Attached files
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EX-32.2 - DELTATHREE INC | v178136_ex32-2.htm |
EX-23.1 - DELTATHREE INC | v178136_ex23-1.htm |
EX-31.2 - DELTATHREE INC | v178136_ex31-2.htm |
EX-21.1 - DELTATHREE INC | v178136_ex21-1.htm |
EX-32.1 - DELTATHREE INC | v178136_ex32-1.htm |
EX-31.1 - DELTATHREE INC | v178136_ex31-1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
x
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the Fiscal Year Ended December 31, 2009, or
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the transition period from __________ to _____________
Commission
File Number: 000-28063
deltathree, Inc.
(Exact
name of registrant as specified in charter)
Delaware
|
13-4006766
|
|
(State
or other jurisdiction of incorporation or organization)
|
(I.R.S.
employer identification no.)
|
|
224
West 35th
Street
New York, New York
|
10001
|
|
(Address
of principal executive offices)
|
(Zip
Code)
|
Registrant's
telephone number, including area code: (212) 500-4850
Securities registered pursuant to
Section 12(b) of the Act: None.
Securities
registered pursuant to Section 12(g) of the Act:
Title of Each Class
|
Name
of Each Exchange on
Which the Securities are
Registered
|
|
Common
Stock, par value $0.001 per share
|
OTC
Bulletin Board
|
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes o No x
Indicate
by a check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes x No o
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files). Yes o
No o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or
any amendment to this Form 10-K. x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer”, “accelerated filer” and
“smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer ¨
|
Accelerated
filer ¨
|
Non-accelerated
filer ¨
|
Smaller
reporting company x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No x
The
aggregate market value of the Common Stock held by non-affiliates of the
Registrant based upon the closing bid of the Common Stock as reported by the OTC
Bulletin Board on June 30, 2009 (the last business day of the Registrant’s most
recently completed second fiscal quarter) was $4,709,275. Solely for purposes of
this calculation, shares beneficially owned by directors and officers of the
Registrant and persons owning 5% or more of the Registrant's Common Stock have
been excluded, in that such persons may be deemed to be affiliates of the
Registrant. Such exclusion should not be deemed a determination or admission by
the Registrant that such individuals or entities are, in fact, affiliates of the
Registrant.
As of
March 25, 2010, the Registrant had outstanding 72,242,933 shares of Common
Stock, par value $0.001 per share.
Documents
incorporated by reference: None
DELTATHREE, INC.
2009
ANNUAL REPORT ON FORM 10-K
TABLE OF
CONTENTS
Page
|
||
PART
I
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||
ITEM
1.
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Business
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3
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ITEM
1A.
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Risk
Factors
|
14
|
ITEM
2.
|
Properties
|
21
|
ITEM
3.
|
Legal
Proceedings
|
22
|
ITEM
4.
|
(Removed and
Reserved)
|
22
|
PART
II
|
||
ITEM
5.
|
Market
for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
|
23
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ITEM
6.
|
Selected
Financial Data
|
24
|
ITEM
7.
|
Management's
Discussion and Analysis of Financial Condition and Results of
Operations
|
25
|
ITEM
8.
|
Financial
Statements and Supplementary Data
|
35
|
ITEM
9.
|
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
|
35
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ITEM
9A(T).
|
Controls
and Procedures
|
35
|
ITEM
9B.
|
Other
Information
|
36
|
PART
III
|
||
ITEM
10.
|
Directors,
Executive Officers and Corporate Governance
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36
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ITEM
11.
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Executive
Compensation
|
40
|
ITEM
12.
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
43
|
ITEM
13.
|
Certain
Relationships and Related Transactions, and Director
Independence
|
45
|
ITEM
14.
|
Principal
Accounting Fees and Services
|
45
|
PART
IV
|
||
ITEM
15.
|
Exhibits,
Financial Statement Schedules
|
46
|
Signatures
|
47
|
|
Index
to Consolidated Financial Statements
|
F-1
|
2
PART
I
The
statements contained in this Annual Report on Form 10-K, or Annual Report, that
are not descriptions of historical facts may be 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 “expects,” “anticipates,”
“targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,”
“estimates,” 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. Please see “Item 1A. Risk Factors” in this Annual Report for
detailed information about the uncertainties and other factors that may cause
actual results to materially differ from the views stated in such
forward-looking statements. All forward-looking statements and risk factors
included in this Annual Report are made as of the date hereof, based on
information available to us as of the date hereof, and we assume no obligation
to update any forward-looking statement or risk factor, whether as a result of
new information, future events, changes in assumptions or
otherwise.
Our
fiscal year ends on December 31 of each calendar year. Each reference to a
fiscal year in this Annual Report refers to the fiscal year ending December 31
of the calendar year indicated. Unless the context requires otherwise,
references to “we,” “us,” “our,” “the Company,” and “deltathree” refer to
deltathree, Inc. and its subsidiaries, collectively.
ITEM 1. BUSINESS
Company
Overview
We are a
global provider of integrated 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. 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 two
primary distribution channels: our service provider and reseller channel, and
our direct-to-consumer channel. We offer a broad suite of private label VoIP
products and services as well as a back-office platform for service providers,
resellers and corporate customers, such as VoIP operators and various corporate
enterprises. 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 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 have
built a privately-managed, state-of-the-art global telecommunications platform
using IP technology and offer our customers a suite of IP video and voice
products, including PC-to-Phone and Broadband Phone products. We provide a
robust set of value-added services and features that enable us to address the
challenges that have traditionally made the provision of telecommunications
services difficult, and we offer our products and services to a global customer
base in a fashion that meets the disparate needs of this diverse customer base.
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.
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.
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. For example, in 2007 we released a next
generation SIP-based PC-to-Phone application, certified many new devices which
function as access points to our services, and added new features and new
calling plans to our offerings.
3
In 2004,
we announced our first major service provider contract with Verizon
Communications to provide the Verizon VoiceWing VoIP service. In
2007, we entered into an agreement with Market America, a leading on-line
shopping and one-to-one marketing company, pursuant to which Market America
launched its Voitel Home Phone Service powered by our Hosted Consumer VoIP
Solution platform. In addition, we entered into an agreement with RCN
Corporation, a leading provider of video, data, and voice services to
residential, business, and commercial/carrier customers, to power its Starpower
Internet Phone Service. In January 2009 Verizon terminated our
service provider agreement effective May 15, 2009. On February 5, 2009, we
entered into a Termination, Settlement Agreement and Mutual Release with RCN,
pursuant to which the service agreement between us and RCN was terminated and
RCN transferred to us some of the subscribers to the VoIP service we had been
providing to RCN under the agreement and paid us a termination fee of
$230,000.
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. pursuant to which we provide digital video and
voice-over-IP services in Australia and New Zealand to ACN Pacific. During the
fourth quarter of 2009 we entered into an agreement with Ojo Service, LLC, a
wholly-owned subsidiary of WorldGate Communications, Inc., a publicly-held
provider of video phone equipment, pursuant to which we provide Ojo Service
digital video and voice-over-IP services in the United
States. WorldGate is majority-owned by WGI Investor LLC, which shares
common majority ownership and a common manager with D4 Holdings, LLC, discussed
below. In 2010 we are continuing to update our network capabilities by adding
content enabler services to our video phone applications and providing mobile
applications. Following the successful integration of these services,
we believe that our full suite of service offerings will constitute a complete
next generation communication service package that will provide our customers
the ability to customize, implement and rapidly launch digital next generation
communications offerings.
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 2007, we acquired the service provider and consumer
business assets (including the customer bases) of Go2Call.com, Inc., a privately
held U.S.-based VoIP solutions provider. However, in 2008 we wrote-off
approximately $2.0 million in goodwill and approximately $1.6 million in
intangible assets acquired in the Go2Call transaction. Through our joip offering
we attempted to expand into other product and geographic consumer markets, but
in 2009 we recognized only $91,000 in revenues from our service agreement with
Panasonic and we do not expect that this will be a significant source of revenue
in the future. In
addition, in February 2009 we entered into a transaction with D4 Holdings LLC,
or D4 Holdings, a Delaware limited liability company, pursuant to which, among
other things, D4 Holdings acquired (i) 39,000,000 shares of our common stock,
representing approximately 54.3% of the total number of issued and outstanding
shares of common stock following the transaction and (ii) a warrant, exercisable
for ten years, to purchase up to an additional 30,000,000 shares of our common
stock at an exercise price of $0.04 per share. D4 Holdings is a
private investment fund whose ownership includes owners of ACN, Inc., or
ACN, a direct seller of telecommunications services. As a result of the
investment in our company by 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 2009 we decided 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. We obtained
additional financing in connection with the transactions with D4 Holdings
described below in “ – Transactions with D4 Holdings”.
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;
|
·
|
continue to update our network
capabilities by adding content enabler services to our video phone
applications and providing mobile applications;
|
·
|
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;
|
·
|
re-launch
our sales and marketing efforts and expand our sales and marketing
capabilities; 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.
|
Transactions
with D4 Holdings
On
February 10, 2009, we entered into a Securities Purchase Agreement with D4
Holdings pursuant to which we issued to D4 Holdings (i) 39,000,000 shares of our
common stock, representing approximately 54.3% of the total number of issued and
outstanding shares of common stock following the transaction, for an aggregate
purchase price of $1,170,000, paid in cash, and (ii) a warrant, exercisable for
ten years, to purchase up to an additional 30,000,000 shares of our common stock
at an exercise price of $0.04 per share. The transaction closed on February 12,
2009.
Upon the
closing of the transaction and pursuant to the terms of the Purchase Agreement,
Noam Bardin resigned as a director and the board of directors appointed Robert
Stevanovski and Anthony Cassara to serve on the board. In addition,
Lior Samuelson resigned as Chairman of the Board and remained a director, and
Robert Stevanovski was appointed to serve as Chairman. Following the
closing of the transaction, our Board of Directors appointed three additional
directors to serve on the Board. The appointments of the three new directors
became effective on March 28, 2009.
4
In
connection with the transaction, the parties also entered into an Investor
Rights Agreement, pursuant to which we have agreed to file, upon the request of
D4 Holdings, a registration statement covering the resale of any shares of our
common stock held by D4 Holdings (including the shares of common stock
underlying the warrant issued to D4 Holdings). Subject to our ability to suspend
the effectiveness of the registration statement for a limited period of time
under certain circumstances, we are required to maintain the effectiveness of
any such registration statement until the earlier of (i) the date on which all
shares of common stock covered by the registration statement have been sold
thereunder or (ii) the date on which all such shares of common stock can be sold
without registration pursuant to Rule 144 or another similar exemption under the
Securities Act of 1933. Subject to certain limitations, D4 Holdings
will also be entitled to “piggy-back” registration rights on all future
registrations by and any registrations initiated by our other
stockholders.
On March
1, 2010, we and our subsidiaries entered into a Loan and Security Agreement with
D4 Holdings, pursuant to which D4 Holdings will provide to us and our
subsidiaries a line of credit in a principal amount of $1,200,000. In
addition, on March 1, 2010, pursuant to the Loan Agreement, we and our
subsidiaries issued a Promissory Note in a principal amount of $1,200,000 to D4
Holdings. On March 2, 2010, we received $500,000 from D4 Holdings
pursuant to a notice of borrowing under the Loan Agreement. Interest on the
loan accrues at the rate of 12% per annum, and the initial payment of accrued
interest is payable on May 1, 2010, and monthly thereafter. We are required to
repay all outstanding principal and interest on March 1, 2011. In addition, we
granted D4 Holdings a security interest in all of our assets to secure our
obligations under the loan.
Industry
Background
VoIP
technology translates voice into data packets, transmits the packets over data
networks such as the Internet or privately managed networks (such as our
network), and reconverts them into voice at the destination. Unlike traditional
telephone networks, VoIP does not use dedicated circuits for each telephone
call; instead, the same VoIP network can be shared by multiple users for voice,
data and video simultaneously. This type of data network is more efficient than
a dedicated circuit network because the data network is not restricted by the
one-call, one-line limitation of a traditional telephone network and, as a
result, greater traffic can be transmitted over this data network. This improved
efficiency creates cost savings that can be passed on to consumers in the form
of lower rates or retained by the VoIP provider. Significant cost savings are
also achieved for international telephone calls carried over data networks
primarily because they bypass the international settlement process, which
represents a significant portion of international long distance tariffs.
Additionally, VoIP allows for features that are not available on traditional
telephony networks - particularly at the consumer level - including voice mail
to email forwarding, find me/follow me, web-based control of call forwarding
preferences, user account review/revision and a host of other features and
functions.
Beyond
cost savings, we believe that VoIP telephony technologies will further the
potential for the Internet to become the preferred medium of communications and
commerce. As a result, VoIP has experienced significant growth in recent years
due to:
·
|
improved
quality and reliability of VoIP calls due to technological advances,
increased network development and greater bandwidth
capacity;
|
·
|
new
product development that allows VoIP providers to offer services not
currently offered by traditional telephone companies;
|
·
|
greatly
improved ease of use, whereby the end-user does not perceive a difference
between use of a traditional telephone and a broadband
telephone;
|
·
|
increasing
demand for long distance communication services driven by the increased
mobility of the global workforce; and
|
·
|
increasing
demand for lower cost telephone service around the
world.
|
As a
result of these growth trends, various service providers, enterprises and
consumers are continuing to procure offerings from VoIP providers such as
deltathree. Specifically, consumers in emerging markets are increasingly using
VoIP-enabled services, such as IP telephones, to realize significant cost
savings on long distance and international calls, while in markets where a
significant number of consumers have access to broadband internet services these
consumers are increasingly viewing VoIP as a viable and more affordable
substitute for their traditional voice telecommunications
provider. In addition, as broadband connectivity has become more
available and less expensive around the world, it is now possible for providers
like us to offer video as well as voice services to businesses and residential
consumers.
Our
Products and Services
Products
We have
built a privately-managed, global network using IP technology and offer our
customers a suite of IP video and voice products. Our products
include:
Digital Video and Voice-over-IP
Services. Through the use of our network we offer a white-label solution
in which our customers have the ability to customize, implement and rapidly
launch digital next generation communications offerings with minimal risk and
investment. For our potential partners, we offer a full spectrum of
service provider back-end support services, including network management,
billing, provisioning, e-commerce as well as custom web and application
development
5
Broadband Phone. Our
Broadband Phone product is a phone replacement solution available to business
and retail customers over the "last mile" through broadband connections via
cable modem, DSL or fixed wireless. In addition to offering capabilities similar
to those offered by traditional telephony providers and allowing users to use
their existing phone, Broadband Phone enables a user to conveniently operate
features and retrieve voice mail through email, web or a phone
interface.
PC-to-Phone. Our PC-to-Phone
offering enables a user to conveniently and inexpensively place a call to a
standard telephone anywhere in the world directly from a personal computer while
remaining on-line.
Services
We
provide a robust set of value-added services that enables us to address the
challenges that have traditionally made the provision of telecommunications
services difficult. These operations management tools include the
following:
·
|
account provisioning:
we provide our service provider and reseller customers with a dedicated
Web page through which they can order additional services or accounts,
generate and activate PINs and perform other customary implementation
functions;
|
·
|
payment processing
systems: we provide our customers with a fraud detection and
prevention system to permit secure credit card transactions over the
Web;
|
·
|
billing and account
management: we provide our customers with real-time, Web-based
access to billing records to check billing and usage information or to
increase prepaid accounts;
|
·
|
customer care: we have
moved and consolidated traditional first tier customer care functions onto
the Web for ease and flexibility and support this with second tier
customer care; and
|
·
|
network operations
care: we provide a Network Operations Center, or NOC, automated
trouble ticket system, which enables our customers to submit, manage, and
follow-up with technical questions and issues online.
|
The
provision of VoIP products and services through our service provider and
reseller sales channel accounted for 88.7% of our total revenues in 2009, while
the provision of VoIP products and services through our direct-to-consumer
channel accounted for 10.4% of our total revenues in 2009.
Our
Distribution Channels
We
market, support and distribute our products and services to tens of thousands of
active users around the globe through our two primary distribution channels: the
service provider and reseller channel and our direct-to-consumer
channel.
Service
Provider and Reseller Channel
We have
developed high-value solutions for the large number of service providers and
resellers that are focused on providing their customers with video and
voice-over-IP products and services.
Our
Hosted Consumer VoIP Solution leverages our VoIP experience and delivers to our
service providers, resellers, and various corporate customers a customizable,
private-label suite of VoIP products and services. Using our infrastructure, we
enable these enterprises to offer their customers different combinations of our
basic products and services, accessible through a single account.
Direct-to-Consumer
Channel
Our
direct-to-consumer channel includes our iConnectHere offering, which provides
VoIP products and services directly to consumers and small businesses online,
and our joip offering, which serves as the exclusive VoIP service provider
embedded in the Globarange cordless phones of Panasonic.
iConnectHere. iConnectHere demonstrates
our products, services and hosting capabilities to our reseller customers and
service providers. Through iConnectHere, an account holder can access all of our
product offerings, including Broadband Phone and PC-to-Phone. Additionally,
iConnectHere permits us to collect usage information on our products and
services and enables us to provide our service provider and reseller customers
with key information and recommendations regarding implementation of our
products and services.
Through
iConnectHere, consumer users can:
·
|
sign
up for any of our services, including Broadband Phone and
PC-to-Phone;
|
·
|
download
our software and/or order IP-based Broadband Phone
devices;
|
·
|
recharge
their accounts, either by entering their credit card information or
authorizing automatic
recharging;
|
6
·
|
send
a PC-to-Phone call;
|
·
|
check
real-time billing and usage information;
|
·
|
communicate
by e-mail with a customer service representative; and
|
·
|
view
answers to frequently-asked questions.
|
joip. In connection with our
strategic cooperation with Panasonic, Panasonic and we have created, developed
and are offering joip-enabled Panasonic Globarange telephones. Our joip offering
is the exclusive VoIP service embedded in these hybrid two-line cordless phones,
which provide both landline and VoIP services.
Our Strategy
Our
strategy is to become a leading worldwide provider of video and voice-over-IP
products and services. The following are key elements of our
strategy:
Capitalize on the
Growth of the video and voice-over-IP Marketplace. We believe we are well
positioned to take advantage of the expected growth of the video and
voice-over-IP services markets. We plan to focus our efforts and
resources on becoming a next generation service provider enabler while
simultaneously maintaining our reseller business.
Offer Flexible
and Modular Deployment Alternatives. We offer our service providers and
resellers a choice of deployment alternatives ranging from full outsourcing to
partial outsourcing through our modular offering suite. Depending on the
particular needs of each of our customers, we design our offering to fit within
their business objectives, available resources and desired level of
participation. We can develop and integrate specific features and functions into
our package, such as various network elements, access components, fulfillment,
and the specific feature/functions the provider can offer to its
end-users.
Pursue Strategic
Relationships.
In addition to our strategy and actions to grow organically as described above,
we also actively evaluate and pursue appropriate strategic relationships that we
believe will continue to expand our customer base and grow our revenues. As
discussed above under “ - Transactions with D4 Holdings”, in February 2009 we
consummated a transaction with D4 Holdings pursuant to which we sold 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. In the third quarter of 2009 we entered
into an agreement with ACN Pacific Pty Ltd., a wholly-owned subsidiary of ACN,
Inc. pursuant to which we provide digital video and voice-over-IP services in
Australia and New Zealand to ACN Pacific. During the fourth quarter of 2009 we
entered into an agreement with Ojo Service, LLC, a wholly-owned subsidiary of
WorldGate Communications, Inc. pursuant to which we provide Ojo Service digital
video and voice-over-IP services in the United States. WorldGate is
majority-owned by WGI Investor LLC, which shares common majority ownership and a
common manager with D4 Holdings, LLC. As a result of the investment in our
company by 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.
Sales
and Marketing
We sell
and market our products and services through our service provider and reseller
channel and our direct-to-consumer channel. In general, our sales and marketing
activities include:
·
|
developing,
deploying and supporting local-specific product features and services,
such as multiple language capabilities, different currency capabilities,
and various payment methods;
|
·
|
engaging
in strategic relationships with customers (including licensed providers);
and
|
·
|
using
various on-line advertising and search strategies to target and optimize
sales efforts.
|
Service
Provider and Reseller Channel
Service Provider Sales. Our experience
in deploying sophisticated solutions provides us with leverage as we introduce
these services to other service providers.
Reseller Program. Through our
reseller program, we contract with smaller service providers and resellers
around the world, which in turn sell our products and services under their own
brand, a white-label brand or our deltathree brand to retailers, businesses,
Internet cafés and others in their local markets. Our experience in providing
differentiated VoIP solutions in the emerging international telecommunications
environment enables us to effectively enter new markets as they open to
competition.
Direct-to-Consumer
Channel
iConnectHere. iConnectHere provides VoIP
products and services directly to consumers and small businesses online. Through
iConnectHere, an account holder can access all of our product offerings,
including Broadband Phone and PC-to-Phone.
7
joip. We launched our joip
service and Globarange offering with Panasonic in August 2007. The
Globarange phone is currently available in different international
locations.
Our
Infrastructure
Network
In order
to deliver our products and services, we operate a privately-managed IP network.
By managing our own network, we have the ability to regulate traffic volumes and
to directly control the quality of service from each originating point of
presence, or POP, to the termination point via a variety of termination options.
Our ability to interconnect to a wide variety of termination options increases
the diversity and robustness of our network, minimizes and eliminates single
points of failure, and simultaneously allows us to benefit from pricing
differences between vendors to the same termination points. In addition, our
network allows us to avoid the significant transmission delays associated with
the Internet, which may impede delivery of high quality, reliable services to
our users.
In 2001,
we introduced our new SIP infrastructure. The SIP protocol is one of the most
advanced VoIP protocols and unlike its predecessors, which were modeled after
traditional telephony protocols, SIP has the ability to scale with a distributed
architecture and at a lower cost. SIP’s superior attributes also include faster
and more cost effective development and lower hardware requirements, which
allows us to incur lower capital expenditure costs. Our SIP network currently
powers all of our offerings. In recent years, we
have continued our pioneering efforts in SIP and these efforts have yielded
significant new releases. For example, in 2007 we released a next generation
SIP-based PC-to-Phone application, certified many new devices which function as
access points to our services, and added new features and new calling plans to
our offerings. In 2009 we began the process of expanding the suite of
our communications offerings into the global video phone services
market. We are continuing to update our network capabilities by
adding content enabled services to our video phone applications and providing
mobile applications.
Our
network is built around a high availability backbone that connects New Jersey,
Atlanta, London and Frankfurt. In each of, and between, these locations we
maintain multiple interconnections or peering arrangements with Internet
backbone and voice providers. These points are strategically located to allow
access from our network to and from the Internet with a high level of
performance. While operating as a private extension of the Internet, our
backbone has a high level of security designed to isolate it from security
threats found on the public Internet.
Access to
our network is possible through several products and services. A call can
originate from the PC-to-Phone product using our downloadable software
application “soft-phones,” a Web browser, or Broadband Phone devices. These
calls enter our network from the Internet through our interconnection
points.
Our
network can terminate calls through our points of presence, or POPs, and
termination providers’ POPs. Termination decisions are based on a sophisticated
routing system that applies routing rules based on origination
point, termination cost and other factors. These rules are consistently
updated to ensure a high level of quality and economic efficiency. Each
termination port is carefully managed with capacity planning tools and
techniques to provide cost-effective service to customers, along with multiple
termination options to ensure the highest possible levels of
redundancy.
We are a
party to service agreements with several telecommunications providers, including
foreign telephone companies, Internet backbone providers and others. Pursuant to
these agreements, we can transport video and voice data packets to our hubs and
terminate calls throughout the world in a cost effective and efficient
manner.
Support
Our NOC
monitors and manages our network from a central location, seven days a week,
24 hours a day. The NOC monitors all aspects of our network, including the
routers, databases, switches, leased lines, Internet connections, gatekeepers
and gateways to ensure that they are functioning at optimal levels. In the event
of a failure of any of these network components, NOC personnel are provided with
a real time, systems-generated notification via an instant messaging system
consisting of pagers, cellular phones, screen pop-ups and e-mail that identifies
the malfunction so that proper measures can be taken to restore service in a
timely fashion. Our NOC utilizes a combination of industry technologies as well
as unique applications developed by us. The NOC serves all of the different
parts of our operations environment, including network nodes, Web servers and
specific applications.
We
provide customer support on various levels to different customers. With respect
to our service provider and reseller customers, we provide customer care and
technical support directly to these customers and they in turn provide their own
support directly to the end users. Customers of iConnectHere and joip receive
technical support and customer care through e-mail support.
Our
services are supported by our on-line interactive customer service and billing
center, which enables an end user to set up an account, receive an account
number and a PIN, pay by credit card for services, find answers to frequently
asked questions and contact customer service representatives. Once a user has
established an account, the user can prepay for additional usage by credit card
as well as access real-time detailed information such as call logs and
transaction records. Through the on-line billing system, a user can personalize
the billing information to select the data most relevant to them. This on-line
interactive customer service and billing center is supported by a human customer
care contact center that provides voice, e-mail and instant messaging support to
the customers.
8
Suppliers
We
outsource to third-party vendors the provisioning of certain of our local
telecommunications services, including local phone numbers, access to the public
switched telephone network, or PSTN, operator assistance, directory listings and
assistance, E-911 emergency services and local number portability. We also
outsource the provisioning of our consumer premises equipment, such as our
analog telephone adapters, IP Phones and gateways, and certain aspects of our
customer care services. We do not rely on any one specific vendor for providing
these services, except for E-911 emergency services and certain specific
services of customer care. While we believe our relations with our suppliers are
good, we believe that we could replace our suppliers if necessary and that
although our ability to provide services to our customers may be impacted in
such a case we do not expect that this would have a material adverse affect on
our business, financial condition and results of operation.
Proprietary
Rights
We rely
and expect to be able to rely on trademark and trade secret laws,
confidentiality agreements and other contractual arrangements with our
employees, strategic partners and others to protect our proprietary
rights.
We have
registered trademarks, and have filed applications for additional registrations,
for “deltathree”, “deltathree making VoIP work for you”, “the IP Communications
Network”, “iConnectHere”, “joip”, “joipy”, “joip just talk”, “Click It”,
“iconnecthere.com” and other trademarks in the United States and
internationally. In connection with our acquisition of the Go2Call businesses,
we acquired the “Go2Call” trademark and a variety of trademarked derivatives of
“Go2Call”. These trademarks may not provide adequate protection against
competitive technology and may not be held valid and enforceable if challenged.
We do not own any registered copyrights.
To
further safeguard our intellectual property, we have a policy that requires our
employees and contractors to execute confidentiality and assignment of
inventions agreements when they begin their relationships with us.
Regulation
Regulatory
Environment Overview
The use
of the Internet and private IP networks to provide VoIP service is a relatively
recent market development. Although the provision of such services is currently
not as regulated as traditional telephony services within the United States, the
Federal Communications Commission, or FCC, has applied some regulation to
certain types of VoIP services and is reviewing whether to apply additional
regulations to VoIP services. In addition, several foreign governments have
adopted or proposed regulations that could restrict or prohibit the provision of
VoIP services. Regulation of Internet telephony providers and services may
materially and adversely affect our business, financial condition, operating
results and future prospects, particularly if increased numbers of governments
impose regulations restricting the use and sale of IP telephony services. In
addition, to the extent we become required to contribute to regulatory funds and
collect and remit regulatory fees, taxes and surcharges this will increases our
costs, which may result in either our increasing the retail price of our service
offerings or reducing our profitability.
Federal
Regulation
Regulatory
Classification of VoIP Services
Although
there are several regulatory proceedings currently pending before federal
authorities, providers of interconnected VoIP services are lightly regulated
compared to providers of traditional telecommunications services. On February
12, 2004, the FCC initiated a generic rulemaking proceeding concerning the
provision of voice and other services using IP technology, including assessing
whether VoIP services should be classified as information services or
telecommunications services. The rulemaking is ongoing and we cannot predict the
outcome of this proceeding. In November 2004, the FCC determined that certain
interconnected VoIP services (meaning VoIP services that can be used to send and
receive calls to or from the PSTN), including some services that are similar to
ours, should be considered interstate services subject to federal rather than
state jurisdiction. Although this ruling was appealed by several
states, on March 21, 2007, the United States Court of Appeals for the Eighth
Circuit affirmed the FCC’s determination.
The FCC’s
generic rulemaking proceeding could result in the FCC determining, for instance,
that certain types of Internet telephony should be regulated like basic
telecommunications services. Thus, Internet telephony would no longer be exempt
from more onerous telecommunications-related regulatory obligations, could
potentially become subject to state telecommunications regulations, and could
become subject to other economic regulations typically imposed on traditional
telecommunications carriers.
9
VoIP
E-911 Matters
On
June 3, 2005, the FCC released an order and notice of proposed rulemaking
concerning VoIP emergency 911 services. The order set forth two primary
requirements for providers of interconnected VoIP services. The order applies to
our iConnectHere and joip customers, or our “retail customers”. We do not
believe that we are responsible for compliance with this order when we sale our
service wholesale to companies who then offer the service to retail end users.
We cannot predict whether we would be subject to any third-party litigation in
connection with such customers who resell our services or whether the rules will
be interpreted as applicable to those who wholesale interconnected VoIP
services.
The order
set forth two primary requirements for providers of interconnected VoIP
services. First, the order requires providers of interconnected VoIP services
like us to notify our retail customers of the differences between the emergency
services available through our offerings and those available through traditional
telephony providers. We also had to receive affirmative acknowledgment from some
of our retail customers that they understand the nature of the emergency
services available through our service. On September 27, 2005, the FCC's
Enforcement Bureau released an order stating that the Enforcement Bureau will
not pursue enforcement actions against interconnected VoIP providers that have
received affirmative acknowledgement from at least 90% of their subscribers. We
received affirmative acknowledgment from more than 95% of our relevant customers
that they understand the nature of the emergency services available through our
service, and thus we believe we are substantially in compliance with the first
aspect of the FCC's June 3 order.
Second,
the order required providers of interconnected VoIP services like us to offer
enhanced emergency dialing capabilities, or E-911, to all of our retail
customers by November 28, 2005. Under the terms of the order, we are
required to use the dedicated wireline E-911 network to transmit customers' 911
calls, callback number and customer-provided location information to the
emergency authority serving the customer's specified location. On
November 7, 2005, the FCC's Enforcement Bureau issued a Public Notice with
respect to that requirement. The Public Notice indicated that providers who have
not fully complied with the enhanced emergency dialing capabilities requirement
are not required to discontinue the provision of services to existing customers,
but that the FCC expects that such providers will discontinue marketing their
services and accepting new customers in areas in which the providers cannot
offer enhanced emergency dialing capabilities where such capabilities are
otherwise available.
Almost
all of our retail customers currently receive E-911 service in conformity with
the FCC’s order. Like many interconnected VoIP providers, we rely on third
parties to route emergency calls originated by our customers. In certain
instances and for some of our customers, the third party provider may route 911
calls to an unofficial emergency call center. Such unofficial call centers may
not be able to receive appropriate call back information. To the extent that
they are so able or callers provide their location information the emergency
dispatchers in such call centers may not then be able to route such calls to the
appropriate public safety answering point. The FCC could find that calls routed
in this manner violates its rules, potentially subjecting us to enforcement
actions including, but not limited to, fines, cease and desist orders, or other
penalties. Moreover, and as is the case with customers for other interconnected
VoIP providers some customers who were receiving service prior to the FCC’s
deadline for compliance with the E-911 regulations may not receive such service.
The FCC permitted service providers to continue to provide service to those
existing customers rather than disconnect those customers. Pursuant to the FCC’s
requirement, after the implementation of the FCC E-911 requirements, we provide
services to our new retail customers only where we can provide the FCC required
E-911 service. We may be required to stop serving those customers to whom we
cannot provide the required enhanced emergency dialing capabilities that were
being serviced prior to the issuance of the FCC’s rules at any
time.
The FCC
is considering modifying its VoIP E-911 rules. In June, 2007, the FCC
released a Notice of Proposed Rulemaking to consider whether it should impose
additional obligations on interconnected VoIP
providers. Specifically, the FCC considered mandating that
interconnected VoIP providers implement a solution that will allow for
automatically determining the location of their customers for purposes of E-911
rather than require customers to manually update their existing location
information (as is the case under the current regulations). Moreover,
the Notice included a tentative conclusion that interconnected VoIP providers
that allow their service to be used in more than one location, like us, be
required to meet the same customer location accuracy standards applicable to
providers of mobile telecommunications services. We cannot predict
the outcome of this proceeding or its potential impact on our
business.
See
“ - State and Local Regulation” below for a discussion of fees we may collect in
the future in connection with providing E-911.
Communications
Assistance for Law Enforcement Act
The
Communications Assistance for Law Enforcement Act, or CALEA, requires certain
communications service providers to assist law enforcement agencies in
conducting lawfully authorized electronic surveillance. On September 23,
2005, the FCC released an order concluding that CALEA applies to interconnected
VoIP providers. In May 2006 the FCC released an order finding that broadband
Internet access service providers and interconnected VoIP providers are required
to implement the same type of CALEA requirements that have been applied to
wireline telecommunications carriers. These include obligations to (1) ensure
that communications equipment, facilities, and services meet interception
assistance capability requirements and (2) develop system security policies and
procedures to define employee supervision and record retention requirements. As
a result of the steps we have taken, we believe that we comply with the
CALEA.
10
Universal
Service Fund
The FCC
decided in June 2006 that interconnected VoIP service providers should be
required to contribute to the universal service fund, or USF. The amount of
universal service contribution for interconnected VoIP service providers is
based on a percentage of revenues earned from end-user interstate services. The
FCC developed three alternatives under which an interconnected VoIP service
provider may elect to calculate its universal service contribution: (1) a
safe harbor that assumes 64.9% of the provider’s end user revenues are
interstate; (2) a traffic study to determine an allocation for interstate
end user revenues; or (3) actual interstate and international end user
revenues. If an interconnected VoIP service provider calculates its universal
service contributions based on its actual percentage of interstate calls, the
FCC suggested that its preemption of state regulation of such services may no
longer apply, in which case the interconnected VoIP service provider could be
subject to regulation by each state in which it operates as well as federal
regulation. In addition, the FCC is considering a number of proposals that could
alter the way that the USF is assessed. For instance, the FCC is considering an
assessment based on the use of telephone numbers. Furthermore, some states may
attempt to impose state universal service contribution requirements on
interconnected VoIP providers such as deltathree. At this time, various states –
including Nebraska and New Mexico – claim that they have the right to require
interconnected VoIP providers to contribute to their respective USF
funds. On March 3, 2008, the U.S. District Court for Nebraska issued
a preliminary injunction and found that Nebraska's state Public Service
Commission does not have jurisdiction to require Universal Service contributions
from VoIP providers. On May 1, 2009, a panel of the U.S. Circuit Court of
Appeals for the Eighth Circuit affirmed the U.S. District court ruling. The
Nebraska and New Mexico state commissions recently filed a petition with the FCC
seeking the authority to impose state USF contribution obligations on
interconnected VoIP providers, like us, with one state seeking retroactive
application. We cannot predict how the FCC may rule on the petition.
If we do become subject to state USF contribution obligations, we may either
have to increase the retail price of our affected service offerings, making our
service less competitive in terms of price as compared to similar
functionalities offered by providers of traditional telecommunications services,
or reduce our profit margins. Retroactive applicability of any state USF fees
would effectively bar us from collecting such fees from our users, reducing our
future profits.
Customer
Proprietary Network Information
On April
2, 2007, the FCC issued an order that tightened existing rules on protection and
use of Customer Proprietary Network Information, or CPNI, and extended coverage
of the CPNI rules to interconnected VoIP service providers. Among other things,
the Order imposes greater obligations on us and other companies like us to
protect CPNI, acquire customer consent prior to engaging in certain kinds of
marketing efforts based on CPNI, train our employees concerning protecting (and
the use of) CPNI and to file formal certifications with the FCC regarding
procedures for protecting this information. As a result of the steps
we have taken, we believe that we comply with this Order.
Access
for People with Disabilities
On June
15, 2007, and effective October 5, 2007, interconnected VoIP providers, like us,
became required to, among other things, make certain that their equipment and
service is accessible to and usable by individuals with disabilities, if readily
achievable. In addition, interconnected VoIP providers like us became obligated
to contribute to the Telecommunications Relay Services, or TRS, fund and to
offer 711 abbreviated dialing for access to relay services. Following March 31,
2009, interconnected VoIP providers are required to route such 711 calls to the
appropriate TRS relay center serving the state in which the caller is located or
the relay center corresponding to the caller’s last registered
address. As a result of the steps we have taken, we believe that we
comply with the applicable requirements.
Regulatory
Fees
On August
6, 2007 and effective November 2007, the FCC adopted an Order concerning the
collection of regulatory fees for Fiscal Year 2007 requiring the collection of
such fees from interconnected VoIP providers like us. Like other interconnected
VoIP providers, we now pay regulatory fees based on interstate and international
revenues.
Local
Number Portability
On November 8, 2007, the FCC released
an Order relating to local number portability imposing local number portability,
or LNP, and related obligations on interconnected VoIP Providers like us. The
Order requires interconnected VoIP providers to contribute to shared numbering
administration costs. Additionally, the Order mandates that we process certain
kinds of telephone number porting requests within certain
timeframes. As a result of the steps we have taken, we believe that
we comply with this Order. Subsequently, on May 13, 2009, the FCC released
another order concerning LNP that further reduces the porting timeframe for
certain types of telephone number porting requests that interconnected VoIP
providers, like us, have to process. It is expected that the new rules imposing
reduced porting timeframes will not be effective until late 2010. Since we are
not a licensed telecommunications carrier, we must rely on third parties to
comply with these porting obligations. If these third parties fail to comply
with these obligations we could be subject to fines, forfeitures and other
penalties by the FCC or state public utilities commissions or we could face
legal liability in state or federal court from customers or carriers. The FCC
also released a Further Notice of Proposed Rulemaking to refresh the record on
how to further improve the porting process, and how to potentially expand the
new one business day porting timeframe to other kinds of ports. We cannot
predict the outcome of this proceeding or its potential impact on us at this
time.
11
Intercarrier
Compensation
The
FCC is currently seeking comment concerning proposed reforms of the intercarrier
compensation system, which is a set of FCC rules and regulations by which
telecommunications carriers compensate each other for the use of their
respective networks. These rules and regulations affect the prices we pay to our
suppliers for access to the facilities and services that they provide to us,
such as termination of calls by our customers onto the public switched telephone
network. In addition, proceedings have been initiated to determine what
intercarrier compensation charges should apply to the termination of VoIP
traffic. We cannot predict what, if any, intercarrier compensation regulations
the FCC’s order may impose on VoIP providers.
Discontinuance
Requirements
In May
2009, the FCC extended discontinuance rules that apply to non-dominant common
carriers to interconnected VoIP providers, like us. The FCC's rules require
non-dominant domestic carriers to provide notice to customers at least 30 days
prior to discontinuing service to a telephone exchange, toll stations serving a
community in whole or in part, and other similar activities that affect a
community or part of a community. Carriers must inform certain state authorities
of the discontinuation, and obtain prior FCC approval before undertaking the
service disruption. The FCC's rules allow for streamlined treatment for FCC
discontinuance approvals and interconnected VoIP providers will be able to take
advantage of the same streamlined procedures afforded to non-dominant carriers.
It is not yet clear how these rules apply to interconnected VoIP
providers. But in the event we discontinue one of our service
offerings in its entirety or if we were to exit the market in whole we would
likely have to comply with these new rules. We do not expect these new
obligations to have a material impact on our business.
Katrina
Reporting Requirements
In June
2007, the FCC adopted various recommendations from its Independent Panel
Reviewing the Impact of Hurricane Katrina on Communications Networks Panel,
including a requirement that certain interconnected VoIP providers submit
reports regarding the reliability and resiliency of their 9-1-1 systems. At this
time, we are not subject to these reporting requirements but may become subject
in the future.
State
and Local Regulation
Some
state and local regulatory authorities believe they retain jurisdiction to
regulate the provision of, and impose taxes, fees and surcharges on, intrastate
Internet and VoIP telephony services, and have attempted to impose such taxes,
fees and surcharges, such as a fee for providing E-911 service. Rulings by the
state commissions on the regulatory considerations affecting Internet and IP
telephony services could affect our operations and revenues, and we cannot
predict whether state commissions will be permitted to regulate the services we
offer in the future.
We have
completed a study of state and local taxes and other fees and have accrued
approximately $150,000 of estimated state and local taxes and other fees due as
of December 31, 2009, out of a total tax accrual of $300,000. We have
also determined that we need to collect and remit sales and excise taxes in
certain states and local jurisdictions and will begin collecting and remitting
such sales and excise taxes in the immediate future. We have begun
the process of registering with the relevant state authorities and entering into
discussions with the relevant state tax authorities to finalize the amounts due.
To the extent we increase the cost of services to our customers to recoup some
of the costs of compliance, this will have the effect of decreasing any price
advantage we may have over traditional telecommunications
companies.
In
addition, it is possible that we will be required to collect and remit taxes,
fees and surcharges in other states and local jurisdictions and which such
authorities may take the position that we should have collected. If so, they may
seek to collect those past taxes, fees and surcharges from us and impose fines,
penalties or interest charges on us. Our payment of these past taxes, fees and
surcharges, as well as penalties and interest charges, could have a material
adverse effect on us.
International
Regulation
The
regulatory treatment of Internet and Internet-based voice services, including IP
telephony or VoIP, outside of the United States varies widely from country to
country. A number of countries may prohibit Internet and IP telephony, while
other countries expressly permit but regulate Internet and IP telephony. Some
countries evaluate proposed Internet and IP telephony service on a case-by-case
basis to determine whether any regulation is necessary or whether it should be
regulated as a voice service or as another telecommunications or data service.
Finally, in many countries neither Internet nor IP telephony have been addressed
by legislation or regulatory action as of the date of this filing. Although we
strive to comply with applicable international IP telephony regulations, we
cannot be certain that we are in compliance with all of the relevant regulations
at any given point in time.
In 2002,
the European Commission adopted a set of directives for a new framework
(Regulatory Framework) for electronic communications regulation that, in part,
attempts to harmonize the regulations that apply to services regardless of the
technology used by the provider. The Regulatory Framework was further amended in
November 2009. Under the Regulatory Framework, there is no distinction in
regulation made based upon technology between switched or packet-based networks.
As a result, some types of IP telephony and VoIP services may be regulated like
traditional telephony services while others may be subject to less stringent
regulation. The European Commission has published a staff working paper aimed at
clarifying the conditions applicable to providers of IP-based services. The
working paper identifies various issues that may arise in relation to IP-based
services including the regulatory classification of Internet telephony and VoIP
under the Regulatory Framework. The European Regulators Group (consisting of
regulators from European Union Member States and the European Commission) has
adopted a Common Statement for VoIP regulation. The European Commission
currently is reviewing how IP telephony services fit into the Regulatory
Framework and analyzing other issues associated with IP telephony, such as
access to numbering resources and provision of emergency services,. Although the
European Commission has recommended that a “light touch” to regulation be taken,
we cannot predict what future actions the European Commission, Member States,
and courts reviewing the Regulatory Framework may take regarding IP telephony
and related matters, or what impact, if any, such actions may have on our
business.
12
Based on
the European Commission's current position, we believe that most providers of IP
telephony would be subjected to no more than minimal regulation such as a
general authorizations or declaration requirements that may be imposed by the
European Union Member States. Several Member States have issued statements or
regulations concerning IP telephony and VoIP while others have issued
consultations requesting industry comments on the applicability of the
Regulatory Framework to various IP telephony and VoIP services in their
respective countries. However, since the Commission's findings on IP telephony
are not binding on the Member States, we cannot assure you that the services
provided over our network will not be deemed “voice telephony” subject to
heightened regulation by one or more EU Member States. Although Member States
are required to adhere to the Regulatory Framework, Member States may not take a
uniform approach in regulating a particular Internet-enabled service including
IP telephony. We cannot predict the manner in which Member States will regulate
our particular services.
As we
make our services available in foreign countries, and as we facilitate sales by
our network partners to end users located in foreign countries, such countries
may claim that we are required to qualify to do business in the particular
foreign country. Such countries may also claim that we are subject to
regulation, including requirements to obtain authorization for the provision of
voice telephony or other telecommunications services, or for the operation of
telecommunications networks. It is also possible that such countries
may claim that we are prohibited in all cases from providing our services or
conducting our business in those countries. Failure to qualify as a foreign
corporation in certain jurisdictions, or to comply with foreign laws and
regulations, may adversely affect our business. In addition, we cannot predict
how a regulatory or policy change of a particular country might affect the
provision of our services.
Our
network partners may also currently be, or in the future may become, subject to
requirements to qualify to do business in a particular foreign country, comply
with regulations (including requirements to obtain authorizations for the
provision of voice telephony or other telecommunications services or for the
operation of telecommunications networks) or cease providing services or
conducting their business as conducted in that country. We cannot be certain
that our network partners either are currently in compliance with any such
requirements, will be able to comply with any such requirements, and/or will
continue in compliance with any such requirements.
Other
Regulation Affecting the Internet
The
European Union has also enacted several directives relating to the Internet,
including regulations that address online commerce and data protection.
International governments are adopting and implementing privacy and data
protection regulations that establish certain requirements with respect to,
among other things, the confidentiality, processing and retention of personal
subscriber information. The potential effect, if any, of these data protection
rules on the development of our business remains uncertain.
Competition
We
compete primarily in the market for enhanced VoIP telephony, and specifically in
the VoIP service provider and reseller markets. This VoIP market is highly
competitive and there are numerous competing providers. We believe that the
primary competitive factors determining our success in the VoIP telephony market
are: quality of service and network capacity; the ability to meet and anticipate
customer needs through multiple service offerings and feature sets; customer
services; and price.
Future
competition could come from a variety of companies in the video and
voice-over-IP industry. This industry includes major companies who have greater
resources and larger subscriber bases than we have, and have been in operation
for many years. In addition, many companies provide, or are planning to provide,
some of the services we offer.
Revenues
and Assets by Geographic Area
For the
year ended December 31, 2009, approximately $11.4 million, or 60%, of our
revenue was derived from international customers, and $7.6 million, or 40%, was
derived from customers in the United States. Most of our long-lived assets are
located in the United States. For more detailed information concerning our
geographic segments, see Note 17 to our financial statements included elsewhere
in this Annual Report.
Employees
As of
December 31, 2009, we had 43 employees, of which 38 were located in Israel
(eight of whom were part-time employees) and five were located in the United
States (none of whom was a part-time employee). We consider our
relationship with our employees to be good. None of our employees is covered by
collective bargaining agreements.
13
Customers
In 2009,
one customer accounted for approximately 25.8% of our annual gross
revenues. On November 3, 2009, we were informed that the operations of
this customer had been suspended. In addition, in 2009 a different
customer accounted for approximately 22.5% of our annual gross revenues; in the
fourth quarter of 2009 this customer accounted for approximately 35% of our
gross revenues. Any significant decline in our sales to any of our material
customers could have a material adverse effect on our business, operating
results and financial condition.
Available
Information
Our
Internet address is www.deltathree.com. Through a link at the Investor Relations
section of our website we make available, free of charge, our annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all
amendments to those reports as soon as reasonably practicable after such
materials have been electronically filed with, or furnished to, the
SEC.
ITEM 1A. RISK FACTORS
Our
business, financial condition and results of operations and the trading price of
our common stock could be materially adversely affected by any of the following
risks as well as the other risks highlighted elsewhere in this Annual Report,
particularly the discussions about regulation, competition and intellectual
property. Additional risks and uncertainties not presently known to us or that
we currently deem immaterial also may impair our business
operations.
Risks
Related to our Company
We
have a history of losses and we are uncertain as to our future
profitability.
Except
for the year ended December 31, 2006, in which we reported net income of
approximately $500,000 but a net loss from operations of $52,000, we have a
history of significant, recurring losses since our inception, and we may
continue to incur significant losses for the foreseeable future. We reported net
losses of $9.3 million in 2007, $11.9 million in 2008 and $3.2 million in 2009.
As of December 31, 2009, our accumulated deficit was approximately $175.8
million. Our revenues may not grow or even continue at their current level.
Going forward, we will need to increase our revenues and/or lower our current
cost structure to reach profitability. If our revenues do not increase and/or if
we are unable to reduce our expenses, we may not be able to reach profitability
again. We cannot assure you that we will be able to reach profitability on a
quarterly or annual basis in the future. These factors raise
substantial doubt about our ability to continue as a going concern.
We
may not be able to expand our revenue.
Our
business strategy is to expand our revenue sources and our distribution channels
in order to include the provision of VoIP video and telephony to different
customer groups. We can neither assure you that we will be able to accomplish
this nor that this strategy will be profitable. Currently, our revenues are
primarily generated by sales of our VoIP telephony products and services through
our service provider and reseller sales channel and our direct-to-consumer
channel. VoIP telephony from these channels generated 99.1%, 98.5% and 98.3% of
our total revenues in 2009, 2008 and 2007, respectively.
We expect
that our revenues for the foreseeable future will be dependent on, among other
factors:
·
|
sales
of our video and voice-over-IP products and services;
|
·
|
the
public’s acceptance and use of video and voice-over-IP
services;
|
·
|
expansion
of our service offerings;
|
·
|
the
effect of competition, regulatory environment, international long distance
rates and access and transmission costs on our prices;
and
|
·
|
continued
improvement of our global network
quality.
|
Our
business strategy assumes, among other things, that the video and voice-over-IP
market will expand significantly. If this market does not expand significantly
we may not be able to expand our revenues and successfully carry out our
business strategy.
The
global financial crisis may have an impact on our business and financial
condition in ways that we currently cannot predict.
The
continued financial crisis and related turmoil in the global financial system
may have an impact on our business and our financial condition, as well as
increase the risk of uncollectible accounts receivable from our customers.
For example, our ability to obtain additional financing may be severely
restricted at a time when we would like, or need, to do so, which could have an
impact on our flexibility to react to changing economic and business
conditions.
14
We
are substantially dependent upon a few material customers, and any significant
decline in our sales to those customers could have a material adverse effect on
our business.
In 2009,
one customer accounted for approximately 25.8% of our annual gross
revenues; On November 3, 2009, we were informed that the operations of this
largest customer had been suspended. The loss of sales to this
customer has had a material adverse effect on our business, results of
operations and financial condition. In addition, in 2009 a different customer
accounted for approximately 22.5% of our annual gross revenues; in the fourth
quarter of 2009 this customer accounted for approximately 35% of our gross
revenues. Any significant decline in our sales to any of our material customers
could also have a material adverse effect on our business, results of operations
and financial condition. In addition, because we have recently begun
focusing on servicing fewer, larger reseller customers rather than many, smaller
reseller customers, it is probable that our dependence upon a few material
customers will increase in the future.
A
continuing decline in telecommunications prices may cause us to lower our prices
to remain competitive, which could prevent our future
profitability.
International
and domestic telecommunications prices have decreased significantly over the
last few years in most of the markets in which we operate, and as a result our
margins have decreased materially. We anticipate that prices will continue to be
reduced in all of the markets in which we do business or expect to do business.
Users who select our services (or our resellers’ or service provider customers’
services) to take advantage of the current pricing differential between
traditional telecommunications prices and our (or our customers’) prices may
switch to traditional telecommunications carriers as such pricing differentials
diminish or disappear, and we will be unable to use such pricing differentials
to attract new customers in the future. Such competition or continued price
decreases may require us to lower our prices to remain competitive, may result
in reduced revenue, a loss or decrease of customers and may prevent our future
profitability.
We
believe that we will need additional capital to continue our
operations.
We have
sustained significant operating losses in recent periods, which have led to a
significant reduction in our cash reserves. As of December 31, 2009,
we had negative working capital of approximately $2.0 million as well as
negative stockholders’ equity of approximately $1.4 million. We believe that we
will continue to experience losses and increased negative working capital and
negative stockholders’ equity in the near future, and that we will not be able
to return to positive cash flow before we require additional capital (in
addition to any further amounts we may borrow from D4 Holdings under the Loan
Agreement) in the near term. Accordingly, we believe that, unless we are able to
increase our revenues, we will not have sufficient funds to continue our current
operations over the foreseeable future if we do not receive additional
financing. There can be no assurance that we will be able to raise
such additional capital on favorable terms or at all. In addition, as
a result of D4 Holdings’ controlling interest in our company, D4 Holdings will
be able to exercise a controlling influence over future issuances of capital
stock or other securities by us and a third party may be deterred from investing
in us.
Intense
competition could reduce our market share and decrease our revenue.
The
market for video and voice-over-IP services is extremely competitive. Our
competitors include companies in the video and voice-over-IP industry. Many of
our existing competitors and potential competitors have broader portfolios of
services, greater financial, management and operational resources, greater
brand-name recognition, larger subscriber bases and more experience than we
have. In addition, our Internet competitors use the Internet instead of a
private network to transmit traffic, and the operating and capital costs of
these providers may be less than ours.
If we are
unable to provide competitive service offerings, we may lose existing customers
and be unable to attract additional customers. In addition, many of our
competitors enjoy economies of scale that result in a lower cost structure for
transmission and related costs, which cause significant pricing pressures within
the industry. To remain competitive, we must continue to invest significant
resources in research and development, sales and marketing, and customer
support. We may not have sufficient resources to make these investments or to
make the technical advances necessary to be competitive, which, in turn, will
cause our business to suffer.
Fluctuations
in our quarterly financial results may make it difficult for investors to
predict our future performance.
Our
quarterly operating results may fluctuate significantly in the future as a
result of a variety of factors, many of which are outside our control. The
factors generally within our control include:
·
|
the
rate at which we are able to attract users to purchase our video and
voice-over-IP products and services;
|
·
|
the
amount and timing of expenses to enhance marketing and promotion efforts
and to expand our infrastructure; and
|
·
|
the
timing of announcements or introductions of new or enhanced services by
us.
|
15
The
factors outside our control include:
·
|
the
timing of announcements or introductions of new or enhanced services by
our competitors;
|
·
|
regulations
in various countries that prohibit us from providing our services
cost-effectively or at all;
|
·
|
technical
difficulties or network interruptions in the Internet or our
privately-managed network; and
|
·
|
general
economic and competitive conditions specific to our
industry.
|
We
believe that quarter-to-quarter comparisons of our historical operating results
may not be a good indication of our future performance, nor would our operating
results for any particular quarter be indicative of our future operating
results.
We
face a risk of failure of computer and communications systems used in our
business.
Our
business depends on the efficient and uninterrupted operation of our computer
and communications systems as well as those that connect to our network. We
maintain communications systems in facilities in New Jersey, Atlanta, London and
Frankfurt. Although we have designed our network to reduce the possibility of
disruptions or other outages, our systems and those that connect to our network
are subject to damage or interruption from natural disasters, power loss,
communications failure, hardware or software malfunction, network failures,
physical or electronic break-ins, sabotage, computer viruses, intentional acts
of terrorism or vandalism and other events that may be or may not be beyond our
control. Any system interruptions that cause our services to be unavailable,
including significant or lengthy telephone network failures or difficulties for
users in communicating through our network or portal, could damage our
reputation and result in a loss of users.
Our
computer systems and operations may be vulnerable to security
breaches.
We
believe that the safety of our network and the secure transmission of
confidential information over the Internet are essential to our operations and
maintaining user confidence in our services. Although we have developed systems
and processes that are designed to protect our network, the consumer information
stored on our network, unauthorized use of our network and other security
breaches, our computer infrastructure is potentially vulnerable to physical or
electronic computer viruses, abuse of use, break-ins and similar disruptive
problems and security breaches that could cause loss (both economic and
otherwise), interruptions, delays or loss of services to our users. We rely on
licensed encryption and authentication technology to effect secure transmission
of confidential information, including credit card numbers. It is possible that
advances in computer capabilities or new technologies could result in a
compromise or breach of the technology we use to protect user transaction data.
A party that is able to circumvent our security systems could misappropriate
proprietary information, cause interruptions in our operations or utilize our
network without authorization. Security breaches also could damage our
reputation and expose us to a risk of loss, litigation and possible liability.
While we have experienced isolated instances of unauthorized use of our network,
and have responded to such events by taking steps to increase our network
security, we cannot guarantee you that our security measures will prevent
security breaches.
Operating
internationally exposes us to additional and unpredictable risks.
We
operate in many international markets. There are certain risks inherent in doing
business on an international basis, including:
·
|
uncertainty
regarding the ability of our resellers to resell our service in compliance
with all laws, rules and regulations in such markets and actions by
foreign governments or foreign telecommunications companies to limit
access to our services;
|
·
|
political
and economic instability;
|
·
|
fluctuations
in exchange rates;
|
·
|
potentially
adverse tax consequences;
|
·
|
potentially
weaker protection of intellectual property rights; and
|
·
|
uncertain
market acceptance and difficulties in marketing efforts due to language
and cultural differences.
|
We
need to retain key personnel to support our products and ongoing
operations.
The
marketing and operations of our products and services will continue to place a
significant strain on our limited personnel, management, and other resources.
Our future success depends upon the continued services of our executive officers
and other key employees whom we rely upon to run our operations; this is
particularly true following the significant reduction in the number of employees
that occurred as a result of the reductions in force that we experienced during
2008 Except for Mr. Effi Baruch, our interim Chief Executive Officer
and President, and Senior Vice President of Technology and Operations, none of
our officers or key employees is subject to an employment agreement for any
specific term. The loss of the services of any of these officers or key
employees could impact our ability to run our operations and delay the
development and introduction of, and negatively impact our ability to sell, our
products, either of which could adversely affect our financial results. We
currently do not maintain key person life insurance policies on any of our
employees.
16
Our
ability to provide our service and to comply with certain regulatory obligations
is dependent in part upon third-party facilities and equipment, the failure of
which could cause delays or interruptions of our service, expose us to legal
liability, damage our reputation, cause us to lose customers and limit our
growth.
Our
success depends on our ability to provide quality and reliable service, which is
in part dependent upon the proper functioning of facilities and equipment owned
and operated by third parties and is, therefore, beyond our control. Unlike
traditional wireline telephone service or wireless service, our service requires
our customers to have an operative broadband Internet connection and an
electrical power supply, which are provided by the customer's Internet service
provider and electric utility company, respectively, and not by us. The quality
of some broadband Internet connections may be too poor for customers to use our
services properly. In addition, if there is any interruption to a customer's
broadband Internet service or electrical power supply, that customer will be
unable to make or receive calls, including emergency calls, using our service.
We also outsource several of our network functions to third-party providers. For
example, we outsource the maintenance of our regional data connection points,
which are the facilities at which our network interconnects with the public
switched telephone network. If our third-party service providers fail to
maintain these facilities properly, or fail to respond quickly to problems, our
customers may experience service interruptions. In addition, our E-911 service
is currently dependent upon a third-party provider. Interruptions in service
from this vendor could cause failures in our customers' access to E-911
services. Finally, our service offerings
that integrate with the public switched telephone network are wholly reliant on
third party network service providers to originate and terminate substantially
all of our calls to users of traditional telephone services. Interruptions in
our service caused by third-party facilities or service providers have in the
past caused and may in the future cause us to lose customers, or cause us to
offer substantial customer credits, which could adversely affect our revenue and
profitability. If interruptions adversely affect the perceived reliability of
our service, we may have difficulty attracting new customers and our brand,
reputation and growth will be negatively impacted.
Our
emergency and E-911 calling services may expose us to significant
liability.
Our
emergency calling service and E-911 calling service are different from the
corresponding services offered by traditional wireline telephone companies.
These differences may lead to failures that would not occur for users of
traditional telephony services. For example, providers of interconnected VoIP
services, like us, must use components of both the wireline and wireless
infrastructure in unique ways that can result in failure. Also, emergency
services provided over the Internet can be adversely impacted by power outages
and network congestion that do not necessarily have the same adverse impact on
users of traditional telephone services. Emergency call centers may not be
equipped with appropriate hardware or software to accurately process and respond
to emergency calls received by consumers of interconnected VoIP services.
Finally, users of nomadic interconnected VoIP services must manually update
their location information, and failure to do so can result in dispatching of
assistance to the wrong location. For these reasons, some of our customers do
not receive emergency services in full compliance with the FCC rules. Any of
these failures could result in enforcement action by the FCC, significant
monetary penalties and restrictions on our ability to offer non-compliant
services.
Third
parties might infringe upon our proprietary technology.
We cannot
assure you that the steps we have taken to protect our intellectual property
rights will prevent misappropriation of our proprietary technology. To protect
our rights to our intellectual property, we rely on a combination of trademarks
and trade secret protection, confidentiality agreements and other contractual
arrangements with our employees, affiliates, strategic partners and others. We
may be unable to detect the unauthorized use of, or take appropriate steps to
enforce, our intellectual property rights. Effective trademark and trade secret
protection may not be available in every country in which we offer or intend to
offer our services. Failure to adequately protect our intellectual property
could materially harm our brand, devalue our proprietary content and affect our
ability to compete effectively. Further, defending our intellectual property
rights could result in significant financial expenses and managerial
resources.
Third parties may claim that our
services infringe upon their intellectual property rights.
Third
parties may assert claims that we have violated a patent or infringed a
copyright, trademark or other proprietary right belonging to them and subject us
to expensive and disruptive litigation. For example, a complaint was
filed in the United States District Court for the Eastern District of
Texas-Tyler Division by Centre One alleging, inter alia, that we have sold
and are offering for sale a VoIP service that infringes a patent held by Centre
One. In addition, we incorporate licensed third-party technology in
some of our products and services. In these license agreements, the licensors
have agreed to indemnify us with respect to any claim by a third party that the
licensed software infringes any patent or other proprietary right so long as we
have not made changes to the licensed software. We cannot assure you that these
provisions will be adequate to protect us from infringement claims. Any
infringement claims and lawsuits, even if not meritorious, could be expensive
and time consuming to defend; divert management’s attention and
resources; require us to redesign our products, if feasible; require us to
pay royalties or enter into licensing agreements in order to obtain the right to
use necessary technologies; and/or may materially disrupt the conduct of our
business.
17
Risks
Related to our Industry
Government
regulation and legal uncertainties relating to IP telephony could harm our
business.
Historically,
voice communications services have been provided by regulated telecommunications
common carriers. We offer voice communications to the public for international
and domestic calls using IP telephony, and we do not operate as a licensed
telecommunications common carrier in many jurisdictions based on specific
regulatory classifications and recent regulatory decisions. However, the growth
of IP telephony has led to close examination of its regulatory treatment in many
jurisdictions, making the legal status of our services uncertain and subject to
change as a result of future regulatory action, judicial decisions or
legislation in any of the jurisdictions in which we operate. Established
regulated telecommunications carriers have sought and may continue to seek
regulatory actions to restrict the ability of companies such as ours to provide
services or to increase the cost of providing such services.
Application
of new regulatory restrictions or requirements to us could increase our costs of
doing business and prevent us from delivering our services through our current
arrangements. In such event, we would consider a variety of alternative
arrangements for providing our services, including obtaining appropriate
regulatory authorizations for our local network partners or ourselves, changing
our service arrangements for a particular country or limiting our service
offerings. Such regulations could limit our service offerings, raise our costs
and restrict our pricing flexibility, and potentially limit our ability to
compete effectively. Furthermore, regulations and laws that affect the growth of
the Internet could hinder our ability to provide our services over the
Internet.
Our
international operations are also subject to regulatory risks, including the
risk that regulations in some jurisdictions will prohibit us from providing our
services (or our resellers from reselling our services) cost-effectively or at
all, which could limit our growth. Currently, there are several countries where
regulations prohibit us and our resellers from offering service. We cannot
assure you that these conditions will not have a material effect on our revenues
and growth in the future. In addition, because customers can use our services
almost anywhere that a broadband Internet connection is available, including
countries where providing VoIP services is illegal, the governments of those
countries may attempt to assert jurisdiction over us, which could expose us to
significant liability and regulation.
We
may not be able to keep pace with rapid technological changes in the
communications industry.
Our
industry is subject to rapid technological change, and we cannot predict the
effect of technological changes on our business. We expect that new services and
technologies will emerge in the market in which we compete. These new services
and technologies may be superior to the services and technologies that we use
and/or may render our services and technologies obsolete.
To be
successful, we must adapt to our rapidly changing market by continually
improving and expanding the scope of services we offer and by developing new
services and technologies to meet customer needs. Our success will depend, in
part, on our ability to license leading technologies and respond to
technological advances and emerging industry standards on a cost-effective and
timely basis. We will need to spend significant amounts of capital to enhance
and expand our services to keep pace with changing technologies.
The
success of our business is affected by customers' unimpeded access to broadband
service. Providers of broadband services may be able to block our services,
which could adversely affect our revenue and growth.
A portion
of our customers must have broadband access to the Internet in order to use our
service. Some providers of broadband access have taken measures that affect
their customers' ability to use our service, such as degrading the quality of
the data packets we transmit over their lines, giving those packets low
priority, giving other packets higher priority than ours, blocking our packets
entirely or attempting to charge their customers more for also using our
services. It is not clear whether suppliers of broadband access services have a
legal obligation to allow their customers to access and use our service without
interference. As
a result of recent decisions by the U.S. Supreme Court and the FCC, providers of
broadband services are subject to relatively light regulation by the FCC.
Consequently, federal and state regulators might not prohibit broadband
providers from limiting their customers' access to VoIP or otherwise
discriminating against VoIP providers. Interference with our service or higher
charges for using our service could cause us to lose existing customers, impair
our ability to attract new customers, and harm our revenue and
growth.
We are
not currently accepting customers in areas where we cannot provide E-911 service
in conformity with the FCC’s rules. This has adversely impacted the ability of
iConnectHere to accept new customers and may also have an adverse effect on our
sales to customers who resell our service.
18
Various
U.S. state and local fees, taxes and surcharges may increase our costs and our
customers' cost of using our services.
Some
state and local regulatory authorities claim that they retain jurisdiction to
regulate the provision of, and impose taxes, fees and surcharges on, intrastate
Internet and VoIP telephony services, and have attempted to impose such taxes,
fees and surcharges, such as a fee for providing E-911 service. There is also a
risk that state authorities may attempt to impose on us state USF contribution
obligations. At this time, at least three states contend that providers of
interconnected VoIP services, like us, should contribute to their respective USF
funds, and Nebraska along with one other state filed a petition with the FCC
seeking authority to impose state USF contributions on interconnected VoIP
providers and sought retroactive authority to do so. We cannot predict how the
FCC will rule on this petition. Should the FCC allow states to impose state USF
contribution obligations on interconnected VoIP providers like us it, and allow
for such authority on a retroactive basis, it could require us to either
increase our retail price or reduce our profit margins and could have a material
adverse effect on our financial position and results of operations. In addition,
it is possible that we will be required to collect and remit taxes, fees and
surcharges in other states and local jurisdictions, and which such authorities
may take the position that we should have collected. If so, they may seek to
collect those past taxes, fees and surcharges from us and impose fines,
penalties or interest charges on us. Our payment of these past taxes, fees and
surcharges, as well as penalties and interest charges, could have a material
adverse effect on us.
We have
completed a study of state and local taxes and other fees and have accrued
approximately $150,000 of estimated state and local taxes and other fees due as
of December 31, 2009, out of a total tax accrual of $300,000. We have
also determined that we need to collect and remit sales and excise taxes in
certain states and local jurisdictions and will begin collecting and remitting
such sales and excise taxes in the immediate future. We have begun
the process of registering with the relevant state authorities and entering into
discussions with the relevant state tax authorities to finalize the amounts due.
To the extent we increase the cost of services to our customers to recoup some
of the costs of compliance, this will have the effect of decreasing any price
advantage we may have over traditional telecommunications
companies.
There
may be risks associated with our ability to comply with funding requirements of
the USF and similar state or federal funds as well as other FCC-mandated funding
requirements or that our customers will cancel service due to the impact of
these or other price increases to their service.
We
began contributing to the USF during the fourth fiscal quarter of 2006 and began
charging our customers a USF surcharge fee. In addition, we are
required to collect and remit other FCC-related fees, such as the TRS fund and
contributions towards local number portability, and the FCC and state public
utilities commissions are considering subjecting interconnected VoIP providers
like us to additional fees and surcharges. The impact of this price
increase on our customers or our inability to recoup the costs or liabilities in
remitting such fees as well as any future fees could have a material adverse
effect on our financial position, results of operations and cash flows, or could
cause some customers to cancel our service due to the loss of any price
advantage we may have over traditional telecommunications
companies.
In
addition, we have an ongoing billing dispute with respect to our contributions
to certain subsidy programs overseen by the FCC. We have filed an
appeal regarding these billings, and expect that many of the billings will
eventually be credited back to us in the third quarter of
2010. During this time, the FCC could consider the unpaid amounts as
delinquent and assess late charges and interest on the unpaid amount until the
credits are given. These late charges will likely not be credited
back to us. The FCC could also pursue collection of the amount
pending resolution of the dispute, prior to any credits being received, or
attempt to impose a monetary fine on us. While we believe that our
claims for these credits are meritorious, any such action by the FCC could have
a material adverse effect on our business, results of operation or financial
condition.
Future
legislation or regulation of our service offerings may increase our costs, which
may result in either our increasing the retail price of our service offerings or
reducing our profitability.
The FCC
has several ongoing proceedings that could negatively impact
us. Specifically, the FCC may reform the system of payments between
companies that connect telephone companies. Such reforms may increase
the charges we pay to other companies for handling our calls. The FCC
may adopt more stringent E-911 obligations. This could result in us
having to deploy new technologies or engage a third party to provide services in
compliance with the new regulations, increasing our costs. The FCC
may determine that some or all of our offerings are properly classified as
“telecommunications” services subjecting our offerings to state and federal
regulations, thereby increasing our compliance costs. The U.S.
Congress, state legislatures, state regulatory commissions and foreign
regulatory commissions could attempt to impose additional obligations on us at
any time. We cannot predict the outcome of the pending FCC
proceedings or what actions such other governmental and regulatory bodies may
take that may affect us.
Risks
Related to our Relationship with D4 Holdings
D4
Holdings controls a majority of our common stock and has the ability to exercise
control over all matters submitted to a stockholder vote.
D4
Holdings currently owns approximately 54.0% of the issued and outstanding shares
of our common stock and, in the event it exercises in full the warrant that we
issued to it to purchase up to an additional 30,000,000 shares of our common
stock at an exercise price of $0.04 per share, it will own approximately 67.5%
of the issued and outstanding shares of our common stock. As long as
D4 Holdings continues to beneficially own more than 50% of the voting power of
our company, D4 Holdings will be able to exercise a controlling influence over
decisions affecting us, including:
·
|
composition
of our board of directors and, through it, our direction and policies,
including the appointment and removal of our officers;
|
·
|
potential
mergers, acquisitions, sales of assets and other significant corporate
transactions;
|
·
|
future
issuances of capital stock or other securities by us;
|
·
|
incurrence
of debt by us;
|
·
|
amendments,
waivers and modifications to any agreements between us and D4
Holdings;
|
19
·
|
payment
of dividends on our capital stock; and
|
·
|
approval
of our business plans and general business
development.
|
In
addition, this concentration of ownership may discourage, delay or prevent a
change in control of our company, which could deprive our stockholders of an
opportunity to receive a premium for their common stock as part of a sale of our
company or result in strategic decisions that could negatively impact the value
and liquidity of our outstanding stock. D4 Holdings also has sufficient voting
power to amend our organizational documents. Furthermore, conflicts of interest
could arise in the future between us and D4 Holdings concerning, among other
things, potential competitive business activities or business opportunities. D4
Holdings is not restricted from competitive activities or investments. We cannot
provide assurance that the interests of D4 Holdings will coincide with the
interests of other holders of our common stock. Also, four of our
seven directors are affiliated with D4 Holdings. As a result, the ability of any
of our other stockholders to influence the management of our company is limited,
which could have an adverse effect on the market price of our
stock.
The
ownership of D4 Holdings includes owners of ACN, and we may engage in commercial
transactions with ACN and its affiliated entities in the future.
D4
Holdings is a private investment fund whose ownership includes owners of ACN.
Several of the members of our board of directors currently serve as officers
and/or directors of ACN. Because ACN is a direct seller of telecommunications
services, we may seek to engage in commercial transactions to provide services
to ACN in the future. During the third quarter of 2009 we entered into an
agreement with ACN Pacific Pty Ltd., a wholly-owned subsidiary of ACN, pursuant
to which we provide digital video and voice-over-IP telecommunications services
in Australia and New Zealand to ACN Pacific. During the fourth quarter of 2009
we entered into an agreement with Ojo Service, LLC, a wholly-owned subsidiary of
WorldGate Communications, Inc. pursuant to which we provide pursuant to which we
provide Ojo Service digital video and voice-over-IP services in the United
States. WorldGate is majority-owned by WGI Investor LLC, which shares
common majority ownership and a common manager with D4 Holdings. Although
we expect that the terms of any such transactions will be established based upon
negotiations between employees of ACN and us and, when appropriate, subject to
the approval of the independent directors on our board or a committee of
disinterested directors, there can be no assurance the terms of any such
transactions will be as favorable to us as might otherwise be obtained in arm’s
length negotiations.
As
a result of D4 Holding’s controlling interest in deltathree a third party may be
deterred from attempting to acquire our company.
D4
Holding’s controlling interest in deltathree could delay, deter or prevent a
third party from attempting to acquire control of us. This may have the effect
of discouraging a third party from making a tender offer or otherwise attempting
to obtain control of us, even though such a change in ownership would be
economically beneficial to us and our stockholders.
Our
stockholders may suffer dilution in the future in the event that D4 Holdings
exercises its warrant.
On
February 12, 2009, we issued to D4 Holdings 39,000,000 shares of our common
stock for an aggregate purchase price of $1,170,000 and a warrant, exercisable
for up to ten years, to purchase up to an additional 30,000,000 shares of our
common stock for a purchase price of $0.04 per share. In the event
that D4 Holdings exercises the warrant, in full or in part, our existing
stockholders may experience significant and immediate dilution.
Risks
Related to our Common Stock
Volatility
of our stock price could adversely affect our stockholders.
From the
time that trading commenced in our common stock in November 1999, the
market price of our common stock has been highly volatile and may continue to be
volatile and could be subject to wide fluctuations in response to factors such
as:
·
|
the
market price for the stock of our major competitors;
|
·
|
variations
in our actual or anticipated quarterly operating results or those of our
competitors;
|
·
|
announcements
by us or our competitors of technological innovations;
|
·
|
introduction
of new products or services by us or our competitors;
|
·
|
announcements
by us or our competitors of significant acquisitions;
|
·
|
our
entry into strategic partnerships or joint ventures;
and
|
·
|
purchases
and sales of our common stock by D4
Holdings.
|
All of
these factors are, in whole or part, beyond our control and may materially
adversely affect the market price of our common stock regardless of our
performance.
Investors
may not be able to resell their shares of our common stock following periods of
volatility because of the market's adverse reaction to such volatility. In
addition, the market price for shares of telecommunications, Internet-related
and technology companies has dramatically decreased. We cannot assure you that
our common stock will trade at the same levels of other telecommunications or
Internet stocks.
20
Our
common stock is quoted on the OTC Bulletin Board, which may increase the
volatility of our stock and make it harder to sell shares of our
stock.
Our
common stock is quoted on the OTC Bulletin Board, which tends to be a highly
illiquid market. There is a greater chance of market volatility for
securities that trade on the OTC Bulletin Board (as opposed to a national
exchange or quotation system), as a result of which stockholders may experience
wide fluctuations and a depressed price in the market price of our securities.
Thus, stockholders may be required to either sell our securities at a market
price which is lower than their purchase price or to hold our securities for a
longer period of time than they planned. Because our common stock
falls under the definition of “penny stock,” trading in our common stock may be
limited because broker-dealers are required to provide their customers with
disclosure documents prior to allowing them to participate in transactions
involving our common stock. These rules impose additional sales practice
requirements on broker-dealers that sell low-priced securities to persons other
than established customers and institutional accredited investors; and require
the delivery of a disclosure schedule explaining the nature and risks of the
penny stock market. As a result, the ability or willingness of broker-dealers to
sell or make a market in our common stock might decline, and stockholders could
find it more difficult to sell their stock.
Risks
Related to our Israel Operations
We
may be negatively impacted by changes in political, military and/or economic
conditions.
Since the
establishment of the State of Israel in 1948, a number of armed conflicts have
taken place between Israel and its Arab neighbors and a state of hostility,
varying from time to time in intensity and degree, has led to security and
economic problems for Israel. A peace agreement between Israel and Egypt was
signed in 1979 and a peace agreement between Israel and Jordan was signed in
1994. However, as of the date hereof Israel has not entered into any peace
agreement with Syria or Lebanon.
Despite
peace related developments, certain countries, companies and organizations
continue to participate in a boycott of Israeli firms. We do not believe that
the boycott has had a material adverse effect on us, but there can be no
assurance that restrictive laws, policies or practices directed towards Israel
or Israeli-based businesses will not have an adverse impact on our business or
financial condition in the future.
Our costs
of operations have at times been affected by changes in the cost of our
operations in Israel resulting from changes in the value of the Israeli shekel
relative to the U.S. dollar. Recently, the weakening of the dollar relative to
the shekel has significantly increased the costs of our Israeli operations,
stated in U. S. dollars.
Israel’s
economy has been subject to numerous destabilizing factors, including a period
of rampant inflation in the early- to mid-l980s, low foreign exchange reserves,
fluctuations in world commodity prices and military conflicts. The Israeli
Government has, for these and other reasons, intervened in the economy by
utilizing, among other means, fiscal and monetary policies, import duties,
foreign currency restrictions and control of wages, prices and exchange rates.
The Israeli Government has periodically changed its policies in all these areas.
Although we derive most of our revenues outside of Israel, a substantial portion
of our expenses are incurred in Israel and are affected by economic conditions
in the country.
All of
these factors are, in whole or part, beyond our control and may materially
adversely affect on our business, financial condition and operating results, or
market price of our common stock regardless of our performance.
We
may be negatively impacted by employees being called for army
service.
Generally,
all male adult citizens and permanent residents of Israel under the age of 41
are, unless exempt, obligated to perform up to 36 days of military reserve
duty annually. Additionally, all such residents are subject to being called to
active duty at any time under emergency circumstances. Furthermore, some of our
officers and employees are currently obligated to perform annual reserve duty.
While we have operated effectively under these requirements since we began
operations, no assessment can be made as to the full impact of such requirements
on our workforce or business if conditions should change, and no prediction can
be made as to the effect on us of any expansion of such
obligations.
ITEM 2. PROPERTIES
We lease
our executive offices at 224 West 35th Street,
New York, N.Y. The term of the lease is until August 31, 2010, with
an option for us to extend the lease through August 31, 2012. Rent expense, net,
for 2009 was $26,343, which includes the rent expense, net, we paid in 2009 for
our previous executive offices located at 419 Lafayette Street, New York,
N.Y
Delta
Three Israel Ltd., a wholly-owned subsidiary of the Company, leases an office
that houses the Company’s research and development facilities in Jerusalem,
Israel. On October 20, 2009, our subsidiary and the owner of the office
executed an amendment to the lease agreement between the parties. The
amendment provides that, amongst other things, retroactive to July 1, 2009, the
number of square meters comprising the office space was reduced by 556 to 734
square meters and the term of the lease was extended to June 30, 2012, with an
option for our subsidiary to extend the term for an additional 36 months
thereafter. Rent expense, net for our subsidiary for 2009 was
$196,150.
21
ITEM 3. LEGAL PROCEEDINGS
On
December 5, 2008, a complaint for patent infringement was filed in the United
States District Court for the Eastern District of Texas (Tyler Division) by
Centre One naming us, Verizon Communications Inc., Vonage Holdings Corp. and
Vonage America Inc. as defendants. The complaint alleges, inter alia, that we and
Verizon are offering for sale “a VoIP service, including, but not limited to, a
service under the name Verizon VoiceWing” that infringes United States Patent
No. 7,068,668, or Patent ’668, entitled “Method and Apparatus for
Interfacing a Public Switched Telephone Network and an Internet Protocol Network
for Multi-Media Communication.”
On April
7, 2009, the court held a status conference and assigned May 6, 2010, and
December 6, 2010, as the dates for the pretrial hearing, or the Markman hearing,
to interpret the construction of Centre One’s claims and the commencement of the
trial, respectively.
On June
9, 2009, Centre One served a Disclosure of Asserted Claims and Infringement
Contentions, in which it accused certain of our VoIP services, in addition to
Verizon VoiceWing, of infringing Patent ’668. Centre One identified
our Hosted Consumer VoIP Solutions, Consumer Group Global Internet Phone
Service, and Reseller Programs as allegedly infringing.
On June
22, 2009, the United States Patent and Trademark Office, or the “PTO”, granted a
request by Verizon Long Distance LLC to reexamine Patent ’668, and issued a
non-final office action rejecting all but two of the 37 claims of Patent ’668 as
not patentable. On July 8, 9, and 10, 2009, we and the other
defendants moved to stay the litigation in the Eastern District of Texas pending
the PTO’s reexamination of Patent ’668. Centre One opposed the stay
motions on July 10, 2009.
On July
14, 2009, Verizon Long Distance, and on August 13, 2009, Vonage and we, filed
Invalidity Contentions seeking to invalidate under 35 U.S.C. §102 and/or §103
all of the claims of Patent ’668 asserted over prior patents and publications of
third parties not disclosed to the PTO at the time that Patent ’668 was
granted.
On August
24, 2009, Centre One amended at the PTO 12 of the 21 claims it had asserted in
the litigation. On September 18, 2009, Centre One moved to amend its
Infringement Contentions to withdraw the claims it had amended at the PTO and to
assert two additional claims of infringement. The other defendants
and us agreed to the withdrawn claims but opposed Centre One’s attempt to assert
new claims. The court has not yet ruled on the motion.
On
October 1, 2009, Vonage separately filed a request for reexamination of the
Patent ’668, stating additional grounds for invalidity beyond those presented by
Verizon Long Distance. The PTO granted Vonage’s request on December
16, 2009, and a first office action on the merits is expected
shortly.
On
February 9 and 12, 2010, Verizon and we respectively moved for a protective
order against further discovery in the litigation and a limited stay of all
deadlines until the court rules on the pending motions to stay. On
February 17, 2010, Centre’s One counsel filed a motion to withdraw as counsel
for Centre One and requested that the court stay all deadlines and discovery in
the litigation until Centre One obtains new counsel. The court
granted the motion on February 19, 2010 and stayed all deadlines in the
litigation for 60 days. The court instructed counsel for the parties to meet
after such time and submit a joint status report containing each party’s
position regarding new dates for the Markman hearing and the commencement of the
trial.
On
February 24, 2010, the court denied our and the other defendants respective stay
motions. In addition, the court denied our and Verizon’s motions for
a protective order and limited stay as moot in light of the 60-day stay the
court had granted on February 19.
Our
examination of the allegations set forth in the Complaint lead us to firmly
believe that we do not infringe any valid claim of Patent ’668. We are
continuing our examination into the allegations set forth in the complaint and
the validity of Patent ’668, and cannot predict with any degree of certainty the
results of our examination and/or the outcome of the suit or determine the
extent of any potential liability or damages.
We, as
well as certain of our former officers and directors, were named as
co-defendants in a number of securities class actions in the United States
District Court for the Southern District of New York, arising out of our initial
public offering, or IPO, in November 1999. In addition, a number of
other issuers and underwriters of public offerings of such issuers (including
the underwriters of our IPO) were named as defendants in such class action suits
in connection with such public offerings. A global settlement was agreed upon
among the plaintiffs, issuers, underwriters and insurers, and received the final
approval of the district judge on October 5, 2009. The settlement did not impose
any liability on us.
We are
not a party to any other material pending legal proceedings, other than ordinary
routine litigation incidental to the business, to which we are a party or of
which any of our property is the subject.
ITEM
4. (REMOVED AND RESERVED)
22
PART
II
ITEM
5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market
Information
Our
common stock is currently listed on the OTC Bulletin Board under the symbol
“DDDC.OB”. The listing of our common stock was transferred from The Nasdaq
Capital Market to the OTC Bulletin Board on March 28, 2008.
The
following table sets forth the high and low sales prices of our common stock for
such time as our common stock was traded on the Nasdaq Capital Market and the
high and low bid prices for such time as our shares have been listed on the OTC
Bulletin Board for the periods indicated:
High
|
Low
|
|||||||
Year ended December 31, 2008 | ||||||||
First
quarter
|
0.53 | 0.12 | ||||||
Second
quarter
|
0.22 | 0.11 | ||||||
Third
quarter
|
0.17 | 0.06 | ||||||
Fourth
quarter
|
0.13 | 0.01 | ||||||
Year ended December 31,
2009
|
||||||||
First
quarter
|
0.20 | 0.01 | ||||||
Second
quarter
|
0.24 | 0.10 | ||||||
Third
Quarter
|
0.65 | 0.12 | ||||||
Fourth
Quarter
|
0.50 | 0.30 | ||||||
Year ending December 31,
2010
|
||||||||
First
Quarter (through March 25)
|
0.37
|
0.11
|
Holders
As of
March 25, 2010, we had 141 holders of record of the 72,242,933 outstanding
shares of our common stock. This does not reflect persons or entities that hold
their stock in nominee or "street" name through various brokerage
firms.
Dividend
Policy
We have
never declared or paid any cash dividends on our capital stock, and do not
anticipate paying any cash dividends on our capital stock in the foreseeable
future. We currently intend to retain future earnings, if any, to finance our
operations and to expand our business. Any future determination to pay cash
dividends will be at the discretion of our board of directors and will be
dependent upon our financial condition, operating results, capital requirements
and other factors that our board of directors considers
appropriate.
Purchases
of Equity Securities by the Issuer and Affiliated Purchasers
None.
23
ITEM
6. SELECTED FINANCIAL DATA
You
should read the selected consolidated financial data together with our
consolidated financial statements and related notes and the section of this
Annual Report entitled “Management's Discussion and Analysis of Financial
Condition and Results of Operations.” The selected financial data for each of
the years in the three-year period ended December 31, 2009, and as of December
31, 2008 and 2009 is derived from our audited financial statements that have
been included in this Annual Report. The selected financial data as of December
31, 2005, 2006 and 2007 and for the years ended December 31, 2005 and 2006 is
derived from consolidated financial statements that have not been included in
this Annual Report.
Year
Ended December 31,
|
||||||||||||||||||||
2005
|
2006
|
2007
|
2008
|
2009
|
||||||||||||||||
(In
thousands)
|
||||||||||||||||||||
Statement
of Operations Data:
|
||||||||||||||||||||
Revenues
|
$
|
29,714
|
$
|
37,953
|
$
|
29,477
|
$
|
20,226
|
$
|
19,002
|
||||||||||
Costs
and operating expenses:
|
||||||||||||||||||||
Cost
of revenues
|
(18,698
|
)
|
(24,375
|
)
|
(21,107
|
)
|
(14,744
|
) |
(16,127
|
) | ||||||||||
Research
and development expenses
|
(3,228
|
)
|
(4,043
|
)
|
(4,669
|
)
|
(3,356
|
) |
(464
|
) | ||||||||||
Selling
and marketing expenses
|
(4,173
|
)
|
(4,956
|
)
|
(5,068
|
)
|
(3,636
|
) |
(1,201
|
) | ||||||||||
General
and administrative expenses
|
(2,912
|
)
|
(3,088
|
)
|
(2,952
|
)
|
(3,130
|
) |
(3,514
|
) | ||||||||||
Depreciation
and amortization
|
(1,931
|
)
|
(1,543
|
)
|
(2,644
|
)
|
(1,836
|
) |
(890
|
) | ||||||||||
Write-off
of goodwill
|
-
|
-
|
-
|
(2,002
|
) |
-
|
||||||||||||||
Write-off
of intangible assets
|
-
|
-
|
(2,680
|
)
|
(1,564
|
) |
-
|
|||||||||||||
Restructuring
expenses
|
-
|
-
|
-
|
(1,223
|
) |
-
|
||||||||||||||
Deferred
revenue restatement
|
-
|
-
|
-
|
(596
|
) |
-
|
||||||||||||||
Total
costs and operating expenses
|
(30,942
|
)
|
(38,005
|
)
|
(39,120
|
)
|
(32,087
|
) |
(22,196
|
) | ||||||||||
Loss
from operations
|
(1,228
|
)
|
(52
|
)
|
(9,643
|
)
|
(11,861
|
) |
(3,194
|
) | ||||||||||
Capital
gain
|
-
|
-
|
-
|
39
|
86
|
|||||||||||||||
Other
non-operating income
|
-
|
-
|
13
|
19
|
15
|
|||||||||||||||
Interest
income, (expense) net
|
418
|
620
|
442
|
(35
|
) |
(72
|
) | |||||||||||||
Income
taxes
|
(44
|
)
|
(61
|
)
|
(126
|
)
|
(28
|
) |
(34
|
) | ||||||||||
Net
income (loss)
|
$
|
(854
|
)
|
$
|
507
|
$
|
(9,314
|
)
|
$
|
(11,866
|
) |
$
|
(3,199
|
) | ||||||
Net
income (loss) per share – basic and diluted
|
$
|
(0.03
|
)
|
$
|
0.02
|
$
|
(0.29
|
)
|
$
|
(0.36
|
) |
$
|
(0.05
|
) | ||||||
Weighted
average shares outstanding – basic and diluted
|
29,672
|
29,771
|
32,427
|
32,870
|
67,878
|
December
31,
|
||||||||||||||||||||
2005
|
2006
|
2007
|
2008
|
2009
|
||||||||||||||||
(In
thousands)
|
||||||||||||||||||||
Balance
Sheet Data:
|
||||||||||||||||||||
Cash
and cash equivalents
|
$
|
3,847
|
$
|
3,790
|
$
|
1,649
|
$
|
1,788
|
$
|
1,514
|
||||||||||
Short-term
investments
|
10,648
|
12,067
|
5,883
|
317
|
366
|
|||||||||||||||
Working
capital (deficit)
|
10,264
|
12,182
|
4,522
|
(723
|
) |
(1,993
|
) | |||||||||||||
Long-term
investments
|
1,216
|
1,085
|
1,085
|
-
|
-
|
|||||||||||||||
Total
assets
|
21,504
|
22,395
|
17,299
|
4,854
|
3,309
|
|||||||||||||||
Total
stockholders’ equity
|
15,561
|
16,618
|
12,024
|
548
|
(1,425
|
) |
24
ITEM
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The
following discussion of our financial condition and results of operations should
be read together with our consolidated financial statements and the related
notes thereto included elsewhere in this Annual Report. This discussion contains
certain forward-looking statements that involve substantial risks and
uncertainties. When used in this report, words such as “anticipate,” “believe,”
“estimate,” “expect,” “target,” “goal,” “project,” “intend,” “plan,” “believe,”
“seek,” variations of such words and similar expressions as they relate to our
management or us are intended to identify such forward-looking statements. Our
actual results, performance or achievements could differ materially from those
expressed in, or implied by, these forward-looking statements. Factors that
might cause such a difference include, but are not limited to, those discussed
in “Risk Factors” and other risks referenced from time to time in our filings
with the SEC. Historical operating results are not necessarily indicative of the
trends in operating results for any future period.
Overview
We are a
global provider of integrated 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 two
primary distribution channels: our service provider and reseller channel, and
our direct-to-consumer channel. We offer a broad suite of private label VoIP
products and services as well as a back-office platform for service providers,
resellers and corporate customers, such as VoIP operators and various corporate
enterprises. 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 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 have
built a privately-managed, state-of-the-art global telecommunications platform
using IP technology and offer our customers a suite of IP video and voice
products, including PC-to-Phone and Broadband Phone products. We provide a
robust set of value-added services and features that enable us to address the
challenges that have traditionally made the provision of telecommunications
services difficult, and we offer our products and services to a global customer
base in a fashion that meets the disparate needs of this diverse customer base.
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.
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.
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. For example, in 2007 we released a next
generation SIP-based PC-to-Phone application, certified many new devices which
function as access points to our services, and added new features and new
calling plans to our offerings.
In 2004,
we announced our first major service provider contract with Verizon
Communications to provide the Verizon VoiceWing VoIP service. In
2007, we entered into an agreement with Market America, a leading on-line
shopping and one-to-one marketing company, pursuant to which Market America
launched its Voitel Home Phone Service powered by our Hosted Consumer VoIP
Solution platform. In addition, we entered into an agreement with RCN
Corporation, a leading provider of video, data, and voice services to
residential, business, and commercial/carrier customers, to power its Starpower
Internet Phone Service. In January 2009 Verizon terminated our
service provider agreement effective May 15, 2009. On February 5, 2009, we
entered into a Termination, Settlement Agreement and Mutual Release with RCN,
pursuant to which the service agreement between us and RCN was terminated and
RCN transferred to us some of the subscribers to the VoIP service we had been
providing to RCN under the agreement. In addition, RCN paid us a termination fee
of $230,000.
25
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. pursuant to which we provide digital video and
voice-over-IP services in Australia and New Zealand to ACN Pacific. During the
fourth quarter of 2009 we entered into an agreement with Ojo Service, LLC, a
wholly-owned subsidiary of WorldGate Communications, Inc., a publicly-held
provider of video phone equipment, pursuant to which we provide Ojo Service
digital video and voice-over-IP services in the United
States. WorldGate is majority-owned by WGI Investor LLC, which shares
common majority ownership and a common manager with D4 Holdings, LLC, discussed
below. In 2010 we are continuing to update our network by adding content enabler
services to our video phone applications, as well as providing mobile
applications. Following the successful integration of these services,
we believe that our full suite of service offerings will constitute a complete
next generation communication service package that will provide our customers
the ability to customize, implement and rapidly launch digital next generation
communications offerings.
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 2007, we acquired the service provider and consumer
business assets (including the customer bases) of Go2Call.com, Inc., a privately
held U.S.-based VoIP solutions provider. However, in 2008 we wrote-off
approximately $2.0 million in goodwill and approximately $1.6 million in
intangible assets acquired in the Go2Call transaction. Through our joip offering
we attempted to expand into other product and geographic consumer markets, but
in 2008 we recognized only $119,000 in revenues from our service agreement with
Panasonic and we do not expect that this will be a significant source of revenue
in the future. In addition, as discussed above under “Item 1. Business --
Transactions with D4 Holdings”, in February 2009 we consummated a transaction
with D4 Holdings pursuant to which we sold 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, Inc., or 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.
Following
a comprehensive review of our strategy in the second quarter of 2009, we decided
to focus our near-term strategy and market initiatives on growing our service
provider business while still supporting our core VoIP reseller and
direct-to-consumer business segments. While our revenues for the fiscal year
ended December 31, 2009, declined substantially compared to our revenues for the
fiscal year ended December 31, 2008, our net loss decreased from approximately
$11.9 million to approximately $3.2 million. As of December 31, 2009, we had
negative working capital equal to approximately $2.0 million and negative
stockholders’ equity equal to approximately $1.4 million.
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:
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, and several of the larger traditional telecommunications companies
have announced intentions to merge, which will create even larger competitors.
We compete with other telecommunications firms in the sale and purchase of
various products and services in many national and international markets and
employ all methods of competition that are lawful and appropriate for such
purposes. 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.
26
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 and by other political
developments and laws and regulations, such as: telecommunications regulations;
war, 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: See “Item 1A.
Risk Factors” for a discussion of the impact of market risks, financial risks
and other risks and uncertainties.
Revenues
Our
revenues are derived mainly from resellers, service providers, and end-users of
our VoIP telephony products and services, including and Broadband Phone and
PC-to-Phone. All revenues are recognized at the time the services are performed.
The provision of VoIP telephony products and services through our service
provider and reseller sales efforts (including sales of our Hosted Consumer VoIP
Solution) accounted for 88.7% and 84.7% of our total revenues in 2009 and 2008,
respectively, while the provision of VoIP telephony through iConnectHere
accounted for 10.4% and 13.8% of our total revenues in 2009 and 2008,
respectively.
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
corporate customers and advertising and promotional expenses incurred to attract
potential consumer users of iConnectHere.
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.
27
Depreciation
and amortization consists of the depreciation calculated on our fixed assets for
the fiscal year ended December 31, 2009, and the amortization of the intangible
assets acquired by us in the purchase of certain assets of Go2Call.
We have
not recorded any income tax benefit for net losses and credits incurred for any
period from inception to December 31, 2009. 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
December 31, 2009, we had net operating losses, or NOLs, generated in the U.S.
of approximately $159 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 will expire
at various dates between 2011 and 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.
Critical
Accounting Policies
The SEC
defines critical accounting policies as those that are, in management's view,
most important to the portrayal of a company's financial condition and results
of operations and most demanding on their calls on judgment, often as a result
of the need to make estimates about the effect of matters that are inherently
uncertain and may change in subsequent periods. We believe our most critical
accounting policies relate to:
Use of
estimates: Our consolidated financial statements are prepared
in conformity with accounting principles generally accepted in the United
States, which require management to make estimates and assumptions that affect
the amounts reported and disclosed in the consolidated financial statements and
the accompanying notes. Actual results could differ materially from these
estimates.
On an
ongoing basis, we evaluate our estimates, including the following:
·
|
the
useful lives of property and equipment and intangible
assets;
|
·
|
commitments
and contingencies, based on the information available at the time we are
making such estimates; and
|
·
|
the
assumptions used for the purpose of determining share-based compensation
using the Black-Scholes option model and various other assumptions that we
believe to be reasonable.
|
We base our estimates on historical
experience, available market information, appropriate valuation methodologies
and various other assumptions that we believe to be reasonable, the results of
which form the basis for making judgments about the carrying values of assets
and liabilities.
Revenue recognition and deferred
revenue: We
record revenue from Internet telephony services based on minutes (or fractions
thereof) of customer usage. We record revenue from related services based on
completion of the specific activities associated with the services. We record
payments received in advance for prepaid services and services to be supplied
under contractual agreements as deferred revenue until such related services are
provided. We estimate the allowance for doubtful accounts by reviewing the
status of significant past due receivables and analyzing historical bad debt
trends and we then reduce accounts receivables by such allowance for doubtful
accounts to expected net realizable value.
Long-lived assets: We assess
the impairment of long-lived assets whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Factors we consider
important which could trigger an impairment review include the
following:
·
|
significant
decrease in the market price of a long-lived asset;
|
·
|
significant
adverse change in the extent or manner in which a long-lived
asset is being used or in its physical
condition;
|
·
|
significant
adverse change in legal factors or in the business climate that could
affect the value of a long-lived asset , including an adverse action or
assessment by a regulator;
|
·
|
accumulation
of costs significantly in excess of the amount originally expected for the
acquisition of the long-lived asset ;
|
·
|
current
period operating or cash flow loss combined with a history of operating or
cash flow losses or a projection or forecast that demonstrates continuing
losses associated with the use of a long-lived asset ;
and
|
·
|
current
expectation that, more likely than not, a long-lived asset will be sold or
otherwise disposed of significantly before the end of its previously
estimated useful life.
|
We
determine the recoverability of long-lived assets based on an estimate of
undiscounted future cash flows resulting from the use of the asset and its
eventual disposition. Such estimation process is highly subjective and involves
significant management judgment. Determination of impairment loss from
long-lived assets to be disposed of is reported at the lower of carrying amount
or fair value less costs to sell.
28
Results
of Operations
The
following table sets forth the statement of operations data presented as a
percentage of revenues for the periods indicated:
Year Ended
December 31,
|
||||||||||||
2007
|
2008
|
2009
|
||||||||||
Revenues:
|
||||||||||||
Total
revenues
|
100.0 | % | 100.0 | % | 100.0 | % | ||||||
Costs
and operating expenses:
|
||||||||||||
Cost
of revenues
|
71.6 | 72.9 | 84.9 | |||||||||
Research
and development expenses
|
15.8 | 16.6 | 2.4 | |||||||||
Selling
and marketing expenses
|
17.2 | 18.0 | 6.3 | |||||||||
General
and administrative expenses (exclusive of non-cash compensation
expense)
|
10.0 | 15.4 | 18.5 | |||||||||
Write-off
of goodwill
|
- | 9.9 | - | |||||||||
Write-off
of intangible assets
|
9.1 | 7.7 | - | |||||||||
Deferred
revenue restatement
|
- | 2.9 | - | |||||||||
Restructuring
expenses
|
- | 6.0 | - | |||||||||
Depreciation
and amortization
|
9.0 | 9.1 | 4.7 | |||||||||
Total
costs and operating expenses
|
132.7 | 158.6 | 116.8 | |||||||||
Loss
from operations
|
(32.7 | ) | (58.6 | ) | (16.8 | ) | ||||||
Capital
gain
|
- | 0.2 | 0.5 | |||||||||
Other
non-operating income
|
- | - | - | |||||||||
Interest
income, net
|
1.5 | (0.2 | ) | (0.3 | ) | |||||||
Income
taxes
|
(0.4 | ) | (0.1 | ) | (0.2 | ) | ||||||
Net
income (loss)
|
(31.6 | ) % | (58.6 | )% | (16.8 | )% |
29
Revenues
Revenues
for 2009 overall decreased by approximately $1.2 million, or 6.5%, to
approximately $19.0 million from approximately $20.2 million in 2008. Both our
reseller and service provider channel, as well as our direct consumer, channels
were affected. Revenues from our reseller and service provider sales channels
decreased approximately $0.3 million, or 2%, from approximately $17.1 million in
2008 to approximately $16.8 million in 2009. In addition, revenues
from our direct consumer channel decreased approximately $0.8 million, or 30%,
from approximately $2.8 million in 2008 to approximately $2.0 million in
2009. Other income decreased approximately $0.1 million, or 33%, from
approximately $0.3 million in 2008 to approximately $0.2 million in
2009.
Within
the reseller business itself, we made a decision in the first quarter of 2009 to
focus on servicing fewer, larger resellers rather than more, smaller
resellers. Consequently, our two largest resellers accounted for
approximately $9.2 million, or approximately 61%, of the revenue generated from
our reseller division in 2009, which represented approximately 48% of our total
revenue for 2009. By comparison, in 2008 our two largest resellers
accounted for approximately $5.0 million, or approximately 36.8%, of the revenue
generated from our reseller division, which equaled approximately 24.8% of our
total revenue for 2008.
Revenues
generated by our service provider division decreased by approximately $2.1
million, or 60%, to $1.4 million for 2009 from $3.5 million for 2008, largely
due to the expiration of our service agreements with Verizon Communications and
RCN Corporation and our development agreement with Panasonic. During the third
quarter of 2009 we entered into an agreement with ACN Pacific Pty Ltd., a
wholly-owned subsidiary of ACN, pursuant to which we provide digital video and
voice-over-IP services in Australia and New Zealand to ACN Pacific. During the
fourth quarter of 2009 we entered into an agreement with Ojo Service, LLC, a
wholly-owned subsidiary of WorldGate Communications, Inc., pursuant to which we
provide pursuant to which we provide Ojo Service digital video and voice-over-IP
services in the United States. WorldGate is majority-owned by WGI Investor LLC,
which shares common majority ownership and a common manager with D4
Holdings.
Sales to
direct consumers decreased by approximately $0.8 million, or 30%, to
approximately $2.0 million in 2009 from approximately $2.8 million in 2008. The
decrease in direct consumer revenues was primarily due to a lack of investment
on our part in our consumer division and an increasingly competitive VoIP market
causing the rates we charge our customers to decline.
On
November 3, 2009, we were informed that the operations of our largest customer
had been suspended. In 2009, this customer accounted for
approximately 25.8% of our annual gross revenues. The loss of revenue
attributable to this customer has had a material adverse effect on our financial
condition and results of operations.
Although
the number of minutes on our network utilized by our customers increased by
approximately 24% from 315 million minutes in 2008 to 390 million in 2009 our
revenues decreased as a result of intense competition in the VoIP industry,
resulting in price reductions in the markets in which we operate.
Costs
and Operating Expenses
Cost of
revenues.
Cost of revenues increased by $1.4 million, or 9.5%, from
$14.7 million in 2008 to $16.1 million in 2009. Although our
network rent cost decreased by 21.1% from $1.9 million in 2008 to $1.5 million
in 2009, our termination cost increased by 16.2% from $11.1 million in 2008
to $12.9 million in 2009. The main reason for the increase in cost of
revenues was an increase in the amount of traffic being terminated over our
network. In addition, due to a reassessment of our cost allocation as a result
of the reductions in force that occurred during 2008, cost of revenue increased
in 2009 by $0.6 million, offset by a decrease of $0.3 million of devices shipped
to new customers and a decrease of $0.3 million for customer support costs we
incurred for joip.
Research and
development expenses. Research and development
expenses decreased by $3.0 million, or 88.2%, from $3.4 million in
2008 to $0.5 million in 2009. The primary reason for the decline was a
decrease in the overall personnel costs of 88.5% to $0.3 million in 2009 from
$2.6 million in 2008. This was due to the reductions in force that occurred in
2008 and the expiration of our development agreement with
Panasonic.
Selling and
marketing expenses. Selling and marketing
expenses decreased by $2.4 million, or 66.6%, to $1.2 million in 2009 from $3.6
million in 2008. The cost of our selling and marketing personnel decreased by
approximately 58.8% to $0.7 million in 2009 from $1.7 million in 2008 following
the reductions in force that occurred in 2008.
General and
administrative expenses. General and administrative
expenses increased by $0.4 million, or 12.9%, to $3.5 million in 2009 from $3.1
million in 2008, due primarily to $1.0 million we recorded as litigation
expenses offset by $0.4 million of revaluation of tax liability that we had
recorded in 2008. Excluding the litigation expenses and the revaluation of the
tax liability, our general and administrative expenses decreased by
approximately $0.3 million during 2009, mostly due to the restructuring that we
effected in 2008.
30
Write-off of
goodwill. As part
of our acquisition of Go2Call, we recognized goodwill of approximately $2.0
million relating to our reseller division. During the third quarter
of 2008, we assessed the value of our reseller division and determined that
based on our then-current financial condition and the state of our reseller
division it would be appropriate to write off the entire $2.0 million of the
goodwill acquired in the Go2Call acquisition. We did not write off any goodwill
in 2009.
Write-off of
intangible assets. In 2008 we wrote off the balance of the
intangible assets associated with the Go2Call transaction. During the
second quarter of 2008, we reached the conclusion that we will not invest
significant resources into a segment of the business that we purchased as part
of the Go2Call transaction. As a result, we decided to write off
$475,000, representing the entire amount of the asset allocated to that portion
of the business, in the second quarter of 2008 to properly adjust the value of
the intangible asset associated with that portion of the business. In
addition, during the third quarter of 2008 we assessed the life of the remaining
intangible assets associated with the purchase of certain assets from Go2Call
and reached the conclusion that the carrying amount of the assets exceeded the
fair value attributable to those assets as a result of our current financial
situation. Consequently, we decided to write off the remaining value
of these assets, or approximately $3.1 million, since we believed that these
assets can no longer sustain their value. We did not write off any intangible
assets in 2009.
Deferred revenue
restatement.
During the first half of 2008, we restated our deferred revenue to include
$0.6 million in deferred revenue liability. We record prepayments we
receive from customers as deferred revenue and recognize such prepayments as
revenue when the customers use them to make (or allow their own customers to
make) calls. In connection with certain sales and marketing promotions,
historically we have provided certain customers with promotional credit in the
form of free minutes. Prior to 2008 our billing system failed to segregate such
promotional minutes and, after they had been used by the customers, incorrectly
recognized the value of such promotional minutes as revenue. As a result, the
amount of deferred revenue we previously recorded was incorrectly understated by
such amount. We discovered this problem in 2008 and restated our deferred
revenue accordingly.
Restructuring
expenses. In 2008 we recorded restructuring expenses totaling
approximately $1.2 million. No such expenses were recorded in 2009. The
restructuring expense were one-time costs related to (i) changes to the
structure of our work force, including reductions in force, that totaled
approximately $0.3 million, (ii) the sublease of our then-current New York
office in 2008 for the remaining term of the lease (for which we accrued the
shortfall between the rental amounts we will be receiving from the subtenant and
the rental amounts we need to pay to the landlord, as well as legal costs and
broker fees associated with the sublease) of approximately $0.6 million, (iii)
severance costs we paid to a former Chief Executive Officer of approximately
$0.1 million and (iv) costs associated with the final termination of the lease
for our principal executive offices of approximately $0.2 million.
Depreciation and
amortization.
Depreciation and amortization decreased by $0.9 million, or 50%,
from $1.8 million in 2008 to $0.9 million in 2009 due to a significant decline
in the value of our fixed assets during this period.
Loss
from Operations
Loss from
operations decreased by $8.7 million, or 73%, from $11.9 million in 2008 to $3.2
million in 2009, due primarily to the decrease in costs and operating expenses
(including selling and marketing expenses) and one-time amortization charges and
expenses recorded during 2008.
Interest
Income, Net
We
recorded interest expense of $72,000 in 2009 compared to $35,000 in
2008.
Income
Taxes, Net
We paid
net income taxes of $34,000 in 2009 compared to $28,000 in 2008.
Net
Loss
Net loss
decreased by $8.8 million, or 73%, from $11.9 million in 2008 to $3.2 million in
2009, due to the foregoing factors.
31
Year Ended December
31, 2008 Compared to Year Ended December 31, 2007
Revenues
Revenues
overall decreased approximately $9.3 million, or 31.5%, to approximately $20.2
million in 2008 from approximately $29.5 million in 2007. All of our
revenue channels were affected. Revenues from our service provider and reseller
sales efforts (both pre-paid and post-paid) decreased approximately $8.0
million, or 31.9%, from approximately $25.1 million in 2007 to approximately
$17.1 million in 2008. In addition, revenues from our direct consumer
channel decreased approximately $1.0 million, or 27%, from approximately $3.8
million in 2007 to approximately $2.8 million in 2008.
Our
revenue decrease can be attributed to a number of factors, the most important
being an increasingly competitive VoIP market causing market rates to
decline. Some of the other factors included the
following:
·
|
our
ongoing financial challenges have caused us to lose certain
customers;
|
·
|
we
were temporarily cut off from certain key termination routes during 2008,
causing a drop in the number of calls being placed over our network into
such key markets; and
|
·
|
a
decline in sales in our service provider and consumer businesses resulting
from our de-emphasis on those units as a result of the
restructuring.
|
As a
result, the number of minutes on our network utilized by our resellers and
end-users dropped by approximately 17% from 380 million in 2007 to 315 million
in 2008.
Furthermore,
our reseller revenues, which made up approximately 66% of our overall revenues
in both 2007 and 2008, were adversely affected by regulatory problems in key
destinations. In addition, the introduction of several competitors offering
lower prices than ours to our biggest markets further adversely affected our
revenues. Revenues generated by resellers we acquired in the Go2Call acquisition
amounted to approximately $1.1 million, or 7%, of our reseller revenues in 2008,
down by $1.9 million, or 62%, from $3.0 million
for 2007.
Revenues
from our service division decreased by approximately $2.0 million, or 36%. from
$5.6 million in 2007 to $3.6 million in 2008, largely due to the expiration of
our service agreements with SBC Communications and Bezek International, together
with the expiration of our development agreement with Panasonic. In
addition, during 2008 Verizon accounted for approximately 10.9% of our gross
revenues; in the fourth quarter of 2008 Verizon accounted for approximately 9.7%
of our gross revenues.
Costs
and Operating Expenses
Cost of
revenues.
Cost of revenues decreased by $6.4 million, or 30.3%, from
$21.1 million in 2007 to $14.7 million in 2008. Although our
network rent cost increased by 36.3% from $1.1 million in 2007 to $1.5 million
in 2008, our termination cost decreased by 30.2% from $15.9 million in 2007
to $11.1 million in 2008. The main reason for the decrease in cost of
revenues was a reduction in the amount of traffic being terminated over our
network. In addition, there were significant pricing pressures put on the
market, as a result of which we generally dropped our rates.
Research and
development expenses. Research and development
expenses decreased by $1.3 million, or 27.7%, from $4.7 million in
2007 to $3.4 million in 2008. The primary reason for the decline was the
decrease in overall personnel costs of 25.7% to $2.6 million in 2008 from $3.5
million in 2007. This was due to the reductions in force that occurred in 2008
and the expiration of our development agreement with Panasonic.
Selling and
marketing expenses. Selling and marketing
expenses decreased by $1.5 million, or 29.4%, to $3.6 million in 2008 from $5.1
million in 2007. The cost of our selling and marketing personnel decreased by
approximately 34.6% to $1.7 million in 2008 from $2.6 million in 2007 as a
result of the reductions in force. The balance was caused by an
increase in promotional and branding activities.
General and
administrative expenses. General and administrative
expenses increased by $0.1 million, or 3%, to $3.1 million in 2008 from $3.0
million in 2007, due primarily to $0.7 million we recorded as a tax liability.
Excluding such tax liability our general and administrative expenses decreased
by approximately $0.6 million during 2008 as a result of the restructuring we
effected in 2008.
Write-off of
goodwill. As part
of our acquisition of Go2Call, we recognized goodwill of approximately $2.0
million relating to our reseller division. During the third quarter
of 2008, we assessed the value of our reseller division and determined that
based on our then-current financial condition and the state of our reseller
division it would be appropriate to write-off the entire value of the goodwill
acquired in the Go2Call acquisition.
Write-off of
intangible assets. In 2008 we wrote off the balance of the
intangible assets associated with the Go2Call transaction. During the
second quarter of 2008, we reached the conclusion that we will not invest
significant resources into a segment of the business that we purchased as part
of the Go2Call transaction. As a result, we decided to write off
$475,000, representing the entire amount of the asset allocated to that portion
of the business, in the second quarter of 2008 to properly adjust the value of
the intangible asset associated with that portion of the business. In
addition, during the third quarter of 2008 we assessed the life of the remaining
intangible assets associated with the purchase of certain assets from Go2Call
and reached the conclusion that the carrying amount of the assets exceeded the
fair value attributable to those assets as a result of our current financial
situation. Consequently, we decided to write off the remaining value
of these assets, or approximately $3.1 million, since we believed that these
assets can no longer sustain their value.
32
Deferred revenue
restatement.
During the first half of 2008, we restated our deferred revenue to
include $0.6 million in deferred revenue liability. We record
prepayments we receive from customers as deferred revenue and recognize such
prepayments as revenue when the customers use them to make (or allow their own
customers to make) calls. In connection with certain sales and marketing
promotions, historically we have provided certain customers with promotional
credit in the form of free minutes. Prior to 2008 our billing system failed to
segregate such promotional minutes and, after they had been used by the
customers, incorrectly recognized the value of such promotional minutes as
revenue. As a result, the amount of deferred revenue we previously recorded was
incorrectly understated by such amount. We discovered this problem in 2008 and
restated our deferred revenue accordingly.
Restructuring
expenses. We recorded restructuring expenses totaling approximately $1.2
million. No such expenses were recorded in the year ended December 31, 2007. The
restructuring expense were one-time costs related to (i) changes to the
structure of our work force, including reductions in force, that totaled
approximately $0.3 million, (ii) the sublease of our then-current New York
office in 2008 for the remaining term of the lease (for which we accrued the
shortfall between the rental amounts we will be receiving from the subtenant and
the rental amounts we need to pay to the landlord, as well as legal costs and
broker fees associated with the sublease) of approximately $0.6 million, (iii)
severance costs we paid to a former Chief Executive Officer of approximately
$0.1 million and (iv) costs associated with the final termination of the lease
for our principal executive offices of approximately $0.2 million.
Depreciation and
amortization.
Depreciation and amortization decreased by $0.8 million, or 30.7%,
from $2.6 million in 2007 to $1.8 million in 2008 due to a lower expense level
of periodic amortizations of intangible assets, which were fully amortized in
the second quarter of 2008.
Loss
from Operations
Loss from
operations increased by $2.3 million, or 24%, from $9.6 million in 2007 to $11.9
million in 2008, due primarily to the decrease in revenues, increase in costs
and operating expenses (including selling and marketing expenses) and a one-time
amortization charge.
Interest
Income, Net
We
recorded interest expense of $0.01 million in 2008 compared to interest earned
of $0.4 million in 2007. This was due to both the drop in our overall
cash and cash equivalents of approximately $6.5 million and the drop in the
overall interest rate achieved on our investments.
Income
Taxes, Net
We paid
net income taxes of $28,000 in 2008 compared to $126,000 in 2007.
Net
Loss
Net loss
increased by $2.6 million, or 28%, from $9.3 million in 2007 to $11.9 million in
2008, due to the foregoing factors.
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 recent losses from operations. For the year ended December 31, 2009,
our net loss from operations decreased by $8.8 million, or 73%, from $11.9
million in 2008 to $3.2 million in 2009. To date, we have an
accumulated deficit of approximately $175.8 million.
As of
December 31, 2009, we had cash and cash equivalents of approximately $1.5
million and restricted cash and short-term investments of approximately $0.4
million, or a total of cash, cash equivalents and restricted cash of $1.9
million, a decrease of $0.2 million from December 31, 2008. The decrease in
cash, restricted cash, and short and long term investments was primarily caused
by the net cash used in operating activities during 2009 of approximately $1.2
million. Our average monthly cash burn during 2009 was approximately $0.1
million (including cash used in our operations and cash used in to pay capital
leases).
Cash used
in or provided by operating activities is net income adjusted for certain
non-cash items and changes in assets and liabilities. We had negative cash flow
from operating activities of approximately $1.2 million during 2009 compared
with negative cash flow from operating activities of approximately
$6.2 million during 2008. The decrease in our cash generated
from operating activities was primarily driven by our net loss of $3.2 million
plus changes in working capital of approximately $2.0 million, depreciation and
amortization of approximately $1.0 million and write-offs for the Go2call
intangible asset of approximately $3.6 million.
33
Net cash
used in investing activities is generally driven by our capital expenditures and
changes in our short and long term investments. In 2009, we spent
$192,000 on capital expenditures and increased our investments by $49,000 offset
by proceeds we received from the sale of property and equipment of $156,000, for
a net decrease of $85,000. In 2008, we spent $0.3 million on capital
expenditures and decreased our investments by $6.7 million, for a net decrease
of $6.4 million.
Financing
cash flows have historically consisted primarily of payments of capital leases
and of proceeds from exercise of employee options. As discussed above under
“Item 1. Business - Transactions with D4 Holdings”, in February 2009 we
consummated a transaction with D4 Holdings pursuant to which we sold 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 $1.2
million. In addition, on March 1, 2010, we and our subsidiaries entered
into a Loan and Security Agreement with D4 Holdings, pursuant to which D4
Holdings agreed to provide to us and our subsidiaries a line of credit in a
principal amount of $1,200,000. On March 2, 2010, we received
$500,000 from D4 Holdings pursuant to a notice of borrowing under the Loan
Agreement. In addition, during 2009 our employees exercised options to
purchase an aggregate of 92,500 shares of common stock, for which we received
the aggregate exercise price of $14,000. In each of 2009 and 2008 we
paid approximately $0.1 million for capital leases.
We
obtained our funding from our utilization of the remaining proceeds from our
IPO, 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 the receipt of $500,000 pursuant to our line of credit with D4 Holdings
in March 2010. These proceeds are maintained as cash, restricted cash, and short
and long term investments. We have sustained significant operating losses in
recent periods, which has led to a significant reduction in our cash
reserves. As of December 31, 2009, we had negative working capital
equal to approximately $2.0 million as well as negative stockholders’ equity
equal to approximately $1.4 million. We believe that we will continue to
experience losses and increased negative working capital and negative
stockholders’ equity in the near future, and that we will not be able to return
to positive cash flow before we require additional capital (in addition to any
further amounts we may borrow from D4 Holdings under the Loan Agreement) in the
near term. 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. As a result of the foregoing factors, there is
substantial doubt about our ability to continue as a going concern.
Contractual
Obligations and Commercial Commitments
The
following table sets forth our future contractual obligations and commercial
commitments in total, for each of the next five years and
thereafter:
Payments due by period (in thousands of
dollars)
|
||||||||||||||||||||
Contractual
obligations
|
Total
|
Less than 1
year
|
1-3 years
|
3-5 years
|
More than 5
years
|
|||||||||||||||
Real
estate leases
|
1,180
|
212
|
424
|
544
|
-
|
|||||||||||||||
Auto
leases
|
245
|
122
|
123
|
-
|
-
|
|||||||||||||||
Capital
leases
|
147
|
144
|
3
|
-
|
-
|
|||||||||||||||
Total
|
1,572
|
478
|
550
|
544
|
-
|
Off-Balance
Sheet Arrangements
None.
Certain
Factors That May Affect Future Results of Operations
The SEC
encourages companies to disclose forward-looking information so that investors
can better understand a company's future prospects and make informed investment
decisions. This Annual Report contains such "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995, as
amended.
Words
such as "may," "anticipate," "estimate," "expects," "projects," "intends,"
"plans," "believes" and words and terms of similar substance used in connection
with any discussion of future operating or financial performance, identify
forward-looking statements. All forward-looking statements are management's
present expectations of future events and are subject to a number of risks and
uncertainties that could cause actual results to differ materially and adversely
from those described in the forward-looking statements. These risks include, but
are not limited to, those set forth under the heading "Risk Factors" contained
in Item 1A of this Annual Report.
In light
of these assumptions, risks and uncertainties, the results and events discussed
in the forward-looking statements contained in this Annual Report or in any
document incorporated by reference might not occur. Stockholders are cautioned
not to place undue reliance on the forward-looking statements, which speak only
as of the date of this Annual Report. We are not under any obligation, and we
expressly disclaim any obligation, to update or alter any forward-looking
statements, whether as a result of new information, future events or otherwise.
All subsequent forward-looking statements attributable to deltathree or to any
person acting on our behalf are expressly qualified in their entirety by the
cautionary statements contained or referred to in this section.
34
The
Company's Consolidated Financial Statements required by this Item are set forth
in Item 15 beginning on page 46 of this Annual Report.
None.
(a)
Evaluation of Disclosure
Controls and Procedures. Each of our principal executive officer and
principal financial officer, after evaluating the effectiveness of our
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e)) and internal control over financial reporting (as defined in
Exchange Act Rules 13a-15(f) and 15d-15(f)) as of the end of the period covered
by this Annual Report, has concluded that, based on such evaluation, and as a
result of the material weaknesses described below, our disclosure controls and
procedures were not adequate and effective to ensure that material information
required to be disclosed by us in the reports that we file and submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms.
(b)
Management’s Report on
Internal Control over Financial Reporting. Management is
responsible for establishing and maintaining adequate internal control over
financial reporting of the Company. We maintain internal control over financial
reporting designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting
principles.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are 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. Therefore, internal control
over financial reporting determined to be effective provides only reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles.
Under the
supervision and with the participation of our Chief Executive Officer and Chief
Financial Officer, management has evaluated internal control over financial
reporting by the Company using the framework for effective internal control
established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Management assessed the
effectiveness of our internal control over financial reporting as of
December 31, 2009.
Based on
this assessment, management concluded that internal controls over financial
reporting were effective as of December 31, 2009. In connection with
this assessment, no material weaknesses in the Company’s internal control over
financial reporting were identified by management. This Annual Report does not
include an attestation report of our registered public accounting firm regarding
internal control over financial reporting. Management's report was not subject
to attestation by our registered public accounting firm pursuant to temporary
rules of the SEC that permit us to provide only management's report in this
Annual Report.
(c)
Changes in Internal
Controls. During the course of 2008 we effected a series of
reductions in force that caused the number of our employees to drop from 148 as
of December 31, 2008, to 44 as of September 30, 2009. As a result of this sharp
decline our ability to ensure a proper segregation of duties amongst different
employees was severely curtailed. This had a material effect on our internal
controls over financial reporting, and resulted in material weaknesses relating
primarily to:
·
|
recording
of revenues and deferred revenues, primarily in the authorization,
monitoring and segregation of duties over our billing system;
and
|
|
·
|
recording
of cost of revenues, primarily in the authorization, monitoring and
segregation of duties over our route purchasing
system.
|
As a
result of the implementation of the above controls and procedures, management
concluded that our internal controls over financial reporting were effective as
of December 31, 2009. Other than actions we have taken to remedy the
material weaknesses identified above, there were no material changes in our
internal control over financial reporting during our most recently completed
fiscal quarter that have materially affected, or are reasonably likely to
materially affect, our internal control over financial
reporting.
35
None.
Directors
Our
Amended and Restated Certificate of Incorporation provides that a director shall
hold office until the annual meeting for the year in which his or her term
expires except in the case of elections to fill vacancies or newly created
directorships. Each director is elected for a one-year term. Set forth below are
the name, age and the positions and offices held by each of our current
directors, his principal occupation, business experience and public company
board experience during at least the past five years, and the experience,
qualifications, attributes or skills that qualify such person to serve on our
Board of Directors.
Robert
Stevanovski, 46. Mr. Stevanovski has served as a director and
Chairman of the Board since February 2009. He is one of the
co-founders of ACN and has served as Chairman of ACN since its founding in 1993.
Mr. Stevanovski has served as Chairman of the Board of WorldGate since April
2009, and he served as WorldGate’s Interim President and CEO from April 2009, to
August 2009. He is the brother of David Stevanovski, also a member of
the Board. Mr. Robert Stevanovski’s areas of relevant experience,
qualifications, attributes or skills include sales and marketing expertise
generally, extensive knowledge of the telecommunications and multi-level
marketing industries, outside board experience with WorldGate and extensive
business and management experience as co-founder and Chairman of
ACN.
Anthony
Cassara, 55. Mr. Cassara has served as a director since
February 2009. Mr. Cassara founded and has served as President of Cassara
Management Group, Inc., a privately held business counseling practice focused on
the telecommunications industry, since October 2000. Prior to founding Cassara
Management Group, Mr. Cassara was President of the Carrier Services division at
Frontier Corporation and later at Global Crossing Ltd. from October 1999 to
December 2000. Mr. Cassara served as a member of the board of directors of
MPower Holding Corporation from May 2002 to August 2006; Teleglobe International
Holdings Ltd. from February 2004 to February 2006; Eschelon Telecom Inc. from
November 2002 to December 2004; and has served as a director of WorldGate since
April 2009. Mr. Cassara’s areas of relevant experience,
qualifications, attributes or skills include telecommunications and information
services; senior leadership roles in global telecommunications companies; public
company board experience, corporate finance, and financial
reporting.
Lior
Samuelson, 61. Mr. Samuelson served as Chairman of the Board
from January 2008 until February 2009, and has served as a director of
deltathree since August 2001. Since August 1999, Mr. Samuelson has served as a
Co-Founder and Principal of Mercator Capital, and served as a director of
Mercator Partners Acquisition Corp. from January 2005 to December 2007. His
experience includes advising clients in the technology, communications and
consumer sectors on mergers, acquisitions and private placements. From March
1997 to August 1999, Mr. Samuelson was the President and Chief Executive Officer
of PricewaterhouseCoopers Securities. Prior to that, he was the President and
Chief Executive Officer of The Barents Group, a merchant bank specializing in
advising and investing in companies in emerging markets. Mr. Samuelson was also
the Co-Chairman of Peloton Holdings, a private equity management company. Before
that, he was a managing partner with KPMG and a senior consultant at Booz, Allen
& Hamilton. Mr. Samuelson’s areas of relevant experience,
qualifications, attributes or skills include extensive experience in finance and
investment banking, public company board experience, financial reporting, and
his long history of service to deltathree and knowledge of its
operations.
David
Stevanovski, 43. Mr. Stevanovski has served as a director
since March 2009. He has served in a number of positions at
ACN, and currently serves as Chief Operating Officer of ACN North America.
Mr. Stevanovski has served as a director of WorldGate since May 2009. Mr.
Stevanovski is the brother of Robert Stevanovski. Mr. David
Stevanovski’s areas of relevant experience, qualifications, attributes or skills
include sales and marketing expertise generally, extensive knowledge of the
telecommunications and multi-level marketing industries, outside board
experience with WorldGate, and extensive operational experience as Chief
Operating Officer of ACN North America.
Gregory
Provenzano, 50. Mr. Provenzano has served as a director since
March 2009. Mr. Provenzano is one of the co-founders of ACN and has served as
President of ACN since its founding in 1993. Mr. Provenzano has served as a
director of WorldGate since May 2009. Mr. Provenzano’s areas of
relevant experience, qualifications, attributes or skills include sales and
marketing expertise generally, extensive knowledge of telecommunications and
multi-level marketing, outside board experience with WorldGate, and extensive
business and management experience as co-founder and President of
ACN.
J. Lyle
Patrick, 57. Mr. Patrick has served as a director since March
2009. Mr. Patrick is currently a financial consultant and has served as the
Interim CFO for FirstCommunications, Inc. since March 2009. Mr. Patrick has
served as chief financial officer of a number of telecommunications companies,
including, most recently, US LEC, a competitive telecommunications company, from
June 2005 to March 2007, and MetroPCS, a wireless communications provider, from
May 2004 to March 2005. Mr. Patrick is a Certified Public
Accountant. Mr. Patrick’s areas of relevant experience,
qualifications, attributes or skills include extensive accounting for public
companies, with particular experience in the telecommunications industry, and
financial reporting.
36
Brian
Fitzpatrick, 48. Mr. Fitzpatrick has served as a director
since August 2009. Mr. Fitzpatrick serves as Managing Director of BT
Wholesale Markets, which is the sales, marketing, implementation, project and
in-life contract management operating division of BT Group Plc. Mr.
Fitzpatrick’s areas of responsibility also include BT Group plc’s global media
and satellite broadcast operations. Mr. Fitzpatrick serves as a member of the BT
Wholesale Executive Board. Prior to joining BT Wholesale Markets in November
2005, Mr. Fitzpatrick was the President of Worldwide Commercial Operations for
Teleglobe International, Ltd. Mr. Fitzpatrick’s areas of relevant experience,
qualifications, attributes or skills include extensive experience, knowledge and
relationships in the international telecommunications industry, sales and
marketing expertise generally, and extensive business and management
experience.
Executive
Officers and Key Employees
Set forth
below is a brief description of the present and past business experience of each
of the persons who currently serve as our executive officers or key employees.
Efraim
Baruch, 34, interim Chief Executive Officer and President, Senior Vice
President of Operations and Technology. In December 2008 Mr. Baruch became our
interim Chief Executive Officer and President; in January 2007, Mr. Baruch
became our Senior Vice President of Operations and Technology. Mr. Baruch has
been with deltathree since 1998. Mr. Baruch began working with deltathree as an
engineer in the Network Operations Center (NOC), and soon after specialized in
the management of data networks and security in our Wide Area Network (WAN)
department. During the past four years he has headed the deltathree VoIP data
and security departments, along with managing the overall responsibility of the
total uptime in the deltathree worldwide network.
Ziv Zviel,
39, Chief Financial Officer and Treasurer. Mr. Zviel joined deltathree in June
2009 as a member of our Finance Department and assumed the positions of Chief
Financial Officer and Treasurer of the Company in August 2009. Mr. Zviel is a
Certified Public Accountant (Israel). Prior to his employment with deltathree,
since September 2007 Mr. Zviel was the Vice President-Finance of LivePerson,
Inc., a provider of real-time chat platforms. From 2002 through 2007, Mr. Zviel
served in various positions - including Corporate Controller, Vice
President-Finance and Operations and Acting Chief Financial Officer - of Magic
Software Enterprises Ltd., a provider of application platform as well
as software integration solutions. Prior to joining Magic Software, Mr.
Zviel was an Audit Manager at Kost, Forer, Gabbay & Kasierer, a member
firm of Ernst & Young International, in its technology practice
group.
Peter
Friedman, 39, General Counsel and Secretary. In October 2007, Mr.
Friedman became our General Counsel and Secretary. Mr. Friedman’s experience is
in the areas of securities offerings and compliance, mergers and acquisitions,
corporate governance, venture capital financing, technology licensing, joint
ventures, and general corporate and commercial matters. Before joining
deltathree, Mr. Friedman served as Senior Associate of Outside Counsel
Solutions, a division of IDT Corporation that outsources U.S. legal services.
Prior to that, Mr. Friedman was associated with the law firms of Weil, Gotshal
& Manges, LLP, Lowenstein Sandler PC and Kronish Lieb Weiner & Hellman,
LLP.
Board
of Directors and Committees of the Board
Our
Amended and Restated Certificate of Incorporation provides that the number of
members of our Board of Directors shall be not less than three and not more than
thirteen. There are currently seven directors on the Board. At each annual
meeting of stockholders, directors are elected to hold office for a term of one
year and until their respective successors are elected and
qualified.
The Board
had five regular meetings and four special meetings during the fiscal year ended
December 31, 2009. During the fiscal year ended December 31, 2009, except for
David Stevanovski, Gregory Provenzano and Brian Fitzpatrick each member of the
Board participated in at least 75% of the aggregate of all Board and committee
(for such committees on which the director served) meetings held during the
period for which he was a director or member of such committee. None of our
directors attended our 2009 Annual Stockholder Meeting. The Board has
established an Audit Committee and a Compensation Committee. The functions of
the committees and their current members are set forth below.
Due to a
decrease in the number of members of the Board after our 2006 Annual
Stockholders Meeting, our Board members determined that it is efficient and
important for each member to actively participate in all matters that were
previously the responsibility of the Nominating and Governance Committee and
dissolved the Nominating and Governance Committee as of September 11, 2006. As
such, each of our Board members participates in, among other matters, the
following nominating and governance-related matters:
·
|
identifying
and recommending qualified candidates for director, and recommending the
director nominees for our annual meetings of
stockholders;
|
·
|
conducting
an annual review of the Board’s performance;
|
·
|
recommending
the director nominees for each of the Board committees;
and
|
·
|
developing
and recommending our company’s corporate governance
guidelines.
|
Furthermore,
our Board adopted a nominating and governance policy that was based on the
former Nominating and Governance Committee Charter. This policy outlines our
Board’s goals, responsibilities, and procedures related to nominating and
governance matters. In this regard, our
Board may consider candidates recommended by stockholders as well as from other
sources such as other directors or officers, third party search firms or other
appropriate sources.
37
For all
potential candidates, the Board considers a number of factors, such as the
extent to which the candidate’s knowledge and experience would fill a need in
the Board and help complement the other directors, a candidate’s personal
integrity and sound judgment, independence, knowledge of the industry in which
we operate, possible conflicts of interest, and concern for the long-term
interests of our stockholders. In addition, although the Company does not have a
formal policy regarding the consideration of diversity in identifying and
evaluating potential director candidates, the Board will consider diversity in
the context of the Board as a whole and takes into account the personal
characteristics (gender, ethnicity and age), skills and experience,
qualifications and background of current and prospective directors diversity as
one factor in identifying and evaluating potential director
candidates. In general, persons recommended by stockholders will be
considered on the same basis as candidates from other sources. If a stockholder
wishes to nominate a candidate to be considered for election as a director at
our 2010 Annual Meeting of Stockholders using the procedures set forth in the
Company's Amended and Restated By-laws, it must follow the procedures described
under "Nomination of Directors" in our Amended and Restated By-laws. If a
stockholder wishes simply to propose a candidate for consideration as a nominee
by our Board, it should submit any pertinent information regarding the candidate
to the Chairman of the Board by mail care of our Secretary at 224 West 35th Street,
New York, New York 10001.
The
Compensation Committee is responsible for:
·
|
evaluating
our compensation policies;
|
·
|
determining
executive compensation, and establishing executive compensation policies
and guidelines; and
|
·
|
administering
our stock option and compensation
plans.
|
As part of these responsibilities, the
Compensation Committee determines the compensation of our Chief Executive
Officer, and conducts its decision making process with respect to this issue
without the presence of the Chief Executive Officer. The Compensation Committee
had one formal meeting and additional informal meetings and discussions during
2009. The Compensation Committee has a charter, a copy of which is
available to our stockholders at the Corporate Governance section of our website
located at www.deltathree.com. The Compensation Committee is
composed of Brian Fitzpatrick (Chairman), Lior Samuelson and J. Lyle
Patrick.
The Audit
Committee is responsible for:
·
|
recommending
to the Board the appointment of the firm selected to serve as our
independent auditors and monitoring the performance of such
firm;
|
·
|
reviewing
and approving the scope of the annual audit and evaluating with the
independent auditors our annual audit and annual financial
statements;
|
·
|
reviewing
with management the status of internal accounting
controls;
|
·
|
evaluating
issues having a potential financial impact on us which may be brought to
the Audit Committee’s attention by management, the independent auditors or
the Board;
|
·
|
evaluating
our public financial reporting documents; and
|
·
|
reviewing
the non-audit services to be performed by the independent auditors, if
any, and considering the effect of such performance on the auditor's
independence.
|
The Audit
Committee had eight meetings during 2009. The Audit Committee has a
charter, a copy of which is available to our stockholders at the Corporate
Governance section of our website located at www.deltathree.com. Following the
resignation of Noam Bardin on February 12, 2009, there were no members of the
Audit Committee. Mr. Patrick was appointed by the Board to serve as the Chairman
of the Audit Committee effective March 28, 2009, the effective time of his
appointment to the board. The Board of Directors has determined that
Mr. Patrick meets the requirements of the applicable Securities and Exchange
Commission rules for membership on the Audit Committee, including Rule 10A-3(b)
under the Exchange Act, is “independent” as defined in Rule 5605(a)(2) of the
Nasdaq Marketplace Rules and qualifies as an “audit committee financial expert”
as defined in Item 407 of Regulation S-K. In June 2009, the
Board appointed Anthony Cassara and Lior Samuelson to serve as additional
members of the Audit Committee. Following his election to the board
on August 6, 2009, the board appointed Brian Fitzpatrick to replace Mr. Cassara
on the Audit Committee. Mr. Fitzpatrick qualifies as “independent” as
defined in Rule 5605(a)(2) of the Nasdaq Marketplace Rules.
As
discussed below under “Director Independence”, we are not currently subject to
the Nasdaq continued listing requirements or the requirements of any other
national securities exchange, including the independence requirements for audit
committees. The Board of Directors has not reached an affirmative
conclusion that Mr. Samuelson is “independent” as such term is described in the
Nasdaq Marketplace Rules. However, the Board of Directors determined
that his membership on the Audit Committee is in the best interest of the
Company and its stockholders in light of his extensive experience in financial
and related matters in our industry and the fact that the Audit Committee was
composed of only two other members. In connection with his
appointment to the Audit Committee, the Board has waived the independence
requirements set forth in the Audit Committee Charter with respect to Mr.
Samuelson. The Board also waived the independence requirements in the
Compensation Committee Charter with respect to Mr. Samuelson in connection with
his appointment to the Compensation Committee on August 6,
2009.
38
The Board has no policy regarding the
need to separate or combine the offices of Chairman of the Board and Chief
Executive Officer and remains free to make this determination from time to time
in a manner that the Board deems most appropriate for our company. Currently, we
have separated the positions of CEO and Chairman of the Board in recognition of
the differences between the two roles. The CEO is responsible for the day to day
leadership and performance of the Company, while the Chairman of the Board (in
collaboration with other members of the Board) sets the strategic direction of
the Company, provides guidance to the management, sets the agenda for the Board
meetings (in collaboration with the other members of the Board) and presides
over meetings of the Board. We believe that separating these
positions allows the Chairman of the Board to lead the board in its fundamental
role of providing direction and guidance to management, while allowing our Chief
Executive Officer to focus on our day-to-day operations. In addition, we believe
that the current separation provides a more effective monitoring and objective
evaluation of the performance of the CEO.
Risk
Management
The Board
is actively involved in the oversight and management of risks that could affect
our company. This oversight and management is conducted primarily through
committees of the Board, as disclosed in the descriptions of each of the
committees above and in the charters of each of the committees, but the full
Board has retained responsibility for general oversight of risks. The Board
regularly receives reports from members of senior management on areas of
material risk to the company, including operational, financial, regulatory and
legal. The Audit Committee oversees management of financial risks (including
liquidity and credit) and approves all transactions with related persons. The
Compensation Committee is responsible for overseeing the management of risks
relating to the Company’s executive compensation plans and arrangements. The
Board satisfies its oversight responsibility through full reports by each
committee chair regarding the committee’s considerations and actions, as well as
through regular reports directly from officers responsible for oversight of
particular risks within the Company.
Legal
Proceedings
Mr.
Cassara served as the President of the Carrier Services division of Global
Crossing Ltd. from October 1999 to December 2000. In 2002, Global
Crossing and certain of its direct and indirect subsidiaries filed voluntary
petitions for relief under Chapter 11 of title 11 of the U.S. Code in the U.S.
Bankruptcy Court for the Southern District of New York.
Mr.
Patrick served as Chief Financial and Accounting Officer of McLeodUSA
Incorporated until his resignation in July 2001. In January 2002,
McLeod filed a voluntary petition for relief under Chapter 11 of title 11 of the
U.S. Code in the U.S. Bankruptcy Court for the District of
Delaware.
Section
16(a) Beneficial Ownership Reporting Compliance
Section
16(a) of the Exchange Act requires that the Company’s directors, executive
officers and persons who own more than 10% of the outstanding common stock of
the Company file initial reports of ownership and reports of changes in
ownership in such common stock with the SEC. Officers, directors and
stockholders who own more than 10% of the outstanding common stock are required
by the SEC to furnish the Company with copies of all Section 16(a) reports they
file.
To our
knowledge, based solely upon our review of the copies of such reports furnished
to us, we believe that all of our directors, officers and holders of more than
10% of any class of our equity securities have complied with the applicable
Section 16(a) reporting requirements.
Code
of Conduct and Ethics
On March
25, 2004, we adopted a Corporate Code of Conduct and Ethics applicable to all
employees and directors of deltathree, including our principal executive
officer, principal financial and accounting officer and controller. There were
no changes made to the Corporate Code of Conduct and Ethics during 2009. The
text of the Corporate Code of Conduct and Ethics is posted on the Corporate
Governance section of our website at www.deltathree.com and will be made
available to stockholders without charge, upon request, in writing to the
Secretary at 224 West 35th Street,
New York, New York 10001. We intend to post on our website any amendments to, or
waivers from, our Code of Conduct and Ethics that apply to our principal
executive officer, principal financial and accounting officer and controller. We
have all of our new employees certify that they have read and understand our
Corporate Code of Conduct and Ethics, and, periodically, we also ask our
existing employees to certify that they have reviewed our Corporate Code of
Conduct and Ethics.
39
Summary
Compensation Table
The
following table shows the total compensation accrued during the fiscal years
ended December 31, 2008 and 2009 to (1) all individuals who served as our Chief
Executive Officer during any part of 2009, (2) our two next most highly
compensated executive officers whose total compensation exceeded $100,000 during
the fiscal year ended December 31, 2009, and (3) one additional individual who
would have met such threshold but for the fact that such individual was not
serving as an executive officer at the end of our last completed fiscal year.
These executive officers are referred to in this Annual Report as our “named
executive officers”.
Name
and Principal Position
|
Year
|
Salary
($)
|
Bonus
($)
|
Stock
Awards
($)(1)
|
Option
Awards
($)(1)
|
All
Other
Compensation
($)
|
Total
($)
|
|||||||||||||||||||
Effi Baruch ,
|
||||||||||||||||||||||||||
Chief
Executive Officer, President and Senior Vice
|
2009
|
179,750 | 10,000 | 29,660 | 124,645 | - | 344,055 | |||||||||||||||||||
President
of Operations and Technology (principal executive officer)
|
2008
|
106,257 | (2) | 30,407 | 24,656 | 79,398 | - | 240,718 | ||||||||||||||||||
Richard
Grant,
|
||||||||||||||||||||||||||
Former
Chief Financial Officer and Treasurer
|
2009
|
(3)
|
123,958 | - | 6,323 | 148,866 | - | 279,148 | ||||||||||||||||||
(principal
financial officer and principal accounting officer)
|
2008
|
175,000 | - | 3,652 | 142,639 | - | 321,291 | |||||||||||||||||||
Dan
Antebi,
|
2009
|
180,000 | - | 35,961 | - | 215,961 | ||||||||||||||||||||
Chief
Commercial Officer and Senior Vice President of Sales and Marketing
(4)
|
2008
|
115,500 | - | - | 9,695 | - | 125,195 | |||||||||||||||||||
Peter
Friedman,
|
2009
|
107,125 | 7,500 | 3,919 | 17,052 | - | 135,596 | |||||||||||||||||||
General
Counsel and Secretary
|
2008
|
117,986 | - | 1,909 | 7,272 | - | 127,167 |
(1)
|
Represents the
aggregate grant date fair value calculated in accordance with ASC 718-10
in connection with the issuance of the applicable restricted stock or
restricted unit award or option award. For a detailed
discussion of the assumptions made in the valuation of stock awards,
please see the Notes to the Consolidated Financial Statements included in
this Annual Report.
|
(2)
|
Represents
the aggregate salary paid to Mr. Baruch as the Senior Vice President of
Operations and Technology from January 1, 2008 to December 9, 2008 and as
the interim Chief Executive Officer and President, and Senior Vice
President of Operations and Technology from December 9, 2008 to December
31, 2008.
|
(3)
|
Mr.
Grant resigned from the Company effective August 15,
2009.
|
(4)
|
Mr.
Antebi joined the Company on May 12, 2008, and resigned effective
February 28, 2010.
|
Employment
Agreement with Mr. Effi Baruch
We
currently have an employment agreement with Mr. Baruch, our interim Chief
Executive Officer and President, and Senior Vice President of Operations and
Technology. The agreement became effective on December 9, 2008, and
was amended as of March 17, 2009, and as of October 20, 2009, and will continue
indefinitely thereafter. Mr. Baruch receives a base salary of
$186,000 per year, which is adjusted as of January 15 each year (beginning 2010)
by the percentage change in the Cost of Price Index during the preceding year.
Mr. Baruch is entitled to receive an annual bonus under our then-applicable
bonus plan equal to up to three (3) months’ salary based on performance criteria
that will be agreed upon by him and the Board of Directors. In the
event of termination of the agreement, the terminating party is required to
provide the other party 90 days’ written notice unless the Company terminates
the agreement for cause, in which case the Company is required to provide such
written notice required by applicable law. In the event the Company
terminates the agreement without cause, Mr. Baruch shall be entitled to receive
a lump sum payment equal to his then-current monthly base salary multiplied by
three.
40
Outstanding
Equity Awards at Fiscal Year-End
The
following table shows certain information with respect to stock options and
unvested stock awards outstanding as of December 31, 2009, for each of the named
executive officers.
Option
Awards
|
Stock
Awards
|
|||||||||||||||||||||||||||
Name
|
Grant
Date
(1)
|
Number
of
Securities
Underlying
Unexercised
Options
(#) Exercisable
|
Number
of
Securities
Underlying
Unexercised
Options
(#) Unexercisable
|
Option
Exercise
Price
($)
|
Option
Expiration
Date
|
Number
of
Shares
or
Units of
Stock
That
Have
Not
Vested
(#)
|
Market
Value
of
Shares
or
Units
of
Stock
That
Have
Not
Vested
($)(2)
|
|||||||||||||||||||||
Effi
Baruch
|
11/4/2003
|
15,000 | - | 1.75 |
11/4/2010
|
|||||||||||||||||||||||
12/22/2004
|
25,000 | - | 2.85 |
11/22/2011
|
||||||||||||||||||||||||
3/30/2008
|
218,750 | 31,250 | (3) | 0.15 |
3/30/2018
|
|||||||||||||||||||||||
5/6/2009
|
- | 100,000 | (4) | 0.14 |
5/6/2019
|
|||||||||||||||||||||||
9/15/2009
|
- | 500,000 | (5) | 0.41 |
9/15/2019
|
|||||||||||||||||||||||
1/1/2008
|
9,750 | (6) | 3,608 | |||||||||||||||||||||||||
Richard
Grant (7)
|
- | - | - | - | - | - | - | |||||||||||||||||||||
Dan
Antebi (8)
|
5/12/2008
|
150,000 | 50,000 | (9) | 0.16 |
5/12/2018
|
||||||||||||||||||||||
5/6/2009
|
- | 100,000 | 0.14 |
5/6/2019
|
||||||||||||||||||||||||
9/15/2009
|
- | 400,000 | 0.41 |
9/15/2019
|
||||||||||||||||||||||||
Peter
Friedman
|
3/30/2008
|
87,500 | 12,500 | (10) | 0.15 |
3/30/2018
|
||||||||||||||||||||||
5/6/2009
|
- | 50,000 | (11) | 0.15 |
5/6/2019
|
|||||||||||||||||||||||
9/15/2009
|
- | 150,000 | (12) | 0.41 |
9/15/2019
|
|||||||||||||||||||||||
10/21/2007
|
5,850 | (13) | 2,165 |
(1)
|
For
a better understanding of this table, we have included an additional
column showing the grant date of the stock options, the restricted shares
and the restricted stock units. Subject to the terms and
conditions contained in any award agreement between the Company and the
holder of any such award, in the event of a change of control of the
Company the outstanding stock options, restricted shares and
restricted stock units granted under our 2009 Stock Incentive Plan or our
Amended and Restated 2004 Stock Incentive Plan, as applicable, will not
accelerate and become immediately vested and exercisable unless otherwise
determined by the Compensation Committee.
|
(2)
|
The
market value of the stock awards is determined by multiplying the number
of shares times $0.37, the closing price of our common stock on The OTC
Bulletin Board on December 31, 2009.
|
(3)
|
Options
to purchase 125,000 shares of common stock vested and became exercisable
on March 30, 2009, options to purchase 31,250 shares vested and became
exercisable on June 30, 2009, options to purchase 31,250 shares vest and
become exercisable on September 30, 2009, options to purchase 31,250
shares vested and became exercisable on December 30, 2009 and options to
purchase 125,000 shares of common stock vest and become exercisable on
March 30, 2010.
|
(4)
|
Options
to purchase 33,333 shares vest and become exercisable on May 6, 2010,
options to purchase 33,334 shares vest and become exercisable on May 6,
2011, and options to purchase 33,333 shares vest and become exercisable on
May 6, 2012.
|
(5)
|
Options
to purchase 125,000 shares vest and become exercisable on each of
September 15, 2010, 2011, 2012 and 2013.
|
(6)
|
Restricted
units to purchase 25,000 shares of our common stock were granted on
January 1, 2008, and vest as follows: units to purchase 12,500 shares
vested on July 1, 2009, and units to purchase 12,500 shares vest on
January 1, 2011.
|
(7)
|
Mr.
Grant resigned from the Company effective August 15, 2009. All options to
purchase shares of common stock previously granted to Mr. Grant that had
not yet vested as of that date expired on that date.
|
(8)
|
Mr.
Antebi resigned from the Company effective February 28, 2010. All options
to purchase shares of common stock previously granted to Mr. Antebi that
had not yet vested as of that date expired on that
date.
|
(9)
|
Options
to purchase 100,000 shares vested and became exercisable on May 12, 2009,
options to purchase 25,000 shares vested and became exercisable on August
12, 2009, options to purchase 25,000 shares vested and became exercisable
on November 12, 2009, and options to purchase 25,000 shares vested and
became exercisable on February 12, 2010.
|
(10)
|
Options
to purchase 50,000 shares vested and became exercisable on March 30, 2009,
options to purchase 12,500 shares vested and became exercisable on June
30, 2009, options to purchase 12,500 shares vested and became exercisable
on September 30, 2009, options to purchase 12,500 shares vested and became
exercisable on December 30, 2009, and options to purchase 12,500 shares
vest and become exercisable on March 30, 2010.
|
(11)
|
Options
to purchase 16,667 shares vest and become exercisable on May 6, 2010,
options to purchase 16,666 shares vest and become exercisable on May 6,
2011, and options to purchase 16,667 shares vest and become exercisable on
May 6, 2012.
|
(12)
|
Options
to purchase 37,500 shares vest and become exercisable on each of September
15, 2010, 2011, 2012 and 2013.
|
(13)
|
A
total of 15,000 restricted shares of our common stock were granted on
October 21, 2007, and vest as follows: 4,200 shares vested and became
exercisable on October 21, 2008, 4,950 shares vested and became
exercisable on October 21, 2009, and 5,850 shares vest and become
exercisable on October 21, 2010.
|
41
Director
Compensation
The
following table shows the total compensation earned for services performed for
us by each member of our Board of Directors during the fiscal year ended
December 31, 2009.
Name
|
Fees
Earned or
Paid in
Cash
($)
|
Stock
Awards
($)(1)
|
All Other
Compensation
($)
|
Total
($)
|
||||||||||||
Noam
Bardin(2)
|
1,875 | (3) | - | (2) | - | 1,875 | ||||||||||
Benjamin
Broder(4)
|
14,582 | (5) | - | (4) | - | 14,582 | ||||||||||
Lior
Samuelson
|
38,124 | (6) | 115,039 | (7) | - | 153,163 | ||||||||||
Robert
Stevanovski
|
- | (8) | - | - | - | |||||||||||
Anthony
Cassara
|
15,833 | (9) | 1,919 | - | 17,752 | |||||||||||
David
Stevanovski
|
- | (8) | - | - | - | |||||||||||
Gregory
Provenzano
|
- | (8) | - | - | - | |||||||||||
J.
Lyle Patrick
|
32,083 | (10) | 1,919 | - | 34,002 | |||||||||||
Brian
Fitzpatrick
|
16,666 | (11) | 1,919 | - | 18,585 |
(1)
|
Represents
the aggregate grant date fair value, calculated in accordance with ASC
718-10, of options to purchase 100,000 shares of the Common Stock granted
to each of Lior Samuelson, Anthony Cassara, J. Lyle Patrick and
Fitzpatrick in 2009. The grants were made pursuant to the 2009 Stock
Incentive Plan. Each of Robert Stevanovski, David Stevanovski
and Gregory Provenzano elected to waive their right to receive such grant.
For a detailed discussion of the assumptions made in the valuation of
stock awards, please see the Notes to the Consolidated Financial
Statements included in this Annual Report.
|
(2)
|
Mr.
Bardin resigned effective February 12,
2009.
|
(3)
|
Represents $1,875
paid to Mr. Bardin for his service as a director until February 12,
2009.
|
(4)
|
Mr.
Broder’s term as a director ended August 6, 2009.
|
(5)
|
Represents
$11,666 paid to Mr. Broder for his services as a director and $2,916 as a
member of the Compensation Committee, in each case until August 6,
2009.
|
(6)
|
Represents
$15,625 paid to Mr. Samuelson for his services as the Chairman of the
Board until February 12, 2009, $17,500 as a director beginning February
12, 2009, $2,916 as a member of the Audit Committee beginning June 10,
2009, and $2,083 as a member of the Compensation Committee beginning
August 6, 2010.
|
(7)
|
In
connection with the change of control that occurred upon the closing of
the sale of the shares of common stock to D4 Holdings in February 2009,
unvested options to purchase 206,250 shares of our common stock that had
been previously granted to Mr. Samuelson under the terms of the Employment
Agreement between the Company and Mr. Samuelson pursuant to which Mr.
Samuelson served as the Chairman of our Board accelerated and became
immediately vested and exercisable pursuant to the terms of the Employment
Agreement.
|
(8)
|
At
this time each of Robert Stevanovski, David Stevanovski and Gregory
Provenzano has elected to waive their right to receive compensation for
their services to the Company. This election is revocable by
each of Messrs. R. Stevanovski, Provenzano and D. Stevanovski at any
time.
|
(9)
|
Represents
$15,000 paid to Mr. Cassara for his services as a director beginning
February 12, 2009, and $833 for his service as a member of the Audit
Committee from June 10, 2009, to August 6, 2009.
|
(10)
|
Represents
$15,000 paid to Mr. Patrick for his services as a director beginning March
28, 2009, $15,000 for his services as the Chairman of the Audit Committee
beginning March 28, 2009, and $2,083 for his services as a member of the
Compensation Committee beginning August 6, 2009.
|
(11)
|
Represents
$8,333 paid to Mr. Fitzpatrick for his services as a director, $2,083 for
his services as a member of the Audit Committee and $6,250 for his
services as the Chairman of the Compensation Committee, in each case
beginning August 6, 2009.
|
Director
Compensation Policy
In May
2009, the Board of Directors approved the following annual cash compensation for
our directors effective as of April 1, 2009:
|
·
|
each
director receives cash compensation of
$20,000;
|
|
·
|
the
Chairman of the Audit Committee receives additional cash compensation of
$20,000;
|
|
·
|
the
Chairman of the Compensation Committee receives additional cash
compensation of $15,000; and
|
|
·
|
each
non-Chairman committee member receives additional cash compensation of
$5,000.
|
At this
time each of Robert Stevanovski, David Stevanovski and Gregory Provenzano has
elected to waive their right to the director cash compensation described
above. This election is revocable by each of Messrs. R. Stevanovski,
Provenzano and D. Stevanovski at any time.
42
We
reimburse each member of our Board of Directors for reasonable travel and other
expenses in connection with attending meetings of the Board of
Directors.
Each of
our directors has the right to elect to convert the total cash compensation that
such director is eligible to receive into shares of our common stock at the
then-applicable market price. Directors have the right to make this
election only during such times as the employees and directors of the Company
are not in a black-out period in trading in securities of the Company and such
director is not in possession of material, non-public information about the
Company. Any such shares so acquired by a director are restricted and
vest only after a period of one year from the date of grant, following which the
director is able to sell such shares in accordance with Rule 144 under the
Securities Act of 1933.
In May
2009, the Board of Directors approved a grant of options to purchase 100,000
shares of our Common Stock under the 2009 Plan to each of the members of the
Board, which became effective upon the approval of the 2009 Plan by our
stockholders at Annual Meeting on August 6, 2009.
As of
March 25, 2010, there were 72,242,933 shares of our common stock issued and
outstanding. Each share of common stock entitles the holder thereof
to one vote with respect to each item to be voted on by holders of the shares of
common stock. We have no other securities, voting or nonvoting,
outstanding.
The
following table sets forth information with respect to the beneficial ownership
of shares of our common stock as of March 25, 2010, by:
·
|
each
person whom we know beneficially owns more than 5% of the common
stock;
|
·
|
each
of our directors individually;
|
·
|
each
of our named executive officers individually; and
|
·
|
all
of our current directors and executive officers as a
group.
|
Unless
otherwise indicated, to our knowledge, all persons listed below have sole voting
and investment power with respect to their shares of common stock. Each person
listed below disclaims beneficial ownership of their shares, except to the
extent of their pecuniary interests therein. Shares of common stock that an
individual or group has the right to acquire within 60 days of March 25, 2010,
pursuant to the exercise of options or the vesting of restricted stock or
restricted units are deemed to be outstanding for the purpose of computing the
percentage ownership of such person or group, but are not deemed outstanding for
the purpose of calculating the percentage owned by any other person
listed.
Number
|
Percentage (1)
|
|||||||
Shares of Common Stock
Beneficially Owned
|
||||||||
Principal
Stockholders:
|
||||||||
D4
Holdings, LLC (2)
|
69,000,000 | 67.5 | % | |||||
349-L
Copperfield Blvd., #407
|
||||||||
Concord,
NC 28025
|
||||||||
Abraham
Ziv-Tal (3)
|
10,300,093 | 14.3 | % | |||||
4
Hanurit Street
Rishpon,
Israel 49615
|
||||||||
Executive
Officers and Directors:
|
||||||||
Effi
Baruch (4)
|
363,333 | * | ||||||
Richard
Grant (5)
|
- | - | ||||||
Dan
Antebi (6)
|
175,000 | * | ||||||
Peter
Friedman (7)
|
125,817 | * | ||||||
Robert
Stevanovski (2)
|
69,000,000 | 67.5 | % | |||||
Anthony
Cassara (8)
|
69,000,000 | 67.5 | % | |||||
Lior
Samuelson (9)
|
502,000 | * | ||||||
David
Stevanovski (8)
|
69,000,000 | 67.5 | % | |||||
Gregory
Provenzano (8)
|
69,000,000 | 67.5 | % | |||||
J.
Lyle Patrick
|
- | - | ||||||
Brian
Fitzpatrick
|
- | - | ||||||
All
directors and executive officers as a group (10 persons)
(10)
|
69,971,150 | 68.4 | % |
*
Less than 1%.
43
(1)
|
Percentage
of beneficial ownership is based on 72,242,933 shares of common stock
outstanding as of March 25, 2010.
|
(2)
|
Ownership
is based on a Schedule 13D filed February 23, 2009 by D4 Holdings, Manna
Holdings, LLC (“Manna Holdings”), Praescient, LLC (“Praescient”) and
Robert Stevanovski and includes 30,000,000 shares of common stock issuable
under a warrant held by D4 Holdings. Robert Stevanovski is the
manager of Praescient, which serves as the sole manager of D4 Holdings and
as the managing member of Manna Holdings. Manna Holdings is the
sole member of D4 Holdings. As such, Mr. Stevanovski,
Praescient and Manna Holdings may be deemed to beneficially own the
securities reported in the table. Each of Mr. Stevanovski,
Praescient and Manna Holdings disclaims beneficial ownership of such
securities, and the information reported herein shall not be deemed an
admission that such reporting person is the beneficial owner of the
securities for any purpose, except to the extent of such person’s
pecuniary interest therein.
|
(3)
|
Ownership
is based on a Form 4 filed March 17, 2010.
|
(4)
|
Includes
(a) options to purchase 323,333 shares of common stock, (b) 27,500
shares of common stock and (c) restricted units to purchase 12,500 shares
of common stock.
|
(5)
|
Mr.
Grant resigned from the Company effective August 15,
2009. Accordingly, the number of shares of common stock that he
beneficially owned as of March 25, 2010, is not included in the
calculation of the number of shares of common stock beneficially owned by
all of our current directors and executive officers as a
group.
|
(6)
|
Includes
options to purchase 175,000 shares of common stock. Mr. Antebi
resigned from the Company effective February 28,
2010. Accordingly, the number of shares of common stock that he
beneficially owned as of March 25, 2010, is not included in the
calculation of the number of shares of common stock beneficially owned by
.all of our current directors and executive officers as a
group.
|
(7)
|
Includes
(a) options to purchase 116,667 shares of common stock and (b) 9,150
restricted shares of common stock.
|
(8)
|
The
securities reported in the table are held directly by D4 Holdings and
include the warrant to purchase 30,000,000 shares of common stock held by
D4 Holdings. Each of Anthony Cassara, David Stevanovski and
Gregory Provenzano beneficially owns a membership interest in Manna
Holdings, which is the sole member of D4 Holdings. As such, each of
Messrs. Cassara, Stevanovski and Provenzano may be deemed to beneficially
own the securities reported herein and owned directly by D4
Holdings. Each of Messrs. Cassara, Stevanovski and Provenzano
disclaims beneficial ownership of such securities, and the information
reported herein shall not be deemed an admission that such reporting
person is the beneficial owner of the securities for any purpose, except
to the extent of his pecuniary interest therein.
|
(9)
|
Includes
(a) 152,000 shares of common stock and (b) options to
purchase 350,000 shares of common stock.
|
(10)
|
Includes (a) 39,159,500
shares of common stock, (b) options to purchase 790,000 shares of
common stock, (c) 9,150 restricted shares of common stock, (d)
restricted units to purchase 12,500 shares of common stock and (e) a
warrant to purchase 30,000,000 shares of common stock held directly (or
deemed to be beneficially owned) by the executive officers and directors
as a group.
|
Equity
Compensation Plan Information
The
following table provides certain aggregate information with respect to shares of
our common stock that may be issued under our equity compensation plans in
effect as of December 31, 2009.
Plan Category
|
Number of
securities to be
issued upon exercise
of outstanding
options, warrants
and rights(1)
|
Weighted-average exercise
price of outstanding options,
warrants and rights
|
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding securities
reflected in first column)
|
|||||||||
Equity
compensation plans approved by security holders
(2)
|
5,893,000 | $ | $0.34 | 6,260,000 | ||||||||
Equity
compensation plans not approved by security holders
|
N/A | N/A | N/A | |||||||||
Total
|
5,893,000 | $ | $0.34 | 6,260,000 |
(1)
|
Does
not include 89,770 restricted shares of our common stock and
restricted units to purchase 32,000 shares of our common stock that had
been granted under our equity compensation plans as of December 31,
2009.
|
(2)
|
These
plans consist of our Amended and Restated 2004 Stock Incentive Plan,
Amended and Restated 2006 Non-Employee Director Stock Plan and 2009 Stock
Incentive Plan. The table also includes information for our 2004
Non-Employee Director Stock Option Plan was terminated, except with
respect to outstanding options previously granted
thereunder.
|
44
Certain
Relationships and Related Transactions
Each of
Robert Stevanovski, Anthony Cassara, David Stevanovski and Gregory Provenzano is
a principal of D4 Holdings, and Robert Stevanovski serves as manager of
Praescient, LLC, the sole manager of D4 Holdings. As a result of
their relationship with D4 Holdings, each of these individuals may be deemed to
have a direct or indirect interest in the transactions contemplated by the
Purchase Agreement and the Investor Rights Agreement, and the Loan Agreement and
the Promissory Note, described above under “Item 1. Business - Transactions with
D4 Holdings”. As described above under “Item 12. Security Ownership
of Certain Beneficial Owners and Management and Related Stockholder Matters”, D4
Holdings beneficially owns an aggregate of 67.5% of our common stock (which
includes 39,000,000 shares of common stock and a warrant to purchase 30,000,000
shares of our common stock).
During
the third quarter of 2009 we entered into an agreement with ACN Pacific, a
wholly-owned subsidiary of ACN, pursuant to which we provide digital video and
voice-over-IP telecommunications services in Australia and New Zealand to ACN
Pacific. Each of Robert Stevanovski, Anthony Cassara, David Stevanovski and
Gregory Provenzano is a principal of ACN, and each of them (other than Anthony
Cassara) serves as an officer of ACN. As a result of their
relationship with ACN, each of these individuals may be deemed to have a direct
or indirect interest in the transactions contemplated by the agreement with ACN
Pacific.
During
the fourth quarter of 2009 we entered into an agreement with Ojo Service, a
wholly-owned subsidiary of WorldGate Communications pursuant to which we will
provide wholesale video and voice-over-IP services in the United
States. WorldGate is majority-owned by WGI Investor LLC, which shares
common majority ownership and a common manager with D4 Holdings. Each of Robert
Stevanovski, Anthony Cassara, David Stevanovski and Gregory Provenzano serves as
a director of WorldGate and has an indirect ownership interest in WGI
Investor. As a result, each of these individuals and D4 Holdings may
be deemed to have a direct or indirect interest in the transactions contemplated
by the agreement with OJO Service.
All
transactions between us and our officers, directors, principal stockholders and
affiliates must be reviewed and approved in advance by the Audit Committee. To
the extent that any member of the Audit Committee has an interest in any such
transaction, the member will recuse himself from considering and voting on the
matter.
Director
Independence
Our
common stock is currently quoted on the OTC Bulletin Board and is not listed on
the Nasdaq Stock Market or any other national securities exchange. Accordingly,
we are not currently subject to the Nasdaq continued listing requirements or the
requirements of any other national securities exchange. Nevertheless, in
determining whether a director or nominee for director should be considered
“independent” the board utilizes the definition of independence set forth in
Rule 5605(a)(2) of the Nasdaq Marketplace Rules. The board has determined that
J. Lyle Patrick and
Brian Fitzpatrick each qualify as “independent” under this rule.
Our
company also would qualify as a “controlled company” under Rule 5615(c)(2) of
the Nasdaq Marketplace Rules because D4 Holdings holds more than 50% of the
voting power of our company. Accordingly, we would have the option to be exempt
from the requirements under Rule 5605 to have:
·
|
a
majority of independent directors;
|
·
|
a
compensation committee composed solely of independent
directors;
|
·
|
compensation
of our executive officers determined by a majority of independent
directors or a compensation committee composed solely of independent
directors;
|
·
|
a
nominating committee composed solely of independent directors;
and
|
·
|
director
nominees selected, or recommended for the Board's selection, either by a
majority of the independent directors or a nominating committee composed
solely of independent directors.
|
Because we are not currently subject to
the Nasdaq continued listing requirements we have not determined to what extent
we would rely on the “controlled company” exemption from any of the foregoing
requirements if we were subject to these requirements.
45
The
following table presents fees for professional audit services rendered by
Brightman Almagor Zohar & Co. for the audit of the Company's annual
financial statements for the years ended December 31, 2008, and December 31,
2009, and fees billed for other services rendered by Brightman Almagor Zohar
& Co. during those periods.
2008
|
2009
|
|||||||
Audit
fees
|
$
|
72,000
|
$
|
65,000
|
||||
Audit-related
fees
|
-
|
-
|
||||||
Tax
fees
|
-
|
2,000
|
||||||
All
other fees
|
-
|
-
|
||||||
Total
|
$
|
72,000
|
$
|
67,000
|
In the
above table, in accordance with the SEC’s definitions and rules, “audit fees”
are fees we paid Brightman Almagor Zohar & Co. for professional services for
the audit of our annual financial statements and review of financial statements
included in our quarterly reports filed with the SEC, as well as for work
generally only the independent auditor can reasonably be expected to provide,
such as statutory audits and consultation regarding financial accounting and/or
reporting standards; “audit-related fees” are fees billed by Brightman Almagor
Zohar & Co. for assurance and related services that are reasonably related
to the performance of the audit or review of our financial statements; “tax
fees” are fees for tax compliance, tax advice and tax planning; and “all other
fees” are fees billed by Brightman Almagor & Co for any services not
included in the first three categories.
Policy
on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of
Independent Auditors
Consistent
with SEC policies regarding auditor independence, the Audit Committee has
responsibility for appointing, setting compensation and overseeing the work of
the independent auditor. In recognition of this responsibility, the Audit
Committee has established a policy to pre-approve all audit and permissible
non-audit services provided by the independent auditor.
Prior to
engagement of the independent auditor for the next year's audit, management will
submit an aggregate of services expected to be rendered during that year for
each of four categories of services to the Audit Committee for
approval.
1. Audit
services include audit work performed in the preparation of financial
statements, as well as work that generally only the independent auditor can
reasonably be expected to provide, including comfort letters, statutory audits,
and attest services and consultation regarding financial accounting and/or
reporting standards.
2. Audit-related
services are for assurance and related services that are traditionally performed
by the independent auditor, including due diligence related to mergers and
acquisitions, employee benefit plan audits, and special procedures required to
meet certain regulatory requirements.
3. Tax
services include all services performed by the independent auditor's tax
personnel except those services specifically related to the audit of the
financial statements, and includes fees in the areas of tax compliance, tax
planning, and tax advice.
4. Other
services are those associated with services not captured in the other
categories. The Company generally does not request such services from the
independent auditor.
Prior to
engagement, the Audit Committee pre-approves these services by category of
service. The fees are budgeted and the Audit Committee requires the independent
auditor and management to report actual fees versus the budget periodically
throughout the year by category of service. During the year, circumstances may
arise when it may become necessary to engage the independent auditor for
additional services not contemplated in the original pre-approval. In those
instances, the Audit Committee requires specific pre-approval before engaging
the independent auditor.
The Audit
Committee may delegate pre-approval authority to one or more of its members. The
member to whom such authority is delegated must report, for informational
purposes only, any pre-approval decisions to the Audit Committee at its next
scheduled meeting.
(a)(1)
Financial Statements.
The
Consolidated Financial Statements filed as part of this Annual Report are
identified in the Index to Consolidated Financial Statements on page F-1
hereto.
(a)(2)
Financial Statement Schedules.
Financial
Statement Schedules have been omitted because the information required to be set
forth therein is not applicable or is shown on the financial statements or notes
thereto.
(a)(3)
Exhibits.
We
hereby file, as exhibits to this Annual Report, those exhibits listed on the
Exhibit Index immediately following the signature page hereto.
46
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this Annual Report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized, on March 29,
2010.
DELTATHREE, INC. | ||
By:
|
/s/ Effi Baruch
|
|
Effi
Baruch
Interim
Chief Executive Officer and President,
Senior
Vice President of Operations and Technology
(Principal
Executive
Officer)
|
KNOW ALL
MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints each of Effi Baruch and Peter Friedman his true and
lawful attorney-in-fact, acting alone, with full power of substitution, for and
in the name, place and stead of the undersigned, in any and all capacities to
sign any and all amendments to this Annual Report on Form 10-K, and to file the
same, with all exhibits thereto, and other documents in connection therewith,
with the Securities and Exchange Commission, and hereby grants to such
attorney-in-fact and agents full power and authority to do and perform each and
every act and thing requisite and necessary to be done, as fully to all intents
and purposes as the undersigned might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent or his substitutes, may
lawfully do or cause to be done by virtue thereof.
Pursuant
to the requirements of the Securities Exchange Act of 1934, this Annual Report
on Form 10-K has been signed by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
Signature
|
Title
|
Date
|
||
/s/ Effi Baruch
|
Interim
Chief Executive Officer and President, Senior
|
March
29, 2010
|
||
Effi
Baruch
|
Vice
President of Operations and Technology
(Principal
Executive Officer)
|
|||
/s/ Ziv Zviel
|
Chief
Financial Officer and Treasurer (Principal
|
March
29, 2010
|
||
Ziv
Zviel
|
Financial
Officer and Principal Accounting Officer)
|
|||
/s/ Robert Stevanovski
|
Chairman
of the Board of Directors
|
March
29, 2010
|
||
Robert
Stevanovski
|
||||
/s/ Anthony Cassara
|
Director
|
March
29, 2010
|
||
Anthony
Cassara
|
||||
/s/ David Stevanovski
|
Director
|
March
29, 2010
|
||
David
Stevanovski
|
||||
/s/ Gregory Provenzano
|
Director
|
March
29, 2010
|
||
Gregory
Provenzano
|
||||
/s/ Lior Samuelson
|
Director
|
March
29, 2010
|
||
Lior
Samuelson
|
||||
/s/ J. Lyle Patrick
|
Director
|
March
29, 2010
|
||
J.
Lyle Patrick
|
||||
/s/ Brian Fitzpatrick
|
Director
|
March
29, 2010
|
||
Brian
Fitzpatrick
|
47
EXHIBIT
INDEX
The
following documents are filed as exhibits to this Annual Report on Form 10-K or
incorporated by reference to exhibits previously filed with the Securities and
Exchange Commission.
Number
|
Description
|
|
3.1
|
Form
of the Company’s Amended and Restated Certificate of Incorporation
(incorporated by reference from our Annual Report on Schedule 14A filed on
April 30, 2002).
|
|
3.2
|
Form
of the Company’s Amended and Restated By-laws (incorporated by reference
from our registration statement on Form S-1 (Registration
No. 333-122242)).
|
|
3.3
|
Certificate
of Amendment to the Company’s Amended and Restated Certificate of
Incorporation (incorporated by reference from our Quarterly Report on Form
10-Q filed on August 14, 2009).
|
|
4.1
|
Specimen
Certificate of Common Stock (incorporated by reference from our
registration statement on Form S-1 (Registration
No. 333-122242)).
|
|
10.1
|
deltathree,
Inc. Amended and Restated 1999 Performance Incentive Plan (incorporated by
reference to Exhibit 10.1 of our Current Report on Form 8-K filed on July
11, 2006). +
|
|
10.2
|
2004
Non-Employee Director Stock Option Plan (incorporated by reference from
our registration statement on Form S-8 (Registration
No. 333-122242)). +
|
|
10.3
|
First
Amendment to the deltathree, Inc. 2004 Non-Employee Director Stock Option
Plan, dated as of December 20, 2005 (incorporated by reference from
Exhibit 10.2 of our Current Report on Form 8-K filed on December 21,
2005). +
|
|
10.4
|
Form
of Option Agreement Pursuant to 2004 Non-Employee Director Stock Option
Plan (incorporated by reference from our Annual Report on Form 10-K filed
on March 31, 2005). +
|
|
10.5
|
deltathree,
Inc. Amended and Restated 2004 Stock Incentive Plan (incorporated by
reference from our Definitive Proxy Statement on Schedule 14A filed on
June 19, 2008). +
|
|
10.5
|
deltathree,
Inc. Amended and Restated 2006 Non-Employee Director Stock Plan
(incorporated by reference from our Definitive Proxy Statement on Schedule
14A filed on June 19, 2008). +
|
|
10.6
|
Form
of Option Agreement Pursuant to 2004 Stock Incentive Plan (incorporated by
reference from our Annual Report on Form 10-K filed on March 31, 2005).
+
|
|
10.7
|
Form
of Restricted Unit Agreement Pursuant to 2004 Stock Incentive Plan
(incorporated by reference from our Annual Report on Form 10-K filed
on March 31, 2008). +
|
|
10.8
|
deltathree,
Inc. 2009 Stock Incentive Plan (incorporated by reference from our
Definitive Proxy Statement on Schedule 14A filed on June 22, 2009).
+
|
|
10.9
|
Form
of deltathree, Inc. 2009 Stock Incentive Plan Incentive Stock Option Grant
Agreement (incorporated by reference from our Quarterly Report on Form
10-Q filed on August 14, 2009).
|
|
10.10
|
Form
of deltathree, Inc. 2009 Stock Incentive Plan Nonstatutory Stock Option
Grant Agreement (for U.S. taxpayers) (incorporated by reference from our
Quarterly Report on Form 10-Q filed on August 14, 2009).
+
|
|
10.11
|
Form
of deltathree, Inc. 2009 Stock Incentive Plan Nonstatutory Stock Option
Grant Agreement under Section 102(b)(2) of the Israeli Income Tax
Ordinance (for Israeli taxpayers) (incorporated by reference from our
Quarterly Report on Form 10-Q filed on August 14, 2009).
+
|
|
10.12
|
Form
of deltathree, Inc. 2009 Stock Incentive Plan Nonstatutory Stock Option
Grant Agreement under Section 3(i) of the Israeli Income Tax Ordinance
(for Israel taxpayers) (incorporated by reference from our Quarterly
Report on Form 10-Q filed on August 14, 2009). +
|
|
10.13
|
Form
of deltathree, Inc. 2009 Stock Incentive Plan Restricted Stock Award
Agreement (for U.S. taxpayers) (incorporated by reference from our
Quarterly Report on Form 10-Q filed on August 14, 2009).
+
|
48
10.14
|
Form
of deltathree, Inc. 2009 Stock Incentive Plan Restricted Stock Award
Agreement (for Israeli taxpayers) (incorporated by reference from our
Quarterly Report on Form 10-Q filed on August 14, 2009).
+
|
|
10.15
|
Employment
Agreement between Effi Baruch and deltathree, Inc., dated as of December
9, 2008 (incorporated by reference from our Current Report on
Form 8-K filed on December 10, 2008). +
|
|
10.16
|
Amendment
No. 1 to Employment Agreement between Effi Baruch and deltathree, Inc.,
dated as of March 17, 2009 (incorporated by reference from our Current
Report on Form 8-K filed on March 18, 2009). +
|
|
10.16
|
Amendment
No. 2 to Employment Agreement between Effi Baruch and deltathree, Inc.,
dated as of March 17, 2009 (incorporated by reference from our Current
Report on Form 8-K filed on October 26, 2009). +
|
|
10.17
|
Offer
of Employment Letter between the Company and Ziv Zviel, dated as of June
18, 2009 (incorporated by reference from our Current Report on Form 8-K
filed on June 18, 2009). +
|
|
10.18
|
Securities
Purchase Agreement, dated as of February 10, 2009, between D4 Holdings,
LLC and deltathree, Inc. (incorporated by reference from our Current
Report on Form 8-K filed on February 12, 2009).
|
|
10.19
|
Investor
Rights Agreement, dated as of February 12, 2009, between D4 Holdings, LLC
and deltathree, Inc. (incorporated by reference from our Current Report on
Form 8-K filed on February 12, 2009).
|
|
10.20
|
Warrant,
dated February 12, 2009, issued by deltathree, Inc. in favor of D4
Holdings, LLC (incorporated by reference from our Current Report on
Form 8-K filed on February 12, 2009).
|
|
10.21
|
Termination,
Settlement Agreement and Mutual Release, dated as of February 5, 2009, by
and between the Company and RCN Digital Services, LLC (incorporated by
reference from our Current Report on Form 8-K filed on February 10,
2009).
|
|
10.22
|
General
Terms, dated as of July 29, 2009, by and between the Company and ACN
Pacific Pty Ltd. (incorporated by reference from our Quarterly Report on
Form 10-Q filed on November 12, 2009).
|
|
10.23
|
Master
Service Agreement, dated as of October 9, 2009, between the Company and
OJO Service (incorporated by reference from our Current Report on Form 8-K
filed on October 16, 2009).
|
|
10.24
|
Promissory
Note, dated March 1, 2010, by deltathree, Inc., Delta Three Israel, Ltd.
and DME Solutions, Inc in favor of D4 Holdings, LLC in a
principal amount of $1,200,000 (incorporated by reference from our Current
Report on Form 8-K filed on March 4, 2010).
|
|
10.25
|
Loan
and Security Agreement, dated as of March 1, 2010, by and among
deltathree, Inc., Delta Three Israel, Ltd., DME Solutions, Inc. and D4
Holdings, LLC. (incorporated by reference from our Current Report on Form
8-K filed on March 4, 2010).
|
|
21.1*
|
Subsidiaries of deltathree,
Inc.
|
|
23.1*
|
Consent of Brightman Almagor
Zohar & Co.
|
|
31.1*
|
Certification of the Chief
Executive Officer, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
31.2*
|
Certification of the Chief
Financial Officer, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
32.1*
|
Certification of the Chief
Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
32.2*
|
Certification of the Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of
2002.
|
*
Filed herewith.
+
Indicates management contract or compensatory plan, contract or
arrangement.
49
Index to Consolidated Financial
Statements
Report of Independent Registered
Public Accounting Firm
|
F-2
|
|||
Consolidated Balance Sheets as of December 31,
2009 and 2008
|
F-3
|
|||
Consolidated Statements of Operations for the
years ended December 31, 2009, 2008, and 2007
|
F-4
|
|||
Statements of Stockholders’ Equity for the years
ended December 31, 2009, 2008, and 2007
|
F-5
|
|||
Consolidated Statements of Cash Flows for the
years ended December 31, 2009, 2008, and 2007
|
F-6
|
|||
Notes to Consolidated Financial
Statements
|
F-7
|
F-1
To the
Board of Directors and
Shareholders
of Deltathree, Inc.
We have
audited the accompanying consolidated balance sheets of deltathree, Inc. (“the
Company”) and its subsidiary as of December 31, 2009 and 2008, and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2009.
These consolidated financial statements are the responsibility of the Company's
management. 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 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 audit 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, such consolidated financial statements, present fairly, in all material
respects, the financial position of the Company and its subsidiary as of
December 31, 2009 and 2008, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2009 in
conformity with accounting principles generally accepted in the United States of
America.
The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company's recurring losses from operations and
deficiency in stockholders' equity (deficiency) raise substantial doubt about
its ability to continue as a going concern. Management's plans concerning these
matters are also discussed in Note 1 to the financial statements. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/Brightman Almagor Zohar &
Co.
|
Brightman
Almagor Zohar & Co.
Certified
Public Accountants
A member
firm of Deloitte Touche Tohmatsu
Tel Aviv,
Israel
March 25,
2010
F-2
CONSOLIDATED
BALANCE SHEETS
($ in
thousands)
December 31,
|
||||||||
2009
|
2008
|
|||||||
ASSETS
|
||||||||
Current
assets:
|
||||||||
Cash
and cash equivalents
|
$ | 1,514 | $ | 1,788 | ||||
Restricted
cash and short-term investments (Note 3)
|
366 | 317 | ||||||
Accounts
receivable, net (Note 4)
|
270 | 760 | ||||||
Prepaid
expenses and other current assets (Note 5)
|
409 | 398 | ||||||
Inventory
|
29 | 33 | ||||||
Total
current assets
|
2,588 | 3,296 | ||||||
Property
and equipment:
|
||||||||
Telecommunications
equipment
|
17,070 | 17,806 | ||||||
Furniture,
fixtures and other
|
628 | 623 | ||||||
Leasehold
improvements
|
793 | 787 | ||||||
Capital
leases
|
422 | 422 | ||||||
Computers
hardware and software
|
9,175 | 9,181 | ||||||
28,088 | 28,819 | |||||||
Less
accumulated depreciation
|
(27,434 | ) | (27,378 | ) | ||||
Property and equipment,
net
|
654 | 1,441 | ||||||
Deposits
|
67 | 117 | ||||||
Total
assets
|
$ | 3,309 | $ | 4,854 | ||||
LIABILITIES
AND STOCKHOLDERS’ EQUITY (DEFICIENCY)
|
||||||||
Current
liabilities:
|
||||||||
Current
portion of capital leases
|
$ | 144 | $ | 148 | ||||
Accounts
payable
|
1,912 | 1,485 | ||||||
Deferred
revenues
|
657 | 771 | ||||||
Other
current liabilities (Note 6)
|
1,868 | 1,615 | ||||||
Total
current liabilities
|
4,581 | 4,019 | ||||||
Long-term
liabilities:
|
||||||||
Capital
leases - net of current portion (Note 7)
|
3 | 147 | ||||||
Severance
pay obligations (Note 8)
|
150 | 140 | ||||||
Total
current liabilities
|
153 | 287 | ||||||
Total
liabilities
|
4,734 | 4,306 | ||||||
Commitments
and contingencies (Note 9)
|
||||||||
Stockholders’
equity (deficiency) (Note 10):
|
||||||||
Share
capital:
|
||||||||
Common Stock, par value $0.001
per share; authorized 75,000,000 shares; issued and outstanding:
72,030,505 at December 31, 2009, and 32,870,105 at December 31,
2008.
|
72 | 33 | ||||||
Additional
paid-in capital
|
174,324 | 173,137 | ||||||
Accumulated
deficit
|
(175,821 | ) | (172,622 | ) | ||||
Total
stockholders’ equity (deficiency)
|
(1,425 | ) | 548 | |||||
Total
liabilities and stockholders’ equity
|
$ | 3,309 | $ | 4,854 |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-3
DELTATHREE
, INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
($ in
thousands, except share data)
2009
|
2008
|
2007
|
||||||||||
Revenues:
|
$
|
19,002
|
$
|
20,226
|
$
|
29,477
|
||||||
Costs
and operating expenses:
|
||||||||||||
Cost
of revenues (exclusive of $536, $584 and $599
|
||||||||||||
depreciation
included in a separate line below, respectively)
|
16,127
|
14,744
|
21,107
|
|||||||||
Research
and development expenses (Note 11)
|
464
|
3,356
|
4,669
|
|||||||||
Selling
and marketing expenses
|
1,201
|
3,636
|
5,068
|
|||||||||
General
and administrative expenses
|
3,514
|
3,130
|
2,952
|
|||||||||
Restructuring
expenses (Note 12)
|
-
|
1,223
|
-
|
|||||||||
Write-off
of goodwill (Note 13)
|
-
|
2,002
|
-
|
|||||||||
Write-off
of intangible assets (Note 14)
|
-
|
1,564
|
2,680
|
|||||||||
Change
in deferred revenue relating to previous years (Note 15)
|
-
|
596
|
-
|
|||||||||
Depreciation
and amortization
|
890
|
1,836
|
2,644
|
|||||||||
Total
costs and operating expenses
|
22,196
|
32,087
|
39,120
|
|||||||||
Loss
from operations
|
(3,194)
|
(11,861)
|
(9,643)
|
|||||||||
Capital
gain
|
86
|
39
|
||||||||||
Other
non-operating income
|
15
|
19
|
13
|
|||||||||
Interest
(expense) income, net
|
(72)
|
(35)
|
442
|
|||||||||
Loss
before income taxes
|
(3,165)
|
(11,838)
|
(9,188)
|
|||||||||
Income
taxes (Note 16)
|
34
|
28
|
126
|
|||||||||
Net
loss
|
$
|
(3,199)
|
$
|
(11,866)
|
$
|
(9,314)
|
||||||
Net
loss per share-basic and diluted
|
$
|
(0.05)
|
$
|
(0.36)
|
$
|
(0.29)
|
||||||
Basic
weighted average number of shares outstanding
|
67,877,743
|
32,870,105
|
32,427,118
|
|||||||||
Diluted
weighted average number of shares outstanding
|
67,877,743
|
32,870,105
|
32,427,118
|
The
accompanying notes are an integral part of these consolidated financial
statements.
F-4
DELTATHREE
, INC.
STATEMENTS
OF STOCKHOLDERS’ EQUITY (DEFICIENCY)
($ in
thousands, except share data)
Common Stock
|
||||||||||||||||||||
Number of
Outstanding
Shares
|
Amount
|
Additional
Paid-in
Capital
|
Accumulated
Deficit
|
Total
Stockholders'
Equity
|
||||||||||||||||
Balance
at January 1, 2007
|
29,808,214
|
30
|
168,030
|
(151,442
|
)
|
16,618
|
||||||||||||||
Go2Call
acquisition
|
2,959,831
|
3
|
4,200
|
4,203
|
||||||||||||||||
Exercise
of employee options
|
35,000
|
–
|
*
|
32
|
32
|
|||||||||||||||
Vesting
of restricted shares
|
67,060
|
–
|
*
|
|||||||||||||||||
Share-based
compensation
|
485
|
485
|
||||||||||||||||||
Loss
for the year
|
(9,314
|
)
|
(9,314
|
)
|
||||||||||||||||
Balance
at December 31, 2007
|
32,870,105
|
$
|
33
|
$
|
172,747
|
$
|
(160,756
|
)
|
$
|
12,024
|
||||||||||
Share-based
compensation
|
390
|
390
|
||||||||||||||||||
Loss
for the year
|
(11,866
|
) |
(11,866
|
) | ||||||||||||||||
Balance
at December 31, 2008
|
32,870,105
|
33
|
173,137
|
(172,622
|
) |
548
|
||||||||||||||
Issuance
of shares to D4 Holdings
|
39,000,000
|
39
|
1,031
|
1,070
|
||||||||||||||||
Vesting
of restricted shares
|
5,600
|
–
|
*
|
|||||||||||||||||
Exercise
of employee options
|
154,800
|
–
|
*
|
14
|
14
|
|||||||||||||||
Share-based
compensation
|
142
|
142
|
||||||||||||||||||
Loss
for the year
|
(3,199
|
) |
(3,199
|
) | ||||||||||||||||
December
31, 2009
|
72,030,505
|
72
|
174,324
|
(175,821
|
) |
(1,425
|
) |
* Less
than $1,000.
The
accompanying notes are an integral part of these consolidated financial
statements.
F-5
DELTATHREE
, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
($ in
thousands)
Year ended December 31,
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
Cash
flows from operating activities:
|
||||||||||||
Net
loss
|
$ | (3,199 | ) | $ | (11,866 | ) | $ | (9,314 | ) | |||
Adjustments
to reconcile net loss to net cash (used in) provided by operating
activities:
|
||||||||||||
Write-off
of intangible assets
|
- | 3,566 | 2,680 | |||||||||
Depreciation
and amortization
|
890 | 1,537 | 1,576 | |||||||||
Amortization
of intangible asset
|
- | 338 | 1,068 | |||||||||
Write-off
of office equipment
|
20 | 357 | - | |||||||||
Write-off
of long term deposits
|
50 | - | - | |||||||||
Tax
provision
|
(400 | ) | 700 | - | ||||||||
Stock-based
compensation
|
142 | 390 | 485 | |||||||||
Capital
gain, net
|
(86 | ) | (39 | ) | – | |||||||
Liability
for severance pay, net
|
10 | (201 | ) | 124 | ||||||||
Provision
for losses on accounts receivable
|
253 | 121 | 110 | |||||||||
Exchange
rates differences on deposits, net
|
- | (1 | ) | (6 | ) | |||||||
Change
in deferred revenues relating to previous years
|
- | 596 | - | |||||||||
Changes
in operating assets and liabilities:
|
||||||||||||
Decrease
in accounts receivable
|
237 | 180 | 115 | |||||||||
(Increase)
decrease in prepaid expenses other current assets
|
(59 | ) | 128 | (82 | ) | |||||||
Decrease
(increase) in inventory
|
4 | 160 | (38 | ) | ||||||||
Increase
(decrease) in accounts payable
|
427 | (1,020 | ) | (778 | ) | |||||||
Decrease
in deferred revenues
|
(114 | ) | (376 | ) | (1,172 | ) | ||||||
Increase
(decrease) in other current liabilities
|
645 | (750 | ) | 120 | ||||||||
2,019 | 5,686 | 4,202 | ||||||||||
Net
cash (used in) operating activities
|
(1,180 | ) | (6,180 | ) | (5,112 | ) | ||||||
Cash
flows from investing activities:
|
||||||||||||
Purchase
of property and equipment
|
(192 | ) | (358 | ) | (724 | ) | ||||||
Proceeds
from sale of property and equipment
|
156 | 141 | - | |||||||||
Long
term investment, net
|
- | 1,085 | - | |||||||||
Decrease
(increase) in short-term investments
|
(49 | ) | 5,566 | 6,184 | ||||||||
Purchase
of Go2Call operations, net
|
- | - | (2,509 | ) | ||||||||
Write-off
of long term deposits
|
50 | - | - | |||||||||
Net
cash (used in) provided by investing
activities
|
(85 | ) | 6,434 | 2,951 | ||||||||
Cash
flows from financing activities:
|
||||||||||||
Payment
of capital leases
|
(140 | ) | (115 | ) | (12 | ) | ||||||
Proceeds
from exercise of options
|
14 | - | 32 | |||||||||
Proceeds
from issuance of shares, net
|
1,070 | - | - | |||||||||
Release
of restricted cash
|
47 | - | - | |||||||||
Net
cash provided by (used in) financing
activities
|
991 | (115 | ) | 20 | ||||||||
Decrease
(increase) in cash and cash equivalents
|
(274 | ) | 139 | (2,141 | ) | |||||||
Cash
and cash equivalents at beginning of year
|
1,788 | 1,649 | 3,790 | |||||||||
Cash
and cash equivalents at end of year
|
1,514 | 1,788 | 1,649 | |||||||||
Supplemental
disclosures of cash flow information:
|
||||||||||||
Cash
paid for:
|
||||||||||||
Taxes
|
25 | 48 | 108 | |||||||||
Supplemental
schedule of investing and financing activities:
|
||||||||||||
Acquisition
of capital leases
|
- | 197 | 225 | |||||||||
Cash
received from:
|
||||||||||||
Proceeds
from issuance of shares
|
1,170 | |||||||||||
Direct
costs paid for services due to issuance of shares
|
(100 | ) | ||||||||||
Total
proceeds
|
(1,070 | ) | - | - | ||||||||
Supplemental
schedule of acquisition of Go2Call
|
||||||||||||
Fixed
assets
|
51 | |||||||||||
Goodwill
|
2,002 | |||||||||||
Intangible
assets
|
5,650 | |||||||||||
Accounts
payable
|
(367 | ) | ||||||||||
Deferred
revenues
|
(624 | ) | ||||||||||
Stock
issuance
|
(4,203 | ) | ||||||||||
Total
|
$ | 2,509 |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-6
DELTATHREE
, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - The
Company
deltathree,
Inc. (the “Company”) is a global provider of integrated Voice over Internet
Protocol, or VoIP, digital video and voice-over-IP services, products, hosted
solutions and infrastructure. The Company was 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. While the
Company began as primarily a low-cost alternative source of wholesale minutes
for carriers around the world, it has evolved into an international provider of
next generation communication services.
Going
Concern
The
Company has sustained significant operating losses in recent periods, which has
led to a significant reduction in its cash reserves. On March 1,
2010, the Company and its subsidiaries entered into a Loan and Security
Agreement with D4 Holdings, pursuant to which D4 Holdings agreed to provide to
the Company and its subsidiaries a line of credit in a principal amount of
$1,200,000. On March 2, 2010, the Company received $500,000 from D4 Holdings
pursuant to a notice of borrowing under the Loan Agreement.
The
Company believes that it will continue to experience losses and increased
negative working capital and negative stockholders’ equity in the near term, and
that it will not be able to return to positive cash flow before it requires
additional capital (in addition to any further amounts it may borrow from D4
Holdings under the Loan Agreement) in the near term. There are no assurances
that the Company 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, the Company’s existing stockholders will experience
significant further dilution. As a result of the foregoing factors, there is
substantial doubt about the Company’s ability to continue as a going
concern.
Note 2
- Summary
of significant accounting policies
a. Basis
of presentation
The
financial statements have been prepared in conformity with U.S. generally
accepted accounting principles.
b.
Principles of
consolidation
The
consolidated financial statements include the accounts of the Company and Delta
Three Israel Ltd., the Company's Israeli subsidiary (the “Subsidiary”). All
significant inter-company accounts and transactions have been
eliminated.
c.
Financial statements in U.S.
dollars
The
reporting currency of the Company is the U.S. dollar ("dollar"). The dollar is
the functional currency of the Company and its subsidiary. Transactions and
balances originally denominated in dollars are presented at their original
amounts. Non-dollar transactions and balances are re-measured into dollars in
accordance with the principles set forth in Statement of Financial Accounting
Standards ("SFAS") No. 52. All exchange gains and losses from translation of
monetary balance sheet items resulting from transactions in non-dollar
currencies are recorded in the statement of operations as they
arise.
d.
Use of
estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported and disclosed in the consolidated financial
statement and the accompanying notes. Actual results could differ from those
estimates
On an
ongoing basis, the Company evaluates its estimates, including those related to
allowances for doubtful accounts receivable, the amortization of deferred
revenue associated with customer accounts, the useful lives of property and
equipment and the value of common stock, common stock options, and restricted
stock for the purpose of determining stock-based compensation. The Company bases
its estimates on historical experience, available market information,
appropriate valuation methodologies, including the Black and Scholes option
model and on various other assumptions that are believed to be reasonable, the
results of which from the basis for making judgments about the carrying values
of assets and liabilities.
F-7
e.
Cash and cash
equivalents
Cash held
in banks are subject to U.S. Federal Depository Insurance Corporation (“FDIC”)
limits of $250,000 and cash held in foreign accounts are
unprotected. Due to the Company’s cash needs, management has
generally held and continues to hold its cash in U.S. banks that are insured
under the FDIC.
f .
Restricted
cash
Restricted
cash represents amounts held in cash, money market funds and certificates of
deposit to support stand-by-letters of credit used as security for third party
vendors.
g.
Marketable
securities
The
Company accounts for its investments in marketable securities using SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities" (“SFAS
No. 115”) [ASC 320-10]. Management determines the appropriate classification of
its investments in marketable securities at the time of purchase and reevaluates
such determinations at each balance sheet date. Securities for which the Company
does not have the intent or ability to hold to maturity are classified as
available-for-sale. Available-for-sale securities are stated at fair value, with
the unrealized gains and losses reported as a separate component of
shareholders' equity under accumulated other comprehensive gain or loss. The
Company has not recorded any unrealized gains or losses to date. The
Company does not currently have any of its assets invested in marketable
securities, but rather all amounts are held in cash.
h.
Inventory
Inventory
consists of the cost of customer equipment and is at the lower of cost
(principally on a standard cost basis which approximates FIFO) or
market.
i.
Property and
equipment
Property
and equipment are stated at cost. Depreciation is calculated using the
straight-line method over the estimated useful lives of the depreciable assets,
which range from two to five years. Leasehold improvements are amortized based
on the straight-line method over the shorter of the term of the lease, or the
estimated useful life of the improvements.
j.
Long lived
assets
The
Company applies the provisions of SFAS No. 144, “Accounting for the Impairment
or Disposal of Long-Lived Assets” [ASC 360-10]. This statement requires that
long-lived assets and certain identifiable intangible assets be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to undiscounted future net cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. At December 31, 2009, there were no
intangible assets listed on the Company’s balance sheet.
k. Write-off
of goodwill and intangible assets
The
Company evaluates its long-lived tangible and intangible assets for impairment
in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” [ASC
350-20] and SFAS No.144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” [ASC 360-10] whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Goodwill
is subject to an annual test for impairment. If such assets are considered
to be impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds the fair value of the
assets. During 2008, the Company amortized approximately $338,000 and
wrote-off approximately $2.0 million in goodwill and $1.6 million in intangible
assets associated with the acquisition of certain assets in the Go2Call
transaction discussed below. During 2009 the Company wrote off approximately
$20,000 of equipment. No other amortizations or write-offs were recorded during
that period.
.
l.
Revenue
recognition
The
Company recognizes revenues from Internet telephony services based on minutes
(or fractions thereof) of customer usage. The Company records payments received
in advance for prepaid services and services to be supplied under contractual
agreements as deferred revenue until such related services are
provided.
F-8
m. Cost of revenues
Cost of
revenues consists primarily of direct costs that the Company pays to third
parties in order to provide telephony services. These costs include access,
transmission and interconnection charges that the Company pays to other access
providers to terminate domestic and international phone calls on the public
switched telephone network. In addition, these costs include the cost to lease
phone numbers, to co-locate in other telephone companies' facilities. These
costs also include taxes that the Company pays on telecommunications services
from our suppliers.
n.
Research and development
expenses
Research
and development expenses are expensed as incurred and consist primarily of
payroll and facilities charges associated with the research and development of
our current and future products.
o.
Income
taxes
The
Company provides for income taxes using the liability approach defined by SFAS
No. 109, “Accounting for Income Taxes” [ASC 740-10]. Deferred tax assets and
liabilities are recognized for the expected tax consequences between the tax
bases of the assets and liabilities and their reported amounts. Valuation
allowances are established when necessary to reduce deferred tax assets to the
amount expected to be realized and are reversed at such time that realization is
believed to be more likely than not.
p. Stock-based
compensation
The
following assumptions were used for the fiscal year 2009: dividend yield of
0.00% for all periods; risk-free interest rate of 4.0%; an expected life of 3-4
years for all periods; and a volatility rate of 65%.
q.
Restricted shares and
restricted units
The
Company has granted restricted shares and restricted units to purchase shares of
the Company’s common stock to retain, reward and motivate those employees who
are deemed critical to the future success of the Company. The restricted share
and restricted unit plan has been approved by the Board of Directors. The
Company values restricted shares and restricted units to purchase shares of our
common stock at the aggregate grant date fair value in accordance with ASC
718-10.
r.
Net income (loss) per
share
Basic and
diluted net income (loss) per share have been computed in accordance with SFAS
No. 128, "Earnings Per Share", [ASC 260-10] using the weighted average number of
common stock outstanding. Diluted earnings per share give effect to all
potential dilutive issuances of ordinary shares that were outstanding during the
period.
s. Concentration of credit risk
The
Company is subject to concentrations of credit risk, which consist principally
of cash and cash equivalents, short-term investments and trade accounts
receivable.
The
Company maintains its cash balances at various financial institutions. The
Company performs periodic evaluations of the relative credit standing of these
institutions.
The
majority of the Company's non-carrier customers prepay for their services. The
Company establishes an allowance for doubtful accounts based upon factors
surrounding the credit risk of customers, historical trends and other
information.
t.
Fair value of financial
instruments
The
financial instruments of the Company consist mainly of cash and cash
equivalents, short-term investments, current accounts receivable, accounts
payable and long-term liabilities. In view of their nature, the fair value of
the financial instruments included in working capital of the Company is usually
identical or close to their carrying amounts.
u.
Derivatives
The
Company applies the provisions of Statement of Financial Accounting Standard
(SFAS) No. 133, “Accounting for Derivative Instruments and Hedging
Activities,” [ASC 815-10] as amended. The standard requires the Company to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through the statement of
operations. If the derivative is a hedge, depending on the nature of the hedge,
changes in the fair value of derivatives will either be offset against the
change in fair value of the hedged assets, liabilities or firm commitments
through earnings, or recognized in other comprehensive income (loss) until the
hedged item is recognized in earnings. The ineffective portion of a derivative’s
change in fair value will be immediately recognized in earnings. The Company use
of derivatives is immaterial.
F-9
v.
Reclassification
Certain
prior years’ amounts have been reclassified in conformity with the current
year's financial statements presentation.
Note 3
- Restricted
cash and short-term investments
The
following is a summary of our restricted cash and available-for-sale securities
as of December 31, 2009 and 2008.
December 31,
|
||||||||
2009
|
2008
|
|||||||
($ in
thousands)
|
||||||||
Restricted
cash (money market funds)*
|
$
|
174
|
$
|
160
|
||||
Bank
deposits
|
192
|
157
|
||||||
Total
restricted cash and short-term investments
|
366
|
317
|
*
Restricted cash represents amounts held in certificates of deposit and money
market funds to support stand-by letters of credit used as security for third
party vendors.
Note 4 - Accounts
receivable, net
Accounts
receivable are stated net of an allowance for doubtful accounts of approximately
$484,000 and $231,000 at December 31, 2009 and 2008,
respectively.
Note 5 - Prepaid
expenses and other current assets
Prepaid
expenses and other current assets consist of the following:
December 31,
|
||||||||
2009
|
2008
|
|||||||
($ in
thousands)
|
||||||||
Government
of Israel (VAT refund and other)
|
$
|
11
|
$
|
34
|
||||
Deposits
with suppliers
|
182
|
109
|
||||||
Prepaid
expenses
|
155
|
238
|
||||||
Other
|
61
|
17
|
||||||
Total
prepaid expenses and other current assets
|
$
|
409
|
$
|
398
|
Note 6 - Other current
liabilities
Other
current liabilities consist of the following:
December 31,
|
||||||||
2009
|
2008
|
|||||||
($ in
thousands)
|
||||||||
Accrued
expenses
|
$
|
1,600
|
$
|
1,117
|
||||
Employees
and related expenses
|
268
|
480
|
||||||
Other
|
-
|
18
|
||||||
Total
other current liabilities
|
$
|
1,868
|
$
|
1,615
|
Note 7 - Capital leases -
net of current portion
Future
minimum non-cancelable lease payments required after December 31, 2009 are as
follows
2010
|
$
|
144
|
||
2011and
thereafter
|
3
|
|||
Total
capital leases
|
$
|
147
|
F-10
Note 8 - Severance pay
obligations
The
Subsidiary is subject to certain Israeli laws and labor agreements that
determine the obligations of the Subsidiary to make severance payments to
dismissed employees and to employees leaving the Subsidiary under certain other
circumstances. The obligation for severance pay benefits, as determined by
Israeli law, is based upon length of service and the employee's most recent
salary. This obligation is partially funded through regular deposits made by the
Subsidiary into unaffiliated companies for managers' insurance policies. Amounts
funded are controlled by the fund trustees and insurance companies and are not
under the control and management of the Subsidiary.
Expenses
(income) relating to employee termination benefits were $211,663, $160,026 and
$19,942 for the years ended December 31, 2009, 2008 and 2007,
respectively.
The
aggregate value of the insurance policies as of December 31, 2009 and 2008 was
$538,192 and $486,632, respectively.
Note 9 - Commitments and
contingencies
a. Lease
commitments
We lease
our executive offices at 224 West 35th Street,
New York, N.Y. The term of the lease is until August 31, 2010, with
an option for us to extend the lease through August 31, 2012. Rent
expense, net, for 2009 was $26,343, which includes the rent expense, net, we
paid in 2009 for our previous executive offices located at 419 Lafayette Street,
New York, N.Y.
Delta
Three Israel Ltd., a wholly-owned subsidiary of the Company, leases an office
that houses the Company’s research and development facilities in Jerusalem,
Israel. On October 20, 2009, our subsidiary and the owner of the office
executed an amendment to the lease agreement between the parties. The
amendment provides that, amongst other things, retroactive to July 1, 2009, the
number of square meters comprising the office space was reduced by 556 to 734
square meters and the term of the lease was extended to June 30, 2012, with an
option for our subsidiary to extend the term for an additional 36 months
thereafter. Rent expense, net for our subsidiary for 2009 was
$196,150.
b. Legal proceedings
On
December 5, 2008, a complaint for patent infringement was filed in the United
States District Court for the Eastern District of Texas (Tyler Division) by
Centre One naming the Company, Verizon Communications Inc., Vonage Holdings
Corp. and Vonage America Inc. as defendants. The complaint alleges, inter alia, that the Company
and Verizon are offering for sale “a VoIP service, including, but not limited
to, a service under the name Verizon VoiceWing” that infringes United States
Patent No. 7,068,668, or Patent ’668, entitled “Method and Apparatus for
Interfacing a Public Switched Telephone Network and an Internet Protocol Network
for Multi-Media Communication.”
On April
7, 2009, the court held a status conference and assigned May 6, 2010, and
December 6, 2010, as the dates for the pretrial hearing, or the Markman hearing,
to interpret the construction of Centre One’s claims and the commencement of the
trial, respectively.
On June
9, 2009, Centre One served a Disclosure of Asserted Claims and Infringement
Contentions, in which it accused certain of the Company’s VoIP services, in
addition to Verizon VoiceWing, of infringing Patent ’668. Centre One
identified the Company’s Hosted Consumer VoIP Solutions, Consumer Group Global
Internet Phone Service, and Reseller Programs as allegedly
infringing.
On June
22, 2009, the United States Patent and Trademark Office, or the “PTO”, granted a
request by Verizon Long Distance LLC to reexamine Patent ’668, and issued a
non-final office action rejecting all but two of the 37 claims of Patent ’668 as
not patentable. On July 8, 9, and 10, 2009, the Company and the
other defendants moved to stay the litigation in the Eastern District of Texas
pending the PTO’s reexamination of Patent ’668. Centre One opposed
the stay motions on July 10, 2009.
On July
14, 2009, Verizon Long Distance, and on August 13, 2009, the Company and Vonage,
filed Invalidity Contentions seeking to invalidate under 35 U.S.C. §102 and/or
§103 all of the claims of Patent ’668 asserted over prior patents and
publications of third parties not disclosed to the PTO at the time that Patent
’668 was granted.
On August
24, 2009, Centre One amended at the PTO 12 of the 21 claims it had asserted in
the litigation. On September 18, 2009, Centre One moved to amend its
Infringement Contentions to withdraw the claims it had amended at the PTO and to
assert two additional claims of infringement. The Company and the
other defendants agreed to the withdrawn claims but opposed Centre One’s attempt
to assert new claims. The court has not yet ruled on the
motion.
On
October 1, 2009, Vonage separately filed a request for reexamination of the
Patent ’668, stating additional grounds for invalidity beyond those presented by
Verizon Long Distance. The PTO granted Vonage’s request on December
16, 2009, and a first office action on the merits is expected
shortly.
On
February 9 and 12, 2010, Verizon and the Company respectively moved for a
protective order against further discovery in the litigation and a limited stay
of all deadlines until the court rules on the pending motions to
stay. On February 17, 2010, Centre’s One counsel filed a motion to
withdraw as counsel for Centre One and requested that the court stay all
deadlines and discovery in the litigation until Centre One obtains new
counsel. The court granted the motion on February 19, 2010 and stayed
all deadlines in the litigation for 60 days. The court instructed counsel for
the parties to meet after such time and submit a joint status report containing
each party’s position regarding new dates for the Markman hearing and the
commencement of the trial.
F-11
On
February 24, 2010, the court denied the Company’s and the other defendants
respective stay motions. In addition, the court denied the Company’s
and Verizon’s motions for a protective order and limited stay as moot in light
of the 60-day stay the court had granted on February 19.
The
Company’s examination of the allegations set forth in the Complaint lead the
Company to firmly believe that it does not infringe any valid claim of Patent
’668. The Company is continuing our examination into the allegations set forth
in the complaint and the validity of Patent ’668, and cannot predict with any
degree of certainty the results of the Company’s examination and/or the outcome
of the suit or determine the extent of any potential liability or
damages.
The
Company, as well as certain of its former officers and directors, were named as
co-defendants in a number of securities class actions in the United States
District Court for the Southern District of New York, arising out of the
Company’s initial public offering, or IPO, in November 1999. In
addition, a number of other issuers and underwriters of public offerings of such
issuers (including the underwriters of the Company’s IPO) were named as
defendants in such class action suits in connection with such public offerings.
A global settlement was agreed upon among the plaintiffs, issuers, underwriters
and insurers, and received the final approval of the district judge on October
5, 2009. The settlement did not impose any liability on the
Company.
The
Company is not a party to any other material pending legal proceedings, other
than ordinary routine litigation incidental to the business, to which the
Company is a party or of which any of its property is the subject.
c. Regulation
Although
there are several regulatory proceedings currently pending before federal
authorities, providers of interconnected VoIP services are lightly regulated
compared to providers of traditional telecommunications services. On February
12, 2004, the FCC initiated a generic rulemaking proceeding concerning the
provision of voice and other services using IP technology, including assessing
whether VoIP services should be classified as information services or
telecommunications services. The rulemaking is ongoing and we cannot predict the
outcome of this proceeding. In November 2004, the FCC determined that certain
interconnected VoIP services (meaning VoIP services that can be used to send and
receive calls to or from the PSTN), including some services that are similar to
ours, should be considered interstate services subject to federal rather than
state jurisdiction. Although this ruling was appealed by several
states, on March 21, 2007, the United States Court of Appeals for the Eighth
Circuit affirmed the FCC’s determination.
The FCC’s
generic rulemaking proceeding could result in the FCC determining, for instance,
that certain types of Internet telephony should be regulated like basic
telecommunications services. Thus, Internet telephony would no longer be exempt
from more onerous telecommunications-related regulatory obligations, could
potentially become subject to state telecommunications regulations, and could
become subject to other economic regulations typically imposed on traditional
telecommunications carriers.
On
June 3, 2005, the FCC released an order and notice of proposed rulemaking
concerning VoIP emergency 911 services. The order set forth two primary
requirements for providers of interconnected VoIP services. The order applies to
our iConnectHere and joip customers, or our “retail customers”. We do not
believe that we are responsible for compliance with this order when we sale our
service wholesale to companies who then offer the service to retail end users.
We cannot predict whether we would be subject to any third-party litigation in
connection with such customers who resell our services or whether the rules will
be interpreted as applicable to those who wholesale interconnected VoIP
services.
The
order set forth two primary requirements for providers of interconnected VoIP
services. First, the order requires providers of interconnected VoIP services
like us to notify our retail customers of the differences between the emergency
services available through our offerings and those available through traditional
telephony providers. We also had to receive affirmative acknowledgment from some
of our retail customers that they understand the nature of the emergency
services available through our service. On September 27, 2005, the FCC's
Enforcement Bureau released an order stating that the Enforcement Bureau will
not pursue enforcement actions against interconnected VoIP providers that have
received affirmative acknowledgement from at least 90% of their subscribers. We
received affirmative acknowledgment from more than 95% of our relevant customers
that they understand the nature of the emergency services available through our
service, and thus we believe we are substantially in compliance with the first
aspect of the FCC's June 3 order.
Second,
the order required providers of interconnected VoIP services like us to offer
enhanced emergency dialing capabilities, or E-911, to all of our retail
customers by November 28, 2005. Under the terms of the order, we are
required to use the dedicated wireline E-911 network to transmit customers' 911
calls, callback number and customer-provided location information to the
emergency authority serving the customer's specified location. On
November 7, 2005, the FCC's Enforcement Bureau issued a Public Notice with
respect to that requirement. The Public Notice indicated that providers who have
not fully complied with the enhanced emergency dialing capabilities requirement
are not required to discontinue the provision of services to existing customers,
but that the FCC expects that such providers will discontinue marketing their
services and accepting new customers in areas in which the providers cannot
offer enhanced emergency dialing capabilities where such capabilities are
otherwise available.
F-12
Almost
all of our retail customers currently receive E-911 service in conformity with
the FCC’s order. Like many interconnected VoIP providers, we rely on third
parties to route emergency calls originated by our customers. In certain
instances and for some of our customers, the third party provider may route 911
calls to an unofficial emergency call center. Such unofficial call centers may
not be able to receive appropriate call back information. To the extent that
they are so able or callers provide their location information the emergency
dispatchers in such call centers may not then be able to route such calls to the
appropriate public safety answering point. The FCC could find that calls routed
in this manner violates its rules, potentially subjecting us to enforcement
actions including, but not limited to, fines, cease and desist orders, or other
penalties. Moreover, and as is the case with customers for other interconnected
VoIP providers some customers who were receiving service prior to the FCC’s
deadline for compliance with the E-911 regulations may not receive such service.
The FCC permitted service providers to continue to provide service to those
existing customers rather than disconnect those customers. Pursuant to the FCC’s
requirement, after the implementation of the FCC E-911 requirements, we provide
services to our new retail customers only where we can provide the FCC required
E-911 service. We may be required to stop serving those customers to whom we
cannot provide the required enhanced emergency dialing capabilities that were
being serviced prior to the issuance of the FCC’s rules at any
time.
The
FCC is considering modifying its VoIP E-911 rules. In June, 2007, the
FCC released a Notice of Proposed Rulemaking to consider whether it should
impose additional obligations on interconnected VoIP
providers. Specifically, the FCC considered mandating that
interconnected VoIP providers implement a solution that will allow for
automatically determining the location of their customers for purposes of E-911
rather than require customers to manually update their existing location
information (as is the case under the current regulations). Moreover,
the Notice included a tentative conclusion that interconnected VoIP providers
that allow their service to be used in more than one location, like us, be
required to meet the same customer location accuracy standards applicable to
providers of mobile telecommunications services. We cannot predict
the outcome of this proceeding or its potential impact on our
business.
The Communications Assistance for Law
Enforcement Act, or CALEA, requires certain communications service providers to
assist law enforcement agencies in conducting lawfully authorized electronic
surveillance. On September 23, 2005, the FCC released an order concluding
that CALEA applies to interconnected VoIP providers. In May 2006 the
FCC released an order finding that broadband Internet access service providers
and interconnected VoIP providers are required to implement the same type of
CALEA requirements that have been applied to wireline telecommunications
carriers. These include obligations to (1) ensure that communications equipment,
facilities, and services meet interception assistance capability requirements
and (2) develop system security policies and procedures to define employee
supervision and record retention requirements. As a result of the
steps the Company has taken, the Company believes that it complies with
CALEA.
The
FCC decided in June 2006 that interconnected VoIP service providers should be
required to contribute to the universal service fund, or USF. The amount of
universal service contribution for interconnected VoIP service providers is
based on a percentage of revenues earned from end-user interstate services. The
FCC developed three alternatives under which an interconnected VoIP service
provider may elect to calculate its universal service contribution: (1) a
safe harbor that assumes 64.9% of the provider’s end user revenues are
interstate; (2) a traffic study to determine an allocation for interstate
end user revenues; or (3) actual interstate and international end user
revenues. If an interconnected VoIP service provider calculates its universal
service contributions based on its actual percentage of interstate calls, the
FCC suggested that its preemption of state regulation of such services may no
longer apply, in which case the interconnected VoIP service provider could be
subject to regulation by each state in which it operates as well as federal
regulation. In addition, the FCC is considering a number of proposals that could
alter the way that the USF is assessed. For instance, the FCC is considering an
assessment based on the use of telephone numbers. Furthermore, some states may
attempt to impose state universal service contribution requirements on
interconnected VoIP providers such as deltathree. At this time, various states –
including Nebraska and New Mexico – claim that they have the right to require
interconnected VoIP providers to contribute to their respective USF
funds. On March 3, 2008, the U.S. District Court for Nebraska issued
a preliminary injunction and found that Nebraska's state Public Service
Commission does not have jurisdiction to require Universal Service contributions
from VoIP providers. On May 1, 2009, a panel of the U.S. Circuit Court of
Appeals for the Eighth Circuit affirmed the U.S. District court ruling. The
Nebraska and New Mexico state commissions recently filed a petition with the FCC
seeking the authority to impose state USF contribution obligations on
interconnected VoIP providers, like us, with one state seeking retroactive
application. We cannot predict how the FCC may rule on the petition.
If we do become subject to state USF contribution obligations, we may either
have to increase the retail price of our affected service offerings, making our
service less competitive in terms of price as compared to similar
functionalities offered by providers of traditional telecommunications services,
or reduce our profit margins. Retroactive applicability of any state USF fees
would effectively bar us from collecting such fees from our users, reducing our
future profits.
On
April 2, 2007, the FCC issued an order that tightened existing rules on
protection and use of Customer Proprietary Network Information, or CPNI, and
extended coverage of the CPNI rules to interconnected VoIP service providers.
Among other things, the Order imposes greater obligations on us and other
companies like us to protect CPNI, acquire customer consent prior to engaging in
certain kinds of marketing efforts based on CPNI, train our employees concerning
protecting (and the use of) CPNI and to file formal certifications with the FCC
regarding procedures for protecting this information. As a result of
the steps we have taken, we believe that we comply with this Order.
On
June 15, 2007, and effective October 5, 2007, interconnected VoIP providers,
like us, became required to, among other things, make certain that their
equipment and service is accessible to and usable by individuals with
disabilities, if readily achievable. In addition, interconnected VoIP providers
like us became obligated to contribute to the Telecommunications Relay Services,
or TRS, fund and to offer 711 abbreviated dialing for access to relay services.
Following March 31, 2009, interconnected VoIP providers are required to route
such 711 calls to the appropriate TRS relay center serving the state in which
the caller is located or the relay center corresponding to the caller’s last
registered address. As a result of the steps we have taken, we
believe that we comply with the applicable requirements.
F-13
On August
6, 2007 and effective November 2007, the FCC adopted an Order concerning the
collection of regulatory fees for Fiscal Year 2007 requiring the collection of
such fees from interconnected VoIP providers like us. Like other interconnected
VoIP providers, we now pay regulatory fees based on interstate and international
revenues.
On
November 8, 2007, the FCC released an Order relating to local number portability
imposing local number portability, or LNP, and related obligations on
interconnected VoIP Providers like us. The Order requires interconnected VoIP
providers to contribute to shared numbering administration costs. Additionally,
the Order mandates that we process certain kinds of telephone number porting
requests within certain timeframes. As a result of the steps we have
taken, we believe that we comply with this Order. Subsequently, on May 13, 2009,
the FCC released another order concerning LNP that further reduces the porting
timeframe for certain types of telephone number porting requests that
interconnected VoIP providers, like us, have to process. It is expected that the
new rules imposing reduced porting timeframes will not be effective until late
2010. Since we are not a licensed telecommunications carrier, we must rely on
third parties to comply with these porting obligations. If these third parties
fail to comply with these obligations we could be subject to fines, forfeitures
and other penalties by the FCC or state public utilities commissions or we could
face legal liability in state or federal court from customers or carriers. The
FCC also released a Further Notice of Proposed Rulemaking to refresh the record
on how to further improve the porting process, and how to potentially expand the
new one business day porting timeframe to other kinds of ports. We cannot
predict the outcome of this proceeding or its potential impact on us at this
time.
In May
2009, the FCC extended to interconnected VoIP providers like us the
discontinuance rules that previously applied only to non-dominant common
carriers. The FCC's rules require non-dominant domestic carriers to provide
notice to customers at least 30 days prior to discontinuing service to a
telephone exchange, toll stations serving a community in whole or in part, and
other similar activities that affect a community or part of a community.
Carriers must inform certain state authorities of the discontinuation, and
obtain prior FCC approval before undertaking the service disruption. The FCC's
rules allow for streamlined treatment for FCC discontinuance approvals and
interconnected VoIP providers will be able to take advantage of the same
streamlined procedures afforded to non-dominant carriers. It is not yet clear
how these rules apply to interconnected VoIP providers. But in the event we
discontinue one of our service offerings in its entirety or if we were to exit
the market in whole we would likely have to comply with these new rules. We do
not expect these new obligations to have a material impact on our
business.
In June
2007, the FCC adopted various recommendations from its Independent Panel
Reviewing the Impact of Hurricane Katrina on Communications Networks Panel,
including a requirement that certain interconnected VoIP providers submit
reports regarding the reliability and resiliency of their 9-1-1 systems. At this
time, we are not subject to these reporting requirements but may become subject
in the future.
There are
several other recent or ongoing regulatory proceedings initiated by various
persons that relate to VoIP and other Internet services. Although the specific
effects of any such future regulations cannot be determined, increased
regulation and the imposition of additional funding requirements may increase
the Company’s costs and adversely affect the Company’s business, financial
condition, operating results and future prospects.
In
addition, some state and local regulatory authorities believe they retain
jurisdiction to regulate the provision of, and impose taxes, fees and surcharges
on, intrastate Internet and VoIP telephony services, and have attempted to
impose such taxes, fees and surcharges, such as a fee for providing E-911
service. Rulings by the state commissions on the regulatory considerations
affecting Internet and IP telephony services could affect the Company’s
operations and revenues, and the Company cannot predict whether state
commissions will be permitted to regulate the services the Company offers in the
future.
The
Company has completed a study of state and local taxes and other fees and has
accrued approximately $150,000 of estimated state and local taxes and other fees
due as of December 31, 2009, out of a total tax accrual of
$300,000. It has also determined that it needs to collect and remit
sales and excise taxes in certain states and local jurisdictions and will begin
collecting and remitting such sales and excise taxes in the immediate
future. The Company has begun the process of registering with the
relevant state authorities and entering into discussions with the relevant state
tax authorities to finalize the amounts due. To the extent the Company increases
the cost of services to its customers to recoup some of the costs of compliance,
this will have the effect of decreasing any price advantage the Company may have
over traditional telecommunications companies.
In
addition, it is possible that the Company will be required to collect and remit
taxes, fees and surcharges in other states and local jurisdictions where it has
not done so, and which such authorities may take the position that the Company
should have collected. If so, they may seek to collect those past taxes, fees
and surcharges from the Company and impose fines, penalties or interest charges
on the Company. Our payment of these past taxes, fees and surcharges, as well as
penalties and interest charges, could have a material adverse effect on the
Company.
F-14
Note 10
- Stockholders'
equity
a. Share capital
The
Company’s common stock is currently listed on the OTC Bulletin Board under the
symbol “DDDC.OB”. The listing of the common stock was transferred from The
Nasdaq National Market (where it had traded since November 22, 1999) to The
Nasdaq Capital Market on September 17, 2002, and from The Nasdaq Capital Market
to the OTC Bulletin Board on March 28, 2008.
b. Change in Control
On
February 10, 2009, the Company entered into the Purchase Agreement with D4
Holdings pursuant to which the Company issued to D4 Holdings the Shares,
representing approximately 54.3% of the total number of issued and outstanding
shares of Common Stock, for an aggregate purchase price of $1,170,000, payable
in cash, and the Warrant, exercisable for ten years, to purchase up to an
additional 30,000,000 shares of Common Stock at an exercise price of $0.04 per
share. The transaction closed on February 12, 2009.
In
connection with the closing of the transaction and pursuant to the terms of the
Purchase Agreement, Noam Bardin resigned as a director and the board of
directors appointed Robert Stevanovski and Anthony Cassara to serve on the
board. In addition, Lior Samuelson resigned as Chairman of the Board
and remained a director, and Robert Stevanovski was appointed to serve as
Chairman. Under the terms of the Purchase Agreement, D4 Holdings had
the right to nominate for appointment by the board one director in addition to
Messrs. Stevanovski and Cassara, and it nominated David
Stevanovski. In addition, on March 4, 2009, the Board of Directors of
the Company increased the size of the board from five to seven members and
filled the two vacancies remaining on the board by appointing Gregory Provenzano
and J. Lyle Patrick as directors. The appointments of the three new
directors to serve on the board became effective on March 28, 2009.
As a
result of the transaction between the Company and D4 Holdings, D4 Holdings
obtained a controlling interest in the Company.
c
. Stock Options
At our
Annual Meeting on August 6, 2009, upon the recommendation of our Board of
Directors our stockholders approved the adoption of our 2009 Stock Incentive
Plan (the “2009 Plan”). Upon the adoption of the 2009 Plan, our 2004 Stock
Incentive Plan and 2006 Non-Employee Director Stock Plan were terminated except
with respect to outstanding awards previously granted under those plans and no
additional awards will be made under those plans. Under the 2009 Plan, the
Compensation Committee is authorized to grant awards, either in the form of
incentive or non-incentive stock options or restricted stock.
As of
December 31, 2009, options to purchase 5,893,000 shares of Common Stock
granted under the Company’s stock incentive plans were exercisable with exercise
prices ranging between $0.15 and $2.95 per share.
A summary
of the status of the Company’s stock incentive plans as of December 31, 2007,
2008 and 2009 and changes during the years then ended, is presented
below:
December 31, 2007
|
December 31, 2008
|
December 31, 2009
|
||||||||||||||||||||||
Number of
Options
|
Weighted
average
Exercise price
|
Number of
Options
|
Weighted
average
Exercise price
|
Number of
Options
|
Weighted
average
Exercise price
|
|||||||||||||||||||
Options
outstanding at beginning of year
|
2,330,835
|
$
|
2.06
|
1,560,020
|
$
|
1.91
|
2,353,541
|
$
|
0.85
|
|||||||||||||||
Granted
during the year
|
-
|
-
|
3,910,000
|
0.16
|
4,660,000
|
0.34
|
||||||||||||||||||
Exercised
during the year
|
35,000
|
0.89
|
-
|
92,500
|
0.15
|
|||||||||||||||||||
Forfeited
during the year
|
735,815
|
1.02
|
3,116,479
|
1.92
|
1,028,041
|
1.39
|
||||||||||||||||||
Outstanding
at end of year
|
1,560,020
|
$
|
1.91
|
2,353,541
|
$
|
0.85
|
5,893,000
|
$
|
0.70
|
|||||||||||||||
Weighted
average fair value of options granted during the year
|
$
|
0.00
|
$
|
0.16
|
$
|
0.34
|
F-15
Additional information regarding
options outstanding as of December 31, 2009, is as follows:
Options Outstanding
|
Options Exercisable
|
||||||||||||||||
Range of
Exercise Prices
|
Number of
Outstanding
|
Weighted average
Remaining
Contractual
Life (Years)
|
Weighted
Average
Exercise Price
|
Number of
Exercisable
Options
|
Weighted
Average
Exercise Price
|
||||||||||||
$ |
0.11
– 0.14
|
740,000
|
9.3
|
0.14
|
-
|
-
|
|||||||||||
$ |
0.15
– 0.16
|
860,000
|
8.3
|
$
|
0.15
|
723,750
|
0.15
|
||||||||||
$ |
0.18
|
400,000
|
9.4
|
0.18
|
-
|
-
|
|||||||||||
$ |
0.21
|
100,000
|
9.5
|
0.21
|
-
|
-
|
|||||||||||
0.39
|
300,000
|
8.1
|
0.39
|
300,000
|
0.39
|
||||||||||||
0.41
|
3,340,000
|
9.7
|
0.41
|
-
|
-
|
||||||||||||
1.75
|
19,500
|
3.3
|
1.75
|
19,500
|
1.75
|
||||||||||||
2.85
– 3.20
|
133,500
|
5.0
|
2.90
|
133,500
|
2.90
|
||||||||||||
5,893,000
|
1,176,750
|
c. Restricted shares of the Company’s
Common Stock
During
the year ended December 31, 2009, the Company did not grant restricted shares of
the Company’s common stock or restricted units to purchase shares of the
Company’s common stock.
Note 11
- Research
and development expenses
Research
and development expenses consist of the following:
Year ended December 31,
|
||||||||||||
($ in
thousands)
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
Salaries
and related expenses
|
$
|
344
|
$
|
2,564
|
$
|
3,498
|
||||||
Consulting
and advisory fees
|
9
|
120
|
235
|
|||||||||
Travel
|
7
|
25
|
104
|
|||||||||
Other
|
104
|
647
|
832
|
|||||||||
Total
research and development expenses
|
$
|
464
|
$
|
3,356
|
$
|
4,669
|
Note 12 - Restructuring
expenses
During
2009, the Company did not record any restructuring expenses; during 2008, the
Company recorded restructuring expense totaling approximately $1.2 million. The
restructuring expense were one-time costs related to: (i) changes to the
structure of the Company’s work force, including reductions in force, that
totaled approximately $0.3 million; (ii) the sublease of the Company’s
then-current New York office in 2008 for the remaining term of the lease (for
which the Company accrued the shortfall between the rental amounts it will be
receiving from the subtenant and the rental amounts it needs to pay to the
landlord, as well as legal costs and broker fees associated with the sublease)
of approximately $0.6 million; (iii) write-offs of equipment from the Company’s
New York office of approximately $0.3 million; and (iv) severance costs the
Company paid to a former Chief Executive officer of approximately $0.1
million.
Note 13 - Write-off of
goodwill
As part
of the Company’s acquisition of Go2Call, it recognized goodwill of approximately
$2.0 million relating to its reseller division. During the third
quarter of 2008, the Company assessed the value of its reseller division and
determined that based on its then-current financial condition and the state of
the reseller division it would be appropriate to write-off the entire value of
the goodwill acquired in the Go2Call acquisition.
F-16
Note 14 - Write-off of
intangible assets
As part
of its assessment of the Company’s then-current financial situation and
operations, management wrote-off the remaining balance of the intangible assets
associated with the Go2Call transaction during 2008. During the second quarter
of 2008, management reached the conclusion that the Company would not invest
significant resources into the segment of the business that the Company
purchased as part of the Go2Call transaction. As a result, the Company
decided to write off $0.5 million, representing the entire amount of the asset
allocated to that portion of the business, in the second quarter of 2008 to
properly adjust the value of the intangible asset associated with that portion
of the business. In addition, during the third quarter of 2008 the
Company assessed the life of the remaining intangible assets associated with the
purchase of certain assets from Go2Call and reached the conclusion that the
carrying amount of the assets exceeded the fair value attributable to those
assets as a result of the Company’s then-current financial
situation. Consequently, the Company decided to write-off the
remaining value of these assets, or approximately $3.1 million, since the
Company believed that these assets can no longer sustain their value without
additional capital contributed to the Company.
Note 15 – Change in deferred
revenue relating to previous years
During
the first half of 2008, the Company restated its deferred revenue to include
$0.6 million in deferred revenue liability. The Company concluded
that the adjustment is not a result of its current operations but rather most
likely occurred during the year ended December 31, 2005 and possibly years
prior. Although the cumulative error might have been material to the
financial statements for the fiscal year ended December 31, 2005, the
Company did not believe that restating the financial statements for the
fiscal year ending December 31, 2005, would have a material impact on the profit
and loss statements of the Company for the years ended December 31, 2006 and
2007.
Note 16
- Income
taxes
a.
Provision for income taxes
No
provision for income taxes was required for the years ended December 31, 2009,
2008 and 2007 due to net losses in these periods.
b. Net operating
losses
As of
December 31, 2009, the Company had net operating losses generated in the U.S.
and Israel of approximately $159 million and $6 million,
respectively.
The
Company’s 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 the Company’s ability to utilize NOLs generated in
the U.S. prior to February 2009 (equal to approximately $156 million) to offset
any income it may generate in the future will be limited to approximately
$600,000 per year from February 2009. The NOLs will expire at various
dates between 2011 and 2029 if not utilized. The Company’s ability to utilize
its remaining NOLs could be additionally reduced if it experiences any further
“ownership change,” as defined under Section 382.
The
Company's net operating losses generated in Israel may be carried forward
indefinitely. The Subsidiary received final tax assessments through the tax year
ended December 31, 2002.
c. In accordance with SFAS No. 109 [ASC
740-10], the components of deferred income taxes are as
follows:
December 31,
|
||||||||
2009
|
2008
|
|||||||
($ in
thousands)
|
||||||||
Net
operating losses carryforwards
|
$
|
15,600
|
$
|
16,200
|
||||
Less
valuation allowance
|
(15,600)
|
(16,200
|
)
|
|||||
Net
deferred tax assets
|
$
|
0
|
$
|
0
|
A
valuation allowance of $15,600,000 and $16,200,000 is provided as of December
31, 2009 and 2008, respectively, as the realization of the deferred tax assets
are not assured.
Year ended December 31,
|
||||||||||||
|
2009
|
2008
|
2007
|
|||||||||
(US$ in
thousands)
|
||||||||||||
Domestic
|
$
|
(3,337)
|
$
|
(12,117
|
)
|
$
|
9,497
|
|||||
Foreign
|
138
|
251
|
309
|
|||||||||
Total
|
$
|
(3,199)
|
$
|
(11,866
|
)
|
$
|
(9,188)
|
F-17
Note 17 - Segment reporting,
geographical information and major customers
The
Company operates in one business segment, IP Telephony services, and makes
business decisions and allocates resources accordingly.
The
following table summarizes the Company’s revenues and long-lived assets by
country. Revenue is attributed to geographic region based on the location of the
customers. Long-lived assets are attributed to geographic region based on the
country in which the assets are located.
Year ended December 31,
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
($ in thousands)
|
||||||||||||
Revenues:
|
||||||||||||
United
States
|
$
|
7,568
|
$
|
9,172
|
$
|
12,677
|
||||||
Europe
|
5,200
|
3,756
|
5,682
|
|||||||||
South
America
|
1,971
|
2,539
|
3,949
|
|||||||||
Far
East
|
949
|
1,505
|
2,559
|
|||||||||
Middle
East
|
2,494
|
2,462
|
3,744
|
|||||||||
Other
|
820
|
792
|
866
|
|||||||||
Total
revenues
|
$
|
19,002
|
$
|
20,226
|
$
|
29,477
|
||||||
Revenues
from major customers exceeding 10% of revenues:
|
||||||||||||
Master
Reseller - A
|
25.8
|
%
|
16.5%
|
-
|
||||||||
Master
Reseller - B
|
22.5
|
%
|
-
|
-
|
||||||||
Service
Provider Customer - A
|
-
|
10.9%
|
-
|
December 31,
|
|||||
2009
|
2008
|
||||
($ in thousands)
|
|||||
Long-lived
assets:
|
|||||
United
States
|
483
|
1,107
|
|||
Israel
|
83
|
271
|
|||
Australia
|
72
|
-
|
|||
Europe
|
13
|
44
|
|||
Other
|
3
|
20
|
|||
Total
long-lived assets
|
654
|
1,441
|
F-18
Selected
Quarterly Financial Information (Unaudited)
Three Months Ended,
|
||||||||||||||||
March 31
|
June 30
|
September 30
|
December 31
|
|||||||||||||
($ in thousands, except per share data)
|
||||||||||||||||
2009
|
||||||||||||||||
Total
revenues
|
$
|
5,252
|
$
|
5,253
|
$
|
4,814
|
$
|
3,683
|
||||||||
Costs
and operating expenses:
|
||||||||||||||||
Cost
of revenues
|
4,211
|
4,553
|
4,034
|
3,329
|
||||||||||||
Research
and development expenses
|
123
|
117
|
94
|
130
|
||||||||||||
Selling
and marketing expenses
|
386
|
301
|
227
|
287
|
||||||||||||
General
and administrative expenses
|
721
|
1,256
|
650
|
887
|
||||||||||||
Depreciation
and amortization
|
274
|
252
|
197
|
167
|
||||||||||||
Total
costs and operating expenses
|
5,715
|
6,479
|
5,202
|
4,800
|
||||||||||||
Loss
from operations
|
(463
|
)
|
(1,226
|
)
|
(388
|
)
|
(1,117
|
)
|
||||||||
Capital
gain
|
14
|
-
|
72
|
- | ||||||||||||
Other
non-operating income
|
15
|
-
|
|
-
|
-
|
|||||||||||
Interest
(expense) income, net
|
(1
|
)
|
(31
|
)
|
(32)
|
(8
|
)
|
|||||||||
Loss
before income taxes
|
(435
|
)
|
(1,257
|
)
|
(348
|
)
|
(1,125
|
)
|
||||||||
Income
taxes
|
6
|
4
|
19
|
5
|
||||||||||||
Net
loss
|
$
|
(441)
|
$
|
(1,261
|
)
|
$
|
(367
|
)
|
$
|
(1,130
|
)
|
|||||
Net
loss per share - basic and diluted
|
$
|
(0.00
|
)
|
$
|
(0.02
|
)
|
$
|
(0.01
|
)
|
$
|
(0.02
|
)
|
||||
Basic
weighted average number of shares outstanding
|
71,932,405
|
71,932,405
|
71,962,405
|
71,999,255
|
||||||||||||
Diluted
weighted average number of shares outstanding
|
71,932,405
|
71,932,405
|
71,962,405
|
71,999,255
|
Three Months Ended,
|
||||||||||||||||
March 31
|
June 30
|
September 30
|
December 31
|
|||||||||||||
($ in thousands, except per share data)
|
||||||||||||||||
2008
|
||||||||||||||||
Total
revenues
|
$
|
5,395
|
$
|
5,393
|
$
|
4,792
|
$
|
4,646
|
||||||||
Costs
and operating expenses:
|
||||||||||||||||
Cost
of revenues
|
4,029
|
4,027
|
3,414
|
3,475
|
||||||||||||
Research
and development expenses
|
1,184
|
1,065
|
607
|
499
|
||||||||||||
Selling
and marketing expenses
|
1,238
|
1,178
|
638
|
581
|
||||||||||||
General
and administrative expenses
|
778
|
427
|
692
|
1,233
|
||||||||||||
Write-off
of intangible assets
|
-
|
475
|
3,091
|
-
|
||||||||||||
One
time item - deferred revenue adjustment
|
-
|
396
|
-
|
-
|
||||||||||||
Restructuring
expenses
|
372
|
585
|
-
|
266
|
||||||||||||
Depreciation
and amortization
|
617
|
399
|
478
|
342
|
||||||||||||
Total
costs and operating expenses
|
8,218
|
8,552
|
8,920
|
6,396
|
||||||||||||
Loss
from operations
|
(2,823
|
)
|
(3,159
|
)
|
(4,128
|
)
|
(1,750
|
)
|
||||||||
Capital
gain
|
-
|
39
|
||||||||||||||
Other
non-operating income
|
-
|
12
|
7
|
-
|
||||||||||||
Interest
(expense) income, net
|
(10
|
)
|
(61
|
)
|
93
|
(57
|
)
|
|||||||||
Loss
before income taxes
|
(2,833
|
)
|
(3,208
|
)
|
(4,028
|
)
|
(1,768
|
)
|
||||||||
Income
taxes
|
6
|
9
|
12
|
1
|
||||||||||||
Net
loss
|
$
|
(2,839
|
$
|
(3,217
|
)
|
$
|
(4,040
|
)
|
$
|
(1,769
|
)
|
|||||
Net
loss per share - basic and diluted
|
$
|
(0.09
|
)
|
$
|
(0.10
|
)
|
$
|
(0.12
|
)
|
$
|
(0.05
|
)
|
||||
Basic
weighted average number of shares outstanding
|
32,870,105
|
32,870,105
|
32,870,105
|
32,870,105
|
||||||||||||
Diluted
weighted average number of shares outstanding
|
32,870,105
|
32,870,105
|
32,870,105
|
32,870,105
|
F-19
Note 18 – Subsequent
Events
On
March 1, 2010, the Company and its subsidiaries entered into a Loan and Security
Agreement with D4 Holdings, pursuant to which D4 Holdings will provide to the
Company and its subsidiaries a line of credit in a principal amount of
$1,200,000. In addition, on March 1, 2010, pursuant to the Loan
Agreement, the Company and its subsidiaries issued a Promissory Note in a
principal amount of $1,200,000 to D4 Holdings. On March 2, 2010, the
Company received $500,000 from D4 Holdings pursuant to a notice of borrowing
under the Loan Agreement.
Interest on
the loan accrues at the rate of 12% per annum, and the initial payment of
accrued interest is payable on May 1, 2010, and monthly thereafter. The Company
is required to repay all outstanding principal and interest on March 1, 2011. In
addition, the Company and its subsidiaries granted D4 Holdings a security
interest in all of their assets to secure their obligations under the
loan.
F-20