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DELTATHREE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) This Management's Discussion and Analysis of Financial Condition and Results of
Operations, or MD&A, should be read in conjunction with the Management's
Discussion and Analysis of Financial Condition and Results of Operations and the
Consolidated Financial Statements and the Notes thereto included in our Annual
Report on Form 10-K for the year ended December 31, 2011.
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Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements are based on current expectations, estimates,
forecasts and projections about us, our future performance, the industries in
which we operate our beliefs and our management's assumptions. In addition,
other written or oral statements that constitute forward-looking statements may
be made by us or on our behalf. Words such as "may," "expect," "anticipate,"
"forecast," "intend," "plan," "believe," "seek," "estimate," variations of such
words and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and
involve certain risks, uncertainties and assumptions that are difficult to
assess. Therefore, actual outcomes and results may differ materially from what
is expressed or forecasted in such forward-looking statements. These risks and
uncertainties include, but are not limited to, the following:
· our ability to increase revenues and generate additional cash;
· our ability to obtain additional capital in the near term to finance
operations;
· our ability to meet our obligations under outstanding indebtedness, and the
impact of any remedies our secured lender may seek thereunder;
· our ability to successfully pursue strategic alternatives in the event we are
unable to increase revenues and generate additional cash;
· our ability to retain key personnel and employees needed to support our
services and ongoing operations and our ability to continue to effectively
maintain our ongoing operations, especially following the reduction in force
that we recently effected;
· our dependence on a small number of key customers for a significant percentage
of our revenue;
· decreasing rates of all related telecommunications services;
· the public's acceptance of Video over Internet Protocol, and the level and
rate of customer acceptance of our new products and services;
· the competitive environment of VoIP telephony and our ability to compete
effectively;
· fluctuations in our quarterly financial results;
· our ability to maintain and operate our computer and communications systems
without interruptions or security breaches;
· our ability to operate in international markets;
· our ability to provide quality and reliable service, which is in part
dependent upon the proper functioning of equipment owned and operated by third
parties;
· the uncertainty of future governmental regulation;
· the outcome of our discussions with the New York City Department of Finance
regarding the outstanding commercial rent tax, interest and penalties it
claims we owe;
· the impact of continuing unrest in the Middle East on our customers doing
business in that region;
· our ability to protect our intellectual property against infringement by
others, and the costs and diversion of resources relating to any claims that
we infringe the intellectual property rights of third parties;
· our ability to comply with governmental regulations applicable to our
business;
· the need for ongoing product and service development in an environment of
rapid technological change; and
· other risks referenced from time to time in our filings with the SEC.
For a more complete list and description of such risks and uncertainties, as
well as other risks, please refer to the section entitled "Risk Factors" in our
Annual Report on Form 10-K for the year ended December 31, 2011, as filed with
the SEC on March 28, 2012, as updated in our Quarterly Report on Form 10-Q for
the quarter ended March 31, 2012, filed with the SEC on May 14, 2012, and our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, filed with
the SEC on August 13, 2012. Except as required under the federal securities laws
and the rules and regulations promulgated thereunder, we do not have any
intention or obligation to update publicly any forward-looking statements or
risk factors after the filing of this report, whether as a result of new
information, future events, changes in assumptions or otherwise.
Overview
We are a global provider of integrated video and voice over Internet Protocol,
or VoIP, telephony services, products, hosted solutions and infrastructure. We
were founded in 1996 to capitalize on the growth of the Internet as a
communications tool by commercially offering Internet Protocol, or IP, telephony
services, or VoIP telephony. VoIP telephony is the real-time transmission of
voice communications in the form of digitized "packets" of information over the
Internet or a private network, similar to the way in which e-mail and other data
is transmitted. While we began as primarily a low-cost alternative source of
wholesale minutes for carriers around the world, we have evolved into an
international provider of next generation communication services.
Today we support tens of thousands of active users around the globe through our
service provider and reseller channel and our direct-to-consumer channel. We
have built a privately-managed, state-of-the-art global telecommunications
platform using IP technology and we offer a broad suite of private label VoIP
products and services as well as a back-office platform. Our operations
management tools include, among others: account provisioning; e-commerce-based
payment processing systems; billing and account management; operations
management; web development; network management; and customer care. Based on our
customizable VoIP solutions, these customers can offer private label video and
voice-over-IP services to their own customer bases under their own brand name, a
"white-label" brand (in which no brand name is indicated and different customers
can offer the same product), or the deltathree brand. At the same time, our
direct-to-consumer channel includes our joip Mobile application (which is a new
cellular phone application providing low cost mobile calls over 3G cellular
networks as well as WiFi networks), iConnectHere offering (which provides VoIP
products and services directly to consumers and small businesses online using
the same primary platform) and our joip offering (which serves as the exclusive
VoIP service provider embedded in the Globarange cordless phones of Panasonic
Communications). We are able to provide our services at a cost per user that is
generally lower than that charged by traditional service providers because we
minimize our network costs by using efficient packet-switched technology and
interconnecting to a wide variety of termination options, which allows us to
benefit from pricing differences between vendors to the same termination points.
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Prior to 1999, we focused on building a privately-managed, global network
utilizing IP technology, and our business primarily consisted of carrying and
transmitting traffic for communications carriers over our network. Beginning in
1999, we began to diversify our offerings by layering enhanced IP telephony
services over our network. These enhanced services were targeted at consumers
and were primarily accessible through our consumer website. During 2000, we
began offering services on a co-branded or private-label basis to service
providers and other businesses to assist them in diversifying their product
offerings to their customer bases. In 2001, we continued to enhance our unique
strengths through our pioneering work with the Session Initiation Protocol, or
SIP, an Internet Engineering Task Force standard that has been embraced by
industry leaders such as Microsoft and Cisco. These efforts culminated in the
launch of our state-of-the-art SIP infrastructure, and in doing so we became the
first major VoIP service provider to deploy an end-to-end SIP network and
services. In recent years, we have continued our pioneering efforts in SIP and
these efforts have yielded significant new releases.
In 2009 we began the process of expanding the suite of our communications
offerings into the global video phone services market. In the third quarter of
2009 we entered into an agreement with ACN Pacific Pty Ltd., a wholly-owned
subsidiary of ACN, Inc., or ACN, pursuant to which we provide digital video and
voice-over-IP services in Australia and New Zealand to ACN Pacific. In December
2010 we entered into an agreement with ACN Korea, a wholly-owned subsidiary of
ACN, pursuant to which we provide digital video and voice-over-IP services in
Korea.
In 2010 we continued to update our network by adding a video mail feature to our
video phone applications and launching our joip mobile application in July
2010. Following the launch of the mobile application, in October 2010 we entered
into a sales agency agreement with ACN pursuant to which ACN sells a private
label version of joip Mobile under the ACN Mobile World brand in the United
States and Canada. In addition, we offer the joip Mobile application on a
white-label basis to other customers. Finally, we entered into affiliate
agreements with different third parties pursuant to which such third parties
refer potential subscribers to our joip Mobile application.
In April 2011 we entered into an introducer agreement with ACN Europe B.V., a
wholly-owned subsidiary of ACN, pursuant to which ACN Europe refers potential
customers in different countries in Europe to a private label version of joip
Mobile sold under the ACN Mobile World brand. In November 2011 we entered into a
service agreement with Momentis U.S. Corp., or Momentis, a multi-level marketing
company, pursuant to which Momentis refers potential customers in North America
to a co-branded offering of joip Mobile and other consumer VoIP products and
services.
On April 3, 2012, we entered into an amendment to our sales agency agreement
with ACN and our introducer agreement with ACN Europe. Pursuant to the terms of
the amendment, beginning April 1, 2012, we are required to pay all then-current
commissions on a timely basis as required under the agreements and a late fee in
the amount of one percent per month of any past-due, unpaid commissions (which,
as of September 30, 2012, was equal to approximately $943,000). In addition,
beginning July 15, 2012, we are required to pay down any unpaid past due amounts
in an amount equal to at least $15,000 per month through June 15, 2013, and at
least $25,000 per month thereafter until such time as the unpaid balance is paid
in full, and are required to pay in full any unpaid, past due amounts upon 30
days' notice. In July 2012 we began making the $15,000 monthly payment. In
addition, in the event of certain insolvency-related events defined in the
agreements, all unpaid amounts will become immediately due and payable effective
immediately prior to such event.
As a complement to the initiatives we have taken to attempt to organically
expand our businesses, we have also evaluated opportunities for growth through
strategic relationships. In February 2009 we consummated a transaction with D4
Holdings pursuant to which we sold to D4 Holdings an aggregate of 39,000,000
shares of our common stock and a warrant to purchase up to an additional
30,000,000 shares of our common stock. D4 Holdings is a private investment fund
whose ownership includes owners of ACN, a direct seller of telecommunications
services. As a result of the transactions with D4 Holdings, we expect to
continue to seek opportunities to provide services to ACN and enter into other
commercial transactions that give us access to ACN's international marketing and
distribution capabilities.
From an operational standpoint, in 2012 we continued to focus our near-term
strategy and market initiatives on growing our service provider and digital next
generation communications offerings while still supporting our core VoIP
reseller and direct-to-consumer business segments.
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Going forward, we expect to:
• actively market our products and services to those entities that wish
to offer white-label digital next generation communications offerings;
• pursue a targeted strategy of identifying and evaluating appropriate
strategic collaborations, such as potentially engaging in commercial
transactions with ACN, that we hope will continue to expand and
diversify our customer base;
• market and sell our direct-to-consumer products and services through
affiliates and our affiliate program; and
• support and maintain our current reseller base, as we expect our
revenue from this key channel will continue to represent a significant
percentage of our total revenue in the foreseeable future.
As of September 30, 2012, we had negative working capital equal to approximately
$5.9 million as well as negative stockholders' equity equal to approximately
$5.6 million. We believe it is probable that we will continue to experience
losses and increased negative working capital and negative stockholders' equity
in the near future and may not be able to return to positive cash flow before we
require additional cash (in addition to any further amounts we may borrow from
D4 Holdings under the Fourth Loan Agreement) in the near term. We may experience
difficulties accessing the equity and debt markets and raising additional
capital, and there can be no assurance that we will be able to raise such
additional capital on favorable terms or at all. If additional funds are raised
through the issuance of equity securities, our existing stockholders will
experience significant further dilution. Because of our significant losses to
date and our limited tangible assets, we do not fit traditional credit lending
criteria, which could make it difficult for us to obtain loans or to access the
capital markets. If we issue additional equity or convertible debt securities to
raise funds, the ownership percentage of our existing stockholders would be
reduced and they may experience significant dilution. New investors may demand
rights, preferences or privileges senior to those of existing holders of our
common stock.
Due to the limited availability of additional loan advances under the Fourth
Loan Agreement, we believe that, unless we are able to increase revenues and
generate additional cash flows, our current cash and cash equivalents will not
satisfy our current projected cash requirements beyond the foreseeable future.
As a result, there is substantial doubt about our ability to continue as a going
concern.
In addition, unless we are able to increase revenues and generate additional
cash flows, based on currently projected cash flows we believe that we may be
unable to pay future scheduled interest and/or principal payments under the
various loan agreements with D4 Holdings as these obligations become due. In the
event that were to occur, if D4 Holdings is not willing to waive compliance or
otherwise modify our obligations such that we are able to avoid defaulting on
such obligations, D4 Holdings could accelerate the maturity of our debts due to
it. Further, because D4 Holdings has a lien on all of our assets to secure our
obligations under the loan agreements, D4 Holdings could take actions under the
loan agreements and seek to take possession of or sell our assets to satisfy our
obligations thereunder. Any of these actions would likely have an immediate
material adverse effect on our business, financial condition or results of
operations.
Due to our ongoing losses and reduction in cash, we initiated restructuring
activities beginning in the second quarter of 2011 in an effort to cut operating
costs significantly and better align our operations with our current business
model. In accordance with the restructuring, we instituted a reduction in force
and decreased the number of full time employees from approximately 53 to 37,
reduced the salaries of all remaining employees by five percent, and decreased
non-material expenses as well as payments to be made to vendors and other third
parties. As of September 30, 2012, we had 23 full time employees.
In view of our current cash resources, nondiscretionary expenses, debt and near
term debt service obligations, we may begin to explore all strategic
alternatives available to it, including, but not limited to, a sale or merger of
our company, a sale of our assets, recapitalization, partnership, debt or equity
financing, voluntary deregistration of its securities, financial reorganization,
liquidation and/or ceasing operations. In the event that we require but are
unable to secure additional funding, we may determine that it is in our best
interests to voluntarily seek relief under Chapter 11 of the U.S. Bankruptcy
Code. Seeking relief under the U.S. Bankruptcy Code, even if we are able to
emerge quickly from Chapter 11 protection, could have a material adverse effect
on the relationships between us and our existing and potential customers,
employees, and others. Further, if we were unable to implement a successful plan
of reorganization, we might be forced to liquidate under Chapter 7 of the U.S.
Bankruptcy Code. There can be no assurance that exploration of strategic
alternatives will result in our pursuing any particular transaction or, if we
pursue any such transaction, that it will be completed.
Trends in Our Industry and Business
A number of factors in our industry and business have a significant effect on
our results of operations and are important to an understanding of our financial
statements. These trends include:
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Overall Economic Factors: Our operations and earnings are affected by local,
regional and global events or conditions that affect supply and demand for
telecommunications products and services. These events or conditions are
generally not predictable and include, among other things, general economic
growth rates and the occurrence of economic recessions; changes in demographics,
including population growth rates; and consumer preferences. Our strategy and
execution focus is predicated on an assumption that these factors will continue
to promote strong desire for the utilization of telephony products and services
and that the cost and feature advantages of VoIP alternatives will not be
negatively impacted by unforeseen changes in these factors.
Industry: The telecommunications industry is highly competitive. In recent years
we have seen new sources of supply for our underlying infrastructure that have
reduced our overall costs of operation, including both advances in
telecommunications technology and advances in technology relating to
telecommunications usage, and have enjoyed the benefits of competition among
these suppliers for a relatively limited amount of viable customers. A key
component of our competitive position, particularly given the number and range
of competing communications products, is our ability to manage operating
expenses successfully, which requires continuous management focus on reducing
unit costs and improving efficiency.
Consumer Demand: There is significant competition within the traditional
telecommunications marketplaces (landline and wireless) and also with other
emerging next generation telecommunications providers, including IP
telecommunications providers, in supplying the overall telecommunications needs
of businesses and individual consumers.
A key component of our competitive position, particularly given the
commodity-based nature of many of our products, is our ability to sell to a
growing demand base for alternative communications products, in both the
developed and developing global marketplace. Within the developed global
marketplace, our ability to sell broadband video and voice-over-IP products and
services is directly linked to the significant growth rate of broadband
adoption, and we expect this trend to continue. We benefit from this trend
because our service requires a broadband Internet connection and our potential
addressable market increases as broadband adoption increases. Within the
developing areas of the world, our ability to sell alternative telephony
products and services is linked to both the increasing baseline economic trends
within these countries as well as the growing desire for individuals and
businesses to communicate and do business outside of their own countries. We
expect these trends to continue, and benefit from them because both the ability
to afford long distance calls and the desire to make them increase as a result.
Political Factors: Our operations and earnings have been, and may in the future
be, affected from time to time in varying degree by political instability,
social unrest (including the recent and continuing social unrest in the Middle
East) and by other political developments and laws and regulations, such as:
telecommunications regulations; war, civil war, armed conflict, terrorism and
other international conflicts; restrictions on production, imports and exports;
price controls; tax increases and retroactive tax claims; expropriation of
property; and cancellation of contract rights. Both the likelihood of such
occurrences and their overall effect upon us vary greatly from country to
country and are not predictable. At the same time, VoIP is becoming legal in
more countries as governments seek to increase competition, and this helps us as
service providers and resellers seek to meet their customers' telecommunications
needs with newly available solutions. Both the likelihood of VoIP legalization
and its overall effect upon us vary greatly from country to country and are not
predictable.
Regulatory Factors: Our business has developed in an environment largely free
from regulation. However, the United States and other countries have begun to
examine how VoIP services should be regulated and to begin instituting such
regulation, and a number of initiatives could have an impact on our business.
These initiatives include the assertion of state regulatory and taxing
authorities over us, FCC rulemaking regarding emergency calling services, the
imposition of law-enforcement obligations like the Communications Assistance for
Law Enforcement Act, referred to as "CALEA", marketing restrictions and data
protection rules for Customer Proprietary Network Information, referred to as
"CPNI", access to relay services for people with disabilities, local number
portability, proposed reforms for the inter-carrier compensation system, and an
ongoing generic rulemaking considering the classification of interconnected VoIP
services under federal law. Complying with regulatory developments will 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 we pay. We may impose additional fees on our customers in
response to these increased expenses. This would have the effect of increasing
our revenues per customer, but not our profitability, and increasing the cost of
our services to our customers, which would have the effect of decreasing any
price advantage we may have over traditional telecommunications companies.
Project Factors: In addition to the factors cited above, the advancement, cost
and results of particular projects depend on the outcome of: negotiations with
potential partners, governments, suppliers, customers or others; changes in
operating conditions or costs; and the occurrence of unforeseen technical
difficulties or enhancements. The likelihood of these items occurring and its
overall positive or negative effect upon us vary greatly from project to project
and are not predictable.
Risk Factors: For a discussion of the impact of market risks, financial risks
and other risks and uncertainties that we face, see "Item 1A. Risk Factors" in
our Annual Report on Form 10-K for the year ended December 31, 2012, as filed
with the SEC on March 28, 2012, as updated in our Quarterly Report on Form 10-Q
for the quarter ended March 31, 2012, filed with the SEC on May 14, 2012, and
our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, filed
with the SEC on August 13, 2012.
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Revenues
Our revenues are derived mainly from resellers, service providers, and direct
consumers of our video and voice-over-IP products and services. Revenue is
recognized from these products and services as follows:
· postpaid minutes: revenue from the sale of minutes on a postpaid basis
(primarily sold to our wholesale resellers) is recognized at the time such
minutes are used;
· prepaid minutes: prepayments for communications services and the sale of
minutes are deferred and recognized as revenue at the time communications
services are provided and at the time the minutes are utilized , service
charges are levied or remaining balances expire. We conduct evaluations of
outstanding prepaid balances that do not have expiration dates or service fees
associated with them to determine, based on terms and condition of agreements
and historical data, whether such balances are likely to be utilized. If we
determine that balances are unlikely to be used, the deferred revenue liability
is reduced accordingly and other revenue is recognized. The outstanding prepaid
balances likely to be utilized are reconciled to our deferred revenue account
and deferred revenue is increased or decreased accordingly to properly reflect
our estimated liability;
· monthly recurring charges: revenue from fees such as set monthly recurring
charges based on the level of service or calling plans that the subscriber
subscribes for is recognized as the applicable service is provided; and
· other revenues: these revenues include, but are not limited to, prepaid
balances with no services fees or expiration dates that are unlikely to be
utilized.
The following sets forth our revenues per segment for the three month and nine
months ended September 30, 2012 and 2011:
Three Months Ended Nine Months Ended
September 30, September 30,
Segment 2012 2011 2012 2011
($ in thousands) ($ in thousands)
Reseller $ 2,163 $ 1,278 $ 5,447 $ 5,383
Direct-to-consumer 989 622 3,223 1,637
Service provider 294 286 872 1,093
Other 76 29 231 92
Total Revenues $ 3,522 $ 2,215 $ 9,773 $ 8,205
The provision of video and voice-over-IP products and services through our
reseller, direct-to-consumer and service provider channels accounted for
approximately 61.4% and 28.1%, 8.3% and 57.7%, and 28.0% and 12.9%, respectively
of our total revenues for the three months ended September 30, 2012 and 2011.
Costs and Operating Expenses
Costs and operating expenses consist of the following: cost of revenues;
research and development expenses; selling and marketing expenses; general and
administrative expenses; and depreciation and amortization.
Cost of revenues consist primarily of network, access, termination and
transmission costs paid to carriers that we incur when providing services and
fixed costs associated with leased transmission lines. The term of our contracts
for leased transmission lines is generally one year or less, and either party
can terminate with prior notice.
Research and development expenses consist primarily of costs associated with
establishing our network and the initial testing of our services and
compensation expenses of software developers involved in new product development
and software maintenance. Since our inception, we have expensed all research and
development costs in each of the periods in which they were incurred.
Selling and marketing expenses consist primarily of expenses associated with our
direct sales force incurred to attract potential service provider, reseller, and
customers. In addition, we expense all sales commissions paid to third parties
that sell our products and services pursuant to the terms of our agreements with
such third parties.
General and administrative expenses consist primarily of compensation and
benefits for management, finance and administrative personnel, insurance
premiums, occupancy costs, legal and accounting fees and other professional
fees. Additionally, we incur expenses associated with our being a public
company, including the costs of directors' and officers' insurance.
Depreciation and amortization consists of the depreciation calculated on our
fixed assets.
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We have not recorded any income tax benefit for net losses and credits incurred
for any period from inception to September 30, 2012. The utilization of these
losses and credits depends on our ability to generate taxable income in the
future. Because of the uncertainty of our generating taxable income going
forward, we have recorded a full valuation allowance with respect to these
deferred assets.
Net Operating Losses
As of September 30, 2012, we had net operating losses, or NOLs, generated in the
U.S. of approximately $23.0 million and Delta Three Israel Ltd., our
wholly-owned subsidiary, had NOLs of approximately $5.0 million. Our issuance of
common stock to D4 Holdings in February 2009 constituted an "ownership change"
as defined in Section 382 of the Internal Revenue Code. As a result, under
Section 382 our ability to utilize NOLs generated in the U.S. prior to February
2009 (equal to approximately $156 million) to offset any income we may generate
in the future will be limited to approximately $600,000 per year from February
2009. The NOLs began to expire in 2011 and will continue to expire at various
dates until 2029 if not utilized. Our ability to utilize our remaining NOLs
could be additionally reduced if we experience any further "ownership change,"
as defined under Section 382.
Results of Operations - Three Months Ended September 30, 2012, Compared to Three
Months Ended September 30, 2011
Revenues
Revenues increased by approximately $1.3 million, or 59%, to approximately $3.5
million for the three months ended September 30, 2012, from approximately $2.2
million for the three months ended September 30, 2011. During this period the
number of minutes carried by our network decreased by approximately 6% from
approximately 93 million minutes during the three months ended September 30,
2011, to approximately 87 million minutes for the corresponding period in 2012.
This was caused, in large part, by a decrease of approximately 26 million
minutes utilized by our second-largest reseller during the three months ended
September 30, 2012, compared to the number of minutes utilized by such reseller
during the corresponding period in 2011. This decrease was partially offset by
an increase in the number of minutes utilized by our largest reseller for which
we terminated a large number of calls to higher-rate destinations during this
period, as this reseller resumed conducting business with us in September 2011
following a period from February 2011 in which the operations of this reseller
were suspended. In addition, despite the overall decrease in the number of
minutes carrier by our network our revenue increased during this period due to
an increase in revenue in our direct-to-consumer division, as the gross margins
from such division are significantly higher than the gross margins generated by
our reseller division.
Revenues generated by our reseller division increased by approximately $885,000,
or 69%, to approximately $2.2 million for the three months ended September 30,
2012, from approximately $1.3 million for the three months ended September 30,
2011. This increase was caused in large part by our largest reseller resuming
conducting business with us in September 2011 following a period from February
2011 in which the operations of this reseller were suspended. Our two largest
resellers accounted for approximately $1.9 million, or approximately 87%, of the
revenue generated from our reseller division for the three months ended
September 30, 2012, which represented approximately 53% of our total revenue for
such period. By comparison, for the three months ended September 30, 2011, our
two largest resellers accounted for approximately 70% of the revenue generated
from our reseller division, or approximately 41% of our total revenue during
such period.
Revenues generated by our service provider division increased by approximately
$8,000, or 3%, from approximately $286,000 for the three months ended September
30, 2011, to approximately $294,000 for the three months ended September 30,
2012. This increase was due to a one-time set-up fee we received from a service
provider during the three months ended September 30, 2012.
Sales to direct consumers increased by approximately $367,000, or 59%, to
approximately $989,000 for the three months ended September 30, 2012, from
approximately $622,000 for the three months ended September 30, 2011. Revenues
generated through our iConnectHere offering declined by approximately $77,000
from approximately $215,000 for the three months ended September 30, 2011, to
approximately $138,000 for the three months ended September 30, 2012. This was
offset by the revenues generated by our joip Mobile offering, which increased
from $389,000 for the three months ended September 30, 2011, to approximately
$843,000 for the three months ended September 30, 2012, primarily as a result of
the sales agency agreement we entered into with ACN, the introducer agreement we
entered into with ACN Europe and the sales agreement we entered into with
Momentis.
Costs and Operating Expenses
Cost of revenues. Cost of revenues increased by approximately $835,000, or 55%,
from approximately $1.5 million for the three months ended September 30, 2011,
to approximately $2.4 million for the three months ended September 30, 2012. Our
network rent cost decreased slightly by approximately $33,000 from approximately
$298,000 for the three months ended September 30, 2011, to approximately
$265,000 for the three months ended September 30, 2012.Our termination cost
increased by approximately $883,000, or 81%, from approximately $1.1 million for
the three months ended September 30, 2011, to approximately $2.0 million for the
three months ended September 30, 2012. The main reason for the increase in
termination cost was the resumption of operations of our largest reseller during
September 2011, which generated approximately $1.4 million of total termination
costs for the three months ended September 30, 2012, partially offset by a
decline in the total termination costs of our second-largest reseller of
approximately $340,000 during this period. In addition, during this period our
largest reseller utilized minutes through our network that were more expensive
for us to purchase than the minutes that were utilized by our second-largest
reseller during this period.
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Research and development expenses. Research and development expenses decreased
by approximately $92,000, or 25%, from approximately $366,000 for the three
months ended September 30, 2011, to approximately $274,000 for the three months
ended September 30, 2012. The main reason for the decrease was the reduction in
the number of employees in our research and development department. As a
percentage of revenues, research and development expenses for the three months
ended September 30, 2012, was approximately 8%compared to approximately 17% for
the three months ended September 30, 2011.
Selling and marketing expenses. Selling and marketing expenses increased by
approximately $43,000, or 10%, to approximately $467,000 for the three months
ended September 30, 2012, from approximately $424,000 for the three months ended
September 30, 2011. The main reason for the increase was an increase in
commissions recorded for ACN, ACN Europe and Momentis, offset by a reduction in
the number of employees in our sales and marketing department. As a percentage
of revenues, selling and marketing expenses decreased to approximately 13% for
the three months ended September 30, 2012, from approximately 19% for the three
months ended September 30, 2011.
General and administrative expenses. General and administrative expenses
decreased by approximately $41,000, or 10%, to approximately $366,000 for the
three months ended September 30, 2012, from approximately $407,000 for the three
months ended September 30, 2011. During the three months ended September 30,
2011, we recorded a credit of $50,000 as a reverse for losses on accounts
receivable in connection with outstanding amounts owed to us by our then-largest
reseller. Excluding this one-time item, our general and administrative expenses
would have decreased in the three months ended September 30, 2012, by
approximately $91,000 from the three months ended September 30, 2011, primarily
due to a reduction in salaries as a result of our restructuring as well as a
reduction in payments to be made to our vendors and other third parties.
Depreciation and amortization. Depreciation and amortization increased by
approximately $3,000, or 8%, from approximately $36,000 for the three months
ended September 30, 2011, to approximately $39,000 for the three months ended
September 30, 2012. This was caused byan acquisition of fixed assets during this
period.
Income (Loss) from Operations
For the three months ended September 30, 2012, we recorded income from
operations of approximately $17,000 compared to a loss from operations of
approximately $542,000 for the three months ended September 30, 2011, due to the
factors set forth above.
Interest Expense, Net
We recorded interest expense of approximately $416,000 for the three months
ended September 30, 2012, compared to approximately $329,000 for the three
months ended September 30, 2011. This increase was due primarily to interest
paid and recorded under our loan agreements with D4 Holdings of approximately
$140,000, and $261,000 we recorded for the warrant we issued to D4 Holdings in
connection with the Second Loan Agreement and the warrant and Convertible Note
we issued to D4 Holdings in connection with the Third Loan Agreement.
Income Taxes, Net
We recorded net income tax expenses of $2,000 for the three months ended
September 30, 2012, compared to $1,000 for the three months ended September 30,
2011.
Net Loss
For the three months ended September 30, 2012, we recorded a net loss of
approximately $401,000 compared to a net loss of approximately $872,000 for the
three months ended September 30, 2011, due to the factors set forth above.
17
Results of Operations - Nine Months Ended September 30, 2012, Compared to Nine
Months Ended September 30, 2011
Revenues
Revenues increased by approximately $1.6 million, or 20%, to approximately $9.8
million for the nine months ended September 30, 2012, from approximately $8.2
million for the nine months ended September 30, 2011. During this period the
number of minutes carried by our network decreased by approximately 10% from
approximately 279 million minutes during the nine months ended September 30,
2011, to approximately 255 million minutes for the corresponding period in 2012.
This was caused, in large part, by a decrease of approximately 52 million
minutes utilized by our second-largest reseller during the nine months ended
September 30, 2012, compared to the number of minutes utilized by such reseller
during the corresponding period in 2011. This decrease was partially offset by
an increase in the number of minutes from our largest reseller for which we
terminated a large number of calls to higher-rate destinations during this
period, as this reseller resumed conducting business with us in September 2011
following a period from February 2011 in which the operations of this reseller
were suspended. In addition, despite the overall decrease in the number of
minutes carrier by our network our revenue increased during this period due to
an increase in revenue in our direct-to-consumer division, as the gross margins
from such division are significantly higher than the gross margins generated by
our reseller division.
Revenues generated by our reseller division were approximately $5.4 million for
both of the nine months ended September 30, 2012 and 2011, although the revenues
generated by division for the nine months ended September 30, 2012, reflected an
increase in each subsequent quarter. Our two largest resellers accounted for
approximately $4.4 million, or approximately 81%, of the revenue generated from
our reseller division for the nine months ended September 30, 2012, which
represented approximately 45% of our total revenue for such period. By
comparison, for the nine months ended September 30, 2011, our two largest
resellers accounted for approximately $3.9 million, or approximately 72%, of the
revenue generated from our reseller division, or approximately 47% of our total
revenue during such period.
Revenues generated by our service provider division decreased by approximately
$221,000, or 21%, from approximately $1.1 million for the nine months ended
September 30, 2011, to approximately $872,000 for the nine months ended
September 30, 2012. This decrease was due to one-time set-up fees we received
from three different service providers during the nine months ended September
30, 2011.
Sales to direct consumers increased by approximately $1.6 million, or 100%, to
approximately $3.2 million for the nine months ended September 30, 2012, from
approximately $1.6 million for the nine months ended September 30, 2011.
Revenues generated through our iConnectHere offering declined by approximately
$234,000 from approximately $700,000 for the nine months ended September 30,
2011, to approximately $466,000 for the nine months ended September 30, 2012.
This was offset by the revenues generated by our joip Mobile offering, which
increased from $874,000 for the nine months ended September 30, 2011, to
approximately $2.7 million for the nine months ended September 30, 2012,
primarily as a result of the sales agency agreement we entered into with ACN,
the introducer agreement we entered into with ACN Europe and the sales agreement
we entered into with Momentis.
Costs and Operating Expenses
Cost of revenues. Cost of revenues decreased by approximately $300,000, or 5%,
from approximately $5.9 million for the nine months ended September 30, 2011, to
approximately $6.2 million for the nine months ended September 30, 2012. Our
network rent cost decreased by approximately $109,000, or 13%, from
approximately $891,000 for the nine months ended September 30, 2011, to
approximately $782,000 for the nine months ended September 30, 2012, and our
termination cost increased by approximately $518,000, or 11%, from approximately
$4.5 million for the nine months ended September 30, 2011 to approximately $5.0
million for the nine months ended September 30, 2012. The main reason for the
increase in termination costs was the resumption of operations of our largest
reseller during September 2011, which utilized minutes through our network that
were most expensive for us to purchase than the minutes that were utilized by
our second-largest reseller during the nine months ended September 30, 2012.
Research and development expenses. Research and development expenses decreased
by approximately $384,000, or 31%, from approximately $1.3 million for the nine
months ended September 30, 2011,to approximately $874,000 for the nine months
ended September 30, 2012. The main reason for the decrease was the reduction in
the number of employees in our research and development department. As a
percentage of revenues, research and development expenses for the nine months
ended September 30, 2012, was approximately 9%compared to approximately 15% for
the nine months ended September 30, 2011.
Selling and marketing expenses. Selling and marketing expenses remained constant
at approximately $1.5 million for the nine months ended September 30, 2012 and
2011. During the nine months ended September 30, 2012 there was a reduction in
the number of employees in our sales and marketing department and a
corresponding reduction in expenses, offset by an increase in commissions paid
to ACN, ACN Europe and Momentis. As a percentage of revenues, selling and
marketing expenses decreased to approximately 16% for the nine months ended
September 30, 2012, from approximately 19% for the nine months ended September
30, 2011.
General and administrative expenses. General and administrative expenses
increased by approximately $267,000, or 34% to approximately $1.0 million for
the nine months ended September 30, 2012, from approximately $775,000 for the
nine months ended September 30, 2011. During the nine months ended September 30,
2011, we recorded a one-time reversal of an accrual of $706,000 for expenses
expected to arise from our litigation with Centre One and a one-time reversal of
an accrual for tax liability of $158,000 that was recorded. This was partially
offset by $146,000 we recorded in 2011 as a provision for losses on accounts
receivable in connection with outstanding amounts owed to us by our largest
reseller. Excluding these one-time items, our general and administrative
expenses would have decreased in the nine months ended September 30, 2012, by
approximately $451,000 from the nine months ended September 30, 2011, primarily
due to a reduction in salaries arising from our restructuring as well as a
reduction in payments to be made to our vendors and other third parties.
18
Accrual for commercial rent tax. As discussed below under - "Liquidity and
Capital Resources", on July 5, 2011, we received a notice from the New York City
Department of Finance, which claimed that we had not paid commercial rent tax
required under the New York City Administrative Code from June 1998 through May
2008 for the two offices that we had leased during that time. The notice stated
that we are obligated to pay the outstanding tax amounts, as well as significant
interest and penalties that were assessed on the unpaid amounts as well as for
the failure to file the applicable tax returns. For the nine months ended
September 30, 2011, we recorded $300,000 as a provision for tax liability.
Depreciation and amortization. Depreciation and amortization decreased by
approximately $32,000, or 23%, from approximately $141,000 for the nine months
ended September 30, 2011, to approximately $109,000 for the nine months ended
September 30, 2012. This was caused bya decline in the value of our fixed assets
during this period.
Income (Loss) from Operations
For the nine months ended September 30, 2012, we recorded income from operations
of approximately $42,000 compared to a loss from operations of approximately
$1.7 million for the nine months ended September 30, 2011, due to the factors
set forth above.
Interest Expense, Net
We recorded interest expense of approximately $1.3 million for the nine months
ended September 30, 2012, compared to approximately $761,000 for the nine months
ended September 30, 2011. This increase was due primarily to interest recorded
under our loan agreements with D4 Holdings of approximately $408,000, and the
expense equal to $782,000 we recorded for the warrant we issued to D4 Holdings
in connection with the Second Loan Agreement and the warrant and Convertible
Note we issued to D4 Holdings in connection with the Third Loan Agreement.
Income Taxes, Net
We recorded net income tax expenses of $6,000 for the nine months ended
September 30, 2012, compared to $9,000 for the nine months ended September 30,
2011.
Net Loss
For the nine months ended September 30, 2012, we recorded a net loss of
approximately $1.3 million compared to a net loss of approximately $2.5 million
for the nine months ended September 30, 2011, due to the factors set forth
above.
Liquidity and Capital Resources
Since our inception in June 1996, we have incurred significant operating and net
losses due in large part to the start-up and development of our operations and
our losses from operations. For the nine months ended September 30, 2012, we
recorded net income from operations of approximately $42,000 compared to a net
loss from operations of approximately $1.7 million for the nine months ended
September 30, 2011. To date, we have an accumulated deficit of approximately
$182.6 million.
As of September 30, 2012, we had cash and cash equivalents of approximately
$288,000 and restricted cash and short-term investments of approximately
$272,000, or a total of cash, cash equivalents and restricted cash of $560,000,
a decrease of approximately $6,000 from December 31, 2011. The increase in cash
and cash equivalents (excluding the restricted cash and short-term investments)
was primarily caused by net cash provided by operating activities of
approximately $50,000 during the nine months ended September 30, 2012, and by
net cash used in investing activity of purchasing new equipment of approximately
$56,000 during the nine months ended September 30, 2012.
Cash used in or provided by operating activities is net loss adjusted for
certain non-cash items and changes in assets and liabilities. We had positive
cash flow from operating activities of approximately $50,000 and negative cash
flow from operating activities of approximately $2.0 million during the nine
months ended September 30, 2012 and 2011, respectively. The increase in our cash
generated from operating activities was primarily due to a decrease in our net
loss of $1.2 million, accumulated interest on short-term loans of $269,000,
amortization of $782,000 related to convertible notes and an increase in
deferred revenues of $154,000, offset by an increase in accounts receivables of
$205,000.
19
Net cash used in or provided by investing activities is generally driven by our
capital expenditures and changes in our short and long-term investments. For the
nine months ended September 30, 2012, we expensed $56,000 for purchases of new
equipment, compared to $99,000 for the nine months ended September 30, 2011. In
addition, during the nine months ended September 30, 2012, restricted cash equal
to $131,000 that was underlying the letter of credit previously provided by us
to the landlord of our subsidiary's office in Jerusalem was released, since such
letter of credit is no longer required under the extension of the lease that we
executed during this period. During the nine months ended September 30, 2012, a
reserve of $242,000 was temporarily held back by our previous payment processor
pending the final calculation and clearance of all payments processed by such
third party.
Net cash used in or provided by financing activities is generally driven by
drawing down amounts available under lines of credit available to us, issuing
shares of our capital stock and receiving cash that we had previously pledged or
otherwise deposited as security for our lenders and creditors. For the nine
months ended September 30, 2012, we did not draw down any amounts under our loan
agreements with D4 Holdings.
Financing cash flows have historically consisted primarily of payments of
capital leases and proceeds from the exercise of options we have granted to our
employees and directors. In February 2009 we consummated a transaction with D4
Holdings pursuant to which we sold to D4 Holdings an aggregate of 39,000,000
shares of our common stock and a warrant to purchase up to an additional
30,000,000 shares of our common stock for an aggregate purchase price of
$1,200,000. In addition, on March 1, 2010, we and our subsidiaries entered into
the First Loan Agreement with D4 Holdings pursuant to which D4 Holdings agreed
to provide us and our subsidiaries a line of credit in a principal amount of
$1,200,000. On August 10, 2010, we and our subsidiaries entered into the Second
Loan Agreement with D4 Holdings, pursuant to which D4 Holdings agreed to provide
us and our subsidiaries an additional line of credit in a principal amount of
$1,000,000. In connection with the Second Loan Agreement, we issued D4 Holdings
a warrant to purchase up to 4,000,000 shares of our common stock at an exercise
price of $0.1312 per share. We have drawn down all amounts available to be
borrowed under the first two lines of credit. On March 2, 2011, we and our
subsidiaries entered into the Third Loan Agreement with D4 Holdings pursuant to
which D4 Holdings agreed to provide us and our subsidiaries an additional line
of credit in a principal amount of $1,600,000. Pursuant to the terms of the
Convertible Note we issued to D4 Holdings in connection with the Third Loan
Agreement, D4 Holdings may elect to convert all or any portion of the
outstanding principal amount under the Convertible Note into that number of
shares of our common stock determined by dividing such principal amount by $0.08
(as may be adjusted under the terms of the Convertible Note). Simultaneous with
our entering into the Third Loan Agreement, D4 Holdings and we entered into an
amendment of the First Loan Agreement pursuant to which (among other things) the
maturity date for repayment of principal under the First Loan Agreement was
extended from March 1, 2011, to March 1, 2012. The maturity date was
subsequently extended by oral agreement of the parties to July 1, 2012, and then
subsequently orally extended again to January 2, 2014, pending the parties
finalizing and entering into a formal amendment. In connection with the Third
Loan Agreement, we issued D4 Holdings a warrant to purchase up to 1,000,000
shares of our common stock at an exercise price of $0.096 per share. We have
drawn down the aggregate principal amount available under the Third Loan
Agreement, the principal amount of which can be converted by D4 Holdings into an
aggregate of 20,000,000 shares of our common stock. On September 12, 2011, we
and our subsidiaries entered into the Fourth Loan Agreement with D4 Holdings,
pursuant to which D4 Holdings agreed to provide us and our subsidiaries an
additional line of credit in a principal amount of $300,000. As of September 30,
2012, we have drawn down the aggregate amount of $200,000 from D4 Holdings
pursuant to notices of borrowing under the Fourth Loan Agreement.
On November 13, 2012, each of us, our subsidiary and DME Solutions, Inc. entered
into the Third Amendment to Loan and Security Agreements, or the "Third
Amendment", and the Amendment to Warrant Agreements, or the "Warrants
Amendment", with D4 Holdings. Pursuant to the Third Amendment and the Warrants
Amendment,
· the maturity date for repayment of principal and interest under the First Loan
Agreement was extended to January 2, 2014;
· the maturity date for repayment of principal and interest under the Second Loan
Agreement was extended to January 2, 2015;
· the maturity date for repayment of principal and interest under each of the
Third and Fourth Loan Agreements was extended to January 2, 2016;
· all interest outstanding under each of the loan agreements was added to the
principal amount outstanding under the respective loan agreement and the
promissory note issued pursuant to each respective loan agreement was increased
by such amount; and
· the exercise price under each of the Warrant Agreements entered into by the
Company and D4 Holdings as of February 12, 2009, August 10, 2010, and March 2,
2011 was amended to $0.02 per share.
In connection with the extension of the maturity dates under the Third
Amendment, we issued to D4 Holdings a Warrant, or together with the Third
Amendment and the Warrants Amendment, the "Transaction Documents", exercisable
for ten years, to purchase up to 10,000,000 shares of our common stock at an
exercise price of $0.02 per share.
There were no options exercised by our employees or directors during the nine
months ended September 30, 2012. For the nine months ended September 30, 2011,
we paid $7,000 for capital leases. We did not record any expenses for capital
leases during the nine months ended September 30, 2012.
On July 5, 2011, we received a notice from the New York City Department of
Finance that claimed that we had not paid commercial rent tax required under the
New York City Administrative Code from June 1998 through May 2008 for the two
offices that we had leased during that time. The notice stated that we are
obligated to pay the outstanding tax amounts, as well as significant interest
and penalties that were assessed on the unpaid amounts as well as for the
failure to file the applicable tax returns. On August 15, 2011, we filed a
response contesting the assessment and/or attempting to negotiate a reduction in
the amounts to be paid. Our appeal was rejected in July 2012 by an examiner in
the Department of Finance, and we have subsequently engaged and begun
discussions with a manager in the Department of Finance and submitted additional
supporting materials. The final outcome of this assessment and our negotiations
with the New York City Department of Finance cannot be determined at this time.
In the event that we are required to pay all or most of the amounts claimed by
the New York City Department of Finance this would have a material adverse
effect on our financial condition and liquidity. During 2011 we recorded
$300,000 as a provision for commercial rent tax.
We experience fluctuations in our cash cycle, as we generally make payments to
our termination suppliers more frequently (often on a weekly basis) than we
receive payments from our customers (often on a monthly basis). In the event one
of our customers did not pay us, we would experience a direct loss of the
amounts we had already paid to our termination suppliers. We maintain our free
cash in accounts with major banks located in the United States, and generally do
not invest such cash in short or long-term investments. As a way to try to
offset our declining cash position we generally seek to extend payment terms to
our suppliers other than our termination providers.
20
We have historically obtained our funding from our utilization of the remaining
proceeds from our initial public offering, offset by positive or negative cash
flow from our operations, and most recently from the sale of shares of our
common stock to D4 Holdings in February 2009 and borrowings under our loan
agreements with D4 Holdings. These proceeds are maintained as cash, restricted
cash, and short and long term investments. We have sustained significant
operating losses in recent periods, which have led to a significant reduction in
our cash reserves.
On April 3, 2012, we entered into an amendment to our sales agency agreement
with ACN and our introducer agreement with ACN Europe. Pursuant to the terms of
the amendment, beginning April 1, 2012, we are required to pay all then-current
commissions on a timely basis as required under the agreements and a late fee in
the amount of one percent per month of any past-due, unpaid commissions (which,
as of September 30, 2012, was equal to approximately $943,000). In addition,
beginning July 15, 2012, we are required to pay down any unpaid past due amounts
in an amount equal to at least $15,000 per month through June 15, 2013, and at
least $25,000 per month thereafter until such time as the unpaid balance is paid
in full, and are required to pay in full any unpaid, past due amounts upon 30
days' notice. In July 2012 we began making the $15,000 monthly payment. In
addition, in the event of certain insolvency-related events defined in the
agreements, all unpaid amounts will become immediately due and payable effective
immediately prior to such event.
As of September 30, 2012, we had negative working capital equal to approximately
$5.9 million as well as negative stockholders' equity equal to approximately
$5.6 million. We believe it is probable that we will continue to experience
losses and increased negative working capital and negative stockholders' equity
in the near future and may not be able to return to positive cash flow before we
require additional cash (in addition to any further amounts we may borrow from
D4 Holdings under the Fourth Loan Agreement) in the near term. We may experience
difficulties accessing the equity and debt markets and raising additional
capital, and there can be no assurance that we will be able to raise such
additional capital on favorable terms or at all. If additional funds are raised
through the issuance of equity securities, our existing stockholders will
experience significant further dilution. Because of our significant losses to
date and our limited tangible assets, we do not fit traditional credit lending
criteria, which could make it difficult for us to obtain loans or to access the
capital markets. If we issue additional equity or convertible debt securities to
raise funds, the ownership percentage of our existing stockholders would be
reduced and they may experience significant dilution. New investors may demand
rights, preferences or privileges senior to those of existing holders of our
common stock.
Due to the limited availability of additional loan advances under the Fourth
Loan Agreement, we believe that, unless we are able to increase revenues and
generate additional cash, our current cash and cash equivalents will not satisfy
our current projected cash requirements beyond the foreseeable future. As a
result, there is substantial doubt about our ability to continue as a going
concern.
In addition, unless we are able to increase revenues and generate additional
cash, based on currently projected cash flows we believe that we may be unable
to pay future scheduled interest and/or principal payments under the various
loan agreements with D4 Holdings as these obligations become due. In the event
that were to occur, if D4 Holdings is not willing to waive compliance or
otherwise modify our obligations such that we are able to avoid defaulting on
such obligations, D4 Holdings could accelerate the maturity of our debts due to
it. Further, because D4 Holdings has a lien on all of our assets to secure our
obligations under the loan agreements, D4 Holdings could take actions under the
loan agreements and seek to take possession of or sell our assets to satisfy our
obligations thereunder. Any of these actions would likely have an immediate
material adverse effect on our business, financial condition or results of
operations.
Due to our ongoing losses and reduction in cash, we initiated restructuring
activities beginning in the second quarter of 2011 in an effort to cut our
operating costs significantly and better align our operations with our current
business model. In accordance with the restructuring, we instituted a reduction
in force and decreased the number of full time employees from approximately 53
to 37, reduced the salaries of all remaining employees by five percent, and
decreased our non-material expenses as well as payments to be made to vendors
and other third parties. As of September 30, 2012, we had 23 full time
employees.
In view of our current cash resources, nondiscretionary expenses, debt and near
term debt service obligations, we may begin to explore all strategic
alternatives available to us, including, but not limited to, a sale or merger of
our company, a sale of our assets, recapitalization, partnership, debt or equity
financing, voluntary deregistration of its securities, financial reorganization,
liquidation and/or ceasing operations. In the event that we are unable to secure
additional funding, we may determine that it is in our best interests to
voluntarily seek relief under Chapter 11 of the U.S. Bankruptcy Code. Seeking
relief under the U.S. Bankruptcy Code, even if we are able to emerge quickly
from Chapter 11 protection, could have a material adverse effect on the
relationships between us and our existing and potential customers, employees,
and others. Further, if we were unable to implement a successful plan of
reorganization, we might be forced to liquidate under Chapter 7 of the U.S.
Bankruptcy Code. There can be no assurance that exploration of strategic
alternatives will result in our company pursuing any particular transaction or,
if we pursue any such transaction, that it will be completed.
21
Off-Balance Sheet Arrangements
None.
Contingencies
For a discussion of contingencies, see Note 3 of the Notes to the Condensed
Consolidated Financial Statements of this report, which is incorporated herein
by reference.
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