection with patent litigation, there is a risk that some of our confidential information could be required to be publicly disclosed. In addition, during the course of patent litigation, there could be public announcements of the results of hearings, motions or other interim proceedings or developments in the litigation. Any litigation claims against us may cause us to incur substantial costs and could place a significant strain on our financial resources, divert the attention of management or restrict our core business.
We may be subject to damages resulting from claims that we, or our employees, have wrongfully used or disclosed alleged trade secrets of former employers.
Some of our employees were previously employed at other communications companies, including our competitors or potential competitors. Although no such claims against us are currently pending, we may be subject to claims that we or these employees have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to commercialize product candidates, which could severely harm our business.
We are exposed to various possible claims relating to our business and our insurance may not fully protect us.
We may incur uninsured liabilities and losses as a result of the conduct of our business. For example, network failures or security breaches could subject us to claims by our customers, and physical damage to the leased facilities in which we maintain our equipment could result in damage or loss to our equipment. We plan to maintain comprehensive liability and property insurance which may not replace the full value of our potential liabilities or losses or cover such claims. We will also evaluate the availability and cost of business interruption insurance. However, should uninsured losses occur, shareholders could lose their invested capital.
The costs incurred by us to develop, implement, and enhance our VoIP services may be higher than anticipated, which could hurt our ability to earn a profit.
We may incur substantial cost overruns in the development and establishment of our VoIP services. For example, delays in the SS-7 enhancement to our VoIP infrastructure will cause us to incur monthly costs related to equipment and network components we are not able to fully utilize. Unanticipated costs may force us to obtain additional capital or financing from other sources, or may cause the loss of your entire investment in our common stock if we are unable to obtain the additional funds necessary to implement our business plan.
We may need to raise additional funds in the future and such funds may not be available on acceptable terms or at all.
We may need to raise additional funds in the future for any number of reasons, including:
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the loss of revenues generated by sales of our services and products;
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the upfront and ongoing costs associated with expanding and enhancing our VoIP infrastructure;
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the costs associated with expanding our sales and marketing efforts;
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the expenses we incur in manufacturing and selling our services and products;
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the costs of developing new products or technologies;
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the cost of obtaining and maintaining regulatory approval or clearance of our products and products in development; and
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the number and timing of acquisitions and other strategic transactions.
If we issue equity or debt securities to raise additional funds, our existing shareholders may experience dilution and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing shareholders. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish valuable rights to our potential products or proprietary technologies, or grant licenses on terms that are not favorable to us. If we cannot raise funds on acceptable terms or at all, we may not be able to develop or enhance our products, execute our business plan, take advantage of future opportunities or respond to competitive pressures or unanticipated customer requirements. In these events, our ability to achieve our development and commercialization goals would be adversely affected.
Additional Risks Related to Regulation
Our industry is subject to regulation that could adversely impact our business.
Traditional telephone service has been subject to significant federal and state regulation. Internet services generally have been subject to far less regulation. Because VoIP services may be viewed as a hybrid by offering both tecommunications services and internet/information services, the VoIP industry has not fit easily within the existing regulatory framework of communications law, and has developed in an environment largely free from regulation. The FCC has not decided how to classify VoIP services for regulatory services but has increasingly imposed obligations on VoIP providers when they are offering services that are equivalent to traditional telecommunications providers, such as E911 capabilities.
The FCC, the U.S. Congress and various regulatory bodies in the states and in foreign countries are evaluating how VoIP may be regulated in the future. Some states, including California, have begun to implement laws that prohibit future regulation of VoIP services on the state level to potentially avert conflicts between future state and federal regulations. However, while some of the existing regulation concerning VoIP is applicable to the entire industry, many regulatory proceedings are focused on specific companies or categories of VoIP services. As a result, both the application of existing rules to us and our competitors and the effect of any future regulatory developments remains uncertain. Legislative and regulatory proceedings are under way, or are being contemplated, by federal and state authorities regarding items relevant to our business, these actions could have a material adverse effect on our business.
Telecommunications services are generally subject to regulation at the federal, state, local and international levels. These regulations affect us, our customers, and our existing and potential competitors. Delays in receiving required regulatory approvals, completing interconnection agreements or other agreements with local exchange carriers or the adoption of new and adverse regulations may have a material adverse effect on us. In addition, future legislative and judicial actions could have a material adverse effect on us.
Future legislation or regulation of the Internet and/or voice and video over IP services could restrict our business, prevent us from offering service or increase our cost of doing business.
At present there are few laws, regulations or rulings that specifically address access to commerce and communications services that utilize internet protocol, including VoIP. We are unable to predict the impact, if any, that future legislation, judicial decisions or regulations concerning internet protocol products and services may have on our business, financial condition, and results of operations. Regulation may be targeted towards, among other things, fees, charges, surcharges, and taxation of VoIP services, liability for information retrieved from or transmitted over the Internet, online content regulation, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, filing requirements, consumer protection, public safety issues like enhanced 911 emergency service, or E911, the Communications Assistance for Law Enforcement Act, or CALEA, the provision of online payment services, broadband residential Internet access, and the characteristics and quality of products and services, any of which could restrict our business or increase our cost of doing business. The increasing growth of the VoIP market and popularity of VoIP products and services heighten the risk that governmental agencies might seek to regulate VoIP and the Internet if state or local governmental agencies decide to regulate VoIP services, as they do for providers of traditional telephone service, such regulation may be preempted by action of the U.S. federal government. Nonetheless, we may become subject to a variety of inconsistent state and local regulations and taxes, which would increase our costs of doing business, and adversely affect our operating results and future prospects.
Further, a regulatory agency could require us to conform to rules that are unsuitable for IP communications technologies or that cannot be complied with due to the nature and efficiencies of IP routing, or are unnecessary or unreasonable in light of the manner in which we offer service to our customers and we may face future obstacles that could impact our business. Because it is not possible to separate Internet services into intrastate and interstate transmission components we may face conflicting state and federal requirements.
Our products must comply with industry standards, FCC regulations, state, local, country-specific and international regulations, and changes may require us to modify existing products and/or services.
In addition to reliability and quality standards, the market acceptance of VoIP is dependent upon the adoption of industry standards so that products from multiple manufacturers are able to communicate with each other. Our VoIP products and services rely heavily on communication standards such as SIP, H.323 and SS-7 and network standards such as TCP/IP to interoperate with other vendors’ equipment. There is currently a lack of agreement among industry leaders about which standard should be used for a particular application, and about the definition of the standards themselves. These standards, as well as audio and video compression standards, continue to evolve. We also must comply with certain rules and regulations of the FCC regarding electromagnetic radiation and safety standards established by Underwriters Laboratories, as well as similar regulations and standards applicable in other countries. Standards are continuously being modified and replaced. As standards evolve, we may be required to modify our existing products or develop and support new versions of our products. We must comply with certain federal, state and local requirements regarding how we interact with our customers, including consumer protection, privacy and billing issues, the provision of 911 emergency service and the quality of service we provide to our customers. The failure of our products and services to comply, or delays in compliance, with various existing and evolving standards could delay or interrupt volume production of our VoIP telephony products, subject us to fines or other imposed penalties, or harm the perception and adoption rates of our service, any of which would have a material adverse effect on our business, financial condition or operating results.
There may be risks associated with the lack of 911 emergency dialing or the limitations associated with E911 emergency dialing with our VoIP services.
In the future, we intend to sell and support IP devices. In May 2005, the FCC unanimously adopted an Order and Notice of Proposed Rulemaking, or NPRM, that requires some VoIP providers to provide emergency 911, or E911, service. On June 3, 2005, the FCC released the text of the First Report and Order and Notice of Proposed Rulemaking in the VoIP E911 proceeding, or the VoIP E911 Order. As a result of the VoIP E911 Order, VoIP service providers that interconnect to the public switched telephone network, or PSTN, or interconnected VoIP providers, will be required to offer the same 911 emergency calling capabilities offered by traditional landline phone companies. All interconnected VoIP providers must deliver 911 calls to the appropriate local public safety answering point, or PSAP, along with call back number and location, where the PSAP is able to receive that information. E911 must be included in the basic service offering; it cannot be an optional or extra feature. The PSAP delivery obligation, along with call back number and location information must be provided regardless of whether the service is “fixed” or “nomadic.” User registration of location is permissible initially, although the FCC is committed to an advanced form of E911 that will determine user location without user intervention. The VoIP E911 Order mandates that existing and prospective customers must be notified of the capabilities and limitations of VoIP service with respect to emergency calling, and interconnected VoIP providers must obtain and maintain affirmative acknowledgement from each customer that the customer has read and understood the notice of limitations and distribute warning labels or stickers alerting consumers and other potential users of the limitations of VoIP 911 service to each new subscriber prior to the initiation of service. In addition, an interconnected VoIP provider must make it possible for customers to update their address (i.e., change their registered location) via at least one option that requires no equipment other than that needed to access the VoIP service. The VoIP E911 Order will increase our cost of doing business and may adversely affect our ability to deliver service to new and existing end users in all geographic regions. We cannot guarantee that E911 service will be available to all of our subscribers. The VoIP E911 Order or follow-on orders or clarifications and potential legislation could have a material adverse effect on our business, financial condition and operating results.
The IP devices we intend to offer could be adversely impacted if network operators are permitted to restrict or degrade access to their broadband networks.
The concept of net neutrality asserts that network operators should not be allowed to charge content or application providers fees for faster delivery or other preferential treatment. This issue has been subject to ongoing regulatory proceedings. Further, federal legislation may also address net neutrality in a manner that requires permits or disallows the FCC to implement its stated net neutrality policy. Such legislation could also require the FCC to modify its policy in whole or in part. Because some of our IP devices and services may utilize the networks of third parties, regulation and potential legislation concerning net neutrality could impact our business. Further, some of our carrier customers rely, in part, on the implementation of net neutrality principles in order to offer their VoIP services. If our carrier customers are adversely impacted by legislative or regulatory action concerning net neutrality, it could also adversely impact us.
Uncertainty regarding whether certain of our services are classified as “telecommunications” or “information” services makes it difficult to predict whether we will need to pay additional charges, surcharges, fees and/or taxes to provide our services and whether we are subject to state and local regulation.
There are many unresolved proceedings at the FCC intended to address whether various types of VoIP services are properly classified as telecommunications services and/or information services. Federal legislation may also impact this determination. If our services are determined to be telecommunications services, we may be subject to additional regulation, including but not limited to the application of additional charges, surcharges, taxes and fees that would adversely impact our business. If it is determined that we provide telecommunications services, we could also be required to comply with state regulation and the related filing requirements that could adversely impact our business.
We may from time to time be subject to disputes with customers and vendors relating to amounts invoiced for services provided which we may not be able to resolve in our favor.
It is not unusual in our industry to occasionally have disagreements with vendors relating to amounts billed for services provided between the recipient of the services and the vendor. To the extent we are unable to favorably resolve these disputes, our revenues, profitability or cash may be adversely affected.
Risks Related to our Common Stock
Our common stock may be considered a “penny stock” and may be difficult to sell.
The Securities and Exchange Commission has adopted regulations which generally define “penny stock” to be an equity security that has a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to specific exemptions. The market price of our common stock is less than $5.00 per share and therefore may be designated as a “penny stock” according to Securities and Exchange Commission rules. This designation requires any broker or dealer selling these securities to disclose certain information concerning the transaction, obtain a written agreement from the purchaser and determine that the purchaser is reasonably suitable to purchase the securities. These rules may restrict the ability of brokers or dealers to sell our common stock and may affect the ability of investors to sell their shares. In addition, since our common stock is currently listed on the NASD’s OTC Pink Sheets, investors may find it difficult to obtain accurate quotations of our common stock and may experience a lack of buyers to purchase such stock or a lack of market makers to support the stock price.
Security analysts of major brokerage firms may not provide coverage of us since there is no incentive for brokerage firms to recommend the purchase of our common stock. No assurance can be given that brokerage firms will want to conduct any secondary public offerings on our behalf in the future.
Our principal shareholders have significant voting power and may take actions that may not be in the best interest of other shareholders.
As of December 31, 2013, our executive officers, directors, and principal shareholders who hold 5% or more of our outstanding common stock beneficially owned, in the aggregate, approximately 71.2% of our outstanding common stock. These shareholders are able to exercise significant control over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interests of all our shareholders.
We incur increased costs and risks as a result of being a public company, particularly in the context of Section 404 of the Sarbanes-Oxley Act of 2002.
We incur increased costs as a result of becoming a public company and from compliance activities related to the Sarbanes-Oxley Act of 2002, or SOX, as well as new rules subsequently implemented by the Securities and Exchange Commission and the NASD, and these costs may continue to increase. These new rules and regulations have increased our legal and financial compliance costs and made some activities more time-consuming and costly. In addition, we incur costs associated with our public company reporting requirements. These rules and regulations to make it more expensive for us to obtain certain types of insurance, including directors’ and officers’ liability insurance and we may be forced to accept reduced policy limits and coverage in the future or incur substantially higher costs to obtain the same or similar coverage. The impact of these events also could make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We are presently evaluating and monitoring developments with respect to new rules and regulations and cannot predict the amount of the additional costs we may incur or the timing of such costs.
Section 404 of SOX requires us to include an internal controls report from management in our Annual Reports on Form 10-K, and we are required to expend significant resources in developing the necessary documentation and testing procedures. Given the risks inherent in the design and operation of internal controls over financial reporting, we evaluated our system of internal controls and concluded that our internal controls over financial reporting is not effective. If our internal controls are not designed or operating effectively, we are required to disclose that our internal control over financial reporting was not effective, as we have done in this Annual Report under Item 9A. Investors may lose confidence in the reliability of our financial statements, which could cause the market price of our common stock to decline and which could affect our ability to operate our business as we otherwise would like to.
Our management has identified a number of material weaknesses in our internal control over financial reporting as of December 31, 2013, which, if not remediated, could result in material misstatements in our annual or interim financial statements in future periods.
In connection with our management’s assessment of our internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act of 2002, our management identified a number of material weaknesses in our internal control over financial reporting as of December 31, 2013. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. As a result, our management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2013. The deficiencies noted at December 31, 2013 were also identified as existing as of December 31, 2012.
The existence of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements or failure to meet reporting obligations, and could result in material misstatements regarding our financial condition and results of operations which in turn could cause investors to lose confidence in reported financial information leading to a decline in our stock price. Furthermore, there are inherent limitations to the effectiveness of controls and procedures, including the possibility of human error and circumvention or overriding of controls and procedures.
The market price of our common stock may be volatile.
The market price of our common stock has been and will likely continue to be highly volatile, as is the stock market in general. Some of the factors that may materially affect the market price of our common stock are beyond our control, such as changes in financial estimates by industry and securities analysts, conditions or trends in the communications industry, announcements made by our competitors or sales of our common stock. These factors may materially adversely affect the market price of our common stock, regardless of our performance.
In addition, the public stock markets have experienced extreme price and trading volume volatility. This volatility has significantly affected the market prices of securities of many companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.
Factors which may adversely affect market prices of our common stock.
Market prices for our common stock will be influenced by a number of factors, including:
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the issuance of new equity securities pursuant to a future offering or acquisition;
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changes in interest rates;
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competitive developments, including announcements by competitors of new products or services or significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
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variations in quarterly operating results;
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changes in financial estimates by securities analysts;
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the depth and liquidity of the market for our common stock;
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investor perceptions of us and the communications industry generally; and
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general economic and other national conditions.
There is no assurance of an established public trading market, and the failure to establish one would adversely affect the ability of our investors to sell their securities in the public market.
At present, there is minimal trading of our securities, and there can be no assurance that an active trading market will develop. Our common stock, however, is traded on the OTC Pink Sheets. The OTC Pink Sheets is an inter-dealer, over-the-counter market that provides significantly less liquidity than the NASD’s automated quotation system, or NASDAQ Stock Market. Quotes for stocks included on the OTC Pink Sheets are not listed in the financial sections of newspapers as are those for the NASDAQ Stock Market. Therefore, prices for securities traded solely on the OTC Pink Sheets may be difficult to obtain and holders of common stock may be unable to resell their securities at or near their original price or at any price.
A significant number of our shares are eligible for sale, and their sale could depress the market price of our common stock.
Sales of a significant number of shares of our common stock in the public market could harm the market price of our common stock. In May 2007 and January 2008 we registered an aggregate of 21,429,000 shares and shares underlying warrants, or 29% of our common stock currently outstanding, for resale in the public market pursuant to Form SB-2 registration statements. As such shares of our common stock are resold in the public market, the supply of our common stock will increase, which could decrease its price. Some or all of our shares of common stock as well as shares of common stock underlying warrants and options may also be offered from time to time in the open market pursuant to an effective registration statement or Rule 144, and these sales may have a depressive effect on the market for our shares of common stock. In general, a person who has held restricted shares for a period of six months may, upon filing with the Securities and Exchange Commission a notification on Form 144, sell into the market shares of our common stock.
Shares eligible for future sale may adversely affect the market price of our common stock.
The former non-affiliated securities holders of InterMetro Delaware who received shares of our common stock in the Business Combination, as well various vendors who were issued shares pursuant to settling vendor obligations, are eligible to sell all of these approximate 7.2 million shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144 promulgated under the Securities Act of 1933, as amended (the “Securities Act”), Rule 144. Any substantial resale, and the possibility of substantial resales, of the common stock under Rule 144 may have an adverse effect on the market price of our common stock by creating an excessive supply.
Provisions in our articles of incorporation and bylaws and under Nevada law may discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.
Our articles of incorporation and bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change of control of our company or changes in our management that the shareholders of our company may deem advantageous. These provisions:
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authorize the issuance of “blank check” preferred stock that our board of directors could issue to increase the number of outstanding shares to discourage a takeover attempt;
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allow shareholders to request that we call a special meeting of our shareholders only if the requesting shareholders hold of record at least a majority of the outstanding shares of common stock;
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provide that the board of directors is expressly authorized to make, alter, amend or repeal our bylaws; and
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provide that business to be conducted at any special meeting of shareholders be limited to matters relating to the purposes stated in the applicable notice of meeting.
We do not foresee paying cash dividends in the foreseeable future.
We have not paid cash dividends on our stock and do not plan to pay cash dividends on our common stock in the foreseeable future.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our principal executive office is located in Simi Valley, California, where we lease a facility with 18,674 square feet of space for $14,000 per month under a lease that expired March 31, 2014 and we are renting our facility on a month by month basis as we negotiate a new lease. We believe that our space will be adequate for our needs and that suitable additional or substitute space in the future will be available to accommodate the foreseeable expansion of our operations. We also lease collocation space for our VoIP equipment in carrier class telecommunications facilities in major metropolitan markets throughout the U.S. and expect to add additional collocation facilities as we expand our VoIP network.
Item 3.
Item 3. Legal Proceedings
From time to time we may be involved in litigation of claims relating to disputes of the cost and quality of services provided by us, our network component vendors, providers of general and administrative services and employees. We may also be involved with litigation or claims of alleged infringement, misuse or misappropriation of intellectual property rights of third parties. In the normal course of business, we may also be subject to claims arising out of our operations, and may file collection claims against delinquent customers. We cannot predict the outcome of any of these proceedings at this time. In cases where a Court has stayed proceeding, we can not predict how long the Court’s stay (if any) will remain in place. In cases where the Company has settled the matter in exchange for future payments, the failure of the Company to honor the payment schedule could result in acceleration of the amount owed, or otherwise adversely impact the Company’s financial condition. A ruling against us in any of the proceedings listed below could have a material adverse impact on our operating results, financial condition and business performance.
A Network Service Provider (“NSP1”) - On May 9, 2013, the Company was served a complaint in California Superior Court filed by NSP1 against the Company asserting various causes of action. The NSP1 claimed that the Company owed charges totaling $204,736. The Company denies that it owes this amount based on technical failures of NSP1. The Company filed a cross-complaint on June 13, 2013 for damages, in excess of NSP1’s asserted claims, due to costs and losses incurred by the Company related to measures taken to ensure continued network reliability to customers and the public. Discovery has not commenced and a court date has been set for late 2014. The Company has previously expensed all services related to NSP1 and does not anticipate any adverse material effect from this matter.
A Network Service Provider (“NSP2”) - On January 17, 2014, the Company settled, subject to payments, NSP2’s action to collect an asserted $478,347 plus interest, amongst other claims. The Company has previously expensed the costs related to the NSP2 settlement.
Universal Service Administrative Company - The Universal Service Administrative Company (USAC) administers the Universal Service Fund (USF). In 2009 and 2010, the Company did not make all of the payments claimed by the USAC and the Federal Communications Commission (FCC). As of December 31, 2013 and 2012, the Company has recorded an aggregate $1.6 million in connection with the USF including balances under settlement arrangements. The Company continues to work with the FCC and the Department of the Treasury to resolve these amounts in long term payment programs. Failure to execute or finalize any significant proposed payment plan would likely have a material adverse effect on the Company.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock
Our common stock is listed on the OTC Pink Sheets and trades under the symbol “IMTO.” At the close of business on March 31, 2014, there were 82,736,093 issued and outstanding common shares which were held by approximately 86 shareholders of record, of which 23,693,453 shares were freely tradable. The balance is restricted stock as that term is used in Rule 144 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
There is currently minimal trading volume for our securities. The following table sets forth certain information with respect to the high and low market prices of our common stock for the periods indicated. These quotations, as provided by the OTC Pink Sheets, reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transaction prices between dealers.
Dividends
We have not declared or paid any cash dividends on our common stock and we do not expect to pay any cash dividends in the foreseeable future. The decision whether to pay cash dividends on our common stock will be made by our Board of Directors, in their discretion, and will depend on our financial condition, operating results, capital requirements and other factors that our Board of Directors considers significant. We currently intend to retain our earnings for funding growth and, therefore, do not expect to pay any dividends in the foreseeable future.
Issued and Outstanding Shares
Effective March 14, 2012, the Company settled a lawsuit brought by a former employee and the former president of Advanced Tel, Inc. (“ATI”), the Company’s wholly owned subsidiary. See Note 2 to the financial statements for a description of this matter. Pursuant to the settlement, the Company has voided a total of 4,089,930 shares that were originally issued to the employee as part of the consideration for the acquisition of ATI.
In addition, pursuant to the settlement, the former employee returned 308,079 shares issued to him, also in connection with the Company’s acquisition of ATI. Such 308,079 shares were transferred back to the Company incrementally, subject to the Company’s payment by the Company of a total of $200,000 in monthly installments through March 2017.
Unregistered Sales of Securities in 2013
During 2013, the Company issued 532,800 shares of its common stock pursuant to the conversion of Series A2 preferred stock. During 2013, the Company also issued 293,978 shares of its common stock pursuant to the exercise of warrants receiving proceeds of $2,940 in connection with the issuance. During 2013, the Company also issued 43,300 shares of its common stock to a consultant pursuant to a consulting services agreement as well as 176,744 shares through the cashless exercise of common stock warrants.
Equity Compensation Plan Information
2004 Stock Option Plan
Our Board of Directors voted unanimously to cause the Company to assume all stock options under the 2004 Stock Plan of InterMetro Delaware (the “2004 Plan”), which were issued and outstanding immediately prior to the closing of the Business Combination, which closed on or about December 29, 2006. All InterMetro Delaware stock options were converted into options to purchase shares of our common stock as of December 29, 2006. Upon the shareholders ratification of the 2004 Plan pursuant to the Schedule 14C Information Statement filed with the Securities and Exchange Commission declared effective May 10, 2007, we froze any further grants of stock options under the 2004 Plan. Any shares reserved for issuance under the 2004 Plan that are not needed for outstanding options granted under that plan will be cancelled and returned to treasury shares. The number of outstanding stock options and the exercise prices were adjusted in the same proportion as the exchange ratio for the outstanding common stock in the Business Combination. The exercise periods and other terms and conditions remained the same.
As of December 31, 2013, we had stock options to purchase 3,221,081 shares of our common stock outstanding under the 2004 Plan all fully vested and exercisable for a period of ten years from the date of initial grant by InterMetro. On November 15, 2010, in order to provide continued economic incentive to option holders, most of whose options were issued at prices that were “out of the money”, the Board of Directors authorized a re-pricing of the stock options under the 2004 Plan to $0.01, the closing price of the Company’s common stock on that date. The Company recognized a charge of $14,000 related to the re-pricing.
For the fiscal years ended December 31, 2013 and 2012, InterMetro issued no stock options under the 2004 Plan. As of December 31, 2013, 1,232,320 of the Company’s outstanding stock options issued pursuant to the 2004 Plan have been exercised.
Omnibus Stock and Incentive Plan
Effective January 19, 2007, our Board of Directors approved the 2007 Omnibus Stock and Incentive Plan (the “2007 Plan”) for directors, officers, employees, and consultants. Our shareholders ratified the 2007 Plan pursuant to the Schedule 14C Information Statement filed with the Securities and Exchange Commission which was declared effective on May 10, 2007. The 2007 Plan allows any of the following types of awards, to be granted alone or in tandem with other awards: (1) Stock options which may be either incentive stock options (“ISOs”), which are intended to satisfy the requirements of Section 422 of the Internal Revenue Code of 1986, as amended, or nonstatutory stock options (“NSOs”), which are not intended to meet those requirements; (2) restricted stock which is common stock that is subject to restrictions, including a prohibition against transfer and a substantial risk of forfeiture, until the end of a “restricted period” during which the grantee must satisfy certain vesting conditions; (3) restricted stock units which entitle the grantee to receive common stock, or cash (or other property) based on the value of common stock, after a “restricted period” during which the grantee must satisfy certain vesting conditions or the restricted stock unit is forfeited; (4) stock appreciation rights which entitle the grantee to receive, with respect to a specified number of shares of common stock, any increase in the value of the shares from the date the award is granted to the date the right is exercised; and (5) other types of equity-based compensation which may include shares of common stock granted upon the achievement of performance objectives.
The 2007 Plan will be administered by the Compensation Committee once this committee is formed, which will at all times be composed of two or more members of the Board of Directors who are not our employees or consultants. Until a Compensation Committee is formed, the 2007 Plan is administered by a majority of independent directors. Any employee or director of, or consultant for, us or any of our subsidiaries or other affiliates will be eligible to receive awards under the 2007 Plan. We have reserved 26,099,040 shares of common stock for awards under the 2007 Plan. In addition, on each anniversary of the 2007 Plan’s effective date on or before the fifth anniversary of the effective date, the aggregate number of shares of our common stock available for issuance under the 2007 Plan will be increased by the lesser of (a) 5% of the total number of shares of our common stock outstanding as of the December 31 immediately preceding the anniversary, (b) 4,713,570 shares, or (c) a lesser number of shares of our common stock that our board, in its sole discretion, determines. In general, shares reserved for awards that lapse or are canceled will be added back to the pool of shares available for awards under the 2007 Plan.
Awards under the 2007 Plan are forfeitable until they become vested. An award will become vested only if the vesting conditions set forth in the award agreement (as determined by the Compensation Committee or the independent directors administering the 2007 Plan) are satisfied. The vesting conditions may include performance of services for a specified period, achievement of performance objectives, or a combination of both. The Compensation Committee also will have authority to provide for accelerated vesting upon occurrence of an event such as a change in control. The 2007 Plan specifically prohibits the Compensation Committee (or the independent directors administering the 2007 Plan) from repricing any stock options or stock appreciation rights. In general, awards under the 2007 Plan may not be assigned or transferred except by will or the laws of descent and distribution. However, the Compensation Committee (or the independent directors administering the 2007 Plan) may allow the transfer of NSOs to members of a 2007 Plan participant’s immediate family or to a trust, partnership, or corporation in which the parties in interest are limited to the participant and members of the participant’s immediate family.
The Board of Directors or the Compensation Committee may amend, alter, suspend, or terminate the 2007 Plan at any time. If necessary to comply with any applicable law (including stock exchange rules), we will first obtain stockholder approval. Amendments, alterations, suspensions, and termination of the 2007 Plan generally may not impair a participant’s (or a beneficiary’s) rights under an outstanding award. However, rights may be impaired if necessary to comply with an applicable law or accounting principles (including a change in the law or accounting principles) pursuant to a written agreement with the participant. Unless it is terminated sooner, the 2007 Plan will terminate upon the earlier of June 23, 2016 or the date all shares available for issuance under the 2007 Plan have been issued and vested.
The Company granted options under its 2007 Plan during the years ended December 31, 2013 and 2012. As of December 31, 2013, none of the Company’s outstanding stock options issued pursuant to the 2007 Plan have been exercised.
Item 6.
Item 6. Selected Financial Data.
As a “smaller reporting company”, under SEC rules, this disclosure is not required.
Item 7.
Item 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition
The following discussion should be read in conjunction with our consolidated financial statements and notes to those statements.
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 $11.6 million for the year ended December 31, 2013.
Our corporate headquarters is located in Simi Valley, California. We lease collocation space for our VoIP equipment in carrier-class telecommunications facilities in metropolitan markets throughout the U.S. and expect to add additional collocation facilities as we expand our VoIP network.
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.
Regulation . Our business has developed in an environment largely free from regulation. However, the FCC has recently examined how VoIP services could be regulated but has yet to classify VoIP providers for regulatory purposes. Instead, on a piecemeal basis, the FCC has imposed some regulatory obligations on VoIP providers that parallel obligations imposed on telecommunications providers, such as universal service contributions, E911 and number portability. Effective in mid-2012, the FCC changed the intercarrier compensation system requiring VoIP providers to pay a form of compensation on a prospective basis. The issue of VoIP regulation on other important issues, such as intercarrier connection obligations, remains unresolved by the FCC, which is currently engaged in proceedings to further define and clarify applicable VoIP regulations. While state regulatory authority over us has been constrained by recent legislation in several states, including California, states may nonetheless strive to independently assert control over some or all of our operations. 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 interconnect and directly purchase facilities from incumbent local exchange carriers under negotiated contracts which can directly include access charges. By purchasing these traditional access services we help mitigate the risk of potential new regulation related to VoIP.
Our Business Model
Historically, we have implemented our business plan through the expansion of our proprietary, cloud-based VoIP infrastructure. Since our inception, we have notably grown our customer base which now includes 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.
In 2006, we dedicated significant resources to acquisition growth, completing our first acquisition of ATI in March 2006. We acquired ATI to add minutes to our network and to access new sales channels and customers. We plan to grow our business through direct sales activities and potentially through acquisitions.
Revenue . We currently generate revenue primarily from the sale of voice minutes that are transported across our VoIP infrastructure. In addition, our wholly owned subsidiary ATI, as a reseller, generates revenues from the sale of voice minutes that are currently transported across other telecom service providers’ networks. Since 2006 we have migrated much of the ATI revenues on to our VoIP infrastructure and intend to continue to migrate some of the remaining ATI revenues in the future. 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:
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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.
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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.
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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.
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Acquisitions.
Although we have not actively pursued acquisitions since 2009, as the world economy rebounds we anticipate a review of the acquisition strategy as one possible method for expanding our revenue base through the acquisition of other voice service providers. In that context, we would plan 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.
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:
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SS-7 based interconnection costs.
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.
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Competitive local exchange carrier costs.
The interconnections between our VoIP infrastructure and our customers’ end users, as well as our retail customers, have historically been purchased on a monthly recurring fixed cost basis from competitive local exchange carriers, or CLECs. Historically, CLEC interconnections had been our largest component of fixed network costs.
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Other fixed costs.
Other significant fixed cost 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:
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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.
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SS-7 based interconnections with local carriers.
The SS-7 based interconnection services and those we intend to purchase for the provision of a majority of our future services, 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 are expected 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:
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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:
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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.
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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.
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Acquisitions of telecommunications businesses.
Should we resume our acquisition activities of telecommunications companies, the completion of these acquisitions and resulting addition of the acquired company’s traffic and revenue to our operations may cause us to 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 and include the costs of being a public company. 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.
Results of Operations
The following table sets forth, for the periods indicated, the results of our operations expressed as a percentage of revenue:
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
Net Revenues. Net revenues decreased $8.5 million, or 42.3%, to $11.6 million for the year ended December 31, 2013 from $20.1 million for the year ended December 31, 2012. Super storm Sandy in October 2012 had a significant negative impact on the telecommunications industry and, as a result, the Company’s revenues have been materially diminished in the current fiscal year. Though the addition of new customers and increased revenues from existing customers contributed approximately $2.5 million to revenue in the year ended December 31, 2013, these gains were offset by an approximate $10.9 million decrease in revenue attributable to the loss of customers or decreased revenue from existing customers. Ten customers accounted for 64.8% and 78.6% of net revenues for the years ended December 31, 2013 and 2012, respectively.
Network Costs. Network costs decreased $5.1 million, or 33.2%, to $10.3 million for the year ended December 31, 2013 from $15.4 million for the year ended December 31, 2012. Included within total network costs, variable network costs decreased by $5.1million to $9.4 million (80.4% of revenues) for the year ended December 31, 2013 from $14.5 million (72.2% of revenues) for the year ended December 31, 2012. Fixed network costs decreased by $32,000 to $919,000 for the year ended December 31, 2013 from $951,000 for the year ended December 31, 2012. Gross margin decreased to 11.3% for the year ended December 31, 2013 from a gross margin of 23.1% for the year ended December 31, 2012. The decrease in gross margin was related primarily to changes in traffic patterns and decrease in volume during the year ended December 31, 2013, such changes primarily attributable to the super storm Sandy event.
Sales and Marketing. Sales and marketing expenses decreased $184,000, or 28.4% to $463,000 for the year ended December 31, 2013 from $647,000 for the year ended December 31, 2012. Sales and marketing expenses as a percentage of net revenues were 4.0% and 3.2% for the year ended December 31, 2013 and 2012, respectively. The decrease is related to the decrease in revenues from which sales commissions are incurred.
General and Administrative. General and administrative expenses decreased $417,000 or 12.5% to $2.9 million for the year ended December 31, 2013 from $3.3 million for the year ended December 31, 2012. General and administrative expenses as a percentage of net revenues were 25.2% and 16.6% for the years ended December 31, 2013 and 2012, respectively. A decrease in payroll of $229,000 and a $137,000 reduction in legal fees contributed to the overall decrease in general and administrative expense from the previous period. In addition, general and administrative expense for the twelve months ended December 31, 2013 included stock-based compensation of $66,000 and 2012 included stock-based compensation of $249,000.
Gain on Conversion of Debt to Common Stock. In the year ended December 31, 2012, the Company recorded a gain related to secured note holders converting debt for common stock at $0.15 when the fair market value of the common stock was $0.08 share.
Accounts Payable Write Off and Gain on Forgiveness of Debt. During the year ended December 31, 2013, the Company made final payments on two payment plans that resulted in the realization of contingent gains. In addition 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 and the final settlement payments, the Company recorded a gain on forgiveness of debt of $640,000 for the year ended December 31, 2013. 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 $51,000 related to these write-offs which is included in accounts payable write-off.
During the year ended December 31, 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 and, in some cases, in exchange for the issuance of shares of the Company’s common stock. As a result of these agreements, the Company recorded a gain on forgiveness of debt of $383,000 for the year ended December 31, 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 $322,000 related to these write-offs which is included in accounts payable write-off.
Interest Expense, net. Interest expense, net decreased $91,000 to $1.0 million for the year ended December 31, 2013 from $1.1 million for the year ended December 31, 2012. The most significant factor was the reduction of interest on secured promissory notes stemming from the October 2012 debt restructure.
Liquidity and Capital Resources
At December 31, 2013, we had $116,000 in cash as compared to $388,000 in cash at December 31, 2012.
The Company’s working capital position, defined as current assets less current liabilities, has historically been negative and was negative $12.1 million at December 31, 2013 as compared to negative $7.5 million at December 31, 2012. Working capital decreased primarily due to the net loss during the period.
Significant changes in cash flows for December 31, 2013 as compared to December 31, 2012:
Net cash used in operating activities was $946,000 for the year ended December 31, 2013 as compared to net cash provided by operating activities of $155,000 for the year ended December 31, 2012. The most significant components of the change that contributed to the decrease in cash from operating activities were the net loss of $2.4 million and non-cash gains of $691,000. A $2.1 million increase in accounts payable offset the loss.
Net cash used in investing activities for the year ended December 31, 2013 was $451,000 and included the purchase of computer and network equipment of $83,000 and software development costs of $368,000 as compared to $83,000 in 2012 which was attributable to the purchase of network-related equipment and costs incurred for software development.
Net cash provided by financing activities for the year ended December 31, 2013 was $1.1 million as compared to net cash used in financing activities of $74,000 for the year ended December 31, 2012. The primary sources of cash from financing activities for the year ended December 31, 2013 were $645,000 proceeds from the sales of Series A2 preferred stock and draws exceeding payments on the Company’s credit line by $517,000. Net cash used in financing activities for the year ended December 31, 2012 included $298,000 of net pay-down of the Company’s line of credit offset by $250,000 proceeds from issuance of preferred stock.
The Company had a working capital deficit of $12,082,000 and had a total stockholders’ deficit of $12,426,000 as of December 31, 2013. 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), interest due on its revolving line of credit (see Note 11) and settlement payments due (see Note 6), all with which the Company has missed scheduled payments. 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, to the Company at any time.
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 states that there is substantial doubt about the Company’s ability to continue as a going concern.
Management believes that the losses in current and past years were primarily attributable to continued decline in revenue and additional costs incurred relating 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 operations. Any sale of additional common stock or convertible equity or debt securities would result in additional dilution to the Company’s stockholders.
Debt
Revolving Credit Facility - The Company entered into agreements, including a Loan and Security Agreement (as subsequently amended, the “Agreement”), effective as of April 30, 2008 with Moriah Capital, L.P. (“Moriah”), pursuant to which the Company could borrow up to $2,400,000 which was subsequently increased to $2,575,000 of which $175,000 was subsequently paid down. The Agreement has been amended several times (the “Amendments”). Amendment No. 13 extended the expiration to August 16, 2012. The balance that remained unpaid at the August 16, 2012 expiration date and at September 30, 2012 was carried until October 12, 2012 when, as discussed below, the Company secured a new credit facility. (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 and had borrowed $2,191,998 as of December 31, 2013. 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. The Company was not in compliance with the cash flow coverage of interest covenant as of December 31, 2013. The Company is in an over-advance position with TAB Bank and is operating under a forbearance agreement.
Effective October 12, 2012 the Company renegotiated terms with its secured note holders. The renegotiated terms included conversion of certain loan balances to common stock, the issuance of warrants and the establishment of new payment terms. The secured note holders converted $1,521,843 that the Company owed into 10,145,523 shares of common stock at $0.15 per share and the Company issued warrants with a term of seven years to purchase 1,521,843 shares of common stock at an exercise price of $0.01 per share. The value associated with these warrants is $101,000. The remaining outstanding balance of $2,374,281, of which $764,221 is eligible to be converted to common stock at the election of the lenders at a rate of $0.50 per share of common stock, included $878,466 owed to related parties. This remaining balance was to be paid in interest only payments of approximately $12,000 per month from January 1, 2013 through September 1, 2013 followed by principal and interest payments of approximately $72,000 per month from September 1, 2013 until September 30, 2014. Most of the scheduled principal and interest payments were not made and the Company paid a total of approximately $19,000 during the twelve months ended December 31, 2013. Of the remaining balances $923,576 will mature on September 30, 2014 with the final payment of all principal and accrued interest at maturity on December 31, 2014. As part of the renegotiated terms with the secured note holders the Company issued additional warrants with a term of seven years to purchase 2,145,000 shares of common stock at a price of $0.25 per share and 650,000 shares of common stock at a price of $0.01 per share. The value associated with these secured note holder warrants is $91,000 and will be recorded as an offset to the principal balance of the secured notes and, beginning in October 2012, will be amortized into interest expenses over the term of the notes using the effective interest method. The warrants are valued using the Black-Scholes formula. The Company recognized a $472,000 gain on the conversion of debt to common stock.
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. VoIP services are recognized as revenue when services are provided primarily based on usage. Revenues derived from sales of calling cards through retail distribution partners are deferred upon sale of the cards. These deferred revenues are recognized as revenue generally at the time card minutes are expended. The Company has revenue sharing agreements based on successful collections. The Company recognizes revenue from these customers at the time of invoicing based on the history of collections with such customers. The Company recognizes 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 Company obligations remain and collection is reasonably assured. Deferred revenue consists of fees received or billed in advance of the delivery of the services or services performed in which collection is not reasonably assured. This revenue is recognized when the services are provided and no significant Company obligations remain. Revenue from the sale of software and related equipment is generally recognized upon receipt by the customer. The Company assesses the likelihood of collection based on a number of factors, including past transaction history and the credit worthiness of the customer. Generally, the Company does not request collateral from customers. If the Company determines that collection of revenues are not reasonably assured, amounts are deferred and recognized as revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash. The Company has revenue sharing agreements with certain customers and recognizes revenue at time of invoicing based on the history of collections with such customers.
Stock-Based Compensation. The Company has applied FASB ASC 718 “Compensation - Stock Compensation.” For grants to employees under its 2004 plan and 2007 plan and to non-employees related to various agreements, the Company estimates the fair value of each option and warrant award on the date of grant using the Black-Scholes pricing model. 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.
Software Development Cost
Research and development costs are charged to expense as incurred. However, the costs incurred for the development of computer software that will be sold, leased, or otherwise marketed are capitalized when technological feasibility has been established. These capitalized technological costs are subject to an ongoing assessment of recoverability based on anticipated future revenues and changes in hardware and software technologies. Amortization of the capitalized software development costs begins when the product is available for general release to customers. Amortization is computed as the ratio of current gross revenues of a product to the total of current and anticipated future gross revenues for the product. The Company had capitalized software development costs of approximately $513,000 and $149,000 as of December 31, 2013 and 2012, respectively, for the development of a software that facilitates the routing of call traffic through lowest cost network. The capitalized software was sold to an initial customer in late September 2013. The Company amortized $4,000 of software development costs in the year ended December 31, 2013 and no software development costs in the year ended December 31, 2012.
.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.
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 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 at least annually or whenever changes in circumstances indicate that the carrying value of the goodwill may not be recoverable. FASB ASC 350 also requires the Company to amortize intangible assets over their respective finite lives up to their estimated residual values. At December 31, 2013 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 December 31, 2013 and 2012. 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.
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.. 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 December 31, 2013. The operating lease for our corporate offices expired March 31, 2014 and we are renting our facility on a month by month basis as we negotiate a new lease. The monthly rent payment is $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.
We had no contractual obligations at December 31, 2013.
Off-Balance Sheet Arrangements
We currently do not have any outstanding derivative financial instruments, off-balance sheet guarantees, interest rate swap transactions, foreign currency forward contracts or any other off-balance sheet arrangements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures Regarding Market Risk
Foreign Currency Market Risks . We currently do not have significant exposure to foreign currency exchange rates as all of our sales are denominated in U.S. dollars.
Interest Rate Market Risk . Our cash is invested in bank deposits and money market funds denominated in U.S. dollars. The carrying value of our cash, restricted cash, accounts receivable, deposits, other current assets, trade accounts payable, accrued expenses and deferred revenue and customer deposits approximate fair value because of the short period of time to maturity.
Recent Accounting Pronouncements
Management does not believe that any recently issued, but not yet effective, accounting standards or pronouncements, if currently adopted, would have a material effect on the Company’s consolidated financial statements.
Item 8.
Item 8. Financial Statements and Supplementary Data
See the Index to Consolidated Financial Statements on Page attached hereto.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As required by Rules 13a-15(e) and 15d-15(e) under the Exchange Act, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Annual Report. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer.
The Company has established a set of disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in the reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms. Disclosure controls are also designed with the objective of ensuring that this information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Based upon their evaluation as of the end of the period covered by this report, the Company’s Chief Executive Officer and Chief Financial Officer were not able to conclude that the Company’s disclosure controls and procedures are effective to ensure that information required to be included in the Company’s periodic Securities and Exchange Commission filings is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission rules and forms. Therefore, under Section 404 of the Sarbane’s-Oxley Act of 2002, they must conclude that these controls and procedures are not effective.
Internal Control over Financial Reporting
The Company’s board of directors was advised by Gumbiner Savett, Inc. (“GSI”), the Company’s independent registered public accounting firm, that during their performance of audit procedures for 2013, GSI identified material weaknesses as defined in Public Company Accounting Oversight Board Standard No. 5, in the Company’s internal control over financial reporting and in the segregation of duties within the accounting department. The Company is not an accelerated filer and GSI did not perform an audit of the Company’s internal controls. These weaknesses were identified in connection with the audit of the financial statements and reported pursuant to the requirements under AU Section 380, Communications with Audit Committees.
The Company’s control over financial reporting has been identified based on the number of error corrections and adjustments to Company prepared audit schedules made by the Company as part of completing a timely audit process. Additionally, the Company identified significant deficiencies surrounding the financial reporting process. Collectively, these represent a material weakness in the financial reporting process.
It was also identified that the size of the Company’s accounting staff prohibited its ability to properly segregate duties, a material weakness that could lead to the inability of the Company’s internal control system to timely identify and resolve accounting and disclosure matters.
Management’s Annual Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projection of any evaluation of effectiveness to future periods is subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management conducted, with the participation of our Chief Executive Officer and our Chief Financial Officer, an assessment, including testing of the effectiveness, of our internal control over financial reporting as of December 31, 2013. Management’s assessment of internal control over financial reporting was conducted using the criteria in Internal Control over Financial Reporting - Guidance for Smaller Public Companies issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. In connection with our management’s assessment of our internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act of 2002, we identified the following material weaknesses in our internal control over financial reporting as of December 31, 2013:
·
While we have implemented control procedures for reviewing all material financial reporting items, certain of our control procedures are not sufficient to prevent the risk that a potential material misstatement of the financial statements would occur without being prevented or detected, specifically with regards to dispute reserves for accounts payable, accruals for third party charges and certain equity accounts. In each case, the Company does not have adequate staffing to ensure that the monitoring processes mitigate risks that external information used is correct and, in the case of equity accounts, that the Company has personnel with adequate understanding of the applicability of accounting principles.
·
We have not maintained sufficient evidence to support that certain of our internal controls over financial reporting activities were performed on a timely basis, specifically related to confirmation testing of disputes of information received from our vendors, variance analysis, accounts receivable analyses and equity accounts.
·
Due to the small size of our Company, we have not adequately divided, or compensated for, functions among personnel to reduce the risk that a potential material misstatement of the financial statements would occur without being prevented or detected with regards to certain of our equity accounts. Specifically, with regards to equity awards, at times information used in our financial reporting is not able to be given to additional competent staff to mitigate the risk of erroneous or inappropriate actions.
Because of the material weaknesses noted above, management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2013, based on Internal Control over Financial Reporting - Guidance for Smaller Public Companies issued by (“COSO”).
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the three months ended December 31, 2013 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
This annual report does not include an attestation report of the Company’ registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permits us to provide only management’s report in this annual report.
Item 9B.
Item 9B. Other Information
None
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The following table lists our executive officers and directors as of December 31, 2013:
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(1) Member of the Audit Committee
Charles Rice has served as a Director and as our Chief Executive Officer and President since December 29, 2006. Mr. Rice is the founder of InterMetro Delaware and has served as the Chairman, Chief Executive Officer and President since its inception in July 2003. Under Mr. Rice’s leadership, InterMetro Delaware was ranked 46th in Entrepreneur magazine’s June 2006 Hot 100 Fastest Growing Businesses in America. From 1999 to 2003, Mr. Rice was Chairman, Chief Executive Officer, and President of CNM Network, Inc., or CNM, a national VoIP carrier. Mr. Rice joined CNM in 1997 and became a member of its board of directors in 1998. From 1998 to 1999, Mr. Rice served as CNM’s Vice President and Chief Operating Officer. Prior to CNM, Mr. Rice spent over 15 years in executive positions. Mr. Rice attended California State University of Northridge.
David Olert has served as Chief Financial Officer since May 2009. Prior to this role, he was the Company’s Corporate Controller since 2007. Prior to joining InterMetro Delaware, Mr. Olert was Controller of Optical Communication Products, Inc., a manufacturer of telecom fiber optic components and prior to that served as Corporate Controller for SMTEK, Inc., a contract manufacturer. Prior to SMTEK, Mr. Olert served twelve years in various entities, primarily publicly traded, as CFO or Corporate Controller and four years in public accounting. Mr. Olert holds a Bachelor degree from Barry University.
Jon deOng has served as our Chief Information Officer since March 28, 2011, as our Chief Technology Officer since December 29, 2006 and as a Director since January 19, 2007. Mr. deOng has served as InterMetro Delaware’s Chief Information Officer or Chief Technology Officer and a director since its inception in July 2003. Prior to joining InterMetro Delaware, Mr. deOng served as the Chief Technology Officer for CNM from 1999 to 2003 and served as a member of CNM’s board of directors from 1999 to 2003. From 1998 to 1999, Mr. deOng served as Vice President of Technology at CNM. Prior to CNM, Mr. deOng was responsible for managing the development and deployment of Netcom On-line Communication Services, Inc.’s Business Center, the core infrastructure systems of Netcom’s web hosting service, later acquired by ICG Communications, Inc. Mr. deOng attended the University of Texas.
Christopher Fogel has served as Chief Technology Officer since March 2011. Previously, Mr. Fogel served as Vice President of Network and Provisioning since the Company's inception in July 2003. Prior to joining InterMetro, Mr. Fogel served as Director of Provisioning for CNM Network from 1998 to 2003, responsible for deploying CNM’s 54 node national IP network. From 1996 to 1998, Mr. Fogel served as Senior Systems Administrator at Netcom Communications, Inc., managing its web hosting platform. Mr. Fogel attended North Dakota State University.
Eric Fuchs has served as Chief Sales Officer for InterMetro since November 2012 and previously served as Vice President of Sales. Fuchs has been with the company since its inception in July of 2003. From 2000 to 2003, Fuchs was Vice President of Sales of CNM Network, Inc. Prior to joining CNM, Fuchs was the Silicon Valley Sales Director at ICG Communications. Previous senior sales positions included Sales Director for National Accounts for Ocular Sciences/American Hydron (OSI), a contact lens manufacturer, where he assisted in the successful acquisition of the assets from Allergan Pharmaceutical's contact lens division. Fuchs holds a B.A. in Organizational Communications with Business Marketing emphasis from Arizona State University.
Joshua Touber has served as a director since January 19, 2007. Mr. Touber has served as a director of InterMetro Delaware since March 2004. Mr. Touber is currently President of TouberMedia, LLC, a media consulting firm. From 1998 to 2003, Mr. Touber was the Chief Operating Officer of Ascent Media Creative Services Group, a subsidiary of Liberty Media Group. In 1995, Mr. Touber founded Virtuosity, a telecommunication services provider that developed the “virtual assistant” product category under the “Wildfire” brand name and has served as its President since its inception.
Robert Grden has served as a director since January 19, 2007. Mr. Grden has served as a director of InterMetro Delaware since August 2004. Mr. Grden is currently the Executive Director for the Wayne County Employee’s Retirement System where he oversees the defined benefit and defined contribution retirement plans. He has worked for the Wayne County since 1991 and held the position of Deputy County Treasurer/Investments. Prior to that, he was a management consultant with Ernst & Young LLP serving clients in a variety of industries. Mr. Grden holds a Bachelor of Science and Bachelor of Administration degree from Lawrence Technological University and a Master of Science and Finance degree from Walsh College
Douglas Benson has served as a director since January 19, 2007. Dr. Benson has served as a director of InterMetro Delaware since May 2006. Dr. Benson is currently the Chief Executive Officer of the Edwin S. Johnston Company, a real estate investment and development company, a position he has held for the past 20 years. Dr. Benson was a founder and majority shareholder of Heritage Bank, a commercial bank in Michigan. Dr. Benson served on the board of directors of Andrews University for over 10 years. Dr. Benson holds a Bachelor of Arts degree from Andrews University and a Doctor of Medicine from Loma Linda University.
Limitation of Liability and Indemnification of Officers and Directors; Insurance
Our Articles of Incorporation limits the liability of directors to the maximum extent permitted by Nevada law. Nevada law provides that directors of a corporation will not be personally liable for monetary damages for breach of their fiduciary duties as directors, except liability for:
·
any breach of their duty of loyalty to the corporation or its shareholders;
·
acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law;
·
unlawful payments of dividends or unlawful stock repurchases or redemptions; or
·
any transaction from which the director derived an improper personal benefit.
Our Bylaws provide that we will indemnify our directors, officers, employees and other agents to the fullest extent permitted by law.
We have separate indemnification agreements with our directors and officers, in addition to the indemnification provided for in our Bylaws. These agreements, among other things, provide that we will indemnify our directors and officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by a director or executive officer in any action or proceeding arising out of such person’s services as one of our directors or officers, or rendering services at our request, to any of our subsidiaries or any other company or enterprise. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and officers.
Insofar as an indemnification for liabilities arising under the Securities Act may be permitted for directors, officers or persons controlling us pursuant to the foregoing provisions, we have been informed that in the opinion of the Securities and Exchange Commission each indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.
Legal Proceedings
There is no pending litigation or proceeding involving any of our directors or officers as to which indemnification is required or permitted, and we are not aware of any threatened litigation or proceeding that may result in a claim for indemnification.
Executive Officers, Directors and Committees
Executive Officers
Our executive officers are appointed by and serve at the discretion of our Board of Directors. We have employment agreements with our executive officers, which are discussed below under the heading “Executive Compensation - Employment Agreements.”
Board of Directors
Our Board of Directors currently consists of five directors. Messrs. Benson and Grden are “independent” as defined in NASDAQ Marketplace Rule 4200(a)(15). Mr. Touber is not independent as he is being compensated for certain consulting projects. Mr. Rice, who is our President and Mr. deOng, who is our Chief Technology Officer, are not independent. We plan to appoint additional independent directors so that a majority of our directors are independent.
The Board of Directors is divided into three classes, Class I, Class II and Class III, with each class serving staggered three-year terms. Directors in each class will hold office until their successors are elected and qualified. The Company has not conducted an annual meeting of shareholders in recent years. The terms of each of the classes of director terms has expired, but all directors continue to serve. All three classes of directors will be subject to shareholder election at the next annual shareholders meeting held by the Company. The members of the classes are divided as follows:
·
Class I is comprised of Messrs. Joshua Touber and Douglas Benson;
·
Class II is comprised of Mr. Robert Grden;
·
Class III is comprised of Messrs. Charles Rice and Jon deOng.
Our Amended and Restated Bylaws provide that the number of persons constituting our Board of Directors may be fixed from time to time, but only by a resolution adopted by a majority of our Board of Directors and provided that such number cannot be less than three nor more than eleven. Vacancies on the Board of Directors and newly created directorships resulting from any increase in the authorized number of directors will be filled by a majority vote of the directors then in office, even if less than a quorum, or by the sole remaining director. Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of one-third (1/3) of the total number of directors. This classification of the Board of Directors may have the effect of delaying or preventing changes in the control of or management of the Company. Our directors may be removed only for cause by the affirmative vote of holders of at least 66 2/3% of our then outstanding capital stock voting together as a single class.
Committees of the Board of Directors
Our Board of Directors currently has a standing Audit Committee. We plan to establish a Compensation Committee and a Nominating and Governance Committee. Until such committees are established, matters otherwise addressed by such committees will be acted upon by the majority of independent directors. The following is a brief description of our committees and contemplated committees.
Audit Committee
Messrs. Benson and Grden are the current members of our Audit Committee. Mr. Grden has been appointed to serve as chairman of the Audit Committee. Mr. Grden meets the criteria under SEC rules for designation as an “Audit Committee Financial Expert.”
Pursuant to the Audit Committee charter, the functions of our Audit Committee includes:
·
meeting with our management periodically to consider the adequacy of our internal controls and the objectivity of our financial reporting;
·
engaging and pre-approving audit and non-audit services to be rendered by our independent auditors;
·
recommending to our Board of Directors the engagement of our independent auditors and oversight of the work of our independent auditors;
·
reviewing our financial statements and periodic reports and discussing the statements and reports with our management, including any significant adjustments, management judgments and estimates, new accounting policies and disagreements with management;
·
establishing procedures for the receipt, retention and treatment of complaints received by us regarding accounting, internal accounting controls and auditing matters;
·
administering and discussing with management and our independent auditors our code of ethics; and reviewing and approving all related-party transactions in accordance with applicable listing exchange rules.
Report of the Audit Committee
Our Audit Committee has reviewed and discussed our audited financial statements for the fiscal year ended December 31, 2013 with senior management. The Audit Committee has also discussed with Gumbiner Savett, Inc. (“GSI”), our independent auditors, the matters required to be discussed by the Auditing Standard No. 16 (Communication with Audit Committees) and received the written disclosures and the letter from GSI required by Independence Standards Board Standard No. 1 (Independence Discussion with Audit Committees). The Audit Committee has discussed with GSI the independence of GSI as our auditors. Finally, in considering whether the independent auditors provision of non-audit services to the Company is compatible with the auditors’ independence for GSI, the Company’s Audit Committee has recommended to the Board of Directors that our audited financial statements be included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 for filing with the United States Securities and Exchange Commission. Our Audit Committee did not submit a formal report regarding its findings.
AUDIT COMMITTEE
Robert Grden
Douglas Benson
Notwithstanding anything to the contrary set forth in any of our previous or future filings under the Securities Act or the Exchange Act that might incorporate this report in future filings with the Securities and Exchange Commission, in whole or in part, the foregoing report shall not be deemed to be incorporated by reference into any such filing.
Code of Conduct
We have adopted a Code of Conduct that applies to all of our directors, officers and employees. The text of the Code of Conduct has been posted on InterMetro’s Internet website and can be viewed at http://www.intermetro.net/conduct.htm . Any waiver of the provisions of the Code of Conduct for executive officers and directors may be made only by the Audit Committee and, in the case of a waiver for members of the Audit Committee, by the Board of Directors. Any such waivers will be promptly disclosed to our shareholders.
Compliance with Section 16(A) of Exchange Act
Section 16(a) of the Exchange Act requires our officers and directors, and certain persons who own more than 10% of a registered class of our equity securities (collectively, “Reporting Persons”), to file reports of ownership and changes in ownership (“Section 16 Reports”) with the Securities and Exchange Commission. Reporting Persons are required by the Securities and Exchange Commission to furnish us with copies of all Section 16 Reports they file.
Based solely on its review of the copies of such Section 16 Reports received by it, or written representations received from certain Reporting Persons, all Section 16(a) filing requirements applicable to our Reporting Persons during and with respect to the fiscal year ended December 31, 2013 have been complied with on a timely basis, except for Mr. Christopher Fogel, who inadvertently failed to file a Form 3 upon his appointment as an executive officer of the Company. Such filing has subsequently been made.
Item 11.
Item 11. Executive Compensation
Executive Officer Compensation
The following table summarizes compensation paid or accrued by the Company for the years ended December 31, 2013, 2012 and 2011 for services rendered in all capacities, by our chief executive officer and the other most highly compensated executive officers during the fiscal years ended December 31, 2013, 2012 and 2011.
Summary Compensation Table
------
(1)
Amounts primarily represent medical insurance premiums and reimbursements for automobile and electronic communication device expenses.
Employment Agreements
Effective on or about January 1, 2007, we assumed from InterMetro Delaware certain employment agreements with our Chief Executive Officer, Charles Rice and our Chief Information Officer, Jon deOng. Each of the agreements was originally entered into as of January 1, 2004 with a term ending after five years, with automatic one-year extensions thereafter, unless either we or the executive provides notice of intention not to renew the agreement at least 60 days prior to the end of its term.
The agreement with Mr. Rice provides for an initial base annual salary of $220,000 and a discretionary annual bonus target of up to 100% of his base annual salary. Mr. Rice accepted a salary reduction to $150,000 in the year ended December 31, 2008. The agreement with Mr. deOng provides for an initial base annual salary of $185,000 and a discretionary annual bonus target of up to 75% of his base annual salary. Mr. deOng accepted a salary reduction to $125,000 in the year ended December 31, 2008. We anticipate senior executive bonuses under each of these agreements will be determined based on various factors, including revenue achievement and operating income (loss) before depreciation and amortization targets, as well as personal contributions. These performance factors may change from year to year. Each of these agreements calls for an 11% yearly increase in annual base salary.
These employment agreements may be terminated by us if the executive acts with gross negligence in the performance of his duties resulting in a breach of his fiduciary duties to us, our board, or our shareholders (provided that we give the executive notice of the basis for the termination and an opportunity for 30 days to cease committing the alleged conduct).
Severance benefits are payable under the agreements if the executive’s employment is terminated (i) if we materially breach the employment agreement or terminates the agreement other than for gross negligence (as described above), (ii) upon the death or disability of the executive, or (iii) on account of non-renewal of the employment agreement after a change in control of our ownership. These severance benefits include (i) a lump sum payment equal to the greater of the sum of the executive’s annual compensation and accrued but unpaid bonus payable through the end of the term of the employment agreement or one year of the executive’s annual base compensation, (ii) continuation medical insurance coverage and other benefits through the end of the term, and (iii) full vesting of all unvested stock options, with the ability to exercise all options granted under the agreement for the remainder of their term.
If the executive terminates his employment for reasons other than our breach of the agreement, he will not be entitled to severance benefits and will have a period of 90 days after notification of termination to exercise his vested options. If the executive’s employment is terminated for gross negligence (as described above), the executive will not be entitled to severance benefits, but he will be entitled to exercise his vested stock options for the remainder of their term.
Outstanding Equity Awards
The following table sets forth information for each of our executive officers regarding the number of shares subject to exercisable and unexercisable stock options to purchase shares of our common stock at the fiscal year ended December 31, 2013.
Outstanding Equity Awards at Fiscal Year-End
------
(1)
Stock options were granted under our 2007 Stock Plan and vested 50% on the date of grant and 1/4 of the balance each quarter thereafter until the remaining stock options were vested.
Director Compensation
As of January 19, 2007, we approved the following non-employee director compensation program. We generally pay our non-employee directors $1,000 per board meeting attended in person and $500 for each telephonic meeting. In addition, we generally compensate members of our board committees as follows: (i) each member of our Audit Committee receives $500 per meeting and (ii) each member of our Compensation Committee and Nominating and Governance Committee receives $350 per meeting. The Chairman of our Audit Committee also receives an annual retainer of $5,000 per year. We intend to grant our directors options under our 2007 Plan in an amount to be determined prior to grant. Not withstanding the generally applicable non-employee director compensation program described above, directors were not compensated in the year ended December 31, 2013 for board member duties.
The following table sets forth the compensation paid or accrued by InterMetro for the year ended December 31, 2013 to InterMetro’s directors.
Director Compensation
------
(1) Amount represents consulting fees for special projects and medical insurance premiums.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth certain information regarding the beneficial ownership of our common stock as of December 31, 2013, by (i) each director, (ii) each executive officer, (iii) all directors and executive officers as a group, and (iv) each person who beneficially owns more than five percent of our common stock. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. Such rules require not only the disclosure of shares over which an individual holds sole voting and investment power, but also shares over which such individual shares voting and investment power. As a consequence, and as indicated in the footnotes below, in many instances this results in duplication in the numbers and percentages reported for the individuals in the table; the aggregate shares held by all officers and directors as a group counts shares beneficially owned by more than one person only once without duplication. In computing the number of shares beneficially owned by a person and the percentage of ownership of that person, shares of common stock subject to a convertible security (e.g. options, warrants or convertible notes) held by that person that are currently exercisable or convertible or become exercisable or convertible within 60 days of December 31, 2013 are deemed outstanding even if they have not actually been issued through exercise or conversion of the convertible security. Those shares, however, are not deemed outstanding for the purpose of computing the percentage ownership of any other person. The percentage ownership of each beneficial owner is based on 82,736,093 outstanding shares of common stock as of December 31, 2013. Except as otherwise listed below, the address of each person is c/o InterMetro Communications, Inc., 2685 Park Center Drive, Building A, Simi Valley, California 93065.
------
* Indicates beneficial ownership of less than one percent.
(1)
Unless otherwise indicated and subject to applicable community property laws, to our knowledge each stockholder named in the table possesses sole voting and investment power with respect to all shares of common stock, except for those owned jointly with that person’s spouse.
(2)
Includes 150,000 shares subject to warrants and 3,000,000 shares subject to stock options, each of which are exercisable within 60 days of December 31, 2013; 165,741 shares which may be acquired pursuant to terms of a convertible promissory note that is convertible at the option of the holder within 60 days of December 31, 2013; 18,142,770 shares over which Mr. Rice would have voting power pursuant to voting agreements upon the exercise of stock options under the 2004 Plan and 2007 Plan or upon exercise of warrants held by others; 5,383,400 shares over which Mr. Rice would have voting power pursuant to voting agreements pursuant to terms of convertible promissory notes held by other lenders to the Company that are convertible at the option of each lender within 60 days of December 31, 2013; and 15,066,046 shares owned by certain of our current and former employees and lenders to the Company over which Mr. Rice maintains voting control. The holder of certain warrants over which Mr. Rice has voting control is not entitled to purchase shares under these certain warrants in an amount that would cause that holder to beneficially own more than 4.99% of the issued and outstanding common shares of the Company, with such limitation voidable by that holder upon 75 days prior notice to the Company. Accordingly, a total of 14,233,503 additional shares subject to these certain warrants are not deemed to be beneficially owned by that holder and the related voting rights are excluded from Mr. Rice’s total.
(3)
Includes 3,250,000 shares subject to stock options that are exercisable within 60 days of December 31, 2013, all of which are subject to a voting agreement with Mr. Rice
(4)
Includes 2,693,162 shares subject to a voting agreement with Mr. Rice over which Mr. Rice has voting control and 500,000 shares subject to stock options that are exercisable within 60 days of December 31, 2013, all of which are subject to a voting agreement with Mr. Rice.
(5)
Includes 462,111 shares subject to a voting agreement with Mr. Rice over which Mr. Rice has voting control and 1,958,077 shares subject to stock options that are exercisable within 60 days of December 31, 2013, all of which are subject to a voting agreement with Mr. Rice..
(6)
Includes 1,400,000 shares subject to stock options that are exercisable within 60 days of December 31, 2013, all of which are subject to a voting agreement with Mr. Rice.
(7)
Includes 1,860,106 shares subject to a voting agreement with Mr. Rice; 1,879,019 shares subject to warrants and 2,184,848 shares subject to stock options, of which 1,879,019 shares from the warrants and 2,000,000 shares from the options are subject to a voting agreement with Mr. Rice, each of which are exercisable within 60 days of December 31, 2013; 1,021,900 shares which may be acquired pursuant to terms of convertible promissory notes that are convertible at the option of the holder within 60 days of December 31, 2013; and 123,246 shares owned by Laurel Research, Inc., of which Mr. Touber is President.
(8)
Includes 684,848 shares subject to stock options that are exercisable within 60 days of December 31, 2013.
(9)
Includes 869,694 shares subject to stock options that are exercisable within 60 days of December 31, 2013.
(10)
Includes 680,065 shares owned by David Marshall Inc., of which David Marshall is the chief executive officer; 3,122,240 shares owned by the David Marshall, Inc. Profit Sharing Trust, of which Mr. Marshall is the Trustee; 680,481 shares which may be purchased by the David Marshall, Inc. Profit Sharing Trust pursuant to warrants that are exercisable within 60 days of December 31, 2013 of which 325,000 shares from these warrants are subject to a voting agreement with Mr. Rice; 648,588 shares owned by Glenhaven Corporation, of which Mr. Marshall is the chief executive officer; and 3,500,000 shares owned by Santa Monica Capital, LLC, of which Mr. Marshall is the manager. Also includes 199,120 shares purchased by David Marshall as reported on his Form 13G filed June 24, 2009.
(11)
Includes 2,152,418 shares subject to a voting agreement with Mr. Rice and 1,822,866 shares subject to warrants that are exercisable within 60 days of December 31, 2013, of which 822,866 shares from the warrants are subject to a voting agreement with Mr. Rice.
(12)
Includes 75,000 shares pursuant to warrants that are exercisable within 60 days of December 31, 2013 and 881,075 shares which may be acquired pursuant to terms of Preferred Series A2 shares at the option of the holder within 60 days of December 31, 2013. The Series A2 shares of the holder as well as the warrants of the holder related to the SeriesA2 shares both provide that the holder shall not be entitled to purchase shares under said warrants nor exercise conversion rights of the Preferred Series A2 shares in an amount that would cause the holder to beneficially own more than 4.99% of the issued and outstanding common shares of the Company, with such limitation voidable by the holder upon 75 days prior notice to the Company. Accordingly, a total of 325,000 additional shares subject to the subject warrants and 1,283,425 shares that could be acquired under the conversion terms of the Series A2 Preferred shares are not deemed to be beneficially owned and are excluded from the total
(13)
Includes 4,354,070 shares which may be acquired pursuant to terms of a promissory note that is convertible at the option of the holder within 60 days of December 31, 2013, which are subject to a voting agreement with Mr. Rice. The promissory note, as well as additional warrants of the holder, provide that the holder shall not be entitled to purchase shares under the warrants nor exercise conversion rights under the promissory note in an amount that would cause the holder to beneficially own more than 4.99% of the issued and outstanding common shares of the Company, with such limitation voidable by the holder upon 75 days prior notice to the Company. Accordingly, a total of 14,233,503additional shares subject to the subject warrants and 7,430 shares that could be acquired pursuant to the terms of the promissory note are not deemed to be beneficially owned and are excluded from the total.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Certain Relationships and Related Transactions
Voting Agreements
Holders of options under our 2004 Plan and 2007 Plan, other than independent directors, are required to enter into an agreement granting Mr. Rice voting rights with respect to the common stock issued upon exercise of their options, which agreements expire ten years after execution thereof.
Holders of shares of common stock issued in October 2012 as a result of the conversion of outstanding principle amounts pursuant to promissory notes have entered into a shareholder agreements granting Mr. Rice voting rights with respect to these shares.
Holders of promissory notes amended or issued in October 2012, which contain rights of conversion for outstanding principle and accrued interest, have entered into shareholder agreements granting Mr. Rice voting rights with respect to the shares of common stock issued upon the exercise of said conversion rights.
Holders of warrants resulting from the amendment to loan agreements in October 2012 have entered into shareholder agreements granting Mr. Rice voting rights with respect to the common stock issued upon exercise of these warrants.
Indemnification Agreements
We have indemnification agreements with each of our directors, officers and certain employees. The indemnification agreements provide that the director or officer will be indemnified to the fullest extent not prohibited by law for claims arising in such person’s capacity as a director or officer no later than 30 days after written demand to us. The agreements further provide that in the event of a change of control, we would seek legal advice from a special independent counsel selected by us and approved by the officer or director, who has not performed services for either party for five years, to determine the extent to which the officer or director would be entitled to an indemnity under applicable law. We believe that these agreements are necessary to attract and retain skilled management with experience relevant to our industry.
Director Independence
See “Item 10. Directors, Executive Officers and Corporate Governance.”
Item 14.
Item 14. Principal Accountant Fees and Services
Gumbiner Savett, Inc. (“GSI”) is our principal accountant firm. GSI has not provided any non-audit services to us during the years ended December 31, 2013 and 2012. The Audit Committee of our Board of Directors has considered whether the provision of non-audit services are compatible with maintaining GSI independence.
Each year the independent auditor’s retention to audit our financial statements, including the associated fee, is approved by the Board before the filing of the previous year’s Annual Report on Form 10-K.
Audit Fees (in thousands):
------
(1)
Audit Fees paid to Gumbiner Savett consist of fees for the audit of our financial statements and review of the interim financial statements included in our quarterly reports.
Pre-Approval Policies and Procedures of Audit and Non-Audit Services of Independent Registered Public Accounting Firm
The Audit Committee’s policy is to pre-approve, typically at the beginning of our fiscal year, all audit and non-audit services, other than de minimis non-audit services, to be provided by an independent registered public accounting firm. These services may include, among others, audit services, audit-related services, tax services and other services and such services are generally subject to a specific budget. The independent registered public accounting firm and management are required to periodically report to the full Board regarding the extent of services provided by the independent registered public accounting firm in accordance with this pre-approval, and the fees for the services performed to date. As part of the Board’s review, the Board will evaluate other known potential engagements of the independent auditor, including the scope of work proposed to be performed and the proposed fees, and approve or reject each service, taking into account whether the services are permissible under applicable law and the possible impact of each non-audit service on the independent auditor’s independence from management. At Audit Committee meetings throughout the year, the auditor and management may present subsequent services for approval. Typically, these would be services such as due diligence for an acquisition, that would not have been known at the beginning of the year.
The Audit Committee has considered the provision of non-audit services, if any, provided by our independent registered public accounting firm to be compatible with maintaining their independence. The Audit Committee will continue to approve all audit and permissible non-audit services provided by our independent registered public accounting firm.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)(1) Financial Statements.
The index to the consolidated financial statements required by this item is set forth on page.
(a)(2) Financial Statement Schedules.
None.
(a)(3) Exhibits.
3.1
Amended and Restated Articles of Incorporation (1)
3.2
Amended and Restated Bylaws (2)
4.1
Specimen Certificate for Common Stock
4.2 *
2004 Stock Option Plan (1)
4.3 *
2007 Omnibus Stock and Incentive Plan (1)
4.4 *
Form of Stock Option Agreement
4.5
Form of Placement Agent Warrant (3)
4.6
Form of Bridge Financing Warrant (3)
4.7
Form of Exchange Agreement, dated as of December 29, 2006 (4)
4.8
Credit Term Agreement for the Bridge Financing, dated December 14, 2006 (4)
4.9
Initial Registration Rights Agreement, dated as of December 29, 2006 (4)
4.10
Additional Registration Rights Agreement, dated as of December 29, 2006 (4)
4.11
Stock Purchase Agreement dated as of March 30, 2006 between InterMetro and David Singer (3)
4.12
Common Stock Purchase Warrant (5)
4.12.1
Form of Secured Note Financing Warrant (6)
4.13
Form of 2008/2009 Bridge Lender Warrants (8)
4.14
Form of Preferred Series A2 Warrant (9)
4.15
Preferred Series A2 Amended Certificate of Designation (10)
9.1
Voting Trust Agreement, dated as of December 29, 2006 (4)
9.2
Voting Trust Agreement, dated as of December 29, 2006 (4)
9.3
Form of Voting Agreement between Charles Rice and Lenders (11)
10.1 *
Employment Agreement dated as of January 1, 2004 between InterMetro and Charles Rice, as amended (3)
10.2 *
Employment Agreement dated as of January 1, 2004 between InterMetro and Jon deOng, as amended (3)
10.3 *
Employment Agreement dated as of January 1, 2004 between InterMetro and Vincent Arena, as amended (3)
10.4 *
Employment Agreement dated as of March 31, 2006 between Advanced Tel, Inc. and David Singer (3)
10.5†
Strategic Agreement dated as of May 2, 2004 between InterMetro and Qualitek Services, Inc. (3)
10.6†
Strategic Agreement dated as of May 2, 2006 between InterMetro and Cantata Technology, Inc. (3)
10.7
Office Lease between InterMetro and Pacific Simi Associates, LLC dated as of April 6, 2006 (3)
10.8†
Services Agreement between InterMetro and 99¢ Only Stores (3)
10.9 *
Form of Indemnification Agreement (3)
10.10
Placement Agent Agreement for the Private Placement, dated December 14, 2006 (4)
10.11
Consulting Agreement with Advisor, dated as of December 29, 2006 (4)
10.12
Loan and Security Agreement, dated January 16, 2008 (7)
10.13
Form of Secured Convertible Promissory Note (7)
10.14
Moriah Capital Promissory Note and Ancillary Loan Agreements (12)
10.15
Promissory Note to TAB Bank and Loan Agreement dated as of October 9, 2012 (13)
10.16
Form of Promissory Note with 2008/2009 Bridge Lenders and Loan Agreements (14)
10.17
Amended and Restated Intercreditor Agreement, dated as of October 9, 2012 (15)
21.1 +
Subsidiaries of InterMetro Communications, Inc.
31.1 +
Section 302 Certification
31.2 +
Section 302 Certification
32.1 +
Section 906 Certification
32.2 +
Section 906 Certification
------
(1)
Incorporated by reference to Exhibits A, B and C of the Schedule 14C Information Statement filed with the Securities and Exchange Commission on March 9, 2007.
(2)
Incorporated by reference to Exhibit 3.1 of the Form 8-K filed with the Securities and Exchange Commission on July 3, 2007.
(3)
Incorporated by reference to Exhibits 4.5, 4.6, 4.11, 10.1, 10.2, 10.4, 10.5, 10.6, 10.7, 10.8 and 10.9 of the Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on February 9, 2007.
(4)
Incorporated by reference to Exhibits 99.1, 99.2, 99.4.1, 99.4.2, 99.6.1, 99.6.2, 99.3 and 99.7 of the Form 8-K filed with the Securities and Exchange Commission on January 9, 2007.
(5)
Incorporated by reference to Exhibits 4.1 and 10.1 of the Quarterly Report o Form 10-Q for the Quarter ended September 30, 2010 as filed with the Securities and Exchange Commission
(6)
Incorporated by reference to Exhibit 4.12.1 of the Form 10-K for the fiscal year ended December 31, 2010 as filed with the Securities and Exchange Commission.
(7)
Incorporated by reference to Exhibits 10.12 and 10.13 of the Form 10-KSB for the fiscal year ended December 31, 2007 as filed with the Securities and Exchange Commission.
(8)
Incorporated by reference to Exhibits 4.13, 4.14 and 4.15 of Form 10Q for the period ending September 30, 2012 as filed with the Securities and Exchange Commission.
(9)
Incorporated by reference to Exhibit 4.16 of Form 10Q for the period ending September 30, 2012 as filed with the Securities and Exchange Commission.
(10)
Incorporated by reference to Form 8K filed with the Securities and Exchange Commission on October 17, 2012.
(11)
Incorporated by reference to Exhibit 9.3 of Form 10Q for the period ending September 30, 2012 as filed with the Securities and Exchange Commission.
(12)
Incorporated by reference to Exhibits 10.16, 10.17, 10.18 and 10.19 of Form 10Q for the period ending September 30, 2012 as filed with the Securities and Exchange Commission.
(13)
Incorporated by reference to Exhibits 10.20 and 10.21 of Form 10Q for the period ending September 30, 2012 as filed with the Securities and Exchange Commission.
(14)
Incorporated by reference to Exhibits 10.22, 10.23, 10.24 and 10.25 of Form 10Q for the period ending September 30, 2012 as filed with the Securities and Exchange Commission.
(15)
Incorporated by reference to Exhibit 10.26 of Form 10Q for the period ending September 30, 2012 as filed with the Securities and Exchange Commission.
+
Filed herewith
*
Management contract or compensatory plan or arrangement
†
Confidential treatment has been requested for portions of this Exhibit which have been filed separately with the Securities and Exchange Commission pursuant to Rule 406 promulgated under the Securities Act.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INTERMETRO COMMUNICATIONS, INC.
Dated: April 15, 2014
By:
/s/ Charles Rice
Charles Rice, Chairman of the Board,
Chief Executive Officer, and President
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Principal Executive Officer
By:
/s/ Charles Rice
Dated: April 15, 2014
Charles Rice, Chairman of the Board,
Chief Executive Officer, and President
Principal Financial Officer
By:
/s/ David Olert
Dated: April 15, 2014
David Olert
Chief Financial Officer
By:
/s/ Jon deOng
Dated: April 15, 2014
Jon deOng
Chief Information Officer and Director
By:
/s/ Joshua Touber
Dated: April 15, 2014
Joshua Touber
Director
By:
/s/ Robert Grden
Dated: April 15, 2014
Robert Grden
Director
By:
/s/ Douglas Benson
Dated: April 15, 2014
Douglas Benson
Director
Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2013 and 2012
Consolidated Statements of Operations for the years ended December 31, 2013 and 2012
Consolidated Statements of Stockholders’ Deficit for the years ended December 31, 2013 and 2012
Consolidated Statements of Cash Flows for the years ended December 31, 2013 and 2012
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
InterMetro Communications, Inc.
We have audited the accompanying consolidated balance sheets of InterMetro Communications, Inc. and subsidiaries (the “Company”) as of December 31, 2013 and 2012 and the related consolidated statements of operations, stockholders’ deficit and cash flows for each of the years in the two-year period ended December 31, 2013. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company incurred net losses in previous years, and as of December 31, 2013 the Company had a working capital deficit of approximately $12,082,000 and a total stockholders’ deficit of approximately $12,426,000. The Company anticipates that it will not have sufficient cash flow to fund its operations in the near term and through fiscal 2014 without the completion of additional financing. These factors, among others discussed below and in Note 1 to the consolidated financial statements, raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are described in Note 1. 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.
The Company has significant contingencies such as lawsuits that are discussed in Note 12 to the consolidated financial statements.
The matters detailed in the preceding paragraphs, individually or in the aggregate, could have material adverse consequences, including a cessation of operations, to the Company at any time.
/S/ GUMBINER SAVETT INC.
GUMBINER SAVETT INC.
Santa Monica, California
April 15, 2014
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
The accompanying notes are an integral part of these consolidated financial statements.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT
(Dollars in Thousands)
The accompanying notes are an integral part of these consolidated financial statements.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
The accompanying notes are an integral part of these consolidated financial statements.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 - Nature of Operations and Summary of Significant Accounting Policies
Company Background - InterMetro Communications, Inc., (hereinafter, “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. The Company owns and operates state-of-the-art VoIP switching equipment and network facilities that are utilized to provide traditional phone companies, wireless phone companies, calling card companies and marketers of calling cards with wholesale voice and data services, and voice-enabled application services. The Company’s customers pay the Company for minutes of utilization or bandwidth utilization on its national voice and data network and the Company’s calling card marketing customers pay per calling card sold. The Company sold routing software to an initial customer in 2013. The Company’s headquarters is located in Simi Valley, California.
Going Concern - The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and settlement of obligations in the normal course of business. The Company had a working capital deficit of $12,082,000 and had a total stockholders’ deficit of $12,426,000 as of December 31, 2013. 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), interest due on its revolving line of credit (see Note 11) and settlement payments due (see Note 6), all of which the Company has missed scheduled payments. 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, to the Company at any time.
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 states that there is substantial doubt about the Company’s ability to continue as a going concern.
Management believes that the losses in current and past years were primarily attributable to continued decline in revenue and additional costs incurred relating 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 operations. Any sale of additional common stock or convertible equity or debt securities would result in additional dilution to the Company’s stockholders.
Principles of Consolidation - The consolidated financial statements include the accounts of InterMetro, InterMetro Delaware, and InterMetro Delaware’s wholly-owned subsidiary, Advanced Tel, Inc. (“ATI”). All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates - In the normal course of preparing financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue Recognition - VoIP services are recognized as revenue when services are provided primarily based on usage. Revenues derived from sales of calling cards through retail distribution partners are deferred upon sale of the cards. These deferred revenues are recognized as revenue generally at the time card minutes are expended. The Company has revenue sharing agreements based on successful collections. The company recognizes revenue from these customers at the time of invoicing based on the history of collections with such customers. The Company recognizes 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 Company obligations remain and collection is reasonably assured. Deferred revenue consists of fees received or billed in advance of the delivery of the services or services performed in which collection is not reasonably assured. This revenue is recognized when the services are provided and no significant Company obligations remain. Revenue from the sale of software and related equipment is generally recognized upon receipt by the customer. The Company assesses 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, the Company does not request collateral from customers. If the Company determines that collection of revenues are not reasonably assured, amounts are deferred and recognized as revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.
Accounts Receivable - Accounts receivable consist of trade receivables arising in the normal course of business. The Company does not charge interest on its trade receivables. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company reviews its allowance for doubtful accounts periodically. The Company determines 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, an additional allowance may be required. Bad debt expense during 2013 and 2012 amounted to $31,000 and $0, respectively.
Network Costs - The Company’s network costs consist of telecommunication costs, leasing collocation facilities and certain build-outs, and depreciation of equipment related to the Company’s network infrastructure. It is not unusual in the Company’s industry to occasionally have disagreements with vendors relating to the amounts billed for services provided between the recipient of those services and the vendor. As a result, the Company currently has disputes with vendors that it believes did not bill certain network charges correctly.
Depreciation and Amortization - Depreciation and amortization of property and equipment is computed using the straight-line method based on the following estimated useful lives:
Telecommunications equipment
2-3 years
Telecommunications software
18 months to 2 years
Computer equipment
2 years
Office equipment and furniture
3 years
Leasehold improvements
Useful life or remaining lease term, which ever is shorter
Maintenance and repairs are charged to expense as incurred; significant betterments are capitalized.
Software Development Costs - Research and development costs are charged to expense as incurred. However, the costs incurred for the development of computer software that will be sold, leased, or otherwise marketed are capitalized when technological feasibility has been established. These capitalized technological costs are subject to an ongoing assessment of recoverability based on anticipated future revenues and changes in hardware and software technologies. Amortization of the capitalized software development costs begins when the product is available for general release to customers. Amortization is computed as the ratio of current gross revenues of a product to the total of current and anticipated future gross revenues for the product. The Company had capitalized software development costs of approximately $513,000 and $149,000 as of December 31, 2013 and 2012, respectively, for the development of a software that facilitates the routing of call traffic through the lowest cost network. The software was sold to an initial customer in late September 2013. The Company amortized $4,000 of software development costs in the year ended December 31, 2013 and no software development costs in the year ended December 31, 2012.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Impairment of Long-Lived Assets - The Company assesses impairment of its other long-lived assets in accordance with the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“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 the Company include:
·
significant underperformance relative to historical or projected future operating results;
·
significant changes in the manner of use of the acquired assets or the strategy for the Company’s overall business; and
·
significant negative industry or economic trends.
When management of the Company determines 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 value if available, or discounted cash flows if not. To date, the Company has not had an impairment of long-lived assets and is not aware of the existence of any indicators of impairment.
Goodwill and Intangible Assets - The Company records 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 at least annually or whenever changes in circumstances indicate that the carrying value of the goodwill may not be recoverable. FASB ASC 350 also requires the Company to amortize intangible assets over their respective finite lives up to their estimated residual values. At December 31, 2013, management does not believe there is any further impairment in the value of goodwill.
Stock-Based Compensation - The Company has applied FASB ASC 718 “Compensation - Stock Compensation.” For grants to employees under its 2004 plan and 2007 plan, the Company estimates the fair value of each option award on the date of grant using the Black-Scholes option-pricing model. 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. The Company granted options under its 2007 plan during the years ended December 31, 2013 and 2012.
Concentration of Credit Risk - Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, accounts receivable, accounts payable, accrued expenses, and short term debt. The Company maintained its cash with major financial institutions located in the United States. Balances are insured by the Federal Deposit Insurance Corporation up to $250,000. Periodically throughout the year the Company maintains balances in excess of federally insured limits. The Company encounters a certain amount of risk as a result of a concentration of revenue from a few significant customers and services provided from vendors. Credit is extended to customers based on an evaluation of their financial condition. The Company generally does not require collateral or other security to support accounts receivable. The Company performs ongoing credit evaluations of its customers and records an allowance for potential bad debts based on available information. To date, such losses, if any, have been within management’s expectations.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company had ten customers that accounted for 65% and 79% of net revenue for the years ended December 31, 2013 and 2012, respectively. The Company had an accounts receivable balance from one and three customers that accounted for 13% and 59% of total accounts receivable at December 31, 2013 and 2012, respectively.
Income Taxes - The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using presently enacted tax rates. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
Segment and Geographic Information - The Company operates in one principal business segment primarily in the United States. All of the operating results and identified assets are located in the United States.
Basic and Diluted Net Loss per Common Share - Basic net income per common share excludes dilution for potential common stock issuances and is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted net income per common share includes dilution for potential common stock issuances when the warrants, options or common stock conversion rights underlying those potential issuances are below the then fair market value of the Company’s common stock and have intrinsic value. As the Company reported a net loss for the twelve months ended December 31, 2013, the conversion of promissory notes and the exercise of stock options and warrants were not considered in the computation of diluted net loss per common share because their effect is anti-dilutive. A total of 24,215,300 potential common stock issuances were included in the calculation of diluted net income for the year ended December 31, 2012.
Recently Adopted Accounting Pronouncements - Management does not believe that any recently issued, but not yet effective, accounting standards or pronouncements, if currently adopted, would have a material effect on the Company’s consolidated financial statements.
2 - Acquisition and Intangible Assets
On March 31, 2011, the Company was notified that the seller and the former president of Advanced Tel, Inc. (“ATI”), the Company’s wholly owned subsidiary, had filed suit against the Company asserting, among other things, that the Company owed said seller certain amounts related to the agreement entered into by the parties (“Purchase Agreement”) when the Company purchased ATI in 2006. On November 30, 2011, the parties arbitrated a settlement with precedent conditions to be performed by the Company in the first quarter of 2012, conditions that were met on March 14, 2012 resulting in dismissal of the suit on March 14, 2012. As part of the settlement the Company voided the disputed 4,089,930 shares originally issued to the seller in 2008 as part of the stock compensation in the Purchase Agreement and the seller returned to the Company the 308,079 shares issued to him in 2006 also originally part of the Purchase Agreement. All shares were returned to the Company’s Treasury. The Company will pay the seller a total of $200,000, of which $126,000 remains unpaid at December 31, 2013 and subject to timely monthly payments through March 2017.
The Company has completed an integration plan for utilizing the Company’s network to carry the ATI customer traffic. The execution of this plan resulted in a significant cost savings. In addition, ATI has a statutory presence in various state jurisdictions that facilitates retail sales that include the initial sale of the Company’s software in September 2013. These factors were used in the present value of net cash flows analysis that supports the carrying value of ATI Goodwill which was $450,000 at December 31, 2013 and 2012.
3 - Prepayments and Other Current Assets
The following is a summary of the Company’s prepayments and other current assets (in thousands):
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4 - Property and Equipment
The following is a summary of the Company’s property and equipment (in thousands):
Depreciation expense included in network costs was $29,000 and $26,000 for the years ended December 31, 2013 and 2012, respectively. Depreciation and amortization expense included in general and administrative expenses was $18,000 and $10,000 for the years ended December 31, 2013 and 2012, respectively.
5 - Accrued Expenses
The following is a summary of the Company’s accrued expenses (in thousands):
6 - Vendor Settlements, Contingent Gains and Gain on Forgiveness of Debt
During the year ended December 31, 2013, the Company made final payments on two payment plans that resulted in the realization of contingent gains. In addition 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 and the final settlement payments, the Company recorded a gain on forgiveness of debt of $640,000 for the year ended December 31, 2013. 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 $51,000 related to these write-offs which is included in accounts payable write-off. At December 31, 2013, the balance in vendor settlements payable was $2,365,000 including $216,000 of deferred gains subject to timely payments. The settlements will be paid in periods ranging from one to sixty months with an aggregate monthly payment of approximately $68,000. The Company may continue to approach vendors to enter into similar agreements as well as continuing to write-off certain accounts payable under statute of limitations.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the year ended December 31, 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 $383,000 for the year ended December 31, 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 $322,000 related to these write-offs which is included in accounts payable write-off. At December 31, 2012, the balance in vendor settlements payable was $2,548,000 including $837,000 of deferred gains subject to timely payments.
7 - Secured Promissory Notes and Advances
2008 Bridge Loan - In November and December 2007, the Company received $600,000 in advance payments, pursuant to the sale of secured notes with individual investors, including $330,000 from related parties. In 2008 the Company received an additional $1,320,000, including $170,000 from related parties, pursuant to the sale of additional secured notes with individual investors, for a total of $1,920,000. The secured notes were issued on January 16, 2008 and were scheduled to mature 13 to 18 months after issuance (“2008 Bridge Loan”). The 2008 Bridge Loan was extended in 2009 to July 15, 2010, and then modified on October 5, 2010 (“2008 Bridge Loan Modification”) to be paid in quarterly installments, of interest, fees and principal, commencing March 31, 2011 and concluding on July 15, 2012. The 2008 Bridge Loan bears interest at a rate of 13% per annum and contains an origination and documentation fee equal to 3% and 2.5%, respectively, of the original principal amount of the note. The 2008 Bridge Loan is collateralized by substantially all of the assets of the Company. Since inception, the Company has incurred $1,647,000 in interest and fees, including $223,000 and $315,000 during the years ended December 31, 2013 and 2012, respectively.
In connection with the notes, the Company originally issued two common stock purchase warrants for every dollar received or 3.84 million common stock purchase warrants with an exercise price of $1.00, (the “Initial Warrants” and the “Additional Warrants”, collectively the “2008 Bridge Origination Warrants”). These 2008 Bridge Origination Warrants contained terms which resulted in 3.84 million shares of common stock being issued in 2009, in accordance with those terms, to extinguish the 2008 Bridge Origination Warrants. In exchange for the first extension of the due date from July 15, 2009 to July 15, 2010 the holder received a common stock purchase warrant (“Extension Warrants”) for each dollar of principal with an exercise price of $0.50 per share that were set to expire on July 14, 2016. The 2008 Bridge Loan Modification extends the term of Extension Warrants to July 14, 2018. In exchange for the 2008 Bridge Loan Modification the holder received a common stock purchase warrant (“2010 Extension Warrants”) for each dollar of principal with an exercise price of $0.01 per share that will expire on October 5, 2017. The value associated with the 2010 Extension Warrants was $11,000 and was recorded as an offset to the principal balance of the secured notes and is being amortized into interest expenses over the term of the notes using the effective interest method. The warrants were valued using the Black-Scholes formula.
The “Initial Warrants” also contained a put feature which gave the holder the option to put the warrant back to the Company for $0.15 per share and had been carried as a liability in the Company’s financial statements. The put feature was eliminated pursuant to the 2008 Bridge Loan Modification and the $288,000 related liability was reclassified to equity.
2009 Bridge Loan- In November and December 2008, two related party secured note holders advanced an additional $310,000 and in 2009 there were advances of an additional $152,500 from existing note holders, including $65,000 from related parties, paying 13% interest per annum. On June 12, 2009, the Company entered into a Short Term Loan and Security Agreement (“2009 Bridge Loan”) with the advance lenders. Per the 2009 Bridge Loan, the maturity date of the loans was extended from June 30, 2009 to February 28, 2010, and then subsequently modified on October 5, 2010 (“2009 Bridge Loan Modification”) to be paid in quarterly installments, of interest, fees and principal, commencing November 30, 2010 and concluding February 28, 2012. On November 30, 2010 the note holders waived their initial installment payment for 60 days to receive their first installment payment as of January 31, 2011. The 2009 Bridge Loan accrues interest at 13% per annum and contain an origination and documentation fee equal to 3% and 2.5%, respectively, of the original principal amount of the note. The 2009 Bridge Loan is collateralized by substantially all of the assets of the Company. Since inception, the Company has incurred $408,000 in interest and fees, including $57,000 and $78,000 during the years ended December 31, 2013 and 2012, respectively.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As was the case for the 2008 Bridge Loan warrants, the provisions of the 2009 Bridge Loan warrants included terms that resulted in the company providing shares of common stock in lieu of exercise under certain conditions, which conditions occurred on June 12, 2009 and resulted in the issuance of 1,387,500 common stock to extinguish the 2009 Bridge Original Warrants. In exchange for the 2009 Bridge Loan Modification the holder received a common stock purchase warrant (“2010 Extension Warrants”) for each dollar of principal with an exercise price of $0.01 per share that expire on October 5, 2017. The value associated with the 2010 Extension Warrants was $3,000 and was recorded as an offset to the principal balance of the secured notes and is being amortized into interest expenses over the term of the notes using the effective interest method. The warrants were valued using the Black-Scholes formula.
The total expense recorded by the Company for amortization of the debt discount related to all warrants was $43,000 and $14,000 for the years ended December 31, 2013 and 2012, respectively. The net amount of the notes was $2,488,000 and $2,319,000 as of December 31, 2013 and 2012, respectively.
Effective October 12, 2012 the Company renegotiated terms with its secured note holders. The renegotiated terms included conversion of certain loan balances to common stock, the issuance of warrants and the establishment of new payment terms. The secured note holders converted $1,521,843 that the Company owed into 10,145,523 shares of common stock at $0.15 per share and the Company issued warrants with a term of seven years to purchase 1,521,843 shares of common stock at an exercise price of $0.01 per share. The value associated with these warrants is $101,000. The remaining outstanding balance of $2,374,281, of which $764,221 is eligible to be converted to common stock at the election of the lenders at a rate of $0.50 per share of common stock, included $878,466 owed to related parties. This remaining balance was to be paid in interest only payments of approximately $12,000 per month from January 1, 2013 through September 1, 2013 followed by principal and interest payments of approximately $72,000 per month from September 1, 2013 until September 30, 2014. Most of the scheduled principal and interest payments were not made and the Company has not received a notice of default from any of the note holders. The Company paid a total of approximately $19,000 during the twelve months ended December 31, 2013. Of the remaining balances $923,576 will mature on September 30, 2014 with the final payment of all principal and accrued interest at maturity on December 31, 2014. As part of the renegotiated terms with the secured note holders the Company issued additional warrants with a term of seven years to purchase 2,145,000 shares of common stock at a price of $0.25 per share and 650,000 shares of common stock at a price of $0.01 per share. The value associated with these secured note holder warrants is $91,000 and has been recorded as an offset to the principal balance of the secured notes and, beginning in October 2012, is being amortized into interest expenses over the term of the notes using the effective interest method. The warrants are valued using the Black-Scholes formula. The Company recognized a $472,000 gain on the conversion of debt to common stock.
The renegotiated terms included, in addition to the conversion of certain amounts owed into common stock, the conversion of any remaining accrued interest into the new secured promissory notes. As a result accrued interest of $1,514,000 was converted and included in balance of the promissory notes due.
Also effective October 12, 2012, the Company entered into agreements with Moriah Capital, L.P. (“Moriah”) to retire the Company’s existing credit facility and to cancel Moriah’s put option to purchase 6,008,500 shares of the Company’s common stock. The Company paid $1,800,000 of the $2,050,000 outstanding principal on the credit facility, plus $45,000 in accrued interest and fees. The Company executed a new promissory note for the remaining $250,000 in principal and $737,500 for the value associated with the put option, resulting in a total note principal of $987,500. Of this amount, $250,000 was due on September 30, 2013 and the remaining principal and accrued interest is due on September 30, 2014. The Company did not make the scheduled principal payment on September 30, 2013. The note accrues interest at the rate of 9% per annum and Moriah may convert the balance owed into shares of common stock with unpaid principal amounts converted at the rate of $0.25 per share and any unpaid accrued interest at the rate of $0.30 per share (see Note 11).
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8 - Long-Term Debt
The Company’s long-term debt consisted of the following:
A summary of future maturities of long-term debt for the twelve months ending December 31st are as follows:
9 - Preferred and Common Stock
Preferred Stock - On May 31, 2007, the Company filed Amended and Restated Articles of Incorporation authorizing 10,000,000 shares of preferred stock, par value $0.001 per share, none of which are issued and outstanding. On November 19, 2009, the Company filed its Certificate of Designation (“C.D.”) and designated a Series A Preferred stock by resolution of the board of directors. The C.D. authorized the sale of 250,000 shares of Series A preferred stock at $1.00 per share, with additional rights, preferences, restrictions and privileges as filed with the Nevada Secretary of State. In January 2013 a stockholder and secured note holder elected to convert all of the 25,000 outstanding shares of Series A preferred shares into 166,500 shares of common stock. As of December 31, 2013 no shares of Series A preferred stock were outstanding and, at December 31, 2012, 25,000 shares of Series A preferred stock were issued and outstanding at $1.00 per share.
On October 12, 2012, the Company filed a C.D. and designated a Series A2 preferred stock authorizing the sale of 1,000,000 non-voting shares of Series A2 preferred stock at $1.00 per share. The shares have a liquidation preference of $1.25 per share plus payment of any accrued but unpaid dividends. To the extent that the Series A2 Preferred Shares had not been otherwise redeemed or converted by December 31, 2013, the Company may redeem all or any portion of such shares at any time after December 31, 2013 at the liquidation preference amount. Also on October 12, 2012, the Company sold 297,103 shares of Series A2 preferred stock together with warrants to purchase 297,103 shares of common stock at an exercise price of $0.20 per share in exchange for a total purchase price of $297,103. The securities were sold to accredited investors in a private placement exempt from registration under Regulation D of the Securities Act of 1933, as amended. The Series A2 preferred stock may be converted into shares of common stock at a conversion rate of 6.66 shares of common stock for each share of Series A2 preferred. The value associated with the Series A2 warrants was $5,000 and the warrants were valued using the Black-Scholes formula. In December 2012, some of the shareholders elected to convert an aggregate of 100,000 Series A2 preferred shares into 666,000 shares of common stock.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On June 28, 2013 the Company sold 370,000 shares of Series A2 Preferred Stock together with warrants to purchase 370,000 shares of common stock at an exercise price of $0.20 per share in exchange for a total purchase price of $370,000. On September 25, October 7 and December 12 the Company sold 25,000, 150,000 and 100,000 shares of Series A2 Preferred Stock, respectively, for a aggregate total purchase prices of $275,000 under the same terms. The securities were sold to accredited investors in a private placement exempt from registration under Regulation D of the Securities Act of 1933, as amended. The Series A2 preferred stock may be converted into shares of common stock at a conversion rate of 6.66 shares of common stock for each share of Series A2 preferred. The value associated with the accompanying warrants was $13,000 and determined using the Black-Scholes formula. During the twelve months ended December 31, 2013, two shareholders elected to convert a total of 55,000 shares of Series A2 preferred shares into 366,300 shares of common stock. As of December 31, 2013 and 2012, 762,103 and 222,103 shares of Series A2 preferred stock were outstanding, respectively.
Common Stock - As of December 31, 2013 and 2012, the total number of authorized shares of common stock, par value $0.001 per share, was 150,000,000 of which 82,736,093 and 81,689,238 shares, respectively, were issued and outstanding.
Exercise of Warrants - During the twelve months ended December 31, 2013, the Company issued 293,978 shares of its common stock pursuant to the exercise of warrants and received proceeds of approximately $3,000 in connection with the issuance.
During the twelve months ended December 31, 2013, the Company issued 176,744 shares of common stock in exchange for a cashless exercise of 200,000 stock warrants previously issued to an equipment vendor.
10 - Stock Options and Warrants
2004 Stock Option Plan - Effective January 1, 2004, the Company’s Board of Directors adopted the 2004 Stock Option Plan for Directors, Officers, and Employees of and Consultants to InterMetro Communications, Inc. (the “2004 Plan”). A total of 5,730,222 shares of the Company’s common stock had been reserved for issuance under the 2004 Plan. Upon shareholder ratification of the 2004 Plan pursuant to the definitive Information Statement on Schedule 14C filed with the Securities and Exchange Commission on March 6, 2007, the Company froze any further grants of stock options under the 2004 Plan. Any shares reserved for issuance under the 2004 Plan that were not needed for outstanding options granted under that plan were cancelled and returned to treasury shares.
The Company had granted a total of 5,714,819 stock options under the 2004 Plan to the officers, directors, and employees, and consultants of the Company, of which 1,261,418 were expired as of December 31, 2012. In the three months ended March 31, 2008, the Company issued 1,143,165 shares of common stock on the cashless exercise of 1,232,320 stock purchase options. The remaining 3,221,081 were fully vested at December 31, 2012 and were originally granted with exercise prices ranging from $0.04 to $0.97 per share. On November 15, 2010, in order to provide continued economic incentive to option holders, most of which were issued at prices that were “out of the money”, the Board of Directors authorized a re-pricing of all the stock options under the 2004 Plan to $0.01, the closing price of the Company’s common stock on that day.
Omnibus Stock and Incentive Plan - Effective January 19, 2007, the Board of Directors approved the 2007 Omnibus Stock and Incentive Plan (the “2007 Plan”) for directors, officers, employees, and consultants. The shareholders ratified the 2007 Plan pursuant to the Schedule 14C Information Statement filed with the Securities and Exchange Commission which was declared effective on May 10, 2007. Any employee or director of, or consultant, for the Company, or any of its subsidiaries or other affiliates, were eligible to receive awards under the 2007 Plan. The Company has reserved 26,099,040 shares of common stock for awards under the 2007 Plan. The 2007 Plan specifically prohibits the re-pricing of any stock options awarded under this plan.
In November 2007, InterMetro granted 2,350,000 stock options to purchase shares of common stock under the 2007 Plan at an average exercise price of $0.25 per share to employees and directors. 1,095,000 of the shares granted were immediately vested at date of grant. 1,050,000 of such options have expired as of December 31, 2012. In October 2008, InterMetro granted 600,000 stock options to purchase shares of common stock under the 2007 Plan at an average exercise price of $0.25 per share to employees and directors. 30% vested at date of grant with the remaining vesting 1/12 per subsequent quarter over the succeeding 3 years, originally expiring 5 years from date of grant. Extension of the expiration date is currently under consideration.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On March 22, 2012, the Company granted 13,500,000 stock options to purchase shares of common stock under the 2007 Plan at an average exercise price of $0.04 per share to employees and directors. 6,750,000 of the options granted were immediately vested at the date of grant. The remaining 6,750,000 options vested 25% per quarter beginning with the quarter ended June 30, 2012 and were fully vested at September 30, 2013. In July 2012, the Company granted 200,000 stock options to purchase shares of common stock under the 2007 Plan at $0.07 per share to employees. 50,000 of the options granted were immediately vested at the date of grant. The remaining 150,000 options vest 12.5% per quarter beginning in the quarter ended December 31, 2012. In September 2012, the Company granted 100,000 stock options to purchase shares of common stock under the 2007 Plan at $0.08 per share to employees. 25,000 of the options granted were immediately vested at the date of grant. The remaining 75,000 options vest 12.5% per quarter beginning in the quarter ended December 31, 2012. In November 2012, the Company granted 250,000 stock options to purchase shares of common stock under the 2007 Plan at $0.08 per share to an employee. 125,000 of the options granted were immediately vested at the date of grant. The remaining 125,000 options vest 25% per quarter beginning in the quarter ending March 31, 2013. In February, 2013 the Company granted 350,000 stock options to purchase shares of common stock under the 2007 Plan at $0.10 per share to employees. 87,500 of the options granted were immediately vested at the date of grant. The remaining 262,500 options vest 12.5% per quarter beginning in the quarter ended June 30, 2013.
The Company recognized compensation expense of $66,000 and $249,000 related to the vesting of the stock option grants in the twelve months ended December 31, 2013 and 2012, respectively. The remaining fair value is being recognized on a straight line basis over the vesting terms. As of December 31, 2013, none of the Company’s outstanding stock options under the 2007 Plan have been exercised.
The following presents a summary of activity under the Company’s 2004 and 2007 Plans for the years ended December 31, 2013 and 2012:
The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the Company’s closing stock price on the last day of the year ended December 31, 2013 and the exercises price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2013. This amount changes based on the fair market value of the Company’s stock. As of December 31, 2013, there remain 9,799,040 shares available for grant.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Additional information with respect to the outstanding options at December 31, 2013 is as follows:
As of December 31, 2013, there was $10,000 of unrecognized compensation cost related to unvested share based compensation arrangements granted under the 2004 and 2007 option plans.
Warrants - On April 30, 2008, the Company negotiated a revolving line of credit, which, as amended in September 2008, November 2008, May 2009, January 2010, September 2010 and December 2010, March 31, 2011, June 30, 2011, September 30, 2011, November 30, 2011 and March 30, 2012 allowed the Company to borrow up to $2.4 million. Warrants to purchase 14,233,503 shares of the Company’s common stock at an exercise price of $0.01 to $0.05 per share were granted in connection with securing and amending this credit facility. See Note 11 for a detail of the warrants issued in connection with this credit facility.
The Company has issued warrants to its secured note holders in connection with the execution of the loan agreements and subsequent amendments. Warrants to purchase an aggregate of 7,710,448 and 8,004,426 shares of the Company’s common stock with exercise prices ranging from $0.01 to $0.50 were outstanding with these note holders as of December 31, 2013 and 2012, respectively. See Note 7 for further details of these warrants.
11 - Credit Facilities
ATI Bank Lines of Credit - ATI had a line of credit with Bank of America with an outstanding balance of $11,000 as of December 31, 2012. The line of credit was paid off and was closed at December 31, 2013.
Revolving Credit Facility - The Company entered into agreements, including a Loan and Security Agreement (as subsequently amended, the “Agreement”), effective as of April 30, 2008 with Moriah pursuant to which the Company could borrow up to $2,400,000 which was subsequently increased to $2,575,000 of which $175,000 was subsequently paid down. The Agreement has been amended several times (the “Amendments”). Amendment No. 13 extended the expiration to August 16, 2012. The balance that remained unpaid at August 16, 2012 expiration date and at September 30, 2012 was carried until October 12, 2012 when, as discussed below, the Company paid off the Moriah facility and secured a new credit facility.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Warrants to purchase 14,233,503 shares of the Company’s common stock at an exercise price of $0.01 to $0.05 per share were granted in connection with securing and amending this credit facility. The expense recognized by the Company in the years ended December 31, 2013 and 2012 from the amortization of the debt discount related to the warrants was $95,000 and $31,000, respectively. The Company calculated the fair value of the warrants using the following assumptions:
Pursuant to the Agreement and Amendments Moriah could have sold certain warrants back to the Company for $737,500. The Company determined that the put options associated with the warrants caused the instrument to contain a net cash settlement feature. In accordance with FASB ASC 480 “Distinguishing Liabilities from Equity,” the put option required liability treatment. As a result, the put warrant liability was recorded at the warrant purchase price of $737,500 as of December 31, 2011. The $737,500 put feature was converted and became part of the promissory note discussed in the following paragraph. The debt discount associated with the put liability for the warrant put feature was amortized over the extended terms of the agreement.
Effective October 12, 2012, the Company entered into agreements with Moriah retiring the Company’s existing credit facility by paying Moriah $1,845,000 and issuing a promissory note in favor of Moriah in the principal amount of $987,500, $250,000 of which is due September 30, 2013. The balance, issued in consideration for the cancellation of Moriah’s put option to purchase 6,008,500 shares of the Company’s common stock, becomes due on September 30, 2014. The note accrues interest at the rate of 9% per annum and Moriah may convert the balance owed into shares of common stock with unpaid principal amounts converted at the rate of $0.25 per share and any unpaid accrued interest at the rate of $0.30 per share. Any warrants that were not previously priced at $0.01 per share of common stock were re-priced to $0.01 per share and the expiration date for all warrants will be September 30, 2019. The value associated with the re-pricing and expiration date extension of the Moriah warrants was $190,000 and was recorded as an offset to the principal balance of the note payable to Moriah and, beginning in October 2012, is being amortized into interest expenses over the term of the note using the effective interest method. The warrants were valued using the Black-Scholes formula. Under the agreements, the Company was subject to a bi-monthly fee of $11,000 through October 15, 2013. The expense recorded for this fee was $209,000 and $66,000 during the year ended December 31, 2013 and 2012, respectively.
The Company incurred interest expense in connection with Moriah of $90,000 and $302,000 for the years ended December 31, 2013 and 2012 respectively, and loan fees and amortization of loan costs of $209,000 and $260,000 for the same periods.
Effective October 12, 2012, the Company secured a new credit facility with Transportation Alliance Bank, Inc. (“TAB Bank”). 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 or 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 is subject to various other fees as defined in the credit facility agreement. The Company borrowed $2,191,998 and $1,663,660 as of December 31, 2013 and 2012, respectively. The loan provides for interest-only monthly payments, is generally secured by all of 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. The Company was not in compliance with the cash flow coverage of interest covenant as of December 31, 2013. The Company recognized $245,000 and $43,000 of interest expense related to the TAB credit facility in the twelve months ended December 31, 2013 and 2012, respectively. The Company is in an over-advance position with TAB Bank and is operating under a forbearance agreement.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12 - Commitments and Contingencies
Facility Lease - The Company leases its facilities in Simi Valley, California under a non-cancelable operating lease that expired on March 31, 2014 at an annual expense of approximately $168,000. The Company is currently renting on a month to month basis. Rent expense was $188,000 and $192,000 for the Company’s facilities for the years ended December 31, 2013 and 2012, respectively.
Vendor Agreements - The Company has entered into agreements with its network partners and other vendors for various services which are, in general, for periods of twelve months and provide for month to month renewal periods.
Vendor Disputes - It is not unusual in the Company’s industry to occasionally have disagreements with vendors relating to the amounts billed for services provided between the recipient of those services and the vendor, or in some cases, to receive invoices from companies that the Company does not consider a vendor. Management does not believe that any dispute settlement would have a material adverse effect on the Company’s financial position or results of operations. Management reviews available information and determines the need for recording an estimate of the potential exposure when the amount is probable and estimable based on FASB ASC 450 “Contingencies.”
The Company has periodically received “credit hold” and disconnect notices from major telecommunications carriers. Suspension of service by any major carrier could have a material adverse effect on the Company’s operations and financial condition. These disconnect notices were generated primarily due to the non-payment of charges claimed by each carrier, including some amounts disputed by the Company. Service has been maintained with each carrier, although further notices are possible if the Company is unable to make timely payments to its counterparties or to resolve the disputed amounts. Such payments would be in addition to current charges generated with such carriers.
The Company has received several notices from state and local regulatory and taxing authorities for its possible failure to file certain documents pertaining to the Company’s wholly-owned subsidiary ATI. The amounts at issue with these potential filings are de minimis.
Legal Proceedings
A Network Service Provider (“NSP1”) - On May 9, 2013, the Company was served a complaint in California Superior Court filed by NSP1 against the Company asserting various causes of action. The NSP1 claimed that the Company owed charges totaling $204,736. The Company denies that it owes this amount based on technical failures of NSP1. The Company filed a cross-complaint on June 13, 2013 for damages, in excess of NSP1’s asserted claims, due to costs and losses incurred by the Company related to measures taken to ensure continued network reliability to customers and the public. Discovery has not commenced and a court date has been set for late 2014. The Company has previously expensed all services related to NSP1 and does not anticipate any adverse material effect from this matter.
A Network Service Provider (“NSP2”) - On January 17, 2014, the Company settled, subject to payments, NSP2’s action to collect an asserted $478,347 plus interest, amongst other claims. The Company has previously expensed the costs related to the NSP2 settlement.
Universal Service Administrative Company - The Universal Service Administrative Company (USAC) administers the Universal Service Fund (USF). In 2009 and 2010, the Company did not make all of the payments claimed by the USAC and the Federal Communications Commission (FCC). As of December 31, 2013 and 2012, the Company has recorded an aggregate $1.6 million in connection with the USF including balances under settlement arrangements. The Company continues to work with the FCC and the Department of the Treasury to resolve these amounts in long term payment programs. Failure to execute or finalize any significant proposed payment plan would likely have a material adverse effect on the Company.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13 - Income Taxes
At December 31, 2013, the Company had net operating loss carryforwards to offset future taxable income, if any, of approximately $41 million for Federal and State taxes. The Federal net operating loss carryforwards begin to expire in 2021. The State net operating loss carryforwards began to expire in 2008.
The following is a summary of the Company’s deferred tax assets and liabilities (dollars in thousands):
The reconciliation between the statutory income tax rate and the effective rate is as follows:
Management has concluded that it is more likely than not that the Company will not have sufficient taxable income within the carryforward period permitted by current law to allow for the utilization of certain of the deductible amounts generating the deferred tax assets; therefore, a full valuation allowance has been established to reduce the net deferred tax assets to zero at December 31, 2013 and 2012.
The Company recognizes the impact of a tax position in the financial statements if that position is more likely than not of being sustained on a tax return upon examination by the relevant taxing authority, based on the technical merits of the position. At December 31, 2013 and 2012, the Company had no unrecognized tax benefits.
The Company recognizes interest and penalties related to income tax matters in interest expense and operating expenses, respectively. As of December 31, 2013 and 2012, the Company has no accrued interest and penalties related to uncertain tax positions.
The Company is subject to taxation in the United States of America (“U.S.”) and files tax returns in the U.S. federal jurisdiction and California (or various) state jurisdiction (s). The Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years before 2008. The Company currently is not under examination by any tax authority.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14 - Cash Flow Disclosures
The table following presents a summary of the Company’s supplemental cash flow information (dollars in thousands):
15 - Related Party Transactions
Effective September 1, 2009, the Company entered into a consulting agreement with one of its board members to provide consulting services. The Company was obligated to pay $6,250 per month plus out of pocket expenses for these services for the period September 1, 2009 to October 31, 2009, then $10,000 per month plus out of pocket expense through January 2011and $15,000 and out of pocket expenses beginning in February 2011. The Company incurred consulting fees under this agreement in the amount of $135,000 and $180,000 for the years ended December 31, 2013 and 2012, respectively. Included in accounts payable is $60,000 and $7,500 of unpaid fees at December 31, 2013 and 2012, respectively.
Commencing in December 2006, the Company entered into a three-year consulting agreement with an affiliate of a stockholder and debt holder pursuant to which the Company received services related to strategic planning, investor relations, acquisitions, and corporate governance. The Company was obligated to pay $13,000 a month for these services, subject to annual increases. In June 2008, the parties orally agreed to cancel the agreement and any future obligation. Included in accrued expense is $182,000 at December 31, 2013 and 2012 for unpaid amounts.
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16 - Quarterly Results (Unaudited)
17 - Subsequent Event
Subsequent to December 31, 2013,the Company sold 651,000 shares of Series B Preferred Stock together with warrants to purchase 651,000 shares of common stock at an exercise price of $0.20 per share in exchange for a total purchase price of $651,000. The securities were sold to accredited investors in private placements exempt from registration under Regulation D of the Securities Act of 1933, as amended. The Series B Preferred stock may be converted into shares of common stock at a conversion rate of 6.66 shares of common stock for each share of Series B Preferred. The value of the warrants issued was approximately $5,800.